Pure Cycle Corporation

Good morning and welcome to PureCycle Corporation's first quarter 2023 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during this conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Mark Harding, President and CEO of PureCycle. You may begin.

Thank you, Jenny. Good morning, everyone. I'd like to welcome you to our first quarter earnings call for our fiscal year 2023. And Happy New Year to you all. We have a slide deck for this. If you can surf over to our website at purecyclewater.com on the landing page, you'll find A button on there where you can click on that and then we will actually forward through the slides, but it'll give you the ability to see some of the text and the slides within the presentation. So, with that, I'm also joined today this morning by Kevin McNeil, our CFO, and Dirk Lashnitz, our Vice President and Director of Land Development, who will also give you updates into some of the business segments and the financial reportings. And then at the end, we'll have a brief Q&A for those of you who want to drill down on some of the specifics. So with that, let me first start with our safe harbor statement, which I'm sure most of you are familiar with, but statements that are not historical facts contained or incorporated by reference in this presentation are forward-looking statements. So with that, I'll get the lawyers out of the room and we'll start. I'll just be very brief on some of the overview of the company, but for those of you that are first-timers to the call or new to the company, we really operate on three primary business segments, really that are fundamentally interconnected to each other. At the DNA level of the company, we're a wastewater utility company where we own water in a water short region here in the state of Colorado in the West. We develop those water rights, and we are cradle to grave on the water rights where we develop the wells, the distribution system, put that water to use in both the land segment, which is a parcel of property that we own that we're doing a master plan community on, and we're building lots for our home builder customers. And then now we are holding back some of those lots and building homes on those for single family rental segment as well. So each of those segments really are interrelated to a vertically integrated platform that we have from the water utility side. Moving on to just describe a little bit briefly about the water segment itself. We have just that whole network of utility operations where we have The diversions for the water supply, whether those are taking water sources from our streams and surface water supplies or groundwater supplies or reuse supplies, we treat that water, we store it. We distribute that out to our customers. We're also responsible for some of the development of that distribution system pursuant to our design standards for our community, which is some of the lands that we have, but others as well. So we have master plan service areas that are very valuable, which we will highlight a little bit later in the presentation. Our customers use that water, they give it back to us, we collect that, we treat it, and then we reuse it. So, we have a use and reuse model. Within that, we get some fee instruments for that. On the water utility side, we get connection charges, which are a one-time connection fee, which between the water and the sewer tap fee are around $32,000, $33,000, and those are paid by the home builder, our home builder customers, and those are typically added into the cost of the home, but that grants the service connection a permanent entitlement to the water supply, and then we get usage fees for that. So, we get a base fee, which really amortizes some of the cost of operating and maintaining the system, and then a consumption charge which is a tiered consumption charge and so what this tends to do is it tries to encourage conservation because the more water you use the more water the higher the cost of the water supply so as you take a look at our water balance you know what we look to do is really keep control over that drop of water where we're taking that from the supply we're treating it we're putting it into our system we're getting it back from our system and then we're reusing that so we do have a very closed-loop system. We do lose a little bit to outdoor irrigation and some evaporation, but those trends are really decreasing, and there's been a lot of press, I'm sure as much as you have seen, about drought and the vulnerabilities of water supply out the West. So the company's emphasis on technology and controlling that drop of water through its continuous life cycle is very important to our systems, and we want to make sure that we're good stewards of this water supply. Taking a little bit of the infrastructure, you know, we build this infrastructure, you know, it's long-lived assets. Water supplies certainly are long lives. Those are perpetual. And then you have a lot of the brick and mortar that we're building associated with that. And, really, this