U.S. Markets closed

Edited Transcript of PCYO earnings conference call or presentation 8-Apr-19 5:00pm GMT

Q2 2019 Pure Cycle Corp Earnings Call

DENVER Apr 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Pure Cycle Corp earnings conference call or presentation Monday, April 8, 2019 at 5:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Mark W. Harding

Pure Cycle Corporation - President, CEO, CFO & Director

================================================================================

Conference Call Participants

================================================================================

* John Rosenberg

* William Christian Miller

J.M. Hartwell L.P. - Principal and Portfolio Manager

* William Spencer Smith

Wm Smith & Co., Investment Banking Arm - President

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and thank you for joining us for this Pure Cycle Corporation Fiscal Year-to-Date and Second Quarter Ended February 28, 2019 Earnings Call. (Operator Instructions)

And now to get it started with opening remarks and introductions, I am pleased to turn the floor to President and CEO, Mr. Mark Harding. Mr. Harding, the floor is yours.

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [2]

--------------------------------------------------------------------------------

Thank you very much. And I'd like to welcome you all to our second quarter earnings call. So this earnings call will be for our 6-month period ending February 28, 2019. As those of you who have followed the company, we do 2 earnings call a year, one at year-end and then one at half year-end. So I'm delighted to be able to update you as to the status of the company.

We do have a slide deck for this presentation, so if you want to follow along with the descriptive part of that, you can log onto our website at purecyclewater.com. If you click over into the Investor tab in there, you'll see the presentation in the center of the graphic there and you can click on that, expand that out and that will allow you to kind of track the audio portion of this with some of the descriptive portions that we'll have through this.

I'll try and note the slide transitions as we move along. But for the most part, welcome to our second quarter call. I'll get the lawyers out of the room first, so our safe harbor statement that this is really not intended to be guidance or provide historical facts or information. There'll be descriptive details that -- some of which will be in the details of our earnings release and some of this will be concepts and plans that the company is pursuing, both within our water utility as well as our development segment.

So with that, we'll go to Slide #3, which really -- it will detail out, really, the kind of areas that we generate some revenue. What's new to this year's reporting that many of you will have not seen is kind of we've incorporated an additional segment for our reporting. So in addition to the water utility segment that we have, we also now report our land development segment. And we have some exciting developments in that, so we'll detail those out as we come along. But for the most part, the present -- the company has a large portfolio of water, so we have about 27,000 acre-feet of water. That portfolio of water enables us to provide water service to up to about 60,000 single-family connections. We generate revenue from 2 forms of fees through that, we get tap fees associated with connecting to our water system and then water usage fee. We have a 930-acre Master Planned Community. So that will describe out our land development segment, and we're developing land for lots. We'll develop single-family and multifamily and commercial retail lots for developers and users of that. And so we have a lot to talk about on the development side.

We have a small portfolio that's generating some oil and gas royalties. And then we provide industrial water to oil and gas in and around our service area. So those are kind of where the shareholder value comes in from all the various assets.

We'll briefly describe our water utility. We're sort of cradle to grave on water utilities where we own the water rights. We develop those water supplies, both in terms of our surface water supplies as well as our groundwater supplies. We treat those supplies, we put them into a distribution system, and then we collect that water back as that turns into wastewater. We retreat that wastewater and we put that back into a separate distribution system. So we have a domestic system and an irrigation system that provide water to our customers in that.

You move to -- let me stay on Slide 4 for those that are new to the company. This is a little bit more detail on what it is that we have and how we really generate the revenue from our utility business. We have that 27,000 acre-feet of water, 60,000 connections of water service capacity.

If you take a look at our tap fees, our current water tap fees are $26,640, our sewer tap fees are $4,600. If you take a look at that map, over 60,000 connections, that's a top line revenue of about $1.8 billion. We generate about $1,500 per connection per year, so about $1,000 per connection on the water side, about $500 per connection on the sewer side, so that buildout, that's about $90 million once we're serving the 27,000 acre-feet into our system.

We currently serve a modest amount of that today, we serve about 400 water connections, about 160 sewer connections.

Moving to our next slide, Slide 5. A little bit about our Master Planned Community and our development activities. We've got about 1,000 acres of property, which is in the right location. It's in the I-70 corridor here in the Denver Metropolitan area. Most of the new investment activity in the Metropolitan Denver area is being concentrated on the I-70 corridor. We have a geologic barrier on our west, so we can't grow much left on the west side of town, so most of the activity has been growing north, south. And I think the highest concentration, really, for the foreseeable future is going to be along the I-70 corridor. So it's going to really concentrate the activity.

What I've tried to describe here is a little bit of the statistics on how our land development segment works. Some of the top line revenue, both in the land development segments and the crossover in that in the water utility segments. So we have about 5,000 single-family connections, and that's going to be made up of a whole host of connections whether that's going to be a detached single-family house, an attached single-family house, some multifamily, single-family houses, commercial, retail, light industrial, schools, any number of connections that you're going to add up to, to get that total of about 5,000 single-family equivalent.

