UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-KSB

PURE CYCLE CORPORATION

(Name of small business issuer as specified in its charter)

Securities registered pursuant to Section 12(g) of the Exchange Act:

Common Stock,

1/3 of $.01 par value

(Title of class)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB  o

Indicate by check mark whether the registrant is a shell company (as defied in Rule 12b-2 of the Exchange Act).

Yes o No ý

Revenues for fiscal year ended August 31, 2005:     $234,654

The approximate aggregate market value of the voting stock and non-voting common equity held by non-affiliates:  $68,553,000 (based upon closing price on the NASDAQ SmallCap market on October 31, 2005)

Number of shares of Common Stock outstanding, as of October 31, 2005:   14,532,148

Transitional Small Business Disclosure Format (Check One): Yes o No ý

Documents incorporated by reference:  Portions of the Registrant’s definitive Proxy Statement for the Registrant’s 2006 Annual Meeting of Stockholders are incorporated by reference under part III of this annual report on form 10KSB.

Table of Contents

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“SAFE HARBOR” STATEMENT UNDER THE UNITED STATES PRIVATE

SECURITIES LITIGATION REFORM ACT OF 1995

Statements that are not historical facts contained in this Annual Report on Form 10-KSB are forward looking statements that involve risk and uncertainties that could cause actual results to differ from projected results.  The words “anticipate,” “believe,” “estimate,” “expect,” “plan,” “intend” and similar expressions, as they relate to us, are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions.  We cannot assure you that any of our expectations will be realized.  Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, without limitation, the timing of development of the areas where we may sell our water, including uncertainties related to the development of projects the Company currently has under contract, the market price of water, changes in applicable statutory and regulatory requirements, uncertainties in the estimation of water available under decrees, costs of delivery of water and treatment of wastewater, uncertainties in the estimation of costs of construction projects, the strength and financial resources of our competitors, our ability to find and retain skilled personnel, climatic and weather conditions, labor relations, availability and cost of material and equipment, delays in anticipated permit and construction dates, environmental risks, the results of financing efforts and the ability to meet capital requirements, and general economic conditions.

PART I

Item 1. Description of Business

General

Pure Cycle Corporation was incorporated in the State of Delaware in 1976.  We were founded on the belief that water is a precious commodity, one that is often undervalued and therefore used inefficiently.  We continue to operate under this belief today. Our business emphasizes the design, construction, operation and maintenance of water and wastewater reclamation systems.  Utilizing our significant water assets located in the Denver, Colorado metropolitan area, we withdraw, treat, store and deliver water to our customers, and then collect wastewater from our customers which is treated and reused through our dual distribution system.  To ensure we have sufficient water to meet the needs of our customers and to promote an efficient and environmentally responsible water management program, we design and operate dual distribution water systems whereby domestic water demands and irrigation demands are provided through separate independent infrastructure.  Our dual distribution system design promotes efficient water resource management and reduces the amount of water that is “wasted” by traditional water systems, enabling us to maximize the use of our valuable water supplies.

The Denver metropolitan region continues to experience tremendous growth and with the limited availability of new water supplies, many metropolitan planning agencies are requiring property developers to demonstrate adequate water availability prior to any consideration for zoning requests for property development.  We believe we are well positioned to market and sell our water and wastewater services to municipalities, developers and homebuilders seeking to develop new communities both within the Lowry Range Property (which is described below) as well as in other areas in the growing Denver metropolitan region.

Description of Our Water Assets and Related Service Agreements

The water assets we own or have the exclusive rights to use consist of the following annual entitlements:

•                  We own approximately 11,650 acre-feet of water located at the Lowry Range Property, which we can “Export” from the Lowry Range Property to supply water to nearby communities and developers in need of additional water supplies (this water asset is referred to as our “Export Water”);

•                  We have the exclusive rights to use, through 2081, approximately 17,620 acre-feet of water located at the Lowry Range Property.  This water is required to be used specifically on the Lowry Range Property (collectively we refer to the 17,620 acre-feet of water designated for use specifically on the Lowry Range Property and the 11,650 acre-feet of Export Water as our “Rangeview Water Supply”);

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•                  Pending satisfactory receipt of a Water Rights Deed, we will own approximately 363 acre-feet of groundwater we acquired from Arapahoe County (the “County”) pursuant to an Agreement for Water Service (the “County Agreement”).  This water will be used in conjunction with our Rangeview Water Supply;

•                  We own approximately 89 acre-feet of water located beneath Sky Ranch (described below) together with the right to purchase an additional 671 acre-feet of water (for a total of 760 acre-feet), which will be used to provide water service to the initial 1,500 taps purchased at Sky Ranch; and

•                  We own conditional water rights in western Colorado that entitle us to build a 70,000 acre-foot reservoir to store tributary water on the Colorado River; a right-of-way permit from the U.S. Bureau of Land Management for property at the dam and reservoir site; and four tributary water wells with a theoretical capacity to produce approximately 56,000 acre-feet of water annually (collectively known as the “Paradise Water Supply”).

Construction of water and wastewater systems and the providing of water and wastewater services are subject to individual water and wastewater service agreements.  We negotiate individual agreements with developers and/or homebuilders to provide the design, construction and operation of water and wastewater systems and services.  Our service contracts outline our obligations to design, construct and operate certain facilities necessary to develop and treat water and treat and reuse wastewater.  These service agreements include the timing of installation of the facilities, required capacities of the systems, and locations for the services to be provided.  Service agreements address all aspects of the development of the water and wastewater systems including: (i) the purchase of water and wastewater taps in exchange for our obligation to construct the wholesale water and wastewater facilities; (ii) the establishment of payment terms, timing and location of “Special Facilities” (if any); and (iii) specific terms related to our provision of ongoing water and wastewater services.

The Rangeview Water Supply and Related Agreements

Rangeview Agreements

We acquired the Rangeview Water Supply in 1996 when (i) on April 4, 1996, the State of Colorado Board of Land Commissioners (the “State Land Board”) and the Rangeview Metropolitan District (the “District”), a quasi-municipal political subdivision of the State of Colorado, entered into the Amended and Restated Lease Agreement, (ii) on April 11, 1996, we entered into the Agreement for Sale of Export Water with the District, and (iii) on April 11, 1996, we entered into the Service Agreement with the District to design, construct, operate and maintain the water systems to provide water service to the Lowry Range Property through 2081 (collectively these agreements are referred to as the “Water Privatization Agreements”).  The Water Privatization Agreements provide that we will design, construct, operate and maintain the District’s water system to provide water service to the District’s customers on the Lowry Range Property.  Pursuant to the Water Privatization Agreements, approximately 17,620 acre-feet of water per year located on the Lowry Range Property is dedicated for use specifically on the Lowry Range Property.    In exchange for providing water service to customers within our service area, we will receive 95% of all amounts received by the District relating to water services, after the District pays the required royalties to the State Land Board initially totaling approximately 12% of gross revenues received from water sales.   The District’s service area is located in Arapahoe County and is bordered by the City of Aurora.  A number of residential housing developments are currently under construction directly adjacent to the District’s service area.

We also design, finance, construct, operate and maintain the District’s wastewater system to provide wastewater service to customers within our service area.  In exchange for providing wastewater service for the District’s customers within our service area, we receive 100% of the District’s wastewater tap fees, and 90% of the District’s wastewater usage fees as well as the rights to sell the reclaimed water.

Lowry Range Property Water and Export Water

The Lowry Range Property encompasses approximately 26,000 acres, of which 24,000 acres are within our exclusive service area.  The Lowry Range Property is located in unincorporated Arapahoe County 15 miles southeast of Denver and 12 miles directly south of the Denver International Airport.  The State Land Board acquired the property in the 1960’s and has stated that the Lowry Range Property is one of the most valuable pieces of property in

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its nearly 2.5 million acre portfolio.  The State Land Board has explored a number of development models for the property including: development similar to that which is ongoing adjacent to the property’s western borders; a new planned community; and a compact development model with high density “village” centers surrounded by large expanses of open space.  In October 2005, the State Land Board announced that it is seeking a partner to “assist with the entitlement, resource planning and development” of the Lowry Range Property.  To do this, the State Land Board issued two requests for proposals (“RFPs”), one for the development of an initial 3,800 acres of the Lowry Range Property and a second for the conservation of a majority of the remaining property.  Also in October 2005, the State Land Board adopted a three-part vision for the overall use of the property, consisting of (i) development of water resources, (ii) open space and conservation plans, and (iii) “smart growth” or contained development of the property.  We do not have any guidance from the State Land Board relating to the timing of any development on the Lowry Range Property; however, responses to the RFPs are due to the State Land Board by April 20, 2006.  Additional water sales will only occur after development has commenced.  In the event development of the Lowry Range Property and the surrounding areas is delayed, or the State Land Board determines to limit the use of significant portions of the Lowry Range Property for open space, we may be required to incur additional short-term or long-term debt obligations or seek to sell additional equity to generate operating capital until demand arises for our water assets.

The Rangeview Water Supply is a combination of tributary surface water, nontributary groundwater rights, and storage rights associated with the Lowry Range Property.  We own the rights to use 11,650 acre-feet of tributary surface water and non-tributary groundwater that can be exported off the Lowry Range Property to serve area users.  We also have the exclusive rights to use an additional 17,620 acre-feet of tributary surface water and nontributary groundwater to serve customers on the Lowry Range Property.  The Export Water we own, together with water that is owned by the State Land Board that we have contracted to utilize under our service agreements, totals over 29,270 acre-feet of water per year.

Based on independent engineering estimates, the 17,620 acre-feet of water designated for use on the Lowry Range Property is capable of providing water service to approximately 46,500 Single Family Equivalent (“SFE”) units, and the 11,650 acre-feet of Export Water we own can serve approximately 33,600 SFE units throughout the Denver metropolitan region, for a combined total service capacity of approximately 80,100 SFEs.  An SFE is defined in the District’s Rules and Regulations as the amount of water required each year by a family of four persons living in a single family house on a standard sized lot.

