PARTICLE DRILLING TECHNOLOGIES, INC.
(a development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements, which include the accounts of Particle Drilling Technologies, Inc. (which is referred to herein as “we,” “us,” “our” or the “Company”) and its subsidiary, have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted in accordance with such rules and regulations. The information furnished in the unaudited interim consolidated financial statements includes normal recurring adjustments and reflects all adjustments, which in the opinion of management are necessary for a fair presentation of such financial statements. Although management believes the disclosures and information presented are adequate to make the information not misleading, these unaudited interim consolidated financial statements should be read in conjunction with the Company’s September 30, 2006 audited consolidated financial statements and notes thereto on Form 10-K. Operating results for the three months ended December 31, 2006 are not necessarily indicative of the results that may be expected for the year ending September 30, 2007.
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates.
Certain reclassifications have been made to conform prior period amounts to the current period presentation. These reclassifications had no effect on net loss, net loss per share, or stockholders’ equity.
2. FINANCIAL CONDITION AND MANAGEMENT PLANS
The Company is currently a development stage company and its continued existence is dependent upon the Company’s successful development of the PID technology and our ability to successfully commercialize this technology. The Company has yet to generate cashflow from operations, and until revenues commence, the Company is highly dependent upon debt and equity funding. Should continuing funding requirements not be met, the Company’s operations may cease to exist. Management cannot provide any assurance that any such financing will be available on acceptable terms or at all.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Impairment of Long-Lived Assets. We evaluate our long-lived assets for indicators of possible impairment by comparison of the carrying amounts to future net undiscounted cash flows expected to be generated by such assets when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s fair value or discounted estimates of future cash flows. We also evaluate the capitalized costs for patents and patent applications filed but not issued for possible impairments. We have not identified any such impairment losses to date. The evaluation of capitalized costs for patents and patent applications is based on a subjective cash flow forecast which is subject to change. We will reassess our cash flow forecast each time there are fundamental changes in the underlying potential use of the patents or patent applications in terms of performance, customer acceptance or other factors that may affect such cash flow forecasts.
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New Accounting Pronouncements. In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. It prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This new standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 should be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that fiscal year. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. Earlier application is permitted as long as the enterprise has not yet issued financial statements, including interim financial statements, in the period of adoption. The Company believes that the adoption of FIN 48 will not have a material impact on our financial position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. The Company believes that the adoption of SFAS No. 157 will not have a material impact on its financial position, results of operations or cash flows.
In September 2006, the FASB issued FSP No. AUG AIR-1, Accounting for Planned Major Maintenance Activities. FSP No. AUG AIR-1 prohibits the use of the accrue-in-advance method for accounting for major maintenance activities and confirms the acceptable methods of accounting for planned major maintenance activities. FSP No. AUG AIR-1 is effective the first fiscal year beginning after December 15, 2006. The Company believes that the adoption of FSP No. AUG AIR-1 will not have a material impact on its financial position, results of operations or cash flows.
In September 2006, the SEC issued SAB 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”(“ SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The pronouncement prescribes an approach whereby the effect of all unrecorded identified errors should be considered on all of the financial statements rather than just either the effect on the balance sheet or the income statement. The Company will adopt the provisions of SAB 108 beginning in fiscal 2007. The adoption of SAB 108 did not have a material impact on the Company’s Consolidated Financial Statements.
