**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D. C. 20549**
   **Form
        10-KSB/A**
   **x**
              **ANNUAL
                  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                  OF 1934**
  **For
        the fiscal year ended December 31, 2004**
  ** ̈**
              **TRANSITIONAL
                  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                  OF 1934**
  **For
        the transition period from** **** **to** **** ****
  **Commission
        file number: 333-64122**
   **VERDISYS,
        I** **NC** **.**
 **(Name
        of small business issuer in its charter)**
   **California**
              **22-3755993****(State
                  of incorporation)**
              **(IRS
                  Employer**
                **Identification
                  Number)**
  **14550
        Torrey Chase Blvd, Suite 330**
 **Houston,
        Texas 77014**
 **(Address
        of principal executive offices)**
  **(281)
        453-2888**
 **(Telephone
        number)**
 
 **Securities
        registered under Section 12(b) of the Exchange Act: None**
  **Securities
        registered under Section 12(g) of the Exchange Act: None**
 
 Check
        whether issuer (1) filed all reports required to be filed by Section 13 or
        15(d)
        of the Exchange Act during the past 12 months (or for such shorter period
        that
        the registrant was required to file such reports), and (2) has been subject
        to
        such filing requirements for the past 90 days.
    Yes x No  ̈
  Check
        if
        there is no disclosure of delinquent filers in response to Item 405 of
        Regulation S-B contained in this form, and no disclosure will be contained,
        to
        the best of the registrant’s knowledge, in definitive proxy or information
        statements incorporated by reference in Part III of the Form 10-KSB or any
        amendments to this Form 10-KSB. x
  Issuer’s
        revenues for the most recent fiscal year: $1,453,344
  The
        aggregate market value of the voting and non-voting common equity held by
        non-affiliates computed by reference to the average bid and asked price of
        such
        common equity, as of February 27, 2005 is $9,050,540.
  The
        number of shares outstanding of each of the issuer’s classes of common equity,
        as of December 31, 2004:
  Common
        Stock: 33,443,691 shares
  
  
    No
        (1)
        annual report to security holders; (2) proxy or information statement; or
        (3)
        any prospectus filed pursuant to Rule 424(b) or (c) of the Securities Act
        of
        1933; are incorporated by reference into any part of this Form 10-KSB.
  Transitional
        Small Business Disclosure Format:  ̈ Yes; x No
 
  **Explanatory
        Note**
 
 Verdisys,
          Inc. (now known as Blast Energy Services, Inc.) is filing this amended
          Annual
          Report on Form 10-KSB/A for the year ended December 31, 2004 (“Amended Annual
          Report”) to amend its Annual Report on Form 10-KSB for the year ended December
          31, 2004 (the “Original Annual Report”), which was filed with the Securities and
          Exchange Commission on March 30, 2005.
 
 The
          Amended Annual Report amends the Company’s financial statements to reflect a
          non-cash adjustment to impair the carrying value of the Company’s Intellectual
          Property as of December 31, 2004, including the associated footnotes to
          the
          financial statements and disclosures under Part I, Item 1 “Financial
          Statements,” Item 2 “Management’s Discussions and Analysis of Financial
          Condition and Plan of Operation - Forward Looking Statements and Part II,
          Item
          8a “Controls and Procedures.” Except for these items no other information in the
          original Report is amended hereby .
 
 
  1
   
 **Table
        of Contents**
  **PART
                  I****DESCRIPTION
                  OF BUSINESS**
              **3**FORWARD-LOOKING
                  STATEMENTS
              3BUSINESS
                  DEVELOPMENT
              3BUSINESS OF
                  ISSUER
              3INDUSTRY
              4ABRASIVE
                  JETTING LATERAL DRILLING SERVICES
              5*Major
                  Customers*
              7Market
              8*Competition*
              8SATELLITE
                  SERVICES
              9*Major
                  Customers*
              9*Market*
              10*Competition*
              10PATENTS AND
                  LICENSES
              10GOVERNMENTAL
                  REGULATION
              11**DESCRIPTION
                  OF PROPERTY**
              **12****LEGAL
                  PROCEEDINGS**
              **13****SUBMISSION
                  OF MATTERS TO A VOTE OF SECURITY HOLDERS**
              **15****PART
                  II****MARKET
                  FOR COMMON EQUITY AND RELATED STOCKHOLDER
                  MATTERS**
              **15****MANAGEMENT’S
                  DISCUSSION AND ANALYSIS OR PLAN OF OPERATION**
              **21****FINANCIAL
                  STATEMENTS**
              **34****CHANGES
                  IN / DISAGREEMENTS WITH ACCOUNTANTS**
              **58****CONTROLS
                  AND PROCEDURES**
              **58****PART
                  III****DIRECTORS
                  AND EXECUTIVE OFFICERS**
              **59****EXECUTIVE
                  COMPENSATION**
              **61****SECURITY
                  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                  MANAGEMENT**
              **63****CERTAIN
                  RELATIONSHIPS AND RELATED TRANSACTIONS**
              **65****EXHIBITS
                  AND REPORTS ON FORM 10-KSB**
              **68****PRINCIPAL
                  ACCOUNTANTS FEES AND SERVICES**
              **70****SIGNATURES**
              **71**
  
 
 
 
 
  2
  **Item
        1. Description of Business**
  **Forward-Looking
        Statements**
  Certain
        statements concerning our plans and intentions included herein may constitute
        forward-looking statements, including, but not limited to, statements identified
        by the words “anticipate”, “believe”, “expect” and similar expressions and
        statements regarding our business strategy, plans, beliefs and objectives
        for
        future operations. Although management believes that the expectations reflected
        in these forward looking statements are reasonable, we can give no assurance
        that such expectations will prove to have been correct. There are a number
        of
        factors that may affect our future results, including, but not limited to,
        (a)
        our ability to obtain additional funding for development and operations,
        (b) the
        continued availability of management to execute the business plan, (c)
        successful deployment and market acceptance of our products and (d) the
        resolution of legal matters that may inhibit the execution of the business
        plan.
 
 This
        annual report may contain both historical facts and forward-looking statements.
        Any forward-looking statements involve risks and uncertainties. Moreover,
        future
        revenue and margin trends cannot be reliably predicted.
  **Business
        Development**
  In
        September 2000, we were incorporated as Rocker & Spike Entertainment, Inc, a
        California corporation. Until December 31, 2000, operations consisted of
        organizational matters and the search for an operating company with which
        to
        perform a merger or acquisition. Effective January 1, 2001, we purchased
        the
        assets and web domain of Accident Reconstruction Communications Network from
        its
        sole proprietor. Following the acquisition, we changed our name from Rocker
        & Spike Entertainment, Inc. to Reconstruction Data Group, Inc. At that time,
        we provided research, communication and marketing exposure to the accident
        reconstruction industry through our website and seminars.
  In
        April
        2003, we entered into a merger agreement with Verdisys, Inc. (“Verdisys”).
        Verdisys was initially incorporated as TheAgZone Inc. in 1999 as a California
        corporation. Its purpose was to provide e-Commerce satellite services to
        agribusiness. They changed their name to Verdisys in 2001, and in 2003, with
        the
        acquisition of exclusive rights to a proprietary lateral drilling process
        throughout most of the U.S. and Canada, they changed their market focus to
        concentrate on services to the oil and natural gas (“oil and gas”) industry.
  The
        merger agreement with Verdisys called for us to be the surviving company.
        In
        connection with the merger, our name changed to Verdisys, our articles of
        incorporation and bylaws remained in effect, the officers and directors of
        Verdisys became our officers and directors, each share of Verdisys’ common stock
        was converted into one share of our common stock, and our accident
        reconstruction assets were sold.
  **Business
        of Issuer**
  Our
        mission is to substantially improve the economics of existing oil and gas
        operations through the application of our licensed and proprietary technologies.
        We have been striving to develop a commercially viable lateral drilling
        technology with the potential to penetrate through well casing and into
        reservoir formations to stimulate oil and gas production. In 2003, with the
        acquisition of exclusive rights to a proprietary horizontal drilling process
        we
        began to deploy lateral drilling services in the field. In mid 2004, it became
        apparent that this process was limited in its application to various types
        of
        oil and gas formations. After redesigning and improving the existing process
        and
        designing and testing some newer technologies, we now believe that we can
        deliver a valuable and cost effective production enhancement service to onshore
        oil and gas producers, particularly operators of marginally producing fields.
        The goal is to make this new service reliably predictable and consistently
        dependable for our customers. Our next step is to build our first new generation
        lateral drilling rig with the capability of abrasive fluid jetting and
        generating much higher hydraulic horsepower. Following favorable results
        and
        customer acceptance of this initial rig’s capabilities, we intend to order the
        construction of additional rigs and significantly grow the deployment of
        our
        abrasive jetting service. Funding for developing this abrasive cutting
        capability into a lateral drilling application is expected to come from current
        and future capital commitments as well as from the proceeds of the assignment
        of
        the exclusive rights acquired in 2003. No assurances can be given that the
        capital from these sources will be adequate. If this is the case, we will
        be
        required to obtain additional capital from equity markets. No assurances
        can be
        given that such capital will be available or that the terms will be acceptable.
  Our
        primary segment will be our abrasive jetting lateral drilling business. We
        intend to deploy a commercially viable lateral drilling technology with the
        potential to penetrate though well casing and into reservoir formations to
        stimulate oil and gas production using specially fabricated mobile drilling
        rigs. This service should provide oil and gas producers with an attractive,
        lower cost alternative to existing well stimulation or horizontal drilling
        services.
  
  3
  Our
        secondary business segment is providing satellite services to oil and gas
        companies. This service allows them to remotely monitor and control well
        head,
        pipeline or drilling operations through low cost broadband data and voice
        services to remote operations where conventional land based communication
        networks do not exist or are too costly to install. Longer term, our vision
        is
        to introduce additional early stage technologies in the energy service sector,
        all of which would fit our mission of helping energy companies economically
        produce more oil and gas.
  **Industry**
  We
        operate in the oilfield service industry which services the broader energy
        industry, where companies explore, develop and produce oil and gas. This
        industry is comprised of a diversity of operators, ranging from the very
        small
        to the extremely large. While the major portion of oil and gas production
        is
        provided by very large international oil companies, there are also a large
        number of smaller independent companies, who own the vast majority of existing
        wells.
 
 As
        a
        smaller firm with a specialized service, we intend to provide lateral drilling
        and satellite services to both small and large operators in the energy industry.
        Initially, the lateral drilling business will be focused toward North American
        onshore-based independent producers while the satellite business already
        has the
        large oil and gas operators as customers. As we grow, we intend to cater
        to all
        segments of the industry in situations where the application of our services
        can
        add value to our customers.
  Demand
        for our services depends on our ability to demonstrate improved economics
        to the
        oil and gas production sector we serve. We believe that they will use our
        lateral drilling service where it costs less than alternative services and/or
        when they perceive it enhances production. It will also be driven by
        macro-economic factors driving oil and gas fundamentals. The report of the
        Energy Information Agency of the U.S. Department of Energy entitled
“International Energy Outlook 2000” forecasts that world oil consumption will
        increase at an annual rate of approximately 2% through 2020 and that world
        gas
        consumption will increase at an annual rate of approximately 3% over the
        same
        period. The projected increase in demand for oil is based on worldwide economic
        and population growth, primarily in developing countries. The projected increase
        in gas consumption over this period is expected to result from higher demand
        across residential, industrial and commercial sectors, as well as from the
        increasing use of gas as a source of fuel for electric power generation,
        particularly in North and South America. We also believe that reliance on
        traditional sources of oil and gas will be limited due to the inadequate
        delivery infrastructure and political unrest in major supplying countries.
  The
        U.S.
        Geological Survey estimates there are 1,400 trillion cubic feet (“Tcf”) of
        recoverable gas resources in the U.S.- enough to last decades - “But most of it
        is off-limits to recover because of restrictive environmental rules and
        lawsuits.” This is particularly the case with drilling moratoriums on the East
        and West Coasts of America, parts of the Rocky Mountain Area and Alaska.
        On its
        website, www.naturalgasfacts.org ,
        the
        American Petroleum Institute advocates “A multi-pronged approach is essential
        for meeting future U.S. gas demand: (1) using energy wisely and conserving
        where
        possible; (2) developing more U.S. supplies; (3) diversifying supplies through
        pipelines to bring Arctic gas to consumers; (4) facilitating more liquefied
        gas
        (LNG) imports.” We believe a more immediate impact can be made by exploiting
        existing U.S. supplies. Developing such supplies is dependent on drilling
        new
        wells in existing fields, or new reserves in expensive less accessible fields.
        We believe our lateral drilling technology can access previously uneconomic
        reserves and bring them to market cost effectively thereby helping to resolve
        this supply/demand imbalance.
  The
        Office of Fossil Energy, U.S. Department of Energy, estimates there are nearly
        500,000 oil wells and 230,000 gas wells that are marginal or classified as
        “stripper” wells. These stripper wells produce either 15 barrels or less of oil
        a day or 60 thousand cubic feet of gas or less a day. Although low producing
        stripper wells account for the “same of the amount of oil that America imports
        from Saudi Arabia” according to the Office of Fossil Energy “together (stripper
        wells) account for 1.25 Tcf of gas, or about 8 percent of the gas produced.”
Such wells are potentially considered uneconomic or marginal with the strong
        potential of being abandoned due to poor production economics. Indeed
        approximately 150,000 marginal wells were abandoned between 1993 and 2000
        “costing the U.S. more than $3.5 billion in lost economic output” according to
        the Office of Fossil Energy. In seeking to revitalize marginal and stripper
        wells both the Department of Energy and American Petroleum Institute have
        emphasized the need for new technologies to access more of the reserves
        available. We believe we have the ability to generate new business by
        re-entering existing wells rather than being dependent on the production
        companies drilling new wells. With our unique abrasive jetting well stimulation
        and lateral drilling technology, we believe we can provide potentially improved
        recovery rates rather than abandoning a field because of the depletion of
        its
        oil or gas reserves.
  We
        believe that producing companies will react to the combination of the increased
        demand and the decreased supply of oil and gas in a manner that requires
        them to
        utilize both segments of our business. We believe that oil and gas producers
        have great economic incentive to recover additional production and reserves
        from
        known reservoirs rather than pursuing a more risky exploration approach.
        Our
        extraction methods may permit producers to add value by potentially recovering
        a
        significant additional percentage of the oil and gas from a reservoir. We
        believe that there exists a large potential market in North America that
        comprises logical candidates to apply our abrasive jetting lateral drilling
        method.
 
