• Expenses associated with developing our water assets; and

• Cash available to continue development of our water rights and service agreements.

Our MD&A section includes the following items:
Our Business - a general description of our business, our services and our business strategy.

Critical Accounting Policies and Estimates - a discussion of our critical accounting policies that require critical judgments, assumptions and estimates.

Results of Operations - analysis of our results of operations for the three fiscal years presented in our financial statements. We present our discussion in the MD&A in conjunction with the accompanying Financial Statements.

Liquidity, Capital Resources and Financial Position - an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements.

Our Business
We are a water and wastewater service provider. We contract with land owners, land developers, home builders, cities, and municipalities to design, construct, operate and maintain water and wastewater systems using our balanced water portfolio consisting of surface water and groundwater supplies, surface water storage, aquifer storage, and reclaimed water supplies. We generate cash flows and revenues by (i) selling taps (connections) to our water and wastewater systems and/or (ii) monthly service fees and consumption charges from metered deliveries. Tap fee (connection) charges are a one-time fee typically paid by developers which are used to recoup the cost of the Company's water rights and for construction of the various facilities required to withdraw, store, treat and deliver water to customers and reclaim, store, treat and deliver treated effluent water to satisfy irrigation demands. Monthly service fees and consumption charges from metered deliveries of water and flat monthly fees for wastewater are paid by customers - homeowners, business owners or consumers of water and wastewater services. Monthly service fees include (i) base monthly fees, (ii) monthly metered water usage fees (both potable and irrigation uses which are charged at different rates), and (iii) other service related fees. We currently provide water service to approximately 247 single family equivalent water connections and approximately 157 single family equivalent wastewater connections. During the fiscal years ended August 31, 2009, 2008 and 2007, we did not sell any water or wastewater taps. During the fiscal years ended August 31, 2009, 2008 and 2007, we received approximately $137,400, $159,700 and $149,500 from the sale of water, respectively, and we received approximately $67,000, $67,000 and $60,300 from monthly wastewater service fees, respectively. Currently all monthly water and wastewater fees are generated utilizing our Rangeview Water Supply. See Critical Accounting Policies and Use of Estimates below regarding our revenue recognition policies.

Critical Accounting Policies and 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 about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with the timing of revenue recognition, the impairment analysis of our water rights, management's valuation of the Tap Participation Fee, and share-based compensation. Below is a summary of these critical accounting policies.
Revenue Recognition
Our revenues consist mainly of tap fees and monthly service fees. As further described in Note 2 to the accompanying financial statements, proceeds from tap sales are deferred upon receipt and recognized in income based on whether we own or do not own the facilities constructed with the proceeds. We recognize tap fees derived from agreements for which we construct infrastructure the customer will own as revenue, along with the associated costs of construction, pursuant to the percentage-of-completion method. The percentage-of-completion method requires management to estimate the percent of work that is completed on a particular project, which could change materially throughout the duration of the construction period and result in significant fluctuations in revenue recognized during the reporting periods throughout the construction process. We did not recognize any revenues pursuant to the percentage-of-completion method during the fiscal years ended August 31, 2009, 2008 or 2007.
Tap fees derived from agreements for which we own the infrastructure are recognized as revenue ratably over the estimated service life of the assets constructed with said fees. Although the cash will be received up-front and most construction will be completed within one year of receipt of the proceeds, revenue recognition may occur over 30 years or more. Management is required to estimate the service life, and currently the service life is based on the estimated useful accounting life of the assets constructed with the tap fees. The useful accounting life of the asset is based on management's estimation of an accounting based useful life and may not have any correlation to the actual life of the asset or the actual service life of the tap. This is deemed a reasonable recognition life of the revenues because the depreciation of the assets constructed generating those revenues will be matched with the revenues. Impairment of Water Assets and Other Long-Lived Assets We review our long-lived assets for impairment at least annually or whenever management believes 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 estimated future undiscounted net cash flows we expect to be generated by the eventual use of the asset. If such assets are considered to be impaired and therefore the costs of the assets deemed to be unrecoverable, the impairment to be recognized would be the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets.
Our water assets will be utilized in the provision of water services which inevitably will encompass many housing and economic cycles. Our service capacities are quantitatively estimated based on an average single family home utilizing .4 acre-feet of water per year. Our water supplies are legally decreed to us through the Water Court. The Water Court decree allocates a specific amount of water (subject to continued beneficial use) which historically has not changed. Thus, individual housing and economic cycles typically do not have an impact on the number of connections we can serve or the amount of water legally decreed to us.
We report assets to be disposed of at the lower of the carrying amount or fair value less costs to sell.