4. REVERSE ACQUISITION WITH MEDXLINK, CORP
On July 14, 2004, MedXLink, Corp. (“MXLK”, or the “Parent”), a Nevada corporation and an inactive publicly-traded company, entered into an Agreement and Plan of Reorganization with Particle Drilling Technologies, Inc., a Delaware corporation (“PDTI-DE”), whereby MXLK agreed to acquire PDTI-DE by merging PDTI Acquisition Corp. (“Merger Sub”), a newly formed Delaware corporation and wholly owned subsidiary of MXLK, with and into PDTI-DE and issued common stock of MXLK in exchange for all the outstanding shares of PDTI-DE. On January 14, 2005, MXLK closed its acquisition of PDTI-DE and issued 16,698,094 shares of common stock (including 3,381,538 shares of common stock issued upon conversion of the same number of shares of Series A Convertible Preferred Stock of PDTI-DE) to holders of common stock of PDTI-DE and reserved for issuance (1) 228,000 shares of common stock pursuant to outstanding warrants to purchase common stock of PDTI-DE, and (2) 3,205,000 shares of common stock pursuant to outstanding options to purchase common stock of PDTI-DE. In addition, 1,342,404 issued and outstanding shares of common stock of the Parent were cancelled for no additional cash consideration in connection with the Merger. Following the merger, the Parent had 18,248,094 shares of common stock issued and outstanding (which included 3,381,538 shares of common stock issued upon conversion of the same number of shares of Series A Convertible Preferred Stock of PDTI-DE) and an additional 3,433,000 shares of common stock reserved for issuance upon exercise of warrants and options as described above. Following the merger, PDTI-DE continued as the surviving corporation under the name of Particle Drilling Technologies, Inc. as a subsidiary of Parent, the Parent changed its name to Particle Drilling Technologies, Inc., and its stock trading symbol changed from MXLK.OB to PDRT.OB. On June 28, 2005, the Company’s shares of common stock began trading on The NASDAQ Capital Market® under the symbol PDRT.
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5. NET LOSS PER COMMON SHARE
The Company has presented basic and diluted net loss per share pursuant to SFAS No. 128, Earnings Per Share. In accordance with SFAS No. 128, basic and diluted net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period. Dilutive net loss per share would give affect to the dilutive effect of common stock equivalents consisting of options and warrants. Potentially dilutive securities have been excluded from the net loss per common share calculation as the effects would be antidilutive. Potentially dilutive securities not included in the computation of weighted average diluted shares of common stock were 2,054,643 and 2,701,790 shares for the three months ended December 31, 2006 and 2005, respectively.
6. COMMON STOCK
In October 2006, the Company issued 5,745 shares of its common stock upon a net cashless exercise of warrants at $0.12 per share.
In October 2006, the Company issued 71,250 shares of its restricted stock to several of its employees.
In October 2006, the Company issued 5,000,000 shares of its common stock from a private placement at $2.35 per share.
In November 2006, the Company issued 6,000 shares of its common stock for cash upon exercise of options at $0.12 per share.
At December 31, 2006, the Company had 30,093,200 shares of common stock outstanding and has outstanding options and warrants to purchase up to 7,173,391 additional shares of the Company’s common stock in the aggregate.
7. STOCK-BASED EMPLOYEE COMPENSATION
In April 2004, the Board of Directors adopted the 2004 Stock Incentive Plan (the “2004 Plan”). The 2004 Plan provides for the issuance of incentive stock options, non-statutory stock options and restricted stock grants to directors, employees and consultants of the Company. Provisions under the 2004 Plan allowed for the issuance of up to 3,500,000 shares of common stock pursuant to awards under the 2004 Plan. As of December 31, 2006, the Company had 111,250 shares of common stock available for issuance pursuant to awards under the 2004 Plan.
In March 2005, the Board of Directors adopted the 2005 Stock Incentive Plan (the “2005 Plan”). The 2005 Plan provides for the issuance of incentive stock options, non-statutory stock options and restricted stock grants to directors, employees and consultants of the Company. Provisions under the 2005 Plan allow for the issuance of options and restricted stock awards to purchase or issue up to 2,000,000 shares of common stock. As of December 31, 2006, the Company had 388,000 shares of common stock available for issuance pursuant to awards under the 2005 Plan.
Stock-based employee compensation expense recorded for awards issued under the 2004 Plan and the 2005 Plan for the three months ended December 31, 2006 and 2005 was $627,627 and $390,549, respectively. Stock-based employee compensation expense recorded for awards issued under the 2004 Plan and the 2005 Plan since inception (June 9, 2003) to December 31, 2006 was $3,307,817.