On the Lowry Range Property, we operate both the water and the wastewater systems during our contract period and the District owns both systems.  However, after 2081 ownership of the water system servicing customers on the Lowry Range Property will revert to the State Land Board, with the District retaining ownership of the wastewater system.  Off the Lowry Range property, we will use our Export Water to provide water and wastewater services to our customers, and we will own the assets.  We plan to contract with third parties for the construction of these facilities.

Export Water

Colorado municipalities have strong incentives to attract commercial development to their areas, as a large portion of their revenues are derived through sales tax receipts.  Cities and municipalities historically have used water availability as a means to attract development.  As water has become scarce, cities and municipalities have begun requiring property developers to demonstrate that they have sufficient water supplies for their proposed projects before the cities and municipalities will consider rezoning applications.

Our water marketing activities are centered around targeting our water and wastewater services to developers and homebuilders developing new areas of the Denver metropolitan area.  Our water supplies are largely undeveloped and are located in the southeast portion of the greater Denver area in Arapahoe County, one of the fastest growing regions of the Denver metropolitan area.  We work with area developers to investigate water supply constraints, water and wastewater utility issues, market demand, transportation concerns, employment centers and other issues in order to identify suitable areas for development.  As projects are identified, the Company negotiates specific water and wastewater service agreements which include the timetable for development, the specifications for water and wastewater service capacities, the timing of those services and the timing of payments for such services.

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A portion of the proceeds from the sale of Export Water are subject to the Comprehensive Amendment Agreement No. 1 (the “CAA”), which is one of the agreements we used to purchase our Export Water and is more fully described in “Item 6 – Critical Accounting Policies – Accounting for CAA Payments” and Note 4 of the accompanying financial statements.

Arapahoe County Fairgrounds Agreement for Water Service

Effective August 3, 2005, we entered into the County Agreement to design, construct, operate and maintain a water system for, and provide water services to, the new Arapahoe County Fairgrounds and Regional Park (the “Fairgrounds”).  The County Agreement includes the following: (i) the County purchased water taps for 38.5 SFEs for approximately $567,500, or $14,740 per tap; (ii) we agreed to design and build certain Special Facilities (defined below) required to provide water service to the Fairgrounds, for which the County will pay us approximately $1.25 million, and (iii) we agreed to buy approximately 363 acre-feet of groundwater from the County for approximately $293,000.  As of August 31, 2005, we have not received the Water Rights Deed, and therefore, we will not capitalize the cost of this water until the satisfactory transfer of this deed.

We expect to service the Fairgrounds using our Export Water, therefore, the tap fees we received generate royalty payments to the State Land Board.  The agreement with the State Land Board requires royalty payments on Export Water sales based on the net revenues we receive.  These net revenues are defined as proceeds from the sale of Export Water less direct and indirect costs, including reasonable overhead charges, associated with the withdrawal, treatment and delivery of Export Water.  Based on this, in September 2005 we made a royalty payment to the State Land Board of approximately $34,500, which is 10% of the net revenues we received from the sale of Export Water taps.  This is shown as Royalties Payable to the State Land Board in the accompanying balance sheet.  In addition to the royalties to the State Land Board the tap fees received from the County are subject to the CAA.  Therefore, approximately $533,000 of the tap fees received from the County, which is the total tap fees less the $34,500 State Land Board royalty, was distributed to the escrow agent, as required by the CAA, in September 2005.  Based on the 2004 CAA acquisitions we made, we received $373,100, or 70% of this distribution, and external parties received $159,900, or 30%.  The $159,900 paid to third parties in September 2005 is reflected in the accompanying balance sheet as Payable to contingent obligation holders.  The tap fees retained by the Company will be used to construct the Wholesale Facilities required to provide water service to the Fairgrounds.

Pursuant to the County Agreement, payment for the design and construction of the Special Facilities required an initial payment of $397,000 (which we received in August 2005), credits totaling $240,000 for the groundwater we purchased from the County as described below, and monthly payments of approximately $6,850 for 10 years (this includes interest at 6% per annum).  The monthly payments begin upon acceptance of the construction of the Special Facilities.

Pursuant to the County Agreement, the payments for the water we purchased from the County were made in the form of water tap credits and credits against the Special Facility surcharges payable to us by the County.  Therefore, instead of the County paying us $567,500 in cash for the water taps, we received a net payment of $514,500 (received in August 2005) and rights to 27 acre-feet of groundwater with a value of approximately $53,000.  Further, instead of the County paying us $1.25 million in cash for the Special Facilities surcharges, we received an initial cash payment of $397,000 (received in August 2005), rights to 336 acre-feet of groundwater with a value of approximately $240,000, and an obligation from the County to pay the remaining $608,000 over the next ten years (as described above).  The water we acquired we will be capitalized as part of “Investments in Water and Water Systems” in our balance sheet upon the satisfactory receipt of the Water Rights Deed.  Additionally, this water is pending final adjudication, and therefore, the amounts acquired, as well as the costs, may be adjusted upon the final adjudication as necessary.

In August 2005, we entered into a contract with a third party to construct a 500,000 gallon water tank for use at the Fairgrounds.  The water tank will cost approximately $900,000, which is payable based on contractual milestones over the next twelve months.  In August 2005, we made the initial payment of $218,500 (which is recorded as construction in progress on the accompanying balance sheet).  No other construction contracts have been entered into

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as of the date of this filing; however, we anticipate all construction activities will be performed by third party contractors.

Sky Ranch Water Supply and Water Service Agreements

On October 31, 2003, and May 14, 2004, we entered into two Water Service Agreements (collectively the “Sky Ranch Agreements”) with the developer of approximately 950 acres of property located 4 miles north of the Lowry Range Property along Interstate 70 in Colorado, known as Sky Ranch.  Under the Sky Ranch Agreements, we will provide water service to the homes and other buildings that are expected to be built at Sky Ranch, which could be as high as 4,850 SFEs.

Based on discussions with the developer of Sky Ranch, we had anticipated the developer purchasing the initial taps in our second quarter of fiscal 2005.  To date, we have not received any payments for tap purchases from the developer, but we continue to have discussions with the developer regarding timing of tap purchases and the expected start date of the project.  The developer has informed us that it is actively engineering the final design of the project and is marketing lots to several national home builders with operations in the Denver area.  Based on these discussions, we have begun the design and engineering of the required water facilities but will not initiate construction until such time as we receive notice from the developer to proceed together with payment for the initial tap purchases.

As part of the Sky Ranch Agreements, the developer will dedicate approximately 537 acre-feet of water to us in exchange for a $3,400 per tap credit for the first 767 water taps purchased.  Additionally, pursuant to the Sky Ranch Agreements, the developer is required to pay us $3.41 million for the construction of certain Special Facilities required to extend service to Sky Ranch.  As of August 31, 2005, none of this water has been dedicated to us because Sky Ranch has not yet purchased any water taps.

On October 31, 2003 we entered into the Denver Groundwater Purchase Agreement (the “DGPA”) which provides us the option to purchase a total of 223 acre-feet of adjudicated water rights owned by the developer of Sky Ranch for five payments of $50,000 each, or a combined total of $250,000.  Under the DGPA, we can acquire 44.6 acre-feet of water per year (or 20% of the total 223 acre-feet) for $50,000.  On March 26, 2004, and May 26, 2005, we exercised our options and purchased a total of 89.2 acre-feet of Denver aquifer groundwater for payments totaling $100,000.  We anticipate exercising our remaining options over the next three years to complete the purchase of the remaining 133.8 acre-feet of Denver aquifer groundwater from Sky Ranch which will require payments totaling $150,000.

By combining the 537 acre-feet of water to be dedicated by the developer of Sky Ranch together with the 89.2 acre-feet of water already purchased, and the 133.8 acre-feet anticipated to be purchased under the DGPA, we will have acquired a total of 760 acre-feet of water from Sky Ranch, which we plan to use to provide water service to the first 1,500 SFEs at Sky Ranch.

Paradise Water Supply

In 1987 we acquired the conditional rights to build a 70,000 acre-foot reservoir to store tributary water on the Colorado River; a right-of-way permit from the U.S. Bureau of Land Management for property at the dam and reservoir site; and four tributary water wells with a theoretical capacity to produce approximately 56,000 acre-feet of water annually.  We will seek to utilize our Paradise Water Supply to deliver water to customers located in the Denver metropolitan area or to customers in the downstream states of Nevada, Arizona and California.  However, due to the strict regulatory requirements for constructing an on-channel reservoir, completing this conditional storage right at its decreed location could be difficult.  As a result, there can be no assurance that we will ever be able to make use of this asset or sell the water profitably.  Every six years our Paradise Water Supply is subject to a Finding of Reasonable Diligence review by the water court and the State Engineer to determine if we are diligently pursuing the development of the water rights.  During fiscal 2005, the State Engineer began this review.  At this time we are unable to estimate when the review will be complete or the final outcome of the review.  An unfavorable outcome could include the State Engineer and water court canceling our conditional rights, which would have a material

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adverse effect on our financial statements.  Since we acquired the Paradise Water Supply in 1987, we have received a satisfactory Finding of Reasonable Diligence at each of these reviews.  We will continue to vigorously defend our rights to the Paradise Water Supply.

In accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”), at least annually, we review our long-term assets, including our Paradise Water Supply, for indicators of impairment. Consistent with SFAS 144, we compare the carrying amount of our Paradise Water Supply asset to the sum of the undiscounted cash flows from the expected eventual use of the asset.  Our assessment of the recoverability of the carrying value of the Paradise Water Supply assumes revenues from water tap sales and monthly metered water usage fees offset by wholesale development costs, which are based on engineering estimates, over a 35 year development horizon.  Based on the latest annual assessment (last test performed as of August 31, 2005), the fair value of the Paradise Water Supply exceeded the carrying value, and therefore, no impairment was found to exist.

Revenues

We generate revenues predominately from three sources: (i) Water and wastewater tap fees, (ii) Construction fees, and (iii) Monthly service fees.

We negotiate the payment terms for tap fees, construction fees, and other water and wastewater service fees with each developer or builder before we commit to providing service and before construction of the project begins.