   4
  Activity
        in the energy services industry tends to be cyclical with oil and gas prices.
        In
        addition to the currently positive industry fundamentals, we believe the
        following sector-specific trends enhance the growth potential of our business:
  •
              While
                  oil prices are unpredictable, they have remained and are projected
                  to
                  remain relatively high by historic terms for several years. Continuing
                  high consumption, limitations in delivery infrastructures and political
                  unrest in major supplying countries are expected to be contributing
                  factors.
  •
              Gas
                  prices are projected to remain high for several years due to the
                  combination of strong demand and major supply constraints. About
                  one-half
                  of U.S. reserves have been depleted with the remainder increasingly
                  expensive and difficult to reach. Significant new supplies from
                  Alaska and
                  the Canadian north require the construction of new pipelines which
                  are
                  estimated to be several years away. The situation is serious enough
                  that
                  Federal Reserve Bank Chairman Greenspan has expressed concern as
                  to its
                  effect as a constraint to U.S. economic growth.
  •
              There
                  is no substitution threat to oil and gas in the foreseeable future.
                  In
                  particular, any significant substitution by hydrogen or any other
                  potential source is believed by management to be some decades away.
  **Abrasive
        Jetting Lateral Drilling Services**
  Our
        abrasive jetting service intends to provide casing milling, well stimulation
        and
        lateral drilling services to oil and gas producers. We have signed an exclusive
        worldwide licensing agreement with Alberta Energy Holdings (“Alberta”) for the
        application of their patent pending Abrasive Fluid Jet (“AFJ”) cutting technique
        to cut through well casing and formation rock in oil and gas wells. AFJ is
        being
        added to, and will enhance the existing principles of lateral drilling and
        completion techniques utilized by us and the industry. Applications of such
        abrasive cutting techniques are a proven feature in industries as diverse
        as
        munitions disposal in the military, offshore platform dismantlement in the
        salvage industry and cutting specialty glass and steel in the machining
        business. We would be among the first to commercially apply the proven abrasive
        fluid techniques to the energy producing business.
  We
        have
        commenced the construction of a new generation drilling rig based upon
        modifications using existing coiled tubing technology. The capabilities of
        our
        new rig will include: 1.0 - 1.5 inch coiled tubing with a depth capability
        of
        8,500 feet, a fluid pressure pumping system generating up to 15,000 pounds
        per
        square inch and a flow rate in excess of twenty gallons per minute; an abrasive
        slurry system capable of delivering 150 pounds of abrasive material at thirty
        minute intervals; and a computer-controlled system to guide and control the
        down-hole formation access tool for precise casing milling and jetting services.
        Based upon our current schedule we expect this rig to be completed and
        commercially ready for service during the summer of 2005. After the initial
        rig
        establishes a reliable and commercial oilfield service, we intend to begin
        construction on additional rigs with similar capabilities as the market demands.
  Abrasive
        cutting utilizes high-pressure fluid and up to 15% of abrasives, such as
        fine
        garnet sand, up to 15,000 pounds per square inch. It can cut through surfaces
        as
        tough as four inches of steel as well as granite rock. Abrasive cutting
        represents an off-the-shelf technology requiring application to drilling
        rather
        than developing a new invention. The successful application of abrasive cutting
        should allow us to provide a range of services to well operators such as
        conventional milling, specially designed completions and well stimulation.
  We
        believe that our abrasive jetting lateral drilling will have the ability
        to
        access previously uneconomic reserves and bring them to market cost effectively,
        due to our unique and environmentally sound drilling process. These services
        have appeal for both small independent operators as well as large integrated
        companies. At our lower comparative costs, we can make it feasible to enhance
        production from a large potential market in North America and worldwide that
        would otherwise be cost prohibitive to recover. The existing oil and gas
        independent producers in North America are leading potential customers of
        these
        services.
  Many
        of
        the nation’s mature oil and gas fields contain new infield reservoir
        compartments and bypassed pockets of productive zones that have not been
        economic to produce. By extending 2” or greater diameter channels extended
        distances in multiple directions from the casing of the well, our lateral
        drilling provides an economic way to enhance production levels of existing
        reservoirs. Our lateral drilling process uses high pressure abrasive fluid
        jetting process, capable of drilling lateral holes from existing wells extended
        distances beyond the near well bore damage in wells as deep as 8,500 feet.
  5
  
  With
        conventional horizontal drilling, the transition from drilling vertically
        to
        horizontal drilling may take 200 feet or more and take many days to accomplish.
        With our patented technology, we can make this transition in two feet in
        a rapid
        fashion. This enables us to be extremely precise in targeting and staying
        within
        specific pay zones for a potentially significant enhancement to the production
        of the well.
  We
        are
        developing abrasive jetting lateral drilling technology using specially designed
        deflection shoes, nozzles and hoses to drill 2” and larger diameter well bores
        into the producing formation in multiple directions. By increasing the surface
        area opened to the producing reservoir, oil or gas production should be
        increased, potentially a large value-added application in conventional drilling
        and completion operations. The figure below more precisely illustrates the
        process.
  
  Our
        abrasive jetting lateral drilling process is designed to work on both new
        and
        existing wells, but may have greater attraction to operators of marginal
        wells
        who may be otherwise ready to abandon these wells because they are no longer
        economically viable. The strong market potential is that this negates the
        continual need for more exploration, new drilling and denser infield drilling.
        Such fields that may be ready to be abandoned and have remaining resource
        potential, can have their production re-established and their economic lives
        significantly extended.
  The
        figure below demonstrates how drilling multiple lateral wells from existing
        vertical well bores can drastically expand the production area within a given
        field. An average vertical well will recover petroleum from an area of up
        to 120
        feet from the well bore. However, each lateral can extend in multiple directions
        from the well bore, thus potentially increasing the area of productive capacity
        several fold. With our lateral drilling process we have the ability to drill
        multiple laterals in different directions and at multiple depths within the
        same
        producing intervals in a matter of days. The average price for our service
        will
        range from $25,000 to $40,000 per well depending upon the size of the project.
        Specialized directional drilling companies typically charge $250,000 or more
        to
        drill horizontally in one direction and in only one horizon and may require
        weeks to drill each well.
  6
  
  Potential
        Benefits of our lateral drilling service:
  ·  Increase
        production rate and recoverable reserves from marginal wells.
 
 ·  Allows
        stimulation of wells with acid, steam, CO 2 ,
        etc.
 
 ·  Allows
        multi-layer application in thicker reservoir zones.
 
 ·  Provides
        an economic alternative to conventional infield drilling programs.
 
 ·  Provides
        a time efficient and cost effective casing milling process.
 
 ·  Offers
        an
        alternative to high cost well stimulation services such as hydraulic fracturing.
 
 ·  Limits
        the time the well is out of production due to rapid jetting times.
  *Major
        Customers*
  We
        currently have no active customers as we are in the construction mode. However,
        we have strong indications of interest in using the new AFJ drill rig once
        it is
        placed into service.
  *Customer
        Acceptance* **
  We
        are
        encouraged by the level of interest from several existing and prospective
        customers in the lateral drilling technology as it relates to conventional
        oil
        and gas production as well as coal bed methane opportunities.
  Our
        abrasive jetting lateral drilling service directly competes with the need
        for
        new wells by laterally drilling from existing wells to extend the pay zone
        resulting in increased production through existing well bores. Our ability
        to
        target new or previously untapped deposits makes our technology potentially
        very
        compelling. By cost effectively extending the accessibility of reserves through
        the existing well bore, our technology can provide an economic alternative
        for a
        customer to add value to an existing field. The field operator’s next best
        economic alternatives are all more expensive than our service. This has the
        potential to be not only compelling economically but also very environmentally
        friendly because it uses previously established well bores rather than building
        new surface locations to drill new wells.
  According
        to the Department of Energy Report - Natural Gas Fundamentals, June, 2003,
        there
        are “Over 7,000 small independent businesses (that) drill 85% of wells and
        produce 65% of gas in the U.S. from over 350,000 U.S. wells.” These independent
        producers are potential customers for our lateral drilling service. In the
        same
        report it estimates 10,000 to 15,000 new gas wells are drilled and completed
        each year costing anywhere from less than $100,000 to several million. These
        new
        wells are necessary just to replace depleted supplies from existing wells
        in an
        effort to maintain current U.S. production levels.
  7
  Recent
        changes in U.S. tax laws provide for incentives to keep smaller oil and gas
        wells pumping even at lower energy prices. Operators of the nation’s 650,000
        marginally producing wells, representing approximately 25% of total U.S.
        production, receive tax credits of up to $9 per well per day. We believe
        such
        credits will be reinvested by the operators toward services such as lateral
        drilling in an effort to increase production and the value of their oil and
        gas
        fields
  *Market* **
  It
        has
        become clear in recent years that while the demand of oil and gas in the
        U.S. is
        growing, its ability to meet this demand from existing and new sources is
        declining. This accelerated decline will require producers to seek new
        extraction methods or technologies to exploit oil and gas production from
        existing fields and our abrasive jetting lateral drilling process is expected
        to
        help supply the need for these new technologies. According to the Department
        of
        Energy, there have been 2.25 million wells drilled in the U.S. since 1949.
        Many
        oil reservoirs have only had 35% of their reserves produced, leaving huge
        potential upsides.
  *Emphasis
        on Gas* **
  The
        United States consumed 22.78 Tcf of gas in 2002 - heating over 60 million
        households and meeting 25% of the country’s energy requirements, according to
        the U.S. Energy Information Administration (EIA). In that same year, U.S.
        production of gas totaled 19.13 Tcf, 84% of the amount consumed. According
        to
        the EIA, this gap between demand and supply is estimated to grow over the
        next
        decade. Demand will grow because gas is a versatile, clean burning and,
        historically, an economic fuel. At the same time, the new domestic fields
        being
        found are smaller and have shorter productive lives. So, with legal and
        political barriers to drilling on new lands, producers will seek alternative
        to
        extend the lives from existing fields, such as new energy service technologies.
  *Competition* **
  
  Source:
        Department of Energy - Natural Gas Fundamentals, June, 2003
  Our
        lateral drilling business should operate in a niche that lies below the more
        expensive and higher impact conventional horizontal drilling business and
        the
        much cheaper and lower impact perforation business. Our lateral drilling
        service
        can provide significant reservoir exposure, and therefore greater production
        potential, like horizontal drilling at closer to the cost of the perforation
        service.
 
 
 
 
 
  8
  Conventional
        horizontal or directional drilling is slow and significantly more expensive
        to
        the extent that it is only being used if its much longer drilling radius
        was
        required as is necessary in offshore or environmentally sensitive areas.
        Companies offering this service include Halliburton, Baker Hughes, Schlumberger
        and other independent service companies. They traditionally drill one lateral
        through the existing well bore. That lateral can take over 200 feet to achieve
        the turn to the horizontal and be limited to only one “pay” zone. It usually
        costs over $250,000 and positive financial returns require very high producing
        rates.
 However,
        many of our competitors are better financed, equipped and resourced than
        us.
  **Satellite
        Services**
  Our
        second business segment provides satellite services to oil and gas producers.
        It
        has been common practice to gather much of the data involved in energy
        management manually. This is not only expensive but also causes a significant
        time lag in the availability of critical management information. The Verdisys
        Satellite Private Network (VSPN’s) services utilize two-way satellite broadband
        to provide oil and gas companies with a wide variety of remote energy management
        applications. Our satellite services can be optimized to provide cost effective
        applications such as Voice over Internet “VoIP”, Virtual Private Networking
“VPN” and Real-time Supervisory Control and Data Acquisition Systems, commonly
        referred to as SCADA. SCADA permits oil and gas companies to dispense with
        a
        manual structure and move to a real-time, automated, energy management program.
        Utilizing SCADA, a service we currently offer, production levels can be
        optimized to meet current market conditions and commitments.
  
  At
        present, we are shipping modem hardware from ViaSat, Isotropic Networks and
        Spacenet, space segment services from SES and Loral and hub services from
        Constellation, Spacenet and Immeon.
  VSPN
        uses
        satellite communications that are low cost and that ensure worldwide
        availability, even in geographic areas with a poor communications
        infrastructure. VSPN is based on industry standards to lower implementation
        costs and to simplify the integration into existing systems. Reliability
        and
        availability are critical considerations for SCADA. VSPN is provided twenty
        four
        hours a day, seven days a week with 98.2% availability virtually anywhere
        in the
        world and there are fewer points of failure than comparable terrestrial
        services. It provides uniform service levels, and is faster and more cost
        effective to deploy. VSPN is also very flexible and easily accommodates site
        additions, relocations, bandwidth expansion, and network reconfiguration.
  Additionally,
        security, integrity, and reliability have been designed into VSPN to ensure
        that
        information is neither corrupted nor compromised. VSPN communications are
        more
        secure than many normal telephone lines.
  *Major
        Customers* **
  Our
        current satellite services customers include Apache Corporation with 40 remote
        sites, BP America Production Company with 20 remote sites, Noble Energy with
        22
        remote sites and Dynegy Inc. with 11 remote sites. We are also breaking into
        new
        markets in West Africa with ExxonMobil, Kellogg Brown & Root Inc. and
        General Electric Power Company. Contracts are usually for hardware, backhaul,
        and bandwidth. We are dependent upon a small number of customers which tend
        to
        be large companies with extensive remote operations. However, virtually any
        oil
        and gas producer, of which there are thousands, is a potential customer for
        our
        satellite services.
  9
  *Market* **
  There
        are
        more than two million oil and gas wells in existence in the United States
        alone,
        many of which could benefit from the economics of Verdisys’ high speed
        connectivity services. Our focus is serving the needs of oil and gas producers
        worldwide to control their production effectively and to enhance customer
        satisfaction by providing worldwide real-time access to information. This
        market
        for satellite services is very competitive with increasing pressure on margins
        as our larger competitors offer services at substantially discounted prices.
        We
        attempt to compete against such competitors by addressing niche market needs
        and
        offering alternative solutions that solve customers’ more difficult
        communication problems at more cost effective rates. We utilize satellite,
        Wi-Fi
        and other wireless technology for the last mile of wellhead connectivity
        for
        these customers and focus almost exclusively on the oil and gas market. The
        common denominator throughout is Multiple Protocol Label Switching “MPLS/ATM”
network transport services.
  *Competition* **
  The
        satellite communication industry is intensely competitive due to overcapacity,
        but the competition is less severe in the oil and gas producing sector. Other
        satellite services providers in the oil and gas industry include Petrocom,
        Stratus Global, Tachyon, Schlumberger and Caprock. Caprock, Schlumberger
        and
        Stratus are focused on the top 5% of the market, particularly offshore
        platforms, and Petrocom and Stratus Global are focused on the offshore market
        using a traditional wireless network. Our satellite services offer advantages
        over those services by:
  •
              Customizing
                  the provided service to better meet the customer’s needs;
  •
              Offering
                  superior speed;
  •
              Providing
                  single vendor convenience; and
  •
              Offering
                  lower up-front infrastructure and operating costs.
  **Insurance**
  Our
        operations are subject to hazards inherent in the oil and gas industry, such
        as
        accidents, blowouts, explosions, craterings, fires and oil spills. These
        conditions can cause:
  •
              personal
                  injury or loss of life,
  •
              damage
                  to or destruction of property, equipment and the environment; and
  •
              suspension
                  of operations
  In
        addition, claims for loss of oil and gas production and damage to formations
        can
        occur in the well service industry. Litigation arising from a catastrophic
        occurrence at a location where our equipment and services are being used
        may
        result in us being named as a defendant in lawsuits asserting large claims.
  We
        maintain insurance coverage that we believe to be customary in the industry
        against these hazards. However, we may not be able to maintain adequate
        insurance in the future at rates we consider reasonable. In addition, our
        insurance is subject to coverage limits and some policies exclude coverage
        for
        damages resulting from environmental contamination. The occurrence of a
        significant event or adverse claim in excess of the insurance coverage that
        we
        maintain or that is not covered by insurance could have a materially adverse
        effect on our financial condition and results of operations.
  **Patents
        and Licenses**
  In
        November 2004, we signed an exclusive worldwide licensing agreement with
        Alberta
        for the application of their patent pending AFJ cutting technique to cut
        through
        well casing in oil and gas wells. The agreement is for a term of ten years
        and
        automatically extends for additional two-year terms unless we give notice
        at
        least thirty days prior to the expiration of any term. The license is
        automatically renewable provided we pay a minimum royalty payment of $50,000
        per
        year beginning with the 12 month period immediately following commercial
        deployment of the first mobile drilling unit.
  