Our Front Range and Arkansas River Water Rights We determine the undiscounted cash flows for our Denver based assets and the Arkansas River Valley assets by estimating tap sales to potential new developments in our service area and along the Front Range, using estimated future tap fees less estimated costs to provide water services, over an estimated development period. Actual new home development in our service area and the Front Range, actual future tap fees, and actual future operating costs, inevitably will vary significantly from our estimates, which could have a material impact on our financial statements as well as our results of operations. We performed an impairment analysis as of August 31, 2009, and determined that our Rangeview and Arkansas River water assets were not impaired and their costs were deemed recoverable. Our impairment analysis is based on development occurring within areas in which we have service agreements (e.g. Sky Ranch and the Lowry Range) as well as in surrounding areas including the Front Range, and the I-70 corridor. We estimate that we have the ability to provide water services to approximately 180,000 SFE's using our combined Front Range and Arkansas River water assets which have a carrying value of approximately $97.5 million as of August 31, 2009. Based on the carrying value of our water rights, the long term and uncertain nature of any development plans, current tap fees of $22,500 and estimated gross margins, we estimate that we would need to add approximately 8,000 new water connections (requiring approximately 4.8% of our portfolio) to generate net revenues sufficient to recover the costs of our Front Range and Arkansas River water assets. If tap fees increase 5%, we would need to add approximately 7,600 new water taps (requiring approximately 4.6% of our portfolio) to recover the costs of our Front Range and Arkansas River water assets. If tap fees decrease 5%, we would need to add approximately 8,400 new water taps (requiring approximately 5.0% of our portfolio) to recover the costs of our Front Range and Arkansas River water assets.
Although the withdrawal of the Lowry Range developer, the Sky Ranch bankruptcy filing, and changes in the housing market throughout the Front Range have delayed our estimated tap sale projections, they do not alter our water ownership, nor our service obligation to these properties or the number of SFE's we can service.
Our Paradise Water Rights
Every six years the Paradise Water Supply is subject to a Finding of Reasonable Diligence review by the Water Court and the State Engineer. For a favorable finding, the Water Court must determine that we continue to diligently pursue the development of the water rights. If the Water Court does not 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. The most recent diligence review was started in our fiscal 2005 and was completed in 2008, but not without objectors and not without us having to agree to certain stipulations to remove the objections. In order to continue to maintain the Paradise water right, over the next six years we must (i) select an alternative reservoir site; (ii) file an application in Water Court to change the place of storage; (iii) identify specific end users and place(s) of use of the water; and (iv) identify specific source(s) of the water rights for use. We fully intend to meet the stipulations by the date of the next diligence review.
For our Paradise Water Supply, we determined the undiscounted cash flows by estimating the proceeds we could derive from the leasing of the water rights to commercial, industrial, and agricultural users along the western slope of Colorado, and based on the impairment analysis we completed at August 31, 2009, we believe the Paradise Water Supply is not impaired and the costs are deemed recoverable.
Tap Participation Fee
On August 31, 2006, we acquired 60,000 acre-feet of Arkansas River water along with approximately 17,500 acres of real property and other associated rights from HP A&M. Along with common stock issued to HP A&M, we agreed to pay HP A&M 10% (this may increase to 20% under circumstances described in Note 8 to the accompanying financial statements) of our tap fees on the sale of the next 40,000 water taps we sell from and after the date of the Arkansas River Agreement, of which 38,937 water taps remain to be paid as of August 31, 2009. The Tap Participation Fee is payable when we sell water taps and receive funds from such water tap sales or other dispositions of property purchased in the HP A&M acquisition. The Tap Participation Fee liability is valued by estimating new home development in our service area over an estimated development period. This was done by utilizing third party historical and projected housing and population growth data for the Denver metropolitan area applied to an estimated development pattern supported by historical development patterns of certain master planned communities in the Denver metropolitan area. This development pattern was then applied to estimated future water tap fees determined by using historical water tap fee trends. Based on updated new home activity in the Denver metropolitan area, we updated the estimated discounted cash flow analysis as of February 28, 2009. Due to a lack of significant changes, no such update was deemed necessary as of August 31, 2009. Actual new home development in our service area and actual future tap fees inevitably will vary significantly from our estimates which could have a material impact on our financial statements as well as our results of operations. An important component in our estimate of the value of the Tap Participation Fee, which is based on historical trends, is that we reasonably expect water tap fees to continue to increase in the coming years. Tap fees are a market based pricing metric which in part demonstrates the increasing costs to acquire and develop new water supplies. It is thus a market metric which in part demonstrates the increasing value of our water assets. We continue to assess the value of the Tap Participation Fee liability and update its valuation analysis whenever events or circumstances indicate the assumptions used to estimate the value of the liability have changed materially. The difference between the net present value and the estimated realizable value will be imputed as interest expense using the effective interest method over the estimated development period utilized in the valuation of the Tap Participation Fee.

