i)
Monthly Service Fees–Monthly wholesale water usage fees are assessed to our customers based on actual metered deliveries to their end-use customers each month. Water usage fees are based on a tiered pricing structure that provides for higher prices as customers use greater amounts of water. The water usage fees for end-use customers on the Lowry Range are noted below in the table below:
Current Lowry Range Tiered Water Usage Pricing Structure
Table D - Lowry Range Tiered Water Usage Pricing Structure |
| Price ($ per thousand gallons) |
Base charge per SFE | $32.27 | $30.35 | $30.35 |
0 gallons to 10,000 gallons | $3.91 | $3.51 | $3.51 |
10,001 gallons to 20,000 gallons | $5.14 | $5.31 | $5.31 |
20,001 gallons to 40,000 gallons | $8.08 | $8.12 | $8.12 |
40,001 gallons and above | $9.87 | $9.55 | $9.55 |
Base charge per SFE per month | | $ | 32.74 | |
Price ($ per thousand gallons used per month) 0 gallons to 15,000 gallons | | $ | 4.63 | |
15,001 gallons to 30,000 gallons | | $ | 8.10 | |
30,001 gallons and above | | $ | 9.95 | |
The figures in Table Dthe table above reflect the amounts charged to the Rangeview District’s end-use customers on the Lowry Range. Pursuant to the Lease, the amounts charged by the Rangeview District to its end-use customers on the Lowry Range cannot exceed the average of similar rates and charges of three surrounding municipal water and wastewater service providers. In exchange for providing water service to the Rangeview District’s Lowry Range customers, we receive 98% of the usage charges received by the Rangeview District relating to water services after deducting the required royalty to the Land Board (described above at Rangeview Water Supply and Lowry Range – Land Board Royalties and Fees).
The amounts charged by the Rangeview District to its end-use customers off the Lowry Range are determined pursuant to the Rangeview District’s service agreements with such customers and such rates may vary. In exchange for providing water service to the Rangeview District’s customers off the Lowry Range, we receive 98% of the usage charges received by the Rangeview District relating to water services after deducting any required royalty to the Land Board. The royalty to the Land Board is required for water service provided utilizing our Rangeview Water Supply, which includes most of our current customers off the Lowry Range except those at Wild Pointe. In exchange for providing wastewater services, we receive 90% of the Rangeview District’s monthly wastewater service and usage fees,Elbert & Highway 86 Commercial District (also known as well as the right to use or“Wild Pointe” described below).
We sell the reclaimed water.
In addition to the tieredbulk water usage pricing structure, we currently chargeat a hydrant rate of $10.50$14.76 per thousand gallons forto commercial and industrial customers. customers through the use of hydrant meters.
We also collect other immaterial fees and charges from customers and other users to cover miscellaneous administrative and service expenses, such as application fees, review fees, reinspection fees, and permit fees.
In exchange for providing wastewater services, we receive 90% of the Rangeview District’s monthly wastewater treatment fees, as well as the right to use or sell the reclaimed water.
ii)
Water and Wastewater Tap Fees
We generate significant revenues from fees charged to customers to connect to our water and Construction Fees–Tapwastewater systems. These fees are known as tap fees. The tap fee is a non-refundable fee that is payable typically paid by developers in advanceat the time a building permit is granted for construction of construction activitiesa home or business and authorizes the property to connect to the water or wastewater system. Once granted, the right stays with the property. We have no obligation to physically connect the property to the lines. Once connected to the water and/or wastewater systems, the customer has live service to receive metered water deliveries from our system and send wastewater into our system. Thus, the customer has full control of the connection right as it can obtain all the benefits from this right. Our systems are non-refundable. Tap fees are typically“wholesale facilities,” namely those assets used to fund constructiondeliver water and wastewater to a service area or major regions or portions thereof. Wells, treatment plants, pump stations, tanks, reservoirs, transmission pipelines, and major sewage lift stations are typical examples of the Wholesale Facilities and defray the acquisition costs of obtaining water rights and operatingwholesale facilities.
The Rangeview District’s 20172020 water tap fees are $24,974,$27,209 per SFE, and its wastewater tap fees are $4,659.$4,752.
In exchange for providing water service to the Rangeview District’s customers on the Lowry Range, we receive 100% of the Rangeview District’s tap fees after deducting the two percent royalty to the Land Board described above. In exchange for providing water service to the Rangeview District’s customers off the Lowry Range, we currently receive 100% of the Rangeview District’s tap fees. If water taps are sold to customers not located on the Lowry Range that are to be serviced utilizingusing the Rangeview Water Supply (other than taps to Sky Ranch, which are exempt), we receive 98% of the two percent royalty toRangeview District’s tap fees and the Land Board would be deducted fromreceives the amount we receive.remaining two percent as a royalty. In exchange for providing wastewater services, whether to customers on or off the Lowry Range, we receive 100% of the Rangeview District’s wastewater tap fees.
Construction and Special Facility Funding Fees
Construction and Special Facility Funding fees are fees we receive, typically in advance, from developers for us to build certain infrastructure such as Special Facilities which arethat is normally the responsibility of the developer.developer because the facilities service only the developer’s property. Those type of facilities may include retail facilities, which distribute water to and collect wastewater from an individual subdivision or a community, and special facilities, which are required to extend services to an individual development and are not otherwise classified as a typical wholesale facility or retail facilities. Temporary infrastructure required prior to construction of permanent water and wastewater systems or transmission pipelines to transfer water from one location to another are examples of special facilities. Once we certify that the special facilities have been constructed in accordance with our design criteria, the developer dedicates the special facilities to the Rangeview District, and we operate and maintain the facilities on behalf of Rangeview.
Consulting Fees–
Consulting fees are fees we receive, typically on a monthly, basis, from municipalities and area water providers alongfor whom we provide contract operation services.
Industrial – Oil and Gas Operations Fees
We provide water for oil and gas operators that are performing hydraulic fracturing, mainly in the I-70 corridor,Niobrara Formation around our service area and our Sky Ranch property. These fees are paid based on the metered gallons of water delivered. Oil and gas drilling in our area is affected by the price of oil and state, local and federal government regulations. The number of wells drilled vary from year to year. Each well utilizes between 10 and 20 million gallons of water during the hydraulic fracturing process, which equates to selling water to between approximately 100 and 200 homes for an entire year. With a large percentage of the acreage surrounding the Lowry Range in Arapahoe, Adams, Elbert, and portions of Douglas Counties already leased by oil companies, we anticipate continuing to provide water for drilling and hydraulic fracturing in the future.
Service to Customers Not on the Lowry Range
In addition to customers on the Lowry Range, we have an exclusive agreement with the Rangeview District to provide water and wastewater service, including the design, construction, operation and maintenance of water and wastewater systems to serve the Rangeview District’s customers located outside the Lowry Range service area (for example Wild Pointe and Sky Ranch) (the “Non-Lowry Service Agreement”). In exchange for providing water and wastewater services to the Rangeview District’s customers that are not on the Lowry Range, we receive 100% of water and wastewater tap fees, 98% of the water usage fees, and 90% of the monthly wastewater service and usage fees received by the Rangeview District from these customers, after deduction of royalties due to the Land Board, if applicable (i.e., if we use a portion of the Rangeview Water Supply, such as the Export Water, to provide service to such customers). We are currently not using the Rangeview Water Supply at Sky Ranch, but we may do so in the future, in which case water usage fees to be collected for such service would become subject to the Land Board royalty.
Sky Ranch Water and Wastewater Service – As described in more detail below, we are developing approximately 930 acres of land as a Master Planned Community known as Sky Ranch. Pursuant to the Non-Lowry Service Agreement, we are the exclusive provider of water and wastewater services to future residents of the Sky Ranch development.
Wild Pointe – Elbert & Highway 86 Commercial Metropolitan District – In 2017, we entered into an agreement with the Rangeview District, which had entered into an agreement with Elbert & Highway 86 Commercial Metropolitan District (the “Elbert 86 District”) to operate and maintain a water system for residential and commercial customers at the Wild Pointe development in Elbert County. The water system includes two deep water wells, a pump station, treatment facility, storage facility, over eight miles of transmission lines, and over 450 acre-feet of water rights serving Wild Pointe. We provided $1.6 million in funding to acquire the exclusive rights to operate and maintain all the water facilities in exchange for payment of the remaining residential and commercial tap fees and annual water use fees. Service to Wild Pointe is governed by the Non-Lowry Service Agreement.
Our Land Development Assets – Sky Ranch
In 2010, we purchased approximately 930 acres of undeveloped land in unincorporated Arapahoe County, which we are actively developing as the master planned community known as Sky Ranch. With the property acquisition, we also acquired nearly 830 acre-feet of water beneath Sky Ranch, and approximately 640 acres of oil and gas mineral rights. Sky Ranch is located 16 miles east of downtown Denver, four miles north of the Lowry Range, and four miles south of Denver International Airport.
Sky Ranch is zoned for residential, commercial, and retail uses, including up to 3,200 homes and more than two million square feet of commercial, retail, and light industrial development. The development of Sky Ranch will occur in multiple filings and phases which will take several years to complete. Our first filing of more than 150 acres is platted for a total of 506 detached single-family residential lots (see illustration below for the layout of filing 1). As of August 31, 2020, we had delivered 483 finished lots in our first filing and the remaining finished lots sold on November 3, 2020. Our second filing, which is planned to have four sub-phases, is approximately 250 acres and is expected to be platted for nearly 900 lots (see illustration below for the proposed layout of filing 2). We plan to begin development activities for filing 2 by the end of calendar 2020. Subsequent to August 31, 2020, we entered into contracts with four home builders to sell 789 finished lots, on which the home builders will construct both attached and detached single-family residential units. We are retaining the remaining 100+ lots for future uses. The total sales price for the 789 lots contracted for is $63.4 million, subject to price escalations depending on development timing. The remaining lots held for future use, assuming comparable lot prices to the contracted prices and excluding escalators, coupled with the contracted-for lots would result in total sales for the second filing of $72.6 million. Our preliminary total cost estimates for developing the nearly 900 lots is $65.6 million. We estimate that more than $48.0 million of this amount will be spent on public improvements that will be eligible for reimbursement by the Sky Ranch CAB. See below for a description of the conditions that may limit our ability to receive reimbursables and a definition of the Sky Ranch CAB.
Filing 1 Illustrative Layout
Filing 2 Illustrative Layout
As the land developer, we are providing finished lots (i.e. lots ready for building permits to construct homes) to each of the home builders. We build, or contract to build, the roads, curbs, wet and dry utilities, storm drains, parks, open spaces, and other related improvements as part of a fully master planned community. Each builder is required to purchase water and sewer taps for each lot from the Rangeview District at the time of permitting, the cost of which depends on the size of the lot, the size of the house, and the amount of irrigated turf. Pursuant to the Non-Lowry Service Agreement, we receive all the water and wastewater tap fees from tap sales at Sky Ranch and 98% of the ongoing monthly water and wastewater service revenues.
Public improvements, such as roads, parks, and water and sanitary sewer mains, storm sewer, and drainage improvements, that are shared by all homeowners in the development and not specific to any private finished lot are ultimately owned by the governmental metropolitan district or other municipality that is responsible for the maintenance of the improvements. Upon completion and acceptance of certain public improvements by the “Sky Ranch Districts” or the “Sky Ranch CAB” (both of which are defined below), we are entitled to receive reimbursement for the verified public improvement costs. Pursuant to the agreements between us and the Sky Ranch CAB, no payment is required by the Sky Ranch CAB with respect to whichreimbursable costs unless and until the Sky Ranch CAB and/or the Sky Ranch Districts issue bonds to reimburse us for all or a portion of advances provided or expenses incurred for reimbursable public improvements. Due to this contingency, reimbursable costs are capitalized and expensed consistent with other development costs until the Sky Ranch CAB reimburses us for the public improvement costs. When we provide contract operations services.receive reimbursement, we reduce any remaining capitalized amounts, with any excess proceeds over the currently remaining capitalized costs being recognized as Other income at the time of payment.
Significant Customers
OurPursuant to our service agreements, the Company must construct all required wholesale water and wastewater salesimprovements (i.e., a wastewater reclamation facility, water supply, storage, treatment and other wholesale facilities) for the provision of water and wastewater service to the property. As of August 31, 2020, we have completed the required wholesale facilities and other infrastructure to provide water for the first 900 homes, and wastewater for over 2,000 homes at Sky Ranch. The most significant wholesale facility built was the wastewater reclamation facility, which cost $10.2 million and has a designed capacity to provide wastewater for more than 2,000 single family homes before requiring expansion. This allows the treatment facility to process wastewater for several development phases at Sky Ranch before additional investment is needed to increase its capacity.
We expect to have other filings developing concurrently with the second filing that will include commercial, retail, and light industrial sites. We expect full development of the Sky Ranch Master Planned Community to take another ten years.
Pursuant to the Sky Ranch Water and Wastewater Service Agreement, dated June 19, 2017, between PCY Holdings, LLC (a wholly-owned subsidiary of ours that holds title to the Sky Ranch land), and the Rangeview District, PCY Holdings, LLC, agreed to construct certain facilities necessary to provide water and wastewater service to Sky Ranch. The Rangeview District, through us as its exclusive service provider, agreed to provide water and wastewater services to the Sky Ranch property. We have installed over 15.5 miles of water delivery and wastewater collection infrastructure at a cost of $4.9 million, which we believe will be reimbursable by the Sky Ranch CAB as outlined above.
We have leased the oil and gas minerals underlying the property to a major independent exploration and production company.
Sky Ranch Metropolitan District Nos. 1, 3, 4, and 5
The Sky Ranch Metropolitan District Nos. 1, 3, 4 and 5 are quasi-municipal corporations and political subdivisions of Colorado formed in 2004 for the purpose of providing service to the Sky Ranch property (the “Sky Ranch Districts”). The Sky Ranch Districts are governed by an elected board of directors. Eligible voters and persons eligible to serve as directors of the Sky Ranch Districts must own an interest in property within the boundaries of the district. We own certain rights and real property interests which encompass the current boundaries of the districts and certain of our employees serve on the boards of directors of the Sky Ranch Districts. The current directors of the districts are Mark W. Harding (our President, Chief Executive Officer and a director), Kevin B. McNeill (our Vice President and Chief Financial Officer), Scott E. Lehman (an employee of ours), Dirk Lashnits (an employee of ours), and one independent board member. Pursuant to Colorado law, directors may receive $100 for each board meeting they attend, up to a maximum of $1,600 per year. Messrs. Harding, McNeill, Lehman, and Lashnits have all elected to forego these payments.
Sky Ranch Community Authority Board
Districts No. 1 and 5 of the Sky Ranch Districts, formed the Sky Ranch Community Authority Board (“Sky Ranch CAB”) to, among other things, design, construct, finance, operate and maintain certain public improvements for the benefit of the property within the boundaries and/or service area of the Sky Ranch Districts. In order for the public improvements to be constructed and/or acquired, it is necessary for each Sky Ranch District and/or the Sky Ranch CAB to be able to fund the improvements and pay its ongoing operations and maintenance expenses related to the provision of services that benefit the property. We entered into agreements, first with Sky Ranch Metropolitan District No. 1 in 2014 and later with the Sky Ranch CAB, that require us to fund expenses related to the construction of an agreed upon list of public improvements for the Sky Ranch Master Planned Community.
In September 2018 and effective as of November 13, 2017, the parties entered into a series of agreements that superseded and consolidated the previous agreements into one primary agreement, the Facilities Funding and Acquisition Agreement (the “Sky Ranch FFAA”), pursuant to which:
| ● | the Sky Ranch CAB agreed to repay to us the amounts owed by Sky Ranch Metropolitan District No. 5; |
| ● | previous agreements between us and Sky Ranch Metropolitan District No. 5 and us and the Sky Ranch CAB were terminated; |
| ● | the Sky Ranch CAB acknowledged all amounts owed to us under the terminated agreements, as well as amounts we incurred to finance the formation of the Sky Ranch CAB; and |
| ● | we agreed to fund expenses related to the construction of an agreed upon list of improvements to be constructed by the Sky Ranch CAB with an estimated cost of $30 million (including improvements already funded) on an as-needed basis for calendar years 2018–2023. |
Advances and verified costs expended by us for expenses related to the Rangeview Water Agreements accountedconstruction of the agreed upon public improvements are reimbursable to us by the Sky Ranch CAB. All reimbursable expense incurred under the agreement accrues interest at a rate of 6% per annum from the time funds are advanced by us to the Sky Ranch CAB or costs are incurred by us for 26%, 67%expenses related to the construction of improvements, as applicable. No repayment is required of the Sky Ranch CAB for advances made or expenses incurred related to the construction of public improvements unless and 19%until the Sky Ranch CAB and/or Sky Ranch Districts issue bonds in an amount sufficient to reimburse us for all or a portion of our total water revenuesadvances or other public improvement expenses incurred. The Sky Ranch CAB agrees to exercise reasonable efforts to issue bonds to reimburse us subject to certain limitations. In addition, the Sky Ranch CAB agrees to utilize any available moneys not otherwise pledged to payment of debt or used for operation and maintenance expenses to reimburse us. Any advances or expenses not paid or reimbursed by the fiscalSky Ranch CAB by December 31, 2058, shall be deemed forever discharged and satisfied in full. During the years ended August 31, 2017, 20162018 through 2020, we advanced the Sky Ranch CAB $26.4 million for the construction of public improvements, including improvements with respect to earthwork, erosion control, streets, drainage, water sewer, stormwater and 2015, respectively.landscaping. In November 2019, the Sky Ranch CAB issued bonds and repaid $10.5 million of the advances to date leaving $15.9 million outstanding as of August 31, 2020. We expect to fund $48.3 million of reimbursable public improvements for filing 2. The Rangeview District hastiming of those expected expenditures and reimbursement from the Sky Ranch CAB will depend on absorption of homes in filing 2.
The current directors of the Sky Ranch CAB are Mark W. Harding (our President, Chief Executive Officer and a director), Kevin B. McNeill (our Vice President and Chief Financial Officer), Scott E. Lehman (an employee of ours), Dirk Lashnits (an employee of ours), and one significant customer, the Ridgeview Youth Services Center (“Ridgeview”).independent board member. Pursuant to Colorado law, directors may receive $100 for each board meeting they attend, up to a maximum of $1,600 per year. Messrs. Harding, McNeill, Lehman, and Lashnits have all elected to forego these payments.