If you take a look at our system development fees, our water tap fees and take that 5,000 over that $26,650, that's about $130 million in tap fee revenues, another $24 million in wastewater tap fee revenue, so that's about $150 million for the water utility operations at Sky Ranch. And then we get that $1,500 per connection per year, so the recurring revenue associated with that will be about $7.5 million a year.

In our land development segment, so we're delivering finished lots. In our first phase, we've got about 100 and -- well, I'm sorry, we've got 151 acres that translates into about 506 single-family detached houses. We're selling, in total, about 4,400 single-family equivalent retail commercial connections in that. And so taking a look at selling those pad sites out at about $70,000 per lot, that could generate up to about $300 million for us on the land side. And then on the commercial side, that's right, those are priced right around that $4, $5 per square foot. So if you take a look at the commercial component of that, that adds about another $35 million. So about $340 million in the land development segment.

A couple of the graphics. We've tried to give you a view of where we were in November in our earnings call at the year-end last year. This is kind of taking a look at the property, looking towards the west with some of our drainage assets. So our drainage assets were fairly complete early on because those are some of the first investments that you make. We've done overlot grading for the entire property. But what you can see is more a maturation of that where you can start to see some of the open space in trail corridor come into shape. We've got some roadways that now go over so that we can connect what's on the right side of that drainage channel to all of the key assets on the left side, which are going to be parks and open space and things like that.

Moving to the next slide. Talk a little bit more about Sky Ranch. So we've been under construction for about a year now. Began breaking ground about March of last year. We have graded -- we've done overlot grading and sub-excavation grading for the entire 151 acres. We've completed the storm-water detention facilities and storm-water collection centers. This is a graphic of the entry roadway. So we've got our entry roadway that goes from the interstate down into the community. So that's Monaghan Road, that's one of our key off-site infrastructures and that is complete. And we've been really working on our wholesale water infrastructure. So we've got domestic water and irrigation water service to the property, and a little bit oversized there, we've got enough capacity to serve about 1,000 connections, so it's a little bit more than our first 506 connections.

And then we're also working on our sewer system, which I think is a little bit more graphic on the next page. So if you go to Slide 7, should be kind of an overview of progress on our sewer plant. The sewer plant's about halfway through, so we've got a lot of the core structure of it. This sewer plant really will be a state-of-the-art sequential batch reactor sewer plant, which will take the water quality all the way back to reuse capability. So Colorado has some innovative regulations that allow us to be able to use and reuse our water supply. So we're treating this water quality back to a usable quality so that we can put that into an irrigation system. And it is safe for human contact, so it is a highly treated water reclamation facility. We really don't like to call them sewer plants anymore because they are water facilities and they do treat that water supply back to a very reusable water supply. And given the limited and availability of water resources in the West, particularly Colorado, and in particular where we are in the Metropolitan area, we want to make sure we use and reuse our water supplies to their fullest extent.

So it gives you kind of a progress report. This will be a very green facility. We've got this facility buried, so we'll have a green roof on it. And we'll have the opportunity to really showcase this as a landmark asset for the company through tours and educational opportunities within the facility itself.

The next slide's going to give you a little bit more graphic about progress to date on how our development is occurring. So to date, we've invested about $17 million into the property. Grading is complete, the wet utilities to 150 lots are complete. So we've got some progress payments that we've been paid. We've got 2 forms of agreements with our builders. We've got a lot development agreement, which allows us to get progress payments as we deliver certain milestones under those contracts, and then a full finished lot delivery contract with one of our builders. And then kind of our wastewater system being at about 50% complete and, again, we'll have a little bit excess inventory on that just because of some economies of scale and how you build out sewer plants. And that particular site is our master planned sewer site, so that will take all sewerage flows or wastewater flows from the entire 930 acres that will deliver that to that particular site.

Here's some of the numbers on that. So some of our numbers in terms of lot development cash flows coming in. So year-to-date, for 2019, we've received $4.4 million; for project to date, about $6.9 million, so close to $7 million to date for the project in total. We recognize revenue on our lot development agreements under percent complete. So we're about 50% complete. So when you're taking a look at how some of these revenues are coming in, we've got some of that revenue under the 2 contracts that we recognize as percent complete. And then the third contract that we have, a finished lot delivery, that's a point in time. So as we deliver that finished lot, we recognize those revenues upfront.

Cost of goods sold on the land development side as well as some of that deferred revenue. So some of the deferred revenue is where the timing of receiving money from our builders on the milestone payments is ahead of our actual construction of the percent complete. So that's why you have a deferred revenue component in there. And as we deliver those finished lots, that deferred revenue will roll into our income.

So that gives you kind of a bit of a progress to date. I'll highlight a little bit more of what to expect on finishing out those Sky Ranch lot deliveries towards the end when we get into the financials. But as we've talked, that's the first phase.