is showing the growth of the company in the last five or six years, really showing about an 86% growth in the capitalized assets class. the various categories of that infrastructure, whether that's water and wastewater treatment facilities, transmission lines, wells, finished water storage, surface water, groundwater supplies, distribution systems, all the components of a water utility you'll find in those. So that'll continue to grow as we keep seeing that. Moving into kind of how the growth of the utility looks like, current customer count is up to about 1,250 new connections. We measured that in terms of the number of single-family equivalent connections on that. And so, you know, we have a combination of residential customers, which would be a standard single-family equivalent, but then we also have commercial and irrigation connections attributable to those. And so just because you might have one irrigation connection, that might represent as many as a couple hundred, as you see down in Lowry, because we have large irrigation requirements down there, of connections. And we rate that to the number of how we bill those out, so the number of base charges that we get for each of those. Talked a little bit about our residential connections at Sky Ranch, which is our development. We have our first phase, which is completely built out, 500 homes. We are into our second phase. Very robust tap sales in our second phase. Dirk will drill down into that a little bit, but we've got 124 taps there. And then a service area that we picked up a couple of years back where we have more than 200 connections between the residential and the commercial connections as well. Moving on, another one of our big customers on the utility side is the industrial space where we sell a lot of water to the oil and gas industry through a number of different operators. Our water supply or service areas and really, you know, the state of Colorado is located over a fairly prolific oil and gas field that's gotten a little bit more attention more recently with the shale oil play. But we are seeing operators drill a number of pads in a number of formations here that consume a tremendous amount of water for oil and gas. And so we continue to see those sales. This is a distribution of how those sales go by quarter. And as you can see, it's kind of all over the map. There's not a lot of predictability to it. They drill year-round. They crack year-round. And a lot of this is really dependent on a permitting process and how aggressive they are. The lead fold interest in these, and particularly in our particular field, has changed hands a number of times, which is pretty typical in the oil and gas industry. But it started out probably in 2000, say, 15, 16 timeframe with a lot of the field assessment and field definition. And now it's kind of moved into more of a well development. So they're developing the field so that they don't do a lot of exploration. They don't do a lot of changing to it. So each rig has a much stronger capacity to drill more wells per pad per year. And so what we're seeing is, you know, when you get a dedicated rig out here, that can drill as much as 25 to 30 wells a year. And they're pretty significant wells. They're two mile Lateral wells on this thing. I think they're experimenting with some three mile lateral wells on it and so they'll continue to Increase the amount of water that they're using depending on their laterals on This is kind of an illustration if you look at the right-hand side of this that'll be kind of a Denver metropolitan area and kind of the growth of the metropolitan area the two red areas or pink areas are That you see in there, those are service areas. If you look at the 1. Kind of transition between the green and the gray there. That's our sky ranch project, which is ideally located. It's on the I 70 corridor. And it really is in the strongest area of growth in the Denver metropolitan area. And we, as a. A developer are really targeting the entry level housing product, which I think in here is very well for us. both in very strong markets as well as in challenging markets. And so, Dirk will talk a little bit more about that. And then our service area at Lowry is a very large pink area, which continues to be really an untapped asset for us. The land is owned by the state of Colorado in trust for the public education system here and is one of the most unique assemblages of land in the country. And as you can see by the picture, the left there most of the development has really come up to the border of that property and so it depends on you know how the state looks to move forward with that but that's certainly an opportunity for us over the next few years that that we look forward to doing the utilities for that we're the exclusive water wastewater provider for that 24,000 acres of continuous property that gives you kind of a sense of the utility side some of the segments that we have in there. I'm going to hand this off to Dirk Lachnitz, who will talk a little bit about our land development activities.

