| PURE CYCLE CORP Item 1A Risk Factors Our business, operations, and financial condition are subject to 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 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 Land Board, which expire in 2081 and entitle us to provide water service to the Lowry Range Property |
| In addition to the Lowry Range, we have service agreements with Sky Ranch, which 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 Land Board, which is in the early stages of considering various development alternatives, but no timetable exists for development |
| As a component of the Sky Ranch Agreements, we are dependent on the development of the property prior to us receiving revenues for water service, which development is under the control of the developer |
| 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 |
| In the event development of the Lowry Range Property and the surrounding areas is delayed, or the 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 |
| 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 close 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 |
| In order to utilize the Arkansas River water acquired in fiscal 2006, we have to apply for a change of use with the Colorado water court and this may take several years to complete |
| The change of use of our Arkansas River water requires a ruling by the Colorado water courts, which could take several years and be a costly and contentious effort since it is anticipated that many parties will oppose the transfer of the water |
| There are several conditions which must be satisfied prior to our receiving a change of use decree for transfer of our Arkansas River water |
| One condition that we must satisfy is a showing of anti-speculation in which we, as the applicant must demonstrate that we have contractual obligations to provide water service to customers prior to the water court ruling on the transfer of a water right |
| The water court is also expected to limit the transfer to the “consumptive use” portion of the water right and to address changing the historic use of the water from agricultural uses to other uses such as municipal and industrial use |
| We expect to face opposition to any consumptive use calculations of the historic agricultural uses of this water |
| The water court may impose conditions on our transfer of the water rights such as requiring us to mitigate the loss of the farming tax base, imposing re-vegetation requirements to convert soils from irrigated to non-irrigated, and imposing water quality measures |
| Any such conditions will likely increase the cost of transferring the water rights |
| 16 ______________________________________________________________________ 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, 2006, 2005 and 2004, we had net losses of approximately dlra793cmam000, dlra1cmam051cmam000 and dlra1cmam976cmam000, respectively, on revenues of approximately dlra271cmam700, dlra234cmam700 and dlra205cmam000, 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 dlra10dtta1 million through the issuance of approximately 2dtta5 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 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 Land Board and our contract with the District |
| 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-based districts |
| 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 Land Board for rate increases |
| There can be no assurance that the 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 our activities relating to the Sky Ranch Agreements to significantly expand our business, and we are actively pursuing additional development opportunities in areas near Sky Ranch, as well as opportunities near our recently acquired Arkansas River water |
| 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 |
| 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 17 ______________________________________________________________________ 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, 2006 has a recorded cost of approximately dlra5dtta5 million |
| Our ability to convert our Paradise Water Supply into an income generating asset is limited |
| Due to the nature of the Paradise Water rights and agreements with other western slope water interests, our use of the Paradise Water Supply is limited to opportunities along the western slope |
| 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 could be difficult |
| 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 would be lost and we would be required to impair the Paradise Water Supply asset and incur a dlra5dtta5 million charge against earnings |
| The State Engineers office began its latest review of our conditional water rights in fiscal 2005 |
| 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 receive dlra75 for each board meeting or a maximum compensation of dlra1cmam200 per year |
| We have made loans to the District to fund its operations |
| At August 31, 2006, total principal and interest owed to us by the District was approximately dlra452cmam200 |
| The District is a party to our agreements with the Land Board and receives fees of 5prca 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 these 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 18 ______________________________________________________________________ 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 US 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 intend to 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 our water and wastewater delivery systems |
| 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 would not be 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 or 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 |
| 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 |
| 19 ______________________________________________________________________ Weaknesses in the Company’s internal controls and procedures could have a material adverse effect on the Company |
| Management is responsible for establishing and maintaining adequate internal control over financial reporting |
| Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with US generally accepted accounting principles (“GAAP”) |
| In making its assessment of internal control over financial reporting as of August 31, 2006, management used the criteria described in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission |
| A material weakness is a control deficiency, or combination of control deficiencies, that results in a more than remote likelihood a material misstatement of the annual or interim financial statements will not be prevented or detected |
| Management determined that a material weaknesses in our internal control over financial reporting existed as of August 31, 2006 |
| See Item 9A — Controls and Procedures for a description of this material weakness |
| The material weakness identified resulted in an adverse opinion by our independent registered public accounting firm on the effectiveness of our internal control over financial reporting |
| We are developing a remediation plan and intend to implement remediation measures during fiscal 2007, designed to remediate the material weakness in our internal controls by August 31, 2007 (See Item 9A — Controls and Procedures) |
| We cannot assure you as to when the remediation plan will be fully implemented, nor can we assure you that additional material weaknesses will not be identified by our management or independent accountants in the future |
| In addition, even after the remedial measures are fully implemented, our internal controls may not prevent all potential error and fraud, because any control system, no matter how well designed, can only provide reasonable and not absolute assurance that the objectives of the control system will be achieved |
| Accounting for the Arkansas River Agreement is not finalized The Company completed the acquisition of the Arkansas River Water Rights and related assets as of August 31, 2006 and has provided purchase accounting based on initial valuations which may be subject to change |
| We are continuing to evaluate future impacts on our balance sheet and statement of operations for fiscal years 2007 and continuing, which could result in a material impact to our financial statements |