Obligations Payable by HP A&M
Certain of the properties we acquired pursuant to the Arkansas River Agreement are subject to outstanding promissory notes with principal and accrued interest totaling approximately $12.0 million at August 31, 2009. These notes are secured by deeds of trust on the properties. We did not assume any of these promissory notes and are not responsible for making any of the required payments under these notes. This responsibility remains solely with HP A&M. However, in the event of default by HP A&M, we may make payments on any or all of the notes and cure any or all defaults. If we do not cure the defaults, we will lose the properties securing the defaulted notes and the water rights associated with said properties. If HP A&M defaults on any of the promissory notes, we can foreclose on a defined amount of Pure Cycle stock issued to HP A&M being held in escrow and reduce the Tap Participation Fee by two times the amount of notes defaulted on by HP A&M. Although the likelihood of HP A&M defaulting on the notes is deemed remote, which is the primary reason these notes are not reflected on our balance sheet, we continue to monitor the status of the notes for any indications of default. We are not aware of any defaults by HP A&M as of August 31, 2009.
Share-based compensation
We estimate the fair value of share-based payment awards made to key employees and directors on the date of grant using the Black-Scholes option-pricing model. We then expense the fair value over the vesting period of the grant using a straight-line expense model. The fair value of share-based payments requires management to estimate/calculate various inputs such as the volatility of the underlying stock, the expected dividend rate, the estimated forfeiture rate and an estimated life of each option. These assumptions are based on historical trends and estimated future actions of option holders and may not be indicative of actual events which may have a material impact on our financial statements. See Note 9 to the accompanying financial statements for further details on share-based compensation expense.
Results of operations
Executive Summary
The results of our operations for the fiscal years ended August 31, 2009, 2008 and 2007 were as follows:

                                                                                                            Change
                                           Fiscal Years Ended August 31,                     2009-2008                   2008-2007
                                      2009             2008             2007               $              %            $             %
Millions of gallons of water
delivered                                 33.9             42.8             44.4              (8.9 )      -21 %          (1.6 )       -4 %
Water revenues generated           $   137,400      $   159,600      $   149,500      $    (22,200 )      -14 %    $   10,100          7 %
Water delivery operating costs
incurred (excluding
depreciation and depletion)        $    54,700      $    58,600      $    54,600      $     (3,900 )       -7 %    $    4,000          7 %
Water delivery gross margin %               60 %             63 %             63 %