So our second phase of this will be to deliver another 480 acres. And that will be a more substantial development. We'll have all sorts of phases going on, on that. So we'll have more single-family detached homes, we'll have some attached homes where there'll be paired product. We'll have some commercial development in there, and that could be a mix of commercial between retail, commercial, light industrial. We'll have some additional amenities, we'll have some school sites that we will dedicate over to the local school system. And so in the first phase, we have 3 builders that are working on sort of that standard single-family detached lot.

In the second phase, we might have as many as 6 different builders. Some of that may be our existing portfolio of builders, but then they are some other builders that will specialize in some of the various product classes that we're offering in our second phase that we don't necessarily have in our first phase.

So you should see that coming online sometime later this summer and then we'll start to do a little bit of selling activity on that. We should be fully open on our first phase. I think the builders are looking at sort of a grand opening later in April towards the end of the month, where they're waiting for just getting some of the electric to their model homes developed. We have, I think, 8 model homes out there now. So they've got those fully developed and staged and ready for some traffic, and have a number of marketing materials that they've done on their websites. We'll have a Sky Ranch website coming to market by the end of the month so that we can help educate buyers what they're looking at, what the master plan of the facility is going to look like and some of the local amenities that we're developing on site.

So with that, we'll move onto some of our other activities. So we do have a large opportunity to provide water for the oil and gas industry. We've got a number of operators in this field. So what you've seen historically have been kind of field-assessment type work where you're looking at drilling a single well, holding leases by production, and so we had a lot of that activity from, maybe, 2015, '16 and '17. So a lot of that activity was still in field assessment form.

And then a number of the operators are kind of moving to more pad site development, where that's kind of taking a look at some efficiencies on having multiple wells per pad site. So I think we've seen a little bit more of that type of activity in 2018 and 2019 with the expectation that they may move to more field development. So depending on the operator, they have different definitions of how many wells they'd like per pad.

So the well -- the field itself is about 200 square miles, it covers a couple of areas in Arapahoe and Adams counties. We have infrastructure that's well positioned to provide water service to this field. We can transfer water to our storage assets. One of the things that we did over the last few months is add to that system. So we've added an additional 1 million barrels of storage so that we can meet some of the peak demands and really serve, not only one, but multiple operators working in the field.

So it's been a very good opportunity to allow us to continue to develop our water supplies. We have a large portfolio that ultimately gets used for domestic water but certainly, has excess capacity today to be able to continue to provide service for oil and gas needs.

So let me talk a little bit about kind of the key performance indicators for our 6 months. Take a look at Slide 16. So our drilling and frac water, our industrial water sales revenues, down a little bit for our 6 months to date for -- compared to 2018, more seasonal. It's very difficult to transfer water over the winter here. And this was a relatively cold winter. So I think it was well suited that a lot of the operators did not do a lot of fracking over the winter. We've drilled a bunch of wells amongst a number of operators. So there's an inventory of wells that will start to frac sometime later this month and carry that through probably for the rest of the year. So you'll see a little bit more activity in the frac water deliveries for the next 6 months.

Our municipal water, wastewater services, are fairly in line, up a little bit on the water side. It's going to be seasonal deliveries for the 6 months ended. Taking a look at our tap fee revenues, tap fees are up significantly. And those are going to be attributable to taps being purchased at Sky Ranch. So you're going to see a healthy activity in tap fee revenues over the next several years, just because we have additional development occurring, both in terms of what we're doing at Sky Ranch as well as the Wild Pointe opportunity. So the developer down at Wild Pointe has expanded out to their last phase. They spent the winter extending roads and the network of water system out in that area. So you should see some more activity in the Wild Pointe development as well in terms of tap fee revenues.

Oil and gas revenues, so we do have some modest revenue coming in from royalties that we have out at Sky Ranch. Those are slightly down, probably just because that well or the 2 wells that really pool into the royalty interest there is about -- I think those came online in 2012, 2013 time frame. So they're all -- they're still gas-driven wells. Well, one of them, I think, has switched over to a pump jack. But one of them still is a gas-driven well, so it's still under gas pressure. But the formation continues to show very good results for our operators that are looking in the field.

And then the land development segment. So this will be a new reporting segment for us, so you'll get a lot of information on that. We'll keep track of the number of homes, the number of lot takedowns, and then also the number of tap fees for each of those lots.

So what we're reporting here is sort of the recognized revenue. We've got significantly more revenue in. To date, I think we've got about $6.9 million in to date, but we've recognized revenues of the $3.3 million based on the percent complete revenue rec model.

So the next 2 slides are really going to be sort of the balance sheet income statement for the 6 months ended. I'll let you guys parse through those. One of the things that you're going to take a look at, that's going to be a significant opportunity to highlight on this is -- and this is kind of summarized in this particular statement. But when you look at the financials as a whole, we'll have significant investments in what we're calling an inventory category. And the inventory category is the amount that we've got invested into lots. So it's hard infrastructure that we've got put into a lot that's yet to be recognized, yet to close on that lot sale. So when you take a look at what those are to date, that's going to be -- that inventory number is going to be land inventory, that then that will roll into earnings as we recognize those revenue from delivery of those finished lots.

