PURE CYCLE CORP (PCYO)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

In Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), “we,” “us,” “our” and "Pure Cycle" refer to Pure Cycle Corporation and all entities owned or controlled by Pure Cycle Corporation. You should read the following discussion in conjunction with our consolidated financial statements and accompanying notes, related MD&A and discussion of our business included in our Annual Report on Form 10-K for the year ended August 31, 2025 (the “2025 Annual Report”) filed with the United States (U.S.) Securities and Exchange Commission (the “SEC”) and the unaudited consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q. The results of operations reported and summarized below are not necessarily indicative of future operating results, and future results could differ materially from those anticipated in forward-looking statements (refer to “Forward-Looking Statements” in this report and Part I, Item 1A. “Risk Factors” in our 2025 Annual Report for further discussion).

We are a diversified water and wastewater service provider, land developer, and home rental company. We provide wholesale water and wastewater services in the Denver, Colorado area, develop land we own into master planned communities, and develop single-family homes for rent. Each of our businesses, providing water and wastewater services, land development and single-family home rentals, generates attractive recurring monthly income.

Recent Developments and Economic Conditions

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The housing market stabilized in 2024 as the Federal Reserve shifted from aggressively increasing interest rates in 2023 to a balanced approach that maintained relatively consistent interest rates through the first half of 2025. In the second half of 2025, the Federal Reserve pivoted from primarily combating inflation to supporting labor market stability and economic activity, implementing a series of interest rate reductions that continued through December 2025. Since December 2025, the Federal Reserve has paused its easing cycle and held rates steady at its January, March, April and June 2026 meetings, leaving the target range for the federal funds rate at 3.50% to 3.75%, as policymakers navigate inflation that has reaccelerated to its highest level since 2023 and remains above the Federal Reserve's target, a labor market that has shown signs of softening, heightened geopolitical uncertainty arising from the military conflict between the United States and Iran, and weak consumer confidence. Although mortgage interest rates remain below their 2024 peaks, they have risen from their early 2026 lows as the energy price shock has pushed inflation higher, and the 30-year fixed rate averaged approximately 6.52% as of mid-June 2026. The housing market continues to face significant headwinds. Consumer demand remains constrained by cumulative affordability challenges, elevated energy costs and heightened economic uncertainty. Furthermore, volatility in the broader macroeconomic environment, driven in part by the military conflict between the United States and Iran, federal trade policies affecting the cost of imported construction materials, and fluctuating consumer confidence, continues to impact builder sentiment and the pace of new home sales. Builder sentiment, as measured by the NAHB/Wells Fargo Housing Market Index, stood at 35 in June 2026, remaining below the breakeven level of 50 for the 26th consecutive month, with approximately 62% of builders continuing to offer sales incentives to attract buyers.

As higher mortgage interest rates, volatile macroeconomic conditions and geopolitical instability have adversely affected the residential real estate market, homebuilders' strategic use of interest rate buydowns and other sales incentives have continued to play a crucial role in driving sales. Despite current interest rates, elevated energy costs, increases in the cost of construction materials and economic uncertainty stemming from actual and anticipated U.S. governmental policy changes, we maintain a positive long-term outlook on land development and the housing market based on fundamental factors remaining positive. These include favorable demographics, the lot and housing supply vs demand imbalance resulting from a decade of underproduction of new homes in relation to population growth, and low resale home inventory. While we remain confident in the long-term growth prospects for the industry given these factors, the current demand for new homes is subject to continued uncertainty due to many factors. The combination of higher mortgage interest rates since early 2022, several years of rising housing prices, renewed inflation, and various other macroeconomic and geopolitical concerns have been moderating housing demand. The Denver metro housing market has reflected these national trends. After home sales fell to their lowest levels since the 2008 financial crisis in early 2026, the spring selling season showed signs of stabilization, with median home prices remaining approximately flat to modestly higher on a sequential basis and sales activity improving from earlier in the year, even as new listings declined and the supply of homes available for sale tightened. Although the Federal Reserve's participants had projected one rate reduction for 2026 as recently as March, the Summary of Economic Projections released following the June 2026 meeting removed that projected reduction, and nine of the eighteen participants who submitted projections instead projected at least one increase in the federal funds rate before the end of 2026, with six projecting two 25 basis point increases. Those participants also raised their median projection for year end 2026 inflation, as measured by the personal consumption expenditures price index, to 3.6% from 2.7% in March, while lowering their projection for real GDP growth.

