Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. see definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one)
|
Large accelerated filer o |
|
Accelerated filer x |
|
Non-accelerated filer o |
Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately $99,373,500 as of March 31, 2007 (based on the last sale price of such stock as quoted on the NASDAQ Capital Market).
As of December 6, 2007, there were 31,629,901 shares of the registrant’s common stock, par value $0.001 per share, outstanding.
Documents incorporated by reference: None
TABLE OF CONTENTS
Unless the context otherwise requires, all references in this report to the “Company,” “we,” “us,” or “our” are to Particle Drilling Technologies, Inc. and its subsidiary.
General
Particle Drilling Technologies, Inc., a Nevada corporation, is a holding company organized on June 14, 2002 and was formerly known as MedXLink Corp. We changed our name to Particle Drilling Technologies, Inc. on January 25, 2005, following the merger on January 14, 2005 of our wholly-owned subsidiary with and into Particle Drilling Technologies, Inc., a Delaware corporation (“PDTI”). Prior to our acquisition of PDTI, we were a shell company. Currently our business consists of one segment and is conducted solely in the United States. Information about our net loss and total assets is located under “Item 8. Financial Statements and Supplementary Data.”
PDTI was formed in March 2004 for the purpose of raising capital and to acquire Particle Drilling, Inc., a Texas corporation. Particle Drilling, Inc. (formerly known as ProDril Acquisition Corp.) was formed in June 2003 for the purpose of acquiring certain assets, patents and other intellectual property, and certain liabilities related to the Particle Impact Drilling technology, which we refer to as the “PID technology” or the “PID System.” Particle Drilling, Inc. was merged with and into PDTI in June 2004.
The patented PID System utilizes a specially-designed “fit for purpose” drill bit fitted with jetting nozzles and polycrystalline diamond compact cutting structures. We refer to this bit as the “PID bit.” The nozzles in the PID bit serve to accelerate hardened steel particles entrained within ordinary drilling mud to fracture and remove the formation ahead of the bit. The particles flow back up the well bore annulus along with the drilling mud and formation cuttings to the surface where the PID System separates and re-circulates the steel particles. The PID System is operated primarily utilizing hydraulic energy that is available on drilling rigs used today in combination with the PID System equipment. Each particle is driven into the rock formation at a high velocity and delivers a force many times greater than the compressional strength of the rock, even in formations that exist in the subsurface at elevated hardness and stress. Depending on the volume of particles introduced into the drilling mud, the number of particle strikes on the formation is typically in excess of four million per minute, thereby yielding a higher rate of penetration than conventional drill bits in suitable formations.
By comparison, conventional drilling methods rely on mechanical energy created by the weight and torque applied to a bit, and the amount of total rotational mechanical energy available on drilling rigs is limited. The result is that the bit gouges out smaller volumes of rock as the compressional strength of the rock increases with depth and pressure. We believe the volume of rock excavated by the PID System is less affected by rock hardness or depth.
The PID System is designed to entrain, circulate, and recover the particles in the mud system without allowing the particles to circulate through the rig pumps. The PID System is designed as a mobile service that we expect to be provided to the oil and gas operator as part of the normal drilling process and is configured to service a well in progress with minimal interference. The particle injection system used on the previous commercial trials consisted of a stage one and stage two eductor mechanism which was powered by a high horsepower quintaplex frac pump. As we have gained more experience with PID drilling and have run the system for longer periods of time, we have determined that the continuously increasing and fluctuating well pressure encountered on recent trials resulted in unexpected levels of maintenance on the frac pump and caused difficulty in maintaining a continuous flow of particles to the drill bit. While the current particle injection system has allowed us to demonstrate the potential of the PID technology, it has been unreliable. In April 2007, we began testing an extruder based injection system and the associated pressure diffuser. The pressure diffuser was determined to be unreliable in July and therefore we began testing a pressurized extruder system. In early August 2007, we were able to successfully inject particles, at a controllable rate, into pressures up to 5,200 pounds per square inch (“psi”). This was the first time that goal was achieved. The next step in the development required a pressure barrier that would allow the pressurized extruder to continuously refill with particles. We selected a high pressure gate valve to serve as the pressure barrier and successfully tested the gate valve in September 2007 for 3,000 cycles, representing approximately three days of operating time. Following this test, all necessary components needed to build the new particle injection system were placed on order. We anticipate that we will be able to assemble and commence in-house testing of the new injection system prior to December 31, 2007.
The PID System has demonstrated higher rates of penetration than current conventional drilling methods. The rate of penetration gains generated by the PID System are expected to result in operators paying less variable drilling costs (e.g., rig time, labor, fuel, bits, rentals), which are purchased as part of the ordinary drilling cycle. As a result, we believe the PID System can reduce drilling costs and lower finding costs, thus improving the overall economics to the oil and gas industry in certain geologic intervals.