Other Assets
Oil and Gas Leases
In 2011, we entered into a three-year Oil and Gas Lease (the “Sky Ranch O&G Lease”) and Surface Use and Damage Agreement and received an up-front payment and a 20% of gross proceeds royalty (less certain taxes) from the sale of any oil and gas produced from the mineral estate we own at Sky Ranch. In 2014, the Sky Ranch O&G Lease was extended for an additional two years. The Sky Ranch O&G Lease is now held by production, and we have been receiving royalties from the oil and gas production from six wells drilled within our Rangeview Water Agreements withmineral interest. During the Rangeview District, we are providing water to Ridgeview on behalf of the Rangeview District. Ridgeview accounted for 21%, 55% and 16% of our total water revenues for the fiscal years ended August 31, 2020 and 2019, we received $669,000 and $148,300 in royalties attributable to these wells.
In September 2017, 2016we entered into a three-year Paid-Up Oil and 2015, respectively.
Our industrial water sales (i) directly and indirectly to ConocoPhillips accounted for approximately 30%,less than1% and 75% and (ii) toGas Lease with Bison Oil and Gas, LLP (the “Bison Lease”) for the purpose of exploring for, developing, producing, and marketing oil and gas from 40 acres of mineral estate we own adjacent to the Lowry Range, and we received an up-front payment of $167,200. The up-front payment received pursuant to the Bison Lease is being recognized into revenue ratably over a three-year period, which expires in September 2020, and was not extended.
In July 2019, we entered into an Agreement on Locations of Oil and Gas Operations covering approximately 16 acres at Sky Ranch with the operator of the Sky Ranch O&G Lease (the “OGOA”). The Company received an up-front payment of $573,700 in fiscal 2019 for the OGOA, which is being recognized as income on a straight-line basis over three years (the term of the OGOA). If after three years the operator has not spud at least one well on the oil and gas operations area, the operator may extend the right to the OGOA one additional year by paying us $75,000. The operator may only extend the OGOA for two additional years for a total of five years.
Arkansas River Land and Minerals
We own approximately 700 acres of land in the Arkansas River Valley in southeastern Colorado. We currently lease all these acres for dry land grazing. We intend to sell the land in due course and have classified it as a long-term investment. We also own approximately 13,900 acres of mineral interests in the Arkansas River Valley, which have a carrying value of $1.4 million. In fiscal 2020, we assessed the recoverability of the Arkansas Valley mineral rights. We determined that the carrying value of these mineral rights is not recoverable. As a result, we recorded an impairment charge of $1.4 million in Non-cash mineral asset impairment charge in the consolidated statements of operations and comprehensive income. We currently have no plans to sell our mineral interests.
Significant Customers
We primarily provide water and wastewater services on the Rangeview District’s behalf to the Rangeview District’s customers. Because the Rangeview District accounts for the majority of our water and wastewater service revenue, we have included the end-use customers of the Rangeview District who generate the most revenue for us on our list of significant customers. Additionally, we have presented the percentages of revenue from water and wastewater services and water and wastewater tap sales separately (versus by the water and wastewater resource development segment or total revenue), because we believe that provides a more meaningful presentation of the relevance of each customer to that service line. Lot sales are generated entirely through sales to three customers as noted below. The tables below present revenue generated from our significant customers for each of the services presented.
For the year ended August 31, 2020 | | Water and wastewater metered services | | | Water and wastewater tap fees | | | Land development (Lot sales recognized) | |
Ridgeview Youth Services | | | 14 | % | | | – | | | | – | |
Conoco / Crestone Peak (oil & gas operations) | | | 45 | % | | | – | | | | – | |
All Sky Ranch Homes (1) | | | 22 | % | | | – | | | | – | |
All Wild Pointe Homes (2) | | | 9 | % | | | 4 | % | | | – | |
Taylor Morrison | | | – | | | | 28 | % | | | 32 | % |
KB Home | | | – | | | | 37 | % | | | 26 | % |
Richmond Homes | | | – | | | | 31 | % | | | 42 | % |
Combined totals presented | | | 90 | % | | | 100 | % | | | 100 | % |
(1) This represents the water and wastewater fees for all homes combined at Sky Ranch and not one individual home
(2) This represents the water and wastewater metered services and water and wastewater tap fees for all homes combined at Wild Pointe and not one individual home
For the year ended August 31, 2019 | | Water and wastewater metered services | | | Water and wastewater tap fees | | | Land development (Lot sales recognized) | |
Ridgeview Youth Services | | | 3 | % | | | – | | | | – | |
Conoco / Crestone Peak (oil & gas operations) | | | 74 | % | | | – | | | | – | |
All Sky Ranch Homes (1) | | | – | | | | – | | | | – | |
All Wild Pointe Homes (2) | | | 3 | % | | | 6 | % | | | – | |
Taylor Morrison | | | – | | | | 27 | % | | | 34 | % |
KB Home | | | – | | | | 29 | % | | | 34 | % |
Richmond Homes | | | – | | | | 38 | % | | | 32 | % |
Combined totals presented | | | 80 | % | | | 100 | % | | | 100 | % |
(1) We did not begin providing significant water and wastewater services to Sky Ranch until fiscal 2020.
(2) This represents the water and wastewater metered services and water and wastewater tap fees for all homes combined at Wild Pointe and not one individual home
The Ridgeview Youth Services customer accounted for approximately 25%, nil,the same dollar sales year over year, but due to the decline in oil and nil, of our total water revenues forgas operations revenue, the percentage increased in fiscal years ended August 31, 2017, 2016 and 2015, respectively.2020 over 2019.
Our Projected Operations
This section should be read in conjunction with Item 1A – Risk Factors.
Along the Colorado Front Range, there are over 70 water providers with varying needs for replacement andand/or new water supplies. We believe that we are well positioned to assist certain of these providers in meeting their current and future water needs.
We design, construct, and operate our water and wastewater facilities using advanced water purificationtreatment and wastewater treatment technologies, which allow us to use our water supplies in an efficient and environmentally sustainable manner. We plan to develop our water and wastewater systems in stages to efficiently meet customer demands in our service areas thereby reducing the amount of up-frontby managing capital costsinvestments required for construction of facilities. We use third-party contractors to construct our facilities as needed. We employ licensed water and wastewater operators to operaterun our water and wastewater systems. As our systems expand, we expect to hire additional personnel to operate our systems, which include water production, treatment, testing, storage, distribution, metering, billing, and operations management.
Our water and wastewater systems conjunctively use surface and groundwater supplies and storage of raw water and highly treated effluentreclaimed water supplies to provide a balanced sustainable water supply for our wholesale customers and their end-use customers. Integrating conservation practices and incentives, together with effective water reuse, demonstrates our commitment to providing environmentally responsible and sustainable water and wastewater services. Water supplies and water storage reservoirs are competitively sought throughout the west and along the Front Range of Colorado. We believe that regional cooperation among area water providers in developing new water supplies, water storage, and transmission and distribution systems provides the most cost effectivecost-effective way of expanding and enhancing service capacities for area water providers. We continue to discussseek opportunities for developing water supplies and water storage opportunities with other area water providers.
16
We expect the development
As we continue expanding and developing our Rangeview Water Supply, to requirewe anticipate needing a significant number of high capacity deep water wells. We anticipate drilling separateThese wells would be drilled into eachone or more of the three principal aquifers located beneath the Lowry Range. Each well is intended to deliverRange, and, as with our current wells, the water would be delivered to central water treatment facilities for treatment prior to delivery to customers. DevelopmentContinued development of our Lowry Range surface water supplies will require facilities to divert surface water to storage reservoirs to be located on the Lowry Range, andadditional treatment facilities to treat the water prior to introduction into our distribution systems. Surfacesystem(s), and additional surface water diversion facilities will be designed with capacities to divert the surface water when available (particularly during seasonal events such as spring run-off and summer storms) for storage in reservoirs to be constructed on the Lowry Range. Based on preliminary engineering estimates,We estimate the full build-out of water and wastewater facilities (including diversion structures, transmission pipelines, reservoirs, and water treatment facilities) on the Lowry Range willto develop and deliver our portfolio of water would cost in excess of $412$850 million, based on estimated costs, and willwould accommodate water service to customers located on and outside the Lowry Range. We expectbelieve this build out towould occur in phases over an extended period of at least 50 years,many decades, and we expect thatbelieve tap fees willwould be sufficient to fund the required infrastructure costs.
Our Denver-based supplies are a valuable, locally available resource located near the point of use. This enables us to incrementally develop infrastructure to produce, treat and deliver water to customers based on their growing demands.
During fiscal 2017,2020, we invested approximately $4.5$6.3 million to construct pipelinesin plant and facilities that interconnect the Rangeview District, WISE, and Sky Ranch water systems.and wastewater systems to provide water and wastewater services to our growing customers at Sky Ranch and elsewhere. We expect to continue to invest in pipelines at the Sky Ranch property in anticipation of the first phase of development. We also expect to add additional wellswater rights and facilities as demand for water grows.our customer demands grow.
The Rangeview District is a participant in the WISE project. This project is developing infrastructure to interconnect providers’ water systems and to extend renewable water sources owned by Denver Water and Aurora Water to participating South Metro water providers, including the Rangeview District and, through our agreements with the Rangeview District, us. This system will diversify our sources of water and will enable providers to move water among themselves, which will increase the reliability of our and others’ water systems. Through the WISE Financing Agreement, we funded the Rangeview District’s purchase of certain rights to use existing water transmission and related infrastructure acquired and constructed by the WISE project. We invested approximately $198,200 in the WISE system during fiscal 2017 and have invested approximately $3.1 million to date. We anticipate that we will be spending approximately $645,500 on this system during fiscal 2018 and $4.6 million during the next four years to fund the Rangeview District’s purchase of its share of the water transmission line and additional facilities, water and related assets for WISE and to fund operations and water deliveries related to WISE. Timing of the investment will vary depending on the schedule of projects within WISE.
We are in the process of developing our Sky Ranch property, including building finishedfinishing lots for home builders, and building theadditional water and wastewater infrastructure for housingresidential and commercial development ofat the property. We currently anticipate construction starting onDuring the first phase of development (506 lots) in early 2018, subject to obtaining approvalsyears ended August 31, 2020 and the timing of the final engineering designs. The timing for us to develop the remaining phases of the property will be largely dependent on the Denver real estate market and the interest we receive from home builders and developers. During fiscal 2017,2019, we invested approximately $902,600$8.5 million and $17.7 million, in our Sky Ranch property,land to deliver the finished lots, which consistedwas done ahead of planning, preliminaryour original schedule and final engineering designs, grading, erosion, sediment control, drainage design,on budget. We anticipate the second filing of Sky Ranch will require $65.6 million of construction costs to deliver the lots, which is planned to occur over three years and be funded by the $72.5 million of total fees to be paid under our lot sales agreements. During the years ended August 31, 2020 and 2019, the initial filing of Sky Ranch produced $5.4 million and $3.4 million, respectively, of water and wastewater facility designs,tap fees, and constructionwe believe we will receive the remaining $5.9 million in water and wastewater tap fees for the lots in the initial filing of approximately 10 milesSky Ranch during our fiscal 2021. We believe the second filing of new transmission lines.Sky Ranch will produce in excess of $22 million in water and wastewater tap fee revenue over several years.
We plan to develop additional water assets within the Denver area and are exploring opportunities to utilize our water assets in areas adjacent to our existing water supplies.
Additionally, we continue to source additional land acquisitions that could be paired with our water to provide additional growth to both our land development and water and wastewater segments.
Water and Growth in Colorado
Calendar year 2020 was a strong year for the Colorado has experiencedhousing market. As COVID-19 escalated, we took measures to protect the health and well-being of our employees, customers, business partners, and their families. 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 robustresult, some of our builder customers reported material net housing order declines during the state-wide stay-at-home order period (March – May). However, as shelter-in-place and stay-at-home orders were removed, the builders reported material increases in orders. Due to COVID-19, we have witnessed several changing consumer patterns, including residents leaving downtown urban areas to buy homes in the suburbs. This put our Sky Ranch community in the enviable position of being able to respond to this demand due to its great location, affordable home prices, available inventory, and easy access to work centers and major transportation corridors. We believe our ability to pair our water to our land and our in-house expertise for operating our systems allowed us to provide home builders with an affordable and sustainable master planned community that allowed our builders to quickly satisfy the increased demand from home buyers.
Despite the economic issues caused by COVID-19, the Colorado housing market over the past 24 months. The key drivershas continued to housing in the area are:
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Housing Starts–From September 2016 to September 2017, annual housing starts increasedgrow. This was fueled by 6%. From September 2015 to September 2016, annual housing starts increased by 24%.
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Unemployment –The unemployment ratepopulation growth in Colorado, was 2.4% at August 31, 2017, comparedwhich is projected to a national unemployment rate of 4.4%. Colorado added an estimated 118,200 jobs from August 2016 to August 2017.
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Population –continue far into the foreseeable future. The Denver Regional Council of Governments, (“DRCOG”), a voluntary association of over 50 county and municipal governments in the Denver metropolitan area, estimates that the Denver metropolitan area population will increase by about 38% from today’s 3.4 million peoplenearly 40% to 4.7 million people by the year 2040. A Statewide Water Supply Initiative report by the Colorado Water Conservation Board estimates that the South Platte River basin, which includes the Denver metropolitan region (and our Sky Ranch community), will grow from a current population of 3.9approximately 4.0 million to 4.9 million by the year 2030, while the state’s population will increase from roughly 5.7 million to 7.2 million.
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Demand –Approximately 70% of This growth furthers the state’s projected population increase is anticipatedneed for sustainable water supplies and intensifies the competition to occur within the South Platte River basin. Significant increases in Colorado’s population, particularly in the Denver metro region and other areas in the water-short South Platte River basin, together with increasing agricultural, recreational, and environmental water demands, will intensify competition for waterobtain those supplies. The estimated population increases are expected to result in demands for water services in excess ofthat exceed the current capabilities of municipal service providers, especially during drought conditions.
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Supply –Growth in the Denver area has trended east with significant activity occurring along the I-70 corridor, an area which enjoys excellent transportation infrastructure with I-70, rail access, and Denver International Airport (“DIA”). The region has significant employment centers, including DIA, the University of Colorado Anschutz Medical Campus, an Amazon fulfillment center, the Rocky Mountain Regional VA Medical Center, Buckley Airforce Base, and more, creating demand for residential, retail, and commercial development opportunities.
The Statewide Water Supply Initiative estimates that population growth in the Denver region and the South Platte River basin could result inrequire an additional water supply demands400,000 acre-feet of over 400,000 acre feetwater by the year 2030.
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Development – What makes this more difficult for land developers and builders is that Colorado law requires property developers to demonstrate that they have sufficient water supplies for their proposed projects before rezoningzoning applications will be considered. These factors indicateThis means developers and builders must solve their own water problems prior to development rather than wait for cities and municipalities to solve the problem. This indicates that water and availability of water will continue to be critical to growth prospects for the region and the state, and that competition for available sources of water will continue to intensify. We focus the marketing
In addition to actively seeking to expand our land holdings for development purposes, we also market our water supplies and services to developers and home builders that are active along the Colorado Front Range as well as other area water providers in need of additional supplies.
Colorado’s future water supply needs will be met through conservation, reuse, and the development of new supplies. The Rangeview District’s rules and regulations for water and wastewater service call for adherence to strict conservation measures, including low-flow water fixtures, high efficiency appliances, and advanced irrigation control devices. Additionally, our systems are designed and constructed using a dual-pipe water distribution system to segregate the delivery of high quality potable drinking water to our local governmental entities and their end-use customers through one system and a second system to supply raw or reclaimed water for irrigation demands.demands in parks and open spaces. About one-half of the water used by a typical Denver-area residential water customer is used for outdoor landscape and lawn irrigation. We believe that raw or reclaimed water supplies provide the lowest cost, most environmentally sustainable water for outdoor irrigation. We expect our systems to include an extensive water reclamation systemprocess in which essentially all effluent water from wastewater treatment plants will be reused to meet non-potable outdoor irrigation water demands. Our dual-distribution systems demonstrate our commitment to environmentally responsible water management policies in our water shortwater-short region.
Labor and Raw Materials
The Builder ContractsWe competitively bid contracts for infrastructure improvements (grading, utilities, roads, water and wastewater infrastructure) at Sky Ranch andRanch. Many of our contractors enter fixed priced contracts where the contracts we enter into to design and construct water facilities are fixed-price contracts in which we bear all or a significant portion of thecontractor is at risk for cost overruns.overruns prior to completion of improvements. Under these fixed-price contracts, the contract prices that we agree to are established in part based on fixed, firm subcontractor quotes on contracts and on cost and scheduling estimates. These quotes or estimates may be based on a number ofseveral assumptions, including assumptions about prices and availability of labor, equipment and materials, and other issues. Increased costs or shortages of skilled labor, and/or concrete, steel, pipe, and other materials could cause increases in property development costs and delays. These shortages and delays may result in delays in the delivery of the residential lots under development reducedor the completion of water or wastewater facilities, increase costs for us or other contractors on our projects, reduce gross margins from lot sales, or both. We plansubject us to penalties or defaults under our agreements. While we contract with third parties for our labor and materials at a fixed price, which should allowwe believe allows us the ability to mitigate the risks associated with shortages of and increases in the cost of labor and building materials.
materials, other unforeseen factors may arise which could increase our costs.
Competition
Competition
Water and Wastewater Services
We negotiate individual service agreements with our governmental customers and with their developers and/or home builders to design, construct and operate water and wastewater systems and to provide services to end-useend use customers of governmental entities and to commercial and industrial customers. These service agreements seek to address all aspects of the development of the water and wastewater systems, including:
| (i) | the purchase of water and wastewater taps in exchange for our obligation to construct certain wholesale facilities; |
| (ii) | the establishment of payment terms, timing, capacity, and location of special facilities (if any); and |
| (iii) | specific terms related to our provision of ongoing water and wastewater services to our local governmental customers as well as the governmental entities’ end-use customers. |
(i)
the purchase of water and wastewater taps in exchange for our obligation to construct certain Wholesale Facilities;
(ii)
the establishment of payment terms, timing, capacity and location of Special Facilities (if any); and
(iii)
specific terms related to our provision of ongoing water and wastewater services to our local governmental customers as well as the governmental entity’s end-use customers.