Water and Wastewater Tap Fees

Tap fees are typically paid by the developer in advance of any construction activities.  Tap fees are designed to: (i) fund construction of the “Wholesale Facilities”, and (ii) defray the acquisition costs of obtaining water rights.  Wholesale Facilities are those facilities necessary to withdraw, treat and deliver water and treat and re-use wastewater, such as wells and pump stations, water collection pipelines, water treatment plants, storage tanks and wastewater treatment plants. Tap fees are payable by the developers in advance of their construction activities, are non-refundable and are typically added to the cost of the house or business.

Under our privatization agreement with the District and the State Land Board, pricing for water tap fees (as well as water usage charges described further below) is controlled through a market-driven pricing mechanism in which our rates and charges may not exceed the average of similar rates and charges of three nearby communities (referred to as the “rate-based districts”).  Due to increases in tap fees at the rate-based districts, effective July 1, 2005, water tap fees increased to $14,740 per tap, which is an increase of 18.7% over the prior year.  Wastewater tap fees remained unchanged at $4,883.  Table 1 provides a summary of our tap fees over the past several years:

Table 1 – Water System Tap Fees

Developers owning rights to either surface water or groundwater underlying their properties can receive a credit against a portion of their tap fees if they sell their water to us.

Construction Fees

The development of water and wastewater systems may require the construction of facilities to extend services to an individual development, which facilities likely would not be used by other customers.  These facilities are commonly referred to as “Special Facilities”.  Special Facilities can include items such as infrastructure required

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during the construction of the permanent water and wastewater systems, transmission pipelines to transfer water from one location to another, temporary storage facilities, etc.  Generally we are not responsible for the design and construction of the Special Facilities - this is the developer’s responsibility - but we are typically responsible for the operation and maintenance of these Special Facilities.  We will accept responsibility for the design and construction of the Special Facilities, if the developer provides funding for the construction and determines the timing, location and capacity levels of the facilities.  We will then budget, plan and manage the construction of the Special Facilities.  If the developer constructs the Special Facilities, they are required to dedicate those to us at no charge.  If we construct the Special Facilities, we capitalize the construction costs, and upon completion, we own the Special Facilities.

If we agree to build the Special Facilities, the funding received from the developer is deferred until construction is completed and the assets are placed into operation.  At that time, the funding from the developer is recorded as income over the estimated service period, which is also the estimated useful life of the assets constructed with those funds.  The depreciation charges for the Special Facilities are recorded as costs of revenue over the estimated useful life of the assets.

Developers are usually responsible for the design and construction of “Retail Facilities” - the water distribution system that transports the water throughout the subdivision or community.  Retail Facilities are constructed pursuant to our design standards and are inspected by our engineers prior to completion.  Once we certify that the Retail Facilities have been constructed in accordance with our design criteria, the developer will dedicate the Retail Facilities to us or the District at no cost.  At Sky Ranch, the developer will dedicate the Retail Facilities to the District.  We, or the District, are then responsible for the operation and maintenance of the Retail Facilities.

“Customer Facilities” consist of water service pipelines, plumbing, meters and other components that carry potable water and reclaimed water from the street to the customer’s house and collect wastewater from the customer’s house and transfer it to the street.  In many cases, portions of the Customer Facilities are constructed by the developer, again pursuant to our design standards, but are owned and maintained by the customer.

Monthly Service Fees

Monthly water usage charges are assessed to each customer connected to our water system and are based on actual metered usage each month.  Water usage pricing is based on a tiered pricing structure which is based on our rate-based districts.  Effective July 1, 2005, the tiered pricing structure increased to the following amounts based on increases at the rate-based districts:

Table 2 – Tiered Pricing Structure

The pricing structure is sensitive to the date and volume of water use.  Based on this, for a typical residential customer using approximately 0.4 acre-feet of water annually, water usage fees would approximate $600 per year.

Wastewater customers are charged a flat monthly fee, which as of July 1, 2005, was increased to $34.80 per tap, or approximately $420 per year per tap.  We also collect other relatively small fees and charges from residential customers and other end users to cover miscellaneous administrative and service expenses, such as application fees, review fees and permit fees.

State Land Board Royalties and District Fees

Under the Water Privatization Agreements, the State Land Board is entitled to royalty payments based on a percentage of revenues earned from water sales that utilize water dedicated for use on the Lowry Range Property or

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for Export Water Sales.  The calculation of royalties depends on whether the customer is located on the Lowry Range Property, or elsewhere, and whether the customer is a public or private entity.  In addition, for water sales to customers located on the Lowry Range Property, the District is entitled to a 5% fee, which is calculated after the royalty payment to the State Land Board, and the District is entitled to a fee of 10% of our wastewater fees (not including wastewater tap fees) for customers on the Lowry Range Property.  The State Land Board does not receive a royalty on wastewater tap fees or service fees.

The Water Privatization Agreements were written prior to any development of the Lowry Range Property or areas outside of the Lowry Range Property that could utilize our Export Water.  For that reason, the Water Privatization Agreements could not anticipate all the specific circumstances that might arise in the future as we enter into and negotiate agreements for the sale of Export Water or for the provision of service to the Lowry Range.  Therefore, the Water Privatization Agreements may not clearly delineate the rights and responsibilities of the parties for each transaction that may arise.  We anticipate that we will be required to enter into negotiations with the State Land Board from time to time to clarify the applicability of contract terms to circumstances that were not anticipated at the time we entered into the Water Privatization Agreements.  We cannot assure you that the outcome of such negotiations will be favorable to us.

Lowry Range Property Customers

For services to customers located on the Lowry Range Property, the District collects fees from customers, pays the royalties to the State Land Board, retains its own fee, and remits the remainder to us.  Payments from customers who are on the Lowry Range Property generate royalties to the State Land Board at a rate of 12% of gross revenues.  The State Land Board has the option to convert their royalty interest whereby, instead of the 12% royalty payments, they could elect to receive royalty payments equal to 50% of the aggregate net profits of the District and us if (i) metered production in any calendar year exceeds 13,000 acre-feet, or (ii) 10,000 surface acres on the Lowry Range Property have been rezoned to a non-agricultural use and finally platted and water tap agreements have been entered into with respect to all improvements to be constructed on such acreage.  To date neither of these conditions has been met.

Export Water Customers

Payments for Export Water also generate royalty payments to the State Land Board.  These royalties vary depending on a number of factors including whether the customer is a public or private entity.

When we withdraw, treat and deliver the water to the user and incur the costs related to this process, the royalty to the State Land Board is based on our “Net Revenues,” which are our gross revenues less costs, including reasonable overhead allocations, incurred as a direct or indirect result of incremental activity associated with the withdrawal, treatment and delivery of Export Water. Royalties payable to the State Land Board for water sold escalate based on the amount of Net Revenue we receive and are lower for sales to a water district or similar municipal or public entity than for sales to a private entity as noted in Table 3: 

Table 3 – Royalties for Export Water Sales

Current Operations

We have designed and constructed, and we currently operate and maintain, water and wastewater facilities that service customers on the Lowry Range Property.  We currently have one water facility that during fiscal 2005

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delivered approximately 52.3 million gallons of potable water ranging from approximately 2 million gallons per month in the winter to over 8 million gallons per month in the summer.  Our wastewater treatment plant currently has a permitted capacity of 130,000 gallons per day and receives about 20,000 gallons per day.

At this time, we operate and maintain all of our water and wastewater facilities with limited assistance from third party contractors.  We design, construct and operate the facilities serving customers on the Lowry Range Property and plan to operate this system, together with facilities serving customers in areas outside the Lowry Range Property, in a unified manner to capitalize on economies of scale.

In 1998, we entered into a water service agreement with the State of Colorado Department of Human Services to provide water and wastewater services to a juvenile correction facility on the northwestern edge of the Lowry Range Property known as the Ridge View Youth Services Center.  We designed this system to provide water and wastewater services to approximately 200 SFEs at the Ridge View Youth Services Center.  Upon completion in 2001, we commenced service to the Ridge View Youth Services Center.  During fiscal 2005, approximately 98% of our total water and wastewater treatment revenues were from two customers.

Projected Operations

In October 2003 and May 2004, we entered into the Sky Ranch Agreements with the developer of Sky Ranch to provide water to the development, which could include up to 4,850 SFE units, as described above.  Under the Sky Ranch Agreements, the developer must purchase at least 400 water taps before occupancy of the first home.  The Sky Ranch Agreements permit the developer to add additional taps annually, with at least 310 taps to be purchased each year after construction begins.  This schedule is designed to provide us with adequate funds with which to construct the Wholesale Facilities needed to provide water service to the areas being built.

We will develop water and wastewater infrastructure in stages to meet demand.  We anticipate that development of the entire 29,270 acre-feet of water located on the Lowry Range Property will require between 250 and 300 high capacity water wells ranging in depth from 800 feet to over 2,500 feet.  We will drill separate wells into each of the three principal aquifers and each well will deliver water to central water treatment facilities for treatment prior to delivery to customers. We also intend to build structures to divert surface water to up to four storage reservoirs to be located on the Lowry Range Property.  The surface water will be diverted when available and, prior to distribution to our customers, will be treated by a separate water treatment facility that we will build specifically to treat surface water.  Based on preliminary independent engineering estimates, the full build-out of water facilities on the Lowry Range property will cost approximately $340 million and will accommodate water service for up to 80,000 SFE units, which includes both customers located in and outside the Lowry Range Property service area.

We design, construct and operate our own wastewater treatment facilities using advanced treatment technologies currently available in the market.  We plan to store our treated effluent water in surface water reservoirs for reuse in our irrigation water system.  The combination of deep well water from our non-tributary water supplies, surface water supplies from two surface water streams that flow through the Lowry Range Property and the reuse of the treated effluent water supplies will provide an integrated water management system that maximizes the use and reuse of our valuable water supplies.  Based upon preliminary engineering estimates, we anticipate the full build-out of wastewater facilities on the Lowry Range Property will cost approximately $68 million and will accommodate up to 12.3 million gallons of wastewater per day serving an estimated 47,000 SFE units.

