UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D. C. 20549
Form
10-KSB/A
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x
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ANNUAL
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the fiscal year ended December 31, 2004
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¨
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TRANSITIONAL
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the transition period from
to
Commission
file number: 333-64122
VERDISYS,
INC.
(Name
of small business issuer in its charter)
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California
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22-3755993
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|
(State
of incorporation)
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(IRS
Employer
Identification
Number)
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14550
Torrey Chase Blvd, Suite 330
Houston,
Texas 77014
(Address
of principal executive offices)
(281)
453-2888
(Telephone
number)
Securities
registered under Section 12(b) of the Exchange Act: None
Securities
registered under Section 12(g) of the Exchange Act: None
Check
whether 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 x No ¨
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 the registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-KSB or any
amendments to this Form 10-KSB. x
Issuer’s
revenues for the most recent fiscal year: $1,453,344
The
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the average bid and asked price of
such
common equity, as of February 27, 2005 is $9,050,540.
The
number of shares outstanding of each of the issuer’s classes of common equity,
as of December 31, 2004:
Common
Stock: 33,443,691 shares
1
No
(1)
annual report to security holders; (2) proxy or information statement; or (3)
any prospectus filed pursuant to Rule 424(b) or (c) of the Securities Act of
1933; are incorporated by reference into any part of this Form 10-KSB.
Transitional
Small Business Disclosure Format: ¨ Yes; x No
Explanatory
Note
Verdisys,
Inc. (now known as Blast Energy Services, Inc.) is filing this amended Annual
Report on Form 10-KSB/A for the year ended December 31, 2004 (“Amended Annual
Report”) to amend its Annual Report on Form 10-KSB for the year ended December
31, 2004 (the “Original
Annual
Report”),
which was filed with the Securities and Exchange Commission on March 30,
2005.
The
Amended Annual Report amends the disclosure under
the
Part I, Item 1 “Financial Statements,” Part I, Item 2 “Management's Discussion
and Analysis and Plan of Operation - Forward Looking Statements,” and Part II,
Item 8a “Controls and Procedures.” Except for these items, no other information
in the original Report is amended hereby.
2
Table
of
Contents
Item
1.
Description of Business
Forward-Looking
Statements
Certain
statements concerning our plans and intentions included herein may constitute
forward-looking statements, including, but not limited to, statements identified
by the words “anticipate”, “believe”, “expect” and similar expressions and
statements regarding our business strategy, plans, beliefs and objectives for
future operations. Although management believes that the expectations reflected
in these forward looking statements are reasonable, we can give no assurance
that such expectations will prove to have been correct. There are a number
of
factors that may affect our future results, including, but not limited to,
(a)
our ability to obtain additional funding for development and operations, (b)
the
continued availability of management to execute the business plan, (c)
successful deployment and market acceptance of our products and (d) the
resolution of legal matters that may inhibit the execution of the business
plan.
This
annual report may contain both historical facts and forward-looking statements.
Any forward-looking statements involve risks and uncertainties. Moreover, future
revenue and margin trends cannot be reliably predicted.
Business
Development
In
September 2000, we were incorporated as Rocker & Spike Entertainment, Inc, a
California corporation. Until December 31, 2000, operations consisted of
organizational matters and the search for an operating company with which to
perform a merger or acquisition. Effective January 1, 2001, we purchased the
assets and web domain of Accident Reconstruction Communications Network from
its
sole proprietor. Following the acquisition, we changed our name from Rocker
& Spike Entertainment, Inc. to Reconstruction Data Group, Inc. At that time,
we provided research, communication and marketing exposure to the accident
reconstruction industry through our website and seminars.
In
April
2003, we entered into a merger agreement with Verdisys, Inc. (“Verdisys”).
Verdisys was initially incorporated as TheAgZone Inc. in 1999 as a California
corporation. Its purpose was to provide e-Commerce satellite services to
agribusiness. They changed their name to Verdisys in 2001, and in 2003, with
the
acquisition of exclusive rights to a proprietary lateral drilling process
throughout most of the U.S. and Canada, they changed their market focus to
concentrate on services to the oil and natural gas (“oil and gas”) industry.
The
merger agreement with Verdisys called for us to be the surviving company. In
connection with the merger, our name changed to Verdisys, our articles of
incorporation and bylaws remained in effect, the officers and directors of
Verdisys became our officers and directors, each share of Verdisys’ common stock
was converted into one share of our common stock, and our accident
reconstruction assets were sold.
Business
of
Issuer
Our
mission is to substantially improve the economics of existing oil and gas
operations through the application of our licensed and proprietary technologies.
We have been striving to develop a commercially viable lateral drilling
technology with the potential to penetrate through well casing and into
reservoir formations to stimulate oil and gas production. In 2003, with the
acquisition of exclusive rights to a proprietary horizontal drilling process
we
began to deploy lateral drilling services in the field. In mid 2004, it became
apparent that this process was limited in its application to various types
of
oil and gas formations. After redesigning and improving the existing process
and
designing and testing some newer technologies, we now believe that we can
deliver a valuable and cost effective production enhancement service to onshore
oil and gas producers, particularly operators of marginally producing fields.
The goal is to make this new service reliably predictable and consistently
dependable for our customers. Our next step is to build our first new generation
lateral drilling rig with the capability of abrasive fluid jetting and
generating much higher hydraulic horsepower. Following favorable results and
customer acceptance of this initial rig’s capabilities, we intend to order the
construction of additional rigs and significantly grow the deployment of our
abrasive jetting service. Funding for developing this abrasive cutting
capability into a lateral drilling application is expected to come from current
and future capital commitments as well as from the proceeds of the assignment
of
the exclusive rights acquired in 2003. No assurances can be given that the
capital from these sources will be adequate. If this is the case, we will be
required to obtain additional capital from equity markets. No assurances can
be
given that such capital will be available or that the terms will be acceptable.
Our
primary segment will be our abrasive jetting lateral drilling business. We
intend to deploy a commercially viable lateral drilling technology with the
potential to penetrate though well casing and into reservoir formations to
stimulate oil and gas production using specially fabricated mobile drilling
rigs. This service should provide oil and gas producers with an attractive,
lower cost alternative to existing well stimulation or horizontal drilling
services.
Our
secondary business segment is providing satellite services to oil and gas
companies. This service allows them to remotely monitor and control well head,
pipeline or drilling operations through low cost broadband data and voice
services to remote operations where conventional land based communication
networks do not exist or are too costly to install. Longer term, our vision
is
to introduce additional early stage technologies in the energy service sector,
all of which would fit our mission of helping energy companies economically
produce more oil and gas.
Industry
We
operate in the oilfield service industry which services the broader energy
industry, where companies explore, develop and produce oil and gas. This
industry is comprised of a diversity of operators, ranging from the very small
to the extremely large. While the major portion of oil and gas production is
provided by very large international oil companies, there are also a large
number of smaller independent companies, who own the vast majority of existing
wells.
As
a
smaller firm with a specialized service, we intend to provide lateral drilling
and satellite services to both small and large operators in the energy industry.
Initially, the lateral drilling business will be focused toward North American
onshore-based independent producers while the satellite business already has
the
large oil and gas operators as customers. As we grow, we intend to cater to
all
segments of the industry in situations where the application of our services
can
add value to our customers.
Demand
for our services depends on our ability to demonstrate improved economics to
the
oil and gas production sector we serve. We believe that they will use our
lateral drilling service where it costs less than alternative services and/or
when they perceive it enhances production. It will also be driven by
macro-economic factors driving oil and gas fundamentals. The report of the
Energy Information Agency of the U.S. Department of Energy entitled
“International Energy Outlook 2000” forecasts that world oil consumption will
increase at an annual rate of approximately 2% through 2020 and that world
gas
consumption will increase at an annual rate of approximately 3% over the same
period. The projected increase in demand for oil is based on worldwide economic
and population growth, primarily in developing countries. The projected increase
in gas consumption over this period is expected to result from higher demand
across residential, industrial and commercial sectors, as well as from the
increasing use of gas as a source of fuel for electric power generation,
particularly in North and South America. We also believe that reliance on
traditional sources of oil and gas will be limited due to the inadequate
delivery infrastructure and political unrest in major supplying countries.
The
U.S.
Geological Survey estimates there are 1,400 trillion cubic feet (“Tcf”) of
recoverable gas resources in the U.S.- enough to last decades - “But most of it
is off-limits to recover because of restrictive environmental rules and
lawsuits.” This is particularly the case with drilling moratoriums on the East
and West Coasts of America, parts of the Rocky Mountain Area and Alaska. On
its
website, www.naturalgasfacts.org,
the
American Petroleum Institute advocates “A multi-pronged approach is essential
for meeting future U.S. gas demand: (1) using energy wisely and conserving
where
possible; (2) developing more U.S. supplies; (3) diversifying supplies through
pipelines to bring Arctic gas to consumers; (4) facilitating more liquefied
gas
(LNG) imports.” We believe a more immediate impact can be made by exploiting
existing U.S. supplies. Developing such supplies is dependent on drilling new
wells in existing fields, or new reserves in expensive less accessible fields.
We believe our lateral drilling technology can access previously uneconomic
reserves and bring them to market cost effectively thereby helping to resolve
this supply/demand imbalance.
The
Office of Fossil Energy, U.S. Department of Energy, estimates there are nearly
500,000 oil wells and 230,000 gas wells that are marginal or classified as
“stripper” wells. These stripper wells produce either 15 barrels or less of oil
a day or 60 thousand cubic feet of gas or less a day. Although low producing
stripper wells account for the “same of the amount of oil that America imports
from Saudi Arabia” according to the Office of Fossil Energy “together (stripper
wells) account for 1.25 Tcf of gas, or about 8 percent of the gas produced.”
Such wells are potentially considered uneconomic or marginal with the strong
potential of being abandoned due to poor production economics. Indeed
approximately 150,000 marginal wells were abandoned between 1993 and 2000
“costing the U.S. more than $3.5 billion in lost economic output” according to
the Office of Fossil Energy. In seeking to revitalize marginal and stripper
wells both the Department of Energy and American Petroleum Institute have
emphasized the need for new technologies to access more of the reserves
available. We believe we have the
ability
to generate new business by re-entering existing wells rather than being
dependent on the production companies drilling new wells. With our unique
abrasive jetting well stimulation and lateral drilling technology, we believe
we
can provide potentially improved recovery rates rather than abandoning a field
because of the depletion of its oil or gas reserves.
We
believe that producing companies will react to the combination of the increased
demand and the decreased supply of oil and gas in a manner that requires them
to
utilize both segments of our business. We believe that oil and gas producers
have great economic incentive to recover additional production and reserves
from
known reservoirs rather than pursuing a more risky exploration approach. Our
extraction methods may permit producers to add value by potentially recovering
a
significant additional percentage of the oil and gas from a reservoir. We
believe that there exists a large potential market in North America that
comprises logical candidates to apply our abrasive jetting lateral drilling
method.
Activity
in the energy services industry tends to be cyclical with oil and gas prices.
In
addition to the currently positive industry fundamentals, we believe the
following sector-specific trends enhance the growth potential of our business:
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While
oil prices are unpredictable, they have remained and are projected
to
remain relatively high by historic terms for several years. Continuing
high consumption, limitations in delivery infrastructures and political
unrest in major supplying countries are expected to be contributing
factors.
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Gas
prices are projected to remain high for several years due to the
combination of strong demand and major supply constraints. About
one-half
of U.S. reserves have been depleted with the remainder increasingly
expensive and difficult to reach. Significant new supplies from Alaska
and
the Canadian north require the construction of new pipelines which
are
estimated to be several years away. The situation is serious enough
that
Federal Reserve Bank Chairman Greenspan has expressed concern as
to its
effect as a constraint to U.S. economic growth.
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There
is no substitution threat to oil and gas in the foreseeable future.
In
particular, any significant substitution by hydrogen or any other
potential source is believed by management to be some decades away.
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Abrasive
Jetting Lateral Drilling Services
Our
abrasive jetting service intends to provide casing milling, well stimulation
and
lateral drilling services to oil and gas producers. We have signed an exclusive
worldwide licensing agreement with Alberta Energy Holdings (“Alberta”) for the
application of their patent pending Abrasive Fluid Jet (“AFJ”) cutting technique
to cut through well casing and formation rock in oil and gas wells. AFJ is
being
added to, and will enhance the existing principles of lateral drilling and
completion techniques utilized by us and the industry. Applications of such
abrasive cutting techniques are a proven feature in industries as diverse as
munitions disposal in the military, offshore platform dismantlement in the
salvage industry and cutting specialty glass and steel in the machining
business. We would be among the first to commercially apply the proven abrasive
fluid techniques to the energy producing business.
We
have
commenced the construction of a new generation drilling rig based upon
modifications using existing coiled tubing technology. The capabilities of
our
new rig will include: 1.0 - 1.5 inch coiled tubing with a depth capability
of
8,500 feet, a fluid pressure pumping system generating up to 15,000 pounds
per
square inch and a flow rate in excess of twenty gallons per minute; an abrasive
slurry system capable of delivering 150 pounds of abrasive material at thirty
minute intervals; and a computer-controlled system to guide and control the
down-hole formation access tool for precise casing milling and jetting services.
Based upon our current schedule we expect this rig to be completed and
commercially ready for service during the summer of 2005. After the initial
rig
establishes a reliable and commercial oilfield service, we intend to begin
construction on additional rigs with similar capabilities as the market demands.
Abrasive
cutting utilizes high-pressure fluid and up to 15% of abrasives, such as fine
garnet sand, up to 15,000 pounds per square inch. It can cut through surfaces
as
tough as four inches of steel as well as granite rock. Abrasive cutting
represents an off-the-shelf technology requiring application to drilling rather
than developing a new invention. The successful application of abrasive cutting
should allow us to provide a range of services to well operators such as
conventional milling, specially designed completions and well stimulation.
We
believe that our abrasive jetting lateral drilling will have the ability to
access previously uneconomic reserves and bring them to market cost effectively,
due to our unique and environmentally sound drilling process. These services
have appeal for both small independent operators as well as large integrated
companies. At our lower comparative costs, we can make it feasible to enhance
production from a large potential market in North America and worldwide that
would otherwise be cost prohibitive to recover. The existing oil and gas
independent producers in North America are leading potential customers of these
services.
Many
of
the nation’s mature oil and gas fields contain new infield reservoir
compartments and bypassed pockets of productive zones that have not been
economic to produce. By extending 2” or greater diameter channels extended
distances in multiple directions from the casing of the well, our lateral
drilling provides an economic way to enhance production levels of existing
reservoirs. Our lateral drilling process uses high pressure abrasive fluid
jetting process, capable of drilling lateral holes from existing wells extended
distances beyond the near well bore damage in wells as deep as 8,500 feet.
With
conventional horizontal drilling, the transition from drilling vertically to
horizontal drilling may take 200 feet or more and take many days to accomplish.
With our patented technology, we can make this transition in two feet in a
rapid
fashion. This enables us to be extremely precise in targeting and staying within
specific pay zones for a potentially significant enhancement to the production
of the well.
We
are
developing abrasive jetting lateral drilling technology using specially designed
deflection shoes, nozzles and hoses to drill 2” and larger diameter well bores
into the producing formation in multiple directions. By increasing the surface
area opened to the producing reservoir, oil or gas production should be
increased, potentially a large value-added application in conventional drilling
and completion operations. The figure below more precisely illustrates the
process.
Our
abrasive jetting lateral drilling process is designed to work on both new and
existing wells, but may have greater attraction to operators of marginal wells
who may be otherwise ready to abandon these wells because they are no longer
economically viable. The strong market potential is that this negates the
continual need for more exploration, new drilling and denser infield drilling.
Such fields that may be ready to be abandoned and have remaining resource
potential, can have their production re-established and their economic lives
significantly extended.
The
figure below demonstrates how drilling multiple lateral wells from existing
vertical well bores can drastically expand the production area within a given
field. An average vertical well will recover petroleum from an area of up to
120
feet from the well bore. However, each lateral can extend in multiple directions
from the well bore, thus potentially increasing the area of productive capacity
several fold. With our lateral drilling process we have the ability to drill
multiple laterals in different directions and at multiple depths within the
same
producing intervals in a matter of days. The average price for our service
will
range from $25,000 to $40,000 per well depending upon the size of the project.
Specialized directional drilling companies typically charge $250,000 or more
to
drill horizontally in one direction and in only one horizon and may require
weeks to drill each well.
Potential
Benefits of our lateral drilling service:
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Increase
production rate and recoverable reserves from marginal wells.
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Allows
stimulation of wells with acid, steam, CO2, etc.
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Allows
multi-layer application in thicker reservoir zones.
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Provides
an economic alternative to conventional infield drilling programs.
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Provides
a time efficient and cost effective casing milling process.
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Offers
an alternative to high cost well stimulation services such as hydraulic
fracturing.
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Limits
the time the well is out of production due to rapid jetting times.
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We
currently have no active customers as we are in the construction mode. However,
we have strong indications of interest in using the new AFJ drill rig once
it is
placed into service.
Customer
Acceptance
We
are
encouraged by the level of interest from several existing and prospective
customers in the lateral drilling technology as it relates to conventional
oil
and gas production as well as coal bed methane opportunities.
Our
abrasive jetting lateral drilling service directly competes with the need for
new wells by laterally drilling from existing wells to extend the pay zone
resulting in increased production through existing well bores. Our ability
to
target new or previously untapped deposits makes our technology potentially
very
compelling. By cost effectively extending the accessibility of reserves through
the existing well bore, our technology can provide an economic alternative
for a
customer to add value to an existing field. The field operator’s next best
economic alternatives are all more expensive than our service. This has the
potential to be not only compelling economically but also very environmentally
friendly because it uses previously established well bores rather than building
new surface locations to drill new wells.
According
to the Department of Energy Report - Natural Gas Fundamentals, June, 2003,
there
are “Over 7,000 small independent businesses (that) drill 85% of wells and
produce 65% of gas in the U.S. from over 350,000 U.S. wells.” These independent
producers are potential customers for our lateral drilling service. In the
same
report it estimates 10,000 to 15,000 new gas wells are drilled and completed
each year costing anywhere from less than $100,000 to several million. These
new
wells are necessary just to replace depleted supplies from existing wells in
an
effort to maintain current U.S. production levels.
Recent
changes in U.S. tax laws provide for incentives to keep smaller oil and gas
wells pumping even at lower energy prices. Operators of the nation’s 650,000
marginally producing wells, representing approximately 25% of total U.S.
production, receive tax credits of up to $9 per well per day. We believe such
credits will be reinvested by the operators toward services such as lateral
drilling in an effort to increase production and the value of their oil and
gas
fields
Market
It
has
become clear in recent years that while the demand of oil and gas in the U.S.
is
growing, its ability to meet this demand from existing and new sources is
declining. This accelerated decline will require producers to seek new
extraction methods or technologies to exploit oil and gas production from
existing fields and our abrasive jetting lateral drilling process is expected
to
help supply the need for these new technologies. According to the Department
of
Energy, there have been 2.25 million wells drilled in the U.S. since 1949.
Many
oil reservoirs have only had 35% of their reserves produced, leaving huge
potential upsides.
Emphasis
on Gas
The
United States consumed 22.78 Tcf of gas in 2002 - heating over 60 million
households and meeting 25% of the country’s energy requirements, according to
the U.S. Energy Information Administration (EIA). In that same year, U.S.
production of gas totaled 19.13 Tcf, 84% of the amount consumed. According
to
the EIA, this gap between demand and supply is estimated to grow over the next
decade. Demand will grow because gas is a versatile, clean burning and,
historically, an economic fuel. At the same time, the new domestic fields being
found are smaller and have shorter productive lives. So, with legal and
political barriers to drilling on new lands, producers will seek alternative
to
extend the lives from existing fields, such as new energy service technologies.
Competition
Source:
Department of Energy - Natural Gas Fundamentals, June, 2003
Our
lateral drilling business should operate in a niche that lies below the more
expensive and higher impact conventional horizontal drilling business and the
much cheaper and lower impact perforation business. Our lateral drilling service
can provide significant reservoir exposure, and therefore greater production
potential, like horizontal drilling at closer to the cost of the perforation
service.
Conventional
horizontal or directional drilling is slow and significantly more expensive
to
the extent that it is only being used if its much longer drilling radius was
required as is necessary in offshore or environmentally sensitive areas.
Companies offering this service include Halliburton, Baker Hughes, Schlumberger
and other independent service companies. They traditionally drill one lateral
through the existing well bore. That lateral can take over 200 feet to achieve
the turn to the horizontal and be limited to only one “pay” zone. It usually
costs over $250,000 and positive financial returns require very high producing
rates.
However,
many of our competitors are better financed, equipped and resourced than us.
Satellite
Services
Our
second business segment provides satellite services to oil and gas producers.
It
has been common practice to gather much of the data involved in energy
management manually. This is not only expensive but also causes a significant
time lag in the availability of critical management information. The Verdisys
Satellite Private Network (VSPN’s) services utilize two-way satellite broadband
to provide oil and gas companies with a wide variety of remote energy management
applications. Our satellite services can be optimized to provide cost effective
applications such as Voice over Internet “VoIP”, Virtual Private Networking
“VPN” and Real-time Supervisory Control and Data Acquisition Systems, commonly
referred to as SCADA. SCADA permits oil and gas companies to dispense with
a
manual structure and move to a real-time, automated, energy management program.
Utilizing SCADA, a service we currently offer, production levels can be
optimized to meet current market conditions and commitments.
At
present, we are shipping modem hardware from ViaSat, Isotropic Networks and
Spacenet, space segment services from SES and Loral and hub services from
Constellation, Spacenet and Immeon.
VSPN
uses
satellite communications that are low cost and that ensure worldwide
availability, even in geographic areas with a poor communications
infrastructure. VSPN is based on industry standards to lower implementation
costs and to simplify the integration into existing systems. Reliability and
availability are critical considerations for SCADA. VSPN is provided twenty
four
hours a day, seven days a week with 98.2% availability virtually anywhere in
the
world and there are fewer points of failure than comparable terrestrial
services. It provides uniform service levels, and is faster and more cost
effective to deploy. VSPN is also very flexible and easily accommodates site
additions, relocations, bandwidth expansion, and network reconfiguration.
Additionally,
security, integrity, and reliability have been designed into VSPN to ensure
that
information is neither corrupted nor compromised. VSPN communications are more
secure than many normal telephone lines.
Major
Customers
Our
current satellite services customers include Apache Corporation with 40 remote
sites, BP America Production Company with 20 remote sites, Noble Energy with
22
remote sites and Dynegy Inc. with 11 remote sites. We are also breaking into
new
markets in West Africa with ExxonMobil, Kellogg Brown & Root Inc. and
General Electric Power Company. Contracts are usually for hardware, backhaul,
and bandwidth. We are dependent upon a small number of customers which tend
to
be large companies with extensive remote operations. However, virtually any
oil
and gas producer, of which there are thousands, is a potential customer for
our
satellite services.
Market
There
are
more than two million oil and gas wells in existence in the United States alone,
many of which could benefit from the economics of Verdisys’ high speed
connectivity services. Our focus is serving the needs of oil and gas producers
worldwide to control their production effectively and to enhance customer
satisfaction by providing worldwide real-time access to information. This market
for satellite services is very competitive with increasing pressure on margins
as our larger competitors offer services at substantially discounted prices.
We
attempt to compete against such competitors by addressing niche market needs
and
offering alternative solutions that solve customers’ more difficult
communication problems at more cost effective rates. We utilize satellite,
Wi-Fi
and other wireless technology for the last mile of wellhead connectivity for
these customers and focus almost exclusively on the oil and gas market. The
common denominator throughout is Multiple Protocol Label Switching “MPLS/ATM”
network transport services.
Competition
The
satellite communication industry is intensely competitive due to overcapacity,
but the competition is less severe in the oil and gas producing sector. Other
satellite services providers in the oil and gas industry include Petrocom,
Stratus Global, Tachyon, Schlumberger and Caprock. Caprock, Schlumberger and
Stratus are focused on the top 5% of the market, particularly offshore
platforms, and Petrocom and Stratus Global are focused on the offshore market
using a traditional wireless network. Our satellite services offer advantages
over those services by:
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Customizing
the provided service to better meet the customer’s needs;
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Offering
superior speed;
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Providing
single vendor convenience; and
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Offering
lower up-front infrastructure and operating costs.
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Insurance
Our
operations are subject to hazards inherent in the oil and gas industry, such
as
accidents, blowouts, explosions, craterings, fires and oil spills. These
conditions can cause:
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personal
injury or loss of life,
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damage
to or destruction of property, equipment and the environment; and
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suspension
of operations
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In
addition, claims for loss of oil and gas production and damage to formations
can
occur in the well service industry. Litigation arising from a catastrophic
occurrence at a location where our equipment and services are being used may
result in us being named as a defendant in lawsuits asserting large claims.
We
maintain insurance coverage that we believe to be customary in the industry
against these hazards. However, we may not be able to maintain adequate
insurance in the future at rates we consider reasonable. In addition, our
insurance is subject to coverage limits and some policies exclude coverage
for
damages resulting from environmental contamination. The occurrence of a
significant event or adverse claim in excess of the insurance coverage that
we
maintain or that is not covered by insurance could have a materially adverse
effect on our financial condition and results of operations.
Patents
and Licenses
In
November 2004, we signed an exclusive worldwide licensing agreement with Alberta
for the application of their patent pending AFJ cutting technique to cut through
well casing in oil and gas wells. The agreement is for a term of ten years
and
automatically extends for additional two-year terms unless we give notice at
least thirty days prior to the expiration of any term. The license is
automatically renewable provided we pay a minimum royalty payment of $50,000
per
year beginning with the 12 month period immediately following commercial
deployment of the first mobile drilling unit.
Under
the
terms of the licensing agreement, as specific phases of the AFJ process are
successfully applied, Alberta is entitled to receive four tranches of warrants
for our common stock. Each tranche will entitle Alberta the right to purchase
250,000 shares of our common stock and each tranche is contingent upon the
attainment of certain specific milestones as fully described in the agreement.
The warrants will have a three-year term, with an exercise price of $0.50 per
share for the first tranche and $0.62 per share for the remaining tranches.
The
initial tranche will be fully vested as of the date of the agreement and the
remaining warrants will vest at 31,250 shares per quarter from the date of
issuance.
Under
the
terms of the agreement, we have agreed to pay Alberta a $10,000 per month
consulting fee for six months beginning on November 30, 2004. In addition,
royalties are payable by us at the rate of $1,000 per well for services billed
at $40,000 or less and for services above $40,000, a royalty of 2% per well
is
payable quarterly. The agreement also provides for the mutual sharing of the
proceeds from the sale of the technology by us, subject to a maximum of $10
million.