To give you a bit of guidance as to how this thing is going to look in the next few months because I know that's what most of you want to know. And so we've got -- I think we've delivered 12 finished lots and these were for model home lots for each of the builders, so each builder got 4 model home lots. And each of the builders, 1 builder built for all 4 model homes. And each of the other 2 builders built 2 model homes, and are reserving 2 lots so that they can put up other models depending on what the customer preferences are for their particular product offerings.

We should see delivery of about another 122 lots sometime, I'm going to say, middle of May. We were hoping to have that done early April, but mother nature was not kind to us from January through March. She was very kind to us in November, December, which allowed us to deliver the roads to allow builders to have those model homes, which is a critical phase for us because they could build those homes over the winter, even though there was bad weather, they could build their model homes. And we couldn't put down asphalt and concrete for curb and gutter just because of the temperature issues attributable to that. So we should see another 120-some-odd deliveries to each of the 3 builders. That will generate about $4.2 million because some of those are going to be the third payment, some of those are going to be finished lot payments, sometime in that first part of May. And then we've got another delivery of maybe another 28 lots to another builder in June so that'll be likely close to another $2 million. And then for the rest of the year, so we have takedown agreements with builders, and we should be delivering maybe another 90 lots through the rest of 2019. And so that might straddle our year-end. So our year-end is 8/31, so the delivery of those should be either -- we're hoping to get that in this fiscal year but it may span over to September into our Q1 of next year, but those deliveries will be all of 2019. And so we're really close to getting the, call it, 130-some-odd lots with our model home lots delivered to our homebuilders by the first part of May, and then another takedown in early summer and then yet another 2 takedowns in sort of the early fall time frame. So that's what you can see -- look forward to seeing is probably another $11 million in calendar 2019 from lot deliveries.

And then correspondingly, they are going to be selling homes. We receive tap fee revenues attributable to those, so as they pull building permits, we get tap fees attributable to those. So to date, I think we've delivered 24 taps to the builders, so even more taps than they have actually taken inventory on the homes. And what they're doing lot-by-lot is they're sort of looking what type of product they're going to be building on each lot and as soon as they got that determined, then they send that information over to us and we can calculate their tap fees attributable to those.

So with that, I'm going to turn it back over to the moderator. And if you've got any detailed questions, certainly ring in and see if I can add a little bit of color to what has been, I think, one of our best period endings for the 6 months. So we're very excited and look to be delivering a lot more in terms of the land development as well as our utility segment.

So with that, I'll turn it back over to the moderator.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) We'll take our first question from Bill Smith with William Smith & Co.

--------------------------------------------------------------------------------

William Spencer Smith, Wm Smith & Co., Investment Banking Arm - President [2]

--------------------------------------------------------------------------------

Mark, congratulations on your progress. A question on the third contract with the third builder, where you get everything at the end and you haven't received any progress payments yet. Do you have any idea when that might be? And what the amount might be for that?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [3]

--------------------------------------------------------------------------------

So we'll be delivering 25 finished lots in that March -- or that May time frame. And then another -- so that's the one that's got 2 back-to-back deliveries. So we'll have those 25 lots that we get about $75,000 per lot. And then another 28 lots in June, so those are going to be the corresponding numbers on attributable to each of those. So close to, let's say, $2 million, $3 million, almost $3.8 million from those 2 lot deliveries, on the finished lot delivery.

--------------------------------------------------------------------------------

William Spencer Smith, Wm Smith & Co., Investment Banking Arm - President [4]

--------------------------------------------------------------------------------

All right. What -- but there's 1 builder, right, where you don't get the progress payments and it's all at the end, is that what you're…

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [5]

--------------------------------------------------------------------------------

Right.

--------------------------------------------------------------------------------

William Spencer Smith, Wm Smith & Co., Investment Banking Arm - President [6]

--------------------------------------------------------------------------------

That's -- you're including that in this calculation?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [7]

--------------------------------------------------------------------------------

Yes, yes, yes. I mean, they've got substantial investments in the project. So we were -- they just had preference for a particular structure, and we priced that into the sales price of what it is that they're getting. They have paid for all of the over x. So they've got substantial investments into each lot, separating the part from us on the finished lot delivery. So they've got probably $10,000 per lot for each, I'd say, probably up to maybe close to 100 lots. So they're vested with the project so that it's not just a finished lot delivery where all of that inventory is held by us.

--------------------------------------------------------------------------------

William Spencer Smith, Wm Smith & Co., Investment Banking Arm - President [8]

--------------------------------------------------------------------------------

And these numbers that you just gave, the deliveries for like June and May and late summer, are those just progress -- the revenue numbers, were those progress-type numbers and not all-in numbers?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [9]

--------------------------------------------------------------------------------

No, those are -- that's actually -- so it does not -- those number do not account for what we've already received to date. So in total, if you look at what we're looking to deliver in 2019, that's closer to about $18 million in the land segment of what we're doing.