Although we have exclusive long-term water and wastewater service contracts for 24,000 acres of the 27,000-acre Lowry Range, Wild Pointe, and Sky Ranch pursuant to the Lowry Service Agreement,our service agreements, providing water and wastewater services to areas other than Wild Pointe, Sky Ranch and a portion of the Lowry Rangeservice is subject to competition. Alternate sources of water are available, principally from other private parties such as farmers or others owning water rights that have historically been used for agriculture, and from municipalities seeking to annex new development areas in order to increase their tax base. Our principal competition in areas close to the Lowry Range is the City of Aurora. Principal factors affecting competition for potential purchasers of our Export Waterwater service include the availability of water for the particular purpose, the cost of delivering the water to the desired location (including the cost of required taps), and the reliability of the water supply during drought periods.periods, and the political climate for additional annexations. We estimate that the water assets we own and have the exclusive right to use have a supply capacity of approximately 60,000 SFE units, and we believe that they provide us with a significant competitive advantage along the Front Range. Our legal rights to the Rangeview Water Supply have been confirmed for municipal use, and our water supply is close to Denver area water users. We believe that our pricing structure is competitive and that our water portfolio is well balanced with senioramong surface water rights, groundwater rights, storage capacity and reclaimed water supplies.
Land Development
Developing raw land is a highly competitive business, requires substantial upfront capital and typically requires many years to complete. There are many developers, as well as properties and development projects, in the same geographic area in which Sky Ranch is located. Competition among developers and projects is determined by the location of the real estate, the market appeal of the development plan, the cost and value of the end product, the developer’s ability to build, market and deliver projects on a timely and cost effective basis, and the availability of water to serve the project. Residential developers sell to home builders, who in turn compete based on location, price/value, market segmentation, product design, and reputation. Commercial, retail, and industrial developers sell to and/or compete with other developers, owners, and operators of real estate for a limited number of potential buyers. We believe we have exceeded the market’s expectations with the delivery of our initial phase lots at Sky Ranch and have demonstrated we have the ability and expertise to continue to deliver lots in a large scale master planned community.
Environmental, Health and Safety Regulation
Provision of water and wastewater services is subject to regulation under the federal Safe Drinking Water Act, the Clean Water Act, related state laws, and federal and state regulations issued under these laws. These laws and regulations establish criteria and standards for drinking water and for wastewater discharges. In addition, we are subject to federal and state laws and other regulations relating to solid waste disposal and certain other aspects of our operations.
Environmental compliance issues may arise in the normal course of operations or as a resultbecause of regulatory changes. We attempt to align capital budgeting and expenditures to address these issues in a timely manner.
Safe Drinking Water Act –
The Safe Drinking Water Act establishes criteria and procedures for the U.S. Environmental Protection Agency (the “EPA”) to develop national quality standards for drinking water. Regulations issued pursuant to the Safe Drinking Water Act and its amendments set standards on the amount of certain microbial and chemical contaminants and radionuclides allowable in drinking water. The State of Colorado has assumed primary responsibility for enforcing the standards established by the Safe Drinking Water Act and has adopted the Colorado Primary Drinking Water Standards (5(Code of Colorado Regulations 5 CCR 1003-1). Current requirements for drinking water are not expected to have a material impact on our financial condition or results of operations as we have made and are making investments to meet existing water quality standards. In the future, we might be required to change our method of treating drinking water and make additional capital investments if additional regulations become effective.
The federal Groundwater Rule became effective December 1, 2009. This rule requires additional testing of water from well sources and under certain circumstances requires demonstration and maintenance of effective disinfection. In 2009, Colorado adopted Article 13 to the Colorado Primary Drinking Water Standards to establish monitoring and compliance criteria for the Groundwater Rule. We have implemented measures to comply with the Groundwater Rule.
Clean Water Act
Clean Water Act–The Clean Water Act regulates wastewater discharges from drinking water and wastewater treatment facilities and storm water discharges into lakes, rivers, streams, and wetlands. The State of Colorado has assumed primary responsibility for enforcing the standards established by the federal Clean Water Act for wastewater discharges from domestic water and wastewater treatment facilities and has adopted the Colorado Water Quality Control Act and related regulations, which also regulate discharges to groundwater. It is our policy to obtain and maintain all required permits and approvals for discharges from our water and wastewater facilities and to comply with all conditions of those permits and other regulatory requirements. A program is in place to monitor facilities for compliance with permitting, monitoring, and reporting for wastewater discharges. From time to time, discharge violations might occur which might result in fines and penalties, but we have no reason to believe that any such fines or penalties are pending or will be assessed.
In the future, we anticipate changing our method of treating wastewater, which will require future additional capital investments, as additional regulations become effective. In 2016, we invested $368,600 to design, permit and construct a 13 million gallon effluent storage reservoir at our wastewater treatment facility and have converted our facility to a zero discharge treatment facility. We are storing the treated effluent water and expect to use the water for agricultural and irrigation uses.
Solid Waste Disposal –
The handling and disposal of residuals and solid waste generated from water and wastewater treatment facilities is governed by federal and state laws and regulations. We have a program in place to monitor our facilities for compliance with regulatory requirements, and we do not anticipate that costs associated with our handling and disposal of waste material from our water and wastewater operations will have a material impact on our business or financial condition.
Employees
We currently have 11 full-time employees.31 employees, all of whom are full-time.
Available Information and Website Address
Our website address is www.purecyclewater.com. We make available free of charge through our website our annual reportsAnnual Reports on Form 10-K, quarterly reportsQuarterly Reports on Form 10-Q, current reportsCurrent Reports on Form 8-K, and all amendments to these reports as soon as reasonably practicable after filing with the Securities and Exchange Commission (“SEC”(the “SEC”).
These reports and all other material we file with the SEC may be obtained directly from the SEC’s website, www.sec.gov/edgar/searchedgar/companysearch.html, under CIK code 276720. The contents of our website are not incorporated by reference into this report. You may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Operating information for the Public Reference Room is available by calling the SEC at 1-800-SEC-0330.
The following section describes the material risks and uncertainties that management believes could have a material adverse effect on our business, financial condition, results of operations, and the market price of our common stock. The risks discussed below include forward-looking statements, and our actual results may differ materially from those discussed in these forward-looking statements. These risks should be read in conjunction with the other information set forth in this report, including the accompanying financial statements and notes thereto.
General Risks Related to Our Company
Our business, operations and financial condition and results may be impacted by the COVID-19 pandemic to varying degrees.
In December 2019, a novel strain of coronavirus, referred to as the COVID-19 virus, was reported to have surfaced in Wuhan, China. Since then, COVID-19 has spread to multiple countries, including the United States. In March 2020, the World Health Organization declared the COVID-19 outbreak a pandemic, and the United States government-imposed travel restrictions on travel between the United States, Europe and other countries. Further, the President of the United States declared the COVID-19 pandemic a national emergency. In addition, the State of Colorado implemented stay-at-home orders requiring everyone to stay-at-home except to obtain or provide essential services such as food and medical care during portions of March through May. Many businesses responded with their own work-from-home or quarantine policies and/or indefinite closures. Since June, most businesses have been allowed to reopen subject to capacity restrictions, social distancing and mask requirements. State and local restrictions have been varying in response to whether the number of COVID-19 cases is increasing or decreasing.
Since December 2019, COVID-19 has resulted in numerous deaths, travel restrictions, closed international borders, enhanced health screening at ports of entry and elsewhere, prolonged quarantines and the imposition of both local and more widespread “work from home” measures, cancellations, supply chain disruptions, and lower consumer demand, as well as general concern and uncertainty. The ongoing spread of COVID-19 has, and is expected to continue to have, a material adverse impact on local economies in the affected jurisdictions and also on the global economy, as cross border commercial activity and market sentiment are increasingly impacted by the outbreak and government and other measures seeking to contain its spread. Our water and wastewater services are essential services, and we intend to continue to provide those services for our customers. However, our land development activities and our ability to expand our water and wastewater services may be disrupted, and we may be delayed in our current projects and timelines, the magnitude of which will depend, in part, on the length and severity of the COVID-19 outbreak. The COVID-19 virus poses the risk that we or our employees, governmental agencies permitting our projects, suppliers, consumers, and other business partners, including our home builders, may be prevented from conducting business activities in the ordinary course for an indefinite period of time, should the United States, the state of Colorado, or local governmental authorities implement further stay-at-home orders or restrictions. Shutdowns or other restrictions could also adversely impact the availability or cost of materials, which could limit our business operations or increase our costs.
The duration of the COVID-19 outbreak and its ultimate impact on the Company and, on the global economy, cannot be determined with certainty. The COVID-19 pandemic and its effects may last for an extended period of time, and could result in significant and continued declines in global financial markets, higher default rates, and a substantial economic downturn or recession. The extent to which COVID-19 will affect the Company will depend on future developments, which are highly uncertain and cannot be predicted, including new information that may emerge concerning the severity of COVID-19 and the actions taken to contain COVID-19. Given the significant economic and financial market disruptions associated with the COVID-19 pandemic, the Company’s results of operations could be adversely impacted.
Our net losses may continueoperations are concentrated in the Front Range area of Colorado; we are subject to general economic conditions in Colorado. Our assets and weoperations are located solely in the Front Range area of Colorado. Our performance could be adversely affected by economic conditions in, and other factors relating to, Colorado, including supply and demand for housing, and zoning and other regulatory conditions. To the extent that the general economic conditions in the Front Range area of Colorado deteriorate, the value of our assets, our results of operations and our financial condition could be materially adversely affected.
We may not have sufficient cash flows from operations or other capital resources to pursue our business objectives. WeWhile we have experienced significantgenerated net losses; ourincome in the past three fiscal years, we have a history of losses. Our cash flows from operations generally have not been sufficient to fund our operations, in the past; and we have been required to raise debt and equity capital and sell assets to remain in operation. Since 2004, we have obtained $76.2raised $76.3 million through (i) the issuance of $25.2$25.3 million of common stock (including the issuance of stock pursuant to the exercise of options, net of expenses), (ii) the issuance of $5.2 million of Convertible Debt,convertible debt, which was converted to common stock on January 11, 2011, and (iii)the sale of our Arkansas River water and land for approximately $45.8 million in cash.cash. Our continuing development of the first 250 homes in the first phase of Sky Ranch requires significant cash expendituresexpenditures. We have advanced the Sky Ranch CAB $26 million for construction of approximately $18public improvements on the Sky Ranch property and expect to advance another $3 million before we will generate positive cash flows fromfor the salecompletion of lotsour initial filing, with another $65.5 million expected to be advanced for filing 2. The Sky Ranch CAB is not required to repay us for advances made or expenses incurred for improvements at Sky Ranch unless and wateruntil the Sky Ranch CAB and/or Sky Ranch Districts issue bonds in an amount sufficient to reimburse us for all or a portion of advances made or expenses incurred. We have funded and sewer tap fees. We expect to continue to fund such expenditures with cash on hand and cash flows from operations. AtAs of August 31, 2017,2020, we had $26$21.8 million of cash and marketable securities on hand. We currently have a limited number of customers. If our cash on hand and future cash flows from operations are not sufficient to fund our operations and the significant capital expenditure requirements to build our water delivery systems andcontinue to develop Sky Ranch, we may be forced to seek to obtain additional debt or equity capital. Economic conditions and disruptions have previously caused substantial volatility in capital markets, including credit markets and the banking industry, increasing the cost, and significantly reducing the availability of financing, which may reoccur in the future. There can be no assurance that financing will be available on acceptable terms or at all.
We experience variability in our operating results on a quarterly basis and, as a result, our historical performance may not be a meaningful indicator of future results. We historically have experienced, and expect to continue to experience, variability in quarterly results. As a result of such variability, our short-term performance may not be a meaningful indicator of future results. Our quarterly results of operations may continue to fluctuate in the future because of a variety of factors, including, among others, the timing of the closings of sales of residential lots and weather-related problems.
Our stock price has been volatile in the past and may decline in the future. Our common stock has experienced significant price and volume fluctuations in the past and may experience significant fluctuations in the future depending upon several factors, some of which are beyond our control. Factors that could affect our stock price and trading volume include, among others, the perceived prospects of our business; differences between anticipated and actual operating results; changes in analysts’ recommendations or projections; the commencement and/or results of litigation and other legal proceedings; and future sales of our common stock by us or by significant shareholders, officers and directors. In addition, stock markets in general have experienced price and volume volatility from time to time, which may adversely affect the market price of our common stock for reasons unrelated to our performance.
Risks Related to Our Business Generally
We are dependent on the housing market and development in our targeted service areas for future revenues. Providing wholesale water service using our Colorado Front Range water supplies is one of our key sources of future revenue. The timing and amount of these revenues will depend in part on housing developments being built near our water assets. The development of the Lowry Range, Sky Ranch and other properties is subject to many factors that are not within our control. If wholesale water sales are not forthcoming or development on the Lowry Range, Sky Ranch or other properties in our targeted service areas is delayed or curtailed, we may need to use our capital resources, incur additional short or long-term debt obligations or seek to sell additional equity. We may not have sufficient capital resources or be successful in obtaining additional operating capital. Although there have been positive market gains in the Colorado housing market in recent years, if a downturn in the homebuilding or credit markets returns, or if the state or national economy weakens and economic concerns intensify, such a development could have a significant negative impact on our business and financial condition and our plans for future development of additional phases of Sky Ranch.
Although the Colorado economy has become increasingly diverse, the oil and gas industry remains an important segment of the Colorado economy. New statutes, regulations or other initiatives that would limit oil and gas exploration or increase the cost of exploration, as well as declines in the price of oil and gas, among other things, could lead to a downturn in the Colorado economy, including increased unemployment, which would likely have a negative impact on the housing market and our business and financial condition.
We may not be able to manage the increasing demands of our expanded operations.We have historically depended on a limited number of employees to administer our existing operations, interface with governmental entities, market our services and plan for the construction and development of our assets. The execution of contracts for lot sales and the continued development of Sky Ranch has increased the size and complexity of our business. The success of our current business and future business development and our ability to capitalize on growth opportunities depends on our ability to attract and retain additional experienced and qualified persons to operate and manage our business. We may not be able to maximize the value of our assets if we are unable to attract and retain qualified personnel and to manage the demands of a workforce that has nearly tripled in the past two years. State regulations set the training, experience and qualification standards required for our employees to operate specific water and wastewater facilities. Failure to find state-certified and qualified employees to support the operation of our facilities could put us at risk for, among other things, regulatory penalties (including fines and suspension of operations), operational errors at the facilities, improper billing and collection processes, claims for personal injury and property damage, and loss of contracts and revenues. We may be unsuccessful in managing our operations and growth.
We are dependent on the services of a key employee. Our success largely depends on the continuing services of our President and Chief Executive Officer, Mark W. Harding. We believe that Mr. Harding possesses valuable knowledge, experience and leadership abilities that would be difficult in the short term to replicate. Mr. Harding also serves on the boards of the Rangeview District, the Sky Ranch Districts, and the Sky Ranch CAB. The loss of Mr. Harding as a key employee and as a director of these boards would cause a significant interruption of our operations.
Our construction of water and wastewater projects and improvements at Sky Ranch may expose us to certain completion, performance, and financial risks. We expect to rely on independent contractors to construct our water and wastewater facilities and Sky Ranch lot improvements. These construction activities may involve risks, including shortages of materials and labor, work stoppages, labor relations disputes, injuries to third parties, damages to property, weather interference, engineering, environmental, permitting, or geological problems and unanticipated cost increases. These issues could give rise to delays, cost overruns or performance deficiencies, or otherwise adversely affect the construction or operation of our water and wastewater delivery systems and the construction and delivery of residential lots. In addition, we may experience quality problems in the construction of our systems and facilities, including equipment failures. We may not meet the required deadlines under our sale and construction contracts. We may face claims from customers or others regarding product quality and installation of equipment placed in service by contractors.
The sales contracts at Sky Ranch and contracts for the water and wastewater facilities that we design and construct are fixed-price contracts, in which we bear all or a significant portion of the risk for cost overruns. Under these fixed-price contracts, contract prices are established in part based on fixed, firm subcontractor quotes on contracts and on cost and scheduling estimates. These quotes or estimates may be based on several assumptions, including assumptions about prices and availability of labor, equipment and materials, and other issues. If these subcontractor quotations or cost estimates prove inaccurate, or if circumstances change, cost overruns may occur, and our financial results would be negatively impacted. In many cases, the incurrence of these additional costs would not be within our control.
Pursuant to various contracts related to the development of Sky Ranch, we guarantee that the project, when completed, will achieve certain performance standards, meet certain quality specifications, and satisfy certain requirements for governmental approvals. If we fail to complete the project as scheduled, meet guaranteed performance standards or quality specifications, or obtain the required governmental approvals, we may be held responsible for cost impacts and/or penalties to the customer resulting from any delay or for the costs to alter the project to achieve the performance standards and the quality specifications and to obtain the required government approvals. To the extent that these events occur and are not due to circumstances for which the customer accepts responsibility or cannot be mitigated by performance bonds or the provisions of our agreements with contractors, the total costs of the project would exceed our original estimates and our financial results would be negatively impacted.
We are required to secure, or to have our subcontractors secure, performance and completion bonds for certain contracts and projects. The market environment for surety companies has become increasingly risk averse. We and our subcontractors secure performance and completion bonds for our contracts from these surety companies. To the extent we or our subcontractors are unable to obtain bonds, we may breach existing agreements and/or not be awarded new contracts. We may not be able to secure performance and completion bonds when required.
Government regulations and legal challenges may delay the closing of the sale of our residential lots, increase our expenses or limit other activities, which could have a negative impact on our results of operations. The approval of numerous governmental authorities must be obtained in connection with both our water and wastewater projects and our land development activities, and these governmental authorities often have broad discretion in exercising their approval authority. We incur substantial costs related to compliance with legal and regulatory requirements. Any increase in legal and regulatory requirements may cause us to incur substantial additional costs. Various local, state and federal statutes, ordinances, rules and regulations concerning health and safety, site and building design, environmental, zoning, and similar matters apply to and/or affect the construction and operation of our water and wastewater systems and our land development activities. For example, zoning or other regulations may seek to limit housing density or create setbacks from oil and gas drilling operations or other restrictions on the use of land. To the extent that these regulations are modified, the value of the land that we already own or the availability of land that we are looking to acquire may decline, either of which may adversely impact the financial position, results of operations and cash flows of our business. In addition, our ability to obtain or renew permits or approvals and the continued effectiveness of permits already granted or approvals already obtained depends on factors beyond our control, such as changes in federal, state and local policies, rules and regulations and their interpretations and application. Furthermore, we are subject to various fees and charges of government authorities designed to defray the cost of providing certain governmental services and improvements. For example, local and state governments have broad discretion regarding the imposition of development fees for projects under their jurisdictions, as well as requiring concessions or that the property developer and/or home builder construct certain improvements to public places such as parks and streets or fund schools.