 
 
  10
  Under
        the
        terms of the licensing agreement, as specific phases of the AFJ process are
        successfully applied, Alberta is entitled to receive four tranches of warrants
        for our common stock. Each tranche will entitle Alberta the right to purchase
        250,000 shares of our common stock and each tranche is contingent upon the
        attainment of certain specific milestones as fully described in the agreement.
        The warrants will have a three-year term, with an exercise price of $0.50
        per
        share for the first tranche and $0.62 per share for the remaining tranches.
        The
        initial tranche will be fully vested as of the date of the agreement and
        the
        remaining warrants will vest at 31,250 shares per quarter from the date of
        issuance.
 
 Under
        the
        terms of the agreement, we have agreed to pay Alberta a $10,000 per month
        consulting fee for six months beginning on November 30, 2004. In addition,
        royalties are payable by us at the rate of $1,000 per well for services billed
        at $40,000 or less and for services above $40,000, a royalty of 2% per well
        is
        payable quarterly. The agreement also provides for the mutual sharing of
        the
        proceeds from the sale of the technology by us, subject to a maximum of $10
        million.
  On
        April
        24, 2003 we entered into an agreement to license the Landers Horizontal Drilling
        Process, based on U.S. Patent Nos. 5,413,184, 5,853,056, and 6,125,949 relating
        to certain oil and gas well production enhancement techniques and devices
        and
        related trade secrets with the inventor and holder of the patents and trade
        secrets, Carl Landers. The license gives us exclusive rights to apply the
        technology and the related trade secrets in all of the U.S. (except for part
        of
        Colorado West of the Rockies, and Utah) and Canada. Mr. Landers also reserves
        the rights to certain applications in which he has a direct interest but
        may not
        compete with us. Any improvements to the technology remain the sole property
        of
        the licensor but are provided to us without additional licensing fees. The
        license terminates upon the expiration of the underlying patents, the earliest
        date being October 1, 2013. We amended the license on September 4, 2003,
        to
        provide for consideration to Mr. Landers of a fixed amount of $500 for every
        well drilled in which the Landers Horizontal Drill method is utilized, instead
        of the original 10% royalty payment, and 500,000 shares of our restricted
        common
        stock. In addition, in exchange for a reduction of the note payable associated
        with the license from $2,750,000 to $2,500,000, we issued an additional 125,000
        shares of our restricted common stock. We amended the license again in February
        2004 when $1,695,000 of outstanding payment obligations to Mr. Landers for
        technology fees were waived in exchange for the issuance of 300,000 shares
        of
        our common stock and the payment of $500,000 in cash.
  On
        March
        8, 2005, we entered into an Assignment of License Agreement with Maxim TEP,
        Inc.
        (“Maxim”). The President and Chief Executive Officer of Maxim is Dan Williams,
        our former President and CEO. Under the assignment, we assigned to Maxim
        our
        rights in the license of the Landers Horizontal Drilling Process; all current
        and future negotiations for assignments, sublicenses or territorial royalty
        pertaining to the license and two lateral drilling rigs. As consideration,
        Maxim
        agreed to pay us a total sum of $1.3 million payable in four installments
        (two
        of which were received by March 22, 2005) and release a $270,000 credit
        obligation we owe to Maxim. In connection with the sale, we fully impaired
        the
        asset while creating an account receivable for the sales value. We will retain
        a
        non-exclusive sublicense interest in the Landers license, as long as we pay
        all
        required royalties on which the Landers Horizontal Technology is utilized.
  The
        lateral drilling technology and related trade secrets are instrumental to
        our
        competitive edge in the oil and gas service industry. We are committed to
        protecting the technology. We cannot assure our investors that the scope
        of any
        protection we are able to secure for our license will be adequate to protect
        it,
        or that we will have the financial resources to engage in litigation against
        parties who may infringe on our exclusive license. We also can not provide
        our
        investors with any degree of assurance regarding the possible independent
        development by others of technology similar to that which we have licensed,
        thereby possibly diminishing our competitive edge.
  **Governmental
        Regulation**
  Our
        operations are subject to various local, state and federal laws and regulations
        intended to protect the environment. Our operations routinely involve the
        handling of waste materials, some of which are classified as hazardous
        substances. Consequently, the regulations applicable to our operations include
        those with respect to containment, disposal and controlling the discharge
        of any
        hazardous oilfield waste and other non-hazardous waste material into the
        environment, requiring removal and cleanup under certain circumstances, or
        otherwise relating to the protection of the environment. Laws protecting
        the
        environment have become more stringent in recent years, and may in certain
        circumstances impose “strict liability,” rendering a party liable for
        environmental damage without regard to negligence or fault on the part of
        such
        party. Such laws may expose us to liability for the conduct of, or conditions
        caused by, others, or for our acts, which were in compliance with all applicable
        laws at the times such acts were performed. Cleanup costs and other damages
        arising as a result of environmental laws, and costs associated with changes
        in
        environmental laws could be substantial and could have a material adverse
        effect
        on our financial condition. Management believes that it conducts our operations
        in substantial compliance with all material federal, state and local laws
        as
        they relate to the environment. Although we have incurred certain costs in
        complying with environmental laws, such amounts have not been material to
        our
        financial results.
  
 
 
 
  11
  We
        depend
        on the demand for our products and services from oil and gas companies. This
        demand is affected by changing taxes, price controls and other laws relating
        to
        the oil and gas industry generally, including those specifically directed
        to
        oilfield operations. The adoption of laws curtailing exploration and development
        drilling for oil and gas in our areas of operation could also adversely affect
        our operations by limiting demand for our products and services. We cannot
        determine the extent to which our future operations and earnings may be affected
        by new legislation, new regulations or changes in existing legislation
        regulations or enforcement.
 
 Our
        satellite services utilize products that are incorporated into wireless
        communications systems that must comply with various government regulations,
        including those of the Federal Communications Commission (FCC). In addition,
        we
        provide services to customers through the use of several satellite earth
        hub
        stations, which are licensed by the FCC. Regulatory changes, including changes
        in the allocation of available frequency spectrum and in the military standards
        and specifications that define the current satellite networking environment,
        could materially harm our business by (1) restricting development efforts
        by us
        and our customers, (2) making our current products less attractive or obsolete,
        or (3) increasing the opportunity for additional competition. Changes in,
        or our
        failure to comply with, applicable regulations could materially harm our
        business and impair the value of our common stock. In addition, the increasing
        demand for wireless communications has exerted pressure on regulatory bodies
        worldwide to adopt new standards for these products and services, generally
        following extensive investigation of and deliberation over competing
        technologies. The delays inherent in this government approval process have
        caused and may continue to cause our customers to cancel, postpone or reschedule
        their installation of communications systems. This, in turn, may have a material
        adverse effect on our sales of products to our customers.
  **Research
        and Development Activities**
  During
        2004 and 2003, we incurred an insignificant amount of research and development
        costs as it relates to our lateral drilling process. We incurred no research
        and
        development costs in our satellite business.
  **Employees**
  As
        of
        December 31, 2004, we had a total of seven employees, all of which were
        full-time employees. A new president and chief financial officer were brought
        into the company in January 2004 ***.*** We
        also
        utilize a number of independent contractors and consultants to assist us
        conducting the drilling operations, installing the telecommunications equipment,
        maintaining and supervising such services, and the like, in order to complement
        our existing work force, as needed from time to time. Our agreements with
        these
        independent contractors and consultants are usually short-term. We are not
        a
        party to any collective bargaining agreement with any employees, and believe
        relations with our employees, independent contractors and consultants are
        good.
  **Item
        2. Description of Property**
  *Office
        Facilities* **
  We
        lease
        approximately 2,000 square feet of office space in Houston, Texas for our
        principal executive office at a cost of $2,800 per month. Our lease has been
        extended through August of 2006.
  *Equipment* **
  As
        of
        December 31, 2004, our primary equipment consisted of three mobile lateral
        drilling rigs, which can be driven to oil and gas fields throughout North
        America. Lateral drilling equipment consists of heavy trucks mounted with
        high
        powered water compressors, flexible hose and other assorted downhole equipment
        which is used to conduct the lateral drilling process with high pressure
        jetting
        technology. We also maintained certain satellite communication and computer
        equipment at our principal executive office.
  We
        believe that our facilities and equipment are in good operating condition
        and
        that they are adequate for their present use. However, the new generation
        drilling rig planned for 2005, will replace our plans to use the existing
        rigs
        designed under the Landers technology. In fact, under an Assignment of License
        Agreement, dated March 8, 2005, two of the existing lateral drilling rigs
        were
        sold.
   12
  **Item
        3. Legal Proceedings**
  *Lawsuits
        Involving Edge Capital Group, Inc. (Settled)* **
  Effective
        January 19, 2005, Edge Capital Group, Inc. (“Edge”), certain entities affiliated
        with Edge, Eric McAfee (our former Vice Chairman) and us, entered into a
        Settlement Agreement and Mutual Release to fully settle and resolve the disputes
        between Edge and its affiliated entities, Mr. McAfee, our directors and us.
        As
        part of the settlement, we issued an aggregate of 750,000 shares of our common
        stock along with warrants to purchase 750,000 shares of our common stock
        to
        Edge. In addition, we agreed to provide Edge a drilling rig to provide certain
        lateral drilling services. As part of the drilling services, Edge has agreed
        to
        provide a fee per well, along with a share of the revenues generated from
        each
        well drilled. Also, as part of the settlement, at closing, we have agreed
        to
        sublicense our Landers horizontal drilling technology to Edge for certain
        limited purposes. As part of the settlement, the parties to the agreement
        have
        agreed to a mutual release and have agreed to dismiss all pending claims
        and
        litigation between them upon performance of the obligations in the settlement
        agreement. If we do not perform our remaining obligations under the settlement
        agreement, this would cause the release to not be effective and could lead
        to
        the underlying lawsuit being reinstituted. An adverse finding in such lawsuit
        against us would have a material adverse effect on our financial condition.
 