Business Strategy and Plan of Operation
We believe the PID System has now demonstrated that drilling using the PID technology is feasible and offers an increased rate of penetration compared to conventional drilling tools in hard and abrasive rock formations. During the fiscal year ended September 30, 2007, we completed a total of three commercial field trials, each of which demonstrated an incremental improved performance in terms of both footage drilled and productive drilling time. During our most recent commercial trial in March 2007, a significant portion of our non-productive drilling time (which prevented us from fully commercializing the PID technology) was due to inconsistent performance from our frac pump-based injection system. Following this trial, we decided to halt further drilling until such time as our new particle injection system was fully developed and tested.
In April 2007, we began shop testing our extruder-based injection system. This system relies upon an auger style volumetric feeder that is capable of delivering a controllable volume of steel particles to the drilling rigs’ high pressure standpipe. This system was initially designed to use the steel particles themselves as a dynamic seal to prevent the high pressure fluid from migrating through the extruder and reaching the atmospheric opening on the top side of the extruder. In order to achieve the dynamic seal, the packed particles were to be fed into a high pressure tubular of sufficient length to diffuse the high pressure fluid coming from the drilling rig’s standpipe. This diffusion principle was tested by a third party firm specializing in porosity and permeability measurements, although this testing was done only under static conditions (that is, the packed particles were not moving at the time of the test).
During the period from April to July 2007, we attempted to inject particles into a high pressure fluid line using the diffusion principle under dynamic conditions with limited success. The properties of the particles, the drilling mud and the overall conditions resulted in the inability to create a particle-pack of sufficient length to diffuse pressure and resulted in the high pressure fluid migrating to the atmospheric side of the extruder. After rigorous testing and consultation with outside experts, we concluded that this solution would not work in a commercial setting and decided in late July 2007 that it was necessary to pressurize the entire extruder system.
In late July 2007, we removed the diffuser from the high pressure side of the extruder and inserted a high pressure chamber on what was previously the atmospheric side of the extruder. The high pressure chamber was sufficiently large to contain enough steel particles to inject at the desired rate for approximately one minute. This modification was successful and it was determined that the steel particles could be injected at the desired rate over a broad range of pressures and with varying mud properties. Following this successful test, we then developed a second chamber separated by a pressure barrier that was capable of closing with steel particles entrained in the system. These pressure barriers were tested through enough cycles to confirm that they are durable enough for commercial application. The upper chamber has been designed to feed the lower chamber on a continuous basis. We believe the new extruder based injection system will be fabricated and ready for shop testing in December 2007. We intend to test the system for 24 to 48 hours before proceeding to the field to conduct our next commercial trial.
During the past two fiscal years, we hired several industry veterans to assist in the development, commercialization and roll-out of this technology. Further, we have successfully resolved many of the surface equipment issues identified during previous trials. We expect to continuously improve efficiencies as we gain more experience with the PID System and as the new extruder—based injection system becomes field proven.
Our operations plan for the remainder of fiscal year 2008 includes: (1) completing the assembly and initial testing of the new extruder-based injection system in the first quarter of fiscal 2008; (2) completing a commercial field trial early in the second quarter of fiscal 2008; (3) securing additional commercial contracts with potential customers; (4) hiring and training additional field and technical personnel; and (5) assembling additional PID Units.
Our initial target customers will continue to be oil and gas operators drilling onshore wells in geologic basins of the U.S. and Canada known to have hard rock and/or highly abrasive formations. We will initially focus our marketing and sales efforts on operators with multi-well drilling programs centered in a few basins. Additionally, we will target customers that exhibit a willingness to embrace emerging technologies.
We expect to deliver value to our customers as a specialty service provider utilizing our patented technology in combination with propritery equipment executed by our engineering and field personnel. Based on the experience of our management team in the oilfield services industry, we believe that no other company currently attempts to deliver a comparable drilling service utilizing technology that is similar to the PID System and that is targeted to serve the hard rock drilling market. Instead, we believe suppliers generally design and sell products for hard rock environments that are based on conventional drilling technology.
We expect to operate in a fashion more comparable to a directional drilling or well stimulation service provider. We will provide our system and field personnel to exploration and production operators, service companies and drilling contractors to operate our system as an integral component of the drilling operation. Initially, we intend to offer our services on a gain sharing basis whereby the cost saved as a result of using the PID System will be shared between us and the exploration and production operator. The PID System is expected to result in higher rates of penetration, thereby reducing drilling costs and lowering finding and development costs to improve the overall economics of the oil and gas industry in certain geologic intervals. In addition, we believe that our customer’s ability to reduce drilling days on their hard rock intervals will translate into more efficient rig utilization, which in turn should allow our customers to drill more wells per year per drilling rig. While this gain sharing business model is our preferred method to gain market share, we believe that equal or greater returns can be achieved through the sale of PID bits and through a more traditional dayrate or fixed fee structure. Initially, we intend to utilize the revenue model most preferred by our potential customer base so long as satisfactory returns are realized.