Municipalities or state water agencies may restrict or place moratoriums on the availability of utilities, such as water and sewer taps, which could have an adverse effect on our business by causing delays or increasing our costs.
We must provide water that meets all federal and state regulatory water quality standards and operate our water and wastewater facilities in accordance with these standards. Future changes in regulations governing the supply of drinking water and treatment of wastewater may have a material adverse impact on our financial results. With respect to service of customers on the Lowry Range, the Rangeview District’s rates might not be sufficient to cover the cost of compliance with additional or more stringent requirements. If the cost of compliance were to increase, we anticipate that the rates of the nearby water providers that the Rangeview District uses to establish its rates and charges would increase to reflect these cost increases, thereby allowing the Rangeview District to increase its rates and charges. However, these water providers may not raise their rates in an amount that would be sufficient to enable the Rangeview District (and us) to cover any increased compliance costs.
In addition, there is a variety of legislation being enacted, or considered for enactment, at the federal, state, and local level relating to energy and climate change. This legislation relates to items such as carbon dioxide emissions control and building codes that impose energy efficiency standards. Such environmental laws may affect, for example, how we manage storm water runoff, wastewater discharges and dust; how we develop or operate on properties on or affecting resources such as wetlands, endangered species, cultural resources, or areas subject to preservation laws; and how we address contamination. As climate change concerns continue to grow, compliance with legislation and regulations of this nature is expected to become more costly. Energy-related initiatives affect a wide variety of companies throughout the United States and the world and, because our operations are dependent on significant amounts of raw materials, such as pipe, steel and concrete, they could have an indirect adverse impact on our operations and profitability to the extent the manufacturers and suppliers of the materials used in the development of our properties are burdened with expensive tariffs, cap and trade and similar taxes and regulations. In addition, tariffs imposed by the United States on imported steel could increase our property development costs. It is possible that new standards could be imposed that will require additional capital expenditures or raise our operating costs. With respect to service of customers on the Lowry Range, the Rangeview District’s rates might not be sufficient to cover the cost of compliance with new requirements. Although we would expect the rates of the nearby water providers that the Rangeview District uses to establish its rates and charges to increase to cover increased compliance costs, such rates may not cover all our costs and our costs of complying with new standards or laws could adversely affect our business, results of operations or financial condition. Our noncompliance with environmental laws could result in fines and penalties, obligations to remediate, permit revocations and other sanctions.
Government agencies may initiate audits, reviews, or investigations of our business practices to ensure compliance with applicable laws and regulations, which can cause us to incur costs or create other disruptions in our business that can be significant. Further, we may experience delays and increased expenses because of legal challenges to our proposed development activities, whether brought by governmental authorities or private parties.
The enactment of Senate Bill 19-181 “Protect Public Welfare Oil and Gas Operations” increased the regulatory authority of local governments in Colorado over facilities siting and surface impacts of oil and gas development, which could have an adverse effect on our water sales to the oil and gas industry for hydraulic fracturing (“fracking”) and demand for new homes at Sky Ranch. Colorado Senate Bill 19-181 (“SB181”) was signed into law on April 16, 2019. Among other things, SB181 authorizes local governments to approve the siting of oil and gas locations and regulate the surface impacts of oil and natural gas development, including empowering local governments to adopt requirements that are more stringent than state requirements. SB181 changes the mission of the Colorado Oil and Gas Conservation Commission from fostering responsible and balanced development to regulating development to minimize adverse impacts to public health and the environment. SB181 also requires the Colorado Oil and Gas Conservation Commission and the Air Quality Control Commission to undertake rulemaking on numerous issues, including environmental protection, facility siting, application fees, and minimizing emissions of hydrocarbons and other compounds. The Colorado Oil and Gas Conservation Commission has proposed rules related to setbacks and siting requirements for well locations that would require any well pad surface proposed to be located greater than 500 feet and less than 2,000 feet from a residential or high occupancy building to obtain an exemption from the Commission by satisfying certain requirements in the rule (such as consent from owners and tenants) or to seek a ruling from the Commission, after a hearing, finding that the conditions of approval will provide substantially equivalent protections to a 2000 foot setback for public health, safety, welfare, the environment and wildlife resources. These and related rulemaking activities by the State Commissions and local governments could lead to delays and additional costs for oil and gas operators, which, in turn, could result in a decline in oil and gas drilling activities. A significant decline in oil and gas drilling activities in and around the Lowry Range and our Sky Ranch property would have an adverse effect on our water sales for fracking and our financial condition. Further, a significant decline in oil and gas activities throughout Colorado could negatively impact the Colorado economy, which could have an adverse effect on demand for new homes at Sky Ranch.
Rulemaking activities by the Colorado Oil and Gas Conservation Commission could adversely impact the number of lots available for land development in Colorado, which could have an adverse effect on our land development activities. As noted above, the Colorado Oil and Gas Conservation Commission has proposed rules related to setbacks and siting requirements for well locations. Depending on how these proposed rules are applied and interpreted, if adopted, they could have the effect of limiting property development within 2,000 feet of a well pad surface. If the proposed rules are implemented or interpreted in a manner that severely limits the exemptions, landowners could be forced to choose between limiting oil and gas development on their property to maximize the land available for residential and commercial development or to limit land development to maximize revenue from oil and gas development. Under a restrictive interpretation of such rules, we might have to limit drilling on our mineral rights at Sky Ranch in order to proceed with the occupancy densities we have planned, which would adversely affect our industrial water sales to the oil and gas industry. Restrictive rules could also reduce the supply of other land acquisition opportunities for development or make such land opportunities less attractive or uneconomical. Additionally, any rules that would require the Land Board to elect between oil and gas or land development with respect to the Lowry Range would likely have an adverse effect on our financial condition, because we have the exclusive right to provide water service to customers on the Lowry Range, including both lessees of the oil and gas rights on the Lowry Range and future occupants of the Lowry Range if the Land Board sells the land for development.
Natural disasters and severe weather conditions could delay the closing of the sale of residential lots at Sky Ranch and increase our costs, which could harm our sales and results of operations. We conduct our operations in the Colorado Front Range, which is subject to natural disasters, including droughts, tornadoes, wildland fires, and severe weather. The occurrence of natural disasters or severe weather conditions in Colorado or elsewhere could delay our construction activities, increase costs, and lead to shortages of labor and materials. If our insurance or the insurance of our subcontractors does not fully cover business interruptions or losses resulting from these events, our results of operations could be adversely affected.
We may be subject to significant potential liabilities because of warranty and liability claims made against us. Design, construction, or system failures related to our water and wastewater delivery systems could result in injury to third parties or damage to property. In addition, as a property developer, we are subject in the ordinary course of our business to warranty claims. We are also subject to claims for losses or injuries that occur during our property development activities. We plan to record warranty and other reserves for the residential lots we sell based on historical trends in our market and our judgment of the qualitative risks associated with the type of lots we sell. We have, and many of our subcontractors have, general liability, property, workers’ compensation, and other business insurance. These insurance policies are intended to protect us against a portion of our risk of loss from claims, subject to certain self-insured retentions, deductibles, and coverage limits. However, it is possible that this insurance will not be adequate to address all warranty and liability claims to which we are subject. Additionally, the coverage offered and the availability of general liability insurance for construction defects are currently limited and policies that can be obtained are costly and often include exclusions based upon past losses insurers suffered as a result of use of defective materials used by other property developers. As a result, our subcontractors may be unable to obtain insurance, and we may have to waive our customary insurance requirements, which increases our and our insurers’ exposure to claims and increases the possibility that our insurance will not be adequate to protect us for all the costs we incur. Any losses that exceed claims against our contractors, the performance bonds and our insurance limits at such facilities could result in claims against us. In addition, if there is a customer dispute regarding performance of our services, the customer may decide to delay or withhold payment to us. No warranty and liability claims have been made against us as of the date of this report.
A major health and safety incident relating to our business could be costly in terms of potential liabilities and reputational damage. Water facility and land development construction sites are inherently dangerous and pose certain inherent health and safety risks to construction workers and other persons on the site. Any failure in health and safety performance may result in penalties for non-compliance with relevant regulatory requirements, and a failure that results in a major or significant health and safety incident is likely to be costly in terms of potential liabilities incurred as a result. Such a failure could generate significant negative publicity and have a corresponding impact on our reputation, our relationships with relevant regulatory agencies or governmental authorities, and our ability to attract customers and employees, which in turn could have a material adverse effect on our business, financial condition and operating results.
Conflicts of interest may arise relating to the operation of the Rangeview District, the Sky Ranch Districts and the Sky Ranch CAB. Our Chief Executive Officer, Chief Financial Officer and two of our employees constitute 80% of the directors of each of the Rangeview District, the Sky Ranch Districts and the Sky Ranch CAB. These officers and employees, along with Pure Cycle, and one unrelated individual, own certain property interests in the 40 acres that constitute the Rangeview District and the acreage that constitutes the Sky Ranch Districts. We have made loans to the Rangeview District to fund its operations. As of August 31, 2020, total principal and interest owed to us by the Rangeview District was just under $1.0 million. Pursuant to our water and wastewater service agreements with the Rangeview District, the Rangeview District retains two percent of the revenues from the sale of water to its end-use customers and 10% of the revenues from the provision of wastewater services to its end-use customers. Proceeds from the fee collections will initially be used to repay the Rangeview District’s obligations to us, but after these loans are repaid, the Rangeview District is not required to use the funds to benefit Pure Cycle.
Similarly, we have made loans to and incurred expenses reimbursable by the Sky Ranch Districts, which amounts were fully refunded to us as of August 31, 2020, and we have advanced the Sky Ranch CAB $26 million for construction of public improvements on the Sky Ranch property. The Sky Ranch CAB is not required to repay us for advances made or expenses incurred for improvements at Sky Ranch unless and until the Sky Ranch CAB and/or Sky Ranch Districts issue bonds in an amount sufficient to reimburse us for all or a portion of advances made or expenses incurred. We have received benefits from our activities undertaken in conjunction with the Rangeview and Sky Ranch Districts and the Sky Ranch CAB, but conflicts may arise between our interests and those of the Rangeview and Sky Ranch Districts and the Sky Ranch CAB and our officers and employees who are acting in dual capacities in negotiating contracts to which we and a district and/or the Sky Ranch CAB are parties. We expect that the Rangeview and Sky Ranch Districts will expand when more properties are developed and become part of the respective districts, and our officers and employees acting as directors of these districts will have fiduciary obligations to those other constituents. Conflicts may not be resolved in the best interests of the Company and our shareholders. In addition, other landowners coming into a district will be eligible to vote and to serve as directors of these districts. Our officers and employees may not remain as directors of these districts, and the actions of subsequently elected boards could have an adverse impact on our operations.
Growth limitations or moratoriums imposed by governmental authorities could adversely affect our land development activities or the land development activities of our customers, which could adversely impact both the land development and water and wastewater segments of our business. The State of Colorado or counties in which our service areas and properties are located may approve limitations or moratoriums on residential growth within their respective boundaries, which limitations or moratoriums could have the effect of delaying, limiting or halting development within Sky Ranch or other areas where we may provide water and wastewater services or develop land. We are not aware of any such proposals in the areas in which we operate, but proposals have been made to limit growth in various communities along the Front Range. Because all of the property in Sky Ranch has been platted, we do not expect future growth moratoriums to restrict Sky Ranch as currently planned; however, if growth moratoriums or restrictions are imposed in the areas in which we provide services or develop land, it could negatively impact our ability to develop our land as planned or our customers’ ability to grow their communities as anticipated, which would also reduce the number of water and wastewater service customers we expect, which would have a negative impact on our business and financial condition.
We could be hurt by efforts to impose liabilities or obligations on us regarding labor law violations by other persons whose employees perform contracted services. The infrastructure and improvements on our water and wastewater systems and on the finished lots we sell or that we must provide pursuant to service agreements and lot development agreements are done by employees of subcontractors and other contract parties. We do not have the ability to control what these contract parties pay their employees or the work rules they impose on their employees. However, there have been efforts by government agencies to hold contract parties like us responsible for violations of wage and hour laws and other work-related laws by firms whose employees are performing contracted-for services. This includes a 2016 National Labor Relations Board (“NLRB”) ruling which held that for labor law purposes a firm could under some circumstances be responsible as a joint employer of its contractors’ employees even if the firm had no direct control over the employees’ terms and conditions of employment. The NLRB ultimately reversed this ruling through a final rule issued in February 2020. The Colorado Department of Labor and Employment proposed similar changes in an April 2020 emergency rulemaking but ultimately withdrew them in May 2020 following a notice and comment period. Although these changes in the joint employer framework have not yet succeeded, governmental rulings that make us responsible for labor practices by our subcontractors could create substantial exposures for us in situations that are not within our control.
Unauthorized access to confidential information and data on our information technology systems and security and data breaches could materially adversely affect our business, financial condition, and operating results. As part of our operations, we rely on our computer systems to process transactions, communicate with our suppliers and other third parties, and on continued and unimpeded access to secure network connections to use our computer systems. We have physical, technical, and procedural safeguards in place that are designed to protect information and protect against security and data breaches as well as fraudulent transactions and other activities. Despite these safeguards and our other security processes and protections, we cannot be assured that all of our systems and processes are free from vulnerability to security breaches (through cyberattacks, which are evolving and becoming increasingly sophisticated, physical breach or other means) or inadvertent data disclosure by third parties or by us. A significant data security breach, including misappropriation of customer, supplier or employee confidential information, could cause us to incur significant costs, which may include potential costs of investigations, legal, forensic and consulting fees and expenses, costs and diversion of management attention required for investigation, remediation and litigation, substantial repair or replacement costs. We could also experience data losses that would impair our ability to manage our business operations, including accounting and project costs, manage our water and wastewater systems or process transactions and have a negative impact on our reputation and loss of confidence of our customers, suppliers and others, any of which could have a material adverse impact on our business, financial condition and operating results.
Risks Related to the Water Segment of Our Business
The rates that the Rangeview District is allowed to charge customers on the Lowry Range for water services are limited by the Lease with the Land Board and our contract with the Rangeview District and may not be sufficient to cover our costs of construction and operation. The prices charged by the Rangeview District for water service on the Lowry Range are subject to pricing regulations set forth in the Lease with the Land Board. Both the tap fees and usage rates and charges are capped at the average of the rates of three nearby water providers. Annually, the Rangeview District surveys the tap fees and rates of the three nearby providers, and the Rangeview District may adjust tap fees and rates and charges for water service on the Lowry Range based on the average of those charged by this group,group. We receive 100% of tap fees and we receive 98% of whateverwater usage fees charged by the Rangeview District chargesto its customers.customers after the deduction of royalties owed to the Land Board. Our costs associated with the construction of water delivery systems and the production, treatment and delivery of water are subject to market conditions and other factors, which may increase at a significantly higher rate than that of the fees we receive from the Rangeview District. Factors beyond our control and which cannot be predicted, such as government regulations, insurance and labor markets, drought, water contamination and severe weather conditions, like tornadoes and floods, may result in additional labor and material costs that may not be recoverable under the current rate structure. Both increased customer demand and increased water conservation may also impact the overall cost of our operations. If the costs for construction and operation of our wholesale water services, including the cost of extracting our groundwater, exceed our revenues, we would be providing water service to the Rangeview District for use at the Lowry Range at a loss. The Rangeview District may petition the Land Board for rate increases; however, there can be no assurance that the Land Board would approve a rate increase request. Further, even if a rate increase were approved, it might not be granted in a timely manner or in an amount sufficient to cover the expenses for which the rate increase was sought.
Our water business is subject to seasonal fluctuations and weather conditions that could affect demand for our water service and our revenues.We depend on an adequate water supply to meet the present and future demands of our customers and their end-use customers and to continue our expansion efforts. Conditions beyond our control may interfere with our water supply sources. Drought and overuse may limit the availability of water. These factors might adversely affect our ability to supply water in sufficient quantities to our customers, and our revenues and earnings may be adversely affected. Additionally, cool and wet weather, as well as drought restrictions and our customers’ conservation efforts, may reduce consumption demands, adversely affecting our revenue and earnings. Furthermore, freezing weather may contribute to water transmission interruptions caused by pipe and main breakage. If we experience an interruption in our water supply, it could have a material adverse effect on our financial condition and results of operations. Demand for our water during the warmer months is generally greater than during cooler months due primarily to additional requirements for water in connection with cooling systems, irrigation systems and other outside water use. Throughout the year, and particularly during typically warmer months, demand will vary with temperature and rainfall levels. If temperatures during the typically warmer months are cooler than expected or there is more rainfall than expected, the demand for our water may decrease and adversely affect our revenues.
SalesOur water sales for the past three years have been highly concentrated among companies providing hydraulic fracturing services to the frackingoil and gas industry, and such sales can fluctuate significantly. Our water sales have been historically highly concentrated directly and indirectly with one companyto three companies providing frackinghydraulic fracturing services to the oil and gas industry on and around the Lowry Range and our Sky Ranch property. SalesGenerally, investment in oil and gas development is dependent on the price of oil and gas. During the years ended August 31, 2020, 2019, and 2018 water sales for oil and gas operations represented 49%, 93%, and 90%, respectively, of our total metered water revenues. We have no long-term contractual commitments that will ensure these sales continue in the future. The oil and gas industry has periodically gone through periods when activity has significantly declined such as earlier this year due to low oil and gas prices caused by increased world-wide production and decreased demand due to stay-at-home orders related to the COVID‑19 pandemic.
Further sales to this customer base as well as renewals of our oil and gas leases, if any, in the future are impacted by statutory ballot initiatives, regulations, rulemaking initiatives by the Colorado Oil and Gas Conservation Commission, court interpretations of the statutory mandate of the Colorado Oil and Gas Conservation Commission, fracking technologies, the success of the wells and the price of oil and gas, among other things. InvestmentFor example, certain interest groups in Colorado opposed to oil and natural gas development generally, and hydraulic fracturing in particular, have advanced ballot initiatives that would significantly curtail oil and natural gas development in the state, including a Colorado proposed initiative that would have made drilling unlawful on approximately 85% of the non-federal surface area of the state of Colorado. Although these initiatives have not passed, interest groups opposed to oil and natural gas development have continued to seek restrictions. The enactment of SB181 and the release of a Colorado Department of Public Health and Environment report dated October 17, 2019, entitled Final Report: Human Health Risk Assessment for Oil & Gas Operations in Colorado, concluding that people living within 2,000 feet of fracking sites could face elevated health risks, may lead to increased opposition and tougher oversight of oil and gas development is dependent onoperations, which could reduce the pricedemand for water for fracking.