On
April
24, 2003 we entered into an agreement to license the Landers Horizontal Drilling
Process, based on U.S. Patent Nos. 5,413,184, 5,853,056, and 6,125,949 relating
to certain oil and gas well production enhancement techniques and devices and
related trade secrets with the inventor and holder of the patents and trade
secrets, Carl Landers. The license gives us exclusive rights to apply the
technology and the related trade secrets in all of the U.S. (except for part
of
Colorado West of the Rockies, and Utah) and Canada. Mr. Landers also reserves
the rights to certain applications in which he has a direct interest but may
not
compete with us. Any improvements to the technology remain the sole property
of
the licensor but are provided to us without additional licensing fees. The
license terminates upon the expiration of the underlying patents, the earliest
date being October 1, 2013. We amended the license on September 4, 2003, to
provide for consideration to Mr. Landers of a fixed amount of $500 for every
well drilled in which the Landers Horizontal Drill method is utilized, instead
of the original 10% royalty payment, and 500,000 shares of our restricted common
stock. In addition, in exchange for a reduction of the note payable associated
with the license from $2,750,000 to $2,500,000, we issued an additional 125,000
shares of our restricted common stock. We amended the license again in February
2004 when $1,695,000 of outstanding payment obligations to Mr. Landers for
technology fees were waived in exchange for the issuance of 300,000 shares
of
our common stock and the payment of $500,000 in cash.
On
March
8, 2005, we entered into an Assignment of License Agreement with Maxim TEP,
Inc.
(“Maxim”). The President and Chief Executive Officer of Maxim is Dan Williams,
our former President and CEO. Under the assignment, we assigned to Maxim
our
rights in the license of the Landers Horizontal Drilling Process; all current
and future negotiations for assignments, sublicenses or territorial royalty
pertaining to the license and two lateral drilling rigs. As consideration,
Maxim
agreed to pay us a total sum of $1.3 million payable in four installments
(two
of which were received by March 22, 2005) and release a $270,000 credit
obligation we owe to Maxim. In connection with the sale, we fully impaired
the
asset while creating an account receivable for the sales value. We will retain
a
non-exclusive sublicense interest in the Landers license, as long as we pay
all
required royalties on which the Landers Horizontal Technology is utilized.
The
lateral drilling technology and related trade secrets are instrumental to our
competitive edge in the oil and gas service industry. We are committed to
protecting the technology. We cannot assure our investors that the scope of
any
protection we are able to secure for our license will be adequate to protect
it,
or that we will have the financial resources to engage in litigation against
parties who may infringe on our exclusive license. We also can not provide
our
investors with any degree of assurance regarding the possible independent
development by others of technology similar to that which we have licensed,
thereby possibly diminishing our competitive edge.
Governmental
Regulation
Our
operations are subject to various local, state and federal laws and regulations
intended to protect the environment. Our operations routinely involve the
handling of waste materials, some of which are classified as hazardous
substances. Consequently, the regulations applicable to our operations include
those with respect to containment, disposal and controlling the discharge of
any
hazardous oilfield waste and other non-hazardous waste material into the
environment, requiring removal and cleanup under certain circumstances, or
otherwise relating to the protection of the environment. Laws protecting the
environment have become more stringent in recent years, and may in certain
circumstances impose “strict liability,” rendering a party liable for
environmental damage without regard to negligence or fault on the part of such
party. Such laws may expose us to liability for the conduct of, or conditions
caused by, others, or for our acts, which were in compliance with all applicable
laws at the times such acts were performed. Cleanup costs and other damages
arising as a result of environmental laws, and costs associated with changes
in
environmental laws could be substantial and could have a material adverse effect
on our financial condition. Management believes that it conducts our operations
in substantial compliance with all material federal, state and local laws as
they relate to the environment. Although we have incurred certain costs in
complying with environmental laws, such amounts have not been material to our
financial results.
We
depend
on the demand for our products and services from oil and gas companies. This
demand is affected by changing taxes, price controls and other laws relating
to
the oil and gas industry generally, including those specifically directed to
oilfield operations. The adoption of laws curtailing exploration and development
drilling for oil and gas in our areas of operation could also adversely affect
our operations by limiting demand for our products and services. We cannot
determine the extent to which our future operations and earnings may be affected
by new legislation, new regulations or changes in existing legislation
regulations or enforcement.
Our
satellite services utilize products that are incorporated into wireless
communications systems that must comply with various government regulations,
including those of the Federal Communications Commission (FCC). In addition,
we
provide services to customers through the use of several satellite earth hub
stations, which are licensed by the FCC. Regulatory changes, including changes
in the allocation of available frequency spectrum and in the military standards
and specifications that define the current satellite networking environment,
could materially harm our business by (1) restricting development efforts by
us
and our customers, (2) making our current products less attractive or obsolete,
or (3) increasing the opportunity for additional competition. Changes in, or
our
failure to comply with, applicable regulations could materially harm our
business and impair the value of our common stock. In addition, the increasing
demand for wireless communications has exerted pressure on regulatory bodies
worldwide to adopt new standards for these products and services, generally
following extensive investigation of and deliberation over competing
technologies. The delays inherent in this government approval process have
caused and may continue to cause our customers to cancel, postpone or reschedule
their installation of communications systems. This, in turn, may have a material
adverse effect on our sales of products to our customers.
Research
and Development Activities
During
2004 and 2003, we incurred an insignificant amount of research and development
costs as it relates to our lateral drilling process. We incurred no research
and
development costs in our satellite business.
Employees
As
of
December 31, 2004, we had a total of seven employees, all of which were
full-time employees. A new president and chief financial officer were brought
into the company in January 2004.
We
also
utilize a number of independent contractors and consultants to assist us
conducting the drilling operations, installing the telecommunications equipment,
maintaining and supervising such services, and the like, in order to complement
our existing work force, as needed from time to time. Our agreements with these
independent contractors and consultants are usually short-term. We are not
a
party to any collective bargaining agreement with any employees, and believe
relations with our employees, independent contractors and consultants are good.
Item
2. Description of Property
Office
Facilities
We
lease
approximately 2,000 square feet of office space in Houston, Texas for our
principal executive office at a cost of $2,800 per month. Our lease has been
extended through August of 2006.
Equipment
As
of
December 31, 2004, our primary equipment consisted of three mobile lateral
drilling rigs, which can be driven to oil and gas fields throughout North
America. Lateral drilling equipment consists of heavy trucks mounted with high
powered water compressors, flexible hose and other assorted downhole equipment
which is used to conduct the lateral drilling process with high pressure jetting
technology. We also maintained certain satellite communication and computer
equipment at our principal executive office.
We
believe that our facilities and equipment are in good operating condition and
that they are adequate for their present use. However, the new generation
drilling rig planned for 2005, will replace our plans to use the existing rigs
designed under the Landers technology. In fact, under an Assignment of License
Agreement, dated March 8, 2005, two of the existing lateral drilling rigs were
sold.
Item
3. Legal Proceedings
Lawsuits
Involving Edge Capital Group, Inc. (Settled)
Effective
January 19, 2005, Edge Capital Group, Inc. (“Edge”), certain entities affiliated
with Edge, Eric McAfee (our former Vice Chairman) and us, entered into a
Settlement Agreement and Mutual Release to fully settle and resolve the disputes
between Edge and its affiliated entities, Mr. McAfee, our directors and us.
As
part of the settlement, we issued an aggregate of 750,000 shares of our common
stock along with warrants to purchase 750,000 shares of our common stock to
Edge. In addition, we agreed to provide Edge a drilling rig to provide certain
lateral drilling services. As part of the drilling services, Edge has agreed
to
provide a fee per well, along with a share of the revenues generated from each
well drilled. Also, as part of the settlement, at closing, we have agreed to
sublicense our Landers horizontal drilling technology to Edge for certain
limited purposes. As part of the settlement, the parties to the agreement have
agreed to a mutual release and have agreed to dismiss all pending claims and
litigation between them upon performance of the obligations in the settlement
agreement. If we do not perform our remaining obligations under the settlement
agreement, this would cause the release to not be effective and could lead
to
the underlying lawsuit being reinstituted. An adverse finding in such lawsuit
against us would have a material adverse effect on our financial condition.
We
had
initiated a lawsuit against Edge that requested a declaratory judgment that
a
purported agreement between us and Edge was not enforceable. It was filed in
Montgomery County, Texas in February 2004. The lawsuit arose from Edge’s
contention that one of our ex-officers committed us to purchase certain alleged
oil and gas properties from Edge. Edge had filed a counterclaim against us
and
asserted claims against Dan Williams (our former President and CEO), Eric
McAfee, Ron Robinson (our former CEO and current Board member), Andrew Wilson
(our former CFO) and our current Board members Joseph Penbera, Frederick Ruiz,
James Woodward and John Block. Edge has also made claims against Solarcom,
L.L.C., DeLage Landen Financial Services, Inc., Andrew Wilson and Allen Voight.
Edge had sought to enforce the agreement we challenged and alleged several
causes of action including claims for fraud, breach of contract, negligence
and
conspiracy. Edge had asserted actual damages in excess of $85 million and has
claimed punitive damages as well.
Edge
and
one of its apparent owners, Frazier Ltd., had initiated a lawsuit in Summin
County, Ohio against us, Solarcom, L.L.C., DeLage Landen Financial Services,
Inc. and Firstmerit Bank, N.A. that sought an injunction against the draw
against a letter of credit pledged as collateral for a credit advanced to Edge.
Edge asserted that its transaction with us was the product of fraud and that
its
creditor, DeLage Landen as assignee from Solarcom, should not be allowed to
draw
against Edge’s letter of credit from Firstmerit. The Ohio state court denied
Edge’s request for a temporary injunction. The pleadings in the Ohio action did
not include any claim for damages from us.
Class
Action Lawsuits (Settled)
In
March
2005, we entered into an agreement, subject to court approval, to settle the
class action lawsuit brought by former shareholders in March 2004 in the U.S.
District Court for the Southern District. Under terms of the agreement, we
will
issue to the class 1,150,000 shares of common stock and pay up to $55,000 in
legal and administrative fees for the plaintiffs. The lawsuit alleged that
we
and our former CEO, Dan Williams, and our former CFO, Andrew Wilson, violated
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5
promulgated thereunder. The lawsuits alleged that the defendants had made
material misstatements about our financial results. More specifically, the
Complaints alleged that the defendants had failed to disclose and indicate:
(1)
that we had materially overstated our net income and earnings per share; (2)
that we prematurely recognized revenue from contracts between us, Edge and
Energy 2000 NGC, Inc. (“Energy 2000”) in violation of GAAP and our own revenue
recognition policy; (3) that we lacked adequate internal controls and was
therefore unable to ascertain the true financial condition of the company;
and
(4) that as a result of recognizing revenue prematurely, our financial results
were inflated at all relevant times. We had filed a motion to dismiss all
actions in the litigation against us.
Securities
and Exchange Commission Investigation Inquiries
We
received notice, in January 2004, that the Securities and Exchange Commission
(“SEC”) has initiated a formal investigation into our reporting practices and
our public statements in 2003.
The
SEC
has requested substantiation and documentary evidence from us concerning the
performance of certain lateral drilling services by subcontractors in the period
from May 2003 to September 2003, supervision of such services by our executive
management at the time, revenue recognition related to the performance of such
services, the third quarter 2003 earnings restatement, public statements
concerning the services performed, and related matters. The SEC has also
requested information and documentary evidence related to our acquisition of
certain assets of QuikView, Inc., a related party company, in June 2003. In
its
letters to us requesting documents, the SEC stated that the staff’s inquiry
should not be construed as an indication that any violations of securities
laws
have occurred or as an adverse reflection on any persons, company or security.
Since
December 2003, we have taken several steps to address issues related to the
SEC’s inquiries, including the termination and replacement of the previous Chief
Executive Officer and Chief Operating Officer and the reassignment of its Chief
Financial Officer. Two directors have resigned from our board and we have
appointed a new CFO. Internal controls have been strengthened overall,
particularly with respect to the public release of information and the
recognition of revenue. We had also initiated an internal investigation of
the
matters of concern to the SEC. Consequently, we restated our second and third
quarter financial statements for fiscal year 2003 and deferred all revenue
related to the aforementioned period until such time that we can substantiate
whether or not the services were performed.
We
are
cooperating fully with the SEC, including the provision of numerous documents
and voluntary testimony by our current executives. In December 2004, the staff
of the SEC notified us that it was considering recommending that the SEC bring
a
civil injunction (including a possible permanent injunction and a civil penalty)
against us alleging violations of provisions of the Sections 10(b), 13(b)(2)(A),
13(b)(2)(B) and 15(d) of the Securities Exchange Act of 1934 and rules
promulgated thereunder in connection with the purchase and sale of our
securities, recordkeeping, internal controls, certification and disclosure
obligations. We were notified of our right to make a Wells submission. We have
provided information to the SEC setting forth the specific steps we have taken
to upgrade the quality and effectiveness of our board of directors, replace
the
previous management team with industry experts, improve our recordkeeping,
internal and disclosure controls, and revenue recognition procedures. Although
we are working to bring the matter to a prompt conclusion, we cannot make any
assurance that the investigation will be resolved positively or that it will
not
have negative effects on our limited resources or our ability to raise capital
and use our stock as acquisition currency during the period of the
investigation.
Claims
by Investor (Partially Settled)
In
February 2005, we entered into an Agreed Judgment and Order of Severance with
Gryphon Master Fund, L.P. (“Gryphon”) as to all breach of contract claims
related to our delay in registering common stock acquired by Gryphon in October
2003. Under the terms of the Agreed Judgment, we are obligated to pay liquidated
damages of $0.5 million to Gryphon on or before September 30, 2005.
Additionally, Gryphon has agreed to abate their remaining claims and related
discovery in the lawsuit against us until after September 30, 2005. We agreed
to
register the shares issued to Gryphon on or before March 2004 or be subject
to
certain liquidated damages. Gryphon had made a claim against us for the maximum
liquidated damages in an amount of $400,000. Gryphon has also
claimed
that it has sustained actual damages in excess of $6.2 million. In July 2004,
Gryphon filed a lawsuit in the state district court in Dallas County, Texas
against us, alleging, among other things, breach of contract and securities
fraud by us. In connection with the lawsuit, Gryphon requested liquidated
damages, actual damages, punitive damages, interest, costs and attorneys’ fees
among other claims. We intend to vigorously defend ourselves in this matter
with
respect to the remaining claims of Gryphon. If Gryphon prevails, it may obtain
significant damages that may have a material adverse effect on our financial
condition.
Claim
by Former CEO
In
July
2004, we were informed that one of our former Chief Executive Officers filed
a
lawsuit against us for breach of contract and wrongful discharge. The lawsuit
seeks relief in excess of $0.5 million related to an alleged employment
agreement and damages related to an excess of 4 million stock options claimed
due pursuant to the alleged employment agreement. The lawsuit was filed in
state
court in San Diego, California. We intend to vigorously defend ourselves in
this
matter. If the plaintiff prevails, they may obtain significant damages that
may
have a material adverse effect on our financial condition.
Energy
2000 (Settled)
In
October 2004, we entered into an agreement with Berg McAfee Companies, Energy
2000 and Eric McAfee (collectively, “McAfee Group”) to settle several
outstanding legal issues. Energy 2000 has agreed to settle a finders fee and
lateral drilling services dispute by delivering 300,000 shares of Natural Gas
Systems, Inc. (“NGS”) stock into escrow for us. We have plans to monetize those
shares as soon as practical. Furthermore, to settle the “Lawsuits Involving Edge
Capital Group, Inc.”, the McAfee Group exchanged 500,000 shares of NGS for
500,000 shares of our common stock. In January of 2005, the McAfee Group
replaced the 500,000 shares of NGS stock with $625,000 in cash. We submitted
that cash and an additional 250,000 shares of our common stock to Edge as part
of that settlement. We have also agreed to dismiss the QuikView, Inc. lawsuit,
which we had filed against certain individuals.
Concluding
Statement
We
have
never been in bankruptcy, receivership or any similar legal proceeding. Other
than the aforementioned legal matters, we are not aware of any other threatened
legal proceedings. The foregoing is also true with respect to each officer,
director and control shareholder as well as any entity owned by any officer,
director and control shareholder, over the last five years.
As
part
of our regular operations, we may become party to various pending or threatened
claims, lawsuits and administrative proceedings seeking damages or other
remedies concerning its’ commercial operations, products, employees and other
matters. Although we can give no assurance about the outcome of these or any
other pending legal and administrative proceedings and the effect such outcomes
may have on the company, except as described above, we believe that any ultimate
liability resulting from the outcome of such proceedings, to the extent not
otherwise provided for or covered by insurance, will not have a material adverse
effect on our financial condition or results of operations.
Item
4. Submission of Matters to a Vote of Security Holders
No
matter
was submitted during the fourth quarter of the fiscal year covered by this
report to a vote of security holders, through the solicitation of proxies or
otherwise.
Part
II
Item
5. Market for Common Equity and Related Stockholder Matters
After
the
consummation of the merger between Reconstruction Data Group, Inc. and Verdisys,
our common stock commenced trading on the OTC Bulletin Board on July 18, 2003
under the symbol “VDYS.” Prior to the merger, our common stock had been listed
for trading on the OTC Bulletin Board under the symbol “RDGI”. The RDGI stock
was listed on January 13, 2003, but active trading did not begin until May
2,
2003. The following table sets forth, for the periods indicated, the high and
low bid prices of a share of our common stock as reported on the OTC Bulletin
Board since active trading began on May 2, 2003. The quotations provided are
for
the over the counter market which reflect interdealer prices without retail
mark-up, mark-down or commissions, and may not represent actual transactions.
|
|
HIGH
|
LOW
|
|||||
|
2003
|
|
|
|||||
|
Second
Quarter (from May 2, 2003)
|
$
|
1.72
|
$
|
1.53
|
|||
|
Third
Quarter
|
$
|
6.32
|
$
|
5.65
|
|||
|
Fourth
Quarter
|
$
|
11.03
|
$
|
10.14
|
|||
|
2004
|
|
|
|||||
|
First
Quarter
|
$
|
9.54
|
$
|
3.35
|
|||
|
Second
Quarter
|
$
|
4.75
|
$
|
1.50
|
|||
|
Third
Quarter
|
$
|
1.95
|
$
|
0.25
|
|||
|
Fourth
Quarter
|
$
|
1.00
|
$
|
0.40
|
|||
Holders
As
of
February 28, 2005, we had 34,973,673 shares of common stock issued and
outstanding and held by approximately 500 shareholders.
Dividends
We
have
never paid cash dividends. At present, we do not anticipate paying any dividends
on our common stock in the foreseeable future and intend to devote any earnings
to the development of the company’s business.
EQUITY
COMPENSATION PLAN INFORMATION
The
following table provides information as of December 31, 2004 regarding
compensation plans (including individual compensation arrangements) under which
equity securities are authorized for issuance:
|
Plan
Category
|
Number of securities
to
be issued
upon
exercise of
outstanding
options,
warrants
and rights
|
Weighted-average
exercise
price of
outstanding options,
warrants
and rights
|
Number of securities
available
for future
issuance under equity
compensation
plans
(excluding
securities
shown in first column)
|
|||||||
|
Equity
compensation plans approved by shareholders
|
|
|
|
|||||||
|
Equity
compensation plans not approved by shareholders
|
2,413,680
|
$
|
1.67
|
5,586,320
|
||||||
|
Total
|
2,413,680
|
$
|
1.67
|
5,586,320
|
||||||
Recent
Sales of Unregistered Securities
The
following table details shares issued under transactions that were a private
offering we believe to be exempt from registration under Regulation D
promulgated under Section 4(2) of the Securities Act. The sales of stock were
to
individuals or entities, each of whom was an accredited investor, as that term
is defined in Rule 501 of Regulation D promulgated under Section 4(2) of the
Securities Act and had adequate access to information pertaining to us.
Furthermore, no advertisements were made and the securities are restricted
pursuant to Rule 144.
|
Date
|
Number of
Shares
of
Common
Stock
|
Value
|
Offering
Costs
|
Other
Terms
|
|||||||||
|
January
and February 2005
|
433,000
|
$
|
216,500
|
15,800
shares of common stock and warrants to purchase 15,800 shares of
our
common stock at $1.00 per share
|
Two
year warrants to purchase 433,000 shares of our common stock at a
price of
$1.00 per share were issued in connection with the private placement.
The
proceeds will be allocated between the common stock and the warrants
based
on their respective relative fair values.
|
||||||||
|
May
through June 2004
|
179,500
|
$
|
359,000
|
17,950
shares of common stock and warrants to purchase 7,180 shares of our
common
stock at $2.00 per share
|
Two
year warrants to purchase 71,800 shares of our common stock at a
price of
$2.00 per share were issued in connection with the private placement.
The
proceeds were allocated between the common stock and the warrants
based on
their respective relative fair values.
|
||||||||
|
July
through August 2003
|
609,000
|
$
|
1,218,000
|
59,400
shares of common stock and warrants to purchase 9,501 shares of our
common
stock at $2.00 per share
|
|
||||||||
The
following table details sales of stock we believe to be exempt from registration
under Section 4(2) of the Securities Act. Each of the recipients of our stock
was an accredited investor, as that term is defined in Rule 501 of Regulation
D
promulgated under Section 4(2) of the Securities Act and had access to
information concerning us and our business prospects. Furthermore, no
advertisements were made and the securities are restricted pursuant to Rule
144.
|
Date
|
Number of
Shares
of
Common
Stock
|
Value
|
Comment
|
|||||||
|
Fourth Quarter of 2004
|
104,000
|
$
|
52,000
|
Shares
issued in payment of consulting services.
|
||||||
|
Fourth
Quarter of 2004
|
250,000
|
$
|
75,000
|
To
settle a dispute with a former consultant.
|
||||||
|
Fourth
Quarter of 2004
|
400,000
|
$
|
200,000
|
Shares
for cash.
|
||||||
|
Third
Quarter of 2004
|
30,000
|
$
|
15,000
|
Shares
issued in payment of a future fundraising effort.
|
||||||
|
Third
Quarter of 2004
|
300,000
|
$
|
213,000
|
Shares
issued in lawsuit settlement.
|
||||||
|
February
2004
|
300,000
|
$
|
1,920,000
|
Shares
issued in payment of outstanding obligations to Mr. Landers for technology
fees.
|
||||||
|
September
2003
|
500,000
|
$
|
2,275,000
|
Shares
issued in exchange for amendment to Landers licensing
agreement.
|
||||||
|
July
2003
|
125,000
|
$
|
250,000
|
Shares
issued in payment of note payable to Mr. Landers.
|
||||||
Other
Sales
In
January 2005, we issued 16,000 shares of our common stock for the payment of
leasing fees valued at approximately $8,000 and 10,666 shares of our common
stock to settle unpaid compensation issues with two former AgZone employees.
We
also issued 388,502 shares of our common stock under a program to compensate
our
directors, employees, contractors and former employees for unpaid wages,
commissions and director fees incurred in 2004. Additionally, 500,000 shares
of
common stock were issued to Edge under the final terms of the lawsuit settlement
agreement.
In
October 2004, we issued 750,000 shares of our common stock in a move to settle
outstanding litigation matters. In a Settlement Agreement and Mutual Release
(“Agreement”) between Edge, Eric McAfee and us, the parties would release each
other from any claims upon the completion of the terms of the Agreement. As
a
part of this Agreement, 250,000 shares of our common stock were placed in escrow
for the benefit of Edge. In October 2004, we entered into an agreement with
Berg
McAfee Companies, Energy 2000 and Eric McAfee (collectively, “McAfee Group”) to
settle several outstanding legal issues. Under this agreement, 500,000 shares
of
our common stock were placed in escrow for the benefit of the McAfee Group.
In
return, the McAfee Group contributed 875,000 shares of NGS. Further detail
on
these agreements can be found in the “litigation” section of this Form 10-KSB.
The shares of stock were issued in transactions we believe to be exempt from
registration under Section 4(2) of the Securities Act. The recipient of our
stock was an accredited investor as defined in Rule 501 of Regulation D
promulgated under Section 4(2) of the Securities Act and had access to
information concerning us and our business prospects. Furthermore, no
advertisements were made and the securities are restricted pursuant to Rule
144.
On
October 23, 2003, we sold 833,333 shares of our common stock to Gryphon Master
Fund, L.P. at $6.00 per share for total proceeds of $5,000,000. Since the 30
day
average closing price of our common stock dropped below $6.00 per share in
the
ten months subsequent to the agreement, we were required to issue 277,778
additional shares of common stock in the fourth quarter of 2004 for no
additional compensation. Therefore a total of 1,111,111 common shares were
issued for an average price of $4.50 per share under this transaction. Stonegate
Securities, Inc. served as our placement agent and offering costs associated
with the sale were $420,000 in cash, warrants to purchase 83,334 shares of
our
common stock at $6.00 per share expiring October 24, 2008 and 20,000 shares
of
our common stock. The warrants are exercisable until October 24, 2008 by paying
cash at the exercise price or by electing a cashless exercise. The transaction
was a private offering we believe to be exempt from registration under
Regulation D promulgated under Section 4(2) of the Securities Act. The sales
of
stock were to individuals or entities, each of whom was an accredited investor,
as that term is defined in Rule 501 of Regulation D promulgated under Section
4(2) of the Securities Act and had adequate access to information pertaining
to
us. Furthermore, no advertisements were made and the securities are restricted
pursuant to Rule 144.
On
July
18, 2003, we, as RDGI, executed an Agreement and Plan of Merger with Verdisys
whereby the shareholders of Verdisys received 25,103,223 shares of our common
stock in exchange for all of the 25,103,223 shares of Verdisys common stock
then
outstanding. The operations and management of Verdisys became our own, and
we
changed our name to Verdisys Inc. The shares of stock were issued in the
transaction we believe to be exempt from registration under Regulation D
promulgated under Section 4(2) of the Securities Act. The issuances were a
share
for share exchange resulting in a similar investment to that originally
contemplated due to the continuation of management and business plan; the
recipients in the exchange were accredited investors as defined in Rule 501
of
Regulation D promulgated under Section 4(2) of the Securities Act, and took
their shares for investment purposes without a view to distribution; they had
access to information concerning us and our business prospects; there was no
general solicitation or advertising for the purchase of our shares; there were
no commissions paid; and the securities are restricted pursuant to Rule 144.