Industry
Oil and natural gas markets have seen a robust pricing environment since 2002. While there has been a decline in natural gas prices during 2007, oil prices have reached record highs. While natural gas prices have recently decreased from historic highs as a result of moderate temperatures and high inventories, we believe the underlying fundamentals continue to support drilling activities and long term natural gas prices. As of November 16, 2007, the Baker Hughes U.S. land rig count was at 1,706, a 7.5% increase from a year earlier.
The increase in working rigs coupled with softer than expected natural gas prices during 2007 has resulted in a decrease in rig day rates that have otherwise enjoyed significant and steady increases over the last five years; however, overall domestic and foreign drilling activity and rig utilization levels are projected to continue to be strong. Current land rig utilization rates are approximately 85% in the U.S. and approximately 95% in key foreign markets. Although there may be occasional decreases in rig day rates due to increased rig supply, we expect rig utilization and drilling activity levels will continue to be robust throughout 2008.
We do not believe the current conventional drilling process using traditional rotary rig equipment and conventional drill bits has fundamentally changed for many years. Typically, gains in rates of penetration and absolute drilling efficiency were very small and incremental until 1989. At that time, fixed cutter polycrystalline diamond compact bits, or “PDC bits,” became a functional alternative to roller cone bits for a limited but growing segment of the drilling market. This technology was focused on wells drilled in softer formations as PDC bits could achieve higher rates of penetration and longer run times, both of which achieved appreciable cost savings by reducing drilling time. The industry has adopted PDC bits for these specific applications, although a PDC bit often costs several times more than a comparable roller cone bit. Despite the increased effectiveness of the PDC bit and other technologies, we believe that operators continue to actively seek ways to improve rates of penetration, particularly in hard rock and abrasive formations, and are very receptive to using promising new technologies to reduce well construction cost.
The PID System
Particle Recovery System – The PID System utilizes a mobile particle delivery and recovery system capable of operating with conventional drilling rigs used in our target markets. Our system is designed to entrain, circulate, and recover the particles without allowing the material to pass through the rig pumps. Previous particle abrasive drilling systems did not have the ability to circulate, separate, and re-inject the abrasive or abrading particles and the material passed through the normal rig pumps. An example is the system known as “Abrasive-Jet Drilling” used by Gulf Research and Development Co., a division of Gulf Oil Corporation (“Gulf”), in the 1960’s and 1970’s. Gulf made a number of significant advances in the technology of delivering particles under pressure for the purpose of increasing rate of penetration. Basically, the Gulf system used fine particle abrasives to abrade the formations in order to remove it. This technology requires very high surface pressures of up to 11,000 psi in order to give the small particle the velocity to abrade the formation ahead of the drill bit. In contrast, the PID System utilizes larger particles at normal rig pressures to fracture the formation ahead of the drill bit.
Rig Integration — The PID System is designed to connect to and service an operational well in progress with minimal interference to normal drilling operations. All PID System equipment is either mounted on skids or trailers, and can be coupled to a conventional drilling rig during a scheduled bit trip. A good portion of the PID System is mobilized and rigged up offline so as not to interfere with the drilling operation in progress. Once the operator is finished with the PID interval, the PID System can generally be taken offline during a bit trip without interfering with normal drilling operations. We believe this operational transparency is extremely important for industry acceptance of the PID System.
PID Bit – We are continuing the development of our fit-for-purpose PID bit. The PID bit is a fixed-cutter and nozzle bit designed with a PDC cutting structure. To date, we have developed and tested a 7 7/8 inch PID bit and an 8 1/2 inch PID bit and have completed the investment casting process on both PID bits so that we can mass produce PID bits at a cost that is less than half the cost of our previous PID bits. Further, we have initiated the design of a 6 1/2 inch PID bit in order to address deeper drilling markets identified to us by prospective customers.
Testing of the PID System
We have now completed four full scale commercial trials using the PID technology. The first three trials were conducted in the Uinta basin in Utah with Gasco Energy, Inc. The first trial was completed in April of 2006 and the last trial was completed in December 2006. During these trials, we deployed for the first time the patented PID System on an actual gas well drilling at depths below 10,000 feet. During these three tests, we demonstrated (i) the PID System was capable of delivering rates of penetration that were in-line with or greater than our target penetration rates, which are three times faster than conventional drilling techniques, (ii) we could inject particles while drilling and (iii) we could successfully recover steel particles from the well bore. Due to the age and condition of the drilling rig used on the first trial, we experienced certain rig integration issues which were resolved prior to the completion of the first trial. We also demonstrated our ability to recover the steel particles from the well bore even following a complete rig pump shut down. During this trial, we demonstrated on multiple occasions that the PID technology does not damage the well bore, even in situations where several thousand pounds of steel particles settle on top of the PID bit.
In order to achieve continuous PID drilling operations, it is critical to continuously inject and recover the injected particles from the well bore, process them and prepare them for reinjection. During the first field trial, the PID System particle recovery unit became overrun with steel particles and was no longer capable of recovering the particles for re-injection. This accounted for 90% of the PID System’s downtime. Based on this experience and the likelihood for this particle recovery unit to cause problems on future wells, we designed a completely new particle recovery unit that was tested successfully on trials two and three. This new recovery unit will be incorporated into all future PID Units.