 We
        had
        initiated a lawsuit against Edge that requested a declaratory judgment that
        a
        purported agreement between us and Edge was not enforceable. It was filed
        in
        Montgomery County, Texas in February 2004. The lawsuit arose from Edge’s
        contention that one of our ex-officers committed us to purchase certain alleged
        oil and gas properties from Edge. Edge had filed a counterclaim against us
        and
        asserted claims against Dan Williams (our former President and CEO), Eric
        McAfee, Ron Robinson (our former CEO and current Board member), Andrew Wilson
        (our former CFO) and our current Board members Joseph Penbera, Frederick
        Ruiz,
        James Woodward and John Block. Edge has also made claims against Solarcom,
        L.L.C., DeLage Landen Financial Services, Inc., Andrew Wilson and Allen Voight.
        Edge had sought to enforce the agreement we challenged and alleged several
        causes of action including claims for fraud, breach of contract, negligence
        and
        conspiracy. Edge had asserted actual damages in excess of $85 million and
        has
        claimed punitive damages as well.
  Edge
        and
        one of its apparent owners, Frazier Ltd., had initiated a lawsuit in Summin
        County, Ohio against us, Solarcom, L.L.C., DeLage Landen Financial Services,
        Inc. and Firstmerit Bank, N.A. that sought an injunction against the draw
        against a letter of credit pledged as collateral for a credit advanced to
        Edge.
        Edge asserted that its transaction with us was the product of fraud and that
        its
        creditor, DeLage Landen as assignee from Solarcom, should not be allowed
        to draw
        against Edge’s letter of credit from Firstmerit. The Ohio state court denied
        Edge’s request for a temporary injunction. The pleadings in the Ohio action did
        not include any claim for damages from us.
  *Class
        Action Lawsuits (Settled)* **
  In
        March
        2005, we entered into an agreement, subject to court approval, to settle
        the
        class action lawsuit brought by former shareholders in March 2004 in the
        U.S.
        District Court for the Southern District. Under terms of the agreement, we
        will
        issue to the class 1,150,000 shares of common stock and pay up to $55,000
        in
        legal and administrative fees for the plaintiffs. The lawsuit alleged that
        we
        and our former CEO, Dan Williams, and our former CFO, Andrew Wilson, violated
        Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule
        10b-5
        promulgated thereunder. The lawsuits alleged that the defendants had made
        material misstatements about our financial results. More specifically, the
        Complaints alleged that the defendants had failed to disclose and indicate:
        (1)
        that we had materially overstated our net income and earnings per share;
        (2)
        that we prematurely recognized revenue from contracts between us, Edge and
        Energy 2000 NGC, Inc. (“Energy 2000”) in violation of GAAP and our own revenue
        recognition policy; (3) that we lacked adequate internal controls and was
        therefore unable to ascertain the true financial condition of the company;
        and
        (4) that as a result of recognizing revenue prematurely, our financial results
        were inflated at all relevant times. We had filed a motion to dismiss all
        actions in the litigation against us.
  *Securities
        and Exchange Commission Investigation Inquiries*
  We
        received notice, in January 2004, that the Securities and Exchange Commission
        (“SEC”) has initiated a formal investigation into our reporting practices and
        our public statements in 2003.
  The
        SEC
        has requested substantiation and documentary evidence from us concerning
        the
        performance of certain lateral drilling services by subcontractors in the
        period
        from May 2003 to September 2003, supervision of such services by our executive
        management at the time, revenue recognition related to the performance of
        such
        services, the third quarter 2003 earnings restatement, public statements
        concerning the services performed, and related matters. The SEC has also
        requested information and documentary evidence related to our acquisition
        of
        certain assets of QuikView, Inc., a related party company, in June 2003.
        In its
        letters to us requesting documents, the SEC stated that the staff’s inquiry
        should not be construed as an indication that any violations of securities
        laws
        have occurred or as an adverse reflection on any persons, company or security.
   13
  Since
        December 2003, we have taken several steps to address issues related to the
        SEC’s inquiries, including the termination and replacement of the previous Chief
        Executive Officer and Chief Operating Officer and the reassignment of its
        Chief
        Financial Officer. Two directors have resigned from our board and we have
        appointed a new CFO. Internal controls have been strengthened overall,
        particularly with respect to the public release of information and the
        recognition of revenue. We had also initiated an internal investigation of
        the
        matters of concern to the SEC. Consequently, we restated our second and third
        quarter financial statements for fiscal year 2003 and deferred all revenue
        related to the aforementioned period until such time that we can substantiate
        whether or not the services were performed.
  We
        are
        cooperating fully with the SEC, including the provision of numerous documents
        and voluntary testimony by our current executives. In December 2004, the
        staff
        of the SEC notified us that it was considering recommending that the SEC
        bring a
        civil injunction (including a possible permanent injunction and a civil penalty)
        against us alleging violations of provisions of the Sections 10(b), 13(b)(2)(A),
        13(b)(2)(B) and 15(d) of the Securities Exchange Act of 1934 and rules
        promulgated thereunder in connection with the purchase and sale of our
        securities, recordkeeping, internal controls, certification and disclosure
        obligations. We were notified of our right to make a Wells submission. We
        have
        provided information to the SEC setting forth the specific steps we have
        taken
        to upgrade the quality and effectiveness of our board of directors, replace
        the
        previous management team with industry experts, improve our recordkeeping,
        internal and disclosure controls, and revenue recognition procedures. Although
        we are working to bring the matter to a prompt conclusion, we cannot make
        any
        assurance that the investigation will be resolved positively or that it will
        not
        have negative effects on our limited resources or our ability to raise capital
        and use our stock as acquisition currency during the period of the
        investigation.
 
 *Claims
        by Investor (Partially Settled)* **
  In
        February 2005, we entered into an Agreed Judgment and Order of Severance
        with
        Gryphon Master Fund, L.P. (“Gryphon”) as to all breach of contract claims
        related to our delay in registering common stock acquired by Gryphon in October
        2003. Under the terms of the Agreed Judgment, we are obligated to pay liquidated
        damages of $0.5 million to Gryphon on or before September 30, 2005.
        Additionally, Gryphon has agreed to abate their remaining claims and related
        discovery in the lawsuit against us until after September 30, 2005. We agreed
        to
        register the shares issued to Gryphon on or before March 2004 or be subject
        to
        certain liquidated damages. Gryphon had made a claim against us for the maximum
        liquidated damages in an amount of $400,000. Gryphon has also claimed that
        it
        has sustained actual damages in excess of $6.2 million. In July 2004, Gryphon
        filed a lawsuit in the state district court in Dallas County, Texas against
        us,
        alleging, among other things, breach of contract and securities fraud by
        us. In
        connection with the lawsuit, Gryphon requested liquidated damages, actual
        damages, punitive damages, interest, costs and attorneys’ fees among other
        claims. We intend to vigorously defend ourselves in this matter with respect
        to
        the remaining claims of Gryphon. If Gryphon prevails, it may obtain significant
        damages that may have a material adverse effect on our financial condition.
  *Claim
        by Former CEO* **
  In
        July
        2004, we were informed that one of our former Chief Executive Officers filed
        a
        lawsuit against us for breach of contract and wrongful discharge. The lawsuit
        seeks relief in excess of $0.5 million related to an alleged employment
        agreement and damages related to an excess of 4 million stock options claimed
        due pursuant to the alleged employment agreement. The lawsuit was filed in
        state
        court in San Diego, California. We intend to vigorously defend ourselves
        in this
        matter. If the plaintiff prevails, they may obtain significant damages that
        may
        have a material adverse effect on our financial condition.
  *Energy
        2000 (Settled)* **
  In
        October 2004, we entered into an agreement with Berg McAfee Companies, Energy
        2000 and Eric McAfee (collectively, “McAfee Group”) to settle several
        outstanding legal issues. Energy 2000 has agreed to settle a finders fee
        and
        lateral drilling services dispute by delivering 300,000 shares of Natural
        Gas
        Systems, Inc. (“NGS”) stock into escrow for us. We have plans to monetize those
        shares as soon as practical. Furthermore, to settle the “Lawsuits Involving Edge
        Capital Group, Inc.”, the McAfee Group exchanged 500,000 shares of NGS for
        500,000 shares of our common stock. In January of 2005, the McAfee Group
        replaced the 500,000 shares of NGS stock with $625,000 in cash. We submitted
        that cash and an additional 250,000 shares of our common stock to Edge as
        part
        of that settlement. We have also agreed to dismiss the QuikView, Inc. lawsuit,
        which we had filed against certain individuals.
  *Concluding
        Statement* **
  We
        have
        never been in bankruptcy, receivership or any similar legal proceeding. Other
        than the aforementioned legal matters, we are not aware of any other threatened
        legal proceedings. The foregoing is also true with respect to each officer,
        director and control shareholder as well as any entity owned by any officer,
        director and control shareholder, over the last five years.
  
  14
  As
        part
        of our regular operations, we may become party to various pending or threatened
        claims, lawsuits and administrative proceedings seeking damages or other
        remedies concerning its’ commercial operations, products, employees and other
        matters. Although we can give no assurance about the outcome of these or
        any
        other pending legal and administrative proceedings and the effect such outcomes
        may have on the company, except as described above, we believe that any ultimate
        liability resulting from the outcome of such proceedings, to the extent not
        otherwise provided for or covered by insurance, will not have a material
        adverse
        effect on our financial condition or results of operations *.*
 
 **Item
        4. Submission of Matters to a Vote of Security Holders**
  No
        matter
        was submitted during the fourth quarter of the fiscal year covered by this
        report to a vote of security holders, through the solicitation of proxies
        or
        otherwise.
  **Part
        II**
  **Item
        5. Market for Common Equity and Related Stockholder Matters**
  After
        the
        consummation of the merger between Reconstruction Data Group, Inc. and Verdisys,
        our common stock commenced trading on the OTC Bulletin Board on July 18,
        2003
        under the symbol “VDYS.” Prior to the merger, our common stock had been listed
        for trading on the OTC Bulletin Board under the symbol “RDGI”. The RDGI stock
        was listed on January 13, 2003, but active trading did not begin until May
        2,
        2003. The following table sets forth, for the periods indicated, the high
        and
        low bid prices of a share of our common stock as reported on the OTC Bulletin
        Board since active trading began on May 2, 2003. The quotations provided
        are for
        the over the counter market which reflect interdealer prices without retail
        mark-up, mark-down or commissions, and may not represent actual transactions.
  **HIGH**
              
              **LOW**2003Second
                  Quarter (from May 2, 2003)
              
              $
              1.72
              
              $
              1.53Third
                  Quarter
              
              $
              6.32
              
              $
              5.65Fourth
                  Quarter
              
              $
              11.03
              
              $
              10.142004First
                  Quarter
              
              $
              9.54
              
              $
              3.35Second
                  Quarter
              
              $
              4.75
              
              $
              1.50Third
                  Quarter
              
              $
              1.95
              
              $
              0.25Fourth
                  Quarter
              
              $
              1.00
              
              $
              0.40
  **Holders**
  As
        of
        February 28, 2005, we had 34,973,673 shares of common stock issued and
        outstanding and held by approximately 500 shareholders.
  **Dividends**
  We
        have
        never paid cash dividends. At present, we do not anticipate paying any dividends
        on our common stock in the foreseeable future and intend to devote any earnings
        to the development of the company’s business.
   15
  **EQUITY
        COMPENSATION PLAN INFORMATION**
  The
        following table provides information as of December 31, 2004 regarding
        compensation plans (including individual compensation arrangements) under
        which
        equity securities are authorized for issuance:
  **Plan
                  Category**
              
              **Number of securities**
                **to
                  be issued**
                **upon
                  exercise of**
                **outstanding
                  options,**
                **warrants
                  and rights**
              
              **Weighted-average**
                **exercise
                  price of**
                **outstanding options,**
                **warrants
                  and rights**
              
              **Number of securities**
                **available
                  for future**
                **issuance under equity**
                **compensation
                  plans**
                **(excluding
                  securities**
                **shown in first column)**Equity
                  compensation plans approved by shareholdersEquity
                  compensation plans not approved by shareholders
              
              
              2,413,680
              
              $
              1.67
              
              
              5,586,320Total
              
              
              2,413,680
              
              $
              1.67
              
              
              5,586,320
  **Recent
        Sales of Unregistered Securities**
  The
        following table details shares issued under transactions that were a private
        offering we believe to be exempt from registration under Regulation D
        promulgated under Section 4(2) of the Securities Act. The sales of stock
        were to
        individuals or entities, each of whom was an accredited investor, as that
        term
        is defined in Rule 501 of Regulation D promulgated under Section 4(2) of
        the
        Securities Act and had adequate access to information pertaining to us.
        Furthermore, no advertisements were made and the securities are restricted
        pursuant to Rule 144.
  **Date**
              
              **Number of**
                **Shares
                  of**
                **Common**
                **Stock**
              
              **Value**
              
              **Offering
                  Costs**
              
              **Other
                  Terms**January
                  and February 2005
              
              
              433,000
              
              $
              216,500
              
              
              15,800
                  shares of common stock and warrants to purchase 15,800 shares of
                  our
                  common stock at $1.00 per share
              
              
              Two
                  year warrants to purchase 433,000 shares of our common stock at
                  a price of
                  $1.00 per share were issued in connection with the private placement.
                  The
                  proceeds will be allocated between the common stock and the warrants
                  based
                  on their respective relative fair values.May
                  through June 2004
              
              
              179,500
              
              $
              359,000
              
              
              17,950
                  shares of common stock and warrants to purchase 7,180 shares of
                  our common
                  stock at $2.00 per share
              
              
              Two
                  year warrants to purchase 71,800 shares of our common stock at
                  a price of
                  $2.00 per share were issued in connection with the private placement.
                  The
                  proceeds were allocated between the common stock and the warrants
                  based on
                  their respective relative fair values.July
                  through August 2003
              
              
              609,000
              
              $
              1,218,000
              
              
              59,400
                  shares of common stock and warrants to purchase 9,501 shares of
                  our common
                  stock at $2.00 per share
  The
        following table details sales of stock we believe to be exempt from registration
        under Section 4(2) of the Securities Act. Each of the recipients of our stock
        was an accredited investor, as that term is defined in Rule 501 of Regulation
        D
        promulgated under Section 4(2) of the Securities Act and had access to
        information concerning us and our business prospects. Furthermore, no
        advertisements were made and the securities are restricted pursuant to Rule
        144.
   16
  
 **Date**
              
              **Number of**
                **Shares
                  of**
                **Common**
                **Stock**
              
              **Value**
              
              **Comment**Fourth Quarter of 2004
              
              
              104,000
              
              $
              52,000
              
              
              Shares
                  issued in payment of consulting services.Fourth
                  Quarter of 2004
              
              
              250,000
              
              $
              75,000
              
              
              To
                  settle a dispute with a former consultant.Fourth
                  Quarter of 2004
              
              
              400,000
              
              $
              200,000
              
              
              Shares
                  for cash.Third
                  Quarter of 2004
              
              
              30,000
              
              $
              15,000
              
              
              Shares
                  issued in payment of a future fundraising effort.Third
                  Quarter of 2004
              
              
              300,000
              
              $
              213,000
              
              
              Shares
                  issued in lawsuit settlement.February
                  2004
              
              
              300,000
              
              $
              1,920,000
              
              
              Shares
                  issued in payment of outstanding obligations to Mr. Landers for
                  technology
                  fees.September
                  2003
              
              
              500,000
              
              $
              2,275,000
              
              
              Shares
                  issued in exchange for amendment to Landers licensing
                  agreement.July
                  2003
              
              
              125,000
              
              $
              250,000
              
              
              Shares
                  issued in payment of note payable to Mr. Landers.
  *Other
        Sales* **
  In
        January 2005, we issued 16,000 shares of our common stock for the payment
        of
        leasing fees valued at approximately $8,000 and 10,666 shares of our common
        stock to settle unpaid compensation issues with two former AgZone employees.
        We
        also issued 388,502 shares of our common stock under a program to compensate
        our
        directors, employees, contractors and former employees for unpaid wages,
        commissions and director fees incurred in 2004. Additionally, 500,000 shares
        of
        common stock were issued to Edge under the final terms of the lawsuit settlement
        agreement.
  In
        October 2004, we issued 750,000 shares of our common stock in a move to settle
        outstanding litigation matters. In a Settlement Agreement and Mutual Release
        (“Agreement”) between Edge, Eric McAfee and us, the parties would release each
        other from any claims upon the completion of the terms of the Agreement.
        As a
        part of this Agreement, 250,000 shares of our common stock were placed in
        escrow
        for the benefit of Edge. In October 2004, we entered into an agreement with
        Berg
        McAfee Companies, Energy 2000 and Eric McAfee (collectively, “McAfee Group”) to
        settle several outstanding legal issues. Under this agreement, 500,000 shares
        of
        our common stock were placed in escrow for the benefit of the McAfee Group.
        In
        return, the McAfee Group contributed 875,000 shares of NGS. Further detail
        on
        these agreements can be found in the “litigation” section of this Form 10-KSB.
        The shares of stock were issued in transactions we believe to be exempt from
        registration under Section 4(2) of the Securities Act. The recipient of our
        stock was an accredited investor as defined in Rule 501 of Regulation D
        promulgated under Section 4(2) of the Securities Act and had access to
        information concerning us and our business prospects. Furthermore, no
        advertisements were made and the securities are restricted pursuant to Rule
        144.
 