A significant portion of oil and gas. While water sales for fracking are now increasing, we have no contractual commitment that will ensure these sales in the future.
We are dependent on the housing market and development in our targeted service areas for future revenues.Providing wholesale water service using our Colorado Front Range water supplies iscome from non-renewable aquifers. A significant portion of our principal sourcewater supplies comes from non-renewable Denver Basin aquifers. The State of future revenue. The timingColorado regulates development and withdrawal of water from the Denver Basin aquifers to a rate of 1 percent of the aggregate amount of these revenues will dependwater determined to be in part on housing developments being built nearstorage each year, which means our water assets. The development ofsupply should last approximately 100 years even if no efforts were made to conserve or recharge the Lowry Range, Sky Ranch and other properties is subject to many factors that are not within our control. If wholesale water sales are not forthcoming or development on the Lowry Range, Sky Ranch or other properties in our targeted service areas is delayed,supply. Nonetheless, we may need to useseek additional water supplies as our capital resources, incur additional short or long-term debt obligations or seeknon-renewable supplies are depleted. While the acquisition of Lost Creek water, a renewable “surface” water right that is diverted from an alluvial aquifer that is hydrologically connected to sell additional equity. Wethe surface water system, mitigates some of the risk of owning non-renewable supplies, if we are unable to obtain sufficient replacement supplies, it would have a material adverse impact on our business and financial condition. Additionally, the cost of developing and withdrawing water from the aquifers will increase over time, and we may not have sufficient capital resources or be successful in obtaining additional operating capital. After several years of significant declines in new home construction, there have been positive market gains inable to recover the Colorado housing market since 2013. However, ifincreased costs through our rates and charges. Increased costs to develop water from the downturn in the homebuilding and credit markets return or if the national economy weakens and economic concerns intensify, itaquifers could have a significant negative impact on our business, results of operations, cash flows and financial condition and our plans for future development of additional phases of Sky Ranch.
condition.
Development on the Lowry Range is not within our control and is subject to obstacles.Development on the Lowry Range is controlled by the Land Board, which is governed by a five-person citizen board of commissioners representing education, agriculture, local government and natural resources, plus one at-large commissioner, each appointed for a four-year term by the Colorado governor and approved by the Colorado Senate. The Land Board’s focus with respect to issues such as development and conservation on the Lowry Range tends to change as membership on the Land Board changes. In addition, there are often significant delays in the adoption and implementation of plans with respect to property administered by the Land Board because the process involves many constituencies with diverse interests. In the event water sales are not forthcoming or development of the Lowry Range is delayed or abandoned, we may need to use our capital resources, incur additional short or long-term debt obligations or seek to sell additional equity. We may not have sufficient capital resources or be successful in obtaining additional operating capital.
Because of the prior use of the Lowry Range as a military facility, environmental clean-up may be required prior to development, including the removal of unexploded ordnance. The U.S. Army Corps of Engineers has been conducting unexploded ordnance removal activities at the Lowry Range for more than 20 years. Continued activities are dependent on federal appropriations, and the Army Corps of Engineers has no assurance from year to year of such appropriations for its activities at the Lowry Range.
We do not have experience with the development of real property.While we have experience designing and constructing water and wastewater facilities and maintaining and operating these facilities, we do not have experience developing real property. We may underestimate the capital expenditures required to develop the first phase of Sky Ranch, including the costs of certain infrastructure improvements. We lack experience in managing property development activities, including the permitting and other approvals required, which may result in delays in obtaining the necessary permits and government approvals.
Our construction of water and wastewater projects may expose us to certain completion, performance and financial risks.We expect to rely on independent contractors to construct our water and wastewater facilities and Sky Ranch lot improvements. These construction activities may involve risks, including shortages of materials and labor, work stoppages, labor relations disputes, weather interference, engineering, environmental, permitting or geological problems and unanticipated cost increases. These issues could give rise to delays, cost overruns or performance deficiencies, or otherwise adversely affect the construction or operation of our water and wastewater delivery systems and the construction and delivery of residential lots pursuant to our Builder Contracts. In addition, we may experience quality problems in the construction of our systems and facilities, including equipment failures. We may not meet the required deadlines under our Builder Contracts. We may face claims from customers or others regarding product quality and installation of equipment placed in service by contractors.
The Builder Contracts for Sky Ranch and for the water facilities that we design and construct are fixed-price contracts, in which we bear all or a significant portion of the risk for cost overruns. Under these fixed-price contracts, contract prices are established in part based on fixed, firm subcontractor quotes on contracts and on cost and scheduling estimates. These estimates may be based on a number of assumptions, including assumptions about prices and availability of labor, equipment and materials, and other issues. If these subcontractor quotations or cost estimates prove inaccurate, or if circumstances change, cost overruns may occur, and our financial results would be negatively impacted. In many cases, the incurrence of these additional costs would not be within our control.
Pursuant to our Builder Contracts for Sky Ranch, we guarantee project completion of water and wastewater delivery systems and lot improvements by a scheduled date. We also guarantee that the project, when completed, will achieve certain performance standards, meet certain quality specifications and satisfy certain requirements for governmental approvals. If we fail to complete the project as scheduled, or if we fail to meet guaranteed performance standards or quality specifications, or obtain the required governmental approvals, we may be held responsible for cost impacts and/or penalties to the customer resulting from any delay or for the costs to alter the project to achieve the performance standards and the quality specifications and to obtain the required government approvals. To the extent that these events occur and are not due to circumstances for which the customer accepts responsibility or cannot be mitigated by performance bonds or the provisions of our agreements with contractors, the total costs of the project would exceed our original estimates and our financial results would be negatively impacted.
We are required to secure, or to have our subcontractors secure, performance and completion bonds for certain contracts and projects. The market environment for surety companies has become more risk averse. We and our subcontractors secure performance and completion bonds for our contracts from these surety companies. To the extent we or our subcontractors are unable to obtain bonds, we may breach existing agreements and/or not be awarded new contracts. We may not be able to secure performance and completion bonds when required.
We may be subject to significant potential liabilities as a result of warranty and liability claims made against us.Design, construction or system failures related to our water and wastewater delivery systems could result in injury to third parties or damage to property. As a property developer, we are also subject in the ordinary course of our business to warranty claims. We are also subject to claims for injuries that occur in the course of our property development activities. We plan to record warranty and other reserves for the residential lots we sell based on historical experience in our market and our judgment of the qualitative risks associated with the type of lots we sell. We have, and many of our subcontractors have, general liability, property, workers’ compensation and other business insurance. These insurance policies are intended to protect us against a portion of our risk of loss from claims, subject to certain self-insured retentions, deductibles and coverage limits. However, it is possible that this insurance will not be adequate to address all warranty and liability claims to which we are subject. Additionally, the coverage offered and the availability of general liability insurance for construction defects are currently limited and policies that can be obtained are costly and often include exclusions based upon past losses those insurers suffered as a result of use of defective materials used by other property developers. As a result, our subcontractors may be unable to obtain insurance, and we may have to waive our customary insurance requirements, which increases our and our insurers’ exposure to claims and increases the possibility that our insurance will not be adequate to protect us for all the costs we incur. Any losses that exceed claims against our contractors, the performance bonds and our insurance limits at such facilities could result in claims against us. In addition, if there is a customer dispute regarding performance of our services, the customer may decide to delay or withhold payment to us.
We have a limited number of employees and may not be able to manage the increasing demands of our expanded operations.We have a limited number of employees to administer our existing assets, interface with applicable governmental bodies, market our services and plan for the construction and development of our assets. We may not be able to maximize the value of our assets because of our limited manpower. We depend significantly on the services of Mark W. Harding, our President and Chief Financial Officer. The loss of Mr. Harding would cause a significant interruption of our operations. Further, the execution of the Builder Contracts for Sky Ranch has increased the size and complexity of our business. The success of our current business and future business development and our ability to capitalize on growth opportunities depends on our ability to attract and retain additional experienced and qualified persons to operate and manage our business. State regulations set the training, experience and qualification standards required for our employees to operate specific water and wastewater facilities. Failure to find state-certified and qualified employees to support the operation of our facilities could put us at risk for, among other things, regulatory penalties (including fines and suspension of operations), operational errors at the facilities, improper billing and collection processes, and loss of contracts and revenues. We may be unsuccessful in managing our assets and growth.
Supply shortages and risks related to the demand for skilled labor and building materials could increase costs and delay closings. The property development industry is highly competitive for skilled labor and materials. Labor shortages in the Colorado Front Range have become more acute in recent years as the supply chain adjusts to uneven industry growth. Increased costs or shortages of skilled labor and/or concrete, steel, pipe and other materials could cause increases in property development costs and delays. We are unable to pass on increases in property development costs to home builders with whom we have already entered into purchase and sale contracts for residential lots, as our contracts fix the price of the lots at the time the contracts are signed, which will be well in advance of property development. Sustained increases in development costs may, over time, erode our margins.
Products supplied to us and work done by subcontractors can expose us to risks that could adversely affect our business. We rely on subcontractors to perform the actual property development, and in many cases, to select and obtain concrete and other materials. Subcontractors may use improper construction processes or defective materials. Defective products can result in the need to perform extensive repairs. The cost of complying with our warranty obligations may be significant if we are unable to recover the cost of repairs from subcontractors, materials suppliers and insurers.
A failure of the water wells or distribution networks that we own or control could result in losses and damages that may affect our business and financial condition and reputation.condition. We distribute water through a network of pipelines and store water in storage tanks and a pond.ponds. A failure of these pipelines, tanks or the pondponds could result in injuries and damage to property for which we may be responsible, in whole or in part. The failure of these pipelines, tanks, or pondponds may also result in the need to shut down some facilities or parts of our water distribution network in order to conduct repairs. Such failures and shutdowns may limit our ability to supply water in sufficient quantities to our customers and to meet the water delivery requirements prescribed by our contracts, which could adversely affect our financial condition,business, results of operations, cash flow, liquidityflows, and reputation.financial condition. Any business interruption or other losses might not be covered by insurance policies or be recoverable through rates and charges, and such losses may make it difficult for us to secure insurance in the future at acceptable rates.
Conflicts of interestContamination to our water supply may arise relatingresult in disruption in our services and litigation, which could adversely affect our business, operating results and financial condition. Our water supplies are subject to the risk of potential contamination, including contamination from naturally occurring compounds, pollution from man-made sources and intentional sabotage. Our land at Sky Ranch and a portion of the Lowry Range have been leased for oil and gas exploration and development. Such exploration and development could expose us to additional contamination risks from related leaks or spills. In addition, we handle certain hazardous materials at our water treatment facilities, primarily sodium hypochlorite. Any failure of our operation of the facilities or any contamination of our supplies, including sewage spills, noncompliance with water quality standards, hazardous materials leaks and spills, and similar events, could expose us to environmental liabilities, claims and litigation costs. If any of these events occur, we may have to interrupt the use of that water supply until we are able to substitute the supply from another source or treat the contaminated supply. We cannot assure you that we will successfully manage these issues, and failure to do so could have a material adverse effect on our future results of operations.
We may incur significant costs in order to treat the contaminated source through expansion of our current treatment facilities or development of new treatment methods. If we are unable to substitute water supply from an uncontaminated water source, or to adequately treat the contaminated water source in a cost-effective manner, there may be an adverse effect on our revenues, operating results and financial condition. The costs we incur to decontaminate a water source or an underground water system could be significant and could adversely affect our business, operating results and financial condition and may not be recoverable in rates.
We could also be held liable for consequences arising out of human exposure to hazardous substances in our water supplies or other environmental damage. For example, private plaintiffs could assert personal injury or other toxic tort claims arising from the presence of hazardous substances in our drinking water supplies. Although we have not been a party to any environmental or pollution-related lawsuits, such lawsuits have increased in frequency in recent years. If we are subject to an environmental or pollution-related lawsuit, we might incur significant legal costs, and it is uncertain whether we would be able to recover the legal costs from ratepayers or other third parties. Our insurance policies may not cover or provide sufficient coverage for the losses associated with or the costs of these claims.
We may be adversely affected by any future decision by the Colorado Public Utilities Commission to regulate us as a public utility. The Colorado Public Utilities Commission (“CPUC”) regulates investor-owned water companies operating for the purpose of supplying water to the public. The CPUC regulates many aspects of public utilities’ operations, including establishing water rates and fees, initiating inspections, enforcement and compliance activities and assisting consumers with complaints. We do not believe that we are a public utility under Colorado law. We currently provide services by contract mainly to the Rangeview District, which supplies the public. Quasi-municipal metropolitan districts, such as the Rangeview District and the Sky Ranch Districts.Districts, are exempt by statute from regulation by the CPUC. However, the CPUC could attempt to regulate us as a public utility. If this were to occur, we might incur significant expense challenging the CPUC’s assertion of jurisdiction, and we may be unsuccessful. In the future, existing regulations may be revised or reinterpreted, and new laws and regulations may be adopted or become applicable to us or our facilities. If we become regulated as a public utility, our ability to generate profits could be limited, and we might incur significant costs associated with regulatory compliance.
The Rangeview District’s and our rights under the Lease have been challenged by third parties. Our officersThe Rangeview District’s and employees constitute 60% ofour rights under the directors ofLease have been challenged by third parties, including the Land Board, in the past. In 2014, in connection with settling a lawsuit filed by us and the Rangeview District against the Land Board, the Land Board, the Rangeview District and we amended and restated the Sky Ranch Districts. Pure Cycle, alongLease to clarify and update a number of provisions. However, there are issues still subject to disagreement and negotiation, including our rights with respect to revenue from our officersExport Water after 2081, and employeesit is likely that during the remaining term (through 2081) of the Lease, the parties will disagree over interpretations of provisions in the Lease again. The Rangeview District’s or our rights under the Lease could be challenged in the future, which could require potentially expensive litigation to enforce our rights.
Our Lowry Range surface water rights are “conditional decrees” and two unrelated individuals, ownrequire findings of reasonable diligence. Our surface water interests and reservoir sites at the 40 acresLowry Range are conditionally decreed and are subject to a finding of reasonable diligence from the Colorado water court every six years. To arrive at a finding of reasonable diligence, the water court must determine that constitutewe continue to diligently pursue the development of said water rights. If the water court is unable to make such a finding, we could lose the water right under review. During each of fiscal 2012 and 2018, the Lowry Range conditional decrees were granted review by the water court, which determined that we and the Rangeview District andmet the acreagediligence criteria. The water court entered a finding of reasonable diligence on the Lowry Range surface water decrees in January 2019. Our next review for reasonable diligence on the Lowry Range surface water decrees will be in January 2025. We believe that constituteswe will be successful in maintaining our decrees as we continue to develop these rights. If the Sky Ranch Districts. We have made loans towater court does not make a determination of reasonable diligence, the value of our interests in the Rangeview District to fund its operations. At August 31, 2017, total principal and interest owed to us by the Rangeview District was $776,400. Pursuant to our water and wastewater service agreements with the Rangeview District, the Rangeview District retains two percent of the revenues from the sale of water to its end-use customers and 10% of the revenues from the provision of wastewater services to its end-use customers. Proceeds from the fee collections will initiallyWater Supply would be used to repay the Rangeview District’s obligations to us, but after these loans are repaid, the Rangeview District is not required to use the funds to benefit Pure Cycle.materially adversely impacted.
Similarly, we have made loans to and incurred expenses reimbursable by the Sky Ranch Districts. At August 31, 2017, total principal and interest owed to us by the Sky Ranch Districts was $215,500. It is anticipated that these amounts will be repaid once Sky Ranch has sold residential units and has a tax base to issue bonds to pay for services. We have received benefits from our activities undertaken in conjunction with these districts, but conflicts may arise between our interests and those of the Rangeview and Sky Ranch Districts and our officers and employees who are acting in dual capacities in negotiating contracts to which both we and a district are parties. We expect that the Rangeview and Sky Ranch Districts will expand when more properties are developed and become part of the respective districts, and our officers and employees acting as directors of these districts will have fiduciary obligations to those other constituents. Conflicts may not be resolved in the best interests of the Company and our shareholders. In addition, other landowners coming into a district will be eligible to vote and to serve as directors of that district. Our officers and employees may not remain as directors of these districts, and the actions of subsequently elected boards could have an adverse impact on our operations.
Our operations are affected by local politics and governmental procedures that are beyond our control. We operate in a highly political environment. We market our water rights to municipalities and other governmental entities run by elected or politically appointed officials. Our principal competitors are municipalities seeking to expand their sales tax base and other water districts. Various constituencies, including our competitors, developers, environmental groups, conservation groups, and agricultural interests, have competing agendas with respect to the development of water rights in Colorado, which means that decisions affecting our business are based on many factors other than economic and business considerations. Additional risks associated with dealing with governmental entities include turnover of elected and appointed officials, changes in policies from election to election, and a lack of institutional history in these entities concerning their prior courses of dealing with the Company. We spend significant time and resources educating elected officials, local authorities and others regarding our water rights and the benefits of contracting with us. Political concerns and governmental procedures and policies may hinder or delay our ability to enter into service agreements or develop our water rights or infrastructure to deliver our water. While we have worked to reduce the political risks in our business through our participation as the service provider for the Rangeview District in regional cooperative resource programs, such as the SMWSA and itsthe WISE partnership with Denver Water and Aurora Water, as well as education and communication efforts and community involvement, our efforts may be unsuccessful.
The number of connections we can serve are affected by local governmental policies that are beyond our control. We market our water rights through service agreements to developers, municipalities and other governmental entities run by elected or politically appointed officials. We believe that our water rights can serve approximately 60,000 single family connections based on standards applied to water providers in Arapahoe, Douglas, and Adams Counties. These standards are policy driven, based on assumed life and reliability of water supplies and may become more restrictive at the discretion of the governmental entity. If these standards become more restrictive, water supplies of all water providers, including those of the Company, may not serve the number of connections that providers currently estimate.
Development on the Lowry Range is not within our control and is subject to obstacles. Development on the Lowry Range is controlled by the Land Board, which is governed by a five-person citizen board of commissioners representing education, agriculture, local government and natural resources, plus one at-large commissioner, each appointed for a four-year term by the Colorado governor and approved by the Colorado Senate. The Land Board’s focus with respect to issues such as development and conservation on the Lowry Range tends to change as membership on the Land Board changes. In addition, there are often significant delays in the adoption and implementation of plans with respect to property administered by the Land Board because the process involves many constituencies with diverse interests. In the event water sales are not forthcoming or development of the Lowry Range is delayed or abandoned, we may need to use our capital resources, incur additional short or long-term debt obligations or seek to sell additional equity. We may not have sufficient capital resources or be successful in obtaining additional operating capital.