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The timing and likelihood of any future rate reductions have accordingly become less certain, and we expect moderate demand to continue throughout 2026 given the compounding headwinds of elevated energy prices, persistent inflation, and ongoing trade policy and geopolitical uncertainty. Given current conditions, we continue to monitor market dynamics and surrounding community performance and will adjust the timing of additional construction expenditures at Sky Ranch as warranted. We believe our segment pricing (entry level) lots and the low inventory of entry level housing in the Denver market will help Sky Ranch navigate a cyclical market better than other surrounding and significantly higher priced communities.

Our future performance and the strategies we implement (and adjust or refine as necessary or appropriate) will depend significantly on the prevailing economic environment, the state of the homebuilding industry, capital, credit and financial market conditions and political and regulatory factors (particularly regarding housing and mortgage loan financing policies and trade policies impacting the cost of construction and building materials). The Federal Reserve's decision to pause its rate cutting cycle, the reacceleration of inflation to its highest level since 2023, the leadership transition at the Federal Reserve, and elevated uncertainty regarding the duration and economic impact of the military conflict between the United States and Iran are expected to be ongoing headwinds for the housing market. Although energy prices have retreated from their heights surrounding the United States and Iran conflict, they remain elevated relative to pre-conflict levels, and the durability of the agreement to end the conflict and the timing and extent of any normalization in global energy markets remain uncertain. Prolonged supply chain disruptions, labor shortages, increased costs as a result of tariffs (including tariffs of up to 50% on steel, aluminum and copper and additional duties on softwood lumber, gypsum and other building products) or other factors and other production related challenges could extend or delay our construction cycle times and intensify construction-related cost pressures beyond those we experienced in 2025 and 2026. Consumer confidence weakened materially during the period, with the University of Michigan Index of Consumer Sentiment falling to a record low in May 2026 before recovering modestly in June, as households reacted to the military conflict and higher gasoline prices. Higher energy costs disproportionately impact lower income households, which represents a significant portion of the entry level buyer demographic we serve. In addition, consumer demand for our homes and our ability to grow and scale revenue and returns in fiscal 2026 could be materially and negatively affected by the above described monetary policy impacts, the economic consequences of the military conflict between the United States and Iran, rising energy costs, or other factors that curtail mortgage loan availability, employment or income growth or consumer confidence in the U.S. and in the Colorado markets.

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Our Business Strategy

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For more than 30 years, we have accumulated and continue to accumulate a portfolio of valuable water rights, land interests and single-family rental homes along the Front Range of Colorado. We have added an extensive network of wholesale water production, storage, treatment and distribution systems and wastewater collection and treatment systems that we operate and maintain to serve domestic, commercial, and industrial customers in the eastern Denver metropolitan region. Our primary land asset, known as Sky Ranch, is in one of the most active Master Planned Communities in the Denver metropolitan region along the rapidly developing I-70 corridor, where we are developing lots for residential, commercial, retail, and light industrial uses. Sky Ranch is zoned to include up to 3,200 single-family and multifamily homes, parks, open spaces, trails, recreational centers, schools, and over two million square feet of retail, commercial and light industrial space, all of which will be serviced by our water and wastewater services segment. Additionally, we have retained lots in our Sky Ranch development for our single-family rental business where we contract with national homebuilders to build the single-family homes we rent, typically under annual lease agreements. With 39 homes currently owned, we continue to evaluate this new line of business, which will include up to 71 rental homes at Sky Ranch by the end of 2026.

Although we report our results of operations through our water and wastewater resource development segment, our land development segment, and our single-family rental segment, we operate these segments as a cohesive business designed to provide a cost effective, sustainable, and value-added business enterprise.

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Water and Wastewater

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Water resources throughout the western U.S., and particularly in Colorado, are a scarce and valuable resource. Our owned and/or controlled portfolio of more than 30,000 acre-feet of water is comprised of groundwater, designated basin groundwater, and surface water supplies. Our other significant water assets include 26,000 acre-feet of adjudicated reservoir sites, two wastewater reclamation facilities, water treatment facilities, potable and raw water storage facilities, wells and water production facilities, and roughly 50 miles of water distribution and wastewater collection lines. Our water supplies and wholesale facilities are primarily located in southeast Denver, an area which is limited in both water availability and infrastructure to produce, treat, store, and distribute water and wastewater. We believe this provides us with a unique competitive advantage in offering these services.