Common
Stock Issued Upon Exercise of Options
|
Date
|
Shares Issued
Upon Exercise
|
Value
|
Comment
|
|||||||
|
Second
Quarter of 2004
|
344,583
|
$
|
34,458
|
|
||||||
|
First
Quarter of 2004
|
25,000
|
$
|
2,500
|
|
||||||
|
Fourth
Quarter of 2003
|
100,000
|
$
|
10,000
|
|
||||||
|
Second
Quarter of 2003
|
2,409,291
|
$
|
240,929
|
In
lieu of cash, we agreed to expense the exercise price.
|
||||||
Common
Stock Issued Upon Exercise of Warrants
|
Date
|
Shares Issued
Upon Exercise
|
Value
|
Comment
|
|||||||
|
Second Quarter of 2004
|
57,658
|
$
|
5,766
|
|
||||||
|
First Quarter of 2004
|
779,597
|
$
|
38,494
|
Includes
cash less exercise of 400,000 warrants for 395,022 shares of common
stock.
|
||||||
|
Fourth Quarter of 2003
|
245,631
|
$
|
29,564
|
|
||||||
|
Third Quarter of 2003
|
269,547
|
$
|
177,751
|
|
||||||
|
Second Quarter of 2003
|
430,000
|
$
|
56,500
|
|
||||||
|
Second Quarter of 2003
|
950,000
|
$
|
95,000
|
Accounts
payable reduced in lieu of cash for exercise.
|
||||||
|
Second Quarter of 2003
|
200,000
|
$
|
20,000
|
Note
payable reduced in lieu of cash for exercise.
|
||||||
Options
The
following table summarizes option grants for the last three years:
|
Date
|
Number
of
Shares
|
Exercise
Price
|
Market
Price
|
Vesting
|
Term
(years)
|
Fair
Value
|
To
Whom Issued
|
|||||||||||||||
|
July 2004
|
770,000
|
$
|
0.90
|
$
|
0.90
|
Quarterly
over 3 years
|
10
|
$
|
689,232
|
Officers
|
||||||||||||
|
May 2004
|
72,000
|
$
|
2.20
|
$
|
2.20
|
Quarterly
over 1 year
|
10
|
$
|
156,913
|
Non-employee
directors
|
||||||||||||
|
Jan 2004
|
230,000
|
$
|
4.28
|
$
|
4.28
|
Quarterly
over 1 year
|
10
|
$
|
890,785
|
Officers
|
||||||||||||
|
Jan 2004
|
80,000
|
$
|
4.28
|
$
|
4.28
|
Immediate
|
10
|
$
|
309,840
|
Non-employee
directors
|
||||||||||||
|
Dec 2003
|
500,000
|
$
|
9.55
|
$
|
9.55
|
10%
immediate, 80% over 12 months, 10% on
performance
|
10
|
$
|
4,061,703
|
Officer/director
|
||||||||||||
|
Aug 2003
|
100,000
|
$
|
4.10
|
$
|
4.10
|
Quarterly
over 1 year
|
5
|
$
|
321,024
|
Employee
|
||||||||||||
|
April 2003
|
750,000
|
$
|
0.10
|
$
|
0.50
|
Quarterly
over 3 years
|
10
|
N/A
|
Officer
|
|||||||||||||
|
April 2003
|
250,000
|
$
|
0.10
|
$
|
0.50
|
Quarterly
over 1 year
|
10
|
N/A
|
Non-employee
directors
|
|||||||||||||
|
April 2003
|
250,000
|
$
|
0.10
|
$
|
0.50
|
Quarterly
over 1 year
|
10
|
N/A
|
Officer/director
|
|||||||||||||
|
April 2003
|
30,000
|
$
|
0.10
|
$
|
0.50
|
Over
4 months
|
10
|
N/A
|
Officer
|
|||||||||||||
|
Dec 2002
|
3,450,000
|
$
|
0.10
|
$
|
0.50
|
Quarterly
over 4 years
|
10
|
N/A
|
Officers
and employees
|
|||||||||||||
|
June 2002
|
350,000
|
$
|
0.10
|
$
|
0.50
|
Quarterly
over 1 year
|
10
|
N/A
|
Officers
and directors
|
|||||||||||||
|
|
||||||||||||||||||||||
|
April 2002
|
105,000
|
$
|
0.10
|
$
|
0.50
|
Quarterly
over 1 year
|
10
|
N/A
|
Employees
|
|||||||||||||
|
April 2002
|
2,000,000
|
$
|
0.10
|
$
|
0.50
|
Quarterly
over 2 years
|
10
|
N/A
|
Officer
|
|||||||||||||
|
April 2002
|
200,000
|
$
|
0.10
|
$
|
0.50
|
Quarterly
over 3 years
|
10
|
N/A
|
Employee
|
|||||||||||||
|
2002
|
1,050,000
|
$
|
0.10
|
$
|
0.50
|
Over
12 months
|
10
|
N/A
|
Officers
|
|||||||||||||
We
recorded expense of $245,829 and $714,524 for the intrinsic value associated
with the options vesting in 2004 and 2003, respectively. The expense is included
in selling, general & administrative expense on the statement of operations.
Warrants
The
following table summarizes warrants granted for the last three years:
|
Date
|
Number
of
Shares
|
Exercise
Price
|
Term
(years)
|
Other
|
|||||||||
|
Jan & Feb 2005
|
408,000
|
$
|
1.00
|
2
|
Issued
in connection with Private Placement.
|
||||||||
|
Jan & Feb 2005
|
15,800
|
$
|
1.00
|
2
|
Offering
costs of Private Placement.
|
||||||||
|
October 2004
|
100,000
|
$
|
0.001
|
1
|
Issued
in connection with aggregate convertible notes of $200,000 to Berg
McAfee
and Eric McAfee. The notes have been discounted for the relative
fair
value of the warrants.
|
||||||||
|
October 2004
|
250,000
|
$
|
0.50
|
3
|
Issued
to Alberta as part of a licensing agreement. The fair value of $199,750
was expensed in 2004.
|
||||||||
|
|
|||||||||||||
|
August 2004
|
140,000
|
$
|
0.80
|
2
|
Issued
to certain subcontractors and the fair value of $98,000 was expensed
in
2004. 20% of the warrants vest immediately and the balance vest 20%
every
90 days thereafter.
|
||||||||
|
July
2004
|
100,000
|
$
|
0.001
|
1
|
Issued
in connection with $200,000 in convertible notes to third party lenders.
The notes have been discounted for the relative fair value of the
warrants.
|
||||||||
|
July
2004
|
75,000
|
$
|
0.01
|
2
|
Issued
in connection with $150,000 in convertible notes to third party lenders.
The notes have been discounted for the relative fair value of the
warrants.
|
||||||||
|
May & June 2004
|
71,800
|
$
|
2.00
|
2
|
Issued
in connection with Private Placement.
|
||||||||
|
June
2004
|
7,180
|
$
|
2.00
|
2
|
Offering
costs of Private Placement.
|
||||||||
|
May
2004
|
37,000
|
$
|
2.00
|
1
|
Issued
in connection with $185,000 in promissory notes to third party lenders.
The notes have been discounted for the relative fair value of the
warrants.
|
||||||||
|
Fall
2003
|
92,835
|
$
|
6.00
|
5
|
Issued
in connection with raising $5,000,000 from Gryphon and the fair value
of
$822,738 has been treated as a cost of fundraising.
|
||||||||
|
Fall
2003
|
9,501
|
$
|
2.00
|
5
|
|
||||||||
|
|
|||||||||||||
|
Summer
2003
|
150,000
|
$
|
0.10
|
1
|
Part
of a settlement, along with $28,000 in cash, with the two original
founders for various debts recorded on the books at $576,000. The
warrants
were valued at $0.40 per share or $60,000, resulting in a contribution
to
capital of $488,000.
|
||||||||
|
May
2003
|
2,644,438
|
$
|
0.10
|
Var
|
Issued
to former employees and the fair value of $1,050,687 were expensed
in
2003.
|
||||||||
|
April
2003
|
200,000
|
$
|
0.10
|
4
|
Issued
to consultants and the fair value of $80,000 was expensed in
2003.
|
||||||||
|
April
2003
|
232,334
|
$
|
0.75
|
1
|
Previously
expired warrants were extended.
|
||||||||
|
2002
|
120,000
|
$
|
0.10
|
4
|
Issued
to investors and fair value of $4,800 expensed in 2002.
|
||||||||
|
2002
|
980,000
|
$
|
0.10
|
5
|
Issued
to consultants and the fair value of $392,000 was expensed in
2002.
|
Item
6. Management’s Discussion and Analysis or Plan of
Operation
The
following discussion does not purport to be complete and should be read in
conjunction with the Financial Statements and Notes thereto included in this
report. This discussion contains certain forward-looking statements that involve
substantial risks and uncertainties. When used in this report the words
“anticipate,” believe,” “estimate,” “expect” and similar expressions as they
relate to our management or us are intended to identify such forward-looking
statements. Our actual results, performance or achievements could differ
materially from those expressed in, or implied by, these forward-looking
statements. Historical operating results are not necessarily indicative of
the
trends in operating results for any future period.
Our
mission is to substantially improve the economics of existing oil and natural
gas operations through the application of our licensed and proprietary
technologies. We have been striving to develop a commercially viable lateral
drilling technology with the potential to penetrate through well casing and
into
reservoir formations to stimulate oil and gas production. In 2003, with the
acquisition of exclusive rights to a proprietary horizontal drilling process
we
began to deploy lateral drilling services in the field. In mid 2004, it became
apparent that this process was limited in its application to various types
of
oil and gas formations. After redesigning and improving the existing process
and
designing and testing some newer technologies, we now believe that we can
deliver a valuable and cost effective production enhancement service to onshore
oil and gas producers, particularly operators of marginally producing fields.
The goal is to make this new service reliably predictable and consistently
dependable for our customers. Our next step is to build our first new generation
lateral drilling rig with the capability of abrasive fluid jetting and
generating much higher hydraulic horsepower. Following favorable results and
customer acceptance of this initial rig’s capabilities, we intend to order the
construction of additional rigs and significantly grow the deployment of our
abrasive jetting service. Funding for developing this abrasive cutting
capability into a lateral drilling application is expected to come from current
and future capital commitments as well as from the proceeds of the assignment
of
the exclusive rights acquired in 2003. No assurances can be given that the
capital from these sources will be adequate. If this is the case, we will be
required to obtain additional capital from equity markets. No assurances can
be
given that such capital will be available or that the terms will be acceptable.
Risk
factors
Although
we believe that our expectations regarding future events are based on reasonable
assumptions, we cannot assure you that such expectations regarding future
developments will be realized. Actual results could differ materially from
those
discussed in the forward-looking statements as a result of certain factors,
including the risk factors described below. The risks and uncertainties
described below are not the only ones we face; there may be additional risks
and
uncertainties not presently known to us or those we currently believe are
immaterial which could also have a negative impact on our business, financial
condition and operating results.
GENERAL
RISKS RELATING TO OUR COMPANY
1.
We have a limited operating history, which makes it difficult to evaluate our
business performance.
We
have
been in existence for a few years, but we have been conducting drilling
operations using the proprietary lateral drilling technology only since June
2003 and satellite services to the oil and gas industry only since June 2002.
We
have commenced the construction of our first rig utilizing the abrasive jetting
technology to the down-hole milling and lateral jetting techniques. Abrasive
jetting has been successfully commercialized in several industries but is not
yet proven in the energy drilling industry. Because we have a limited operating
history, there is little historical financial data upon which an investor may
evaluate our business performance. Our revenue and income potential are
unproven. An investor must consider the risks, uncertainties, expenses and
difficulties frequently encountered by companies in their early stages of
development, particularly companies with limited capital in a rapidly evolving
market. These risks and difficulties include our ability to develop our
infrastructure, reliability in the milling process in our lateral drilling
technology, attract and maintain a base of customers, provide customer support,
personnel, and facilities to support our business, and respond effectively
to
competitive and technological developments. Our business strategy may not be
successful or may not successfully address any of these risks or difficulties.
While we believe our business model will permit us to generate substantial
revenues, there is no guarantee that the revenues will be realized. Failure
to
realize the revenue may have a material adverse effect on our financial
condition.
2.
We are an investment risk because business and marketing strategies planned
are
not proven.
We
have
no established basis to assure investors that business or marketing strategies
will be successful. We are highly dependent upon the acquisition of subscribers
for our satellite division; selection of, and productivity from, appropriate
oil
and gas wells; as well as the effective application of technologies and services
within operations. Our business model and marketing strategies anticipate such
application and productivity, yet are unproven by a significant history of
business operations. Failure to prove that our business model and strategies
work through continued operations may have a material adverse effect on our
business and financial condition.
3.
We may require additional capital in the future, which may not be available
to
us.
We
may
need to raise additional funds through public or private debt or equity
financing or other various means. Adequate funds may not be available when
needed or may not be available on favorable terms. If we raise additional funds
by issuing equity securities, dilution to existing stockholders will result,
and
such equity may have rights, preferences and privileges senior to those of
our
common stock. If we raise additional funds by issuing debt securities, we may
be
required to agree to covenants that may restrict our ability to expend or raise
capital in the future. If funding is insufficient at any time in the future,
we
may be unable to fund acquisitions, take advantage of business opportunities
or
respond to competitive pressures. Failure to raise additional capital in the
future may have a material adverse effect on our financial condition.
4.
Our auditors have expressed doubt as to our ability to continue as a going
concern.
As
noted
in the Independent Auditors Report (See Financial Note 2), our continued
substantial operating losses raise substantial doubt as to our ability to
continue as a going concern. We are in an early stage of development and are
rapidly depleting our cash resources, therefore we have determined that we
will
need to raise additional financing in the short term to continue in operation
and fund future growth. We incurred liquidated damages claimed by an investor
of
$500,000 related to the timing of providing registration rights for the private
financing that it arranged in November 2003. We also have significant contingent
liabilities, which may be determined adversely to us. If we are unable to raise
additional financing to satisfy these obligations this would have a material
adverse effect on our operations.
We
currently plan to raise additional financing. The use of stock for currency
in
financing or making acquisitions may be heavily curtailed while we are under
SEC
investigation. (See Financial Note 17) If we are unable to arrange new financing
or generate sufficient revenue from new business arrangements, we will be unable
to continue in our current form and will be forced to restructure or seek
creditor protection.
5.
We experienced operating losses in 2002, 2003 and 2004, and this trend may
continue.
We
suffered net losses of $3,128,782 for the year ended December 31, 2002,
$7,356,045 for the year ended December 31, 2003, and $8,766,108 for the year
ended December 31, 2004. The volatility underlying the early stage nature
of our
business and our industry prevents us from accurately predicting future
operating conditions and results, and we could continue to have losses. It
is
uncertain when, if ever, we will have significant operating income or cash
flow
from operations sufficient to sustain operations. If cash needs exceed available
resources, there can be no assurances that additional capital will be available
through public or private equity or debt financings. Sustained losses will
continue to have a material adverse effect on our business.
6.
Significant amounts of our outstanding common shares are restricted from
immediate resale but may be available for resale into the market in the near
future, possibly causing the market price of our common stock to drop
significantly.
As
of
February 28, 2005, we had 34,973,673 shares of common stock issued, outstanding
and held by 481 shareholders of record.
As
restrictions on resale for outstanding shares end, the market price could drop
significantly if the holders of these restricted shares sell them or are
perceived by the market as intending to sell them in an excessive amount
relative to the market demand for our shares. An excessive sale of our shares
may result in a material adverse effect on the price of our common stock, and
our ability to raise capital.
7.
One principal stockholder can influence the corporate and management policies
of
our company.
Berg
McAfee Companies, and its affiliates, effectively control approximately 30%
of
the outstanding common stock. Therefore, Berg McAfee Companies, and its
affiliates, may have the ability to substantially influence all decisions made
by us. Additionally, Berg McAfee Companies, and its affiliates, control could
have a negative impact on any future takeover attempts or other acquisition
transactions. Furthermore, certain types of equity offerings require stockholder
approval depending on the exchange on which shares of a company’s common stock
is
traded.
In the event we are required to obtain stockholder approval of a financing,
Berg
McAfee Companies, and its affiliates ownership, could block such a financing.
The control by one principal stockholder results in less control by our board
of
directors, management and the remaining stockholders. Please read ‘Certain
Relationships and Related Transactions.’
8.
We may sustain losses resulting from our extension of credit to non-paying
customers.
We
have,
prior to February 2004, conducted much of our drilling activities for related
parties, and we did not require collateral in support of our account
receivables. This resulted, on occasion, in an impediment to us obtaining full
payment for accounts receivable. Although we are implementing procedures to
combat this credit risk, there can be no assurance that our efforts will be
successful. Failure to guard against credit risk may have a material adverse
effect on our financial condition.
9.
Securities and Exchange Investigation Inquiries may continue to draw on our
limited financial resources and continue to negatively impact our ability to
raise additional capital.
We
received notice that the Securities and Exchange Commission has initiated a
formal investigation into our reporting practices and public statements about
the company in 2003.
The
SEC
has requested substantiation and documentary evidence from us concerning the
performance of certain lateral drilling services by subcontractors in the period
from May 2003 to September 2003, supervision of such services by our executive
management at the time, revenue recognition related to the performance of such
services, the third quarter 2003 earnings restatement, public statements
concerning the services performed, and related matters. The SEC has also
requested information and documentary evidence related to our acquisition of
certain assets of QuikView, Inc., a related party company, in June 2003. In
its
letters to us requesting documents, the SEC stated that the staff’s inquiry
should not be construed as an indication that any violations of securities
laws
have occurred or as an adverse reflection on any persons, company or security.
Since
December 2003, we have taken several steps to address issues related to the
SEC’s inquiries, including the termination and replacement of the previous Chief
Executive Officer and Chief Operating Officer. Two directors have resigned
from
our board and we have appointed a new CFO. Internal controls have been
strengthened overall, particularly with respect to the public release of
information and the recognition of revenue. We also initiated an internal
investigation of the matters of concern to the SEC. Consequently, we restated
our second and third quarter financial statements for 2003 and decided to defer
all revenue related to the aforementioned period until such time that we can
substantiate whether or not the services were performed.
We
are
cooperating fully with the SEC, including the provision of numerous documents
and voluntary testimony by our current executives. In December 2004, the staff
of the SEC notified us that it was considering recommending that the SEC bring
a
civil injunction (including a possible permanent injunction and a civil penalty)
against us alleging violations of provisions of the Sections 10(b), 13(b)(2)(A),
13(b)(2)(B) and 15(d) of the Securities Exchange Act of 1934 and rules
promulgated thereunder in connection with the purchase and sale of our
securities, recordkeeping, internal controls, certification and disclosure
obligations. We were notified of our right to make a Wells submission. We have
provided information to the SEC setting forth the specific steps we have taken
to upgrade the quality and effectiveness of our board of directors, replace
the
previous management team with industry experts, improve our recordkeeping,
internal and disclosure controls, and revenue recognition procedures. Although
we are working to bring the matter to a prompt conclusion, we cannot make any
assurance that the investigation will be resolved positively or that it will
not
have negative effects on our limited resources or our ability to raise capital
and use our stock as acquisition currency during the period of the
investigation.
10.
We have entered into a settlement agreement relating to the litigation with
Edge. If we do not perform certain obligations under the settlement agreement,
the lawsuit could be reinstituted. An adverse finding the in the lawsuit would
have a material adverse effect on our financial condition.
We
initiated a lawsuit against Edge in Montgomery County, Texas in February 2004
that requested a declaratory judgment that a purported agreement between us
and
Edge was not enforceable. The lawsuit arose from Edge’s contention that one of
our ex-officers committed the company to purchase certain alleged oil and gas
properties from Edge. Edge filed a counterclaim against us and asserted claims
against new parties including persons related to Edge’s financing source and
current and our former officers and directors. Edge sought to enforce the
agreement we challenge, and alleged several causes of action including claims
for fraud, breach of contract, negligence, and conspiracy and claimed actual
and
punitive damages in excess of $85 million.
Effective
January 19, 2005, we, Edge, certain entities affiliated with Edge, and Eric
McAfee (our former Vice-Chairman) entered into a Settlement Agreement and Mutual
Release to fully settle and resolve the disputes between Edge and its affiliated
entities, us and our directors, and Mr. McAfee. As part of the settlement,
we
issued to Edge Capital an aggregate of 750,000 shares of its common stock,
along
with warrants to purchase 750,000 shares of common stock. In addition, we also
agreed to provide to Edge a drilling rig to provide certain lateral drilling
services. As part of the drilling services, Edge has agreed to provide a fee
per
well, along with a share of the revenues generated from each well drilled.
Also,
as part of the settlement, at closing, we agreed to sublicense its Landers
horizontal drilling technology to Edge on a non-exclusive basis to enable Edge
to develop fields in which it has an economic interest. Under the sublicense,
Edge will be prohibited from performing services for others, except that it
will
have a limited right of first refusal to perform such services in the event
we
elect to not perform such services. The sublicense will have a 5-year term
and
be limited to the United States and Canada. As part of the settlement, the
parties to the agreement have agreed to a mutual release and have agreed to
dismiss all pending claims and litigation between them upon performance of
the
obligations in the settlement agreement. If we do not perform our remaining
obligations under the settlement agreement, this would cause the release to
not
be effective and could lead to the underlying lawsuit being reinstituted. An
adverse finding in such lawsuit against us would have a material adverse effect
on our financial condition. See “Legal Proceedings.”
11.
We are subject to certain additional lawsuits. If these lawsuits are successful
and substantial damages are awarded, these damages would have a material adverse
effect on our financial condition.
In
February 2005, we entered into an Agreed Judgment and Order of Severance with
Gryphon as to all breach of contract claims related to our delay in registering
common stock acquired by Gryphon in October 2003. Under the terms of the Agreed
Judgment, we are obligated to pay liquidated damages and attorney fees of
$500,000 to Gryphon on or before September 30, 2005. Additionally, Gryphon
has
agreed to abate their remaining claims and related discovery in the lawsuit
against us until after September 30, 2005. We agreed to register the shares
issued to Gryphon on or before March 2004 or be subject to certain liquidated
damages. Gryphon made a claim against us for the maximum liquidated damages
in
an amount of $400,000. Gryphon has also claimed that it has sustained actual
damages in excess of $6.2 million. In July 2004, Gryphon filed a lawsuit in
state district court in Dallas, Texas against us, alleging, among other things,
breach of contract and securities fraud by us. In connection with the lawsuit,
Gryphon requested liquidated damages, actual damages, punitive damages,
interest, cost and attorneys’ fees among other claims. We intend to vigorously
defend ourselves in this matter with respect to the remaining claims of Gryphon.
In
July,
2004 we were informed that our former Chief Executive Officer filed a lawsuit
against us for breach of contract and wrongful discharge. These claims seek
relief in excess of $500,000 related to an alleged employment agreement and
damages related to an excess of 4 million stock options claimed due pursuant
to
the alleged agreement. The lawsuit was filed in state court in San Diego,
California. We intend to vigorously defend ourselves.
An
adverse outcome in any of the above litigation would have a material adverse
effective on our financial condition and result of operations. Please see the
section ‘Legal Proceedings.’
12.
Our common stock is currently traded over the counter on the Over-the-Counter
market and is considered a “penny stock” resulting in potential illiquidity and
high volatility in the market price of our common stock.
The
market price of our common stock is likely to be highly volatile as is the
stock
market in general as well as the capital stock of most small cap companies.
Our
common stock currently trades over the counter on the OTC Bulletin Board, where
stocks typically suffer from lower liquidity. This may lead to depressed trading
prices, greater price volatility and difficulty in buying or selling shares
in
large quantities. Currently, there is a limited trading market for our common
stock, and we cannot predict when, if ever, a fully developed public market
for
the common stock will occur.
13.
Because our common stock is considered a “penny stock,” certain rules may impede
the development of increased trading activity and could affect the liquidity
for
stockholders.
Penny
stocks generally are equity securities with a price of less than $5.00 per
share
other than securities registered on certain national securities exchanges or
quoted on the NASDAQ stock market, subject to certain exceptions for companies
which exceed certain minimum tangible net worth requirements.
Our
common stock is subject to the SEC’s “penny stock rules”. The rules impose
additional sales practice requirements on broker-dealers who sell penny stock
securities to persons other than established customers and accredited investors.
For transactions covered by these rules, the broker-dealer must make a special
suitability determination for the purchase of penny stock securities and have
received the purchaser’s written consent to the transaction prior to the
purchase. Additionally, for any transaction involving a penny stock, unless
exempt, the “penny stock rules” require the delivery, prior to the transaction,
of a disclosure schedule relating to the penny stock market. The broker-dealer
also must disclose the commissions payable to both the broker-dealer and the
registered representative and current quotations for the securities. And,
monthly statements must be sent disclosing recent price information on the
limited market in penny stocks. These rules may restrict the ability of
broker-dealers to sell our securities and may have the effect of reducing the
level of trading activity of our common stock in the secondary market. In
addition, the penny-stock rules could have an adverse effect on our ability
to
raise capital in the future from offerings of our common stock.
On
January 12, 2004, the SEC proposed amendments to the penny stock rules to ensure
that investors continue to receive the protections of those rules. The SEC
also
is proposing that broker-dealers be required to enhance their disclosure
schedule to investors who purchase penny stocks, and that those investors have
an explicit “cooling-off period” to rescind the transaction. These amendments
could place further constraints on broker-dealers’ ability to sell our
securities.
14.
Our operations are subject to inherent risks that are beyond our control and
these risks may not be fully covered under our insurance policies.
Our
operations are subject to hazards inherent in the oil and gas industry, such
as
accidents, blowouts, explosions, craterings, fires and oil spills. These
conditions can cause:
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•
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personal
injury or loss of life;
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•
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damage
to or destruction of property, equipment and the environment; and
|
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•
|
suspension
of operations.
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In
addition, claims for loss of oil and gas production and damage to formations
can
occur in the well service industry. Litigation arising from a catastrophic
occurrence at a location where our equipment and services are being used may
result in us being named as a defendant in lawsuits asserting large claims.
We
maintain insurance coverage that we believe to be customary in the industry
against these hazards. However, we may not be able to maintain adequate
insurance in the future at rates we consider reasonable. In addition, our
insurance is subject to coverage limits and some policies exclude coverage
for
damages resulting from environmental contamination. The occurrence of a
significant event or adverse claim in excess of the insurance coverage that
we
maintain or that is not covered by insurance could have a materially adverse
effect on our financial condition and results of operations.
15.
We are subject to various operational and performance risks related to projects
that we undertake and services that we provide.
We
are
subject to various operational and performance risks related to projects that
we
undertake and services that we provide. These risks include:
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•
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changes
in the price or the availability of commodities that we use;
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•
|
non-performance,
default or bankruptcy of key suppliers or subcontractors;
|
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•
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cost
over-runs and operating cost inflation resulting from fixed-price
projects; and
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•
|
failure
by one or more parties to perform a complex business arrangement
for
technically demanding projects.
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Failure
to guard against operational and performance risks may have a material adverse
effect on our financial condition.
16.
Our markets may be adversely affected by oil and gas industry conditions that
are beyond our control.
Oil
and
gas industry conditions are influenced by numerous factors over which we have
no
control, such as the supply of and demand for oil and gas, domestic and
worldwide economic conditions, political instability in oil producing countries
and merger and divestiture activity among oil and gas producers. Those
conditions could adversely impact the level of drilling and workover activity
by
some of our customers. This reduction in activity may cause a decline in the
demand for our services or adversely affect the price of our services. We cannot
accurately predict either the future level of demand for our services or future
conditions of the well service industry. A decline in the demand for our
services may have a material adverse effect on our business.
17.
Our success depends on key members of our management, the loss of whom could
disrupt our business operations.
We
depend
to a large extent on the services of some of our executive officers and
directors. The loss of the services of either John O’Keefe, or David Adams could
disrupt our operations. We have entered into employment agreements with several
of our key executives that contain non-compete provisions. Notwithstanding
these
agreements, we may not be able to retain our executive officers and may not
be
able to enforce the non-compete provisions in the employment agreements. Failure
to retain key members of our management may have a material adverse effect
on
our business.
RISKS
RELATED TO OUR ABRASIVE JETTING DRILLING BUSINESS
1.
We currently have no active customers and in the past were highly dependent
on a
small number of customers, two of whom are related parties.
We
have
no active customers for our abrasive jetting lateral drilling services since
we
are in the construction mode. We currently have only indications of interest
in
the new AFJ drill rig once it is placed into service. We can give no assurance
that these indications of interest will turn into actual customers.
In
the
past a relatively limited number of customers has accounted for a substantial
portion of our revenue. One customer accounted for 14%, 38% and 87% of total
revenues in 2004, 2003 and 2002, respectively. In the second half of 2003,
53%
of our revenue was derived from services provided to three customers. Of those
three customers, two may be considered related parties. In the same period,
52%
of our revenue was derived from services provided to the two related parties.