Because of the prior use of the Lowry Range as a military facility, environmental clean-up may be required prior to development, including the removal of unexploded ordnance. The U.S. Army Corps of Engineers has been conducting unexploded ordnance removal activities at the Lowry Range for more than 30 years. Continued activities are dependent on federal appropriations, and the Army Corps of Engineers has no assurance from year to year of such appropriations for its activities at the Lowry Range.
Risks Related to the Land Development Segment of Our Business
The homebuilding industry is cyclical and a deterioration in industry conditions or downward changes in general economic or other business conditions could adversely affect our business, results of operations, cash flows and financial condition. The residential homebuilding industry is cyclical and is highly sensitive to changes in general economic conditions such as levels of employment, consumer confidence and income, availability of mortgage financing for acquisitions, interest rate levels and inflation, among other factors. Additionally, the residential housing market is impacted by federal and state personal income tax rates and provisions, and government actions, policies, programs and regulations directed at or affecting the housing market, including the Tax Cuts and Jobs Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, tax benefits associated with purchasing and owning a home, and the standards, fees and size limits applicable to the purchase or insuring of mortgage loans by government-sponsored enterprises and government agencies. In fiscal 2019, housing starts in Colorado declined compared to housing starts in fiscal 2018. However, in fiscal 2020 housing starts in Colorado increased compared to fiscal 2019. Although the number of housing starts continues to be better than during the last economic downturn, if the recovery of the Colorado housing market reverses, we could experience declines in the market value of our inventory and demand for our lots, which could have a material adverse effect on our business, results of operations, cash flows and financial condition.
We have limited experience with the development of real property. While we have extensive experience designing and constructing water and wastewater facilities and maintaining and operating these facilities, we have limited experience developing real property. We may underestimate the capital expenditures required to develop Sky Ranch, including the costs of certain infrastructure improvements. We also have limited experience in managing property development activities, including the permitting and other approvals required, which may result in delays in obtaining the necessary permits and government approvals.
Significant competition from other development projects could adversely affect our results. Land development is a highly competitive business. There are numerous land developers, as well as properties and development projects, in the same geographic area in which Sky Ranch is located. Many of our land development competitors may have advantages over us, such as more favorable locations, which may provide more desirable schools and easier access to roads and shopping, or amenities that we may not offer, as well as greater financial resources. If other development projects are found to be more attractive to home buyers, home builders or other developers or operators of real estate based on location, price, or other factors, then we may be pressured to reduce our prices or delay further development, either of which could materially adversely affect our business, results of operations, cash flows and financial condition.
The funds that we are advancing to the Sky Ranch CAB for construction of public improvements might not be repaid, which would negatively impact our income, gross margin on selling lots, and cash flows. We have advanced the Sky Ranch CAB $26 million for construction of public improvements and expect to fund an additional estimated $3 million in buildout costs for filing one and $48 million for filing two that we expect will be reimbursable by the Sky Ranch CAB. No payment is required by the Sky Ranch CAB with respect to construction of public improvements unless and until the Sky Ranch CAB and/or the Sky Ranch Districts have funds or issue municipal bonds in an amount sufficient to reimburse the Company for all or a portion of advances provided or expenses incurred for reimbursables. The ability and obligation of the Sky Ranch CAB to reimburse us is dependent on sufficient home sales and commercial development occurring at Sky Ranch to create a tax base that would enable the Sky Ranch CAB to issue bonds to pay for the improvements. If development at Sky Ranch is delayed or curtailed for any reason, including regulatory restrictions, a downturn in the economy or default by one or more of the builders at Sky Ranch, the Sky Ranch CAB may not have sufficient revenues to issue bonds. Because the timing of the issuance and approval of any bonds is subject to considerable uncertainty, any potential reimbursable costs for the construction of public improvements, including construction support activities, are not included on our consolidated balance sheets and are initially capitalized in Land development inventories. If the bonds have not been approved and issued prior to the sale of the lots serviced by the public improvements, the costs are expensed through Land development construction costs when the lots are sold consistent with other construction related costs. If bonds ultimately are issued, upon receipt of reimbursements by the Company, the Company records the reimbursements received as Other income to the extent that costs have previously been expensed and reduces Land development inventories by any remaining reimbursables received. Failure of the Sky Ranch CAB to repay a significant portion of the funds that we have advanced for public improvements would negatively impact our income, gross margin on selling lots and cash flows.
Supply shortages and risks related to the demand for skilled labor and building materials could increase costs and delay closings. The property development industry is highly competitive for skilled labor and materials. Labor shortages in the Colorado Front Range have become more acute in recent years as the supply chain adjusts to uneven industry growth. Increased costs or shortages of skilled labor and/or concrete, steel, pipe and other materials could cause increases in property development costs and delays. We are unable to pass on increases in property development costs to home builders with whom we have already entered into purchase and sale contracts for residential lots, as our contracts fix the price of the lots at the time the contracts are signed, which will be well in advance of property development. Sustained increases in development costs may, over time, erode our margins.
Products supplied to us and work done by subcontractors can expose us to risks that could adversely affect our business. We rely on subcontractors to perform the actual property development, and in many cases, to select and obtain concrete and other materials. Subcontractors may use improper construction processes or defective materials. Defective products can result in the need to perform extensive repairs. The cost of complying with our warranty obligations may be significant if we are unable to recover the cost of repairs from subcontractors, materials suppliers and insurers.
We may purchase additional land parcels for development or other purposes, thereby exposing us to certain financial risks. In the future, we may purchase additional land parcels for development or other purposes. As noted above, land development requires significant cash expenditures before positive cash flows can be generated from the sale of lots and water and sewer tap fees. If there is considerable lag time between the time we acquire land and the time we begin selling finished lots, we may generate significant operating losses. In addition, if sales of homes on the finished lots are delayed, our revenue from water and wastewater resource development services will be delayed. If our cash on hand and future cash flows from operations are not sufficient to fund our operations and the significant capital expenditure requirements to develop any acquired land and build water and wastewater systems, we may be forced to seek to obtain additional debt or equity capital. There can be no assurance that financing will be available on acceptable terms or at all.
Delays in property development may extend the time it takes us to recover our property development costs.costs and delay our revenue from water and wastewater resource development services. We incur many costs, such as the costs of preparing land, finishing and entitling lots, installing roads, sewers, water systems and other utilities, taxes and other costs related to ownership of the land and/or developing lots on behalf of builders who purchase the land, before we close on the sale of residentialfinished lots to home builders. If the rate at which we develop residential lots slows, we may incur additional costs, and it may take longer for us to recover our costs. In addition, if sales of homes on the finished lots are delayed, our revenue from utilitywater and wastewater resource development services will be delayed.
Government regulations A significant downturn in the housing market could cause our builders to delay building homes on their lots until market conditions improve. Builders with contracts that do not require purchasing the lot until we deliver a finished, ready-to-build lot could walk away from the contract anytime prior to closing without consequence other than the forfeiture of their upfront deposits for the lot, utilities and legal challenges may delayother improvements. If a builder elected to walk away without cause, we would be entitled to keep these deposits as liquidated damages, but the closing of the sale of our residential lots, increase our expenses or limit other activities, which could have a negative impact on our results of operations. The approval of numerous governmental authorities must be obtained in connection with our property development activities, and these governmental authorities often have broad discretion in exercising their approval authority. We incur substantial costs related to compliance with legal and regulatory requirements. Any increase in legal and regulatory requirements may cause us to incur substantial additional costs. Various local, state and federal statutes, ordinances, rules and regulations concerning building, health and safety, site and building design, environment, zoning, and similar matters apply to and/or affect property developers like us. In addition, our ability to obtain or renew permits or approvals and the continued effectiveness of permits already granted or approvals already obtained depends on factors beyond our control, such as changes in federal, state and local policies, rules and regulations and their interpretations and application. Furthermore, we are also subject to various fees and charges of government authorities designed to defray the cost of providing certain governmental services and improvements. For example, local and state governments have broad discretion regarding the imposition of development fees for projects under their jurisdictions, as well as requiring concessions or that the property developer and/or home builder construct certain improvements to public places such as parks and streets or fund schools.
Municipalities or state water agencies may restrict or place moratoriums on the availability of utilities, such as water and sewer taps, which could have an adverse effect on our business by causing delays or increasing our costs.
We must provide water that meets all federal and state regulatory water quality standards and operate our water and wastewater facilities in accordance with these standards. Future changes in regulations governing the supply of drinking water and treatment of wastewater may have a material adverse impact on our financial results. With respect to service of customers on the Lowry Range, the Rangeview District’s rates mightdeposits would not be sufficient to cover the cost of compliance with additional or more stringent requirements.expenses we expect to incur to finish the lots for delivery. We would not be able to recover our costs until we were able to sell the finished lots to another builder. If the costoriginal builder did not go through with the closing due to a poor housing market, we would likely have difficulty finding another buyer for the same reason..
Fluctuations in real property values may require us to write-down the book value of compliance were to increase, we anticipate that the rates of the nearby water providers that the Rangeview District uses to establish its rates and charges would increase to reflect these cost increases, thereby allowing the Rangeview District to increase its rates and charges. However, these water providers may not raise their rates in an amount that would be sufficient to enable the Rangeview District (and us) to cover any increased compliance costs.
In addition, thereour land interests. The land development industry is a variety of legislation being enacted, or considered for enactment, at the federal, state and local level relating to energy and climate change. This legislation relates to items such as carbon dioxide emissions control and building codes that impose energy efficiency standards. Such environmental laws may affect, for example, how we manage storm water runoff, wastewater discharges and dust; how we develop or operate on properties on or affecting resources such as wetlands, endangered species, cultural resources, or areas subject to preservation laws;significant variability and how we address contamination.fluctuations in real property values. As climate change concerns continuea result, the Company may be required to grow, compliancewrite-down the book value of its Sky Ranch or other land interests in accordance with legislation and regulations of this nature are expected to become more costly. Energy-related initiatives affect a wide variety of companies throughoutaccounting principles generally accepted in the United States of America, and the world and, because our operations are now dependent on significant amountssome of raw materials, such as steel and concrete, they could have an indirect adverse impact on our operations and profitability to the extent the manufacturers and suppliers of the materials used in the development of our properties are burdened with expensive cap and trade and similar energy related taxes and regulations. It is possible that new standardsthose write-downs could be imposed that will require additional capital expenditures or raise our operating costs. With respect to servicematerial. Any material write-downs of customers on the Lowry Range, the Rangeview District’s rates might not be sufficient to cover the cost of compliance with new requirements. Although we would expect the rates of the nearby water providers that the Rangeview District uses to establish its rates and charges to increase to cover increased compliance costs, such rates may not cover all our costs and our costs of complying with new standards or laws could adversely affect our business, results of operations or financial condition. Our noncompliance with environmental laws could result in fines and penalties, obligations to remediate, permit revocations and other sanctions.
Government agencies may initiate audits, reviews or investigations of our business practices to ensure compliance with applicable laws and regulations, which can cause us to incur costs or create other disruptions in our business that can be significant. Further, we may experience delays and increased expenses as a result of legal challenges to our proposed development activities, whether brought by governmental authorities or private parties.
Our Lowry Range surface water rights are “conditional decrees” and require findings of reasonable diligence.Our surface water interests and reservoir sites at the Lowry Range are conditionally decreed and are subject to a finding of reasonable diligence from the Colorado water court every six years. To arrive at a finding of reasonable diligence, the water court must determine that we continue to diligently pursue the development of said water rights. If the water court is unable to make such a finding, we could lose the water right under review. During fiscal 2012, the Lowry Range conditional decrees were granted their first review by the water court, which determined that we and the Rangeview District met the diligence criteria. The water court entered a finding of reasonable diligence on the Lowry Range surface water decrees on February 11, 2012. Our next diligence period will be in February 2018. If the water court does not make a determination of reasonable diligence in 2018, it would materially adversely impact the value of our interests in the Rangeview surface water supply.
Contamination to our water supply may result in disruption in our services and litigation, which could adversely affect our business, operating results and financial condition.Our water supplies are subject to the risk of potential contamination, including contamination from naturally occurring compounds, pollution from man-made sources and intentional sabotage. Our land at Sky Ranch and a portion of the Lowry Range have been leased for oil and gas exploration and development. Such exploration and development could expose us to additional contamination risks from related leaks or spills. In addition, we handle certain hazardous materials at our water treatment facilities, primarily sodium hypochlorite. Any failure of our operation of the facilities or any contamination of our supplies, including sewage spills, noncompliance with water quality standards, hazardous materials leaks and spills, and similar events could expose us to environmental liabilities, claims and litigation costs. If any of these events occur, we may have to interrupt the use of that water supply until we are able to substitute the supply from another source or treat the contaminated supply. We cannot assure you that we will successfully manage these issues, and failure to do soassets could have a material adverse effect on our futurebusiness, prospects, financial condition or results of operations.
We may incur significant costs The Company assesses its land interests when indicators of impairment exist. Indicators of impairment include a decrease in order to treat the contaminated source through expansion of our current treatment facilities or development of new treatment methods. If we are unable to substitute water supply from an uncontaminated water source, or to adequately treat the contaminated water source in a cost-effective manner, there may be an adverse effect on our revenues, operating results and financial condition. The costs we incur to decontaminate a water source or an underground water system could be significant and could adversely affect our business, operating results and financial condition and may not be recoverable in rates.
We could also be held liable for consequences arising out of human exposure to hazardous substances in our water supplies or other environmental damage. For example, private plaintiffs could assert personal injury or other toxic tort claims arising from the presence of hazardous substances in our drinking water supplies. Although we have not been a party to any environmental or pollution-related lawsuits, such lawsuits have increased in frequency in recent years. If we are subject to an environmental or pollution-related lawsuit, we might incur significant legal costs, and it is uncertain whether we would be able to recover the legal costs from ratepayers or other third parties. Our insurance policies may not cover or provide sufficient coverage for the costs of these claims.
We may be adversely affected by any future decision by the Colorado Public Utilities Commission to regulate us as a public utility.The Colorado Public Utilities Commission (“CPUC”) regulates investor-owned water companies operating for the purpose of supplying water to the public. The CPUC regulates many aspects of public utilities’ operations, including establishing water rates and fees, initiating inspections, enforcement and compliance activities and assisting consumers with complaints. We do not believe we are a public utility under Colorado law. We currently provide services by contract mainly to the Rangeview District, which supplies the public. Quasi-municipal metropolitan districts, such as the Rangeview District and the Sky Ranch Districts, are exempt by statute from regulation by the CPUC. However, the CPUC could attempt to regulate us as a public utility. If this were to occur, we might incur significant expense challenging the CPUC’s assertion of jurisdiction, and we may be unsuccessful. In the future, existing regulations may be revised or reinterpreted, and new laws and regulations may be adopted or become applicable to us or our facilities. If we become regulated as a public utility, our ability to generate profits could be limited, and we might incur significant costs associated with regulatory compliance.
The Rangeview District’s and our rights under the Lease have been challenged by third parties.The Rangeview District’s and our rights under the Lease have been challenged by third parties, including the Land Board, in the past. In 2014, in connection with settling a lawsuit filed by us and the Rangeview District against the Land Board, the Land Board, the Rangeview District and we amended and restated the Lease to clarify and update a number of provisions. However, there are issues still subject to negotiation and it is likely that during the remaining 64-year term of the Lease the parties will disagree over interpretations of provisions in the Lease again. The Rangeview District’s or our rights under the Lease could be challenged in the future, which could require potentially expensive litigation to enforce our rights.
Our operations are concentrated in the Front Range area of Colorado; we are subject to general economic conditions in Colorado.Our water assets and operations are located solely in the Front Range area of Colorado. Our performance could be adversely affected by economic conditions in, and other factors relating to, Colorado, including supply and demand for housing zoning and other regulatory conditions. Todue to soft market conditions; competitive pricing pressures that reduce the extent the general economic conditionsaverage sales price of finished lots; sales absorption rates below management expectations; a decrease in the Front Range area of Colorado deteriorate, the value of our assets, our results ofhomes or the underlying land due to general market conditions, actual or perceived risks due to proximity to oil and gas drilling operations, or other reasons; and our financial condition could be materially adversely affected.a decrease in projected cash flows for a project.
Natural disastersOur land development segment may be subject to risks related to oil and severe weather conditionsgas operations in the vicinity of our Sky Ranch development, which could delayhave an adverse impact on the closingmarketability and/or value of our Sky Ranch property. We have leased the saleminerals underlying Sky Ranch to a wholly owned subsidiary of residentiala major independent exploration and production company. Oil and gas extraction is an inherently dangerous activity that can potentially lead to air and water contamination, fire, explosion or other hazards. While the State of Colorado, local governments, and private operators have regulations and procedures in place intended to mitigate these risks, there can be no assurances that these safeguards will be effective in all cases with respect to any oil and gas activity around Sky Ranch. The existence of oil and gas wells and drilling activity in or near our property and public concern regarding the negative health impacts from emissions near drilling and hydraulic fracturing sites, including those detailed in a recent 380-page report submitted to the Colorado Department of Public Health and Environment entitled the Final Report: Human Health Risk Assessment for Oil & Gas Operations in Colorado dated October 17, 2019, may adversely impact the marketability and/or value of the lots at Sky Ranch and increasedecrease demand for homes in proximity to oil and gas operations, negatively impacting our costs,land development segment, which could harmalso negatively impact our salesbusiness and results of operations. We conduct our property development operations in the Colorado Front Range, which is subject to natural disasters, including droughts, tornadoes, wildland fires, and severe weather. The occurrence of natural disasters or severe weather conditions in Colorado or elsewhere could delay property development, increase costs by delaying closings and lead to shortages of labor and materials. If our insurance or the insurance of our subcontractors does not fully cover business interruptions or losses resulting from these events, our results of operations could be adversely affected. For example, as a result of Hurricane Harvey in the Texas Gulf Coast, the cost of pipe increased approximately 35%. This additional cost is not clearly reimbursable by insurance.
We could be hurt by efforts to impose liabilities or obligations on persons with regard to labor law violations by other persons whose employees perform contracted services. The infrastructure and improvements on our water and wastewater systems and on the finished lots we sell or that we must provide pursuant to service agreements and lot development agreements are done by employees of subcontractors and other contract parties. We do not have the ability to control what these contract parties pay their employees or the work rules they impose on their employees. However, various governmental agencies are trying to hold contract parties like us responsible for violations of wage and hour laws and other work related laws by firms whose employees are performing contracted-for services. A 2016 National Labor Relations Board ruling holds that for labor law purposes a firm could under some circumstances be responsible as a joint employer of its contractors’ employees even if the firm had no direct control over the employees’ terms and conditions of employment. If that ruling is upheld on appeal, it could make us responsible for collective bargaining obligations and labor law violations by our subcontractors. Governmental rulings that make us responsible for labor practices by our subcontractors could create substantial exposures for us in situations that are not within our control.