8. COMMITMENTS AND CONTINGENCIES
In June 2006, we extended the lease for our commercial operating facility that expired on June 30, 2006 for one additional year. The lease for our commercial operating facility will expire on June 30, 2007. The total future minimum lease payments under this lease as of December 31, 2006 are $30,000.
In April 2006, the Company entered into a thirteen (13) month lease agreement for new corporate offices that commenced in May 2006. We moved our previous corporate offices that were located at 1021 Main Street, Suite 2650, Houston, Texas 77002, to 11757 Katy Freeway, Suite 1300, Houston, Texas 77079. In April 2006, we delivered to the lessor a security deposit of $9,400. The total future annual minimum lease payments as of December 31, 2006 are $56,400.
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In July 2006, we entered into a contract to purchase a quintaplex frac pump to be used with PID Unit #2 which is currently under construction. In connection with this contract, we paid $320,499 as a deposit and will pay another $930,000 during the assembly phase and upon completion.
9. INCOME TAXES
The Company reports its income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, which calls for the utilization of the asset and liability method of accounting for income taxes. Under this method, deferred taxes are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted marginal tax rates and laws that will be in effect when the differences reverse. Temporary differences have been created for all stock option plans and are included in our SFAS No. 109 computation. For the quarter ended December 31, 2006, there were permanent and temporary differences of approximately $6,000 and $283,000, respectively. At December 31, 2006, we had cumulative net operating loss carryforwards of approximately $19,113,000, which expire in years 2007 through 2025. No effect has been shown in the consolidated financial statements for the net operating loss carryforwards as the likelihood of future tax benefit from such net operating loss carryforwards is not determinable at this time. Accordingly, the potential tax benefits of the net operating loss carryforwards, estimated based upon tax rates at December 31, 2006, have been offset by valuation reserves of the same amount.
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion of our financial condition and results of operations should be read together with the unaudited consolidated financial statements and related notes that are included elsewhere in this report. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. We undertake no obligation to update any forward-looking statements except as required by law.
Overview
On January 14, 2005, we acquired Particle Drilling Technologies, Inc., a privately-held Delaware corporation (“PDTI”). As a result of this acquisition, our company, which previously had no material operations, acquired the business of PDTI and we are now engaged in the development of the Particle Impact Drilling System, a patented system utilizing a specially designed “fit for purpose” drill bit fitted with jetting nozzles and polycrystalline diamond compact cutting structures for use in the oil and gas drilling industry.
We are a development-stage company and have a limited operating history. Our predecessor company for financial reporting purposes was formed on June 9, 2003 to acquire the technology related to the Particle Impact Drilling System (the “PID technology”). We are still developing this technology, and to date, we have not generated any revenues from our operations. As we continue to execute our operations plan, we expect our development and operating expenses to increase.
Research and development. We have made and expect to continue to make substantial investments in research and development activities in order to develop and market the PID technology. Research and development costs consist primarily of general and administrative and operating expenses related to research and development activities. We expense research and development costs as incurred except for property, plant and equipment related to research and development activity that have an alternative future use. Property, plant and equipment for research and development activity that have an alternative future use are capitalized and the related depreciation is expensed as research and development costs.
General and administrative. General and administrative expenses consist primarily of salaries and benefits, office expense, professional services, and other corporate overhead costs. We have experienced and expect to continue to experience increases in general and administrative expenses as a result of: (1) reporting and compliance obligations applicable to publicly-held companies; (2) our continuing efforts to develop, test and prepare the PID technology for commercialization; and (3) the hiring of additional personnel.
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Results of Operations
Three Months Ended December 31, 2006 Compared to Three Months Ended December 31, 2005
Research and development. Research and development expenses were $1,664,843 and $1,285,485 for the three months ended December 31, 2006 and 2005, respectively, representing an increase of $379,358. This increase was primarily the result of approximately $271,619 for supplies, transportation and other operational costs in connection with our commercial trials. The remainder of the increase is related to continuing development of a new particle injector system, current contstruction of the Company’s second PID Unit, bonus accruals and stock-based compensation for research and development personnel during the three months ended December 31, 2006.