 On
        October 23, 2003, we sold 833,333 shares of our common stock to Gryphon Master
        Fund, L.P. at $6.00 per share for total proceeds of $5,000,000. Since the
        30 day
        average closing price of our common stock dropped below $6.00 per share in
        the
        ten months subsequent to the agreement, we were required to issue 277,778
        additional shares of common stock in the fourth quarter of 2004 for no
        additional compensation. Therefore a total of 1,111,111 common shares were
        issued for an average price of $4.50 per share under this transaction. Stonegate
        Securities, Inc. served as our placement agent and offering costs associated
        with the sale were $420,000 in cash, warrants to purchase 83,334 shares of
        our
        common stock at $6.00 per share expiring October 24, 2008 and 20,000 shares
        of
        our common stock. The warrants are exercisable until October 24, 2008 by
        paying
        cash at the exercise price or by electing a cashless exercise. The transaction
        was a private offering we believe to be exempt from registration under
        Regulation D promulgated under Section 4(2) of the Securities Act. The sales
        of
        stock were to individuals or entities, each of whom was an accredited investor,
        as that term is defined in Rule 501 of Regulation D promulgated under Section
        4(2) of the Securities Act and had adequate access to information pertaining
        to
        us. Furthermore, no advertisements were made and the securities are restricted
        pursuant to Rule 144.
  
 
  17
  
 On
        July
        18, 2003, we, as RDGI, executed an Agreement and Plan of Merger with Verdisys
        whereby the shareholders of Verdisys received 25,103,223 shares of our common
        stock in exchange for all of the 25,103,223 shares of Verdisys common stock
        then
        outstanding. The operations and management of Verdisys became our own, and
        we
        changed our name to Verdisys Inc. The shares of stock were issued in the
        transaction we believe to be exempt from registration under Regulation D
        promulgated under Section 4(2) of the Securities Act. The issuances were
        a share
        for share exchange resulting in a similar investment to that originally
        contemplated due to the continuation of management and business plan; the
        recipients in the exchange were accredited investors as defined in Rule 501
        of
        Regulation D promulgated under Section 4(2) of the Securities Act, and took
        their shares for investment purposes without a view to distribution; they
        had
        access to information concerning us and our business prospects; there was
        no
        general solicitation or advertising for the purchase of our shares; there
        were
        no commissions paid; and the securities are restricted pursuant to Rule 144.
  *Common
        Stock Issued Upon Exercise of Options* **
  **Date**
              
              **Shares Issued**
                **Upon Exercise**
              
              **Value**
              
              **Comment**Second
                  Quarter of 2004
              
              
              344,583
              
              $
              34,458First
                  Quarter of 2004
              
              
              25,000
              
              $
              2,500Fourth
                  Quarter of 2003
              
              
              100,000
              
              $
              10,000Second
                  Quarter of 2003
              
              
              2,409,291
              
              $
              240,929
              
              
              In
                  lieu of cash, we agreed to expense the exercise price.
  *Common
        Stock Issued Upon Exercise of Warrants* **
  **Date**
              
              **Shares Issued**
                **Upon Exercise**
              
              **Value**
              
              **Comment**Second Quarter of 2004
              
              
              57,658
              
              $
              5,766First Quarter of 2004
              
              
              779,597
              
              $
              38,494
              
              
              Includes
                  cash less exercise of 400,000 warrants for 395,022 shares of common
                  stock.Fourth Quarter of 2003
              
              
              245,631
              
              $
              29,564Third Quarter of 2003
              
              
              269,547
              
              $
              177,751Second Quarter of 2003
              
              
              430,000
              
              $
              56,500Second Quarter of 2003
              
              
              950,000
              
              $
              95,000
              
              
              Accounts
                  payable reduced in lieu of cash for exercise.Second Quarter of 2003
              
              
              200,000
              
              $
              20,000
              
              
              Note
                  payable reduced in lieu of cash for exercise.
 
  18
  *Options* **
  The
        following table summarizes option grants for the last three years:
  **Date**
              
              **Number
                  of**
                **Shares**
              
              **Exercise**
                **Price**
              
              **Market**
                **Price**
              
              **Vesting**
              
              **Term**
                **(years)**
              
              **Fair
                  Value**
              
              **To
                  Whom Issued**July 2004
              
              
              770,000
              
              $
              0.90
              
              $
              0.90
              
              
              Quarterly
                  over 3 years
              
              
              10
              
              $
              689,232
              
              
              OfficersMay 2004
              
              
              72,000
              
              $
              2.20
              
              $
              2.20
              
              
              Quarterly
                  over 1 year
              
              
              10
              
              $
              156,913
              
              
              Non-employee
                  directorsJan 2004
              
              
              230,000
              
              $
              4.28
              
              $
              4.28
              
              
              Quarterly
                  over 1 year
              
              
              10
              
              $
              890,785
              
              
              OfficersJan 2004
              
              
              80,000
              
              $
              4.28
              
              $
              4.28
              
              
              Immediate
              
              
              10
              
              $
              309,840
              
              
              Non-employee
                  directorsDec 2003
              
              
              500,000
              
              $
              9.55
              
              $
              9.55
              
              
              10%
                  immediate, 80% over12
                  months, 10% on performance
              
              
              10
              
              $
              4,061,703
              
              
              Officer/directorAug 2003
              
              
              100,000
              
              $
              4.10
              
              $
              4.10
              
              
              Quarterly
                  over 1 year
              
              
              5
              
              $
              321,024
              
              
              EmployeeApril 2003
              
              
              750,000
              
              $
              0.10
              
              $
              0.50
              
              
              Quarterly
                  over 3 years
              
              
              10
              
              
              N/A
              
              
              OfficerApril 2003
              
              
              250,000
              
              $
              0.10
              
              $
              0.50
              
              
              Quarterly
                  over 1 year
              
              
              10
              
              
              N/A
              
              
              Non-employee
                  directorsApril 2003
              
              
              250,000
              
              $
              0.10
              
              $
              0.50
              
              
              Quarterly
                  over 1 year
              
              
              10
              
              
              N/A
              
              
              Officer/directorApril 2003
              
              
              30,000
              
              $
              0.10
              
              $
              0.50
              
              
              Over
                  4 months
              
              
              10
              
              
              N/A
              
              
              OfficerDec 2002
              
              
              3,450,000
              
              $
              0.10
              
              $
              0.50
              
              
              Quarterly
                  over 4 years
              
              
              10
              
              
              N/A
              
              
              Officers
                  and employeesJune 2002
              
              
              350,000
              
              $
              0.10
              
              $
              0.50
              
              
              Quarterly
                  over 1 year
              
              
              10
              
              
              N/A
              
              
              Officers
                  and directorsApril 2002
              
              
              105,000
              
              $
              0.10
              
              $
              0.50
              
              
              Quarterly
                  over 1 year
              
              
              10
              
              
              N/A
              
              
              EmployeesApril 2002
              
              
              2,000,000
              
              $
              0.10
              
              $
              0.50
              
              
              Quarterly
                  over 2 years
              
              
              10
              
              
              N/A
              
              
              OfficerApril 2002
              
              
              200,000
              
              $
              0.10
              
              $
              0.50
              
              
              Quarterly
                  over 3 years
              
              
              10
              
              
              N/A
              
              
              Employee2002
              
              
              1,050,000
              
              $
              0.10
              
              $
              0.50
              
              
              Over
                  12 months
              
              
              10
              
              
              N/A
              
              
              Officers
  We
        recorded expense of $245,829 and $714,524 for the intrinsic value associated
        with the options vesting in 2004 and 2003, respectively. The expense is included
        in selling, general & administrative expense on the statement of operations.
   19
  *Warrants* **
 
 The
        following table summarizes warrants granted for the last three years:
 
 **Date**
              
              **Number
                  of**
                **Shares**
              
              **Exercise**
                **Price**
              
              **Term**
                **(years)**
              
              **Other**Jan & Feb 2005
              
              
              408,000
              
              $
              1.00
              
              
              2
              
              
              Issued
                  in connection with Private Placement.Jan & Feb 2005
              
              
              15,800
              
              $
              1.00
              
              
              2
              
              
              Offering
                  costs of Private Placement.October 2004
              
              
              100,000
              
              $
              0.001
              
              
              1
              
              
              Issued
                  in connection with aggregate convertible notes of $200,000 to Berg
                  McAfee
                  and Eric McAfee. The notes have been discounted for the relative
                  fair
                  value of the warrants.October 2004
              
              
              250,000
              
              $
              0.50
              
              
              3
              
              
              Issued
                  to Alberta as part of a licensing agreement. The fair value of
                  $199,750
                  was expensed in 2004.August 2004
              
              
              140,000
              
              $
              0.80
              
              
              2
              
              
              Issued
                  to certain subcontractors and the fair value of $98,000 was expensed
                  in
                  2004. 20% of the warrants vest immediately and the balance vest
                  20% every
                  90 days thereafter.July
                  2004
              
              
              100,000
              
              $
              0.001
              
              
              1
              
              
              Issued
                  in connection with $200,000 in convertible notes to third party
                  lenders.
                  The notes have been discounted for the relative fair value of the
                  warrants.
  July
                  2004
              
              
              75,000
              
              $
              0.01
              
              
              2
              
              
              Issued
                  in connection with $150,000 in convertible notes to third party
                  lenders.
                  The notes have been discounted for the relative fair value of the
                  warrants.May & June 2004
              
              
              71,800
              
              $
              2.00
              
              
              2
              
              
              Issued
                  in connection with Private Placement.June
                  2004
              
              
              7,180
              
              $
              2.00
              
              
              2
              
              
              Offering
                  costs of Private Placement.May
                  2004
              
              
              37,000
              
              $
              2.00
              
              
              1
              
              
              Issued
                  in connection with $185,000 in promissory notes to third party
                  lenders.
                  The notes have been discounted for the relative fair value of the
                  warrants.Fall
                  2003
              
              
              92,835
              
              $
              6.00
              
              
              5
              
              
              Issued
                  in connection with raising $5,000,000 from Gryphon and the fair
                  value of
                  $822,738 has been treated as a cost of fundraising.Fall
                  2003
              
              
              9,501
              
              $
              2.00
              
              
              5Summer
                  2003
              
              
              150,000
              
              $
              0.10
              
              
              1
              
              
              Part
                  of a settlement, along with $28,000 in cash, with the two original
                  founders for various debts recorded on the books at $576,000. The
                  warrants
                  were valued at $0.40 per share or $60,000, resulting in a contribution
                  to
                  capital of $488,000.
  20
  
 May
                  2003
              
              
              2,644,438
              
              $
              0.10
              
              
              Var
              
              
              Issued
                  to former employees and the fair value of $1,050,687 were expensed
                  in
                  2003.April
                  2003
              
              
              200,000
              
              $
              0.10
              
              
              4
              
              
              Issued
                  to consultants and the fair value of $80,000 was expensed in
                  2003.April
                  2003
              
              
              232,334
              
              $
              0.75
              
              
              1
              
              
              Previously
                  expired warrants were extended.2002
              
              
              120,000
              
              $
              0.10
              
              
              4
              
              
              Issued
                  to investors and fair value of $4,800 expensed in 2002.2002
              
              
              980,000
              
              $
              0.10
              
              
              5
              
              
              Issued
                  to consultants and the fair value of $392,000 was expensed in
                  2002.
  **Item
        6. Management’s Discussion and Analysis or Plan of Operation**
  The
        following discussion does not purport to be complete and should be read in
        conjunction with the Financial Statements and Notes thereto included in this
        report. This discussion contains certain forward-looking statements that
        involve
        substantial risks and uncertainties. When used in this report the words
“anticipate,” believe,” “estimate,” “expect” and similar expressions as they
        relate to our management or us are intended to identify such forward-looking
        statements. Our actual results, performance or achievements could differ
        materially from those expressed in, or implied by, these forward-looking
        statements. Historical operating results are not necessarily indicative of
        the
        trends in operating results for any future period.
  Our
        mission is to substantially improve the economics of existing oil and natural
        gas operations through the application of our licensed and proprietary
        technologies. We have been striving to develop a commercially viable lateral
        drilling technology with the potential to penetrate through well casing and
        into
        reservoir formations to stimulate oil and gas production. In 2003, with the
        acquisition of exclusive rights to a proprietary horizontal drilling process
        we
        began to deploy lateral drilling services in the field. In mid 2004, it became
        apparent that this process was limited in its application to various types
        of
        oil and gas formations. After redesigning and improving the existing process
        and
        designing and testing some newer technologies, we now believe that we can
        deliver a valuable and cost effective production enhancement service to onshore
        oil and gas producers, particularly operators of marginally producing fields.
        The goal is to make this new service reliably predictable and consistently
        dependable for our customers. Our next step is to build our first new generation
        lateral drilling rig with the capability of abrasive fluid jetting and
        generating much higher hydraulic horsepower. Following favorable results
        and
        customer acceptance of this initial rig’s capabilities, we intend to order the
        construction of additional rigs and significantly grow the deployment of
        our
        abrasive jetting service. Funding for developing this abrasive cutting
        capability into a lateral drilling application is expected to come from current
        and future capital commitments as well as from the proceeds of the assignment
        of
        the exclusive rights acquired in 2003. No assurances can be given that the
        capital from these sources will be adequate. If this is the case, we will
        be
        required to obtain additional capital from equity markets. No assurances
        can be
        given that such capital will be available or that the terms will be acceptable.
  *Risk
        factors* **
  Although
        we believe that our expectations regarding future events are based on reasonable
        assumptions, we cannot assure you that such expectations regarding future
        developments will be realized. Actual results could differ materially from
        those
        discussed in the forward-looking statements as a result of certain factors,
        including the risk factors described below. The risks and uncertainties
        described below are not the only ones we face; there may be additional risks
        and
        uncertainties not presently known to us or those we currently believe are
        immaterial which could also have a negative impact on our business, financial
        condition and operating results.
 