We experience variability in our operating results on a quarterly basis and, as a result, our historical performance may not be a meaningful indicator of future results. We historically have experienced, and expect to continue to experience, variability in quarterly results. As a result of such variability, our short-term performance may not be a meaningful indicator of future results. Our quarterly results of operations may continue to fluctuate in the future as a result of a variety of factors, including, among others, the timing of the closings of sales of residential lots and weather-related problems.
Our stock price has been volatile in the past and may decline in the future.Our common stock has experienced significant price and volume fluctuations in the past and may experience significant fluctuations in the future depending upon a number of factors, some of which are beyond our control. Factors that could affect our stock price and trading volume include, among others, the perceived prospects of our business; differences between anticipated and actual operating results; changes in analysts’ recommendations or projections; the commencement and/or results of litigation and other legal proceedings; and future sales of our common stock by us or by significant shareholders, officers and directors. In addition, stock markets in general have experienced price and volume volatility from time to time, which may adversely affect the market price of our common stock for reasons unrelated to our performance.
financial condition.
Item 1B – Unresolved Staff Comments
None.
Corporate Office
Effective January 2016, we entered into an operating lease for approximately 2,500 square feet of office and warehouse space. The lease has a two-year term with payments of $3,000 per month.
Water Related Assets
In addition to the water rights and adjudicated reservoir sites that are described in Item 1 – Our Water and Land Assets, we also own or have exclusive rights to use, through the Rangeview District a 1.0 million-gallon and two 500,000-gallon treated water tank, 400,000-barrel storage reservoir, a 300,000-barreltanks, three storage reservoir, threereservoirs that can store 1.7 million barrels of water (71.4 million gallons), five deep water wells, athree alluvial wells, three pump station, and severalstations, over 50 miles of water pipelinetransmission and distribution lines, and more than 20 miles of wastewater collection pipelines in Arapahoe County, Colorado. Although owned by the Rangeview District, we operateIn conjunction with Wild Pointe, and maintain another 500,000-gallon water tank, two deep water wells, a pump station, three alluvial wells, the Rangeview District’s wastewater treatment plant, and water distribution and wastewater collection pipelines that serve customers located at the Lowry Range. Although owned by the Elbert 86 District, we have exclusive rights to use, operate and maintain two water tanks with a combined capacity of 438,000-gallons of water,438,000 gallons, two deep water wells, a pump station, and 10ten miles of transmission line for thelines serving customers at Wild Pointe development in Elbert County. These assets are used to provide service to our customers.
Land and Mineral Interests
We own approximately 931780 acres of land known asremaining at our Sky Ranch that is described further inItem 1 – Our Water and Land Assets –Master Planned Community as well as approximately 634 net mineral acres at Sky Ranch.We own 40 acres of land that comprise the current boundaries of the Rangeview District.District (together with all the minerals). We also own approximately 700 acres of land in the Arkansas River Valley, which is currently classified as land held for sale.and we hold 13,900 acres of mineral interests in the Arkansas River Valley in Southeast Colorado in Otero, Bent and Prowers Counties.
Item 3 – Legal Proceedings
None.
Item 4 – Mine Safety Disclosures
None.
PART II
Item 5 – Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is traded on The NASDAQ Stock Market under the symbol “PCYO.” The high and low sales prices of our common stock, by quarter, for the fiscal years ended August 31, 2016 and 2015 are presented below:
Table E - Market Information |
Fiscal 2017 quarters ended: | | | | |
Market price of common stock | | | | |
High | $8.73 | $8.10 | $5.70 | $5.93 |
Low | $6.55 | $5.20 | $4.90 | $4.60 |
| | | | |
HoldersFiscal 2016 quarters ended: | | | | |
Market price of common stock | | | | |
High | $5.20 | $4.91 | $5.12 | $5.73 |
Low | $4.34 | $4.29 | $3.65 | $4.56 |
Holders
On October 17, 2017,29, 2020, there were 552772 holders of record of our common stock.
Dividends
We have never paid any dividends on our common stock and expect for the foreseeable future to retain all of our capital and earnings from operations, if any, for use in expanding and developing our business.water and land development businesses. Any future decision as to the payment of dividends will be at the discretion of our board of directors and will depend upon our earnings, financial position, capital requirements, plans for expansion and such other factors as our board of directors deems relevant. The terms of our Series B Preferred Stock prohibit payment of dividends on common stock unless all dividends accrued on the Series B Preferred Stock have been paid and require dividends to be paid on the Series B Preferred Stock if proceeds from the sale of Export Water exceed $36,026,232. For further discussion, see Note 8 – Shareholders’ Equity to the accompanying consolidated financial statements.
Performance Graph1
This graph compares the cumulative total return of our common stock for the last five fiscal years with the cumulative total return for the same period of the S&P 500 Index and a peer group index.2The graph assumes the investment of $100 in common stock in each of the indices as of the market close on August 31 and reinvestment of all dividends.
| 8/12 | 8/13 | 8/14 | 8/15 | 8/16 | 8/17 |
| | | | | | |
Pure Cycle Corporation | 100.00 | 260.00 | 326.00 | 250.00 | 242.00 | 362.50 |
S&P 500 | 100.00 | 118.70 | 148.67 | 149.38 | 168.13 | 195.43 |
Peer Group | 100.00 | 119.89 | 133.12 | 139.83 | 178.40 | 213.02 |
1.
This performance graph is not “soliciting material,” is not deemed “filed” with the SEC and is not to be incorporated by reference in any of our filings under the Securities Act or the Exchange Act whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.
2.
The Peer Group consists of the following companies that have been selected on the basis of industry focus or industry leadership: American States Water Company, Aqua America, Inc., Artesian Resources Corp., California Water Service Group, Connecticut Water Service, Inc., Middlesex Water Company, SJW Corp., and The York Water Company.
Recent Sales of Unregistered Securities; Use of Proceeds Fromfrom Registered Securities
None.
PurchasePurchases of Equity Securities Byby the Issuer and Affiliated Purchasers
None.
Item 6 – Selected Financial Data
Table F - Selected Financial Data |
In thousands (except per share data) | For the Fiscal Years Ended August 31, |
| | | | | |
Summary Statement of Operations Items: | | | | | |
Total revenue | $1,227.8 | $452.2 | $1,196.6 | $2,023.1 | $615.6 |
(Loss) income from continuing operations | $(1,678.8) | $(1,230.3) | $(575.1) | $285.5 | $(1,227.9) |
Net loss | $(1,710.9) | $(1,310.6) | $(23,127.9) | $(311.4) | $(4,150.4) |
Basic and diluted loss per share | $(0.07) | $(0.06) | $(0.96) | $(0.01) | $(0.17) |
Weighted average shares outstanding | 23,754 | 23,781 | 24,041 | 24,038 | 24,038 |
Selected Financial Data Table
| |
Summary Balance Sheet Information: | | | | | |
Current assets | $27,124.3 | $29,085.9 | $39,580.9 | $4,463.3 | $9,900.0 |
Total assets | $69,787.6 | $70,879.6 | $73,060.9 | $108,173.8 | $108,618.3 |
Current liabilities | $940.2 | $482.2 | $1,499.1 | $3,274.4 | $5,402.3 |
Long-term liabilities | $1,341.3 | $1,399.5 | $1,476.4 | $13,868.9 | $65,443.5 |
Total liabilities | $2,281.5 | $1,881.7 | $2,975.5 | $17,143.3 | $70,845.8 |
Equity | $67,506.1 | $68,997.9 | $70,085.5 | $91,030.5 | $37,772.5 |
In thousands (except per share data)
| | For the Fiscal Years Ended August 31, | |
| | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
Summary Statement of Operations Items: | | | | | | | | | | | | | | | |
Total revenue | | $ | 25,855.2 | | | $ | 20,361.5 | | | $ | 6,959.2 | | | $ | 1,227.8 | | | $ | 452.2 | |
Income (loss) before taxes | | $ | 8,919.1 | | | $ | 3,528.0 | | | $ | 132.7 | | | $ | (1,678.8 | ) | | $ | (1,230.3 | ) |
Net income (loss) | | $ | 6,750.4 | | | $ | 4,811.1 | | | $ | 414.7 | | | $ | (1,710.9 | ) | | $ | (1,310.6 | ) |
Basic income (loss) per share | | $ | 0.28 | | | $ | 0.20 | | | $ | 0.02 | | | $ | (0.07 | ) | | $ | (0.06 | ) |
Diluted income (loss) per share | | $ | 0.28 | | | $ | 0.20 | | | $ | 0.02 | | | $ | (0.07 | ) | | $ | (0.06 | ) |
Weighted-average basic shares outstanding | | | 23,845 | | | | 23,795 | | | | 23,760 | | | | 23,754 | | | | 23,781 | |
Weighted-average diluted shares outstanding | | | 24,062 | | | | 24,003 | | | | 23,930 | | | | 23,754 | | | | 23,781 | |
| | As of August 31, | |
| | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
Summary Balance Sheet Information: | | | | | | | | | | | | | | | |
Current assets | | $ | 25,991.2 | | | $ | 23,537.7 | | | $ | 27,918.2 | | | $ | 27,124.3 | | | $ | 29,085.9 | |
Total assets | | $ | 89,761.1 | | | $ | 83,721.4 | | | $ | 71,906.6 | | | $ | 69,787.6 | | | $ | 70,879.6 | |
Current liabilities | | $ | 6,218.6 | | | $ | 8,297.2 | | | $ | 2,054.0 | | | $ | 940.2 | | | $ | 482.2 | |
Long-term liabilities | | $ | 1,498.6 | | | $ | 693.1 | | | $ | 399.4 | | | $ | 1,341.3 | | | $ | 1,399.5 | |
Total liabilities | | $ | 7,717.2 | | | $ | 8,990.3 | | | $ | 2,453.4 | | | $ | 2,281.5 | | | $ | 1,881.7 | |
Shareholders’ equity | | $ | 82,043.8 | | | $ | 74,731.1 | | | $ | 69,453.2 | | | $ | 67,506.1 | | | $ | 68,997.9 | |
The following items had a significant impact on our operations:
(a) | In fiscal 2020, due to land development activities at Sky Ranch, we recognized $18.9 million in revenue from lot sales and $5.7 million in revenue from the sale of water and wastewater taps. Our revenue from water sales decreased by 78% to $1.0 million primarily related to the decline in the demand for industrial water sales, and we recorded a non-cash long-lived asset impairment charge of $1.4 million on our mineral rights in the Arkansas Valley, Colorado, in both cases due to the drop of the price of crude oil as a result of increased world-wide production and lower demand because of the COVID-19 pandemic and related shelter-in-place and stay-at-home orders. We invested $8.0 million in our land, water and wastewater systems, including $1.9 million for the wastewater facility at Sky Ranch, $586,400 for the purchase of equipment, and $8.5 million in costs related to the development of our Sky Ranch property. During fiscal 2020, we had net sales or maturities of marketable securities of $5.2 million. In addition, we received $10.5 million as partial reimbursement for advances we made to the Sky Ranch CAB to fund the construction of public improvements at the Sky Ranch property. Of the $10.5 million we received, $6.3 million was recognized in Other income and the remaining $4.2 million partially reduced the remaining capitalized costs in Land development inventories. |
(b) | In fiscal 2019, due to land development activities at Sky Ranch, we recognized $12.0 million in revenue from lot sales and $3.4 million in revenue from the sale of water and wastewater taps. Our revenue from water sales increased by 2% to $4.7 million primarily related to industrial water sales. We invested $14.1 million in our water and wastewater systems, including $8.1 million for the wastewater facility at Sky Ranch and $3.5 million for a water right and land acquisition, $354,000 for the purchase of equipment and $17.7 million in costs related to the development of our Sky Ranch property. During fiscal 2019, we had net sales or maturities of marketable securities of $3.7 million. In addition, we released our valuation allowance on our net deferred tax assets and recognized a deferred tax benefit of $1.3 million. |
(c) | In fiscal 2018, we invested $1.1 million in our water and wastewater systems, $1.8 million for the construction of pipelines, $5.3 million related to the development of our Sky Ranch property, and $445,400 for the purchase of equipment. During fiscal 2018, we had net sales or maturities of marketable securities of $11.4 million. Our revenue from water sales increased by 452% to $4.6 million primarily related to industrial water sales. In addition, we began construction at Sky Ranch and recognized $2.1 million in revenue from platted lot sales under the percentage-of-completion method. |
(d) | In fiscal 2017, we invested $2.5 million in our water and wastewater systems, $4.4 million for the construction of pipelines, $0.9 million related to development of our Sky Ranch property, and $95,400 for the purchase of equipment. During fiscal 2017, we had sales or maturities of marketable securities of $9.8 million. |
(e) | In fiscal 2016, we invested $923,800 in our water and wastewater systems and $285,600 for planning and design of our Sky Ranch property. We also purchased land for $450,300 in the Arkansas River Valley in Southeastern Colorado. |
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(b)
In fiscal 2016, we invested $923,800 in our water and wastewater systems and $285,600 for planning and design of our Sky Ranch property. We also purchased three farms for approximately $450,300 in order to correct dry-up covenant issues related to water-only farms in order obtain the release of the escrow funds related to the Company’s farm sale to Arkansas River Farms, LLC.
(c)
In fiscal 2015, we sold our remaining farm assets for approximately $45.8 million, for a loss of approximately $22.3 million. In conjunction with the sale, we repaid $4.9 million in mortgage debt relating to the farms and we invested approximately $3.5 million into our water systems. Financial results for the farm assets have been reflected as discontinued operations and all prior periods have been reclassified.
(d)
In fiscal 2014, in order to protect our farm assets, we acquired the remaining approximately $2.6 million of the $9.6 million in notes defaulted on by High Plains A&M, LLC (“HP A&M”).Additionally, we borrowed $1.75 million, sold farms for $5.8 million, and invested $3.7 million in our water systems. Additionally, we recorded an impairment of approximately $400,000 on land and water rights held for sale, and we recorded a gain of $1.3 million upon completing the sale of certain farms that we previously impaired in fiscal 2012.
(e)
In fiscal 2013, in order to protect our farm assets, we acquired approximately $7 million of the $9.6 million in HP A&M defaulted notes. Additionally, we sold 1,500,000 unregistered shares of Pure Cycle common stock owned by HP A&M for $2.35 per share, yielding approximately $3.4 million, net of expenses.
Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The discussion and analysis below includes certain forward-looking statements that are subject to risks, uncertainties and other factors, as described in “Risk Factors” and elsewhere in this Annual Report on Form 10-K, that could cause our actual growth, results of operations, performance, financial position and business prospects and opportunities for this fiscal year and the periods that follow to differ materially from those expressed in, or implied by, those forward-looking statements.Readers are cautioned that forward-looking statements contained in this Annual Report on Form 10-K should be read in conjunction with our disclosure under the heading “FORWARD-LOOKING STATEMENTS” on page 1.
The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand the results of operations and our financial condition and should be read in conjunction with the accompanying consolidated financial statements and the notes thereto included in Part II, Item 8 of this Annual Report on Form 10-K. The following sections focus on the key indicators reviewed by management in evaluating our financial condition and operating performance, including the following:
●Revenues generated from providing water and wastewater services;
Revenue generatedRevenues from water and wastewater services;
tap sales;Revenues from lot sales at Sky Ranch;
●
Expenses associated with developing our water and land assets;
Expenses associated with developing lots at Sky Ranch; and
●
Cash available to continue development of our land, water rights and service agreements.
agreements
Our MD&A section includes the following items:
Our BusinessExecutive Summary – a summary of important financial metrics in fiscal 2020;
Our Business –a general description of our business, our services, and our business strategy.strategy;
Critical Accounting Policies and Use of Estimates – a discussion of our critical accounting policies that require critical judgments, assumptions, and estimates.estimates;
Results of Operations – ananalysis of our results of operations for the three fiscal years presented in our accompanying consolidated financial statements. We present our discussion in the MD&A in conjunction with the accompanying financial statements.statements; and
Liquidity, Capital Resources and Financial Position – an analysis of our cash position and cash flows, as well as a discussion of our financial obligations.
Our BusinessExecutive Summary
Pure Cycle Corporation is a Colorado corporation that provides wholesaleFiscal 2020 was highlighted by the substantial completion of the initial phase of our Sky Ranch property. Other notable items include the following:
Total revenue increased to $25.9 million for fiscal 2020 (a $5.5 million or 27% increase compared to fiscal 2019) primarily due to lot sales and water and wastewater servicestap fees at Sky Ranch
Net income increased to customers$6.8 million for fiscal 2020 (a $1.9 million or 40% increase compared to fiscal 2019), primarily due to lot sales, partial satisfaction of governmental entitiesthe contingency related to public improvement reimbursables, and commercialwater and industrial customerswastewater tap fees at Sky Ranch
Fully diluted earnings per common share for fiscal 2020 was $0.28 versus $0.20 for fiscal 2019
Total assets increased to $89.8 million as of August 31, 2020 (a $6.0 million or 7.2% increase compared to 2019), primarily due to increased cash from payments for lots and is in the process of providing finished lots to national home builders developing single family homes on itswater, and wastewater taps at Sky Ranch land holdings.and a $10.5 million expense reimbursement from the Sky Ranch CAB through bond proceeds of which $4.2 million reduced Land development inventories on the consolidated balance sheet and $6.3 million was recognized as Other income - Reimbursement of construction costs - related party on the consolidated statements of operations and comprehensive income and increased Investments in water and wastewater systems on the consolidated balance sheet; and
Total equity increased to $82.0 million as of August 31, 2020 (a $7.3 million or 9.8% increase compared to 2019), primarily due to net income for fiscal 2020
Our utility services include
In fiscal 2020, total revenues were $25.9 million, primarily consisting of $18.9 million of lot sales recognized under the percentage-of-completion method as well as a point in time for one home builder customer, and a combined $5.6 million from the sale of 201 and 189 water production, storage, treatment, bulk transmissionand wastewater taps. The number of wastewater taps sold are less than the number of water taps sold because we do not sell wastewater taps at Wild Pointe. Wild Pointe customers are on septic systems. Comparatively, in fiscal 2019, total revenues were $20.4 million, primarily from $12.0 million of recognized lot sales and $3.5 million from the sale of 119 and 113 water and wastewater taps. Other income increased in fiscal 2020 mainly due to retail distribution systems, wastewater collection and treatment, irrigation water treatment and transmission, construction management, billing and collection and emergency response. Our land operations include developing finished lotsthe $6.3 million of reimbursables we received from the Sky Ranch CAB for home builders and commercial users who develop homes and businessespartial reimbursement of public improvement costs we funded at Sky Ranch. In total, we received $10.5 million from the Sky Ranch CAB for partial reimbursement of public improvement costs we funded, the remaining $4.2 million reduced Land development inventories on our Sky Ranch property.consolidated balance sheet. Due to the strong performance of our land development segment, which produced the lot sales and lead to the increase in water and wastewater taps sales, along with the recognition of the $6.3 million of other income from receipt of the reimbursables, net income increased to $6.8 million for fiscal 2020 compared to $4.8 million for fiscal 2019, for an increase of 40%.