In November 2006, we completed our second commercial trial with Gasco. On this trial, we entered the well at a depth of 11,535 feet and drilled approximately 92 feet in 7 hours during the first day of drilling. Certain issues with our frac pump driven injector system limited our drilling performance on the second day and the trial was concluded after drilling a total of 118 feet. The subsequent conventional bit averaged 90 feet in each 24-hour period during the following five days.
In December 2006, we completed our third commercial trial with Gasco. On this trial, we further improved our performance by drilling approximately 121 feet in 8 hours during a 24-hour period. This was our best performance to date, although the frac pump suffered maintenance issues and we were forced to suspend drilling.
In February 2007, we signed a one-year contract with a large independent oil and gas company that is operating in the United States to conduct a series of commercial trials in the Deep Bossier trend in east Texas. In March 2007, we completed the assembly of our new PID System that included a second frac pump. The new PID System is skid mounted, which allows for quicker rig-up and rig-down. It is also fully automated, based on a variable frequency electric drive system and contains several redundant components further minimizing the risk of disruption.
In March 2007, we conducted our first field trial with this operator in the Travis Peak Formation, which we believe is one of the most abrasive and hard formations in the world. During this field trial, we drilled approximately 212 feet in 12 hours during our first 24 hours of drilling, a substantial improvement from our prior field trials. This trial was suspended as a result of our inability to continue particle injection because of injector related issues.
The frac pump suffered a number of performance related issues on several of the commercial trials. For example, once drilling reached a total depth of approximately 12,500 feet on the Travis Peak trial, the frac pump was unable to generate enough pressure to continue consistent particle injection rates though it was running at close to its peak sustainable performance level.
Despite the successful improvement in drilling performance from well to well, we determined in April 2007 to focus on the continued development and testing of a new particle injection system and notified our customers that we would not conduct any further field trials until such time as a new injection system was field ready.
Our primary products still need to demonstrate commercial reliability in order to fully realize the potential of the PID technology. Our operations plan calls for completion of the new injection system and further research and development, followed by a second commercial trial in the Travis Peak formation in east Texas. Poor performance of our new particle injection system or other unexpected events while conducting future commercial trials could further extend the shop and laboratory testing phase, which would delay the full commercialization of the PID System and increase the funds needed to complete our research and development. This would have the effect of slowing our advancement as funds otherwise intended to build new PID Systems and expand our operations may be needed to conduct additional research and development.
Competition
We believe that no other company currently attempts to deliver a comparable drilling service utilizing technology that is similar to the PID System and that is targeted to serve the hard rock drilling market. It is important to note that the oilfield services industry is highly competitive, and most of our potential competitors have greater financial resources than we do. Many of our potential competitors have been in the oilfield service business for many years and have well-established business contacts with exploration and production companies. Competitors may enter markets served or proposed to be served by us, and we may not be able to compete successfully against such companies or have adequate funds to compete effectively. Recent developments in PDC bits have made them more durable and capable of drilling in certain hard rock environments; however, many customers operating in our target markets continue to utilize conventional bits.
Patents
Our predecessor company acquired the intellectual property and certain assets and assumed certain liabilities underlying the PID technology in January 2004 pursuant to certain acquisition agreements in which we agreed to (1) purchase certain of the assets and assume certain of the liabilities of ProDril Services Inc. (“PSI”) and ProDril Services International, Ltd. (“PSIL”) related to the PID technology, (2) purchase certain patents related to the PID technology from Curlett Family Limited Partnership, Ltd. (“CFLP”), (3) acquire certain technology licenses from CCORE Technology and Licensing, Ltd. (“CTL”), (4) continue the funding of initial research and development expenses with respect to the technology acquired, and (5) take steps towards the commercialization of the PID technology.
Pursuant to such acquisition agreements with CFLP, we acquired from CFLP their entire right, title and interest throughout the world in and to patents related to the PID technology, including all CFLP inventions and the following patents:
• U.S. Patent No. 6,386,300, issued May 14, 2002, entitled “Formation cutting method and system.”
• Patents in Canada, Australia, and Great Britain that correspond to U.S. Patent No. 6,386,300
• U.S. Patent No. 6,581,700, issued June 24, 2003, entitled “Formation cutting method and system.”
• U.S. Patent No. 7,258,176, issued April 21, 2007, entitled “Drill Bit.”
In addition to the inventions embodied in the CFLP patents described above, we have made system improvements and inventions apart from the CFLP agreement. Accordingly, we have since made numerous other applications for patents, including provisional, utility and continuation-in-part patent applications for various PID System components and apparatuses. There are presently 41 pending patent applications: 15 in the United States and 26 outside of the United States. One of the United States applications was recently allowed and is in the process of being formally issued by the United States patent office and all others are pending.