General and administrative. General and administrative expenses were $1,298,544 and $990,962 for the three months ended December 31, 2006 and 2005, respectively, representing an increase of $307,582. This increase was primarily the result of increased costs related to bonus accruals and stock-based compensation during the three months ended December 31, 2006.
Other income (expenses). Other income was $124,926 and $108,464 for the three months ended December 31, 2006 and 2005, respectively, representing an increase in other income of $16,462. The increase was primarily attributable to the additional funds from the private placement that was completed in October 2006.
Liquidity and Capital Resources
Our principal sources of liquidity are cash and cash equivalents. We expect that cash requirements through the end of the fiscal year 2007 will be primarily to fund research and development activities, to continuously improve service capabilities, to expand operations, general and administrative costs and capital expenditures. We believe we have sufficient cash and cash equivalents to meet our working capital and capital expenditure requirements for at least the next 12 months; however, our continued existence depends on the successful development of the PID technology and our ability to successfully commercialize this technology. To date we have not yet generated cashflow from operations, and until we commence recognizing revenue, we are highly dependant upon debt and equity funding. If we are not able to meet our funding requirements, our operations may cease to exist. We cannot provide any assurance that any such funding will be available on acceptable terms or at all.
Since inception on June 9, 2003 through December 31, 2006, we have financed our operations through private sales of our equity and the issuance of convertible notes payable, totaling net proceeds of $30,189,968. As of December 31, 2006, we had $11,188,221 in cash and cash equivalents. In October 2006, we completed a private sale of five million shares of our common stock for $2.35 per share and warrants to purchase 1.5 million shares at $3.25 per share, yielding gross proceeds of $11,750,000.
Cash Flows from Operating Activities. Cash flow used for operations is primarily affected by our research and development progress and business development. Net cash flows used in operating activities during the three months ended December 31, 2006 were $1,683,208 compared to $1,660,477 for the three months ended December 31, 2005. The increase from fiscal 2005 to fiscal 2006 was the result of our increased spending on research and development and our increased level of general and administrative cost as discussed above.
Cash Flows from Investing Activities. Cash flow used in investing activities for the three months ended December 31, 2006 was $92,761 compared to $54,506 for the three months ended December 31, 2005. The cash flows used in investing activities consist of $52,556 for the purchase of property, plant and equipment and $40,205 for costs associated with patent expenses. We anticipate that our capital expenditures for the next year will continue to be fully funded from our available cash and cash equivalents.
Cash Flow from Financing Activities. Net cash provided by (used in) financing activities for the three months ended December 31, 2006 was $10,672,604 compared to ($19,511) for the three months ended December 31, 2005. On October 19, 2006, the Company completed the sale of five million shares of its common stock to institutional and other accredited investors at $2.35 per share. The Company received gross proceeds of $11.75 million, which we intend to use to manufacture additional PID Systems, to hire and train qualified personnel, to fund a new particle injection system, to fund additional research and development, for general corporate purposes and for expenses associated with the offering.
In addition, the investors received warrants to purchase 1.5 million shares of the Company’s common stock with an exercise price of $3.25 per share. The warrants will be exercisable commencing on April 22, 2007 and will expire on October 19, 2011. The Company has valued these warrants at $2,835,000 using the Black-Scholes option pricing model and this amount was charged to shareholders equity.
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Contractual Obligations. In April 2006, we entered into a thirteen month lease agreement for our new corporate offices at 11757 Katy Freeway, Suite 1300, Houston, Texas 77079, that commenced in May 2006. In connection with the execution of this new lease agreement, we delivered to the lessor a security deposit of $9,400. The total future minimum lease payments under this lease at December 31, 2006 are $56,400.
In June 2006, we extended the lease for our commercial operating facility that expired June 30, 2006 for one additional year. The lease for our commercial operating facility will expire June 30, 2007. The total future minimum lease payments under this lease at December 31, 2006 are $30,000.