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We provide wholesale water and wastewater servi

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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.

Executive Summary

We saw a decrease in our land development segment revenue during fiscal 2025 due to the timing of lot deliveries with our national homebuilders. We also saw a decrease in our water sales, primarily from a decrease in selling water to oil and gas operators. Our water and wastewater tap fees revenue increased in fiscal 2025 due to the timing of our national homebuilder’s production schedules in Phase 2B and 2C.  Our single-family rental business experienced a modest increase in revenue due to increasing monthly rent for the majority of our rental homes in fiscal 2025. Although the housing market is slowing, we continue to see demand for affordable housing in our local market and have focused our land development activity in fiscal 2025 on ensuring that we are delivering the type of products that our national homebuilder partners desire in our Sky Ranch Master Planned Community. Phases 1 and 2A are complete, Phase 2B is approximately 97% complete, Phase 2C is approximately 82% complete and Phase 2D is approximately 43% complete. We continue to work on projects to expand our water assets to be competitive to sell water to oil and gas operators and have the infrastructure in place for future land development opportunities.  In fiscal 2025 we began construction of four new alluvial wells on the Lowry Ranch. Our notable financial highlights from fiscal 2025 include the following:

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Recent Developments

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The housing market stabilized in 2024 as the Federal Reserve shifted from an aggressive monetary policy in 2023 to a more balanced approach that continued into the first half of 2025 with relatively consistent interest rates. In the second half of 2025, interest rates began to decrease as the Federal Reserve signaled a shift in its monetary policy from primarily fighting inflation to supporting the labor market and economic activity, which it began implementing through interest rate cuts.  However, the housing market continues to face headwinds as consumer demand was influenced by ongoing affordability challenges and uncertainty resulting from federal trade policies and employment and economic uncertainties. Additionally, the housing market has faced volatility due to other macroeconomic and geopolitical conditions, including weakened consumer confidence.

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Although higher mortgage interest rates and volatile macroeconomic and geopolitical conditions may persist for some time, homebuilders' strategic use of interest rate buydowns as incentives has played a crucial role in driving sales during higher interest rates. Despite higher interest rate and recent market uncertainty stemming from actual and anticipated U.S. governmental policy changes, we maintain a positive long-term outlook on land development and the housing market based on fundamental factors remaining positive. These include favorable demographics, the lot and housing supply-demand imbalance resulting from a decade-plus of underproduction of new homes in relation to population growth, and low resale home inventory. While we remain confident in the long-term growth prospects for the industry given these factors, the current demand for new homes is subject to continued uncertainty due to many factors. The combination of higher mortgage interest rates since early 2022, several years of rising housing prices, elevated inflation, and various other macroeconomic and geopolitical concerns has been moderating housing demand. Although interest rates may decline, we expect moderate to lower demand to continue throughout 2026. Given current conditions, we continue to monitor market dynamics and surrounding community performance and adjust the timing of additional construction expenditures at Sky Ranch as warranted. We believe our segment pricing (entry level) lots and the low inventory of entry level housing in the Denver market will help Sky Ranch navigate a changing market better than other surrounding and significantly higher priced communities.

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Our future performance and the strategies we implement (and adjust or refine as necessary or appropriate) will depend significantly on prevailing economics, the homebuilding industry, capital, credit and financial market conditions and a stable and constructive political and regulatory environment (particularly regarding housing and mortgage loan financing policies and trade policies impacting the cost of construction and building materials). The continuing impact of the Federal Reserve’s policies for the federal funds interest rate and other measures to moderate persistent U.S. inflation and the uncertainty regarding future Federal Reserve monetary policy are expected to be ongoing headwinds for the housing market in 2026 and beyond. Prolonged supply chain disruptions, labor shortages, increased costs as a result of tariffs or other factors and other production-related challenges could extend or delay our construction cycle times and intensify construction-related cost pressures beyond our experience in 2025. In addition, consumer demand for our homes and our ability to grow and scale revenue and returns in fiscal 2026 could be materially and negatively affected by the above-described monetary policy impacts or other factors that curtail mortgage loan availability, employment or income growth or consumer confidence in the U.S. or in the Colorado markets. The potential extent and effect of these factors on our business is highly uncertain, unpredictable and outside our control, and our past performance, including in fiscal 2024 and 2025, should not be considered indicative of future results.

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Results of Operations

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The results of our operations for the fiscal years ended August 31, 2025 and 2024 were as follows:

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