In
addition, Edge, our only non-related customer in that period, has refused to
pay
for wells drilled in the second half of 2003, resulting in a total of $1,993,000
being reversed or deferred.
We
expect
that a high percentage of our revenue from our AFJ services will be provided
by
a limited number of customers for the near term or until we can deploy
additional AFJ drill rigs.
2.
We may not be able to protect our abrasive jetting lateral drilling technology
which could result in competition with service providers utilizing an infringing
technology.
The
license agreement allocates responsibility in maintaining the status of the
patents underlying the technology we license with the U.S. Patent and Trademark
Office to the licensor. Although the licensor has performed this obligation
in
the past, there can be no assurance that the licensor will have the ability
to
continue to maintain the patents. In the event we had to assume these
responsibilities additional pressure on our financial resources would result.
An
inability to continue operations under the exclusivity granted by the licensing
agreement may have a material adverse effect on our business.
3.
Our customers may not realize the expected benefits from our abrasive jetting
lateral drilling technology, which may impair market acceptance of our lateral
drilling services.
Our
lateral drilling business is heavily dependent upon our clients achieving
enhanced production, or lower costs, from certain types of existing oil and
gas
wells. Many of the wells for which the abrasive jetting lateral drilling
technology will be used on have been abandoned for some time due to low
production volumes or other reasons. In some cases, we have experienced
difficulty in having the enhanced production reach the market due to the
gathering field pipeline system’s disrepair resulting from the age of the fields
and the reliability of the milling process. There can be no assurance that
our
abrasive jetting lateral drilling technology will achieve enhanced production
from every well drilled, or that, if enhanced production is achieved initially,
it will continue for the duration necessary to achieve payout or that it will
reach the market on a timely basis. The failure to achieve projected
enhancements could result in making the application of the technology uneconomic
for our clients. Please see the section ‘Abrasive Jetting Lateral Drilling
Services’ for an explanation on how we will attempt to achieve an economic
benefit for our clients. Failure to achieve an economic benefit for our clients
in the provision of this service may have a material adverse effect on our
business.
4.
We may be unable to accurately identify oil and gas wells on which our abrasive
jetting lateral drilling technology will enhance oil and gas recovery, which
may
impair the market acceptance of our lateral drilling services.
Our
lateral drilling business is heavily dependent on our ability to correctly
identify with our clients, the appropriate oil and gas wells that will produce
the enhanced revenues or lower costs. Certain subsurface conditions are not
conducive to the use of our high pressure abrasive jetting lateral drilling
technology, and certain wells may have been severely depleted or otherwise
negatively impacted in some manner by the operator. While we have added an
evaluation screening technique and other new technology and improvements
relating to analysis of depleted fields,
the
failure to identify the correct types of oil and gas wells could result in
not
realizing the expected economic returns which could initially have a material
adverse effect on our business, financial condition and operating results.
5.
Competition within the well service industry may adversely affect our ability
to
market our services.
The
well
service industry is highly competitive and includes several large companies,
such as Halliburton, Baker Hughes, Schlumberger and other independent drilling
companies that possess substantially greater financial and other resources
than
we do. These greater resources could allow those competitors to compete more
effectively than we can. Additionally, the number of rigs available continues
to
exceed demand, resulting in active price competition. Moreover, many contracts
are awarded on a bid basis, which further increases competition based on price.
Failure to successfully compete within our industry may have a material adverse
effect on our business.
6.
We may be subject to environmental requirements which may increase our costs
or
liabilities related to our lateral drilling operations.
Given
the
manner in which we currently operate our business, we are not regulated to
the
extent that an oil and gas company is with respect to environmental laws, rules
and regulations in the U.S. and other countries, including those covering
hazardous materials, because we generally do not own the properties we service.
However, environmental requirements generally are becoming increasingly strict.
In the future, we may be held liable for certain failures relating to
environmental regulations. Sanctions for failure to comply with these
requirements, many of which may be applied retroactively, may include:
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•
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administrative,
civil and criminal penalties;
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•
|
revocation
of permits; and
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•
|
corrective
action orders, including orders to investigate and/or clean up
contamination.
|
Liability
for damages arising as a result of environmental laws could be substantial
and
could have a material adverse effect on our results of operations. The
liabilities incurred as a result of complying with environmental requirements
or
failure on our part to comply with applicable environmental requirements may
have a material adverse effect on our financial condition. There can be no
assurance that governmental laws will not broaden in scope in the future to
cover the types of services that we currently provide. Failure to comply with
environmental laws could have a material negative impact on our financial
condition.
7.
Changes in environmental laws may decrease demand for our services.
Changes
in environmental laws may negatively impact demand for our services. Activity
by
oil and gas exploration and production companies may decline if, for example,
the Environmental Protection Agency promulgates more stringent environmental
regulations such as land use policies. If oil and gas exploration and production
activities decline, this could have a material adverse effect on our operating
results.
RISKS
RELATED TO OUR SATELLITE BUSINESS
1.
We are highly dependent upon a few key providers who furnish satellite
networking components, hardware, and technological services.
Our
satellite business is heavily dependent on agreements with Spacenet, ViaSat
and
other equipment and service providers. These strategic relationships provide
key
network technology, satellite data transport, hardware and software. Failure
of
Spacenet, ViaSat or other key relationships to meet our expectations or
termination of a relationship with one of our key providers may have a material
adverse effect on our business.
2.
We depend upon our vendors and their affiliates to provide services that we
require to operate the network we use to provide services to our customers.
We
are
not and do not plan to become a licensee of the Federal Communications
Commission (“FCC”) and do not hold any authorization to operate satellite
communications facilities. We depend upon licenses held by Spacenet and ViaSat
and their subsidiaries for our satellite communications. If the licenses held
by
Spacenet and ViaSat are limited or revoked, if the FCC limits the number of
its
customer premises earth stations or if Spacenet or ViaSat fails to operate
the
earth stations providing service to us and our subscribers in a satisfactory
manner, our operating results may be materially adversely affected.
3.
We rely on third-party independent contractors to install our customer premises
equipment at new subscribers’ businesses and homes.
We
do not
control the hiring, training, certification and monitoring of the employees
of
our third-party independent contractors. If growth of our new subscriber base
outpaces growth of our installer base or if the installers fail to provide
the
quality of service that our customers expect, our operating results may be
materially adversely affected.
4.
The service we provide is entirely dependent on the functionality of satellites
on which we lease transponders and on our computer and communications hardware
and software.
Our
ability to provide service is entirely dependent on the functionality of
satellites on which we lease transponders. These satellites may experience
failure, loss, damage or destruction from a variety of causes, including war,
anti-satellite devices and collision with space debris. If this occurs, we
are
likely to suffer:
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•
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permanent
loss of service;
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•
|
temporary
gaps in service availability; or
|
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•
|
decreased
quality of service.
|
Such
a
failure in the service we provide may have a material adverse effect on our
business, financial condition and operating results.
The
ability to provide timely information and services depends also on the efficient
and uninterrupted operation of our computer and communications hardware and
software systems. These systems and operations are vulnerable to damage or
interruption from human error, natural disasters, telecommunication failures,
break-ins, sabotage, computer viruses, intentional acts of vandalism and similar
events. We are in the process of designing and plan to implement a disaster
recovery plan. Despite precautions, there is always the danger that human error
or sabotage could substantially disrupt the system. Any such failure may have
a
material adverse effect on our business.
5.
We may be unable to attract or retain subscribers.
If
we are
unable to attract or retain subscribers, our telecommunications business will
be
harmed. Our success depends upon our ability to rapidly grow our subscriber
base. Several factors may negatively impact this ability, including:
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•
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loss
of our existing sales employees, resulting in our lack of access
to
potential subscribers;
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•
|
failure
to establish and maintain the Verdisys brand through advertising
and
marketing, or erosion of our brand due to misjudgments in service
offerings;
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•
|
failure
to develop or acquire technology for additional value added services
that
appeals to the evolving preferences of our subscribers;
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•
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failure
to meet our expected minimum sales commitments to Spacenet and ViaSat;
and
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•
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failure
to provide the minimum transmission speeds and quality of service
our
customers expect.
|
In
addition, our service may require customers to purchase our satellite system
equipment and to pay our monthly subscriber fees. The price of the equipment
and
the subscription fees may be higher than the price of many dial-up, DSL and
cable modem internet access services, where available. In some instances, we
expect to subsidize our subscribers’ customer premises equipment to encourage
the purchase of our service and to offset our higher relative costs but such
subsidy may not be possible. Failure to attract or retain subscribers may have
a
material adverse effect on our business.
6.
We may fail to manage any potential growth or expansion, negatively impacting
our quality of service or overcapacity impacting profitability.
If
we
fail to manage our potential rapid growth and expansion effectively or expand
and allocate our resources efficiently, we may not be able to retain or grow
our
subscriber base. If our assumptions regarding the usage patterns of our
subscribers are wrong or if our subscribers’ usage patterns change, we will have
either too little or too much satellite capacity, both of which could harm
our
business.
If
we
achieve the substantial subscriber growth that we anticipate, we will need
to
procure additional satellite capacity. If we are unable to procure this
capacity, we may be unable to provide service to our subscribers or the quality
of service we provide may not meet their expectations. Failure to manage any
potential growth may have a material adverse effect on our business.
7.
Our current services may become obsolete due to the highly competitive and
continued advancement of the satellite industry. Larger service providers may
provide services reduced pricing.
Intense
competition in the internet services market and inherent limitations in existing
satellite technology may negatively affect the number of our subscribers.
Competition in the market for consumer internet access services is intense,
and
we expect the level of competition to intensify in the future. We compete with
providers of various high-speed communications technologies for local access
connections such as cable modem and DSL. We also may face competition from
traditional telephone companies, competitive local exchange carriers and
wireless communication companies. As our competitors expand their operations
to
offer high speed internet services, we may no longer be the only high-speed
service available in certain markets. We also expect additional competitors
with
satellite-based networks to begin operations soon. In particular, some satellite
companies have announced that in the future they may offer high-speed internet
service at the same price or at a lower price than we currently intend to offer
and are offering our services. Many of our current and potential competitors
have longer operating histories, greater brand name recognition, larger
subscriber bases and substantially greater financial, technical, marketing
and
other resources than we have. Therefore, they may be able to respond more
quickly than we can respond to new or changing opportunities, technologies,
standards or subscriber requirements. Any such competition may have a material
adverse effect on our business.
8.
We may be mistaken in our belief as to future growth of the satellite broadband
market.
While
we
believe that the trend toward satellite broadband information services in the
energy market will continue to develop, our future success is highly dependent
on increased use of these services within the sector. The number of satellite
broadband users willing to pay for online services and information may not
continue to increase. A failure in the market for satellite broadband services
to develop as expected may have a material adverse effect on our business.
9.
We may be subject to significant liability for our products.
If
our
products contain defects, we may be subject to significant liability claims
from
subscribers and other users of our products and incur significant unexpected
expenses or lost revenues. Our telecommunications products are complex and
may
contain undetected errors or failures. If this happens, we may experience delay
in or loss of market acceptance and sales, products returns, diversion of
research and development resources, injury to our reputation or increased
service and warranty costs. We also have exposure to significant liability
claims from our customers because our products are designed to provide critical
communications services. Although we attempt to limit such exposure through
product liability insurance and through contractual limitations in our customer
agreements, such precautions may not cover all potential claims resulting from
a
defect in one or more of our products. Failure of our products to perform
satisfactorily may have a material adverse effect on our operating results.
Critical
Accounting Policies
The
following is a discussion of our critical accounting policies pertaining to
accounts receivable, equipment, license, revenue recognition and the use of
estimates.
Accounts
Receivable
Trade
accounts receivable are recorded at the invoiced amount and do not bear
interest. The allowance for doubtful accounts represents our estimate of the
amount of probable credit losses existing in our accounts receivable. We
determine the allowance based on management’s estimate of likely losses based on
a review of current open receivables and our historical write-off experience.
We
review the adequacy of our allowance for doubtful accounts quarterly.
Significant individual accounts receivable balances and balances which have
been
outstanding greater than 90 days are reviewed individually for collectibility.
Account balances, when determined to be uncollectible, are charged against
the
allowance.
Equipment
Equipment,
including betterments which extend the useful life of the asset, are stated
at
cost. Maintenance and repairs are charged to expense when incurred. We provided
for the depreciation of our equipment using the straight-line method over the
estimated useful lives. Our method of depreciation does not change when
equipment becomes idle; we continue to depreciate idled equipment on a
straight-line basis. No provision for salvage value is considered in determining
depreciation of our equipment. We review our assets for impairment when events
or changes in circumstances indicate that the carrying values of certain assets
either exceed their respective fair values or may not be recovered over their
estimated remaining useful lives. Provisions for asset impairment are charged
to
income when estimated future cash flows, on an undiscounted basis, are less
than
the asset’s net book value. Impairment charges are recorded based on discounted
cash flows. There were no impairment charges to equipment during the years
ended
December 31, 2004 and 2003.
License
In
March
2005, we entered into an agreement to sell our lateral drilling license for
$1.3
million and have fully impaired the asset while creating an account receivable
for the sales value. We provide for amortization of our license using the
straight-line method over the estimated useful lives. We review our carrying
value of the license for impairment on an annual basis or when events or
changes
in circumstances indicate that the carrying values may no longer be appropriate.
We assess recoverability of the carrying value of the asset by estimating
the
future net cash flows expected to result from the asset, including eventual
disposition. If the future net cash flows are less than the carrying value
of
the asset, an impairment loss is recorded equal to the difference between
the
asset’s carrying value and fair value. There were no impairment charges to the
lateral drilling license during the years ended December 31, 2003 but we
charged
$3.2 million to impairment expense at December 31, 2004.
Revenue
Recognition
All
revenue is recognized when persuasive evidence of an arrangement exists, the
service or sale is complete, the price is fixed or determinable and
collectibility is reasonably assured. Revenue is derived from sales of satellite
hardware, satellite bandwidth, satellite service and lateral drilling services.
Revenue from satellite hardware is recognized when the hardware is installed.
Revenue from satellite bandwidth is recognized evenly over the term of the
contract. Revenue from satellite service is recognized when the services are
performed. We provide no warranty but sell commercially obtained 3 to 12 month
warranties for satellite hardware. We have a 30 day return policy. Revenue
for
lateral drilling services is recognized when the services are performed and
collectibility is reasonably assured and when collection is uncertain, revenue
is recognized when cash is collected. In accordance with Emerging Issues Task
Force Issue No. 00-14, we recognize reimbursements received from third parties
for out-of-pocket expenses incurred as revenues and account for out-of-pocket
expenses as direct costs.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
certain estimates and assumptions that affect the reported amounts of assets
and
liabilities and disclosures of contingent assets during the reporting period.
Actual results could differ from such estimates.
Estimates
are used by management in the following financial reporting areas:
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•
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Allowance
for doubtful accounts,
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•
|
Depreciation
and amortization,
|
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•
|
Asset
impairment,
|
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•
|
Income
taxes and
|
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•
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Stock
option disclosures.
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For
additional information on our accounting policies, see Note 1 of Notes to
Financial Statements included as part of Item 7 of this Report.
Fiscal
Year ended December 31, 2004 Compared to the Fiscal Year Ended December 31,
2003
Lateral
Drilling Services
Lateral
Drilling Services’ revenues increased by $273,000 to $739,000 for the year ended
December 31, 2004 compared to $466,000 for the year ended December 31, 2003.
The
operating margin from Lateral Drilling Services improved by $419,000 to a loss
of $129,000 for the year ended December 31, 2004 compared to a loss of $548,000
for the year ended December 31, 2003. We have had mixed results using the
Landers technology and therefore have been unable to generate a profit during
either year. The 2003 results were also negatively affected by the initial
start-up costs of the lateral drilling service.
Effective
as of October 27, 2004, we entered into a licensing agreement to develop a
new
generation of lateral drilling technology using the AFJ process. In the short
term, the development activity will decrease lateral drilling revenues until
such time as the new technology rigs are deployed into commercial operations.
Satellite
Communications Services
Satellite
Communication Services’ revenues increased by $296,000 to $715,000 for the year
ended December 31, 2004 compared to $419,000 for the year ended December 31,
2003. The operating margin from Satellite Communication Services improved by
$163,000 to a loss of $6,000 for the year ended December 31, 2004 compared
to a
loss of $169,000 for the year ended December 31, 2003. As this segment of our
business grows it becomes more efficient and realizes economies of scale.
As
hardware is sold, we recognize the revenue in the period it is delivered to
the
customer. We bill some of our bandwidth contracts in advance, but recognize
revenue over the period benefited. At December 31, 2004, there was $317,615
reflected in the balance sheet as deferred revenue relating to Satellite
Communication Services.
Selling,
General and Administrative
Selling,
general and administrative (“SG&A”) expenses decreased by $1.9 million to
$4.7 million for the year ended December 31, 2004 compared to $6.6 million
for
the year ended December 31, 2003. The following table details the major
components of SG&A expense over the periods.
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|
2004
|
2003
|
Increase
(Decrease)
|
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|
Payroll
and related costs
|
$
|
773,538
|
$
|
828,117
|
$
|
(54,579
|
)
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|
Option
and warrant expense
|
747,480
|
2,392,291
|
(1,644,811
|
)
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||||||
|
License
fee
|
735,192
|
—
|
735,192
|
|||||||
|
Legal
fees
|
718,678
|
518,077
|
200,601
|
|||||||
|
External
services
|
567,883
|
446,606
|
121,277
|
|||||||
|
Insurance
|
447,109
|
157,254
|
289,855
|
|||||||
|
Liquidated
damages
|
500,000
|
—
|
500,000
|
|||||||
|
Travel
& entertainment
|
139,627
|
193,393
|
(53,766
|
)
|
||||||
|
Office
rent
|
66,777
|
42,325
|
24,452
|
|||||||
|
Communications
|
55,842
|
60,935
|
(5,093
|
)
|
||||||
|
Expired
purchase option
|
—
|
620,000
|
(620,000
|
)
|
||||||
|
Purchase
guarantee
|
—
|
300,000
|
(300,000
|
)
|
||||||
|
Impairment
on software
|
—
|
1,000,000
|
(1,000,000
|
)
|
||||||
|
Miscellaneous
|
265
|
55,541
|
(55,276
|
)
|
||||||
|
|
$
|
4,752,391
|
$
|
6,614,539
|
$
|
(1,862,148
|
)
|
|||
The
decrease in option and warrant expense can be attributed to the fact that in
2004, we started issuing options at market price and therefore recognized no
expense under our accounting policy (see Financial Note 14). The license fee
is
related to the lateral drilling license and note payable with Carl Landers.
We
issued 300,000 shares of our common stock with a value of $1.9 million to reduce
the then outstanding note balance by $1.2 million and record expense of $0.7
million. Legal fees continue to increase due to the level of legal activity
we
have experienced over the last two years. Our external services have increased
due to greater reliance on independent contractors instead of employees and
rising audit fees. The increase in the cost of insurance was primarily
attributable to the increase in the directors and officers liability policy
premium due to legal activity. The liquidated damages relate to our delay in
registering shares that we sold (see Financial Note 13). In 2003, we paid $0.5
million for a sixteen day option to purchase a large gas field with significant
gas production. The purchase option expired and we incurred additional fees
of
$120,000 related to the transaction. In 2003, we guaranteed Edge’s purchase of
oil and gas properties from another entity (see Financial Note 17). In 2003,
we
issued 2 million shares of common stock for what management believed was
satellite communications management software pursuant to an asset purchase
agreement with a related party. Subsequently, management determined that the
software was impaired by $1.0 million.
Depreciation
and Amortization
Depreciation
and amortization expense increased by $293,000 to $0.5 million for the year
ended December 31, 2004 compared to $220,000 for the year ended December 31,
2003. This increase can be attributed to the depreciation on the four drilling
rigs in service for 2004, compared to only two rigs in service for three months
of 2003 and the amortization on the drilling license acquired in late 2003.
Debt
Forgiveness Income
In
2003,
we negotiated settlements with 9 vendors for various debts originally recorded
on the books at $0.5 million for $44,000 cash and 33,333 shares of stock valued
at $.50 resulting in debt forgiveness income of $460,000. There was no similar
event in 2004.
Gain
or Loss on Sale of Property
In
2004,
we had a net loss from the sale and or disposition of equipment in the normal
course of business of $11,000. In 2003, we recognized a gain of $120,000 from
the assignment of a 75% net revenue interest in property located in Monroe,
Louisiana. We received the net revenue interest from a third party in exchange
for agreeing to perform lateral drilling services on the property. In October
2003, we assigned the net revenue interest to Edge for $200,000. Edge paid
us
$120,000 and agreed to pay the balance of $80,000 by March 31, 2004. The $80,000
was not collected and under terms of the Settlement Agreement and Mutual Release
entered into with Edge, we have relinquished our right to these funds (See
Item
3. Legal Proceedings).
Asset
Impairment Expense
We
charged $3,175,000 to impairment expense at December 31, 2004 to recognize
the
difference in the carrying value and the market price when we entered into
the
sale of the Landers license to Maxim for $1.3 million.
Interest
Expense
Interest
expense decreased by $108,000 to $105,000 for the year ended December 31, 2004
compared to $213,000 for the year ended December 31, 2003. The decrease in
expense can be attributed to an average debt outstanding for the year ended
December 31, 2004 of approximately $0.7 million compared to average debt
outstanding of approximately $1.9 million for the year ended December 31, 2003.
Net
Loss
The
net
loss for the year ended December 31, 2004 increased to $8.8 million from
$7.4
million for the year ended December 31, 2003. The increase is attributable
to
the major items explained above. The tax benefit associated with our loss
has
been fully reserved as we have recurring net losses and it is more likely
than
not that tax benefits will not be realized.
Liquidity
and Capital Resources
As
of
December 31, 2004 and 2003, our cash balance was $267,000 and $1.4 million,
respectively. The cash balance at December 31, 2003 was generated by an equity
offering and was utilized to pay debt and to fund operations. We have $185,000
of debt that becomes due on May 14, 2005, $350,000 of convertible notes that
becomes due on December 31, 2005 and a $50,000 note that is due on demand.
In
addition, we have $200,000 of convertible notes with related parties that mature
on May 31, 2006. Both sets of convertible notes are convertible into common
stock at the rate of one share for each $2.00 of principal and interest
outstanding.
In
February 2005, we entered into an Agreed Judgment and Order of Severance with
Gryphon as to all breach of contract claims related to our delay in registering
common stock acquired by Gryphon in October 2003. Under the terms of the Agreed
Judgment, we are obligated to pay liquidated damages of $0.5 million to Gryphon
on or before September 30, 2005. In March 2005, we agreed to sell our master
license for the Landers lateral drilling technology and retain a sub-license
for
$1.3 million in cash and the release of $270,000 of supplier obligations. The
1.3 million will be collected over the course of 2005.
We
are
also subject to significant contingent liabilities as more fully described
in
the Notes to the Financial Statements (See Financial Note 17).
As
noted
in the Independent Auditors Report (See Financial Note 2) due to the continued
substantial operating losses that we have incurred raises substantial doubt
as
to our ability to continue as a going concern. We are in an early stage of
development and are rapidly depleting our cash resources, therefore we have
determined that we will need to raise additional financing in the short term
to
continue in operation and fund future growth. We currently plan to raise
additional financing in the quarter ending March 31, 2005. The use of stock
for
currency in financing or making acquisitions has been heavily curtailed while
we
have been under SEC investigation. (See Financial Note 17) If we are unable
to
arrange new financing or generate sufficient revenue from new business
arrangements, we will be unable to continue in our current form and will be
forced to restructure or seek creditor protection.
Capital
Expenditures
We
expect
to spend approximately one million dollars in 2005 for the building of the
first
rig utilizing the AFJ cutting technology. As of December 31, 2004, we had no
commitments towards this project. The project will be financed either through
the issuance of stock, debt, project equity or from the proceeds of the license
sold in March of 2005. Capital expenditures for 2004 were $3,705 as compared
to
$799,493 from 2003. Capital expenditures for 2003 include the purchase of four
drilling rigs for $737,720.
Research
and Development, Patents and Licenses
We
believe our future success depends on the ability to effectively utilize the
lateral drilling technology obtained in a license granted by Mr. Landers and
the
AFJ technology currently under development. See “Patents and Licenses” in the
Description of Business section of this Form 10-KSB.
Item
7. Financial Statements
Index
to Financial Statements
|
|
Page
|
|
Report
of Independent Registered Public Accounting Firm
|
35
|
|
Balance
Sheet at December 31, 2004
|
36
|
|
Statements
of Operations Years
ended December 31, 2004 and 2003
|
37
|
|
Statements
of Stockholders’ Equity Years
ended December 31, 2004 and 2003
|
38
|
|
Statements
of Cash Flows Years
ended December 31, 2004 and 2003
|
40
|
|
Notes
to Financial Statements
|
41 -
57
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors
Verdisys,
Inc.
Houston,
Texas
We
have
audited the accompanying balance sheet of Verdisys, Inc. as of December 31,
2004
and the related statements of operations, stockholders’ equity and cash flows
for each of the two years then ended. These financial statements are the
responsibility of Verdisys’ management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We
conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audits 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
audits provide 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 Verdisys, Inc. as of December
31,
2004 and the results of its operations and cash flows for each of the two years
then ended in conformity with accounting principles generally accepted in the
United States of America.
The
accompanying financial statements have been prepared assuming that Verdisys
will
continue as a going concern. As discussed in Note 2 to the financial statements,
Verdisys suffered recurring losses from operations and has a working capital
deficiency, which raises substantial doubt about its ability to continue as
a
going concern. Management’s plans regarding those matters also are described in
Note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
As
described in Note 23 to the financial statements, the accompanying consolidated
balance sheet as of December 31, 2004 and consolidated statement of operations
and cash flows for the year ended have been restated to reflect the impairment
of the carrying value of the Company's intellectual property as of December
31,
2004.
MALONE
& BAILEY, PC
www.malone-bailey.com
Houston,
Texas
March
21,
2005 (March 29, 2006 as to the effects of the restatement as described in
Note
23)
VERDISYS,
INC.
BALANCE
SHEET
December
31, 2004
|
ASSETS
|
(Restated)
|
|||
|
Current
Assets
|
|
|||
|
Cash
|
$
|
266,917
|
||
|
Accounts
receivable, net of allowance for doubtful accounts of
$30,000
|
58,726
|
|||
|
Lease
receivable
|
125,000
|
|||
|
License
receivable
|
1,300,000
|
|||
|
Other
current assets
|
44,076
|
|||
|
Total
Current Assets
|
1,794,719
|
|||
|
Equipment,
net of accumulated depreciation of $130,467
|
447,401
|
|||
|
License,
net of accumulated amortization of $549,167
|
-
|
|||
|
Total
Assets
|
$
|
2,242,120
|
||
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|||
|
Current
Liabilities
|
|
|||
|
Accounts
payable
|
$
|
738,442
|
||
|
Accrued
expenses
|
1,270,732
|
|||
|
Deferred
revenue
|
254,726
|
|||
|
Customer
deposit
|
276,850
|
|||
|
Notes
payable - related parties, net of unamortized discount of
$7,674
|
102,326
|
|||
|
Notes
payable, net of unamortized discount of $74,148
|
400,852
|
|||
|
Total
Current Liabilities
|
3,043,928
|
|||
|
Long
Term Liabilities
|
|
|||
|
Notes
payable - related parties, net of unamortized discount of
$50,622
|
149,378
|
|||
|
Deferred
revenue, less current portion
|
81,878
|
|||
|
Total
Liabilities
|
3,275,184
|
|||
|
Commitments
& Contingencies
|
|
|||
|
Stockholders’
Equity
|
|
|||
|
Common
Stock, $.001 par value, 50,000,000 shares authorized, 33,443,691
shares
issued and outstanding
|
33,444
|
|||
|
Additional
paid-in capital
|
26,000,119
|
|||
|
Accumulated
deficit
|
(27,066,627
|
)
|
||
|
Total
Stockholders’ Equity
|
(1,033,064
|
)
|
||
|
Total
Liabilities and Stockholders’ Equity
|
$
|
2,242,120
|
||
See
accompanying summary of accounting policies and notes to financial
statements.