  21
  **GENERAL
        RISKS RELATING TO OUR COMPANY**
  **1.
        We have a limited operating history, which makes it difficult to evaluate
        our
        business performance.**
  We
        have
        been in existence for a few years, but we have been conducting drilling
        operations using the proprietary lateral drilling technology only since June
        2003 and satellite services to the oil and gas industry only since June 2002.
        We
        have commenced the construction of our first rig utilizing the abrasive jetting
        technology to the down-hole milling and lateral jetting techniques. Abrasive
        jetting has been successfully commercialized in several industries but is
        not
        yet proven in the energy drilling industry. Because we have a limited operating
        history, there is little historical financial data upon which an investor
        may
        evaluate our business performance. Our revenue and income potential are
        unproven. An investor must consider the risks, uncertainties, expenses and
        difficulties frequently encountered by companies in their early stages of
        development, particularly companies with limited capital in a rapidly evolving
        market. These risks and difficulties include our ability to develop our
        infrastructure, reliability in the milling process in our lateral drilling
        technology, attract and maintain a base of customers, provide customer support,
        personnel, and facilities to support our business, and respond effectively
        to
        competitive and technological developments. Our business strategy may not
        be
        successful or may not successfully address any of these risks or difficulties.
        While we believe our business model will permit us to generate substantial
        revenues, there is no guarantee that the revenues will be realized. Failure
        to
        realize the revenue may have a material adverse effect on our financial
        condition.
  **2.
        We are an investment risk because business and marketing strategies planned
        are
        not proven.**
  We
        have
        no established basis to assure investors that business or marketing strategies
        will be successful. We are highly dependent upon the acquisition of subscribers
        for our satellite division; selection of, and productivity from, appropriate
        oil
        and gas wells; as well as the effective application of technologies and services
        within operations. Our business model and marketing strategies anticipate
        such
        application and productivity, yet are unproven by a significant history of
        business operations. Failure to prove that our business model and strategies
        work through continued operations may have a material adverse effect on our
        business and financial condition.
  **3.
        We may require additional capital in the future, which may not be available
        to
        us.**
  We
        may
        need to raise additional funds through public or private debt or equity
        financing or other various means. Adequate funds may not be available when
        needed or may not be available on favorable terms. If we raise additional
        funds
        by issuing equity securities, dilution to existing stockholders will result,
        and
        such equity may have rights, preferences and privileges senior to those of
        our
        common stock. If we raise additional funds by issuing debt securities, we
        may be
        required to agree to covenants that may restrict our ability to expend or
        raise
        capital in the future. If funding is insufficient at any time in the future,
        we
        may be unable to fund acquisitions, take advantage of business opportunities
        or
        respond to competitive pressures. Failure to raise additional capital in
        the
        future may have a material adverse effect on our financial condition.
  **4.
        Our auditors have expressed doubt as to our ability to continue as a going
        concern.**
  As
        noted
        in the Independent Auditors Report (See Financial Note 2), our continued
        substantial operating losses raise substantial doubt as to our ability to
        continue as a going concern. We are in an early stage of development and
        are
        rapidly depleting our cash resources, therefore we have determined that we
        will
        need to raise additional financing in the short term to continue in operation
        and fund future growth. We incurred liquidated damages claimed by an investor
        of
        $500,000 related to the timing of providing registration rights for the private
        financing that it arranged in November 2003. We also have significant contingent
        liabilities, which may be determined adversely to us. If we are unable to
        raise
        additional financing to satisfy these obligations this would have a material
        adverse effect on our operations.
  We
        currently plan to raise additional financing. The use of stock for currency
        in
        financing or making acquisitions may be heavily curtailed while we are under
        SEC
        investigation. (See Financial Note 17) If we are unable to arrange new financing
        or generate sufficient revenue from new business arrangements, we will be
        unable
        to continue in our current form and will be forced to restructure or seek
        creditor protection.
  **5.
        We experienced operating losses in 2002, 2003 and 2004, and this trend may
        continue.**
  We
        suffered net losses of $3,128,782 for the year ended December 31, 2002,
        $7,356,045 for the year ended December 31, 2003, and $8,766,108 for the year
        ended December 31, 2004. The volatility underlying the early stage nature
        of our
        business and our industry prevents us from accurately predicting future
        operating conditions and results, and we could continue to have losses. It
        is
        uncertain when, if ever, we will have significant operating income or cash
        flow
        from operations sufficient to sustain operations. If cash needs exceed available
        resources, there can be no assurances that additional capital will be available
        through public or private equity or debt financings. Sustained losses will
        continue to have a material adverse effect on our business.
 
  22
  **6.
        Significant amounts of our outstanding common shares are restricted from
        immediate resale but may be available for resale into the market in the near
        future, possibly causing the market price of our common stock to drop
        significantly.**
  As
        of
        February 28, 2005, we had 34,973,673 shares of common stock issued, outstanding
        and held by 481 shareholders of record.
  As
        restrictions on resale for outstanding shares end, the market price could
        drop
        significantly if the holders of these restricted shares sell them or are
        perceived by the market as intending to sell them in an excessive amount
        relative to the market demand for our shares. An excessive sale of our shares
        may result in a material adverse effect on the price of our common stock,
        and
        our ability to raise capital.
  **7.
        One principal stockholder can influence the corporate and management policies
        of
        our company.**
  Berg
        McAfee Companies, and its affiliates, effectively control approximately 30%
        of
        the outstanding common stock. Therefore, Berg McAfee Companies, and its
        affiliates, may have the ability to substantially influence all decisions
        made
        by us. Additionally, Berg McAfee Companies, and its affiliates, control could
        have a negative impact on any future takeover attempts or other acquisition
        transactions. Furthermore, certain types of equity offerings require stockholder
        approval depending on the exchange on which shares of a company’s common stock
        is
  traded.
        In the event we are required to obtain stockholder approval of a financing,
        Berg
        McAfee Companies, and its affiliates ownership, could block such a financing.
        The control by one principal stockholder results in less control by our board
        of
        directors, management and the remaining stockholders. Please read ‘Certain
        Relationships and Related Transactions.’
  **8.
        We may sustain losses resulting from our extension of credit to non-paying
        customers.**
  We
        have,
        prior to February 2004, conducted much of our drilling activities for related
        parties, and we did not require collateral in support of our account
        receivables. This resulted, on occasion, in an impediment to us obtaining
        full
        payment for accounts receivable. Although we are implementing procedures
        to
        combat this credit risk, there can be no assurance that our efforts will
        be
        successful. Failure to guard against credit risk may have a material adverse
        effect on our financial condition.
  **9.
        Securities and Exchange Investigation Inquiries may continue to draw on our
        limited financial resources and continue to negatively impact our ability
        to
        raise additional capital.**
  We
        received notice that the Securities and Exchange Commission has initiated
        a
        formal investigation into our reporting practices and public statements about
        the company in 2003.
  The
        SEC
        has requested substantiation and documentary evidence from us concerning
        the
        performance of certain lateral drilling services by subcontractors in the
        period
        from May 2003 to September 2003, supervision of such services by our executive
        management at the time, revenue recognition related to the performance of
        such
        services, the third quarter 2003 earnings restatement, public statements
        concerning the services performed, and related matters. The SEC has also
        requested information and documentary evidence related to our acquisition
        of
        certain assets of QuikView, Inc., a related party company, in June 2003.
        In its
        letters to us requesting documents, the SEC stated that the staff’s inquiry
        should not be construed as an indication that any violations of securities
        laws
        have occurred or as an adverse reflection on any persons, company or security.
  Since
        December 2003, we have taken several steps to address issues related to the
        SEC’s inquiries, including the termination and replacement of the previous Chief
        Executive Officer and Chief Operating Officer. Two directors have resigned
        from
        our board and we have appointed a new CFO. Internal controls have been
        strengthened overall, particularly with respect to the public release of
        information and the recognition of revenue. We also initiated an internal
        investigation of the matters of concern to the SEC. Consequently, we restated
        our second and third quarter financial statements for 2003 and decided to
        defer
        all revenue related to the aforementioned period until such time that we
        can
        substantiate whether or not the services were performed.
  We
        are
        cooperating fully with the SEC, including the provision of numerous documents
        and voluntary testimony by our current executives. In December 2004, the
        staff
        of the SEC notified us that it was considering recommending that the SEC
        bring a
        civil injunction (including a possible permanent injunction and a civil penalty)
        against us alleging violations of provisions of the Sections 10(b), 13(b)(2)(A),
        13(b)(2)(B) and 15(d) of the Securities Exchange Act of 1934 and rules
        promulgated thereunder in connection with the purchase and sale of our
        securities, recordkeeping, internal controls, certification and disclosure
        obligations. We were notified of our right to make a Wells submission. We
        have
        provided information to the SEC setting forth the specific steps we have
        taken
        to upgrade the quality and effectiveness of our board of directors, replace
        the
        previous management team with industry experts, improve our recordkeeping,
        internal and disclosure controls, and revenue recognition procedures. Although
        we are working to bring the matter to a prompt conclusion, we cannot make
        any
        assurance that the investigation will be resolved positively or that it will
        not
        have negative effects on our limited resources or our ability to raise capital
        and use our stock as acquisition currency during the period of the
        investigation.
  23
  **10.
        We have entered into a settlement agreement relating to the litigation with
        Edge. If we do not perform certain obligations under the settlement agreement,
        the lawsuit could be reinstituted. An adverse finding the in the lawsuit
        would
        have a material adverse effect on our financial condition.**
  We
        initiated a lawsuit against Edge in Montgomery County, Texas in February
        2004
        that requested a declaratory judgment that a purported agreement between
        us and
        Edge was not enforceable. The lawsuit arose from Edge’s contention that one of
        our ex-officers committed the company to purchase certain alleged oil and
        gas
        properties from Edge. Edge filed a counterclaim against us and asserted claims
        against new parties including persons related to Edge’s financing source and
        current and our former officers and directors. Edge sought to enforce the
        agreement we challenge, and alleged several causes of action including claims
        for fraud, breach of contract, negligence, and conspiracy and claimed actual
        and
        punitive damages in excess of $85 million.
  Effective
        January 19, 2005, we, Edge, certain entities affiliated with Edge, and Eric
        McAfee (our former Vice-Chairman) entered into a Settlement Agreement and
        Mutual
        Release to fully settle and resolve the disputes between Edge and its affiliated
        entities, us and our directors, and Mr. McAfee. As part of the settlement,
        we
        issued to Edge Capital an aggregate of 750,000 shares of its common stock,
        along
        with warrants to purchase 750,000 shares of common stock. In addition, we
        also
        agreed to provide to Edge a drilling rig to provide certain lateral drilling
        services. As part of the drilling services, Edge has agreed to provide a
        fee per
        well, along with a share of the revenues generated from each well drilled.
        Also,
        as part of the settlement, at closing, we agreed to sublicense its Landers
        horizontal drilling technology to Edge on a non-exclusive basis to enable
        Edge
        to develop fields in which it has an economic interest. Under the sublicense,
        Edge will be prohibited from performing services for others, except that
        it will
        have a limited right of first refusal to perform such services in the event
        we
        elect to not perform such services. The sublicense will have a 5-year term
        and
        be limited to the United States and Canada. As part of the settlement, the
        parties to the agreement have agreed to a mutual release and have agreed
        to
        dismiss all pending claims and litigation between them upon performance of
        the
        obligations in the settlement agreement. If we do not perform our remaining
        obligations under the settlement agreement, this would cause the release
        to not
        be effective and could lead to the underlying lawsuit being reinstituted.
        An
        adverse finding in such lawsuit against us would have a material adverse
        effect
        on our financial condition. See “Legal Proceedings.”
  **11.
        We are subject to certain additional lawsuits. If these lawsuits are successful
        and substantial damages are awarded, these damages would have a material
        adverse
        effect on our financial condition.**
  In
        February 2005, we entered into an Agreed Judgment and Order of Severance
        with
        Gryphon as to all breach of contract claims related to our delay in registering
        common stock acquired by Gryphon in October 2003. Under the terms of the
        Agreed
        Judgment, we are obligated to pay liquidated damages and attorney fees of
        $500,000 to Gryphon on or before September 30, 2005. Additionally, Gryphon
        has
        agreed to abate their remaining claims and related discovery in the lawsuit
        against us until after September 30, 2005. We agreed to register the shares
        issued to Gryphon on or before March 2004 or be subject to certain liquidated
        damages. Gryphon made a claim against us for the maximum liquidated damages
        in
        an amount of $400,000. Gryphon has also claimed that it has sustained actual
        damages in excess of $6.2 million. In July 2004, Gryphon filed a lawsuit
        in
        state district court in Dallas, Texas against us, alleging, among other things,
        breach of contract and securities fraud by us. In connection with the lawsuit,
        Gryphon requested liquidated damages, actual damages, punitive damages,
        interest, cost and attorneys’ fees among other claims. We intend to vigorously
        defend ourselves in this matter with respect to the remaining claims of Gryphon.
  In
        July,
        2004 we were informed that our former Chief Executive Officer filed a lawsuit
        against us for breach of contract and wrongful discharge. These claims seek
        relief in excess of $500,000 related to an alleged employment agreement and
        damages related to an excess of 4 million stock options claimed due pursuant
        to
        the alleged agreement. The lawsuit was filed in state court in San Diego,
        California. We intend to vigorously defend ourselves.
  An
        adverse outcome in any of the above litigation would have a material adverse
        effective on our financial condition and result of operations. Please see
        the
        section ‘Legal Proceedings.’
 
 **12.
        Our common stock is currently traded over the counter on the Over-the-Counter
        market and is considered a “penny stock” resulting in potential illiquidity and
        high volatility in the market price of our common stock.**
  The
        market price of our common stock is likely to be highly volatile as is the
        stock
        market in general as well as the capital stock of most small cap companies.
        Our
        common stock currently trades over the counter on the OTC Bulletin Board,
        where
        stocks typically suffer from lower liquidity. This may lead to depressed
        trading
        prices, greater price volatility and difficulty in buying or selling shares
        in
        large quantities. Currently, there is a limited trading market for our common
        stock, and we cannot predict when, if ever, a fully developed public market
        for
        the common stock will occur.
  