--------------------------------------------------------------------------------

William Spencer Smith, Wm Smith & Co., Investment Banking Arm - President [10]

--------------------------------------------------------------------------------

Okay. And that's just the land that we're talking about?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [11]

--------------------------------------------------------------------------------

That's just the land, that's right. That does not -- that's not tap fees and that's not what we're doing in the utility segment.

--------------------------------------------------------------------------------

Operator [12]

--------------------------------------------------------------------------------

And we'll take our next question from William Miller with Hartwell.

--------------------------------------------------------------------------------

William Christian Miller, J.M. Hartwell L.P. - Principal and Portfolio Manager [13]

--------------------------------------------------------------------------------

Bill Miller. Curious -- I'm just curious. If you looked out 3 years, could you give us the percentage of revenue that you would have coming from lot sales, oil and gas and then just the water utilities? And you haven't talked at all about the use of your cash, and whether some of that is earmarked for acquisitions or stock buyback. Because you are going to be in the next 3 to 5 years flush with cash, so could you comment on that as well?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [14]

--------------------------------------------------------------------------------

Well, I love your optimism. So I will reiterate Slide #2 of the presentation, which is the crystal ball of what it is that we're doing. What -- I think most of our builders are fairly optimistic about what it is that we're doing at Sky Ranch. And it's really because of price point. We have -- this is a pretty flat piece of property, so development costs are pretty predictable, pretty tangible. So we're developing and delivering lots at a reasonable price, which allows them to put up an entry-level home. Now entry-level homes here in Colorado are -- it's stunning that you can say $300,000 and entry-level home in the same sentence, but that's kind of where the market is here in the Denver area and there's none of it out there. So we are really one of the few projects that can deliver a home for in something in the low $300,000s. I mean, a lot of times people will advertise low $300,000s. But by the time you get there and get it bought and get it done, it somehow creeps up into $400,000. So I think the builders look at this as a terrific opportunity and they want to do -- I think they wanted to have enough inventory, where they can put their marketing machines together and really be aggressive about their sales so that they're delivering, call it, 7 to 10 homes a month. If they're -- and the early months will probably not be quite that volume. But as they get going and we start to get into the second season of that, I think that's what they are going to take a look at. So if you look at that with 3 builders, that probably puts this first phase into about a 2.5-year inventory number. And so if you take a look at 506 lots, and we're going to pull down that kind of sales volume over the 2-year period, that gives you $70,000 average price, that's about $35 million in revenue attributable to the sale of the first 506.

We hope to have that second phase up in sort of the next summer. So we'll start breaking ground on that sometime this fall. We don't have quite the same level of off-site infrastructure, so we have some on-sites that we'll do. But I think that will deliver a little bit quicker than the first one did. So maybe we have -- instead of just 3 builders, maybe we have 6 or 7 builders in total. And we hope to have same level of absorptions on all of those. So you're going to see phased absorptions on this thing. So maybe we're pulling down $18 million, $20 million a year, year-over-year on the land development side. They're going to have to have tap fees attributable to those, so maybe another $4 million or $5 million in tap fee revenues. Oil and gas, I think that's going to be fairly stable. We'll probably look at somewhere between 25 and 35 wells for the foreseeable future, depending on how quickly some of the other operators in the field ramp up their operations. And then the trailing revenue, which, as you build out, those kind of get higher and higher. So the first 500 units start to add another $7.5 million. So again, high-quality problem, where the company is really now monetizing a lot of the historic assets that we've accumulated and built and now are investing into, so it's going to really strengthen the balance sheet.

What we've tried to operate under is sort of maintaining our cash balance in that $10 million area. So we have been very studious about not overspending on getting capacity of finished lots or excess capacity in our utility system where you have too much on it.

We do have excess capacity in our water system, we do have excess capacity in our sewer system for delivery of Sky Ranch. But those were logical investments. We wanted to make sure that we had some economies of scale there, and we were able to be reactive and be able to focus energies into the land side and delivering more lots. And not have to catch up to those lots with the water and the sewer system capacity. So then you start to look at how are we looking at expanding the company and what are things that are exciting for the company.

Certainly, we are pursuing opportunities for acquisitions in water systems and wastewater systems and other service areas, where we can bring our systems to other water systems that then can grow because they are constricted by water availability. So where we can bring our water as leverage for them to add new connections to their communities, that's -- those would be areas that we like a lot. There are some that are more material like Sky Ranch that may just need some expertise for operating efficiencies and we can bring our operational efficiencies to that and take a look at some of those that we've got that we're working on.