VERDISYS,
INC.
STATEMENTS
OF OPERATIONS
Years
Ended December 31, 2004 and 2003
|
|
2004
|
2003
|
|||||
|
Revenue
|
(Restated)
|
|
|||||
|
Satellite
Service - third parties
|
$
|
714,634
|
$
|
419,247
|
|||
|
Drilling
Services
|
|||||||
|
Third
parties
|
716,163
|
7,444
|
|||||
|
Related
parties
|
22,547
|
458,750
|
|||||
|
Total
Revenue
|
1,453,344
|
885,441
|
|||||
|
Cost
of Services Provided
|
|||||||
|
Satellite
Services
|
|||||||
|
Third
parties
|
720,912
|
588,498
|
|||||
|
Drilling
Services
|
|||||||
|
Third
parties
|
868,160
|
787,560
|
|||||
|
Related
parties
|
—
|
226,611
|
|||||
|
Total
Cost of Services Provided
|
1,589,072
|
1,602,669
|
|||||
|
Gross
Loss
|
(135,728
|
)
|
(717,228
|
)
|
|||
|
Operating
Expenses
|
|||||||
|
Selling,
general & administrative
|
4,752,391
|
6,614,539
|
|||||
|
Depreciation
and amortization
|
512,706
|
219,692
|
|||||
|
Bad
debts
|
73,249
|
172,003
|
|||||
|
Asset
Impairment
|
3,175,833 | ||||||
|
Operating
Loss
|
(8,649,907
|
)
|
(7,723,462
|
)
|
|||
|
Other
(Income) Expense
|
|||||||
|
Debt
forgiveness income
|
—
|
(460,235
|
)
|
||||
|
Loss
(gain) on sale of property
|
11,237
|
(120,000
|
)
|
||||
|
Interest
income
|
(89
|
)
|
(417
|
)
|
|||
|
Interest
expense
|
105,053
|
213,235
|
|||||
|
Total
other (income) expense
|
116,201
|
(367,417
|
)
|
||||
|
Net
Loss
|
$
|
(8,766,108
|
)
|
$
|
(7,356,045
|
)
|
|
|
Basic
and diluted net loss per share
|
$
|
(.28
|
)
|
$
|
(.33
|
)
|
|
|
Weighted
average shares outstanding
|
31,415,041
|
22,180,185
|
|||||
See
accompanying summary of accounting policies and notes to financial
statements.
VERDISYS,
INC.
STATEMENT
OF STOCKHOLDERS’ EQUITY
Years
Ended December 31, 2003 and 2004 (Restated)
|
|
Preferred
Stock
|
Common
Stock
|
|||||||||||
|
|
Shares
|
Amount
|
Shares
|
Amount
|
|||||||||
|
Balances,
December 31, 2002
|
1,410,000
|
$
|
705,000
|
13,553,139
|
$
|
13,553
|
|||||||
|
Series
B preferred stock exchanged for common stock
|
(1,410,000
|
)
|
(705,000
|
)
|
1,410,000
|
1,410
|
|||||||
|
Stock
issued for:
|
|
|
|
|
|||||||||
|
Cash,
net of fundraising costs
|
|
|
2,740,733
|
2,741
|
|||||||||
|
Services
|
|
|
4,679,194
|
4,679
|
|||||||||
|
Accounts
payable
|
|
|
33,333
|
33
|
|||||||||
|
Notes
payable and accrued interest
|
|
|
2,890,688
|
2,891
|
|||||||||
|
Cash
exercise of warrants and options
|
|
|
1,995,178
|
1,995
|
|||||||||
|
Cashless
exercise of warrants for note payment
|
|
|
200,000
|
200
|
|||||||||
|
Note
payment on lease
|
|
|
125,000
|
125
|
|||||||||
|
Reduction
of royalty
|
|
|
500,000
|
500
|
|||||||||
|
RDGI
merger
|
|
|
1,500,000
|
1,500
|
|||||||||
|
Fair
value of options and warrants issued for services
|
|
|
|
|
|||||||||
|
Contribution
to capital
|
|
|
|
|
|||||||||
|
Net
loss
|
|
|
|
|
|||||||||
|
Balances,
December 31, 2003
|
—
|
—
|
29,627,265
|
29,627
|
|||||||||
|
Stock
issued for:
|
|
|
|
|
|||||||||
|
Cash,
net of fundraising costs
|
|
|
829,500
|
830
|
|||||||||
|
Services
|
|
|
47,950
|
48
|
|||||||||
|
Accounts
payable
|
|
|
104,000
|
104
|
|||||||||
|
Notes
payable, accrued interest and licensing fees
|
|
|
300,000
|
300
|
|||||||||
|
Cash
exercise of warrants and options
|
|
|
1,207,198
|
1,207
|
|||||||||
|
Prior
fundraising agreement
|
|
|
277,778
|
278
|
|||||||||
|
Lawsuit
settlements
|
|
|
1,050,000
|
1,050
|
|||||||||
|
Fair
value of options and warrants issued for services
|
|
|
|
|
|||||||||
|
Net
Loss
|
|
|
|
|
|||||||||
|
Balances,
December 31, 2004
|
—
|
$
|
—
|
33,443,691
|
$
|
33,444
|
|||||||
VERDISYS,
INC.
STATEMENT
OF STOCKHOLDERS’ EQUITY
Years
Ended December 31, 2003 and 2004 (Restated)
|
|
Paid-In
Capital
|
Retained
Deficit
|
Totals
|
|||||||
|
Balances,
December 31, 2002
|
$
|
6,098,924
|
$
|
(10,944,474
|
)
|
$
|
(4,126,997
|
)
|
||
|
Series
B preferred stock exchanged for common stock
|
703,590
|
|
|
|||||||
|
Stock
issued for:
|
|
|
|
|||||||
|
Cash,
net of fundraising costs
|
6,559,409
|
|
6,562,150
|
|||||||
|
Services
|
1,619,660
|
|
1,624,339
|
|||||||
|
Accounts
payable
|
16,633
|
|
16,666
|
|||||||
|
Notes
payable and accrued interest
|
1,503,299
|
|
1,506,190
|
|||||||
|
Cash
exercise of warrants and options
|
366,820
|
|
368,815
|
|||||||
|
Cashless
exercise of warrants for note payment
|
19,800
|
|
20,000
|
|||||||
|
Note
payment on lease
|
249,875
|
|
250,000
|
|||||||
|
Reduction
of royalty
|
2,274,500
|
|
2,275,000
|
|||||||
|
RDGI
merger
|
(1,500
|
)
|
|
—
|
||||||
|
Fair
value of options and warrants issued for services
|
1,844,311
|
|
1,844,311
|
|||||||
|
Contribution
to capital
|
488,000
|
|
488,000
|
|||||||
|
Net
loss
|
|
(7,356,045
|
)
|
(7,356,045
|
)
|
|||||
|
Balances,
December 31, 2003
|
21,743,321
|
(18,300,519
|
)
|
3,472,429
|
||||||
|
Stock
issued for:
|
|
|
|
|||||||
|
Cash,
net of fundraising costs
|
633,170
|
|
634,000
|
|||||||
|
Services
|
(48
|
)
|
|
—
|
||||||
|
Accounts
payable
|
51,873
|
|
51,977
|
|||||||
|
Notes
payable, accrued interest and licensing fees
|
1,919,700
|
|
1,920,000
|
|||||||
|
Cash
exercise of warrants and options
|
80,010
|
|
81,217
|
|||||||
|
Prior
fundraising agreement
|
(278
|
)
|
|
—
|
||||||
|
Lawsuit
settlements
|
836,950
|
|
838,000
|
|||||||
|
Fair
value of options and warrants issued for services
|
735,421
|
|
735,421
|
|||||||
|
Net
Loss
|
|
(8,766,108
|
)
|
(8,766,108
|
)
|
|||||
|
Balances,
December 31, 2004
|
$
|
26,000,119
|
$
|
(27,066,627
|
)
|
$
|
(1,033,064
|
)
|
||
VERDISYS,
INC.
STATEMENT
OF CASH FLOWS
Years
Ended December 31, 2004 and 2003
|
|
2004
|
2003
|
|||||
|
Cash
Flows From Operating Activities
|
(Restated)
|
|
|||||
|
Net
loss
|
$
|
(8,766,108
|
)
|
$
|
(7,356,045
|
)
|
|
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|||||
|
Stock
issued for services or litigation
|
1,573,192
|
1,624,339
|
|||||
|
Release
of deferred revenue from litigation settlement
|
(565,750
|
)
|
—
|
||||
|
Option
and warrant expense
|
544,579
|
1,844,311
|
|||||
|
Amortization
of note discount
|
58,398
|
—
|
|||||
|
Depreciation
and amortization
|
512,706
|
219,692
|
|||||
|
Debt
forgiveness income
|
—
|
(460,235
|
)
|
||||
|
Guarantee
of third party debt
|
(300,000
|
)
|
300,000
|
||||
|
Loss
(gain) on sale of property
|
11,237
|
(120,000
|
)
|
||||
|
Asset
impairment
|
3,175,833
|
||||||
|
Bad
debts
|
73,249
|
172,003
|
|||||
|
Changes
in:
|
|
|
|||||
|
Accounts
receivable
|
32,131
|
(201,747
|
)
|
||||
|
Accounts
receivable - related party
|
—
|
(23,960
|
)
|
||||
|
Lease
receivable
|
50,000
|
—
|
|||||
|
Employee
advances
|
—
|
42,620
|
|||||
|
Accounts
payable
|
473,437
|
(277,755
|
)
|
||||
|
Accrued
expenses
|
787,767
|
(171,815
|
)
|
||||
|
Deferred
revenue
|
15,039
|
724,648
|
|||||
|
Customer
deposit
|
208,568
|
68,282
|
|||||
|
Net
Cash Used In Operating Activities
|
(2,115,722
|
)
|
(3,615,662
|
)
|
|||
|
Cash
Flows From Investing Activities
|
|
|
|||||
|
Purchase
of equipment
|
(3,705
|
)
|
(459,493
|
)
|
|||
|
Cash
payments for license
|
—
|
(100,000
|
)
|
||||
|
Proceeds
from sale of property
|
12,500
|
120,000
|
|||||
|
Deposit
on equipment purchase
|
—
|
(340,000
|
)
|
||||
|
Loan
to third party
|
—
|
(100,000
|
)
|
||||
|
Net
Cash Provided By (Used In) Investing Activities
|
8,795
|
(879,493
|
)
|
||||
|
Cash
Flows From Financing Activities
|
|
|
|||||
|
Proceeds
from sales of common stock
|
634,000
|
6,562,150
|
|||||
|
Proceeds
from exercise of options and warrants
|
81,217
|
368,815
|
|||||
|
Proceeds
from notes payable, related parties
|
345,000
|
50,000
|
|||||
|
Proceeds
from notes payable
|
475,000
|
—
|
|||||
|
Payments
on notes payable, related parties
|
(35,000
|
)
|
(363,558
|
)
|
|||
|
Payments
on note payable related to license
|
(500,000
|
)
|
(748,760
|
)
|
|||
|
Net
Cash Provided By Financing Activities
|
1,000,217
|
5,868,647
|
|||||
|
Net
change in cash
|
(1,106,710
|
)
|
1,373,492
|
||||
|
Cash
at beginning of year
|
1,373,627
|
135
|
|||||
|
Cash
at end of year
|
$
|
266,917
|
$
|
1,373,627
|
|||
|
Cash
paid during the year for:
|
|
|
|||||
|
Interest
|
$
|
—
|
$
|
176,240
|
|||
|
Income
taxes
|
$
|
—
|
$
|
—
|
|||
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
NOTE
1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business.
Verdisys, Inc. (“Verdisys”) was formed in California on April 7, 1999 as
TheAgZone, Inc. In January 2001, the name was changed to Verdisys, Inc. In
May
2001, Verdisys began selling secure intra-company and wide-area network
satellite communications systems to energy companies to manage distant oil
and
gas producing wells, power distribution and other equipment sites by remote
computer control. In June 2003, Verdisys began selling a lateral drilling
technique using high pressure water jetting for the enhancement and production
of oil and gas reserves using licensed technology acquired in April 2003.
On
July
18, 2003, Verdisys signed an Agreement and Plan of Merger with Reconstruction
Data Group, Inc. (“RDGI”), a publicly-reporting inactive entity. The
shareholders of Verdisys received 25,202,539 shares of RDGI in exchange for
all
of the 25,202,539 shares of Verdisys then outstanding. Verdisys became a
wholly-owned subsidiary of RDGI. As of that transfer, Verdisys shareholders
owned 94.4% of the outstanding stock of the combined entity.
In
2004
and 2003, Verdisys provided lateral drilling services through the utilization
of
its drilling rigs by oil and gas operators primarily in Texas and Louisiana.
Verdisys also provided satellite services to oil and gas companies throughout
North America and West Africa.
Management
Estimates.
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, as well as certain financial statement
disclosures. While management believes that the estimates and assumptions used
in the preparation of the financial statements are appropriate, actual results
could differ from these estimates.
Cash
Equivalents.
Highly
liquid investments with original maturities of three months or less are
considered cash equivalents.
Revenue
Recognition.
All
revenue is recognized when persuasive evidence of an arrangement exists, the
service or sale is complete, the price is fixed or determinable and
collectibility is reasonably assured. Revenue is derived from sales of satellite
hardware, satellite bandwidth, satellite service and lateral drilling services.
Revenue from satellite hardware is recognized when the hardware is installed.
Revenue from satellite bandwidth is recognized evenly over the term of the
contract. Revenue from satellite service is recognized when the services are
performed. Verdisys provides no warranty but sells commercially obtained 3
to 12
month warranties for satellite hardware. Verdisys has a 30 day return policy.
Revenue for lateral drilling services is recognized when the services are
performed and collectibility is reasonably assured and when collection is
uncertain, revenue is recognized when cash is collected.
Allowance
for Doubtful Accounts.
Bad
debt expense is recognized based on management’s estimate of likely losses per
year, based on past experience and an estimate of current year uncollectible
amounts.
Equipment.
Equipment is valued at cost. Maintenance and repairs are charged to expense
as
incurred. Renewals and betterments which extend the life or improve existing
equipment are capitalized. Upon disposition or retirement of equipment, the
cost
and related accumulated depreciation are removed and any resulting gain or
loss
is reflected in operations. Depreciation is provided using the straight-line
method over the estimated useful lives of the assets, which are three to seven
years.
Impairment
of Long-Lived Assets.
Verdisys reviews the carrying value of its long-lived assets annually or
whenever events or changes in circumstances indicate that the historical
cost-carrying value of an asset may no longer be appropriate. Verdisys assesses
recoverability of the carrying value of the asset by estimating the future
net
cash flows expected to result from the asset, including eventual disposition.
If
the future net cash flows are less than the carrying value of the asset, an
impairment loss is recorded equal to the difference between the asset’s carrying
value and fair value.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
Stock
Options and Warrants.
Verdisys
accounts for all stock-based employee compensation plans in accordance with
Statement of Financial Accounting Standard No. 123, Accounting
for Stock-Based Compensation
(“SFAS
No. 123”), which permits the measurement of compensation expense in accordance
with Accounting Principles Board Opinion 25 Accounting
for Stock Issued to Employees
(“APB
25”). Under APB 25, no stock-based employee compensation cost is reflected in
net income, as all options granted under those plans had an exercise price
equal
to or in excess of the market value of the underlying common stock on the date
of grant. Verdisys accounts for stock-based compensation issued to non-employees
in accordance with the provisions of SFAS No. 123 and EITF No. 96-18,
Accounting
for Equity Investments That Are Issued to Non-Employees for Acquiring, or in
Conjunction with Selling Goods or Services.
Common
stock issued to non-employees and consultants is based upon the fair value
of
the services received or the fair value of the equity instruments issued
whichever value is more reliably measurable. The following table illustrates
the
effect on net loss and net loss per share if Verdisys had applied the fair
value
provisions of SFAS No. 123 to stock-based employee compensation.
|
|
2004
|
2003
|
|||||
|
Net
loss as reported
|
$
|
(8,766,108
|
)
|
$
|
(7,356,045
|
)
|
|
|
Less:
stock based compensation determined under fair value- based
method
|
(2,337,230
|
)
|
(828,737
|
)
|
|||
|
Pro
forma net loss
|
$
|
(11,103,338
|
)
|
$
|
(8,184,782
|
)
|
|
|
Basic
and diluted net loss per common share: As reported
|
$
|
(.28
|
)
|
$
|
(.33
|
)
|
|
|
Pro
forma
|
(.35
|
)
|
(.37
|
)
|
|||
The
weighted average fair value of the stock options granted during 2004 and 2003
was $1.78 and $7.30, respectively. Variables used in the Black-Scholes
option-pricing model include (1) 1.5% risk-free interest rate, (2) expected
option life is the actual remaining life of the options as of each year end,
(3)
expected volatility is zero, and (4) zero expected dividends.
Income
Taxes.
Verdisys utilizes the asset and liability method in accounting for income taxes.
Under this method, deferred tax assets and liabilities are recognized for
operating loss and tax credit carryforwards and for the 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 year in which those temporary differences are expected
to
be recovered or settled. The effect on deferred tax assets and liabilities
of a
change in tax rates is recognized in the results of operations in the period
that includes the enactment date. A valuation allowance is recorded to reduce
the carrying amounts of deferred tax assets unless it is more likely than not
that such assets will be realized.
Earnings
Per Share.
Basic
earnings per share equals net earnings divided by weighted average shares
outstanding during the year. Diluted earnings per share includes the impact
on
dilution from all contingently issuable shares, including options, warrants
and
convertible securities. The common stock equivalents from contingent shares
are
determined by the treasury stock method. Verdisys has incurred net losses for
the years ended December 31, 2004 and 2003 and has, therefore, excluded certain
securities from the computation of diluted earnings per share as the effect
would be anti-dilutive.
Recently
Issued Accounting Pronouncements.
In
December 2004, the FASB issued SFAS No. 123R, “Accounting for Stock-Based
Compensation.” SFAS No. 123R establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods
or
services. This Statement focuses primarily on accounting for transactions in
which an entity obtains employee services in share-based payment transactions.
SFAS No. 123R requires that the fair value of such equity instruments be
recognized as expense in the historical financial statements as services are
performed. Prior to SFAS No. 123R, only certain pro forma disclosures of fair
value were required. SFAS No. 123R shall be effective for small business issuers
as of the beginning of the first interim or annual reporting period that begins
after December 15, 2005. The impact of the adoption of this new accounting
pronouncement would be similar to the Company’s calculation of the pro forma
impact on net income of FAS 123 included in Note 1 above.
Reclassifications.
Certain
amounts in the financial statements of the prior year has been reclassified
to
conform to the presentation of the current year for comparative purposes.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
NOTE
2 - GOING CONCERN
As
shown
in the accompanying financial statements, Verdisys incurred recurring net
losses
of $8,766,108 and $7,356,045 in 2004 and 2003, respectively, has an accumulated
deficit of $27,066,627 and a working capital deficit of $1,249,209 as of
December 31, 2004. These conditions create an uncertainty as to Verdisys’
ability to continue as a going concern. Management is trying to raise additional
capital through sales of common stock or convertible instruments as well
as
seeking financing from third parties. The financial statements do not include
any adjustments that might be necessary if Verdisys is unable to continue
as a
going concern.
NOTE
3 - LEASE RECEIVABLE
In
November of 2004, Verdisys sold one of its lateral drilling rigs to an unrelated
third party under the terms of a seven month direct financing lease. After
the
lease payment for the seventh month is earned and received, the customer has
the
right to purchase the unit at a nominal cost of $1 on a “as is, where is” basis.
The monthly payments are $25,000 resulting in a total purchase price of
$175,000. The net book value of the equipment sold by Verdisys was $148,879.
At
December 31, 2004, the receivable consists of five future lease payments. Under
the terms of the lease a $25,000 security deposit was collected, this deposit
can be applied to the last lease payment. Unearned income under the lease as
of
December 31, 2004 was $18,990.
NOTE
4 - EQUIPMENT
Equipment
consisted of the following at December 31, 2004:
|
Description
|
Life
|
Amount
|
|||||
|
Lateral
drilling equipment
|
5
years
|
$
|
548,480
|
||||
|
Computer
equipment
|
3
years
|
29,388
|
|||||
|
|
|
577,868
|
|||||
|
Less:
accumulated depreciation
|
|
(130,467
|
)
|
||||
|
|
|
$
|
447,401
|
||||
Lateral
drilling equipment consists of three heavy trucks mounted with high powered
water compressors, flexible hose and other assorted downhole equipment which
is
used to conduct the lateral drilling process with high pressure jetting
technology (see Note 22).
Depreciation
expense totaled $159,352 and $23,881 in 2004 and 2003, respectively.
NOTE
5 - LATERAL DRILLING LICENSE & NOTE PAYABLE ON LICENSE TO RELATED PARTY
In
April
2003, an individual licensed his horizontal drilling technology and equipment
to
Verdisys for $2,750,000 plus 10% of related gross revenue from lateral drilling
operations. Verdisys paid $100,000 upon signing and signed a note payable for
$2,650,000 plus effective interest of 12.14% due in monthly installments from
May 2003 through March 2004.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
In
July
2003, Verdisys issued 125,000 shares in exchange for a $250,000 reduction of
the
note payable. In August 2003, Verdisys and the licensor amended the agreement
whereby, in exchange for 500,000 shares of Verdisys common stock and the grant
of a board seat, the licensor agreed to eliminate the 10% royalty and instead
receive $500 per well serviced. The stock price at the time of the amendment
was
$4.55 per share, resulting in a $2,275,000 increase in the carrying value of
the
license. Verdisys did not make the December 2003 or January 2004 payment on
the
note payable. In February 2004, Verdisys and the licensor agreed to restructure
the note payments. Verdisys issued the licensor 300,000 shares of common stock
and $500,000 in cash for the unpaid amounts due under the original note. The
300,000 shares had a value of $1,920,000 with approximately $1,185,000 reducing
the overall note balance and approximately $735,000 recognized as compensation
expense.
NOTE
6 - ACCRUED EXPENSES
Accrued
expenses at December 31, 2004 consisted of the following:
|
Description
|
Amount
|
|||
|
Liquidated
damages (see Note 17)
|
$
|
500,000
|
||
|
Accrued
payroll
|
328,034
|
|||
|
Litigation
settlement (see Note 22)
|
240,000
|
|||
|
Director
fees
|
78,250
|
|||
|
Interest
|
49,934
|
|||
|
Other
|
74,514
|
|||
|
|
$
|
1,270,732
|
||
NOTE
7 - DEFERRED REVENUE
Verdisys
bills some of its satellite bandwidth contracts in advance over periods ranging
from 3 months to 36 months. Verdisys recognizes revenue evenly over the
contract. Deferred revenue related to satellite services totaled $317,615,
of
which $235,737 will be recognized in 2005 and $81,878 will be recognized during
2006.
Deferred
revenue also includes the unearned income of $18,989 related to the equipment
financing lease discussed in Note 3.
NOTE
8 - NOTES PAYABLE, RELATED PARTIES
Notes
payable, related parties at December 31, 2004 consisted of the following:
|
One
year unsecured notes with officers and directors, 8%, maturing on
May 14,
2005, issued in connection with 40% warrant coverage to purchase
Verdisys
common stock at $2.00 per share during the term of the
note.
|
$
|
110,000
|
||
|
Convertible
promissory notes with related individual and entity, 8%, maturing
on May
31, 2006, issued in connection with 100% warrant coverage to purchase
Verdisys common stock at $.001 per share until October 26, 2005,
conversion rate of one share of common stock for every $2.00 of
outstanding principal and unpaid interest.
|
200,000
|
|||
|
Less:
discount for warrants
|
58,296
|
|||
|
|
251,704
|
|||
|
Less:
current maturities
|
102,326
|
|||
|
Long-term
debt, related parties
|
$
|
149,378
|
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
NOTE
9 - NOTES PAYABLE
Notes
payable at December 31, 2004 consisted of the following:
|
One
year unsecured notes, 8%, maturing on May 14, 2005, issued in connection
with 40% warrant coverage to purchase Verdisys common stock at $2.00
per
share during the term of the note.
|
$
|
75,000
|
||
|
Convertible
promissory notes, 8%, maturing on December 31, 2005, issued in connection
with 100% warrant coverage to purchase Verdisys common stock until
December 31, 2005, conversion rate of one share of common stock for
every
$2.00 of outstanding principal and unpaid interest.
|
350,000
|
|||
|
Note
payable, individual, 10%, due on demand
|
50,000
|
|||
|
Less:
discount for warrants
|
74,148
|
|||
|
|
$
|
400,852
|
NOTE
10 - RELATED PARTY REVENUES
Energy
2000 NGC, Inc. (“Energy 2000”) is a subsidiary of Berg McAfee Energy, LLC, which
is a wholly owned subsidiary of Berg McAfee Companies. Berg McAfee Companies
are
beneficial owners of more than 25% of Verdisys and Eric McAfee is a former
Vice
Chairman of the board and Chief Executive Officer of Verdisys. In April 2003,
Verdisys signed a drilling service contract with Energy 2000, whereby Energy
2000 would have paid Verdisys a minimum of $1,800,000 for lateral drilling
of 45
wells. This contract was a fixed amount due to Verdisys dependent upon the
number of wells drilled and offshoot lateral bores drilled. In addition,
Verdisys would receive an 80 percent interest in the net operating income after
payback from these properties and also be reimbursed for 20 percent of its
field
costs. In September, 2003 Verdisys entered into another contract with Energy
2000 for an additional 57 wells with terms similar to the original contract.
This contract was suspended for lack of payment.
Natural
Gas Systems, Inc. (“NGS”) is an independent company with substantial
shareholdings owned by Eric McAfee. In September 2003, Verdisys signed a
drilling service contract with NGS, whereby NGS would have paid Verdisys a
minimum of $7,800,000 for lateral drilling of 120 wells. This contract was
a
fixed amount due to Verdisys dependent upon the number of wells drilled and
offshoot lateral bores drilled. In addition, Verdisys would receive a 70 percent
interest in the net operating income after payback from these properties. This
contract was renegotiated in February 2004 to a smaller agreement with an
initial four well commitment and removed the Verdisys’ rights to
post-production. The contract was subsequently suspended.
Verdisys
billed $666,250 and $153,960 to Energy 2000 and NGS, respectively, for services
performed in 2003. Verdisys received $397,500 and $130,000, respectively.