In connection with our acquisition of the PID technology, we agreed to make certain royalty payments to PSI and PSIL. Under our agreement with PSI, we are obligated to pay PSI a royalty on a quarterly basis equal to 18.0% of our earnings before interest, income taxes, depreciation and amortization (“EBITDA”) derived from the use of the PID technology for such quarter until an aggregate of $67,500,000 has been paid to PSI. Under our agreement with PSIL, we are obligated to pay PSIL a royalty on a quarterly basis equal to 2.0% of our EBITDA derived from the use of the PID technology for such quarter until an aggregate of $7,500,000 has been paid. We have also entered into additional royalty agreements that require us to pay a total of 4.0% of our quarterly gross revenue derived from the use of the PID technology to certain entities from
which we acquired the PID technology. These royalty obligations will have the effect of limiting our liquidity and our profitability. As of September 30, 2007, no payments had been made or accrued with respect to these royalty obligations.
We have continued to enhance and improve upon the PID technology and to develop additional technology and know-how in the application of the PID technology. The PID technology and related technologies remain core to our business, and we have continued to seek patent protection in the United States and other countries in which we expect there to be a significant market for our technology.
Research and Development
We are in the early phase of commercial deployment and will continue to invest in research and development. Our research and development program is intended to improve existing products and processes, develop new products and processes, and improve engineering standards and practices that will serve the changing needs of our customers. Our expenditures for research and development activities were $5,894,101 in 2007, $5,964,438 in 2006, and $2,802,155 in 2005.
In our effort to enhance the PID technology, we will continue to seek less expensive ways to manufacture PID bits and other key components of our system and to identify efficiencies going forward. Further, we intend to continue investing in research and development in order to expand the market opportunities for PID technology.
Environmental Regulations
We are subject to numerous and changing local, state, and federal laws and regulations concerning the use, storage, treatment, disposal and general handling of materials, some of which may be considered to be hazardous substances and wastes, and restrictions concerning the release of pollutants and contaminants into the environment. These laws and regulations may require us to obtain and maintain certain permits and other authorizations mandating procedures under which we must operate and restrict emissions and discharges. Many of these laws and regulations provide for strict joint and several liabilities for the costs of cleaning up contamination resulting from releases of regulated materials, substances and wastes into the environment. Violation of these laws and regulations as well as terms and conditions of operating permits issued to us may result in the imposition of administrative, civil, and criminal penalties and fines, remedial actions or, in more serious situations, shutdowns or revocation of permits or authorizations. We believe that future compliance by our operating businesses with existing laws and regulations will not have a material adverse effect on us and that future capital expenditures for environmental remediation will not be material.
We regularly monitor and review our operations, procedures and policies for compliance with environmental laws and regulations and our operating permits. There can be no assurance that a review of our past, present or future operations by courts or federal, state, local or foreign regulatory authorities will not result in determinations that could have a material adverse effect on us. In addition, the revocation of any of our material operating permits, the denial of any material permit application or the failure to renew any interim permit, could have a material adverse effect on us. In addition, compliance with more stringent environmental laws and regulations, more vigorous enforcement policies, or stricter interpretations of current laws and regulations, or the occurrence of an industrial accident, could have a material adverse effect on us.
Employees
As of December 13, 2007, we had 22 employees. None of our employees are covered by collective bargaining agreements. We believe that relationships with our employees are satisfactory.
Website
Our website is www.particledrilling.com. The filings we make with the Securities and Exchange Commission (“SEC”), such as Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, are available free of charge through our website as soon as reasonably practicable after they have been filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 (the “1934 Act”). Forms 3, 4 and 5 filed with respect to equity securities under Section 16(a) of the 1934 Act are also available on our website. All of these materials are located at the “Investor Relations” link on our website.
Our website also includes the following corporate governance materials, at the link “Corporate Governance”: the Code of Business Conduct & Ethics and charters of each Board committee, consisting of the Audit Committee, the Compensation Committee, and the Nominating and Corporate Governance Committee. You may also obtain a printed copy of any of the
materials referenced above by contacting us through our website or at the following address: Particle Drilling Technologies, Inc., 5611 Baird Court, Houston, Texas 77041.
We have limited sources of liquidity and may not be able to obtain sufficient funding to realize positive cash flows.
We require substantial capital to pursue our operating strategy and execute our business plan. As we have no revenue and therefore limited sources of cash, we will continue to rely on external sources for liquidity, and for the foreseeable future, our principal source of working capital will be from capital we have raised through private placements of our securities and other external sources. In management’s opinion, based on available cash and cash equivalents on hand as of September 30, 2007, we will need to reduce overhead and research and development costs as compared to previous years, complete the sale of various non-core assets or may need to raise additional outside capital in order to maintain sufficient liquidity to meet our working capital and capital expenditure requirements for the next 12 months.
Our current monthly operating overhead is approximately $350,000, excluding research and development project costs and non-cash expenses such as depreciation, stock-based compensation and other non-cash expenses, and we expect that such amount will increase as we expand our operations. Should we require additional capital, we may not be able to obtain funds from external sources in sufficient amounts to fund our business plan.