We use third party contractors to construct our facilities and we employ licensed water and wastewater operators to operate our water and wastewater systems.  At full build-out, we expect to employ approximately 50 professionals to operate our systems, read meters, bill customers, and manage our operations.  We will take advantage of advanced technologies to keep personnel requirements and operating costs low, such as systems that enable meter readings and billings to be done remotely, reducing associated handling and labor costs.

Rangeview Metropolitan District

The Rangeview Metropolitan District is a quasi-municipal corporation and political subdivision of Colorado formed in 1986 for the purpose of providing water and wastewater service to the Lowry Range Property.  The

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District will utilize the 17,620 acre-feet of water leased to it by the State Land Board located on the Lowry Range Property for service to customers on the Lowry Range Property.

The District is run by an elected board of directors.  The only eligible voters and the only persons eligible to serve as directors are the owners of property within the boundaries of the District.  We own certain rights to the real property which encompass the current boundaries of the District.  The current directors of the District are Mark W. Harding, Scott E. Lehman (both are employees of Pure Cycle), Ryan T. Clark (by reason of his role as manager of TPC Ventures, LLC, Ryan Clark is deemed an indirect beneficial owner of more than 10% of Pure Cycle common stock) and Tom Lamm.

We are party to a Right of First Refusal Agreement with the owners of the property comprising the District.  Pursuant to a tenancy in common agreement, in the event of death, bankruptcy or incompetence of any tenant, that tenant’s estate or representative must offer the property interest of that tenant to the remaining tenants for purchase.  If the remaining tenants do not purchase all of such person’s interest, the property must be offered to us pursuant to the Right of First Refusal Agreement.  In addition, if any tenant wants to sell his interest in the parcel, such tenant must find a bona fide buyer and then offer the property to us.  We have the right, at our option, to buy the property by matching the terms of the bona fide third party offer or by paying the appraised value of the property as determined by independent appraisers.  A tenant may also negotiate a sale directly with us if he elects not to locate a bona fide buyer.  Each of the directors listed above, as well as Pure Cycle, currently own an undivided interest in the land comprising the District.  Under applicable Colorado law, entities are not qualified to serve as directors of municipal districts and may not vote.  Our President and Secretary serve as elected members of the Board of Directors of the District.  Pursuant to Colorado law, directors are entitled to receive $50 for each board meeting or a maximum of $950 per year.

We and the board of directors of the District transact business on an arms-length basis.  The conflicts of interest of the directors in transactions between us and the District are disclosed in filings with the Colorado Secretary of State.  The District and we were each represented by separate legal counsel in negotiating the water service agreement and wastewater service agreement between the parties.  The agreements were also approved by the two members of the District’s board who were not our employees and by the State Land Board.

It is likely that at some point in the future, the board of directors of the District will be comprised entirely of directors independent from us.  As the State Land Board develops the Lowry Range Property, landowners on the Lowry Range Property may petition to include their land within the District’s boundaries.  Provided such petition complies with applicable law, the District is required by its lease with the State Land Board to proceed with due diligence to include the area designated in such petition within the District’s boundaries.  As the District’s boundaries expand, the base of persons eligible to serve as directors and eligible to vote will also increase.

Water Reclamation

With interest heightened by a recent drought in Colorado and the fact that over 60 percent of the water that originates in Colorado leaves the state, most water providers in Colorado are actively pursuing the use of reclaimed wastewater for irrigation and other non-potable uses.  In many ways we have led the effort in the metropolitan area to design water reuse systems and have assisted in establishing regulatory standards for water reuse water quality standards, having participated in the Department of Public Health’s regulatory rule making process defining water quality standards for reuse water.  Our master plan for our service area, which includes the Lowry Range Property and services to Sky Ranch, and all other areas in which we will provide services, calls for the installation of a dual pipe water distribution and reclamation system.  A dual pipe distribution system is where one pipe supplies the customer with pure potable drinking water and a second pipe supplies raw or reclaimed water to homes for irrigation and other nonpotable uses.  About one-half of the water needed to meet Denver-area residential water demands is used for landscaping and the irrigation of lawns.  We, along with most major water providers, believe that raw or reclaimed water supplies provide an essentially drought-proof supply of irrigation water for the Front Range and our service area.

The Colorado Department of Public Health and Environment in August 2005, adopted rules defining water quality standards for raw and reclaimed water uses for residential irrigation customers.  We expect that the

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implementation of an extensive water reclamation system, in which essentially all wastewater treatment plant effluent water will be re-used to meet nonpotable water demands, will greatly expand our capability to provide quality water service and will reinforce our philosophy that emphasizes the importance of water recycling.

Competition

Although we have exclusive long term water and wastewater service contracts for the Lowry Range Property, providing water service using our Export Water is subject to competition.  Alternate sources of water are available, principally from other private parties, such as farmers owning senior water rights that are no longer being economically used in agriculture and municipalities seeking to annex newly developed areas in order to increase their tax base.  Our principal competition in areas close to the Lowry Range Property is the neighboring City of Aurora.  The principal factors affecting competition for potential purchasers of Export Water include the availability of water for the particular purpose, the cost of delivering the water to the desired location, and the reliability of the water supply during drought periods.  We believe that our assets provide us with a competitive advantage because our legal rights to the assets have been confirmed for municipal use, our water supply is close to Denver area water users and our pricing structure is competitive.  Further, the size of the Lowry Range Property and the amount of property that can be served by the Export Water will provide us with economies of scale that should give us advantages over our competitors.

Water to Meet Colorado’s Demand

In common with large portions of the desert west, the Denver metropolitan area is semi-arid, receiving an average of only 13 inches of precipitation annually.  Eighty percent of the State’s water supplies reside west of the Continental Divide, while 80 percent of the population resides east of the Continental Divide.  Roughly 80 percent of Colorado’s annual surface water supply comes from snow melt.  Due to wide fluctuations in snowfall from year to year and area to area, the amount of surface water that can be captured for use varies greatly.  Further, the State is obligated through compacts and treaties to allow much of the water that originates in the State to flow out of the State for use by downstream out-of-state users.

Most of the State’s population resides along the “front range,” which extends from Pueblo to Fort Collins and lies along the eastern side of the Rocky Mountains.  The largest population center is the greater Denver metropolitan area which has been growing at above average rates for decades.  By the 1960s, water available during an average precipitation year from Denver’s primary source of surface water, the South Platte River, was no longer sufficient to meet the area’s needs.  To address this imbalance, numerous reservoirs and tunnels have been built to transport an average of 500,000 acre-feet per year of Arkansas River water and Colorado River water located in western and southern Colorado to metropolitan Denver water providers.  Even with this diversion, the U.S. Department of the Interior has identified the Denver metropolitan area as one that is ‘highly likely’ to experience a ‘water supply crisis’ by 2025.

The Denver Regional Council of Governments (“DRCOG”), a voluntary association of 50 county and municipal governments in the Denver metropolitan area, estimates that from the year 2005 to 2030 the population in the Denver metropolitan area will grow to 3.9 million people, an increase of 1.3 million people.  To accommodate this growth, DRCOG has estimated that the Denver metropolitan area will grow from roughly 500 square miles to roughly 770 square miles during the same 25-year period.  This will add approximately 350,000 new single family equivalent connections which will require more than 100,000 acre-feet of water annually.

With our Rangeview Water Supply, based on independent engineering evaluations, we are positioned to supply water to meet the needs of approximately 80,000 single family equivalent connections, or approximately 320,000 people.

Risk Factors

Our business faces significant risks.  These risks include those listed below and may include additional risks of which we are not currently aware or which we currently do not believe are material.  If any of the events or

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circumstances described in the following risk factors actually occurs, our business could be materially adversely affected.  These risks should be read in conjunction with the other information set forth in this report.

We are dependent on the development of Sky Ranch, the Lowry Range Property and other areas near our Rangeview Water Supply that are potential markets for our Export Water.

We expect that our principal source of future revenue will be from long term contracts with the State Land Board, which expire in 2081 and entitle us to provide water service to the Lowry Range Property and the Sky Ranch Agreements that entitle us to provide water service to the Sky Ranch development.  The timing and amount of these revenues will depend significantly on the development of these areas.  The Lowry Range Property is owned by the State Land Board, which is in the early stages of considering various development alternatives, but no timetable exists for development.  We are not able to determine the timing of water sales or the timing of development.  There can be no assurance that development will occur or that water sales will occur on acceptable terms or in the amounts or time required for us to support our costs of operation.  Because of the prior use of the Lowry Range Property as a military facility, environmental clean-up may be required prior to development, including the removal of unexploded ordnance.  There is often significant delay in adoption of development plans, as the political process involves many constituencies with differing interests.  In the event water sales are not forthcoming or development of the Lowry Range Property is delayed, we may incur additional short or long-term debt obligations or seek to sell additional equity to generate operating capital.

Our operations are significantly affected by the general economic conditions for real estate development and the pace and location of real estate development activities in the greater Denver metropolitan area, most particularly areas such as Sky Ranch which are near to our Rangeview Water Supply and thus are potential markets for our Export Water.  Increases in the number of our water and wastewater connections, our connection fees and our billings and collections will depend on real estate development in this area.  We have no ability to control the pace and location of real estate development activities which affect our business.

Our net losses may continue and we may not have sufficient liquidity to pursue our business objectives.

We have experienced significant net losses and could continue to incur net losses.  For the years ended August 31, 2005 and 2004, we had net losses of approximately $1,051,000 and $1,976,000, respectively, on revenues of $235,000 and $205,000, in the respective periods.  Our cash flows from operations have been insufficient to fund our operations in the past, and we have been required to raise debt and equity capital to remain in operation.  Since 1998, we have raised approximately $10.1 million through the issuance of approximately 2.5 million shares of common stock to support our operations.  Our ability to fund our operational needs and meet our business objectives will depend on our ability to generate cash from future operations.  If our future cash flow from operations and other capital resources are insufficient to fund our operations and the significant capital expenditure requirements to build our water delivery systems, we may be forced to reduce or delay our business activities, or seek to obtain additional debt or equity capital, which may not be available on acceptable terms, or at all.