In July 2006, we entered into a contract to purchase a quintaplex frac pump to be used with PID Unit #2 which is currently under construction. In connection with this contract, we paid $320,499 as a deposit and will pay another $930,000 during the assembly phase and upon completion.
| | Payments Due by Period | |
Contractual Obligations | | | | Total | | Less than 1
year | | 1 - 3 years | | 3 - 5 years | | More than 5
years | |
Long-Term Debt Obligation and Short Term Notes Payable (including current portion) | | $ | 132,555 | | $ | 119,775 | | $ | 12,780 | | $ | — | | $ | — | |
Purchase Obligations | | 301,974 | | 301,974 | | | | | | | |
Frac Pump | | 930,000 | | 930,000 | | | | | | | |
Operating Lease Obligations | | 86,400 | | 86,400 | | — | | — | | — | |
Total | | $ | 1,450,929 | | $ | 1,438,149 | | $ | 12,780 | | $ | — | | $ | — | |
| | | | | | | | | | | | | | | | | | |
Off-Balance Sheet Arrangements
In connection with the acquisition of the PID technology in January 2004, PDTI entered into a Royalty Agreement with ProDril Services, Incorporated (“PSI”) pursuant to which we are obligated to pay PSI a royalty on a quarterly basis equal to 18% of our earnings before interest, income taxes, depreciation and amortization (“EBITDA”) derived from the use of the PID technology, until an aggregate of $67,500,000 has been paid. PDTI also entered into a Royalty Agreement in January 2004 with ProDril Services, International, Ltd. (“PSIL”) pursuant to which we are obligated to pay PSIL a royalty on a quarterly basis equal to 2% of our EBITDA derived from the use of the PID technology, until an aggregate of $7,500,000 has been paid. In addition, we are obligated to pay CCORE Technology and Licensing, Ltd. (“CTL”), PSI and PSIL a royalty equal to 1.6%, 1.2% and 1.2%, respectively, of our quarterly gross revenue, derived from the use of the PID technology. As of December 31, 2006, we had no revenues or EBITDA; therefore no royalties have been paid or accrued.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our most significant judgments and estimates used in the preparation of our consolidated financial statements.
Reverse Acquisition. The acquisition of PDTI in January 2005 was accounted for as a reverse acquisition. Pursuant to the guidance in Appendix B of SEC Accounting Disclosure Rules and Practices Official Text, we believe the acquisition of PDTI was a merger of a private operating company into a non-operating public shell corporation with nominal net assets which typically results in the owners and management of the private company having actual or effective operating control of the combined company after the transaction, with the shareholders of the former public shell continuing only as passive investors. These transactions are considered by the staff of the Securities and Exchange Commission to be capital transactions in substance, rather than business combinations. That is, the transaction is equivalent to the issuance of stock by the private company for the net monetary assets of the shell corporation, accompanied by a recapitalization. Accordingly, the reverse acquisition has been accounted for as a recapitalization. For accounting purposes, PDTI is considered the acquirer in
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the reverse acquisition. The historical financial statements are those of PDTI. Net loss per share for periods prior to the merger in January 2005 is restated to reflect the number of equivalent shares received by the acquiring company.
Impairment of Long-Lived Assets. We evaluate our long-lived assets for indicators of possible impairment by comparison of the carrying amounts to future net undiscounted cash flows expected to be generated by such assets when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s fair value or discounted estimates of future cash flows. We also evaluate the capitalized costs for patents and patent applications filed but not issued for possible impairments. We have not identified any such impairment losses to date. The evaluation of capitalized costs for patents and patent applications is based on a subjective cash flow forecast which is subject to change. We will reassess our cash flow forecast each time there are fundamental changes in the underlying potential use of the patents or patent applications in terms of performance, customer acceptance or other factors that may affect such cash flow forecasts.