Even if we are able to demonstrate full commercial success with our products, we may require additional capital in the future to produce our products in sufficient commercial quantities in order for us to realize positive cash flows. Any such additional capital may lead to additional dilution of our shareholders. Additionally, it may be difficult for us to raise additional capital in sufficient quantities or at all.
We have a limited operating history and no revenues and are subject to risks inherent in a new business enterprise. As a result, we have not demonstrated to date that we can fully implement our business plan or that the PID technology will be profitable in a commercial application.
The business of PDTI was originally established in June 2003 to: (1) purchase certain of the assets and assume certain of the liabilities of PSI and PSIL related to the PID technology; (2) purchase certain patents underlying the PID technology from CFLP; (3) acquire certain technology licenses related to the PID technology from CTL; (4) continue the funding of research and development expenses with respect to the technology acquired; and (5) take steps towards the commercialization of the PID technology. To date, the business has not generated revenue from its operations. We may not be able to fully commercialize our product or generate profitable revenues. Additionally, we and our business have a limited operating history that investors can analyze to aid them in making an informed judgment as to the merits of an investment in us. Any investment in us should be considered a high risk investment because you will be investing in a company with unforeseen costs, expenses, competition, and other problems to which new ventures are often subject. In addition, the technology we acquired is still in the early stage of development for commercial use and has produced only limited results in a commercial setting. Because we are an early stage company, our prospects must be considered in light of the risks, expenses, and difficulties encountered in establishing a new business in a highly competitive industry.
The PID System is a new technology and it may not be fully accepted in the marketplace to the degree anticipated by management.
The PID technology has only been used or deployed in limited commercial gas wells. To management’s knowledge, no company has yet marketed a salable product using the technology we are developing. Market acceptance of our products will largely depend upon our ability to demonstrate the PID System’s efficiency, cost effectiveness, safety features and ease of use. We may not be able to demonstrate that the PID System can effectively be deployed on a significant number of commercial oil and gas wells in a safe and cost-effective manner. The use of the PID technology will also depend upon concerted sales efforts by our management team. The PID System may never be fully accepted in the market in preference to other competing technologies that currently exist or that may subsequently be developed. If our products are not fully accepted by the marketplace, we may not realize sufficient revenues or cash flow to execute our operations plan and we may be forced to pursue a different strategy or liquidate our company.
In order to enter the oilfield services market on a full scale basis, we must successfully complete additional research and development, the cost of which may exceed the amounts we have budgeted in our operations plan. Any such cost overruns
could exhaust our available capital and force us to raise additional capital, which capital may not be available or may lead to additional dilution of our shareholders.
Our primary products must demonstrate satisfactory performance in a significant number of oil and gas wells. Our operations plan calls for further research and development, including the development of different bit sizes and the completion of our development effort to deliver a new particle injection system. Poor performance of the PID bit or other components of the PID System while conducting commercial trials could reveal additional unidentified issues and further extend the shop and laboratory testing phase, which could further delay the full commercialization of the PID System and increase the funds needed to complete our research and development. Further, in order to fully implement our business plan, we will be required to hire and train a substantial number of new employees. Currently, the oilfield industry is strained and operating at near full capacity from a human resource perspective, which could limit our ability to hire and train adequate qualified personnel. These circumstances would have the effect of slowing our advancement as funds otherwise intended to build new PID Systems and expand our operations may be needed to conduct additional research or procure and train adequate human resources.
Regardless of the success of the initial research and development, we will require additional research and development and capital spending to continuously improve our service capabilities and expand our operations. In addition, regardless of the amount of research and development completed by us, our products may never be fully adopted in a significant number of oil and gas wells.
We are obligated to make certain royalty payments that will limit our profitability.
In connection with our acquisition of the PID technology, we agreed to make certain royalty payments to PSI and PSIL. Under our agreement with PSI, we are obligated to pay PSI a royalty on a quarterly basis equal to 18.0% of EBITDA derived from the use of the PID technology for such quarter until an aggregate of $67,500,000 has been paid to PSI. Under our agreement with PSIL, we are obligated to pay PSIL a royalty on a quarterly basis equal to 2.0% of our EBITDA derived from the use of the PID technology for such quarter until an aggregate of $7,500,000 has been paid. We have also entered into additional royalty agreements that require us to pay a total of 4.0% of our quarterly gross revenue derived from the use of the PID technology to certain entities from which we acquired the PID technology. These royalty obligations will have the effect of limiting our liquidity and our profitability.
We rely on the intellectual property rights we acquired to the PID technology and we may not be able to successfully protect or defend our intellectual property rights. Our competitive position depends to a significant extent on our ability to assert and defend our intellectual property rights in order to restrict other competitors from offering similar services.