The rates we are allowed to charge customers are limited by the District’s contract with the State Land Board and our contract with the District and may be insufficient to cover our costs of construction and operation.

The prices we can charge for our water and wastewater services are subject to pricing regulations set in the District’s contract with the State Land Board and our contract with the District.  Both the tap fees and our usage rates and charges are based on the average of the rates of our rate-based districts.  Annually we survey the tap fees and rates of our rate-based districts and set our tap fees and rates and charges based on the average of those charged by this group.  Our costs associated with the construction of water delivery systems and the production, treatment and delivery of our water are subject to market conditions and other factors, which may increase at a significantly greater rate than the prices charged by our rate-based districts.  Factors beyond our control and which cannot be predicted, such as drought, water contamination and severe weather conditions, like tornadoes and floods, may result in additional labor and material costs that may not necessarily be recoverable under our operations and maintenance contracts, creating additional differences from the costs of our rate base water providers.  Increased customer demand can also increase the overall cost of our operations.  If the costs for construction and operation of our water services, including the cost of extracting our groundwater, exceed our revenues, we may petition the State Land

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Board for rate increases.  There can be no assurance that the State Land Board would approve a rate increase beyond the average of the rate-based districts.  Our profitability could be negatively impacted if we experience an imbalance of costs and revenues and are not successful in receiving approval for rate increases.

We only have three employees and may not be able to manage the increasing demands of our expanding operations.

We expect that our activities relating to the Sky Ranch agreement will significantly expand our business, and we are actively pursuing additional development opportunities in areas near Sky Ranch, as well as acquisition opportunities to continue to grow our operations.  We currently have only three employees to administer our existing assets, interface with applicable governmental bodies, market our services and plan for the construction and development of our future assets.  We may not be able to maximize the value of our water assets because of our limited manpower.  We depend significantly on the services of Mark W. Harding, our President.  The loss of Mr. Harding would cause a significant interruption of our operations.  The success of our future business development and ability to capitalize on growth opportunities depends on our ability to attract and retain additional experienced and qualified persons to operate and manage our business.  State regulations set the training, experience and qualification standards required for our employees to operate specific water and wastewater facilities.  Failure to find state-certified and qualified employees to support the operation of our facilities could put us at risk, among other things, for operational errors at the facilities, for improper billing and collection processes, and for loss of contracts and revenues.  We cannot assure you that we can successfully manage our assets and our growth.

Our business is subject to governmental regulation and permitting requirements.  We may be adversely affected by any future decision by the Colorado Public Utilities Commission to regulate us as a public utility and to impose regulation.

The Colorado Public Utilities Commission (“CPUC”) regulates investor-owned water companies that hold themselves out to the public as serving, or ready to serve, all of the public in a service area.  The CPUC regulates many aspects of public utilities’ operations, including the location and construction of facilities, establishing water rates and fees, initiating inspections, enforcement and compliance activities and assisting consumers with complaints.

Although we act as a service provider under contracts with quasi-municipal metropolitan districts that are exempt by statute from regulation by the CPUC, the CPUC could decide to regulate us as a public utility.  If this were to occur, we might incur significant expense challenging the CPUC’s assertion of authority, and we may be unsuccessful.  In the future, existing regulations may be revised or reinterpreted, and new laws and regulations may be adopted or become applicable to us or our facilities.  If we become regulated as a public utility, our ability to generate profits could be limited and we might incur significant costs associated with regulatory compliance.

There are many obstacles to our ability to sell our Paradise Water Supply.

We currently earn no revenues from our Paradise Water Supply, which as of August 31, 2005 has a recorded cost of approximately $5.5 million.  Our ability to convert our Paradise Water Supply into an income generating asset is limited.  While there is demand for water in the downstream states of California, Nevada and Arizona, Colorado law prohibits the export of water out of state without obtaining a Water Court decree.  To issue a decree the Water Court must find that the export is not in violation of the provisions of interstate compacts and does not prevent Colorado from complying with its interstate compact obligations.  In addition, there are significant difficulties and costs involved in transporting the water out of the Colorado River watershed to the Denver metropolitan area.  As part of our Water Court decree for the Paradise Water Supply, we are permitted to construct a storage facility on the Colorado River.  However, due to the strict regulatory requirements for constructing an on-channel reservoir, completing the conditional storage right at its decreed location would also be difficult. As a result, we cannot assure you that we will ever be able to make use of this asset or sell the water profitably.

Our Paradise Water Supply is also conditioned on a Finding of Reasonable Diligence from the water court every six years. To arrive at that finding, a water court must determine that we continue to diligently pursue the development of the water rights, either by us or by some third party who has a contractual commitment for its use.  If the water court is unable to make such a finding, our right to the Paradise Water Supply may be lost. The State

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Engineers office began its latest review of our conditional water rights in fiscal 2005.  At this time we are unable to estimate when the review will be complete or the outcome of this review.  Since we acquired the Paradise Water Supply in 1987, we have received a satisfactory Finding of Reasonable Diligence at each of these reviews.

Conflicts of interest may arise relating to the operation of the District.

Our officers, employees and a majority shareholder, constitute a majority of the directors of the Rangeview Metropolitan District and Pure Cycle, along with our officers and employees and one unrelated individual, own as tenants in common, the 40 acres that form the District.  Pursuant to State law, directors are entitled to receive $50 for each board meeting or a maximum compensation of $950 per year.  We have made loans to the District to fund its operations.  At August 31, 2005, total principal and interest owed to us by the District was approximately $431,000.  The District is a party to our agreements with the State Land Board and receives fees of 5% of the revenues from the sale of water on the Lowry Range Property, and will hold title to the water distribution system at the Sky Ranch development.  Proceeds from the fee collections will initially be used to repay the District’s obligations to us, but after these loans are repaid, the District is not required to use the funds to benefit Pure Cycle.  We have received benefits from our activities undertaken in conjunction with the District, but conflicts may arise between our interests and those of the District, and with our officers who are acting in dual capacities in negotiating contracts to which both we and the District are parties.  We expect that the District will expand when more properties are developed and become part of the District, and our officers acting as directors of the District will have fiduciary obligations to those other constituents.  There can be no assurance that all conflicts will be resolved in the best interests of Pure Cycle and its stockholders.  In addition, other landowners coming into the District will be eligible to vote and to serve as directors of the District.  There can be no assurances that our officers and employees will remain as directors of the District or that the actions of a subsequently elected board would not have an adverse impact on our operations.

We are required to maintain stringent water quality standards and are subject to regulatory and environmental risks.

We must provide water that meets all federal and state regulatory water quality standards and operate our water and wastewater facilities in accordance with the standards. We face contamination and pollution issues regarding our water supplies. Improved detection technology, increasingly stringent regulatory requirements, and heightened consumer awareness of water quality issues contribute to an environment of increased focus on water quality. In contrast with other providers in Colorado, we are combining the water delivery and wastewater treatment processes, which may introduce technical treatment issues that make compliance with water quality standards more difficult.  We cannot assure you that we will be able in the future to reduce the amounts of contaminants in our water to acceptable levels. In addition, the standards that we must meet are constantly changing and becoming more stringent. For example, in February 2002, the U.S. Environmental Protection Agency lowered the arsenic standard in drinking water from 50 parts per billion to 10 parts per billion.  Future changes in regulations governing the supply of drinking water and treatment of wastewater may have a material adverse impact on our financial results.

We handle certain hazardous materials at our water treatment facilities, primarily sodium hypochlorite.  Any failure of our operation of the facilities in the future, including sewage spills, noncompliance with water quality standards, hazardous materials leaks and spills, and similar events could expose us to environmental liabilities, claims and litigation costs.  We cannot assure you that we will successfully manage these issues, and failure to do so could have a material adverse effect on our future results of operations by increasing our costs for damages and cleanup.

Our contracts for the construction of water and wastewater projects may expose us to certain completion and performance risks.

We will rely on independent contractors to construct our water and wastewater facilities. These construction activities may involve risks, including shortages of materials and labor, work stoppages, labor relations disputes, weather interference, engineering, environmental, permitting or geological problems and unanticipated cost increases.  These issues could give rise to delays, cost overruns or performance deficiencies, or otherwise adversely affect the construction or operation of the water delivery system.

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In addition, we may experience quality problems in the construction of our systems and facilities, including equipment failures.  We cannot assure you that we will not face claims from customers or others regarding product quality and installation of equipment placed in service by contractors.

Certain of our contracts may be fixed-price contracts, in which we may bear all, or a significant portion of, the risk for cost overruns. Under these fixed-price contracts, contract prices are established in part based on fixed, firm subcontractor quotes on contracts and on cost and scheduling estimates.  These estimates may be based on a number of assumptions, including assumptions about prices and availability of labor, equipment and materials, and other issues. If these subcontractor quotations or cost estimates prove inaccurate, or if circumstances change, cost overruns may occur, and our financial results would be negatively impacted.  In many cases, the incurrence of these additional costs is not within our control.

We may have contracts in which we guarantee project completion by a scheduled date. At times, we may guarantee that the project, when completed, will achieve certain performance standards. If we fail to complete the project as scheduled, or if we fail to meet guaranteed performance standards, we may be held responsible for cost impacts and/or penalties to the customer resulting from any delay or for the costs to alter the project to achieve the performance standards. To the extent that these events occur, and are not due to circumstances for which the customer accepts responsibility, and cannot be mitigated by performance bonds or the provisions of our agreements with contractors, the total costs of the project could exceed our original estimates and our financial results would be negatively impacted.

Our customers may require us to secure performance and completion bonds for certain contracts and projects.  The market environment for surety companies has become more risk averse.  We secure performance and completion bonds for our contracts from these surety companies.  To the extent we are unable to obtain bonds, we may not be awarded new contracts.  We cannot assure you that we can secure performance and completion bonds where required.

We may operate engineering and construction activities for water and wastewater facilities where design, construction or system failures could result in injury to third parties or damage to property.  Any losses that exceed claims against our contractors, the performance bonds and our insurance limits at facilities so managed could result in claims against us.  In addition, if there is a customer dispute regarding performance of our services, the customer may decide to delay or withhold payment to us.