However, Verdisys has inadequate documentation to substantiate whether some
of
the services were performed. For Energy 2000, Verdisys was able to substantiate
$328,750 of revenue leaving $68,750 in deferred revenue. Verdisys billed $20,547
and $2,000 to Energy 2000 and NGS, respectively, for expenses incurred in 2004.
The amount billed to Energy 2000 was deemed uncollectible and the amount billed
to NGS was collected. As of December 31, 2004, deferred revenues from related
parties totaled $0. In October 2004, Verdisys entered into an agreement with
Berg McAfee Companies, Energy 2000 and Eric McAfee to settle several outstanding
legal issues. Under the agreement, Verdisys is entitled to retain the $68,750
and Energy 2000 has waived all claims to the funds.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
NOTE
11 - INCOME TAXES
During
2004 and 2003, Verdisys incurred net losses and, therefore, had no tax
liability. The net deferred tax asset generated by the loss carry-forward has
been fully reserved. The cumulative net operating loss carry-forward is
approximately $18,000,000 at December 31, 2004, and will expire in the years
2019 through 2024.
At
December 31, 2004, deferred tax assets consisted of the following:
|
Deferred
tax assets
|
|
|||
|
Net
operating losses
|
$
|
6,300,000
|
||
|
Less:
valuation allowance
|
(6,300,000
|
)
|
||
|
Net
deferred tax asset
|
$
|
0
|
||
The
change in the valuation allowance for the years ended December 31, 2004 and
2003
totaled $1,800,000 and $4,383,879, respectively.
NOTE
12 - PREFERRED STOCK
650,000
and 760,000 shares of Series B preferred stock were issued in 2001 and 2002,
respectively, for $.50 per share. In early 2003, Verdisys converted all
1,410,000 shares of Series B convertible preferred stock into 1,410,000 shares
of common stock.
There
are
currently no preferred shares issued or outstanding. Verdisys currently has
no
authorized preferred stock.
NOTE
13 - COMMON STOCK
In
the
second quarter of 2003, Verdisys sold 1,239,000 shares of common stock in
private placements for between $.50 and $.75 per share for total proceeds of
$779,250 before $15,100 costs of fundraising.
In
the
second quarter of 2003, Verdisys converted $1,506,190 of notes payable and
accrued interest to investors to 2,890,688 shares of common stock.
In
the
second quarter of 2003, director and employee options were exercised at $.10
per
share for 2,409,291 shares of common stock. In lieu of cash, Verdisys agreed
to
expense the exercise price as compensation of $240,929.
In
the
second quarter of 2003, warrants were exercised for 1,580,000 shares of common
stock. $56,500 in cash was received for the exercise of 430,000 warrants,
accounts payable was reduced by $95,000 for the exercise of 950,000 warrants
and
notes payable to investor was reduced by $20,000 for the exercise of 200,000
warrants.
In
April
2003, Verdisys issued 2,000,000 shares of common stock purportedly to acquire
the assets of QuikView, Inc. The shares were valued at $1,000,000 and have
been
accounted for as expense.
In
June
2003, 100,000 shares valued at $75,000 were issued to a consultant.
In
May
2003, Verdisys issued 33,333 shares of stock for a $16,666 reduction in accounts
payable.
On
July
18, 2003, Verdisys signed an Agreement and Plan of Merger with RDGI, a
publicly-reporting inactive entity. The shareholders of Verdisys received
25,103,223 shares of RDGI in exchange for all of the 25,202,539 shares of
Verdisys then outstanding. RDGI was renamed Verdisys and the former Verdisys
Entity was extinguished. As of that transfer, Verdisys shareholders owned 94.4%
of the outstanding stock and RDGI shareholders owned 1,500,000 shares or 1.6%
of
the combined entity.
In
July
and August 2003, Verdisys sold 609,000 shares of common stock at $2.00 per
share
in a private placement for total proceeds of $1,218,000. Offering costs
consisted of 59,400 shares of restricted common stock and 9,501 warrants
exercisable at $2.00 per share anytime through September 5, 2008.
In
the
third quarter of 2003, warrants were exercised for 269,547 shares of common
stock. $177,751 in cash was received for the exercise.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
In
the
third quarter of 2003, Verdisys issued 625,000 shares of common stock to the
licensor of the lateral drilling license. 125,000 shares were for a reduction
of
the note payable by $250,000 and 500,000 were for an amendment to the royalty
agreement. The 500,000 shares were valued at $2,275,000.
In
September 2003, 144,903 shares granted in 2001, but never recorded, were issued
to former employees and valued at the 2001 value of $52,160.
In
October 2003, Verdisys sold 833,333 shares of common stock to Gryphon Master
Fund, L.P. (“Gryphon”) at $6.00 per share for $5,000,000 total proceeds.
Offering costs associated with the sale were $420,000 in cash, 83,334 warrants
at $6.00 per share that expire October 24, 2008, 9,501 warrants at $2.00 per
share that expire in September 2008 and 20,000 shares of common stock. The
warrants are exercisable at any time prior to October 24, 2008 by paying cash
at
the exercise price or by electing a cashless exercise. In October 2004, Verdisys
issued 277,778 additional shares of common stock for no additional compensation
as the 30 day average closing price of Verdisys’ common stock dropped below
$6.00 per share in the ten months subsequent to the agreement. After this
issuance, a total of 1,111,111 common shares were issued for an effective
average price of $4.50 per share.
In
the
fourth quarter of 2003, Verdisys issued 25,000 shares of common stock valued
at
$256,250 to a consultant for services.
In
the
fourth quarter 2003, warrants were exercised for 245,631 shares of common stock
and options were exercised for 100,000 shares of common stock for $29,564 and
$10,000, respectively.
In
February 2004, Verdisys issued 300,000 shares of common stock as part of a
renegotiation of a note associated with the lateral drilling license and the
license agreement. The shares had a value of $1,920,000 with $1,184,808 reducing
the note balance and $735,192 recognized as expense.
In
the
first quarter of 2004, warrants were exercised for 779,957 shares of common
stock and options were exercised for 25,000 shares of common stock for $38,494
and $2,500, respectively. The exercised warrants included a cashless exercise
of
400,000 warrants for 395,022 shares of common stock.
In
the
second quarter of 2004, warrants were exercised for 57,658 shares of common
stock and options were exercised for 344,583 shares of common stock for $5,766
and $34,458, respectively.
From
May
through June 2004, Verdisys sold 179,500 shares of common stock at a price
of
$2.00 per share in a private placement for total proceeds of $359,000. Two
year
warrants to purchase 71,800 shares of common stock at a price of $2.00 per
share
were issued in connection with the private placement. The proceeds were
allocated between the common stock and the warrants based on their respective
relative fair values. Offering costs consisted of 17,950 shares of common stock
and 7,180 warrants exercisable at $2.00 per share until August 23, 2006.
During
the third quarter of 2004, Verdisys issued 30,000 shares of common stock for
commissions on a future fundraising effort. Verdisys also issued 300,000 shares
of common stock for a lawsuit settlement valued at $213,000.
During
the fourth quarter of 2004, Verdisys issued 104,000 shares of common stock
in
payment of consulting services valued at $52,000. Verdisys also sold 250,000
shares of common stock at a price of $0.30 per share in the fourth quarter
to
settle a dispute with a former consultant.
In
October 2004, Verdisys issued 750,000 shares of common stock in a move to settle
outstanding litigation matters. In a Settlement Agreement and Mutual Release
(“Agreement) between Edge Capital Group, Inc. (“Edge”), Eric McAfee and
Verdisys, the parties would release each other from any claims upon the
completion of the terms of the Agreement (see Note 17). One of the provisions
under the Agreement was that 250,000 shares of Verdisys common stock were issued
to Edge and 500,000 shares of Verdisys common stock were issued to Eric McAfee.
During
the fourth quarter of 2004, Verdisys sold 400,000 shares of common stock at
a
price of $0.50 per share to Berg McAfee. The sale had a provision that allows
the buyer to re-price the shares to the extent Verdisys offers more favorable
terms to third parties prior to March 31, 2005. This provision will result
in
the issuance of two year warrants to purchase 400,000 shares of Verdisys common
stock at a price of $1.00 per share.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
NOTE
14 - STOCK OPTIONS AND WARRANTS
Options
In
April
2003, Verdisys granted options to purchase 780,000 shares of common stock to
an
employee, options to purchase 250,000 shares of common stock to non-employee
directors and options to purchase 250,000 shares of common stock to an employee
director. The options all have an exercise price of $0.10 per share and a ten
year term. The market value at time of grant was $0.50 per share resulting
in an
intrinsic value of $512,000. 30,000 options vest monthly over four months,
750,000 options vest quarterly over three years and 500,000 options vest
quarterly over one year.
In
August
2003, Verdisys granted options to purchase 100,000 shares of common stock to
an
employee at an exercise price of $4.10 per share, the market price at the date
of grant. The options vest quarterly over one year and have a five year term.
In
December 2003, Verdisys granted options to purchase 500,000 shares of common
stock to an officer/director with an exercise price of $9.55 per share, the
market price at the date of grant. The options have a ten year term. 50,000
vest
immediately, 50,000 were to vest by December 31, 2003 if Verdisys could collect
all of the Edge disputed accounts receivable by December 31, 2003 and the
remaining 400,000 options vest evenly over 12 months in 2004. Because Verdisys
was unable to collect the accounts receivable from Edge, 50,000 of the 500,000
options were forfeited.
Verdisys
recorded expense of $714,524 for the intrinsic value associated with options
vesting in 2003. The expense is included in selling, general &
administrative expense on the statement of operations.
In
January 2004, Verdisys granted options to purchase 230,000 shares of common
stock to officers and options to purchase 80,000 shares of common stock to
non-employee directors at an exercise price of $4.28 per share, the market
price
at the date of grant. The options have a ten year term. The options granted
to
the officers vest quarterly over one year, while the options granted to the
directors vested immediately.
In
May
2004, Verdisys granted options to purchase 72,000 shares of common stock to
non-employee directors at an exercise price of $2.20 per share, the market
price
at the date of grant. The options vest quarterly over one year and have a ten
year term.
In
July
2004, Verdisys granted options to purchase 770,000 shares of common stock to
officers at an exercise price of $0.90 per share, the market price at the date
of grant. The options vest quarterly over three years and have a ten year term.
Verdisys
recorded expense of $245,829 for the intrinsic value associated with options
vesting in 2004. The expense is included in selling, general &
administrative expense on the statement of operations.
Warrants
Verdisys
issues warrant to non-employees from time to time. The board of directors has
discretion as to the terms under which the warrants are issued. All warrants
vest immediately unless specifically noted in warrant agreements.
In
April
2003, Verdisys issued warrants to purchase 200,000 shares of common stock at
$0.10 per share. Half of the warrants expire in January 2007 and the remainder
expires in January 2008. The warrants have a fair value of $80,000 which was
expensed when the warrants were granted.
During
the summer of 2003, Verdisys negotiated settlements the two original founders
for various debts recorded on the books at $576,000 by paying cash of $28,000
and issuing warrants to purchase 150,000 shares of common stock at $0.10 per
share. The warrants were valued at $0.40 or $60,000, resulting in a contribution
to capital of $488,000 (see Note 19).
During
the fall of 2003, Verdisys issued warrants to purchase 92,835 shares of common
stock, 83,334 at $6.00 per share that expire October 2008 and 9,501 at $2.00
per
share that expire September 2008. The warrants were issued in connection with
raising the $5,000,000 from Gryphon (see Note 13) and their fair value of
$822,738 was treated as a cost of fundraising.
Verdisys
issued warrants to purchase 2,644,438 shares of common stock in 2003 at an
exercise price $0.10 per share. The fair value of $1,050,687 has been expensed
accordingly in 2003.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
In
2003,
previously expired warrants to purchase 232,334 shares of common stock were
extended and exercised. At the time of the extension Verdisys stock was selling
for $0.50 per share in private placements and the warrant was exercised at
$0.75
per share. Using the minimum value method, the modification resulted in no
additional compensation expense.
In
May
2004, Verdisys borrowed $185,000 under one year promissory notes issued to
certain private investors with interest of 8%. Warrants to purchase 37,000
shares of our common stock at $2.00 per share were issued in connection with
the
notes (see Notes 8 and 9). The warrants have a term of one year. The notes
have
been discounted for the relative fair value of the warrants.
From
May
to June 2004, Verdisys issued warrants to purchase 71,800 shares of common
stock
at $2.00 per share in connection with the private placement that raised $359,000
(see Note 13). An additional warrant to purchase 7,180 shares of common stock
at
$2.00 per share was issued as part of the offering costs of the private
placement. The warrants have a term of two years.
In
July
2004, Verdisys issued $200,000 in convertible notes to third party lenders
and
warrants to purchase 100,000 shares of common stock at an exercise price of
$0.001 per share. The warrants have a term of one year. We also issued $150,000
in convertible notes to third party lenders and warrants to purchase 75,000
shares of common stock at an exercise price of $0.01 per share. The warrants
have a term of two years. The notes have been discounted for the relative fair
value of the warrants (see Note 9).
In
August
2004, Verdisys issued warrants to purchase 140,000 shares of common stock at
$0.80 per share to certain subcontractors. The warrants vest at the rate of
20%
immediately and then 20% every 90 days thereafter until fully vested. The
warrants have a term of two years. The fair value of $98,000 was expensed in
2004.
In
October 2004, Verdisys issued $200,000 in convertible notes to Berg McAfee
Company and Eric McAfee ($100,000 each) and warrants to purchase 100,000 shares
of common stock at $0.001 per share (see Note 8). The warrants have a term
of
one year. The notes have been discounted for the relative fair value of the
warrants.
In
October 2004, Verdisys issued warrants to purchase 250,000 shares of common
stock at $0.50 per share to Alberta Energy Holdings (“Alberta”) as part of a
licensing agreement (see Note 17). The warrants have a term of three years.
The
fair value of $199,750 was expensed in 2004.
Summary
information regarding options and warrants is as follows:
|
|
Options
|
Weighted
Average
Share Price
|
Warrants
|
Weighted
Average
Share Price
|
|||||||||
|
Outstanding
at December 31, 2002
|
9,502,189
|
$
|
0.10
|
3,550,909
|
$
|
0.33
|
|||||||
|
Year
ended December 31, 2003:
|
|
|
|
|
|||||||||
|
Granted
|
1,880,000
|
2.83
|
3,319,607
|
0.26
|
|||||||||
|
Exercised
|
(2,509,291
|
)
|
0.10
|
(2,092,961
|
)
|
0.10
|
|||||||
|
Forfeited
|
(4,760,522
|
)
|
0.23
|
(352,840
|
)
|
0.31
|
|||||||
|
Outstanding
at December 31, 2003
|
4,112,376
|
1.35
|
4,424,715
|
0.38
|
|||||||||
|
Year
ended December 31, 2004:
|
|
|
|
|
|||||||||
|
Granted
|
1,152,000
|
1.89
|
780,980
|
0.48
|
|||||||||
|
Exercised
|
(369,583
|
)
|
0.10
|
(837,605
|
)
|
0.10
|
|||||||
|
Forfeited
|
(2,481,113
|
)
|
1.47
|
(573,871
|
)
|
0.18
|
|||||||
|
Outstanding
at December 31, 2004
|
2,413,680
|
$
|
1.67
|
3,794,219
|
$
|
0.49
|
|||||||
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
Options
outstanding and exercisable as of December 31, 2004:
|
Outstanding
|
Exercisable
|
|||||||||
|
Exercise Price
|
Number
of
Shares
|
Remaining
life
|
Number
of
Shares
|
|||||||
|
$ 0.10
|
5,000
|
6
years
|
5,000
|
|||||||
|
0.10
|
118,556
|
7
years
|
118,556
|
|||||||
|
0.10
|
954,792
|
8
years
|
685,790
|
|||||||
|
9.55
|
183,332
|
9
years
|
183,332
|
|||||||
|
4.28
|
310,000
|
9
years
|
252,500
|
|||||||
|
2.20
|
72,000
|
9
years
|
36,000
|
|||||||
|
0.90
|
770,000
|
10
years
|
128,333
|
|||||||
|
|
2,413,680
|
1,409,511
|
||||||||
Warrants
outstanding and exercisable as of December 31, 2004:
|
Outstanding
|
Exercisable
|
|||||||||
|
Exercise Price
|
Number
of
Shares
|
Remaining
life
|
Number
of
Shares
|
|||||||
|
$ 0.00 -
0.15
|
1,150,000
|
1
years
|
1,150,000
|
|||||||
|
2.00
|
378,482
|
1
years
|
378,482
|
|||||||
|
0.01
- 0.50
|
260,889
|
2
years
|
218,889
|
|||||||
|
1.00
|
85,000
|
2
years
|
85,000
|
|||||||
|
2.00
|
16,180
|
2
years
|
16,180
|
|||||||
|
0.10
- 0.50
|
1,810,833
|
3
years
|
1,810,833
|
|||||||
|
2.00
|
9,501
|
4
years
|
9,501
|
|||||||
|
6.00
|
83,334
|
4
years
|
83,334
|
|||||||
|
|
3,794,219
|
3,752,219
|
||||||||
NOTE
15 - CONCENTRATIONS
One
customer accounted for 14% and 38% of total revenues in 2004 and 2003,
respectively. Related parties accounted for 2% and 52% of total revenues in
2004
and 2003, respectively.
Verdisys
at times has cash in bank in excess of Federal Deposit Insurance Corporation
(“FDIC”) insurance limits. At December 31, 2004, Verdisys had $160,262 in cash
in excess of FDIC insurance limits.
Verdisys
performs ongoing credit evaluations of its customers’ financial condition and
does not generally require collateral from them.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
NOTE
16 - COMMITMENTS & CONTINGENCIES
In
August
2003, Verdisys obtained a 75% net revenue interest in property located in
Monroe, Louisiana from a third party in exchange for agreeing to perform lateral
drilling services on the property. In October 2003, Verdisys assigned the net
revenue interest to Edge for $200,000. Edge only paid Verdisys $120,000.
Verdisys agreed to refund the money to Edge if Verdisys did not deliver a lease
between Edge and the original owner within 90 days if Edge desired. As of
December 31, 2004, Verdisys had not delivered the necessary lease and Edge
had
the right under the agreement to request a refund of the $120,000 (see Note
20).
Effective January 19, 2005, Verdisys, Edge and certain other parties entered
in
a settlement agreement and mutual release to fully settle and resolve disputes
among the parties. Under the settlement, Verdisys will retain the $120,000
already received and both Edge and Verdisys will drop their claims in the
dispute. See Note 22 for further details.
Under
the
terms of the Landers lateral drilling license (see Note 5), Verdisys is
obligated to pay a royalty of $500 for every well in which that technology
is
utilized. The Landers license expires upon the expiration of the underlying
patents, the earliest date being October 2013.
Under
the
terms of an exclusive worldwide licensing agreement for the application of
Abrasive Fluid Jet (“AFJ”) cutting technique, Verdisys agreed to pay Alberta a
$10,000 per month consulting fee for six months beginning on November 30, 2004.
In addition, royalties are payable by Verdisys at the rate of $1,000 per well
for services billed at $40,000 or less and for services above $40,000, a royalty
of 2% per well is payable quarterly. As specific phases of the AFJ process
are
successfully applied, Alberta is entitled to receive four tranches of warrants
to purchase 250,000 shares of common stock. The first tranche has already been
issued (see note 14). The warrants have a three year term, with an exercise
price of $0.62 per share for the pending tranches. The agreement also provides
for the mutual sharing of the proceeds from the sale of the technology with
Verdisys, subject to a maximum of $10 million. The AFJ license is for a term
of
ten years and automatically extends for additional two-year terms.
Three
of
Verdisys’ employees are under employment agreements. One agreement was entered
into June 2003 and provides for a base salary of $150,000 in year one, $180,000
in year two and $210,000 in year three. The other agreements have a one year
term but provide for one year renewals. One of the agreements is for a minimum
base salary of $185,000, while the other agreement provides for a $20,000
escalation for two years from the original base salary of $175,000 in 2004.
NOTE
17 - LITIGATION
Lawsuits
involving Edge Capital Group, Inc. (Settled)
Effective
January 19, 2005, Edge, certain entities affiliated with Edge, Eric McAfee
(Verdisys’ former Vice Chairman) and Verdisys, entered into a Settlement
Agreement and Mutual Release to fully settle and resolve the disputes between
Edge and its affiliated entities, Mr. McAfee, Verdisys’ directors and Verdisys
(see Note 22). The settlement removed Verdisys’ liability for a $300,000
guarantee and deferred revenue of $497,000. In July 2003, Verdisys guaranteed
Edge’s purchase of oil and gas properties from another entity for $450,000. Edge
paid $150,000 and signed a note payable for $300,000 due in 2004. Edge defaulted
on the note and had requested Verdisys to pay the amounts due. In June 2003,
Verdisys signed an agreement to drill wells for Edge and Edge paid $497,000
in
2003. Edged had disputed whether services were actually performed and requested
the $497,000 to be returned to their third party financing source but did not
initiate any court action. Verdisys had inadequate documentation to substantiate
what services were actually performed, so the revenue was deferred in 2003.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
Verdisys
had initiated a lawsuit against Edge that requested a declaratory judgment
that
a purported agreement between Verdisys and Edge was not enforceable. It was
filed in Montgomery County, Texas in February 2004. The lawsuit arose from
Edge’s contention that one of Verdisys’ ex-officers committed the company to
purchase certain oil and gas properties from Edge. Edge had filed a counterclaim
against Verdisys and asserted claims against Dan Williams (Verdisys’ former
President and CEO), Eric McAfee, Ron Robinson (Verdisys former CEO and current
Board member), Andrew Wilson (Verdisys former CFO) and Verdisys current Board
members Joseph Penbera, Frederick Ruiz, James Woodward and John Block. Edge
has
also made claims against Solarcom, L.L.C., DeLage Landen Financial Services,
Inc., Andrew Wilson and Allen Voight. Edge had sought to enforce the agreement
Verdisys challenged and alleged several causes of action including claims for
fraud, breach of contract, negligence and conspiracy. Edge had asserted actual
damages in excess of $85 million and had claimed punitive damages as well.
Edge
and
one of its apparent owners, Frazier Ltd., initiated a lawsuit in Summin County,
Ohio against Verdisys, Solarcom, L.L.C., DeLage Landen Financial Services,
Inc.
and Firstmerit Bank, N.A. that sought an injunction against the draw against
a
letter of credit pledged as collateral for a credit advanced to Edge. Edge
asserted that its transaction with Verdisys was the product of fraud and that
its creditor, DeLage Landen as assignee from Solarcom, should not be allowed
to
draw against Edge’s letter of credit from Firstmerit. The Ohio state court
denied Edge’s request for a temporary injunction. The pleadings in the Ohio
action did not include any claim for damages from Verdisys.
Class
Action Lawsuit (Settled)
In
March
2005, Verdisys entered into an agreement, subject to court approval, to settle
the class action lawsuit brought by former shareholders in March 2004 in the
U.S. District Court for the Southern District. Under terms of the agreement,
Verdisys will issue to the class 1,150,000 shares of common stock and pay up
to
$55,000 in legal and administrative fees for the plaintiffs. The lawsuit alleged
that Verdisys and its former CEO, Dan Williams, and Verdisys’ former CFO, Andrew
Wilson, violated Sections 10(b) and 20(a) of the Securities Exchange Act of
1934, and Rule 10b-5 promulgated thereunder. The lawsuit alleged that defendants
made material misstatements about Verdisys’ financial results. More
specifically, the Complaints alleged that defendants failed to disclose and
indicate: (1) that Verdisys had materially overstated its net income and
earnings per share; (2) that Verdisys prematurely recognized revenue from
contracts between Verdisys, Edge Capital and Energy 2000 in violation of GAAP
and its own revenue recognition policy; (3) that Verdisys lacked adequate
internal controls and was therefore unable to ascertain the true financial
condition of the company; and (4) that as a result of recognizing revenue
prematurely, Verdisys’ financial results were inflated at all relevant times.
Verdisys had filed a motion to dismiss all actions in the litigation against
it.
Securities
and Exchange Commission Investigation Inquiries
Verdisys
received notice in January 2004 that the Securities and Exchange Commission
(“SEC”) has initiated a formal investigation into its reporting practices and
public statements about Verdisys in 2003.
The
SEC
has requested substantiation and documentary evidence from Verdisys concerning
the performance of certain lateral drilling services by subcontractors in the
period from May 2003 to September 2003, supervision of such services by
Verdisys’ executive management at the time, revenue recognition related to the
performance of such services, the third quarter 2003 earnings restatement,
public statements concerning the services performed, and related matters. The
SEC has also requested information and documentary evidence related to Verdisys’
acquisition of certain assets of QuikView, Inc., a related party company, in
June, 2003. In its letters to Verdisys requesting documents, the SEC stated
that
the staff’s inquiry should not be construed as an indication that any violations
of securities laws have occurred or as an adverse reflection on any persons,
company or security.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
Since
December 2003, Verdisys has taken several steps to address issues related to
the
SEC’s inquiries, including the termination and replacement of the previous Chief
Executive Officer and Chief Operating Officer and the reassignment of its Chief
Financial Officer. Two directors have resigned from the Verdisys’ board and
Verdisys has appointed a new CFO. Internal controls have been strengthened
overall, particularly with respect to the public release of Verdisys information
and the recognition of revenue. Verdisys had also initiated an internal
investigation of the matters of concern to the SEC. Consequently, Verdisys
restated its second and third quarter financial statements for fiscal year
2003
and deferred all revenue related to the aforementioned period until such time
that it can substantiate whether or not the services were performed.
Verdisys
is cooperating fully with the SEC, including the provision of numerous documents
and voluntary testimony by its current executives. In December 2004, the staff
of the SEC notified Verdisys that it was considering recommending that the
SEC
bring a civil injunction (including a possible permanent injunction and a civil
penalty) against Verdisys alleging violations of provisions of the Sections
10(b), 13(b)(2)(A), 13(b)(2)(B) and 15(d) of the Securities Exchange Act of
1934
and rules promulgated thereunder in connection with the purchase and sale of
securities of Verdisys, recordkeeping, internal controls, certification and
disclosure obligations. Verdisys was notified of its right to make a Wells
submission. Verdisys has provided information to the SEC setting forth the
specific steps it has taken to upgrade the quality and effectiveness of its
board of directors, replace the previous management team with industry experts,
improve its recordkeeping, internal and disclosure controls, and revenue
recognition procedures. Although Verdisys is working to bring the matter to
a
prompt conclusion, it cannot make any assurance that the investigation will
be
resolved positively or that it will not have negative effects on Verdisys’
limited resources or its ability to raise capital and use its stock as
acquisition currency during the period of the investigation.
Claims
by Investor (Partially Settled)
In
February 2005, Verdisys entered into an Agreed Judgment and Order of Severance
with Gryphon Master Fund, L.P. (“Gryphon”) as to all breach of contract claims
related to Verdisys’ delay in registering common stock acquired by Gryphon in
October 2003 (see Note 22). Under the terms of the Agreed Judgment, Verdisys
is
obligated to pay liquidated damages of $500,000 to Gryphon on or before
September 30, 2005 (see Note 6). Additionally, Gryphon has agreed to abate
their
remaining claims and related discovery in the lawsuit against Verdisys until
after September 30, 2005. Verdisys agreed to register the shares issued to
Gryphon on or before March 2004 or be subject to certain liquidated damages.