Wastewater treatment revenues      $    67,000      $    67,000      $    60,300      $          -          0 %    $    6,700         11 %
Wastewater treatment operating
costs incurred                     $    20,200      $    18,900      $    22,800      $      1,300          7 %    $   (3,900 )      -17 %
Wastewater treatment gross
margin %                                    70 %             72 %             62 %

General and administrative
expenses                           $ 1,942,200      $ 2,316,800      $ 2,476,500      $   (374,600 )      -16 %    $ (159,700 )       -6 %

Net losses                         $ 5,728,100      $ 6,926,700      $ 6,914,700      $ (1,198,600 )      -17 %    $   12,000          0 %

Water and Wastewater Usage Revenues
Our water service charges are based on a tiered pricing structure that provides for higher prices as customers use greater amounts of water. Our rates and charges are established based on the average of three surrounding water providers. Table B in Item 1 - Business, outlines our tiered pricing structure and changes during the fiscal years ended August 31, 2009, 2008 and 2007, respectively.
Our wastewater customers are charged flat monthly fees based on their number of tap connections.
Fiscal 2009 compared to fiscal 2008
Water deliveries during fiscal 2009 dropped approximately 21% over water deliveries in fiscal 2008, due mainly to precipitation being higher in fiscal 2009, particularly in the late spring and early summer months which are the main irrigation months. Water usage fees in fiscal 2009 decreased 14% over fiscal 2008 which is mainly a result of the decreased water usage which was partially offset by the increased water usage fees.
Wastewater usage fees remained at $39.50 per wastewater tap per month. Gross margins for water services decreased approximately 3% in 2009 compared to 2008. This was due to the decreased water usage as noted above. The decrease in the gross margin percentage was not as large as the decrease in water usage due to our efforts to maintain costs knowing water usage was decreasing. Gross margins for wastewater services in fiscal 2009 decreased 2% over fiscal 2008 due to timing of various testing procedures. Fiscal 2008 compared to fiscal 2007
Water deliveries during fiscal 2008 dropped approximately 4% over water deliveries in fiscal 2007, due mainly to precipitation being higher in fiscal 2008. However, water usage fees in fiscal 2008 increased 7% over fiscal 2007 which is mainly a result of the timing of water usage and an increasing block pricing scale (as of July 1, 2007) for an entire fiscal year in 2008 versus two months in fiscal 2007.
Wastewater usage fees remained at $39.50 per wastewater tap per month and before that they increased July 1, 2007, from $34.80 to $39.50 per wastewater tap per month. Consistent with water taps, the increased wastewater fees in fiscal 2008 is a result of the higher usage fees being charged for the entire fiscal 2008 versus two months in fiscal 2007.
Gross margins for water services remained constant from fiscal 2007 to fiscal 2008. Gross margins for wastewater services in fiscal 2008 increased 10% over fiscal 2007 due to certain testing and compliance expenses incurred during fiscal 2007 not experienced in fiscal 2008. General and Administrative and Other Expenses General and administrative ("G&A") expenses for the fiscal years ended August 31, 2009, 2008 and 2007 were impacted by the share-based compensation expenses as follows (amounts are approximate):

                             Table H - G&A Expenses

                                                                                                         Change
                                         Fiscal Years Ended August 31,                    2009-2008                  2008-2007
                                    2009             2008             2007              $             %            $             %
G&A expenses as reported         $ 1,942,200      $ 2,316,300      $ 2,476,500      $ (374,100 )       16 %    $ (160,200 )        6 %
Share-based compensation
expenses                            (325,500 )       (351,500 )       (287,300 )        26,000         -7 %       (64,200 )       22 %

G&A expenses less share-based
compensation expenses            $ 1,616,700      $ 1,964,800      $ 2,189,200      $ (348,100 )       18 %    $ (224,400 )       10 %