WaterOur Business
We are a diversified land and Wastewater Utilities
Our utility operations position us as awater resource development company. At our core we are an innovative and vertically integrated wholesale water and wastewater service provider which means we own or control substantially all assets necessarythat, in addition to provideowning and developing wholesale water and wastewater servicesresources, develops a master planned community on land we own and to our customers. This includes owning or controlling (i)which we provide water rights whichand wastewater services. We have accumulated valuable water and land interests over the past 30 years and have developed an extensive network of wholesale water production, storage, treatment and distribution systems, and wastewater collection and treatment systems that we use to provideserve domestic, irrigation,commercial and industrial customers in the Denver metropolitan region. Our primary land asset, Sky Ranch, is located in one of the most active development areas in the Denver metropolitan region along the I-70 corridor, and we are developing lots at Sky Ranch for residential, commercial, retail, and light industrial uses.
Although we report our results of operations in two segments, our water and wastewater service segment and our land development segment, we operate these segments as a cohesive business designed to our wholesale customers (weprovide a cost effective, sustainable and value added business enterprise.
Water and Wastewater
Water resources throughout the western United States and more prominently in Colorado are a scarce and valuable resource. We own or control a portfolio of 29,500 acre-feet of groundwater and surface water groundwater, reclaimedsupplies, 26,000 acre-feet of adjudicated reservoir sites, wastewater reclamation facilities, water rightstreatment facilities, potable and raw water storage rights), (ii)facilities, wells and water production facilities, and roughly 50 miles of water distribution and wastewater collection lines. Our water supplies and wholesale facilities are located in southeast Denver, in Arapahoe County, an area which is limited in both water availability and infrastructure (such as wells, diversion structures, pipelines, reservoirs and treatment facilities) required to withdraw,produce, treat, store, and deliverdistribute water (iii) infrastructure required to collect, treat, store and reuse wastewater, and (iv) infrastructure required to treat and deliver reclaimed water for irrigation use.which we believe provides us with a unique competitive advantage in offering these services.
We currently provide wholesale water and wastewater service predominately to two local governmental customers. Our wholesale domestic customers aregovernments, including the Rangeview District, Arapahoe County, the Sky Ranch CAB, and Arapahoe County. WeElbert 86 District. Our mission is to provide servicesustainable, reliable, high quality water to Rangeview District’s end-useour customers pursuant to individual Lowry Service and Off-Lowry Service Agreements, serving 391collect and treat wastewater using advance water connections and 157 wastewater connections located in southeastern metropolitan Denver. In addition to providing domestictreatment systems, which produce high quality reclaimed water we provide untreatedcan reuse for outdoor irrigation and industrial demands. By using and reusing our water supplies, we seek to industrial customersdemonstrate good stewardship over our valuable water rights in the oilwater-scarce Denver, Colorado region. We design, permit, construct, operate and gas industry located in our service areas and adjacent to our service areas for hydraulic fracturing. Oil and gas operators have leased approximately 135,000 acres within and adjacent to our service areas for the purpose of exploring oil and gas interests in the Niobrara and other formations, and this activity had led to increased water demands.
We plan to utilize our significant water assets along with our adjudicated reservoir sites to providemaintain wholesale water and wastewater services to localsystems that we own or operate on behalf of governmental entities which in turn will provide residential/commercialentities. 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 servicesrevenues, regulatory water quality monitoring, sampling, testing, and reporting requirements to communitiesthe Colorado Department of Public Health and Environment.
Our water and wastewater service segment generates revenue from the following sources, described in greater detail in Item 1 – Business above:
Monthly water usage and wastewater treatment fees;
One-time water and wastewater tap (connection) fees;
Construction and Special Facility funding fees;
Industrial – oil and gas operation fees
Land Development
In 2017, we launched our land development segment. We are actively developing the Sky Ranch Master Planned Community located along the eastern slope of Colorado in the area generally referred to as the Front Range. Principally, we target the I-70 corridor which is located east of downtown Denver and south of Denver International Airport. This area is predominately undeveloped and is expected to experience substantial growth over the next 30 years.We also plan to continue to provide water service to commercial and industrial customers.
Land Development
Our land development services at Sky Ranch include development of up to 4,400 single-family and multi-family homes, and over 1.6 million square feet ofresidential, commercial, retail, and light industrial development.lots. Sky Ranch will develop in multiple phasesis zoned to include up to 3,200 single-family and multifamily homes, parks, open spaces, trails, recreational centers, schools, and over a numbertwo million square feet of years.retail, commercial and light industrial space just four miles south of DIA. Our first phaseland development activities include the design, permitting, and construction of 151 acres is platted for 506 detached single-family residential lots. We have entered into agreements with three nationalall of 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 forand commercial customers. Our land development activities generate revenue from the sale of all 506finished lots as well as construction revenues from activities where we construct infrastructure on behalf of others. Land development of which is anticipated to begin in early 2018, with model homes scheduledrevenues come from our home builder customers under specific agreements for construction in the fall of 2018. We expect to phase the development of our initial 506 lots beginning with delivery of approximately 150finished lots in 2018, delivering an additional 100 lots in mid-2019as well as reimbursements for the construction of public improvements, such as roads, curbs, storm water, drainage, sidewalks, parks, open space, trails etc., which come from the local governmental entity, the Sky Ranch CAB, subject to the approval and issuance of municipal bonds to fund such reimbursements.
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 balancewater 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 the lotsthese investments to eachmatch take-down commitments from our home builder depending on home sales. We estimate that build outcustomers without significant excess capacity in any of our initial 506 lots will take between three and four years.these investments.
In June 2017, we entered into purchase and sale agreements (collectively, the “Purchase and Sale Contracts”)separate contracts with three separatenational home builders (Richmond American Homes, Taylor Morrison, and KB Home), pursuant to which we agreed to sell and each builder agreed to purchase, a certain number (totaling 506) of506 total single-family, detached residential lots at the Sky Ranch property. We will be developing finished lots for each of the three home builders (which are lots on which homes are ready to be built that include roads, curbs, wet and dry utilities, storm drains andother improvements). Each builder is required to purchase water and sewer taps for the lots from the Rangeview District, the cost of which depends on the size of the lot, the size of the house, and the amount of irrigated turf. Pursuant to the Off-Lowry Service Agreement, we will receive all of the water tap fees and wastewater tap fees and 90% of the monthly service fees and usage fees for wastewater services received by the Rangeview District from customers at Sky Ranch. We will also receive 98% of the usage fees for water services received by the Rangeview District from customers at Sky Ranch, after deduction, in most instances, of the royalty to the Land Board related to the use of the Rangeview Water Supply.
The closing of the transactions contemplated by each Purchase and Sale Contract is subject to customary closing conditions, including, among others, the builder’s completion to its satisfaction of a title review and other due diligence of the property, the accuracy of the representations and warranties made by us in the Purchase and Sale Contract, and a commitment by the title company to issue to the builder a title policy, subject to certain conditions. Within three business days of the execution of each Purchase and Sale Contract, each builder paid an earnest money deposit. Each builder had a 60-day due diligence period during which it had the right to terminate the Purchase and Sale Contract and receive a full refund of its earnest money deposit. The initial due diligence period was extended; however, on November 10, 2017, each builder completed its due diligence period and agreed to continue with its respective Purchase and Sale Contract. Pursuant to certain Purchase and Sale Contracts, the builder is required to make an additional earnest money deposit or deposits after the due diligence period and/or final approval of the entitlements for the property. The earnest money deposit or deposits will be applied to the payment of the purchase price of the lots at closing in accordance with a specified takedown schedule or be paid to us in the event of certain defaults by a builder. Pursuant to each Purchase and Sale Contract, we must obtain final approval of the entitlements for the property by August 2018 (which date we may extend by six months).
We are obligated, pursuant to the Purchase and Sale Contracts, or separate Lot Development Agreements (the “Lot Development Agreements” and, together with the Purchase and Sale Contracts, the “Builder Contracts”),these contracts, to construct infrastructure and other improvements, such as roads, curbs and gutters, park amenities, sidewalks, street and traffic signs, water and sanitary sewer mains and stubs, storm water management facilities, and lot grading improvements for delivery of finished lots to each builder. PursuantWe were also required to the Builder Contracts, we must cause the Rangeview District to install and construct off-sitewholesale infrastructure improvements (i.e.(i.e., drainage and storm water retention ponds, a wastewater reclamation facility and wholesale water facilities) for the provision of water and wastewater service to the property. As of August 31, 2020, we have substantially completed all of the wholesale infrastructure improvements for the initial residential lots, which included the completion of a wastewater reclamation facility that can serve approximately 2,000 SFE’s in Sky Ranch before expansion. Pursuant to various agreements, we provide financing to the Rangeview District and the Sky Ranch Districts (through the Sky Ranch CAB) as described in Note 14 – Related Party Transactions to the accompanying consolidated financial statements for the majority of the improvements at Sky Ranch. In conjunction with our approvals withfrom Arapahoe County for the Sky Ranch project, we, and/ortogether with the Rangeview District andand/or Sky Ranch Districts and/or the Sky Ranch DistrictsCAB, are obligated to maintain a deposit into an account the anticipated costswith Arapahoe County to install and construct substantially all the off-siteensure completion of certain public infrastructure improvements (which include drainage, wholesale water and wastewater,to warranty the improvements for a one-year period following completion and entry roadway), whichdelivery. As of August 31, 2020, $1.0 million remains on deposit, with the warranty period set to expire in October 2021.
As of August 31, 2020, we estimate will be approximately $10.2 million.
We estimatehave expended $33.5 million related to the total capital required to develop lots indevelopment of the first phase (506 lots)filing of Sky Ranch is approximately $27.8out of the total estimated $35.8 million. We anticipate the remaining $2.3 million will be spent during our fiscal 2021. These amounts include estimated reimbursable costs of $29.0 million, for which we received a partial reimbursement of $10.5 million in November 2019. We believe the remaining $18.5 million remaining reimbursables from the Sky Ranch CAB will be paid from future municipal bonds as the project continues to grow its assessed value and estimate lotstax base. As of August 31, 2020, lot sales to home builders to generate $35generated $35.1 million providing a margin on lotsin cash payments, with the remaining $1.6 million paid in November 2020, which combined represents the full $36.7 million sales price contracted for with the home builders. In addition, as of approximately $7.2 million. Utility revenues are derived from tap fees (which vary depending on lot size, house size, and amountAugust 31, 2020, the Sky Ranch development produced $8.9 million of irrigated turf) and usage fees (which are monthly water and wastewater fees). Our currenttap fees, and we expect that an additional $5.9 million of tap fees will be received during our fiscal 2021.
In December 2020, we expect to begin construction on the second filing at Sky Ranch, water tap fees are $26,650 (per SFE),which is expected to include nearly 900 residential lots. Subsequent to August 31, 2020, we entered into separate agreements with four home builders (KB Home, Meritage Homes, DR Horton and wastewater taps fees are $4,659 (per SFE).
We have begun designChallenger Homes) pursuant to which we agreed to sell 789 single-family attached and preliminary engineering fordetached residential lots at the Sky Ranch property. Due to our secondstrong performance in phase which will include approximately 320 acres of residential development and 160 acres of commercial, retail, and industrial development along the Interstate-70 frontage. We expect to have multiple phases being developed concurrently and would expect the full developmentone of the Sky Ranch project, we were able to occur over 10 – 14 years, depending on demand.realize a 30% increase in our lot price from $75,000 for a 50’ lot in phase one to $97,000 for the same 50’ lot in phase two. This next filing at Sky Ranch will incorporate approximately 250 acres and is planned to be completed in four sub-phases. The timing of cash flows will include certain milestone deliveries, including, but not limited to, completion of governmental approvals for final plats, installation of wet utility public improvements, and final completion of lot deliveries.
Critical Accounting Policies and Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with the timing of revenue recognition, the impairment of water assets and other long-lived assets, fair value estimates and share-based compensation. Below is a summary of these critical accounting policies.
Revenue Recognition
Our revenuesRevenues derived from our water and wastewater services consist mainly of monthly servicemetered wholesale water usage and wastewater treatment fees, tap fees, construction fees,fees/special facility funding, and consulting fees. AsRevenues derived from land development activities consist mainly of lot sales and project management service fees. Revenue is recognized from our water and wastewater segment and land development segment as described below and further described in Note 2 – Summary of Significant Accounting Policies to the accompanying consolidated financial statements, proceedsstatements.
Water and Wastewater Revenue
Monthly wholesale water charges are assessed to our customers based on actual metered usage each month plus a base monthly service fee assessed per SFE unit served. One SFE is a customer, whether residential, commercial or industrial, that imparts a demand on our water or wastewater systems are computed based on the demand of a single-family detached home of four persons living on a standard-sized 5,500 square foot lot. Water consumption pricing uses a tiered pricing structure where the cost of water increases as customers use more water. We recognize wholesale water usage revenues at a point in time upon delivering water to our customers or our governmental customers’ end-use customers, as applicable. Revenues recognized by us from tap salesthe sale of Export Water and constructionother portions of our “Rangeview Water Supply” off the Lowry Range are shown gross of royalties to the Land Board. Revenues recognized by us from the sale of water on the Lowry Range are shown net of royalties paid to the Land Board and amounts retained by the Rangeview District.
In addition, we provide water for hydraulic fracturing to industrial customers in the oil and gas industry who are located in and adjacent to our service areas. Oil and gas operations revenues are recognized at a point in time upon delivering water to a customer, unless other special arrangements are made.
We recognize wastewater treatment revenues monthly based on a fixed flat monthly fee and actual monthly usage charges. The monthly wastewater treatment fees are deferred upon receiptshown net of amounts retained by the Rangeview District. Costs of delivering water and recognized in income based on whether we own or do not own the facilities constructed with the proceeds. We recognize tap and construction fees derived from agreements for which we construct infrastructure owned by others as revenue, along with the associated costs of construction, pursuantproviding wastewater services to the percentage-of-completion method. The percentage-of-completion method requires management to estimate the percent of work that is completed on a particular project, which could change materially throughout the duration of the construction period and result in significant fluctuations in revenue recognized during the reporting periods throughout the construction process. During the fiscal year ended August 31, 2017, we recognized $203,200 in tap fee revenues associated with the Wild Pointe acquisition. We did not recognize any tap revenues during the fiscal years ended August 31, 2016 or 2015.
Tap and construction fees derived from agreements for which we own the infrastructurecustomers are recognized as incurred.
A tap constitutes a right to connect to the wholesale water and wastewater systems through a service line to a residential or commercial building or property, and once granted, the customer may make a physical tap into the wholesale line(s) to connect its property for water and/or wastewater service. The right stays with the property. We have no obligation to physically connect the property to the lines. Once connected to the water and/or wastewater systems, the customer has live service to receive metered water deliveries from our system and send wastewater into our system. We recognize water and wastewater tap fees as revenue ratablyat the time we grant a right for the customer to tap into the water or wastewater service line to obtain service.
The Rangeview District sets water usage, wastewater treatment, and tap fees for the customers we serve through our service agreements with the Rangeview District.
We recognize construction fees, including fees received to construct special facilities, over time as the estimated service lifeconstruction is completed.
Consulting fees are fees we receive, typically monthly. We earn these fees from municipalities and area water providers along the I-70 corridor for which the Company provides contract operations services. Consulting fees are recognized monthly based on a flat monthly fee plus charges for additional work performed, if applicable.
Land Development Revenue
Revenues derived from lot sales depend on the terms of the assets constructedagreement with said fees. Although the cashbuilder. Lots are completed and sold pursuant to distinct agreements with each home builder. These agreements follow one of two formats. One format is the sale of a fully finished lot, whereby the purchaser pays for a ready-to-build finished lot and the sales price is paid in a lump-sum amount upon completion of the finished lot that is building permit ready. We recognize revenues at the point in time of the closing of the sale of a finished lot in which control transfers to the builder as the transaction cycle is complete, and we have no further obligations for the lot. Our second format is the sale of finished lots pursuant to a lot development agreement with builders, whereby we receive payments in stages. Because the builder (i.e., the customer) takes ownership and control of the lot at the first closing and subsequent improvements made by us improve the builder’s lot as construction progresses, we account for revenue over time with progress measured based upon costs incurred to date compared to total expected costs (percent complete methodology). Any revenue in excess of amounts entitled to be billed is reflected on the balance sheet as a contract asset and amounts received up-frontin excess of revenue recognized are recorded as deferred revenue. We do not have any material significant payment terms as all payments are expected to be received within 12 months after the delivery of the platted lot. We adopted the practical expedient for financing components and most construction will be completeddo not need to account for a financing component of these lot sales as the delivery of lot sales is expected to occur within one year of receipt of the proceeds, revenue recognition may occur over 30 years or more. Managementwhen we begin construction on those lots.
The Sky Ranch CAB is required to estimateconstruct certain public improvements, such as water distribution systems, sewer collection systems, storm water systems, drainage improvements, roads, curbs, sidewalks, landscaping and parks, the service life, and currently the service life is based on the estimated useful accounting lifecosts of the assets constructedwhich may qualify as reimbursable costs. Pursuant to our agreements with the tap fees. The useful accounting life ofSky Ranch CAB (see Note 14 – Related Party Transactions to the asset is based on management’s estimation and may differ fromaccompanying consolidated financial statements), we are obligated to finance this infrastructure, which we have substantially completed for the actual life ofinitial filing. These public improvements are constructed pursuant to design standards specified by the asset Sky Ranch Districts and/or the actual service lifeSky Ranch CAB, Rangeview District, or other governmental entities, and after inspection and acceptance, are turned over to the applicable governmental entity to operate and maintain. Because these public improvements are owned and operated on behalf of the tap due to a varietygovernmental entity, they may qualify for reimbursement.