Gryphon made a claim against Verdisys for the maximum liquidated damages in
an
amount of $400,000. Gryphon has also claimed it has sustained actual damages
in
excess of $6.2 million. In July 2004, Gryphon filed a lawsuit in the state
district court in Dallas County, Texas against Verdisys, alleging, among other
things, breach of contract and securities fraud by Verdisys. In connection
with
the lawsuit, Gryphon requested liquidated damages, actual damages, punitive
damages, interest, costs and attorneys’ fees among other claims Verdisys intends
to vigorously defend itself in this matter with respect to the remaining claims
of Gryphon. If Gryphon prevails, it may obtain significant damages that may
have
a material adverse effect on Verdisys’ financial condition.
Claims
by Former CEO
In
July
2004, Verdisys was informed that a former Chief Executive Officer of Verdisys
filed a lawsuit against Verdisys for breach of contract and wrongful discharge.
The lawsuit seeks relief in excess of $500,000 related to an alleged employment
agreement and also seeks damages related to an excess of 4 million stock options
claimed due pursuant to the alleged agreement. The lawsuit was filed in state
court in San Diego, California. Verdisys intends to vigorously defend itself
in
this matter. If the plaintiff prevails, it may obtain significant damages that
may have a material adverse effect on Verdisys’ financial condition.
Verdisys,
Inc.
NOTES TO
FINANCIAL
STATEMENTS
Energy
2000 (Settled)
In
October 2004, Verdisys entered into an agreement with Berg McAfee Companies,
Energy 2000 and Eric McAfee (collectively, “McAfee Group”) to settle several
outstanding legal issues. Energy 2000 has agreed to settle a finders fee and
lateral drilling services dispute by delivering 300,000 shares of NGS stock
into
escrow for Verdisys. Due to uncertainties on the liquidity of the shares,
Verdisys has assigned no value to them as of December 31, 2004. Furthermore,
to
settle the “Lawsuits involving Edge Capital Group, Inc.”, the McAfee Group
exchanged into escrow 500,000 shares of NGS stock for 500,000 shares of Verdisys
common stock. In January 2005, the McAfee Group replaced the 500,000 shares
of
NGS stock with $625,000 in cash. Verdisys submitted that cash and an additional
250,000 shares of Verdisys common stock to Edge as part of the settlement.
Verdisys also has agreed to dismiss the QuikView, Inc. lawsuit, which it had
filed against certain individuals.
General
Verdisys
has never been in bankruptcy, receivership or any similar legal proceeding.
Other than the aforementioned legal matters, Verdisys is not aware of any other
threatened legal proceedings. The foregoing is also true with respect to each
officer, director and control shareholder as well as any entity owned by any
officer, director and control shareholder, over the last five years.
As
part
of its regular operations, Verdisys may become party to various pending or
threatened claims, lawsuits and administrative proceedings seeking damages
or
other remedies concerning its’ commercial operations, products, employees and
other matters. Although Verdisys can give no assurance about the outcome of
these or any other pending legal and administrative proceedings and the effect
such outcomes may have on the company, except as described above, Verdisys
believes that any ultimate liability resulting from the outcome of such
proceedings, to the extent not otherwise provided for or covered by insurance,
will not have a material adverse effect on Verdisys’ financial condition or
results of operations.
NOTE
18 - NON-CASH TRANSACTIONS ON CASH FLOW STATEMENT
|
|
2004
|
2003
|
|||||
|
Seller
financed purchase of license with note
|
$
|
1,184,808
|
$
|
2,650,000
|
|||
|
Stock
issued for license amendment
|
—
|
2,275,000
|
|||||
|
Stock
issued for reduction of note payable on license
|
—
|
250,000
|
|||||
|
Contributions
to capital by founders for debt forgiveness
|
—
|
488,000
|
|||||
|
Conversion
of notes payable to common stock
|
—
|
1,245,000
|
|||||
|
Conversion
of accrued interest on notes payable to common stock
|
—
|
261,190
|
|||||
|
Conversion
of Series B preferred stock to common stock
|
—
|
705,000
|
|||||
|
Stock
issued for accounts payable
|
51,977
|
16,666
|
|||||
|
Warrants
exercised with notes payable
|
—
|
20,000
|
|||||
|
Warrants
issued with notes payable
|
190,842
|
—
|
|||||
NOTE
19 - DEBT FORGIVENESS INCOME & CONTRIBUTION TO CAPITAL
During
2003, Verdisys negotiated settlements with 9 vendors for various debts
originally recorded on the books at $520,501 for $43,600 cash and 33,333 shares
of stock valued at $.50 or $16,666 resulting in debt forgiveness income of
$460,235. During the same period, Verdisys negotiated settlements with the
two
original founders for various debts recorded on the books at $576,000 for
$28,000 cash and 150,000 warrants exercisable at $.10 and valued at $.40 or
$60,000 resulting in a contribution to capital of $488,000.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
NOTE
20 - GAIN ON SALE OF PROPERTY
In
August
2003, Verdisys obtained a 75% net revenue interest in property located in
Monroe, Louisiana from a third party in exchange for agreeing to perform lateral
drilling services on the property. In October 2003, Verdisys assigned the net
revenue interest to Edge for $200,000. Edge paid Verdisys $120,000 and agreed
to
pay the balance of $80,000 by March 31, 2004. Verdisys agreed to refund the
money to Edge if Verdisys did not deliver a lease between Edge and the original
owner within 90 days if Edge desired. Verdisys recognized a $120,000 gain for
the monies received due to a $0 cost basis by Verdisys. The $80,000 was not
collected and under terms of the Settlement Agreement and Mutual Release entered
into with Edge effective January 19, 2005, Verdisys has relinquished its right
to these funds. See Note 22 for further detail.
NOTE
21 - BUSINESS SEGMENTS
Verdisys
has two reportable segments: (1) lateral drilling and (2) satellite service.
A
reportable segment is a business unit that has a distinct type of business
based
upon the type and nature of services and products offered.
Verdisys
evaluates performance and allocates resources based on profit or loss from
operations before other income or expense and income taxes. The accounting
policies of the reportable segments are the same as those described in the
summary of significant accounting policies. The table below reports certain
financial information by reportable segment:
|
|
For the Years Ended December 31,
|
||||||
|
|
2004
|
2003
|
|||||
|
Revenues
from external customers
|
(Restated)
|
|
|||||
|
Lateral
drilling
|
$
|
738,710
|
$
|
466,194
|
|||
|
Satellite
service
|
714,634
|
419,247
|
|||||
|
|
$
|
1,453,344
|
$
|
885,441
|
|||
|
Depreciation
and amortization
|
|
|
|||||
|
Lateral
drilling
|
$
|
499,631
|
$
|
215,258
|
|||
|
Corporate
|
13,075
|
4,434
|
|||||
|
|
$
|
512,706
|
$
|
219,692
|
|||
|
Operating
loss 1
|
|
|
|||||
|
Lateral
drilling
|
$
|
(1,521,185
|
)
|
$
|
(935,238
|
)
|
|
|
Satellite
service
|
(195,521
|
)
|
(169,251
|
)
|
|||
|
Corporate
|
(6,933,201
|
)
|
(6,618,973
|
)
|
|||
|
|
$
|
(8,649,907
|
)
|
$
|
(7,723,462
|
)
|
|
|
Acquisition
of equipment
|
|
|
|||||
|
Lateral
drilling
|
$
|
—
|
$
|
767,420
|
|||
|
Corporate
|
3,705
|
32,073
|
|||||
|
|
$
|
3,705
|
$
|
799,493
|
|||
_____________________________
|
1
|
-
Operating loss is total operating revenue less operating expenses,
selling
general & administrative expenses, depreciation and amortization, bad
debts and does not include other income and expense or income taxes.
|
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
One
customer of Verdisys lateral drilling, Maxim Energy, represented approximately
14% of total revenue in 2004. Energy 2000, a customer of Verdisys lateral
drilling and a related party, represented approximately 38% of total revenue
in
2003.
Verdisys
assets at December 31, 2004 were as follows:
|
(Restated)
|
||||
|
Lateral
drilling
|
$
|
1,854,643
|
||
|
Satellite
service
|
73,936
|
|||
|
Corporate
|
313,541
|
|||
|
|
$
|
2,242,120
|
All
of
Verdisys’ long-term assets are attributable to North America. The following
table sets forth financial information with respect to Verdisys’ revenues by
geographic area:
|
|
2004
|
2003
|
|||||
|
United
States
|
$1,279,053
|
$885,441
|
|||||
|
Africa
|
174,291
|
—
|
|||||
|
|
$
|
1,453,344
|
$
|
885,441
|
|||
NOTE
22 - SUBSEQUENT EVENTS
In
January and February 2005, Verdisys issued 433,000 shares of common stock for
$216,500 in a private placement for $0.50 per share. Two year warrants to
purchase 433,000 common shares at $1.00 per share were attached to the common
stock. Offering costs consisted of 15,800 shares of common stock and warrants
to
purchase 15,800 shares of common stock at $1.00 per share.
In
January 2005, we issued 16,000 shares of common stock for the payment of leasing
fees valued at approximately $8,000 and 10,666 shares of common stock to settle
unpaid compensation issues with two former AgZone employees. Verdisys also
issued 388,502 shares of common stock under a program to compensate our
directors, employees, contractors and former employees for unpaid wages,
commissions and director fees accrued in 2004.
Effective
January 19, 2005, Verdisys, Edge, certain entities affiliated with Edge and
Eric
McAfee entered into a settlement agreement and mutual release to fully settle
and resolve the disputes. As part of the settlement, Verdisys issued an
aggregate of 750,000 shares of common stock along with warrants to purchase
750,000 shares of common stock to Edge. 250,000 shares were issued during
October 2004 and the remaining 500,000 shares were issued in 2005 and were
valued at $240,000. In addition, Verdisys agreed to provide Edge a drilling
rig
to provide certain lateral drilling services in return for a fee per well and
a
share of the revenues generated from each well drilled. Upon closing of the
settlement, Verdisys will sublicense the lateral drilling technology to Edge
for
certain limited purposes. As part of the settlement, the parties to the
agreement have agreed to a mutual release and to dismiss all pending claims
and
litigation upon performance of the obligations in the settlement agreement.
If
the remaining obligations under the settlement agreement are not performed,
this
would cause the release to not be effective and could lead to the underlying
lawsuit being reinstituted. The settlement agreement has been reflected in
the
2004 Statement of Operations, but had less than a $1,000 of impact as the
settlement costs were offset by the write-off of previously accrued liabilities.
In
February 2005, Verdisys entered into an Agreed Judgment and Order of Severance
with Gryphon as to all breach of contract claims related to Verdisys’ delay in
registering common stock acquired by Gryphon in October 2003. Under the terms
of
the Agreed Judgment, Verdisys is obligated to pay liquidated damages of $500,000
to Gryphon on or before September 30, 2005. Additionally, Gryphon has agreed
to
abate their remaining claims and related discovery in the lawsuit against
Verdisys until after September 30, 2005.
VERDISYS,
INC.
NOTES TO
FINANCIAL
STATEMENTS
On
March
8, 2005, Verdisys entered in an Assignment of License Agreement with Maxim
TEP,
Inc. (“Maxim”). The President and Chief Executive Officer of Maxim is Dan
Williams, a former president and CEO of Verdisys. Verdisys and Carl Landers
entered into a license agreement on April 23, 2003 for the exclusive use of
the
Landers horizontal drilling process (see Note 5). Under the Assignment, Verdisys
assigned to Maxim its rights in the license; all current and future negotiations
for assignments, sublicenses or territorial royalty pertaining to the license
and two lateral drilling rigs. The first rig is to be delivered upon payment
of
the first installment by Maxim and the second rig is to be delivered no later
than June 30, 2005. As consideration, Maxim agreed to pay Verdisys a total
of
$1.3 million in cash and release a $270,000 credit obligation owed by Verdisys
to Maxim. The cash payments will be made in four installments: $300,000 on
March
9, 2005; $100,000 on March 18, 2005; $500,000 on June 3, 2005 and $400,000
on
September 2, 2005. Verdisys will retain a non-exclusive sublicense interest
as
long as Verdisys pays all required royalties on which the Landers horizontal
technology is utilized.
In
March
2005, Verdisys, Inc, entered into an agreement, subject to court approval,
to
settle the class action lawsuit brought by former shareholders in March 2004
in
the U.S. District Court for the Southern District. Under the terms of the
agreement, Verdisys would issue to the class 1,150,000 shares of common stock
and pay up to $55,000 in legal and administrative fees for the plaintiffs.
NOTE
23 - RESTATEMENT
The
2004 financial statements have been restated to reflect an agreement
to sell our lateral drilling license for $1.3 million and the non-cash
impairment of our License asset.
The
accounts affected by the restatement are:
|
As
reported
|
Adjustments
|
As
restated
|
||||||||
|
License
|
$
|
5,025,000
|
$
|
(5,025,000
|
)
|
-
|
||||
|
Accumulated
amortization
|
(549,167
|
)
|
549,167
|
-
|
||||||
|
Net
Book Value
|
4,475,833
|
(4,475,833
|
)
|
-
|
||||||
|
Asset
impairment expense
|
-
|
3,175,833
|
3,175,833
|
|||||||
|
License
receivable
|
-
|
1,300,000
|
1,300,000
|
|||||||
Item
8. Changes In / Disagreements with Accountants on
Accounting and Financial Disclosure
None.
Item
8a. Controls and Procedures
Our
management, including the Principal Executive Officer and Principal Financial
Officer, have conducted an evaluation of the effectiveness of disclosure
controls and procedures pursuant to Exchange Act Rule 13a-15. This evaluation
was conducted as of December 31, 2004. Based on that evaluation, the Principal
Executive Officer and Principal Financial Officer concluded that, relative
to the valuation of the Company's intellectual property, the
disclosure controls and procedures were not effective in ensuring that (i)
information required to be disclosed by Verdisys in the reports that it files
or
submits under the Exchange Act is accumulated and communicated to Verdisys
management, including the Principal Executive Officer and Principal Financial
Officer, as appropriate to allow timely decisions regarding required disclosure,
and (ii) information required to be filed in the reports it files or submits
is
recorded, processed, summarized and reported, within the time periods specified
in the SEC’s rules and forms. There have been no changes in internal controls or
in other factors that occurred during the last fiscal quarter that has
materially affected, or is reasonably likely to materially affect our internal
controls over financial reporting. In
the
future, the Company and its independent accountants will institute a procedure
to thoroughly review the carrying value of its intangible assets relative
to
indicated market value, including without limitation the net present value
of
future cash flows from the intellectual property to indicate whether the
asset
should be impaired.
The
Audit
Committee, along with management, has reinforced internal controls and has
implemented stringent policies regarding business engagements and activities.
These policies and procedures cover the areas of approval and authority limits,
segregation of duties, internal audit procedures, revenue recognition,
contractual commitments, documentation and customer acceptance, and staggered
levels of internal checks and balances. Operating documents, such as the
“Verdisys Accounting Operations Manual,” “Employee Handbook” and “Approval
Authorities” have been revised and adopted to describe such policies and train
personnel. Since the earnings restatement in November 2003, the Committee has
increased the frequency of its meetings and has directly reviewed and approved
internal policies and procedures. They have also been directly involved in
recruiting key personnel, namely a new CFO, a new controller and meeting with
our auditors.
Audit
Committee Report
The
Audit
Committee has reviewed and discussed the audited financial statements with
management. The Audit Committee has discussed with the independent auditors
the
matters required to be discussed by SAS 61, as may be modified or supplemented.
The Audit Committee has received the written disclosures and the letter from
the
independent accountants required by Independence Standards Board Standard No.
1,
as may be modified or supplemented, and has discussed with the independent
accountant the independent accountant’s independence. Based on the review and
discussions conducted by the Audit Committee, the Audit Committee recommended
to
the Board of Directors that the audited financial statements be included in
our
Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004 for
filing with the Commission.
Joseph
J.
Penbera, PhD - Chairman
John
R.
Block
O.
James
Woodward III
Sarbanes-Oxley
Act
While
the
effective date of Section 404 of the Sarbanes-Oxley Act for non-accelerated
filers like us has been delayed until fiscal years ending on or after July
15,
2006, our Board and management remain committed to implementation. We have
already completed several steps such as an audit committee charter.
Part
III
Item
9. Directors and Executive Officers
The
names
of our directors and executive officers and certain additional information
with
respect to each of them are set forth below. The dates set forth under “Year
First Became Director” below indicate the year in which our directors first
became a director of our predecessor in interest, Verdisys, Inc.
|
Name
|
Age
|
Current
Position
|
Year First
Became
Director
|
|||
|
David
M. Adams
|
53
|
President
|
|
|||
|
|
|
Co-Chief
Executive Officer
|
N/A
|
|||
|
John
O’Keefe
|
56
|
Co-Chief
Executive Officer
|
|
|||
|
|
|
Chief
Financial Officer
|
N/A
|
|||
|
John
R. Block
|
70
|
Director1
|
2000
|
|||
|
Joseph
J. Penbera, Ph.D.
|
57
|
Director1
|
1999
|
|||
|
Ronald
J. Robinson, Ph.D.
|
59
|
Director
|
2002
|
|||
|
Frederick
R. Ruiz
|
61
|
Director
|
1999
|
|||
|
O.
James Woodward, III
|
69
|
Chairman
of the Board1
|
1999
|
_________________________
1 -
Member
of Audit Committee
Statements
below pertaining to the time at which an individual became one of our directors,
executive officers or founders refers to the time at which the respective
individual achieved his respective status with us or our predecessor in
interest, Verdisys, Inc.
David
M. Adams
has
served as our President and COO since January 2004, and became Co-Chief
Executive Officer in May 2004. From 1989 to 2000, Mr. Adams served as General
Manager of Baker Hughes, E&P Solutions, and from 2001 to 2004; he served as
President and General Manager of Subsea Mudlift Drilling Co., LLC, a subsidiary
of Hydril Co., LP. Mr. Adams has a degree in petroleum engineering from the
University of Texas and is a registered Professional Engineer.
John
O’Keefe
has
served as our Executive Vice President and CFO since January 2004 and became
Co-Chief Executive Officer in May 2004. From 1999 to 2000, Mr. O’Keefe served as
Vice President of Investor Relations of Santa Fe Snyder, and from 2000 to 2003,
he served as Executive Vice President and CFO of Ivanhoe Energy. Mr. O’Keefe has
a B.A. in Business from the University of Portsmouth, is a Chartered Accountant
and graduated from the Program for Management Development (PMD) from the Harvard
Graduate School of Business in 1985 under sponsorship of Sun Oil Co.
John
R. Block
has
served as a director on our Board since May 2000. He currently serves as
President of the Food Distributors International, an organization that
represents the wholesale grocery and foodservice distribution industry. Prior
to
that, Mr. Block served as Secretary of Agriculture for the U.S. Department
of
Agriculture from 1981 to 1986. He currently serves as a director of John Deere
and Co. and Hormel Foods Corp.
Joseph
J. Penbera, Ph.D.
co-founded our company and has served as a director on our Board since its
inception in April 1999. Since 1985, he has been a Professor of Business at
California State University, Fresno, where he previously served as Dean of
the
Craig School of Business. Dr. Penbera was Senior Economist at Westamerica Bank,
Regency Bancorp and California Bank from 1999 to 2002. Dr. Penbera is on the
board of directors of Gottschalks, Inc., a publicly traded regional department
store and Rug Doctor, Inc. Dr. Penbera received his Ph.D. from American
University, his M.P.A. from Bernard Baruch School and his B.A. from Rutgers
University.
Ronald
J. Robinson, Ph.D.
was
appointed as our interim President and CEO in December 2003 and has served
as
Chairman of our Board since January 2002. With the appointment of David Adams
as
President and Co-Chief Executive Officer, John O’Keefe as Co-Chief Executive
Officer and Jim Woodward as Chairman of the Board, Dr. Robinson now serves
only
as Director. From 1996 to 2001, Dr. Robinson served as president of Texaco
Technologies, a subsidiary of Chevron Texaco. From 2001 to 2003, Dr. Robinson
was head of the Petroleum Engineering Department at Texas A&M University.
Dr. Robinson currently serves as a director of Ensyn Group Inc. Dr. Robinson
received his Ph.D. in Petroleum Engineering from Texas A&M University, an
M.S. in Physics from Baylor University and a B.S. in Physics and Mathematics
from the University of Southern Colorado.
Frederick
R. Ruiz
has
served as a director on our Board since its inception in April 1999. He
co-founded and is Chairman of the Board of Ruiz Food Products, Inc., a privately
held frozen food company. Mr. Ruiz currently serves as a director of McClatchy
Newspapers, Inc. and Gottschalks, Inc., each of which are publicly traded,
the
California Chamber of Commerce and the Hispanic College Fund. During 2004,
Mr.
Ruiz was named to the California University System Board of Regents.
O.
James Woodward III
has
served as a director on our Board since its inception in April 1999 and was
elected Chairman of the Board in May 2004. From 1992 to 1999, Mr. Woodward
was
an attorney in private practice in Fresno, California. From 1995 to 2000, he
was
Chairman of MJ Construction Co., a Fresno, California based construction
company, and from 2001 to 2003, he served as a consultant in Fresno, California.
Mr. Woodward has been in private practice as an attorney since 2003 and is
currently Of Counsel with Baker, Manock and Jensen. He currently serves on
the
board of directors of Gottschalks, Inc. Mr. Woodward received his M.B.A. from
Stanford Graduate School of Business and his J.D. from the University of
California, Berkeley Law School.
All
directors will serve in such capacity until the next annual meeting of our
shareholders and until their successors have been elected and qualified. The
officers serve at the discretion of our directors. There are no familial
relationships among our officers and directors, nor are there any arrangements
or understanding between any of our directors or officers or any other person
pursuant to which any officer or director was or is to be selected as an officer
or director.
No
non-compete or non-disclosure agreements exist between our management and any
prior or current employer.
Our
directors are aware of no petitions or receivership actions having been filed
or
court appointed as to our business activities, officers, directors, or key
personnel.
We
have
not, nor anticipate, making loans to any of our officers, directors, key
personnel, 10% stockholders, relatives thereof, or controllable entities. None
of our officers, directors, key personnel, or 10% stockholders has guaranteed
or
co-signed any bank debt, obligation, or any other indebtedness pertaining to
us.
Audit
Committee
Our
Board
of Directors has established an Audit Committee. The Audit Committee meets
with
management and our independent auditors to determine the adequacy of internal
controls and other financial reporting matters. In addition, the committee
provides an avenue for communication between the independent auditors, financial
management and the Board. Our Board of Directors have determined that for the
purpose of and pursuant to the instructions of item 401(e) of regulation S-B
titled Audit Committee Financial Expert, Joseph J. Penbera, PhD possesses the
attributes of an audit committee financial expert. Dr. Penbera is one of our
Board members and is the Chairman of the Audit Committee. Dr. Penbera is
independent as defined by item 401(e)(ii) of regulation S-B. He receives
compensation for board service only and is not otherwise an affiliated person.
Code
of Ethics
We
have
adopted a code of ethics that applies to our senior officers such as the
principal executive officer, principal financial officer, principal accounting
officer and persons performing similar functions. A code of ethics relates
to
written standards that are reasonably designed to deter wrongdoing and to
promote;
|
•
|
Honest
and ethical conduct, including the ethical handling of actual or
apparent
conflicts of interest between personal and professional relationships;
|
|
•
|
Full,
fair, accurate, timely and understandable disclosure in reports and
documents that are filed with, or submitted to, the SEC and in other
public communications made by an issuer;
|
|
•
|
Compliance
with applicable governmental laws, rules and regulations;
|
|
•
|
The
prompt internal reporting of violations of the code to an appropriate
person or persons identified in the code; and
|
|
•
|
Accountability
for adherence to the code.
|
Our
code
of ethics was filed as Exhibit 14.1 of our 10-KSB for the year ended December
31, 2003. Our code of ethics is posted on our website at www.verdisys.com.
We will
provide to any person without charge, upon written request to our corporate
secretary at our principal executive office, a copy of our code of ethics.
Item
10. Executive Compensation
Dr.
Robinson served as interim CEO from January to May 2004 and President for a
brief period in January 2004 until Messrs. Adams and O’Keefe were elevated to
Co-CEOs. Other than for Dr. Robinson, Mr. Adams and Mr. O’Keefe, we have no
other person that is a named executive officer as of December 31, 2004.
Compensation
Summary
The
following table provides certain summary information concerning compensation
for
the last three fiscal years earned by or paid to our Chief Executive Officers
and each of our other executive officers who had compensation in excess of
$100,000 during the last fiscal year (collectively, the “Named Executive
Officers”).
SUMMARY
COMPENSATION TABLE
|
|
|
Annual
Compensation
|
Award(s)
|
Payouts
|
|
||||||||||||||||||||
|
Position
|
Year
|
Salary
($)
|
Bonus
($)
|
Other
Annual
Compensation(1)
($)
|
Restricted
Stock
Award
(s)
($)
|
Securities
Underlying
Options/SARs
(#)
|
LTIP
Payouts
($)
|
All
Other
Compensation
($)
|
|||||||||||||||||
|
Ronald
J. Robinson
|
2004
|
90,000
|
0
|
10,000
|
0
|
12,000
|
0
|
0
|
|||||||||||||||||
|
Former
|
2003
|
70,000
|
0
|
0
|
0
|
700,000
|
0
|
0
|
|||||||||||||||||
|
Interim
CEO
|
2002
|
0
|
0
|
0
|
0
|
50,000
|
0
|
0
|
|||||||||||||||||
|
David
M. Adams
|
2004
|
181,146
|
50,000
|
0
|
0
|
500,000
|
0
|
0
|
|||||||||||||||||
|
Co-CEO
|
2003
|
0
|
0
|
0
|
0
|
0
|
0
|
0
|
|||||||||||||||||
|
COO
|
2002
|
0
|
0
|
0
|
0
|
0
|
0
|
0
|
|||||||||||||||||
|
John
O’Keefe
|
2004
|
172,570
|
40,000
|
0
|
0
|
500,000
|
0
|
0
|
|||||||||||||||||
|
Co-CEO
|
2003
|
0
|
0
|
0
|
0
|
0
|
0
|
0
|
|||||||||||||||||
|
CFO
|
2002
|
0
|
0
|
0
|
0
|
0
|
0
|
0
|
|||||||||||||||||
_________________________
| (1) |
During
the periods indicated, perquisites for each individual named in the
Summary Compensation Table aggregated less than 10% of the total
annual
salary and bonus reported for such individual in the Summary Compensation
Table. Accordingly, no such amounts are included in the Summary
Compensation Table.
|
Option
Grants
The
following table provides certain information with respect to options granted
to
our Named Executive Officers named in the Summary Compensation Table during
the
fiscal year ended December 31, 2004 under our stock option plan:
OPTION
GRANTS IN 2004
|
Name
|
Number
of
Securities
Underlying
Options
Granted
|
Percent
of
Total
Granted to
Employees
in
Fiscal
Year
|
Exercise
Price
|
Market
Price
on
Date
of
Grant
|
Expiration
Date
|
|||||||||||
|
Ronald
J. Robinson
|
12,000
|
1
|
%
|
$
|
4.28
|
$
|
4.28
|
1/21/2014
|
||||||||
|
David
M. Adams
|
150,000
|
13
|
%
|
$
|
4.28
|
$
|
4.28
|
1/21/2014
|
||||||||
|
|
350,000
|
30
|
%
|
$
|
0.90
|
$
|
0.90
|
7/29/2014
|
||||||||
|
John
O’Keefe
|
80,000
|
7
|
%
|
$
|
4.28
|
$
|
4.28
|
1/21/2014
|
||||||||
|
|
420,000
|
36
|
%
|
$
|
0.90
|
$
|
0.90
|
7/29/2014
|
||||||||
Option
Exercises and Values
The
following table sets forth the information concerning option exercises and
the
value of unexercised options held by our Named Executive Officers named in
the
Summary Compensation Table as of the end of the last fiscal year.