Our success depends on certain patents and patent applications that we purchased from CFLP, CTL, PSI and PSIL, along with other proprietary intellectual property rights we have developed or intend to develop. We rely on a combination of nondisclosure and other contractual arrangements and trade secret, patent, copyright, and trademark laws to protect our proprietary rights and the proprietary rights of third parties from whom we license intellectual property. The steps we have taken to protect our rights may not be adequate to deter misappropriation of our proprietary information. We also may not be able to detect unauthorized use of and take appropriate steps to enforce our intellectual property rights. In addition, the laws of some foreign countries may not protect our proprietary rights as fully or in the same manner as do the laws of the United States. Also, despite the steps taken by us to protect our proprietary rights, others may develop technologies that are similar or superior to the PID technology and/or design around the proprietary rights we own.
We are also subject to the risk of litigation alleging infringement of third-party intellectual property rights. Any such claims could require us to spend significant sums in litigation, pay damages, develop non-infringing intellectual property or acquire licenses to the intellectual property which is the subject of the asserted infringement. If we are unable to successfully enforce our intellectual property rights, or if claims are successfully brought against us for infringing the intellectual property rights of others, such events could cause us to pay substantial damages, cause us to lose a key competitive advantage, force us to conduct additional research to develop non-infringing technology or cause us to have to pursue a different business strategy.
We may face intense competition in our industry from companies with a more established reputation and greater financial resources than us.
The oilfield services industry is highly competitive, and most of our potential competitors have greater financial resources than we do. Many of our potential competitors have been in the oilfield drilling business for many years and have
well-established business contacts with exploration and production companies. Competitors may enter markets served or proposed to be served by us, and we may not be able to compete successfully against such companies or have adequate funds to compete effectively.
If we are able to successfully commercialize the PID technology, we expect that demand for our PID System will depend on oil and natural gas industry activity and expenditure levels that are directly affected by trends in oil and natural gas prices and other factors.
If we are able to successfully commercialize the PID technology, we expect that demand for our PID System will be substantially dependent on the level of exploration, development and production activity of, and the corresponding capital spending by, oil and natural gas companies. Oil and natural gas companies typically reduce exploration and development activity during periods of low or volatile oil and natural gas prices. The markets for oil and natural gas historically have been volatile and are likely to continue to be so in the future. Prices for oil and natural gas are subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and natural gas, market uncertainty and a variety of other factors that are beyond our control. Any prolonged reduction in oil and natural gas prices will depress the level of exploration, development and production activity by our customers which will result in a decrease in the demand for our PID System and could have a material adverse effect on our financial condition or results of operations.
Factors affecting the prices of oil and natural gas include:
• the level of demand for oil and natural gas;
• worldwide political, military and economic conditions, including, but not limited to, the ability of the Organization of Petroleum Exporting Countries to set and maintain production levels and prices for oil;
• oil and natural gas production/inventory levels;
• the policies of governments regarding the exploration for and production and development of their oil and natural gas reserves;
• global weather conditions;
• interest rates and cost of capital; and
• tax laws.
Because our PID System is used in potentially hazardous applications and operations, our business is subject to risks associated with events that result in personal injuries, loss of life, damage to or destruction of property, equipment or the environment and suspension of operations.
Our PID System is used in potentially hazardous drilling applications. These activities are dangerous and accidents can result in:
• personal injury;
• loss of life;
• damage to or destruction of property, equipment and the environment; and
• suspension of operations.
Litigation arising from a catastrophic occurrence at a location where our PID System is used may result, in the future, in our being named as a defendant in lawsuits asserting potentially large claims.
The frequency and severity of any of these incidents would affect our operating costs, insurability and relationships with customers, employees and regulators. Any increase in the frequency or severity of these incidents, or the general level of
compensation awards resulting from these incidents, could affect our ability to obtain projects from oil and natural gas companies or insurance covering these incidents.
Compliance with environmental and other government regulations could adversely affect our business.
Our business is significantly affected by federal, state and local laws and regulations relating to:
• the oil and natural gas industry; and
• worker safety and environmental protection.
If we are able to successfully commercialize the PID technology, we expect that demand for our PID System will be affected by a variety of factors, including taxes, price controls and the adoption or amendment of laws and regulations. For example, the adoption of laws and regulations curtailing the exploration and development of oil and natural gas in our expected areas of operation for economic, environmental or other policy reasons could adversely affect our operations by limiting demand for our products and services.
The technical requirements of the foreign, federal, state and local laws and regulations affecting our businesses are becoming increasingly complex and stringent. For instance, some environmental laws may provide for “strict liability” for damages to natural resources or threats to public health and safety, rendering a party liable for environmental damage without regard to negligence or fault on the part of the party. Sanctions for noncompliance with these laws and regulations may include:
• revocation of permits;
• issuance of corrective action orders;
• assessment of administrative, civil or criminal penalties; and
• issuance of injunctions restricting or prohibiting our operations.
Some environmental laws provide for joint and several strict liability for remediation of spills and releases of hazardous substances. In addition, we may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances, as well as damage to natural resources. These laws and regulations also may expose us to liability for the conduct of, or conditions caused by, others, or for our acts that were in compliance with applicable laws at the time the acts were performed.