The changes in G&A expenses, with and without share-based compensation expenses, are mainly attributable to the following:
Fiscal 2009 compared to fiscal 2008
From fiscal 2008 to fiscal 2009, G&A expenses, without share-based compensation expenses, decreased approximately 18%, which is mainly a result of management's cost cutting efforts in light of the poor economy and lack of new home development in our targeted service areas. Specifically, the following accounts decreased during 2009:
• Excluding share-based compensation expenses our salary and salary related expenses in fiscal 2009 and 2008 were $465,800 and $463,900, respectively, which is less than a 5% change. Salary and salary related expenses including share-based compensation expenses totaled approximately $791,300 and $815,400 for the fiscal years ended August 31, 2009 and 2008, respectively. This decrease is less than 5%.

• Consulting fees decreased approximately $143,900, or 63%, from approximately $227,600 in fiscal 2008 to approximately $83,700 in fiscal 2009. This was entirely due to the decrease in use of consultants as a result of the withdrawal of the developer from the Lowry Range development project.

• Professional fees (legal and accounting) decreased approximately $93,900, or 24%, from approximately $386,000 in fiscal 2008 to approximately $292,100 in fiscal 2009. This is a result of our reduced use of legal counsel as a result of the withdrawal of the developer from the Lowry Range development project and less activity in Water Court.

• Costs associated with being a corporation and costs associated with being a publicly traded entity decreased approximately $66,700, or 52%, from $127,900 in fiscal 2008 to approximately $61,100 in fiscal 2009. This is due primarily to the elimination of franchise fees paid to the State of Delaware due to our reincorporation into Colorado.

Fiscal 2008 compared to fiscal 2007
From fiscal 2007 to fiscal 2008, G&A expenses decreased approximately 10%, which is mainly a result of:
• Excluding share-based compensation expenses our salary and salary related expenses in fiscal 2008 and 2007 were $463,900 and $805,200, respectively, a decrease of $341,300 or 42%. Salary and salary related expenses including share-based compensation expenses totaled approximately $815,400 and $1.1 million for the fiscal years ended August 31, 2008 and 2007, respectively. The decrease in salaries is mainly attributable to management and employee wages remaining unchanged in 2008 and there being no incentive compensation paid in 2008 as compared to incentive compensation of $330,000 being paid in fiscal 2007 upon the completion of the July 2007 equity offering.

• Professional fees (legal and accounting) totaled approximately $386,000 and $470,300, for 2008 and 2007, respectively. This decrease of $84,300 is a result of legal and accounting bills incurred in fiscal 2007 related to our consultations with the Staff of the Commission which did not recur in 2008.

• Costs associated with being a corporation and costs associated with being a publicly traded entity decreased approximately $92,900 from $220,800 in fiscal 2007 to approximately $127,900 in fiscal 2008. This is due primarily to the elimination of franchise fees paid to the State of Delaware due to our reincorporation into Colorado.

The above decreases were offset by the following significant increases.
• During fiscal 2008 and 2007, we expensed approximately $330,500 and $255,900 related to water assessment charges payable to the FLCC. This is an increase of $74,600, which is a result of the FLCC increasing assessments for the current fiscal year. This represents our share (based on the number of FLCC shares we own) of FLCC's annual operating and maintenance expenditures. Additionally, in fiscal 2008 and 2007 we expensed approximately $49,700 and $37,200, respectively, for work performed in the Arkansas River Valley on our behalf by HP A&M. The increase is a result of increased salaries to the HP A&M farm management personnel which resulted in an increase in our costs.

• We paid approximately $227,600 and $40,000 in consulting fees related to our discussions with the former developer of the Lowry Range concerning the potential development of six sections of the Lowry Range in fiscal 2008 and 2007, respectively.

Depreciation and depletion charges for the fiscal years ended August 31, 2009, 2008 and 2007 were approximately $381,700, $381,300 and $366,100, respectively, which are changes of less than 5% per fiscal year. . . .