Item 2.    Description of Property

We currently occupy approximately 1,800 square feet of office space at a cost of $1,000 per month, which is leased from the estate of our former CEO, Mr. Thomas P. Clark, at the address shown on the cover page.  The lease is a month-to-month agreement that can be cancelled by either party at any time.

We own a total gross volume of 1,165,000 acre-feet (approximately 11,650 acre-feet per year) of non-tributary groundwater, an option to substitute 1,650 acre-feet of tributary surface water in exchange for a total gross volume of 165,000 acre-feet of non-tributary groundwater, and surface storage rights from the District.  See “Item 1. Description of Our Water Assets and Related Service Agreement - Rangeview Water Supply and Related Agreements”.  We are a party to two eighty-five year Water Privatization Agreements with the District and the State Land Board which entitle us to design, construct, operate and maintain the water and wastewater systems which serve customers within the District’s service area.  In exchange, we receive 95% of all amounts received by the District for water services net of royalties totaling 12% of gross revenues to the State Land Board, 100% of the District’s wastewater tap fees and 90% of the District’s wastewater usage fees.

We own approximately 70,000 acre-feet of conditional water rights, water wells and related assets in the State of Colorado by assignment and quitclaim deed.  See “Item 1. Description of Our Water Assets and Related Service Agreement - Paradise Water Supply.”

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We own 89.2 acre-feet of groundwater located in the Sky Ranch development.  This represents 40% of the 223 acre-feet of groundwater we will own upon exercise of our options under the DGPA.  See “Item 1. Description of Our Water Assets and Related Service Agreement – Sky Ranch Water Supply and Water Service Agreements.”

We own an undivided 59.9% interest as a tenant-in-common in a 40-acre parcel of undeveloped land located in unincorporated Arapahoe County comprising the Rangeview Metropolitan District.

Item 3.    Legal Proceedings

None

Item 4.    Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of stockholders during the quarter ended August 31, 2005.

PART II

Item 5.    Market for Common Equity and Related Stockholder Matters

Markets

Our common stock is traded on the NASDAQ SmallCap market under the symbol PCYO.  Table 4 shows, for the fiscal periods indicated, the high and low sales prices of our common stock as reported by NASDAQ.  Effective April 26, 2004, we completed a ten-for-one reverse stock split.  Accordingly, all amounts have been restated to reflect the reverse split.

Table 4 High and Low Sales Prices

On October 31, 2005, the last reported sale price of our common stock was $6.50 per share, and there were 3,572 holders of record of our common stock.

Dividends

We have never paid any dividends on our common stock and expect for the foreseeable future to retain all of our earnings from operations, if any, for use in expanding and developing our business.  Any future decision as to the payment of dividends will be at the discretion of our board of directors and will depend upon our earnings, financial position, capital requirements, plans for expansion and such other factors as our board of directors deems relevant.  The terms of our Series B Preferred Stock prohibit payment of dividends on common stock unless all dividends accrued on the Series B Preferred Stock have been paid.

Recent Sales of Unregistered Securities

Effective March 18, 2005, we amended certain of our outstanding warrants to allow the warrant holders to use the current market value of the underlying stock as consideration for the payment of the exercise price of the warrants.  Immediately following such amendments, warrant holders holding rights to purchase 39,282 shares of Common Stock having a warrant exercise price of $1.80 per share used 9,568 shares underlying such warrants and having a current market value of $7.39 per share to purchase 29,714 newly issued shares of common stock.  As of

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August 31, 2005, we continue to have outstanding warrants to purchase 15,612 shares of common stock at an exercise price of $1.80 per share.

All of these shares were issued in reliance of Section 4(2) of the Securities Exchange Act of 1933, as amended, as transactions not involving a public offering.

Item 6.    Management’s Discussion and Analysis of Financial Condition or Plan of Operation

Readers are cautioned that forward-looking statements contained in this Form 10-KSB should be read in conjunction with our disclosure under the heading: “SAFE HARBOR STATEMENT UNDER THE UNITED STATES PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995” on page 3.

General

Pure Cycle is an investor owned water and wastewater provider engaged in the design, operation and maintenance of water and wastewater systems primarily in the Denver metropolitan area with assets available to serve areas in the southwestern United States.  We own approximately 1.2 million acre-feet of water (11,650 acre-feet annually) and have entered into two 85 year water and wastewater Service Agreements with the District and the State Land Board which enable us to provide water and wastewater service to the District’s service area and other customers located throughout the Denver area.

We are aggressively pursuing the marketing and sale of our services to developers and home builders in the Denver metropolitan region to generate current and long term revenues.  As a result of the continuing growth of the Denver metropolitan region and the limited availability of new water supplies, many metropolitan planning agencies are requiring property developers to first demonstrate adequate water availability prior to any consideration for zoning requests on property development.  This has resulted in us marketing our water to area developers and home builders seeking to develop new projects as well as other municipal water providers in need of additional water supplies.

We also market our 70,000 acre-feet of Paradise Water Supply to private and municipal water providers in Nevada, Arizona and California, although significant legal issues relating to interstate water transfers exist.  We continue to identify, market and discuss our water supply arrangements with private companies and municipal water providers to whom we have made proposals.  However, due to the strict regulatory requirements for constructing an on-channel reservoir at its current decreed location, which is required for us to utilize this asset, we cannot assure you that we will ever be able to make use of this asset or sell the water profitably.

Critical Accounting Policies

Our financial statements are prepared in accordance with Accounting Principles Generally Accepted in the United States of America (“GAAP”), which requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.

We have identified certain key accounting policies on which our financial condition and results of operations are dependent. These key accounting policies most often involve complex matters or are based on subjective judgments or decisions.  In the opinion of management, our most critical accounting policies are those related to revenue recognition, impairment of water assets and other long-lived assets, depletion and depreciation, accounting for Participating Interests in Export Water, royalty and other obligations, and income taxes.  Management periodically reviews its estimates, including those related to the recoverability and useful lives of assets.  Changes in facts and circumstances may result in revised estimates.

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Revenue Recognition

Our revenues consist mainly of tap fees, construction fees and monthly service fees.  Emerging Issues Task Force Issue No. 00-21 Revenue Arrangements with Multiple Deliverables (“EITF 00-21”), governs how to identify when goods or services, or both, that are separately delivered but included in a single sales arrangement should be accounted for individually.  Based on the criteria of EITF 00-21, we account for each of the items contained in our service agreements individually.  That is, we determine the proper revenue recognition for tap fees, construction fees and services fees independent of one another.

We recognize revenues relating to the sale of water and wastewater taps as income upon receipt of payment if the Wholesale Facilities required to provide the service are in place and operational.  If the Wholesale Facilities are not in place and operational, we defer recognition of the tap fee revenue until the required facilities are completed and placed in service.  We recognize construction fees received to build assets that we will own, as income over the estimated service life, which is also the estimated useful life of the assets.  Additionally, we capitalize construction costs and amortize those as costs of revenue over the assets estimated useful life.  We recognize water and wastewater service revenues at the end of the month in which the services are performed.  Water service fees are based upon metered water deliveries to customers.  Wastewater customers are charged flat monthly fees.

Impairment of Water Assets and Other Long-Lived Assets

We review our long-lived assets for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  We measure recoverability of assets to be held and used by a comparison of the carrying amount of an asset to future undiscounted net cash flows we expect to be generated by the eventual use of the asset (the fair value).  If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.  We report assets to be disposed of at the lower of the carrying amount or fair value less costs to sell.  We believe there were no impairments in the carrying amounts of our investments in water and water systems at August 31, 2005.

Accounting for CAA Payments

The balance sheet liability captioned “Participating Interests in Export Water Supply” (the “Participating Interests”) represents an obligation which arose under the Water Commercialization Agreement (the “WCA”), as amended by the CAA.

Upon entering the CAA, we recorded an initial liability of approximately $11.1 million, which represents the cash we received and used to purchase our Export Water Supply.  In return we agreed to remit a total of $31.8 million of proceeds received from the sale of Export Water to the Participating Interest holders.  In accordance with EITF Issue No 88-18 Sales of Future Revenues, the obligation for the $11.1 million was recorded as debt, and the remaining $20.7 million contingent liability is not reflected on our balance sheet as the obligation to pay this is contingent on our ability to sell Export Water, for which the amounts and the timing are not reasonably determinable.

As of August 31, 2005, the remaining Participating Interests liability reflected on our balance sheet totaled $8.2 million, and the contingent liability not reflected on our balance sheet totaled $15.2 million.  For more information see “Note 4 – Participating Interests in Export Water” to the accompanying financial statements.

Royalty and other obligations

Revenues from the sale of Export Water are shown net of royalties payable to the State Land Board.  Revenues from the sale of water on the Lowry Range Property are shown net of the royalties to the State Land Board and the fees retained by the District.

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Depletion and depreciation of water assets

Water supplies that are being utilized are depleted on the basis of units produced divided by the total volume of water adjudicated in the water decrees.  Water systems are depreciated on a straight line basis over their estimated useful lives.

Income taxes

We use the asset and liability method of accounting for income taxes.  Under the asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  A valuation allowance is provided for deferred tax assets until realization is more likely than not.

Results of Operations

Water and Wastewater Usage Revenues

During fiscal 2005, we delivered approximately 52.3 million gallons of water compared to the delivery of 56.3 million gallons of water in fiscal 2004, a 7% decrease.  These water deliveries generated water usage revenues of $152,000 in fiscal 2005, and $146,000 in fiscal 2004, a 4% increase.  Our water service charges are based on a tiered pricing structure that provides for higher prices as customers use greater amounts of water.  Table 2 included above in Item 1 – Description of Business, outlines our tiered pricing structure.  The increase in usage fees is due primarily to higher seasonal water deliveries during peak times and increased usage fees effective July 1, 2005, which were based on increases at our rate-based districts.