So we're going to see a little bit of that, hopefully, see some of that in 2019. And then we can kind of continue to grow and invest on that and really just kind of ramp up. We're going to ramp up both in terms of our operational capacities as well as our delivery to deliver more water, more domestic quarter, wastewater and more industrial water for continued oil and gas development. So I think all of those avenues are going to continue to roll for us and we want to be -- we have been very cautious about our balance sheet and making sure that we're using our cash position and not having -- we don't have any debt, we don't have any leverage in this. To the extent that something exciting comes along, we'd certainly look to use more leverage than we would your equity capital. So we're kind of equity hawks on this thing. And I think as you all have seen, we're not an issuer. I think our last -- last time we issued shares was almost a decade ago. And we continue to make sure that we are very, very stewardship over that invested capital. To the extent that the market cannot appreciate the value of the company and doesn't translates into share price, those are opportunities for us to weigh in on that and bring back some of that equity and be able to do some of that.

And then also take a look at some dividends. Everybody wants to hold a utility for the dividend potential. And so as our recurring revenue from operations on water and sewer revenues come in and they start to continue to grow, you're likely to see some dividend declarations on that. So in order of priority and how management and I think our Board look at it, if we think we can put that money to use through an acquisition, we'll certainly pursue that. If it doesn't meet our acquisition threshold and the market's not understanding the value of the company, we can take a look at some buyback programs. And then filter into that some dividend opportunities with some recurring cash flows so that the market gets there.

I mean, I've talked with you and many people about we're kind of in that odd space where we're not getting a lot of love on coverage, we're not going to get any coverage from the banks because we're not an issuer, we're not going to get any coverage from the industry because we're a little bit small and they can't get into something less than $1 billion market cap. So what I'm going to do is pull as hard as I can to get to that market cap.

--------------------------------------------------------------------------------

William Christian Miller, J.M. Hartwell L.P. - Principal and Portfolio Manager [15]

--------------------------------------------------------------------------------

That's great, Mark. But if you looked out, say, 3 years, what do you think the recurring revenue would be? That's one thing. And the second thing is, given the state of Denver real estate in general, where there's no capacity around, why aren't you thinking of raising prices for the second phase of this development and for your other activities?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [16]

--------------------------------------------------------------------------------

All of those are clearly opportunities, I'll do the latter first. We do think that there's some opportunity to participate with our builders in this. We want to make sure that we continue to get high absorption in this. And so we don't want to overburden the property. But by the same token, we want to participate to the upside from builders as they continue to find value in what it is that they're building as well. So we might take a look at a participation in fixing a certain pricing point and then participate above a certain sale price for the house as well as a little bit more favorable lot prices to us in the equation. On the recurring revenue, I think within 3 years, the first phase of Sky Ranch will be built out. So we'll have the $7.5 million in annual revenue coming in from water sewer fees from that. We'll have the other phases coming online so those will be rapidly growing. I think we still have a very attractive industrial frac sale that will be contributing in that $4 million to $8 million, depending on the number of operators that are in the field. So if you look at us 2 years ago, we had maybe $1 million in recurring revenue. If you look at us 3 years from now, so within a 5-year span, maybe going from $1 million to $15 million is not unreasonable. But I refer back to my Slide 2.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

(Operator Instructions) We'll move next to John Rosenberg with Loughlin Water.

--------------------------------------------------------------------------------

John Rosenberg, [18]

--------------------------------------------------------------------------------

I have a couple of question -- well, I have a question pertaining to your relationship with the CAB, the Community Authority Board. As I read through, at some point in the future, they will be -- do they have -- do you have a note receivable out to them now? Have you performed activities for which they will later -- that entity will reimburse Pure Cycle in the future?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [19]

--------------------------------------------------------------------------------

Yes. So let me describe that for a little bit.

--------------------------------------------------------------------------------

John Rosenberg, [20]

--------------------------------------------------------------------------------

Yes, it's tough to read.

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [21]

--------------------------------------------------------------------------------

Yes. And it doesn't come across all that well in the disclosure. I mean, we try and do as good a job as we can. What that is? So Colorado is a growth pays its own way state. And so what happens is, every new development has to have their own tax structure for that development. So they set their own mill levies for that little development. They may be part of a bigger comprehensive city, county or otherwise, but all of their infrastructure that they need to deliver, those citizens that are going to live there are going to pay for those infrastructures. And so we deliver a lot of public improvements as part of being a developer, we're going to deliver roads, curbs, gutter, drainage ways, parks, open space, rec centers, all that stuff are public assets, they will be owned by the public. In some cases, they're owned by the county, in some cases, they'll be owned by that CAB, that Community Authority Board. And so what happens is, we're advancing those moneys, they receive those assets, we have a note receivable from them. And when they get assess value, when they have homes, when they have property tax, mill levies and customers that are living there, that will provide what we call bonding capacity to repay those advances. So if...

--------------------------------------------------------------------------------

John Rosenberg, [22]

--------------------------------------------------------------------------------

Sorry, if I may interrupt you, this is kind of like a water authority in California? Kind of somewhat analogous to that, it can issue tax increment financing?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [23]

--------------------------------------------------------------------------------

Somewhat analogous if you look at -- yes, that's exactly right.