 
 
 
  24
  **13.
        Because our common stock is considered a “penny stock,” certain rules may impede
        the development of increased trading activity and could affect the liquidity
        for
        stockholders.**
  Penny
        stocks generally are equity securities with a price of less than $5.00 per
        share
        other than securities registered on certain national securities exchanges
        or
        quoted on the NASDAQ stock market, subject to certain exceptions for companies
        which exceed certain minimum tangible net worth requirements.
  Our
        common stock is subject to the SEC’s “penny stock rules”. The rules impose
        additional sales practice requirements on broker-dealers who sell penny stock
        securities to persons other than established customers and accredited investors.
        For transactions covered by these rules, the broker-dealer must make a special
        suitability determination for the purchase of penny stock securities and
        have
        received the purchaser’s written consent to the transaction prior to the
        purchase. Additionally, for any transaction involving a penny stock, unless
        exempt, the “penny stock rules” require the delivery, prior to the transaction,
        of a disclosure schedule relating to the penny stock market. The broker-dealer
        also must disclose the commissions payable to both the broker-dealer and
        the
        registered representative and current quotations for the securities. And,
        monthly statements must be sent disclosing recent price information on the
        limited market in penny stocks. These rules may restrict the ability of
        broker-dealers to sell our securities and may have the effect of reducing
        the
        level of trading activity of our common stock in the secondary market. In
        addition, the penny-stock rules could have an adverse effect on our ability
        to
        raise capital in the future from offerings of our common stock.
  On
        January 12, 2004, the SEC proposed amendments to the penny stock rules to
        ensure
        that investors continue to receive the protections of those rules. The SEC
        also
        is proposing that broker-dealers be required to enhance their disclosure
        schedule to investors who purchase penny stocks, and that those investors
        have
        an explicit “cooling-off period” to rescind the transaction. These amendments
        could place further constraints on broker-dealers’ ability to sell our
        securities.
  **14.
        Our operations are subject to inherent risks that are beyond our control
        and
        these risks may not be fully covered under our insurance policies.**
  Our
        operations are subject to hazards inherent in the oil and gas industry, such
        as
        accidents, blowouts, explosions, craterings, fires and oil spills. These
        conditions can cause:
  •
              personal
                  injury or loss of life;
  •
              damage
                  to or destruction of property, equipment and the environment; and
  •
              suspension
                  of operations.
  In
        addition, claims for loss of oil and gas production and damage to formations
        can
        occur in the well service industry. Litigation arising from a catastrophic
        occurrence at a location where our equipment and services are being used
        may
        result in us being named as a defendant in lawsuits asserting large claims.
  We
        maintain insurance coverage that we believe to be customary in the industry
        against these hazards. However, we may not be able to maintain adequate
        insurance in the future at rates we consider reasonable. In addition, our
        insurance is subject to coverage limits and some policies exclude coverage
        for
        damages resulting from environmental contamination. The occurrence of a
        significant event or adverse claim in excess of the insurance coverage that
        we
        maintain or that is not covered by insurance could have a materially adverse
        effect on our financial condition and results of operations.
  **15.
        We are subject to various operational and performance risks related to projects
        that we undertake and services that we provide.**
  We
        are
        subject to various operational and performance risks related to projects
        that we
        undertake and services that we provide. These risks include:
  •
              changes
                  in the price or the availability of commodities that we use;
 
 •
              non-performance,
                  default or bankruptcy of key suppliers or subcontractors;
  •
              cost
                  over-runs and operating cost inflation resulting from fixed-price
                  projects; and
  •
              failure
                  by one or more parties to perform a complex business arrangement
                  for
                  technically demanding projects.
  Failure
        to guard against operational and performance risks may have a material adverse
        effect on our financial condition.
  25
  **16.
        Our markets may be adversely affected by oil and gas industry conditions
        that
        are beyond our control.**
  Oil
        and
        gas industry conditions are influenced by numerous factors over which we
        have no
        control, such as the supply of and demand for oil and gas, domestic and
        worldwide economic conditions, political instability in oil producing countries
        and merger and divestiture activity among oil and gas producers. Those
        conditions could adversely impact the level of drilling and workover activity
        by
        some of our customers. This reduction in activity may cause a decline in
        the
        demand for our services or adversely affect the price of our services. We
        cannot
        accurately predict either the future level of demand for our services or
        future
        conditions of the well service industry. A decline in the demand for our
        services may have a material adverse effect on our business.
  **17.
        Our success depends on key members of our management, the loss of whom could
        disrupt our business operations.**
  We
        depend
        to a large extent on the services of some of our executive officers and
        directors. The loss of the services of either John O’Keefe, or David Adams could
        disrupt our operations. We have entered into employment agreements with several
        of our key executives that contain non-compete provisions. Notwithstanding
        these
        agreements, we may not be able to retain our executive officers and may not
        be
        able to enforce the non-compete provisions in the employment agreements.
        Failure
        to retain key members of our management may have a material adverse effect
        on
        our business.
  **RISKS
        RELATED TO OUR ABRASIVE JETTING DRILLING BUSINESS**
  **1.
        We currently have no active customers and in the past were highly dependent
        on a
        small number of customers, two of whom are related parties.**
  We
        have
        no active customers for our abrasive jetting lateral drilling services since
        we
        are in the construction mode. We currently have only indications of interest
        in
        the new AFJ drill rig once it is placed into service. We can give no assurance
        that these indications of interest will turn into actual customers.
  In
        the
        past a relatively limited number of customers has accounted for a substantial
        portion of our revenue. One customer accounted for 14%, 38% and 87% of total
        revenues in 2004, 2003 and 2002, respectively. In the second half of 2003,
        53%
        of our revenue was derived from services provided to three customers. Of
        those
        three customers, two may be considered related parties. In the same period,
        52%
        of our revenue was derived from services provided to the two related parties.
        In
        addition, Edge, our only non-related customer in that period, has refused
        to pay
        for wells drilled in the second half of 2003, resulting in a total of $1,993,000
        being reversed or deferred.
  We
        expect
        that a high percentage of our revenue from our AFJ services will be provided
        by
        a limited number of customers for the near term or until we can deploy
        additional AFJ drill rigs.
  **2.
        We may not be able to protect our abrasive jetting lateral drilling technology
        which could result in competition with service providers utilizing an infringing
        technology.**
  The
        license agreement allocates responsibility in maintaining the status of the
        patents underlying the technology we license with the U.S. Patent and Trademark
        Office to the licensor. Although the licensor has performed this obligation
        in
        the past, there can be no assurance that the licensor will have the ability
        to
        continue to maintain the patents. In the event we had to assume these
        responsibilities additional pressure on our financial resources would result.
        An
        inability to continue operations under the exclusivity granted by the licensing
        agreement may have a material adverse effect on our business.
  **3.
        Our customers may not realize the expected benefits from our abrasive jetting
        lateral drilling technology, which may impair market acceptance of our lateral
        drilling services.**
  Our
        lateral drilling business is heavily dependent upon our clients achieving
        enhanced production, or lower costs, from certain types of existing oil and
        gas
        wells. Many of the wells for which the abrasive jetting lateral drilling
        technology will be used on have been abandoned for some time due to low
        production volumes or other reasons. In some cases, we have experienced
        difficulty in having the enhanced production reach the market due to the
        gathering field pipeline system’s disrepair resulting from the age of the fields
        and the reliability of the milling process. There can be no assurance that
        our
        abrasive jetting lateral drilling technology will achieve enhanced production
        from every well drilled, or that, if enhanced production is achieved initially,
        it will continue for the duration necessary to achieve payout or that it
        will
        reach the market on a timely basis. The failure to achieve projected
        enhancements could result in making the application of the technology uneconomic
        for our clients. Please see the section ‘Abrasive Jetting Lateral Drilling
        Services’ for an explanation on how we will attempt to achieve an economic
        benefit for our clients. Failure to achieve an economic benefit for our clients
        in the provision of this service may have a material adverse effect on our
        business.
 
  26
  **4.
        We may be unable to accurately identify oil and gas wells on which our abrasive
        jetting lateral drilling technology will enhance oil and gas recovery, which
        may
        impair the market acceptance of our lateral drilling services.**
  Our
        lateral drilling business is heavily dependent on our ability to correctly
        identify with our clients, the appropriate oil and gas wells that will produce
        the enhanced revenues or lower costs. Certain subsurface conditions are not
        conducive to the use of our high pressure abrasive jetting lateral drilling
        technology, and certain wells may have been severely depleted or otherwise
        negatively impacted in some manner by the operator. While we have added an
        evaluation screening technique and other new technology and improvements
        relating to analysis of depleted fields, the failure to identify the correct
        types of oil and gas wells could result in not realizing the expected economic
        returns which could initially have a material adverse effect on our business,
        financial condition and operating results.
  **5.
        Competition within the well service industry may adversely affect our ability
        to
        market our services.**
  The
        well
        service industry is highly competitive and includes several large companies,
        such as Halliburton, Baker Hughes, Schlumberger and other independent drilling
        companies that possess substantially greater financial and other resources
        than
        we do. These greater resources could allow those competitors to compete more
        effectively than we can. Additionally, the number of rigs available continues
        to
        exceed demand, resulting in active price competition. Moreover, many contracts
        are awarded on a bid basis, which further increases competition based on
        price.
        Failure to successfully compete within our industry may have a material adverse
        effect on our business.
  **6.
        We may be subject to environmental requirements which may increase our costs
        or
        liabilities related to our lateral drilling operations.**
  Given
        the
        manner in which we currently operate our business, we are not regulated to
        the
        extent that an oil and gas company is with respect to environmental laws,
        rules
        and regulations in the U.S. and other countries, including those covering
        hazardous materials, because we generally do not own the properties we service.
        However, environmental requirements generally are becoming increasingly strict.
        In the future, we may be held liable for certain failures relating to
        environmental regulations. Sanctions for failure to comply with these
        requirements, many of which may be applied retroactively, may include:
  •
              administrative,
                  civil and criminal penalties;
  •
              revocation
                  of permits; and
  •
              corrective
                  action orders, including orders to investigate and/or clean up
                  contamination.
  Liability
        for damages arising as a result of environmental laws could be substantial
        and
        could have a material adverse effect on our results of operations. The
        liabilities incurred as a result of complying with environmental requirements
        or
        failure on our part to comply with applicable environmental requirements
        may
        have a material adverse effect on our financial condition. There can be no
        assurance that governmental laws will not broaden in scope in the future
        to
        cover the types of services that we currently provide. Failure to comply
        with
        environmental laws could have a material negative impact on our financial
        condition.
  **7.
        Changes in environmental laws may decrease demand for our services.**
  Changes
        in environmental laws may negatively impact demand for our services. Activity
        by
        oil and gas exploration and production companies may decline if, for example,
        the Environmental Protection Agency promulgates more stringent environmental
        regulations such as land use policies. If oil and gas exploration and production
        activities decline, this could have a material adverse effect on our operating
        results.
 
 **RISKS
        RELATED TO OUR SATELLITE BUSINESS**
  **1.
        We are highly dependent upon a few key providers who furnish satellite
        networking components, hardware, and technological services.**
  Our
        satellite business is heavily dependent on agreements with Spacenet, ViaSat
        and
        other equipment and service providers. These strategic relationships provide
        key
        network technology, satellite data transport, hardware and software. Failure
        of
        Spacenet, ViaSat or other key relationships to meet our expectations or
        termination of a relationship with one of our key providers may have a material
        adverse effect on our business.
  
 
  27
  **2.
        We depend upon our vendors and their affiliates to provide services that
        we
        require to operate the network we use to provide services to our customers.**
  We
        are
        not and do not plan to become a licensee of the Federal Communications
        Commission (“FCC”) and do not hold any authorization to operate satellite
        communications facilities. We depend upon licenses held by Spacenet and ViaSat
        and their subsidiaries for our satellite communications. If the licenses
        held by
        Spacenet and ViaSat are limited or revoked, if the FCC limits the number
        of its
        customer premises earth stations or if Spacenet or ViaSat fails to operate
        the
        earth stations providing service to us and our subscribers in a satisfactory
        manner, our operating results may be materially adversely affected.
  **3.
        We rely on third-party independent contractors to install our customer premises
        equipment at new subscribers’ businesses and homes.**
  We
        do not
        control the hiring, training, certification and monitoring of the employees
        of
        our third-party independent contractors. If growth of our new subscriber
        base
        outpaces growth of our installer base or if the installers fail to provide
        the
        quality of service that our customers expect, our operating results may be
        materially adversely affected.
  **4.
        The service we provide is entirely dependent on the functionality of satellites
        on which we lease transponders and on our computer and communications hardware
        and software.**
  Our
        ability to provide service is entirely dependent on the functionality of
        satellites on which we lease transponders. These satellites may experience
        failure, loss, damage or destruction from a variety of causes, including
        war,
        anti-satellite devices and collision with space debris. If this occurs, we
        are
        likely to suffer:
  •
              permanent
                  loss of service;
  •
              temporary
                  gaps in service availability; or
  •
              decreased
                  quality of service.
  Such
        a
        failure in the service we provide may have a material adverse effect on our
        business, financial condition and operating results.
  The
        ability to provide timely information and services depends also on the efficient
        and uninterrupted operation of our computer and communications hardware and
        software systems. These systems and operations are vulnerable to damage or
        interruption from human error, natural disasters, telecommunication failures,
        break-ins, sabotage, computer viruses, intentional acts of vandalism and
        similar
        events. We are in the process of designing and plan to implement a disaster
        recovery plan. Despite precautions, there is always the danger that human
        error
        or sabotage could substantially disrupt the system. Any such failure may
        have a
        material adverse effect on our business.
  **5.
        We may be unable to attract or retain subscribers.**
  If
        we are
        unable to attract or retain subscribers, our telecommunications business
        will be
        harmed. Our success depends upon our ability to rapidly grow our subscriber
        base. Several factors may negatively impact this ability, including:
  •
              loss
                  of our existing sales employees, resulting in our lack of access
                  to
                  potential subscribers;
  •
              failure
                  to establish and maintain the Verdisys brand through advertising
                  and
                  marketing, or erosion of our brand due to misjudgments in service
                  offerings;
  •
              failure
                  to develop or acquire technology for additional value added services
                  that
                  appeals to the evolving preferences of our subscribers;
  •
              failure
                  to meet our expected minimum sales commitments to Spacenet and
                  ViaSat; and
 