Our wastewater customers are charged a flat monthly fee, which also increased effective July 1, 2005.  During fiscal 2005 and 2004, our wastewater revenues totaled $58,000 and $55,000, respectively.

We incurred approximately $17,000 in operating costs related to the water system for both fiscal 2005 and 2004, and we incurred approximately $9,000 and $11,000 in operating costs related to the wastewater system in fiscal 2005 and 2004, respectively.  The decrease in operating costs for the wastewater system is due mainly to one time expenses incurred in 2004 that improved the efficiency of the operations and benefited 2005.

General and Administrative and Other Expenses

General and administrative expenses for fiscal years 2005 and 2004 were $1.35 million and $823,000, respectively.  The increase of $527,000 or 64%, was due mainly to the following factors:

•                  Salaries and related expenses, including healthcare costs, increased by $224,000 to $691,000, due to the addition of a new controller in September 2004, higher than anticipated increases in healthcare premiums, and a bonus paid to our President.

•                  Franchise taxes increased more than $74,000 over the prior year due to increases in the authorized and outstanding common stock following the equity offering in 2004.  In early 2005, we reduced the number of shares authorized to be issued which will reduce the 2006 franchise taxes.

•                  Board of director fees increased by $61,000 to $111,000 due to us obtaining a directors and officers insurance policy and the addition of one Board member in February 2005.

•                  Legal expenses increased by $58,000 to $124,000 due to increased legal work related to increased operations, the signing of the County Agreement, and related corporate legal requirements.  We are not aware of any claims or litigation against the Company.

Interest income increased by $107,000 to $150,000 in fiscal year 2005, due primarily to the temporary investment of proceeds from our stock offering in the fourth quarter of fiscal 2004 in marketable securities.

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Interest expense decreased by $140,000 to $34,000 in fiscal 2005, due primarily to the repayment of certain notes following the stock offering in the fourth quarter of fiscal 2004.

Our net loss decreased by $925,000 to $1.1 million.  General and administrative expenses increased over the year, which increased our net loss; however, overall net loss decreased in 2005 due to us recording approximately $1.1 million of extinguishment charges relating to our acquisition of a portion of the CAA and the LCH obligation in fiscal 2004, which did not recur in fiscal 2005.

Liquidity and Capital Resources

Our working capital, defined as current assets less current liabilities, at August 31, 2005 was approximately $5.0 million, and we had cash and cash equivalents and marketable securities on hand totaling $5.5 million at August 31, 2005. We believe that at August 31, 2005, we have sufficient working capital to fund our operations for the next year.  However, there can be no assurances that we will be successful in marketing the water from our primary water projects in the near term.  In the event increased revenues and cash flows from providing water services are not achieved, we may incur additional short or long-term debt or seek to sell additional equity securities to generate working capital to support our operations.

Development of any of the water that we have, or are seeking to acquire, will require substantial capital investments.  We anticipate that additional capital for the development of the water will be financed by the entity purchasing such water through the sale of water taps to developers and water delivery charges to users.  A water tap charge refers to a charge we impose to fund construction of Wholesale Facilities and permit access to a water delivery system (e.g., a single-family home’s tap into our water system), and a water service charge refers to a water customer’s monthly water bill, generally charged per 1,000 gallons of water delivered to the customer.  Annually, the developer must purchase not less than a minimum number of taps, the proceeds from which are used to expand the capacity of our Wholesale Facilities to deliver water to additional customers in the development.  We anticipate that the system tap fees will be sufficient to generate funds with which we can design and construct the necessary Wholesale Facilities.  However, once we receive tap fees from a developer, we are contractually obligated to construct the Wholesale Facilities for the taps paid for, even if our costs are not covered by the fees we receive.  We can not assure you that our source of cash will be sufficient to cover our capital costs.

On August 3, 2005, we entered into the County Agreement to provide water service to the Fairgrounds.  Pursuant to the County Agreement we will design and build the Special Facilities and the Wholesale Facilities, which are expected to be completed in April 2006, for an anticipated Fairgrounds opening date in July 2006.

Funding of $1.25 million for the construction of the Special Facilities will come from the County and will be provided as follows:  (i) an initial payment of $397,000 (received in August 2005), (ii) credits for the County selling us 336 acre-feet of groundwater valued at $240,000 (the water asset will be recorded in our balance sheet upon satisfactory delivery of the Water Rights Deed), and (iii) $608,000 paid over ten years, which will include interest at 6%, which based on currently scheduled payments will result in us receiving $205,000 in interest.  These funds will be used to construct the Special Facilities, which we will own and operate.  We anticipate construction costs paid to contractors will total approximately $1.3 million.  We made the initial payment of $218,500 on the water tower in August 2005.  Construction of this tower began in September 2005.  The remaining payments for the water tower, totaling $680,000, are due upon the completion of various milestones throughout construction.

We will also design and build the Wholesale Facilities utilizing funds from the sale of water taps to the County.  The net funds that we retained of $321,000 (which is the total tap fees of $568,000 net of water dedication credits of $52,000, royalty payments to the State Land Board of $35,000 and payments to external CAA holders of $160,000) will be used to construct facilities that will provide water service to the Fairgrounds, provide capacity to our existing customers and provide us required systems for potential additional development opportunities in and around the Fairgrounds.  The construction of the Wholesale Facilities is expected to begin in March 2006, and we expect third party contracts to cost a total of approximately $96,000.  We will own and operate the Wholesale Facilities.

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When the Fairgrounds begin operations, we will charge the County water usage fees consistent with the Rates and Charges included in the District’s Rules and Regulations, which are expected to cover the costs of providing the ongoing water service.

On October 31, 2003, and then on May 14, 2004, we entered into the Sky Ranch Agreements with the developer of Sky Ranch.  Pursuant to the Sky Ranch Agreements we will provide water for all homes and buildings to be constructed at Sky Ranch, which could go as high as 4,850 SFE units.  Additionally, the developer must purchase at least 400 water taps before occupancy of the first home.  The Sky Ranch Agreements permit the developer to add additional taps annually, with at least 310 taps to be purchased each year.  This schedule is designed to provide us with adequate funds with which to construct the Wholesale Facilities needed to provide water service to the areas being developed.

To the extent that water service is provided using Export Water, we are required to pay a royalty to the State Land Board equal to 12% of the net revenue after deducting our costs.  If the developer exercises its option to purchase Export Water, we expect to dedicate approximately 1,200 acre-feet, or approximately 10%, of our Export Water supply (which is about 4.2% of our overall Rangeview Water Supply) for this project.  We estimate we will spend approximately $25.0 million for infrastructure costs related to the development and delivery of water to the Sky Ranch development.

At August 31, 2005, we had outstanding debt to three related parties totaling $1.46 million (which includes $763,000 of accrued interest).  Of the $1.46 million, $189,000 bears simple interest at 9.01%, $52,000 bears simple interest at 8.36%, $425,000 bears simple interest at the Applicable Federal Rate for short-term obligations (3.58% at August 31, 2005) and $27,000 bears no interest.  The notes are payable at various dates between August 2007, and October 2007.  Interest is not payable on a current basis, but does accrue and is added to the principal monthly.

Operating Activities

Operating activities include revenues we receive from the sale of water and wastewater services to our customers, costs incurred in the delivery of those services, general and administrative expenses, and depletion/depreciation expenses.

During fiscal 2005, cash used in operating activities was approximately $818,000 compared to $528,000 in fiscal 2004.  Operating costs increased due to increased health insurance costs, management bonuses, payment of board of director fees and annual retainers, increased legal fees and payments made to the District which were offset by us not expending any funds to repurchase contingent obligations as we did in fiscal 2004.  Accrued interest on the note receivable of approximately $17,000 was offset by accrued interest on notes payable of approximately $34,000.  In 2004, we repaid $1.6 million of debt along with approximately $2.0 million of accrued interest so the level of cash required for operations during fiscal 2006 should remain lower than in previous years.  We will continue to provide domestic water and wastewater service to customers in our service area and we will continue to operate and maintain our water and wastewater systems with our own employees.

Investing Activities

We continue to invest in the acquisition, development and maintenance of both the Rangeview and Paradise water assets and intend to exercise our option to acquire the next 20% of the Sky Ranch groundwater under the DGPA for $50,000 in fiscal 2006.  These investments include legal and engineering fees associated with adjudicating additional water through the Water Court system, as well as right-of-way permit fees to the Department of Interior Bureau of Land Management for our Paradise Water Supply.  Additionally, with the anticipated start of construction at Sky Ranch, and the construction of the facilities required to provide water service to the Arapahoe County Fairgrounds, we anticipate cash required by investing activities to increase in fiscal 2006.

Cash provided by investing activities for fiscal 2005 was approximately $198,000.  During fiscal 2005, we maintained temporary investments of funds generated from the equity offering in fiscal 2004.  Costs of approximately $405,000 were capitalized to our water assets, which included approximately $223,000 related to the start of construction of the water system required to provide water service to the Fairgrounds.  During fiscal 2005,

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we received option payments totaling $60,400 from the developer of Sky Ranch related to the potential use of Export Water.  Cash used by investing activities for fiscal 2004, was approximately $4.1 million which included the initial investment of funds from the equity offering.  We capitalize certain acquisition, legal, engineering and permitting costs relating to the improvement of our water assets.

Financing Activities

Cash provided by financing during fiscal 2005 was approximately $1.0 million compared to $5.7 million in fiscal 2004.  Significant financing items during fiscal 2005 and 2004 included the receipt of approximately $677,000 related to exercises of stock options in 2005 and the receipt of approximately $10.6 million from the sale of stock in the equity offering and from the exercising of warrants in 2004.  In 2004, proceeds from the equity offering where partially offset by the repurchase of certain CAA interests for approximately $2.8 million in cash and $2.0 million of debt payments.