Stock-Based Compensation. In December 2004, the Financial Accounting Standards Board (“FASB”) issued a revision to SFAS No. 123, Share-Based Payment. This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This statement does not change the accounting guidance for share-based payment transactions with parties other than employees provided in SFAS No. 123 as originally issued. This statement is effective for new awards and those modified, repurchased or cancelled in interim or annual reporting periods beginning after June 15, 2005. We early adopted this standard upon inception.
Research and Development. The costs of materials and equipment or facilities that are acquired or constructed for research and development activities and that have alternative future uses are capitalized as tangible assets when acquired or constructed. The cost of such materials consumed in research and development activities and the depreciation of such equipment or facilities used in those activities are research and development costs. However, the costs of materials, equipment, or facilities acquired or constructed for research and development activities that have no alternative future uses are considered research and development costs and are expensed at the time the costs are incurred.
Income Taxes. The Company reports its income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, which calls for the utilization of the asset and liability method of accounting for income taxes. Under this method, deferred taxes are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted marginal tax rates and laws that will be in effect when the differences reverse. Temporary differences have been created for all stock option plans and are included in our SFAS No. 109 computation. For the quarter ended December 31, 2006, there were permanent and temporary differences of approximately $6,000 and $283,000, respectively. At December 31, 2006, we had cumulative net operating loss carryforwards of approximately $19,113,000, which expire in years 2007 through 2025. No effect has been shown in the consolidated financial statements for the net operating loss carryforwards as the likelihood of future tax benefit from such net operating loss carryforwards is not determinable at this time. Accordingly, the potential tax benefits of the net operating loss carryforwards, estimated based upon tax rates at December 31, 2006, have been offset by valuation reserves of the same amount.
Net Loss per Share. The Company has presented basic and diluted net loss per share pursuant to SFAS No. 128, Earnings Per Share. In accordance with SFAS No. 128, basic and diluted net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period. Dilutive net loss per share would give affect to the dilutive effect of common stock equivalents consisting of options and warrants. Potentially dilutive securities have been excluded from the net loss per common share calculation as the effects would be antidilutive. Potentially dilutive securities not included in the computation of weighted average diluted shares of common stock because the impact of these potentially dilutive securities were anti-dilutive were 2,054,643 and 2,701,790 shares for the three months ended December 31, 2006 and 2005, respectively.
Forward-Looking Statements
Statements in this quarterly report on Form 10-Q that are not historical facts (including any statements concerning plans and objectives of management for future operations or economic performance, or assumptions or forecasts related thereto) are forward-looking statements subject to Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements can be identified by the use of forward-looking terminology including “forecast,” “may,”
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“believe,” “expect,” “anticipate,” “estimate,” “continue” or other similar words. These statements discuss future expectations, contain projections of results of operations or of financial condition or state other “forward-looking” information. We and our representatives may from time to time make other oral or written statements that are also forward-looking statements.
These forward-looking statements are made based upon our management’s current plans, expectations, estimates, assumptions and beliefs concerning future events impacting us and therefore involve a number of risks and uncertainties. We caution that forward-looking statements are not guarantees and that actual results could differ materially from those expressed or implied in the forward-looking statements as a result of certain factors, including but not limited to dependence upon energy industry spending, the volatility of oil and gas prices, weather interruptions, the results of testing of our products, the availability of capital resources and the other factors described under “Item 1A. Risk Factors” in our annual report on Form 10-K for the year ended September 30, 2006 and filed with the SEC on December 14, 2006. We undertake no obligation to update any forward-looking statements except as required by law.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We believe that we do not have any material exposure to financial market risk and we do not enter into foreign currency or interest rate transactions.
Item 4. Controls and Procedures
As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, an evaluation was performed under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operation of our “disclosure controls and procedures” (as defined under Rule 13a-15(e) and Rule 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q filed with the SEC. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2006.