--------------------------------------------------------------------------------

John Rosenberg, [24]

--------------------------------------------------------------------------------

It will be able to issue municipal bonds then against, once it's established as a cash flowing entity?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [25]

--------------------------------------------------------------------------------

That's right. So and pulling the trigger on that, you can do it early and pay higher interest rates and have more capitalized interest. Or you can do it when it's more mature, or you have lower interest rates and a higher bonding capacity. And so we have chosen to do that at a later date, to have a little bit more bonding capacity to squeeze every dollar that we can out of that mill levy and the taxable bonding capacity of that community.

--------------------------------------------------------------------------------

John Rosenberg, [26]

--------------------------------------------------------------------------------

I see. And that's presently carried on the balance sheet under note receivable?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [27]

--------------------------------------------------------------------------------

Well, yes. So there'll be some in the note receivable. And then as we finish the delivery of those lots, what you'll see is numbers will roll out of our inventory, and they'll go to the P&L and then we'll have a footnote that will describe what total amounts are still owed to us as part of that note receivable from the CAB.

--------------------------------------------------------------------------------

John Rosenberg, [28]

--------------------------------------------------------------------------------

I see. And my next question pertains to SB 181. Do you -- could you -- your thoughts on what that -- on the ground on what that could do for development of oil and gas, I believe northeast of you right now?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [29]

--------------------------------------------------------------------------------

Well, I'm interested in what happens northeast of them, I'm more interested in what happens on top of where we're at.

--------------------------------------------------------------------------------

John Rosenberg, [30]

--------------------------------------------------------------------------------

I see. Okay, I didn't know where the Niobrara -- I'm not so up on my geography, my apologies.

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [31]

--------------------------------------------------------------------------------

No, that's okay. I mean, the overall Niobrara is exactly the same portion, same field that the operators that are working in our area are developing. And so there's couple schools of thought on 181. One of them being, okay, we have a very vocal minority, a very strong conservation contingency out of Boulder that really wants to limit oil and gas development in Boulder. And in so doing, wants to say, well, we in Boulder know what we're doing and we want to limit that and we want to limit it for the rest of the state and the rest of the state's not so keen on doing that. And so most of 181 was, as I understood it, to transfer more authority, more control to the local jurisdictions, which on its state, fine. If Boulder doesn't want to have oil and gas development, Boulder should not get oil and gas development and the rest of the state can continue to do oil and gas development. So at the local control level, I think that that's probably within reach. One of the things that we didn't want to see happen is we didn't want to have different standards. We didn't want to have Boulder develop under standard A, and Arapahoe County develop under standard B. We want to have a unified standard. It's a binary issue. If you don't want a development, then don't develop; but if you are going to develop, you know how that is going to be and you have a central agency that's regulating that. And so part of it was locally controlled, part of it was strengthening some of that statewide controls that make it predictable and definable for communities that want to continue to encourage oil and gas development.

So both of those things have happened. I think we'll wait and see as to what the statewide regulations do, that either work with industry, which I think is the tenor, is to find ways to work with industry to address the concerns that maybe some of the public might or the regulatory climate has. But then continue to allow those jurisdictions that have had active oil and gas development to continue oil and gas development. And so that's what I can tell you about it.

What I don't know that I have a good crystal ball is to say, well, what kind of influence is that going to have as the state -- as the industry as a whole. Colorado is an oil and gas state, we're an oil and gas producer. And so it would be hard for me to envision Colorado not being an oil and gas producer. Boulder may not be an oil and gas producer, but the state of Colorado, I think will continue to be an oil and gas producer. That is the best I can give you.

--------------------------------------------------------------------------------

Operator [32]

--------------------------------------------------------------------------------

(Operator Instructions) We'll go next to [Bill Cunningham.]

--------------------------------------------------------------------------------

Unidentified Analyst, [33]

--------------------------------------------------------------------------------

I actually have a question, this actually has to do with the table in the 10-Q on segment operating margins, which I was looking at, for starters, the lot fee revenue and the lot fee gross margin, which surprised me being so small at 6%. But this kind of ties into the car discussion, where I saw the paragraph on that, where, when that first phase is finished, you expect a total of $36 million from the builders with a cost of $35 million. So that would be, I presume, the same kind of calculation as what you're doing here for the part that's completed so far.

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [34]

--------------------------------------------------------------------------------

Yes.