Impact of Recently Issued Accounting Pronouncements

In December 2004, the FASB issued Statement of Financial Accounting Standard No. 123 (revised 2004) Share-Based Payment (“SFAS 123R”) which is a revision of SFAS 123 and addresses the accounting for employee stock options. SFAS 123R is effective for public companies that file as small business issuers for annual periods beginning after December 15, 2005 (SFAS 123R is effective for us beginning fiscal 2007 or September 1, 2006).  SFAS 123R supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows.  Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123.  However, SFAS 123R requires that all share-based payments to employees, including grants of employee stock options, be recognized in the income statement based on their fair values.  Pro forma disclosure is no longer an alternative.  We have not yet completed our evaluation of the impact of SFAS 123R, but we expect the adoption to have a material effect on our financial statements.  See “Note 2 – Summary of Significant Accounting Policies” in the accompanying financial statements for pro-forma disclosures required under SFAS 123.

Total Contractual Cash Obligations

Our contractual obligations with defined maturities consists entirely of our long-term debt with related parties.  The total obligations to these related parties, including accrued interest, is $1.46 million.  Of this, $877,000 is due in August 2007; $552,000 is due in September 2007; and $27,000 is due in October 2007.  The holder of the notes due in August 2007 is a party to the CAA and has agreed that if the amount of principal and accrued interest on these notes is paid under the CAA prior to the maturity date of the notes, the notes will be cancelled.

In August 2005, we entered into an agreement with a contractor to build a 500,000 gallon water tower for use at the Fairgrounds. The contract calls for milestone payments over the next twelve months totaling approximately $680,000, following a $218,500 payment made in August 2005.

We are also contingently liable for payments to third parties totaling $23.4 million upon the sale of Export Water.  The timing of these payments is determined based on sales of Export Water.  Therefore, it is unknown if and when these payments will ultimately be made.

Employees and Significant Customers

We currently have three full-time employees.

For the years ended August 31, 2005 and 2004, 98% and 96% of our revenues were from two customers, respectively.

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Item 7. Financial Statements

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Report of Independent Registered Public Accounting Firm

The Board of Directors
Pure Cycle Corporation:

We have audited the accompanying balance sheet of Pure Cycle Corporation (the “Company”) as of August 31, 2005, and the related statements of operations, stockholders’ equity, and cash flows for the year then ended.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pure Cycle Corporation as of August 31, 2005, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

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Report of Independent Registered Public Accounting Firm

The Board of Directors

Pure Cycle Corporation:

We have audited the accompanying balance sheet of Pure Cycle Corporation (the Company) as of August 31, 2004, and the related statements of operations, stockholders’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pure Cycle Corporation as of August 31, 2004, and the results of its operations and its cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.

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PURE CYCLE CORPORATION

BALANCE SHEETS

See accompanying Notes to Financial Statements

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PURE CYCLE CORPORATION

STATEMENTS OF OPERATIONS

See accompanying Notes to Financial Statements

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PURE CYCLE CORPORATION

STATEMENTS OF STOCKHOLDERS’ EQUITY

YEARS ENDED AUGUST 31, 2005 AND 2004

See accompanying Notes to Financial Statements

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PURE CYCLE CORPORATION

STATEMENTS OF CASH FLOWS

See accompanying Notes to Financial Statements

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PURE CYCLE CORPORATION

NOTES TO FINANCIAL STATEMENTS

AUGUST 31, 2005 AND 2004

NOTE 1 – ORGANIZATION

Description of Business.  Pure Cycle Corporation (the “Company”) was incorporated in Delaware in 1976.  The Company owns water assets located in the Denver, Colorado metropolitan area and on the western slope of Colorado.  The Company is currently using its water assets located in the Denver metropolitan area to provide water and wastewater services to customers located in its service area.  The Company operates water and wastewater systems and provides services which include the design and construction of the systems as well as the operation and maintenance of the systems.  The Company also owns water recycling technologies which are capable of processing wastewater into potable drinking water. The Company’s main focus is to provide water and wastewater service to customers within its service area and other areas in the Denver metropolitan area.

The Company believes that at August 31, 2005, it has sufficient working capital and financing sources to fund its operations for at least the next year.  However, there can be no assurances that the Company will be successful in marketing the water from its primary water projects on terms that are acceptable to the Company.  The Company’s ability to ultimately realize its investment in its primary water projects is dependent on its ability to successfully market the water, or in the event it is unsuccessful, to sell the underlying water assets.  In the event increased sales are not achieved, the Company may incur additional short or long-term debt or seek to sell additional shares of the Company’s common or preferred stock or stock purchase warrants, as deemed necessary by the Company, to generate sufficient working capital.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition.  The Company generates revenues mainly from three sources; (i) water and wastewater tap fees, (ii) construction fees, and (iii) monthly water usage fees and wastewater service fees.  Emerging Issues Task Force Issue No. 00-21 Revenue Arrangements with Multiple Deliverables (“EITF 00-21”), governs how to identify when goods or services, or both, that are separately delivered but included in a single sales arrangement should be accounted for separately.  Based on the criteria of EITF 00-21, the Company accounts for each of the items addressed in the service agreement separately.

The Company recognizes revenues from the sale of water and wastewater taps as income upon receipt if the facilities required to provide water or wastewater services are in place and operational.  If the facilities are not in place and operational, the Company defers recognition of the tap fees until the facilities are completed and placed in operation.  The Company defers construction fees received for assets that it will own and reflects them as deferred construction funding on the balance sheet.  Deferred construction fees are recognized as revenue over the estimated service period which is also the estimated useful life of the assets constructed.  The Company recognizes water usage revenues upon delivering water to customers.  The Company recognizes wastewater processing revenues based on flat fees assessed per single family equivalent (“SFE”) unit served.  An SFE is defined in the Rangeview Metropolitan District’s (the “District” – described in Note 3) Rules and Regulations as the amount of water required each year by a family of four persons living in a single family house on a standard sized lot.

Costs to construct the Wholesale Facilities and Special Facilities are capitalized as incurred, including interest, if the costs meet the Company’s capitalization criteria, which are then depreciated over their estimated useful lives.  Costs of delivering water and providing wastewater service to customers are recognized as incurred.

The Company did not recognize any tap fee revenue or construction revenue during the years ended August 31, 2005 and 2004.  As of August 31, 2005, the Company has deferred recognition of $375,894 of tap fee revenue for tap sales to Arapahoe County and $44,415 of option payments received from Sky Ranch, both of which are more fully explained in Note 3.

Use of Estimates.  The preparation of financial statements in conformity with Accounting Principles Generally Accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

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Cash and Cash Equivalents.  Cash and cash equivalents include all highly liquid debt and equity instruments with original maturities of three months or less. The Company’s cash equivalents are comprised of money market funds, investments in debt securities and investments in commercial paper.  As of August 31, 2005, the Company has no investments in equity instruments.

Restricted Cash.  Restricted cash is comprised of (i) $174,890 of proceeds received by the Company from Arapahoe County for Export Water sales (see Notes 3 and 4), that are to be remitted to an escrow agent and paid to external parties as required by the Comprehensive Amendment Agreement No. 1 (the “CAA”), and (ii) $15,000 of proceeds received by the Company from Sky Ranch (see Notes 3 and 4) that are to be remitted to an escrow agent and paid to external parties as required by the CAA.

Financial Instruments.  Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, investments in marketable securities and notes payable – related parties. The Company places its cash equivalents and investments with a high credit-quality financial institution. The Company invests its excess cash primarily in money market instruments, commercial paper obligations, corporate bonds and US government treasury obligations.  To date, the Company has not experienced significant losses on any of these investments.  The notes payable – related parties bear interest at rates that approximate market.

Cash Flows.  During fiscal 2005 and 2004, respectively, the Company paid $0 and $485,999 of interest.  No cash was paid for income taxes in either fiscal 2005 or 2004.  See Note 7 for discussion regarding non-cash exchange of common stock for warrants.

Marketable Securities.  Management determines the appropriate classification of its investments in debt and equity securities at the time of purchase and reevaluates such determinations each reporting period. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity.  The Company had no investments classified as held-to-maturity at August 31, 2005 or 2004.

Debt securities for which the Company does not have the positive intent or ability to hold to maturity are classified as available-for-sale, along with any investments in equity securities.  Securities classified as available-for-sale are marked-to-market at each reporting period. Changes in value on such securities are recorded as a component of Accumulated comprehensive income. The cost of securities sold is based on the specific identification method.

The following is a summary of marketable securities at August 31, 2005:

The following is a summary of marketable securities at August 31, 2004:

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In fiscal 2005, gross realized losses totaled $15,563, while gross realized gains totaled $11,996 in fiscal 2004.  The aggregate fair value of investments with unrealized gains as of August 31, 2005 and 2004 was $3,257,837 and $4,755,465, respectively.  The aggregate fair value of investments with unrealized losses as of August 31, 2005 and 2004 was $1,388,685 and $506,456, respectively.  The investments that are in a net loss position are deemed to be temporary losses based on the nature of the corporate bond markets and the significant fluctuations that have occurred in the markets over the past several years.  The Company actively monitors the performance of its investments and adopted a new investment policy in fiscal 2005, to more closely align its investment portfolio with its expected capital requirements.  All losses incurred during 2005 were the result of the Company shortening its average maturity in its investment portfolio to allow it more flexibility regarding anticipated capital needs in the short-term and to allow it to capitalize on interest rates that have continued to rise since the equity offering in 2004, when the majority of the investments were made.

The Company’s marketable securities mature at various dates through 2007.  However, these securities represent the temporary investment of capital and it is not managements’ intention to hold these securities until maturity.

Long-Lived Assets.  The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the eventual use of the asset.  If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets.  Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.  The Company believes there are no impairments in the carrying amounts of its long-lived assets at August 31, 2005.

Water and Wastewater Systems.  The Company capitalizes design and construction costs related to construction activities as water or wastewater systems, and it capitalizes certain legal, engineering and permitting costs relating to the adjudication and improvement of its water assets.

Depletion and Depreciation of Water Assets.  The Company depletes its water assets that are being utilized on the basis of units produced divided by the total volume of water adjudicated in the water decrees.  Water systems are depreciated on a straight line basis over their estimated useful lives of 30 years.

Stock-Based Compensation.  The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees.  The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation as specified in SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No. 123. The pro forma disclosure of net loss and loss per share required by SFAS No. 123 is shown below.