There was no change in our internal control over financial reporting during our first quarter of fiscal 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Part II—Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On October 12, 2006, a holder of an outstanding warrant exercised its right to purchase 6,000 shares of our common stock at $0.12 per share on a cashless exercise basis. The fair market value of our common stock on the date of exercise was $2.78. As a result of this cashless exercise, we issued 5,745 shares of our common stock to the holder of this warrant and withheld issuing 255 shares of our common stock in satisfaction of the exercise price under the warrant.
The shares of our common stock issued upon exercise of the warrant described above were issued in an exchange between us and our existing security holders in which no commission or other remuneration was paid or given directly or indirectly for soliciting such exchange. As a result, the issuance of such shares of common stock was exempt from registration pursuant to Section 3(a)(9) under the Securities Act of 1933.
Item 5. Other Information
On February 1, 2007, the Compensation Committee recommended that the Board of Directors approve a new Bonus Plan (the “Bonus Plan”) for the fiscal year ending September 30, 2007. The Bonus Plan was approved by the Board of Directors on the same date. Under the Bonus Plan, bonuses may be awarded to the Company’s employees, including the Company’s executive officers, upon the satisfaction of certain goals based on a percentage of annual base salaries. The goals include attaining measured results for some or all of the following categories: cash flow, capital and research and development budgets, revenues, research and development and operations performance, and safety.
Under the terms of the Bonus Plan, the Company’s employees, including its executive officers, may receive a bonus calculated based on a percentage of their annual base salary. The ultimate percentage of annual base salary used to calculate bonuses, if any bonuses are paid, will be at the sole discretion of the Compensation Committee. The target percentage and
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the high percentage of base salary set by the Compensation Committee to be used for purposes of calculating bonuses to the Company’s employees, including its executive officers, are as follows:
| | Target Percentage | | High Percentage | |
Staff (Operations, Accounting & Administrative) | | 10 | % | 20 | % |
Manager | | 15 | % | 30 | % |
Senior Manager | | 25 | % | 40 | % |
Executive (other than President and Chief Executive Officer) | | 40 | % | 80 | % |
President and Chief Executive Officer | | 50 | % | 100 | % |
The annual base salaries of the Company’s Named Executive Officers that will be used for purposes of calculating the target and high percentage bonuses under the Bonus Plan are as follows:
| | Base Salary | |
Jim B. Terry | | $ | 252,000 | |
J. Chris Boswell | | $ | 231,000 | |
Thomas E. Hardisty | | $ | 189,000 | |
Gordon Tibbits | | $ | 150,000 | |
John D. Schiller is not expected to be a Named Executive Officer for fiscal 2007.
Also on February 1, 2007, the Board of Directors adopted the Particle Drilling Technologies, Inc. 2007 Stock Incentive Plan (the “2007 Incentive Plan”). The 2007 Incentive Plan became effective upon its adoption by the Board of Directors so long as the 2007 Incentive Plan is approved by the stockholders of the Company by February 1, 2008. The Company has submitted to 2007 Incentive Plan to the stockholders of the Company for approval at the 2007 Annual Meeting of Stockholders to be held on March 5, 2007.
The 2007 Incentive Plan provides for the granting from time to time of options and restricted stock to employees, consultants and directors of the Company and its affiliates. The maximum number of shares of common stock that will be available for issuance under the 2007 Incentive Plan is 1,500,000 shares (subject to adjustment upon a reorganization, stock split, recapitalization, or other change in the Company’s capital structure in accordance with the terms of the 2007 Plan).
See the Company’s definitive proxy statement filed with the Securities and Exchange Commission on February 2, 2007 for more information about the 2007 Incentive Plan. A copy of the 2007 Incentive Plan is filed herewith and is incorporated herein by reference.
Item 6. Exhibits
Exhibits:
Exhibit
No. | | | | Description |
10.1 | | Bonus Plan for fiscal 2007* |
| | |
10.2 | | Particle Drilling Technologies, Inc. 2007 Stock Incentive Plan* |
| | |
31.1 | | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.* |
| | |
31.2 | | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.* |
| | |
32.1 | | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.** |
| | |
32.2 | | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.** |
* Filed herewith
** Furnished herewith
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