Our stockholders may experience substantial dilution as a result of the exercise of outstanding options and warrants to purchase our common stock or future issuances of additional shares of our common stock, any of which could have an adverse effect on the market price of our common stock.
In connection with our acquisition of our subsidiary, Particle Drilling Technologies, Inc., a Delaware corporation, we assumed warrants to purchase 86,141 shares of common stock and options issued under PDTI’s 2004 Incentive Stock Plan to purchase 2,760,000 shares of common stock. In connection with the private placement of our common stock in February 2005, we granted the placement agent warrants to purchase 1,500,000 shares of our common stock, of which 205,000 were still outstanding as of September 30, 2007. In connection with the private placement of our common stock in October 2006, we granted the investors warrants to purchase 1,500,000 shares of our common stock. Since our acquisition of PDTI, we have issued options to purchase an additional 1,303,375 shares of our common stock under our equity incentive plans. The common stock issuable upon exercise of these options and warrants represents approximately 18% of our outstanding shares of common stock on a fully-diluted basis. The exercise of these options and warrants would result in substantial dilution to our existing stockholders and any sales of these shares of common stock, or the perception that these sales might occur, could lower the market price of our common stock.
We may also issue additional shares of our common stock or other securities that are convertible into or exercisable for common stock in connection with the hiring of personnel, future acquisitions, future public offerings or private placements of
our securities for capital raising purposes, or for other business purposes. Future sales of substantial amounts of our common stock, or the perception that sales could occur, could have a material adverse effect on the market price of our common stock.
Our common stock has experienced, and may continue to experience, price volatility. The limited trading volume of our common stock may contribute to this price volatility.
The trading price of our common stock has been, and may continue to be, highly volatile. We believe this volatility is due to, among other things, our lack of revenues, current expectations of our future financial performance and the volatility of the stock market in general.
Moreover, our common stock, which began trading on The NASDAQ Capital Market® on June 28, 2005, does not have substantial trading volume. During the year ended September 30, 2007, the average daily trading volume of our common stock as reported by The NASDAQ Capital Market® was approximately 121,000 shares, which represents less than 1% of our outstanding shares of common stock. As a result, relatively small trades of our common stock may have a significant impact on the price of our common stock and, therefore, may contribute to the price volatility of our common stock.
Because of the limited trading volume in our common stock and the price volatility of our common stock, you may be unable to sell your shares of common stock when you desire or at the price you desire. Moreover, the inability to sell your shares in a declining market because of such illiquidity or at a price you desire may substantially increase your risk of loss.
We presently do not intend to pay cash dividends on our common stock.
We currently anticipate that no cash dividends will be paid on our common stock in the foreseeable future. While our dividend policy will be based on the operating results and capital needs of the business, we anticipate that all earnings, if any, will be retained to finance the future expansion of our company.
Item 1B. Unresolved Staff Comments
None Applicable
We currently lease our 48,750 square foot executive office and industrial facility located at 5611 Baird Court, Houston, Texas 77041. The term of this lease is for 60 months and commenced in September 2007.
We believe that our property is generally in good condition, is well maintained, and is generally suitable and adequate to conduct our business.
On February 17, 2006, PDTI closed a settlement agreement, entered into on February 8, 2006, related to certain litigation styled Cause No. 2004-63506, Particle Drilling Technologies, Inc. vs. Harry B. Curlett, Curlett Family Limited Partnership, Ltd., CCore Technology and Licensing, Ltd., and Deep Heat Energy Corporation, in the 333rd Judicial District Court of Harris County, Texas. As part of the settlement agreement, all parties released all claims against each other, and, on February 21, 2006, the Court dismissed all claims among the parties with prejudice. The Court’s dismissal became final on March 24, 2006.
Also as part of the settlement agreement, PDTI and Curlett Family Limited Partnership, Ltd. (“CFLP”) amended the Exclusive License Agreement between PDTI’s predecessor, ProDril Acquisition Company, and CFLP, dated June 1, 2003, to limit the parties’ respective obligations to share information with each other and to terminate as of February 18, 2006, the parties’ respective rights to the other party’s improvements to the PID Technology. The settlement agreement provided that the parties would integrate these amendments into an Amended Exclusive License Agreement by March 10, 2006.
During efforts to draft an Amended Exclusive License Agreement reflecting the amendments made in the settlement agreement, CFLP took the position that PDTI has a greater obligation to share information with it than provided in the amendments and that CFLP has greater rights in PDTI’s improvements than provided in the amendments. On March 20,
2006, PDTI and CFLP were unable to settle their dispute over these issues through mediation. Prior to the conclusion of that process, however, CFLP filed the following lawsuit.
On March 24, 2006, CFLP filed Civil Action No. 4:06-CV-01012, Curlett Family Limited Partnership, Ltd. v. Particle Drilling Technologies, Inc., a Delaware Corporatio