--------------------------------------------------------------------------------

Unidentified Analyst, [35]

--------------------------------------------------------------------------------

But then there's another $27 million coming in. So you're going to be, from that first segment, collecting a total of $63 million and the $35 million estimated expense. So I come up with, when all is said and done and the dust is settled, that you're going to have a gross margin in excess of 40% there. Am I looking at that correctly?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [36]

--------------------------------------------------------------------------------

You are. So now I will caveat that with 1 caveat. Those are the correct numbers. And so this concept of bonding capacity, and so the mill levies that we set and the AV that gets defined pursuant to the sale price of the house, when you take a look at a standard residential development and just have the mill levies available from residential, because as a remind -- I will recall that we're a sales tax incentive state. And so the bulk of our revenue, we get almost 4x the amount of revenue from commercial retail sales tax as we do from residential sales tax. So if our project were just limited to residential, we might get half of that $27 million back on the reimbursables that qualify because we wouldn't have the bonding capacity for it. But because we have 160 acres of commercial, we'll actually have excess revenues over our reimbursable. So we believe we'll get 100% of our reimbursables back. It may be in phases, it may be over several phases. But you're right, that's the margin that we're going to get because of how those reimbursables are and the type of development that we have.

--------------------------------------------------------------------------------

Unidentified Analyst, [37]

--------------------------------------------------------------------------------

Okay. And then when do you expect to be -- you said you're going to defer the issuance of the bonds until the last moment possible. What's your kind of time frame you're thinking when that's going to be happening?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [38]

--------------------------------------------------------------------------------

Yes, I might pull you back from that. I'm not so sure that I'm going -- I don't think I said to the last moment possible. It's certainly the later in the cycle that you develop those bonds, the cheaper the interest rate is, but there's a certain window where it's kind of like a flat yield curve. So as you get a certain number of units on, it doesn't matter how many more units, it's just going to still have the same interest rate. And so we will be issuing our bonds kind of at the start of that flat yield curve for the AV within the community. After -- and my -- we're working with several different bonding firms right now, as a matter of fact, to kind of propose out how that process would work and the number of connections that we have that give the bond market enough comfort level and a trade-off between maturity of development and interest rate. And so -- and I'll just -- I'll throw the numbers at you just to illustrate this. We've got no homes out there and we want to finance all that infrastructure, we can do that. So the bond market is accustomed to doing that type of financing, maybe you pay a higher interest rate, maybe your interest rates are at 8%. If you've got 50 homes out there and then the next 500 coming, then your interest rate might be 7.5%. If you've got 500 homes out there, and you want to have 500 homes financed, maybe your interest rate is 3.5%. So somewhere between 3.5% and 5%, 6% is kind of that sweet spot on where you want to do that. And is that 100 homes? Is that 150 homes? And that's what we're getting that question answered. But it may be -- you may see some bonding later this year. We may choose to pull that trigger later this year.

--------------------------------------------------------------------------------

Unidentified Analyst, [39]

--------------------------------------------------------------------------------

Okay, very good. My one other question on the segments and the operating gross margins was on the tap fees. I see for the quarter, there's $467,000 of revenue there but no cost allocated against it, no gross margin reported. So it appears you're reporting 100% gross margin on that?

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [40]

--------------------------------------------------------------------------------

Yes. No, we do add that into it. I think how we might be taking a look at that reporting is going to be consolidated into the overall water utility segment. And so we might -- you bring up a good point there, [Bill]. It might be incumbent on us to be able to kind of describe those costs a little bit more in the footnotes because it does get lost in the overall water segment. And so I hadn't thought of that, but that might be another table that we could add to help clarify for the reader what those cost of goods sold are going to be for each of the incremental taps that are coming online because they're not reported as 100%, but it does get lost in the overall utility segment.

--------------------------------------------------------------------------------

Unidentified Analyst, [41]

--------------------------------------------------------------------------------

Yes, that would be great, because what I first -- when I first saw the small margin on the home lots and then saw the tap fees, I was thinking that maybe the tap fee revenue was part of what I should be looking at in the lot fee -- adding that to the lot fee income to come up with a reasonable margin. But then, of course, as I saw the footnote and saw that was something totally different, I didn't know, I'd want an add-on.

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [42]

--------------------------------------------------------------------------------

I know, we do. We do want to segment those, right, yes, that's exactly right. So very good point. Thank you. We will clarify that in the next filing.

--------------------------------------------------------------------------------

Operator [43]

--------------------------------------------------------------------------------

(Operator Instructions)

--------------------------------------------------------------------------------

Mark W. Harding, Pure Cycle Corporation - President, CEO, CFO & Director [44]

--------------------------------------------------------------------------------

Well, let me jump back in and what I'll do is, if you all had a question that technology wasn't allowing you to get in, don't hesitate to just give me a call and I can clarify some of that. We will post this replay up to our website by end of day so that you can kind of listen in it again and if it spurs another question that maybe you didn't get the first time, don't hesitate to give us a call.

With that, I'll sign off and I'll thank you all for your continued support and look forward to continued results for all of our valuable assets and thanks again.

--------------------------------------------------------------------------------

Operator [45]

--------------------------------------------------------------------------------

Ladies and gentlemen, this does conclude today's teleconference, and we thank you all for your participation. You may now disconnect your line, and we hope that you enjoy the rest of your day.