Thanks, Mark. Good morning. Land development. So here's our flagship project called Sky Ranch. Every time I see it in its overall view, it always reminds me of the dreaded Tetris piece from that game. But this is a 930 acres like Mark said, on the developing edge of development out on the east side of Denver. Has 3,200 residential lots capacity and 2 million square feet of commercial capacity. And we're about 15 miles east of downtown Denver. Sky Ridge has probably got about a 10 to 15 year build out that'll be heavily dependent on our market conditions. We're going to build this out in multiple phases. Over the last probably four or five years, you've heard us talk a lot about our first phase. The first 500 lots, that's pretty much in the books. And we're now moving on to our second phase. That first phase is the block on the left side of the picture. And then our second phase is kind of the middle portion of the parcel. And then future phases will Grow out to the east and then our commercial pieces the northern block adjacent to I-70 We plan to build about average probably about 250 lots per year out here and we'll layer in our schools and commercial pieces and rec centers all those things that go along with a master plan community and So phasing, as I mentioned, phase one in the book, that was 500 lots. We have had our pilot program for our build-to-rent lots. So we have four occupied units in that phase, 100% complete. Then moving into our second phase, this is 850 lots. We're subdividing this into four subphases. That's 2A through 2D. Well underway in our phase two, a, that's about eighty percent complete and hope to have that completed later this year, beginning of two thousand twenty four. We've started our infrastructure for phase to be. We'll, we'll hope to start that in earnest quarters, two through four of this year. And then phase is the thirty fourth sub phase to see and to D. Um, we'll, we'll build out in subsequent years. Um, our, our phase 2 way, we, uh, we just had our 1st, few residents move in there. So that's exciting. Um, we have delivered all our lots to to the. Builder customers there, um, as you saw by our, uh, water caps. Number on previous slides, uh, those are indicative of the number of homes that have the builders have started. So we're right around that 120, 130 houses started and I think the builders have sold probably about 20, 25% of their lots and they'll look to have those sold out the remainder of this calendar year and then we'll be looking to have that second phase come online for the next batch of lots to not interrupt that That's sales cycle. All right, so this is the details on the phasing. These are, this is the phase two, 850 lots broken down into four sub phases. We got our lot revenues. Those numbers are what we, our income from sales of the lots to the builders. Then we have our tap revenues. Those are the water and sewer connection components that Mark mentioned. Then we have our costs to develop the lots. And then we have our reimbursable components, and those are the costs attributable to public infrastructure that are eligible for receivable reimbursement through public dollars, whether that's taxes or bonding. The graphs on the bottom of the sheet here, the bar graph, and then the far right pie chart, those are our builder breakdown, builder distribution. So we have our four builders in this phase, and that's by builder. And then that center pie chart is our product mix. So those six slices of that pie represent the different product market product segmentation, which I think is a good balance of product offerings and quite good diversity. And on to some market conditions here, sort of the news of the day. Start with the good, so the positive things, the pent-up demand for new home sales. We think there's good upside here. Back to the 2005-06 timeframe, there was about 1.4 million in home sales. And even in this latest upswing in 01-02, or 21-22, we were only at 600,000. So I think that represents a good upside for us. In that first quarter, we've seen the mortgage rates start to stabilize, still kind of hovering around. 6%, and that's in historical norms. Lot delivery is still trailing home starts. So in other words, we are still selling more homes than we are delivering finished lots. So from our standpoint, being in the business of selling lots, that's good potential there. I'd like to see that demand. Our home builders in Sky Ranch are all ranked nationally. All four in the second phase are in the top 15. I think three of them are in the top 10, two of them are in the top five. Top one. Yeah, top one, top two even. Good for stability and in it for the long haul. They've certainly seen some of the market swings and are good partners in helping mitigate that. Low unemployment. This is obviously a really important one. We hope that stays positive. House prices, still appreciating. Buying a house, still a good investment. Lower average days on the market. Houses are still selling pretty quickly, and those are some typical numbers there. Last year we were down, in Denver at least, we were under 10 days on average, and houses were selling above asking price, sight unseen, day of asking. So a year ago we had that peak, and even today with some of the slowdown, we're still seeing days on market in the 20s. So that's all still good outlook. Onto the bad or opportunities that we have here. Again, the abrupt uptick in interest rates kind of shocked the system, and I think we're Slowly adjusting to that. Again, we're still in kind of historical norms. A lot of the important metrics still trending downward. Builder confidence is down. Applications for mortgages are down. Buyer traffic in the model homes is down. Home sales are all down. And then combine that with higher material and labor costs. then our cancellations on contracts are still up you know I think at the end of the day for us the houses are too costly need to figure out ways to kind of recalibrate that the land development side that we do is a link in that chain and how do we adjust and for those changing markets. And the way we do that is mostly on a timing, from a timing standpoint. And that's really our challenge is trying to time our deliveries. We have a long lead time in development business. We're probably anywhere from at the earliest six months to most, more likely a year out from when that demand comes online. So we have that challenge on trying to find the right time to build our lots. And here's just a slide of a couple of the touches on the job growth chart, interest rates, and some sales information. Back to Mark.