AGGREGATED
OPTION EXERCISES IN 2004
AND
OPTION VALUES AT DECEMBER 31, 2004
|
|
|
|
Number
of Securities
Underlying
Unexercised
Options
Held at
December
31, 2004
|
Value
of Unexercised
In-The-Money
Options Held at
December
31, 2004
|
|||||||||||||||
|
Name
|
Shares
Acquired on
Exercise
|
Value
Realized
|
Exercisable
|
Unexercisable
|
Exercisable
|
Unexercisable
|
|||||||||||||
|
Ronald
J. Robinson
|
None
|
None
|
189,332
|
6,000
|
$
|
0
|
$
|
0
|
|||||||||||
|
David
M. Adams
|
None
|
None
|
170,834
|
329,166
|
$
|
0
|
$
|
0
|
|||||||||||
|
John
O’Keefe
|
None
|
None
|
130,000
|
370,000
|
$
|
0
|
$
|
0
|
|||||||||||
Note:
Value
of
Unexercised In-The-Money Options Held at December 31, 2004 computed based on
the
difference between aggregate fair market value and aggregate exercise price.
The
fair market value of our common stock on December 31, 2004 was $0.47, based
on
the closing price on the OTC Bulletin Board .
Compensation
of Directors
We
pay
our directors fees for attendance at board and other committee meetings in
the
form of cash compensation or similar remuneration, and reimburse them for any
out-of-pocket expenses incurred by them in connection with our business.
Currently,
each independent director earns compensation of $1,000 per month with an
additional $1,000 per month for chairing a committee with the exception of
the
audit committee chair who receives an additional $2,000 per month and the
chairman of the board who receives an additional $3,000 per month. Meeting
fees
accrue at a rate of $1,000 per day for regularly scheduled Board meetings.
Currently, only the chairman of the board is receiving cash payments towards
fees earned. All independent directors receive options to purchase 12,000 shares
per year.
Employment
Agreements
Ronald
J. Robinson
In
July
2003, we entered into an advisory agreement with Dr. Robinson, and we amended
the agreement in December 2003. Pursuant to the agreement, as amended, Dr.
Robinson agreed to serve as our interim President and CEO until a suitable
replacement was found. For his services as interim President and CEO, he
received an option to purchase 500,000 shares of our common stock pursuant
to a
12 month vesting schedule (except with respect to 50,000 shares that were tied
to certain revenue milestones for the fourth quarter of 2003 and which
milestones were not met), and he receives monthly compensation of $20,000 and
a
monthly office allowance of $2,500. Dr. Robinson also served as Chairman of
the
Board. In January 2004, David Adams was selected to serve as President thus
terminating Dr. Robinson’s service as interim President.
David
M. Adams
In
January 2004, we entered into an employment agreement with David Adams. The
term
of the agreement is for one year, and it may be renewed at the pleasure of
both
parties. Pursuant to the agreement, Mr. Adams serves as our President and COO
in
exchange for a base salary of $185,000 per year. Mr. Adams also received an
option to purchase 150,000 shares of common stock to vest quarterly over the
initial term of the employment agreement. Mr. Adams also received a signing
bonus in the amount of $50,000 on the effective date of the employment
agreement, and is entitled to participate in our annual incentive compensation
program with a potential bonus being up to fifty percent of his base salary.
John
O’Keefe
In
January 2004, we entered into an employment agreement with John O’Keefe. The
term of the agreement is for one year, and it may be renewed at the pleasure
of
both parties. Pursuant to the agreement, Mr. O’Keefe serves in the position of
Executive Vice President and Chief Financial Officer in exchange for a base
annual salary of $175,000 for the first twelve months of his employment,
$195,000 for the second year of employment and $215,000 for the third year
of
employment. Mr. O’Keefe also received an option to purchase 80,000 shares of
common stock to vest quarterly over the initial term of the employment
agreement. Mr. O’Keefe received a one time payment of $40,000 as a sign-on bonus
and is entitled to participate in our annual compensation program with a
potential bonus being up to fifty percent of his base salary.
Item
11. Security Ownership of Certain Beneficial Owners and
Management
The
following table presents certain information regarding the beneficial ownership
of our common stock as of February 28, 2005 by (i) each person who is known
by
us to own beneficially more than 5% of the outstanding shares of our common
stock, (ii) each of our directors, (iii) our Named Executive Officers, and
(iv)
all directors and executive officers as a group. Each of the persons listed
in
the table has sole voting and investment power with respect to the shares
listed.
Common
Stock
|
Name
and Address of Beneficial Owner
|
Amount and Nature
of
Beneficial Owner
|
Percentage
of Class (1)
|
|||||
|
Berg
McAfee Companies (2)
|
10,040,752
|
(3)
|
28.0
|
%
|
|||
|
100600
N. De Anza Blvd., #250
|
|
|
|||||
|
Cupertino,
California 95014
|
|
|
|||||
|
Eric
McAfee
|
1,825,400
|
(4)(5)
|
5.2
|
%
|
|||
|
100600
N. De Anza Blvd, #250
|
|
|
|||||
|
Cupertino,
California 95014
|
|
|
|||||
|
David
M. Adams
|
333,332
|
(6)
|
*
|
||||
|
President
and co-CEO
|
|
|
|||||
|
John
O’Keefe
|
283,334
|
(7)
|
*
|
||||
|
Co-CEO
& CFO
|
|
|
|||||
|
John
R. Block
|
194,000
|
(8)
|
*
|
||||
|
Director
|
|
|
|||||
|
Joseph
J. Penbera
|
1,012,952
|
(9)
|
2.9
|
%
|
|||
|
Director
|
|
|
|||||
|
Ronald
J. Robinson
|
550,332
|
(10)
|
1.6
|
%
|
|||
|
Director
|
|
|
|||||
|
Frederick
R. Ruiz
|
401,366
|
(11)
|
1.1
|
%
|
|||
|
Director
|
|
|
|||||
|
O.
James Woodward III
|
240,500
|
(12)
|
*
|
||||
|
Director
|
|
|
|||||
|
Total
Shares of 5% or more Beneficial Ownership
|
11,866,152
|
(13)
|
32.8
|
%
|
|||
|
Total
Shares of Officers and Directors as a group
|
3,015,816
|
8.4
|
%
|
||||
_________________________
* Less
than 1%
Notes:
|
(1)
|
Each
beneficial owner’s percentage ownership is based upon 34,973,673 shares of
common stock outstanding as of February 28, 2005 and assumes the
exercise
or conversion of all
options, warrants and other convertible securities held by such person
and
that are exercisable or convertible within 60 days after February
28,
2005.
|
|
(2)
|
Berg
McAfee Companies is controlled by Clyde Berg and Eric McAfee. Mr.
McAfee
is our former Vice-Chairman.
|
|
(3)
|
Includes
820,014 shares issuable upon exercise of warrants and 52,067 shares
issuable upon conversion of convertible debt.
|
|
(4)
|
Includes
250,000 shares issuable upon exercise of warrants and 52,067 shares
issuable upon conversion of convertible debt.
|
|
(5)
|
Does
not include shares beneficially owned by Berg McAfee.
|
|
(6)
|
Includes
266,666 shares issuable upon exercise of options and 5,000 shares
issuable
upon exercise of warrants
|
|
(7)
|
Includes
220,000 shares issuable upon exercise of options and 5,000 shares
issuable
upon exercise of warrants.
|
|
(8)
|
Includes
82,000 shares issuable upon exercise of options and 2,000 shares
issuable
upon exercise of warrants.
|
|
(9)
|
Includes
82,000 shares issuable upon exercise of options and 5,000 shares
issuable
upon exercise of warrants.
|
|
(10)
|
Includes
195,332 shares issuable upon exercise of options.
|
|
(11)
|
Includes
82,000 shares issuable upon exercise of options and 5,000 shares
issuable
upon exercise of warrants.
|
|
(12)
|
Includes
94,000 shares issuable upon exercise of options.
|
|
(13)
|
Includes
shares beneficially owned by Berg McAfee and Eric McAfee.
|
Holders
As
of
February 28, 2005 we had 34,973,673 shares of common stock issued and
outstanding and held by approximately 500 shareholders.
Item
12. Certain Relationships and Related Transactions
Energy
2000 NGC, Inc. and Natural Gas Systems, Inc.
Energy
2000 NGC, Inc. (“Energy 2000”) is a subsidiary of Berg McAfee Energy, LLC, which
is a wholly owned subsidiary of Berg McAfee Companies (“Berg McAfee”). Berg
McAfee has a more than 25% beneficial interest in us. Natural Gas Systems,
Inc.
(“NGS”) is an independent company with substantial shareholdings owned by Eric
McAfee, a 50% owner of Berg McAfee and one of our former directors. Energy
2000
and NGS are beneficially owned 80% and 23% respectively by Berg McAfee or Eric
McAfee personally.
We
billed
$666,250 and $153,960 to Energy 2000 and NGS, respectively, for services
performed in 2003. We received $397,500 and $130,000, respectively. However,
for
Energy 2000 we had inadequate documentation to substantiate whether some of
the
services were performed. For Energy 2000, we were able to substantiate $328,750
of revenue leaving $68,750 in deferred revenue. We billed $20,457 and $2,000
to
Energy 2000 and NGS, respectively, for expenses incurred in 2004. The amount
billed to Energy 2000 was deemed uncollectible and the amount billed to NGS
was
collected. At December 31, 2004, we have no receivables or deferred revenues
from related parties.
In
September 2003, we signed a drilling service contract with NGS, whereby NGS
would have paid us a minimum of $7,800,000 for the lateral drilling of 120
wells. This contract was for a fixed amount with the total price dependent
upon
the number of wells serviced and offshoot lateral bores drilled. In addition,
we
would receive a 70 percent interest in the net operating income after payback
from these properties.
In
April
2003, we signed a drilling service contract with Energy 2000, whereby Energy
2000 would have paid us a minimum of $1,800,000 for the lateral drilling of
45
wells. This contract was for a fixed amount, dependent upon the number of wells
serviced and offshoot lateral bores drilled. In addition, we would receive
an 80
percent interest in the net operating income after payback from these properties
and also be reimbursed for 20 percent of its field costs. In September, 2003
we
entered into another contract with Energy 2000 for an additional 57 wells with
terms similar to the original contract. These contracts have been suspended
for
lack of payment.
Lateral
drilling services for these two customers ceased in December 2003 because of
a
change in Verdisys management.
Berg
McAfee Companies
In
addition to the transactions involving Energy 2000 and NGS, we had an additional
transaction with Berg McAfee. In December 2004, Berg McAfee purchased 400,000
shares of our common stock at a price of $0.50 per share in a private
transaction. In October 2004, Berg McAfee loaned us $100,000 under the terms
of
a convertible promissory note bearing interest at 8% and maturing May 31, 2006.
In connection with the note, we issued warrants to purchase 50,000 shares of
common stock at $2.00 per share during the term of the note to Berg McAfee.
Eric
McAfee
In
addition to the transactions involving Energy 2000, NGS and Berg McAfee, we
had
the additional transactions with Eric McAfee.
On
January 19, 2005, we entered into a settlement agreement and mutual release
with
Eric McAfee, Edge Capital Group, Inc. (“Edge”) and certain entities affiliated
with Robert Frazier, Sr. As part of the settlement, Mr. McAfee paid us $625,000
and gave us 300,000 shares of NGS common stock in exchange for 500,000 shares
of
our common stock. Mr. McAfee has signed a Funding Agreement to acknowledge
an
obligation to Verdisys of $375,000, currently secured by the 300,000 shares
of
NGS common stock. The $625,000 in cash was then distributed to Edge along with
750,000 shares of our common stock. At the closing of the settlement agreement,
the parties have agreed to a mutual release and have agreed to dismiss all
pending claims and litigation between them.
In
October 2004, Mr. McAfee loaned us $100,000 under the terms of a convertible
promissory note bearing interest at 8% and maturing May 31, 2006. In connection
with the note, we issued warrants to purchase 50,000 shares of common stock
at
$2.00 per share during the term of the note to Mr. McAfee.
We
had a
consulting agreement with Mr. McAfee for $10,000 per month through April 30,
2005, with $120,000 due during 2004 and $40,000 in 2005. This agreement was
cancelled upon his resignation as a director.
In
April
2003, we issued 2,000,000 shares of our common stock for what management
believed was satellite communications management software pursuant to an asset
purchase agreement with a related party. Management in place as of August 2003
maintained the software was not useful and impaired it as of June 30, 2003.
Eric
McAfee, a principal to the counterparty in the transaction, acquired 11.5%
of
the 2,000,000 shares. In June 2004, we filed a lawsuit against Eric McAfee,
Mark
Crone and QuikView Inc. in an attempt to negate the transaction. In November
2004, we dismissed the lawsuit against all defendants with prejudice.
In
April
2003, Mr. McAfee was granted options to purchase 50,000 shares of our common
stock for his role as a director. The options had an exercise price of $0.10
per
share, but where granted when the market value was $0.50 per share. The options
vested quarterly over one year and have a ten year term. Mr. McAfee’s role as a
director terminated effective March 2, 2004.
Directors
and Officers
In
July
2004, we granted options to purchase 350,000 shares of our common stock to
David
M. Adams and options to purchase 420,000 shares of our common stock to John
O’Keefe. Mr. Adams is our president and co-CEO, while Mr. O’Keefe is our co-CEO
and CFO. The options have a ten year term and are exercisable at $0.90 per
share, the market price at date of grant. The options vest quarterly over three
years.
In
May
2004, we granted options to purchase 12,000 shares of our common stock to the
following directors; John R. Block, Joseph J. Penbera, Frederick R. Ruiz and
Ronald J. Robinson. We also granted options to purchase 24,000 shares of our
common stock to O. James Woodward III, another director. The options have a
ten
year term and are exercisable at $2.20 per share, the market price at date
of
grant. The options vest quarterly over one year.
In
May
2004, Messrs. Adams, O’Keefe, Penbera and Ruiz loaned $25,000 to us, while Mr.
Block loaned $10,000. The notes bear interest at 8% and mature on May 14, 2005.
In connection with the notes we issued warrants to purchase 5,000 shares of
common stock to Messrs. Adams, O’Keefe, Penbera and Ruiz and warrants to
purchase 2,000 shares of common stock to Mr. Block. The warrants are exercisable
at $2.00 per share.
In
January 2004, we granted options to purchase 150,000 shares of our common
stock
to Mr. Adams and options to purchase 80,000 shares of our common stock to
Mr.
O’Keefe. We also granted options to purchase 20,000 shares of our common stock
to the following directors; Messrs. Block, Penbera, Ruiz and Woodward. The
options have a ten year term and are exercisable at $4.28 per share, the
market
price at date of grant. The options granted to the officers vest quarterly
over
one year, while the options granted to the directors vested immediately.
In
January 2004, we entered into an employment agreement with Mr. O’Keefe to serve
as CFO. The agreement stipulates compensation of $175,000 in year one, $195,000
in year two and $215,000 in year three. The agreement renews annually.
In
December 2003, we entered into an employment agreement with Mr. Adams to serve
as CEO. The agreement provides for a base salary of not less than $185,000.
The
agreement renews annually.
In
December 2003, we granted options to purchase 500,000 shares of our common
stock
to Ronald J. Robinson, our then chairman of the board and interim CEO. The
options have a ten year term and are exercisable at $9.55 per share, the market
price at date of grant. 50,000 vested immediately, 50,000 were performance
options and did not vest, and the remaining 400,000 options vest evenly over
12
months in 2004.
In
April
2003, we granted options to purchase 50,000 shares of our common stock to each
of our directors. The directors awarded options were Messrs. Block, Penbera,
Robinson, Ruiz and Woodward. We also granted options to purchase 200,000 shares
of our common stock to our interim CEO, Mr. Robinson. The options all have
an
exercise price of $0.10 per share and were granted at a time when the market
value was $0.50 per share. The options vest quarterly over one year and have
a
ten year term.
Item
13. Exhibits and Reports on Form 10-KSB
(a)
Exhibits
Index
of Exhibits
Verdisys,
Inc. includes by reference, unless otherwise indicated, the following exhibits:
|
Number
|
Description
|
|
|
2.1
|
Agreement
and Plan of Reorganization, dated April 24, 2003, as amended June
30,
2003; Filed July 18, 2003 with the SEC, Report on Form
8-K
|
|
|
3.1
|
Restated
Articles of Incorporation dated July 15, 2003 Filed June 29, 2004
with the
SEC, Form SB-2
|
|
|
3.2
|
Bylaws,
as amended September 25, 2003 Filed June 29, 2004 with the SEC, Form
SB-2
|
|
|
4.1
|
Form
of Subscription Agreement Filed August 11, 2004 with the SEC, Form
10-QSB
|
|
|
4.2
|
Form
of Warrant Agreement Filed August 11, 2004 with the SEC, Form
10-QSB
|
|
|
4.3
|
Form
of Promissory Note Filed August 11, 2004 with the SEC, Form
10-QSB
|
|
|
4.4
|
Form
of Convertible Promissory Note Filed August 11, 2004 with the SEC,
Form
10-QSB
|
|
|
4.5
|
Form
of Registration Rights Agreement Filed August 11, 2004 with the SEC,
Form
10-QSB
|
|
|
10.1
|
Employment
Agreement - John O’Keefe, dated January 6, 2004 Filed April 15, 2004 with
the SEC, Form 10-KSB
|
|
|
10.2
|
Employment
Agreement - David Adams, dated December 31, 2003 Filed April 15,
2004 with
the SEC, Form 10-KSB
|
|
|
10.3
|
Advisor
Agreement - Dr. Ron Robinson, amended December 11, 2003 Filed April
15,
2004 with the SEC, Form 10-KSB
|
|
|
10.4
|
Employment
Agreement - Andrew Wilson, dated June 2003 Filed November 20, 2003
with
the SEC, Form 10-QSB, as amended
|
|
|
10.5
|
License
Agreement - Carl W. Landers, dated April 24, 2003; Filed October
6, 2003
with the SEC, Report on Form 8-K
|
|
|
10.6
|
Amendment
to License Agreement - Carl W. Landers, dated September 4, 2003;
Filed
October 6, 2003 with the SEC, Report on Form
8-K
|
|
10.7
|
Second
Amendment to License Agreement - Carl W. Landers, dated February
28, 2004;
Filed February 28, 2004 with the SEC, Report on Form
8-K
|
|
|
10.8
|
Technology
Report, “Landers Technology”, dated October 13, 2003 Filed November 20,
2003 with the SEC, Form 10-QSB, as amended
|
|
|
10.9
|
Subscription
Agreement, Gryphon Master Fund, L.P., dated October 23, 2003 and
Registration Rights Agreement dated October 24, 2003 Filed October
27,
2003 with the SEC, Report on Form
8-K
|
|
Number
|
Description
|
|
|
10.10
|
Form
of Registration Rights Agreement, re: Private Placement Offering
July/August 2003 Filed December 3, 2003 with the SEC, Form 10-QSB,
as
amended
|
|
|
10.11
|
Alternative
Form of Registration Rights Agreement, re: Offering July/August 2003
Filed
December 3, 2003 with the SEC, Form 10-QSB, as amended
|
|
|
10.12
|
Placement
Agency Agreement, Stonegate Securities, Inc., dated August 26, 2003
Filed
November 20, 2003 with the SEC, Form 10-QSB, as amended
|
|
|
10.13
|
Independent
Contractor Agreement, Terronne Petroleum Corporation, dated August
1, 2003
Filed November 20, 2003 with the SEC, Form 10-QSB, as
amended
|
|
|
10.14
|
Master
Services Contract, Esperada Energy Partners, L.L.C., dated March
2004
Filed April 15, 2004 with the SEC, Form 10-KSB
|
|
|
10.15
|
Services
Contract, Maxim Energy, Inc., dated March 2004 Filed April 15, 2004
with
the SEC, Form 10-KSB
|
|
|
10.16
|
Services
Contract, Natural Gas Systems, dated January 2004 Filed April 15,
2004
with the SEC, Form 10-KSB
|
|
|
10.17
|
Contract
- Natural Gas Systems, “Delhi Field”, dated September 22, 2003; Filed
November 20, 2003 with the SEC, Form 10-QSB, as amended
|
|
|
10.18
|
Services
Contract, Amvest Osage, Inc.; dated January 2004 Filed April 15,
2004 with
the SEC, Form 10-KSB
|
|
|
10.19
|
Acknowledge
of amounts owed at September 30, 2003 re. Edge Capital Group contract
dated June 16, 2003 Filed November 20, 2003 with the SEC, Form 10-QSB,
as
amended
|
|
|
10.20
|
Contract
- Edge Capital Group, “Franklin Field”, dated September 27, 2003 Filed
November 20, 2003 with the SEC, Form 10-QSB, as amended
|
|
|
10.21
|
Contract
- Edge Capital Group, “Monroe Field”, dated June 16, 2003 Filed August 20,
2003 with the SEC, Form 10-QSB, as amended
|
|
|
10.22
|
Addendum
to Contract, Edge Capital Group, “Monroe Field”, dated November 19, 2003
Filed November 20, 2003 with the SEC, Form 10-QSB, as
amended
|
|
|
10.23
|
Contract
- Noble Energy, re: Satellite Services, dated September 17, 2003
Filed
November 20, 2003 with the SEC, Form 10-QSB, as amended
|
|
|
10.24
|
Contract
- Apache Corp., re: Satellite Services, dated September 11, 2002
Filed
November 20, 2003 with the SEC, Form 10-QSB, as amended
|
|
|
10.25
|
Contract
- Energy 2000 NGC, “Monroe Field”, dated April 30, 2000 Filed August 20,
2003 with the SEC, Form 10-QSB, as amended
|
|
|
10.26
|
Verdisys,
Inc. 2003 Stock Option Plan; Filed November 20, 2003 with the SEC,
Form
10-QSB, as amended
|
|
|
10.27
|
Master
Service Contract - BlueRidge Gas Partners, LLC - June 23, 2004 Filed
August 11, 2004 with the SEC, Form 10-QSB
|
|
|
10.28
|
Master
Service Contract - VJI Natural Resources, LLC - July 20, 2004 Filed
August
11, 2004 with the SEC, Form 10-QSB
|
|
Number
|
Description
|
|
|
10.29
|
Contract/Order
- U. S. Department of Energy - June 4, 2004 and Letter of Intent,
Radial
Drilling Optimization Services - April 14, 2004 Filed August 11,
2004 with
the SEC, Form 10-QSB
|
|
|
10.30
|
Contract
- License Agreement between Alberta Energy Holdings, Inc. and Verdisys,
Inc. for Abrasive Fluid Jet Technology, dated October 27, 2004 Filed
November 15, 2004 with the SEC, Form 10-QSB
|
|
|
10.31
|
Contract
- Agreement among Verdisys, Berg McAfee Companies, Energy 2000 NGC,
and
Eric McAfee Filed November 15, 2004 with the SEC, Form
10-QSB
|
|
|
10.32
|
Settlement
Agreement and Mutual Release dated as of January 19, 2005 by and
among
Verdisys, Inc., Eric McAfee, Edge Capital Group, Inc. and certain
entities
affiliated with Robert Frazier, Sr. Filed February 4, 2005 with the
SEC,
Form 8-K
|
|
|
10.33
|
Assignment
of License Agreement dated March 8, 2005 by and among Verdisys, Inc.
and
Maxim TEP, Inc. Filed March 14, 2004 with the SEC, Form
8-K
|
|
|
Certification
of Principal Executive Officer pursuant to Section 302
|
||
|
Certification
of Principal Accounting Officer pursuant to Section 302
|
||
|
Certification
of Principal Executive Officer pursuant to Section 1350
|
||
|
Certification
of Principal Accounting Officer pursuant to Section
1350
|
_________________________
* Filed
herewith
(b)
Reports on Form 8-K
During
the quarter ending December 31, 2004, we had no filings on Form 8-K with the
Securities and Exchange Commission.
Item
14. Principal Accountants Fees and Services
Audit
Fees
The
aggregate fees billed for each of the last two fiscal years for professional
services rendered by the principal accountant for the audit of our annual
financial statements and for services provided by the accountant in connection
with statutory and regulatory filings or engagements for the last two fiscal
years were: $95,970 in Fiscal Year 2004 and $58,000 in Fiscal Year 2003.
Audit-Related
Fees
No
aggregate fees were billed in each of the last two fiscal years for assurance
and related services by the principal accountant that are reasonably related
to
the performance of the audit or review of our financial statements, and are
not
reported under the prior caption Audit Fees.
Tax
Fees
No
aggregate fees were billed in each of the last two fiscal years for professional
services rendered by the principal accountant for tax compliance, tax advice,
and tax planning.
All
Other Fees
No
other
services were provided, nor aggregate fees billed, other then such services
or
fees which have been previously disclosed herein.
Our
Audit
Committee has approved all of the services performed by our principal accountant
for the fiscal year ending December 31, 2004.
Signatures
In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
|
Verdisys,
Inc.
|
||
|
(Registrant)
|
||
|
By:
|
/s/
David M. Adams
|
|
|
David
M. Adams
|
||
|
Co-Chief
Executive Officer
|
||
|
Principal
Executive Officer
|
||
| Date: March 29, 2005 | ||
In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on
the
dates indicated.
|
By:
|
/s/
David M. Adams
|
By:
|
/s/
John O’Keefe
|
|
|
David
M. Adams
|
|
John
O’Keefe
|
|
|
President
|
|
Co-Chief
Executive Officer
|
| Co-Chief Executive Officer | Chief Financial Officer | ||
| Principal Executive Officer | Principal Accounting Officer | ||
|
Date:
March 29, 2005
|
Date:
March 29, 2005
|
||
|
By:
|
/s/
John R. Block
|
By:
|
/s/
Joseph J. Penbera, Ph.D.
|
|
|
John
R. Block
|
|
Joseph
J. Penbera, Ph.D.
|
| Director | Director | ||
|
Date:
March 29, 2005
|
Date:
March 29, 2005
|
||
|
By:
|
/s/
Ronald J. Robinson, Ph.D.
|
By:
|
/s/
Frederick R. Ruiz
|
|
|
Ronald
J. Robinson, Ph.D.
|
|
Frederick
R. Ruiz
|
|
|
Director
|
|
Director
|
|
Date:
March 29, 2005
|
Date:
March 29, 2005
|
||
|
By:
|
/s/
O. James Woodward III
|
|
|
|
|
O.
James Woodward III
|
|
|
|
|
Director
|
|
|
|
Date:
March 29, 2005
|
|
|
|
66