 •
              failure
                  to provide the minimum transmission speeds and quality of service
                  our
                  customers expect.
  In
        addition, our service may require customers to purchase our satellite system
        equipment and to pay our monthly subscriber fees. The price of the equipment
        and
        the subscription fees may be higher than the price of many dial-up, DSL and
        cable modem internet access services, where available. In some instances,
        we
        expect to subsidize our subscribers’ customer premises equipment to encourage
        the purchase of our service and to offset our higher relative costs but such
        subsidy may not be possible. Failure to attract or retain subscribers may
        have a
        material adverse effect on our business.
  28
  **6.
        We may fail to manage any potential growth or expansion, negatively impacting
        our quality of service or overcapacity impacting profitability.**
  If
        we
        fail to manage our potential rapid growth and expansion effectively or expand
        and allocate our resources efficiently, we may not be able to retain or grow
        our
        subscriber base. If our assumptions regarding the usage patterns of our
        subscribers are wrong or if our subscribers’ usage patterns change, we will have
        either too little or too much satellite capacity, both of which could harm
        our
        business.
  If
        we
        achieve the substantial subscriber growth that we anticipate, we will need
        to
        procure additional satellite capacity. If we are unable to procure this
        capacity, we may be unable to provide service to our subscribers or the quality
        of service we provide may not meet their expectations. Failure to manage
        any
        potential growth may have a material adverse effect on our business.
  **7.
        Our current services may become obsolete due to the highly competitive and
        continued advancement of the satellite industry. Larger service providers
        may
        provide services reduced pricing.**
  Intense
        competition in the internet services market and inherent limitations in existing
        satellite technology may negatively affect the number of our subscribers.
        Competition in the market for consumer internet access services is intense,
        and
        we expect the level of competition to intensify in the future. We compete
        with
        providers of various high-speed communications technologies for local access
        connections such as cable modem and DSL. We also may face competition from
        traditional telephone companies, competitive local exchange carriers and
        wireless communication companies. As our competitors expand their operations
        to
        offer high speed internet services, we may no longer be the only high-speed
        service available in certain markets. We also expect additional competitors
        with
        satellite-based networks to begin operations soon. In particular, some satellite
        companies have announced that in the future they may offer high-speed internet
        service at the same price or at a lower price than we currently intend to
        offer
        and are offering our services. Many of our current and potential competitors
        have longer operating histories, greater brand name recognition, larger
        subscriber bases and substantially greater financial, technical, marketing
        and
        other resources than we have. Therefore, they may be able to respond more
        quickly than we can respond to new or changing opportunities, technologies,
        standards or subscriber requirements. Any such competition may have a material
        adverse effect on our business.
  **8.
        We may be mistaken in our belief as to future growth of the satellite broadband
        market.**
  While
        we
        believe that the trend toward satellite broadband information services in
        the
        energy market will continue to develop, our future success is highly dependent
        on increased use of these services within the sector. The number of satellite
        broadband users willing to pay for online services and information may not
        continue to increase. A failure in the market for satellite broadband services
        to develop as expected may have a material adverse effect on our business.
  **9.
        We may be subject to significant liability for our products.**
  If
        our
        products contain defects, we may be subject to significant liability claims
        from
        subscribers and other users of our products and incur significant unexpected
        expenses or lost revenues. Our telecommunications products are complex and
        may
        contain undetected errors or failures. If this happens, we may experience
        delay
        in or loss of market acceptance and sales, products returns, diversion of
        research and development resources, injury to our reputation or increased
        service and warranty costs. We also have exposure to significant liability
        claims from our customers because our products are designed to provide critical
        communications services. Although we attempt to limit such exposure through
        product liability insurance and through contractual limitations in our customer
        agreements, such precautions may not cover all potential claims resulting
        from a
        defect in one or more of our products. Failure of our products to perform
        satisfactorily may have a material adverse effect on our operating results.
  **Critical
        Accounting Policies**
  The
        following is a discussion of our critical accounting policies pertaining
        to
        accounts receivable, equipment, license, revenue recognition and the use
        of
        estimates.
 
 *Accounts
        Receivable*
  Trade
        accounts receivable are recorded at the invoiced amount and do not bear
        interest. The allowance for doubtful accounts represents our estimate of
        the
        amount of probable credit losses existing in our accounts receivable. We
        determine the allowance based on management’s estimate of likely losses based on
        a review of current open receivables and our historical write-off experience.
        We
        review the adequacy of our allowance for doubtful accounts quarterly.
        Significant individual accounts receivable balances and balances which have
        been
        outstanding greater than 90 days are reviewed individually for collectibility.
        Account balances, when determined to be uncollectible, are charged against
        the
        allowance.
 
  29
  *Equipment*
  Equipment,
        including betterments which extend the useful life of the asset, are stated
        at
        cost. Maintenance and repairs are charged to expense when incurred. We provided
        for the depreciation of our equipment using the straight-line method over
        the
        estimated useful lives. Our method of depreciation does not change when
        equipment becomes idle; we continue to depreciate idled equipment on a
        straight-line basis. No provision for salvage value is considered in determining
        depreciation of our equipment. We review our assets for impairment when events
        or changes in circumstances indicate that the carrying values of certain
        assets
        either exceed their respective fair values or may not be recovered over their
        estimated remaining useful lives. Provisions for asset impairment are charged
        to
        income when estimated future cash flows, on an undiscounted basis, are less
        than
        the asset’s net book value. Impairment charges are recorded based on discounted
        cash flows. There were no impairment charges to equipment during the years
        ended
        December 31, 2004 and 2003.
  *License*
  In
        March
        2005, we entered into an agreement to sell our lateral drilling license for
        $1.3
        million and have fully impaired the asset while creating an account receivable
        for the sales value. We provide for amortization of our license using the
        straight-line method over the estimated useful lives. We review our carrying
        value of the license for impairment on an annual basis or when events or
        changes
        in circumstances indicate that the carrying values may no longer be appropriate.
        We assess recoverability of the carrying value of the asset by estimating
        the
        future net cash flows expected to result from the asset, including eventual
        disposition. If the future net cash flows are less than the carrying value
        of
        the asset, an impairment loss is recorded equal to the difference between
        the
        asset’s carrying value and fair value. There were no impairment charges to the
        lateral drilling license during the years ended December 31, 2003 but we
        charged
        $3.2 million to impairment expense at December 31, 2004.
  *Revenue
        Recognition*
  All
        revenue is recognized when persuasive evidence of an arrangement exists,
        the
        service or sale is complete, the price is fixed or determinable and
        collectibility is reasonably assured. Revenue is derived from sales of satellite
        hardware, satellite bandwidth, satellite service and lateral drilling services.
        Revenue from satellite hardware is recognized when the hardware is installed.
        Revenue from satellite bandwidth is recognized evenly over the term of the
        contract. Revenue from satellite service is recognized when the services
        are
        performed. We provide no warranty but sell commercially obtained 3 to 12
        month
        warranties for satellite hardware. We have a 30 day return policy. Revenue
        for
        lateral drilling services is recognized when the services are performed and
        collectibility is reasonably assured and when collection is uncertain, revenue
        is recognized when cash is collected. In accordance with Emerging Issues
        Task
        Force Issue No. 00-14, we recognize reimbursements received from third parties
        for out-of-pocket expenses incurred as revenues and account for out-of-pocket
        expenses as direct costs.
  *Use
        of Estimates*
  The
        preparation of financial statements in conformity with accounting principles
        generally accepted in the United States of America requires management to
        make
        certain estimates and assumptions that affect the reported amounts of assets
        and
        liabilities and disclosures of contingent assets during the reporting period.
        Actual results could differ from such estimates.
  Estimates
        are used by management in the following financial reporting areas:
  •
              Allowance
                  for doubtful accounts,
  •
              Depreciation
                  and amortization,
  •
              Asset
                  impairment,
  •
              Income
                  taxes and
 
 •
              Stock
                  option disclosures.
  For
        additional information on our accounting policies, see Note 1 of Notes to
        Financial Statements included as part of Item 7 of this Report.
   30
  **Fiscal
        Year ended December 31, 2004 Compared to the Fiscal Year Ended December 31,
        2003**
  *Lateral
        Drilling Services*
  Lateral
        Drilling Services’ revenues increased by $273,000 to $739,000 for the year ended
        December 31, 2004 compared to $466,000 for the year ended December 31, 2003.
        The
        operating margin from Lateral Drilling Services improved by $419,000 to a
        loss
        of $129,000 for the year ended December 31, 2004 compared to a loss of $548,000
        for the year ended December 31, 2003. We have had mixed results using the
        Landers technology and therefore have been unable to generate a profit during
        either year. The 2003 results were also negatively affected by the initial
        start-up costs of the lateral drilling service.
  Effective
        as of October 27, 2004, we entered into a licensing agreement to develop
        a new
        generation of lateral drilling technology using the AFJ process. In the short
        term, the development activity will decrease lateral drilling revenues until
        such time as the new technology rigs are deployed into commercial operations.
  *Satellite
        Communications Services*
  Satellite
        Communication Services’ revenues increased by $296,000 to $715,000 for the year
        ended December 31, 2004 compared to $419,000 for the year ended December
        31,
        2003. The operating margin from Satellite Communication Services improved
        by
        $163,000 to a loss of $6,000 for the year ended December 31, 2004 compared
        to a
        loss of $169,000 for the year ended December 31, 2003. As this segment of
        our
        business grows it becomes more efficient and realizes economies of scale.
  As
        hardware is sold, we recognize the revenue in the period it is delivered
        to the
        customer. We bill some of our bandwidth contracts in advance, but recognize
        revenue over the period benefited. At December 31, 2004, there was $317,615
        reflected in the balance sheet as deferred revenue relating to Satellite
        Communication Services.
  *Selling,
        General and Administrative*
  Selling,
        general and administrative (“SG&A”) expenses decreased by $1.9 million to
        $4.7 million for the year ended December 31, 2004 compared to $6.6 million
        for
        the year ended December 31, 2003. The following table details the major
        components of SG&A expense over the periods.
  **2004**
              
              **2003**
              
              **Increase**
                **(Decrease)**Payroll
                  and related costs
              
              $
              773,538
              
              $
              828,117
              
              $
              (54,579
              )Option
                  and warrant expense
              
              
              747,480
              
              
              2,392,291
              
              
              (1,644,811
              )License
                  fee
              
              
              735,192
              
              
              —
              
              
              735,192Legal
                  fees
              
              
              718,678
              
              
              518,077
              
              
              200,601External
                  services
              
              
              567,883
              
              
              446,606
              
              
              121,277Insurance
              
              
              447,109
              
              
              157,254
              
              
              289,855Liquidated
                  damages
              
              
              500,000
              
              
              —
              
              
              500,000Travel
                  & entertainment
              
              
              139,627
              
              
              193,393
              
              
              (53,766
              )Office
                  rent
              
              
              66,777
              
              
              42,325
              
              
              24,452Communications
              
              
              55,842
              
              
              60,935
              
              
              (5,093
              )Expired
                  purchase option
              
              
              —
              
              
              620,000
              
              
              (620,000
              )Purchase
                  guarantee
              
              
              —
              
              
              300,000
              
              
              (300,000
              )Impairment
                  on software
              
              
              —
              
              
              1,000,000
              
              
              (1,000,000
              )Miscellaneous
              
              
              265
              
              
              55,541
              
              
              (55,276
              )$
              4,752,391
              
              $
              6,614,539
              
              $
              (1,862,148
              )
   31
  The
        decrease in option and warrant expense can be attributed to the fact that
        in
        2004, we started issuing options at market price and therefore recognized
        no
        expense under our accounting policy (see Financial Note 14). The license
        fee is
        related to the lateral drilling license and note payable with Carl Landers.
        We
        issued 300,000 shares of our common stock with a value of $1.9 million to
        reduce
        the then outstanding note balance by $1.2 million and record expense of $0.7
        million. Legal fees continue to increase due to the level of legal activity
        we
        have experienced over the last two years. Our external services have increased
        due to greater reliance on independent contractors instead of employees and
        rising audit fees. The increase in the cost of insurance was primarily
        attributable to the increase in the directors and officers liability policy
        premium due to legal activity. The liquidated damages relate to our delay
        in
        registering shares that we sold (see Financial Note 13). In 2003, we paid
        $0.5
        million for a sixteen day option to purchase a large gas field with significant
        gas production. The purchase option expired and we incurred additional fees
        of
        $120,000 related to the transaction. In 2003, we guaranteed Edge’s purchase of
        oil and gas properties from another entity (see Financial Note 17). In 2003,
        we
        issued 2 million shares of common stock for what management believed was
        satellite communications management software pursuant to an asset purchase
        agreement with a related party. Subsequently, management determined that
        the
        software was impaired by $1.0 million.
 
 *Depreciation
        and Amortization*
  Depreciation
        and amortization expense increased by $293,000 to $0.5 million for the year
        ended December 31, 2004 compared to $220,000 for the year ended December
        31,
        2003. This increase can be attributed to the depreciation on the four drilling
        rigs in service for 2004, compared to only two rigs in service for three
        months
        of 2003 and the amortization on the drilling license acquired in late 2003.
  *Debt
        Forgiveness Income*
  In
        2003,
        we negotiated settlements with 9 vendors for various debts originally recorded
        on the books at $0.5 million for $44,000 cash and 33,333 shares of stock
        valued
        at $.50 resulting in debt forgiveness income of $460,000. There was no similar
        event in 2004.
  *Gain
        or Loss on Sale of Property*
  In
        2004,
        we had a net loss from the sale and or disposition of equipment in the normal
        course of business of $11,000. In 2003, we recognized a gain of $120,000
        from
        the assignment of a 75% net revenue interest in property located in Monroe,
        Louisiana. We received the net revenue interest from a third party in exchange
        for agreeing to perform lateral drilling services on the property. In October
        2003, we assigned the net revenue interest to Edge for $200,000. Edge paid
        us
        $120,000 and agreed to pay the balance of $80,000 by March 31, 2004. The
        $80,000
        was not collected and under terms of the Settlement Agreement and Mutual
        Release
        entered into with Edge, we have relinquished our right to these funds (See
        Item
        3. Legal Proceedings).
  *Asset
        Impairment Expense*
 We
        charged $3,175,000 to impairment expense at December 31, 2004 to recognize
        the
        difference in the carrying value and the market price when we entered into
        the
        sale of the Landers license to Maxim for $1.3 million.
 
 *Interest
        Expense*
  Interest
        expense decreased by $108,000 to $105,000 for the year ended December 31,
        2004
        compared to $213,000 for the year ended December 31, 2003. The decrease in
        expense can be attributed to an average debt outstanding for the year ended
        December 31, 2004 of approximately $0.7 million compared to average debt
        outstanding of approximately $1.9 million for the year ended December 31,
        2003.
  *Net
        Loss*
  The
        net
        loss for the year ended December 31, 2004 increased to $8.8 million from
        $7.4
        million for the year ended December 31, 2003. The increase is attributable
        to
        the major items explained above. The tax benefit associated with our loss
        has
        been fully reserved as we have recurring net losses and it is more likely
        than
        not that tax benefits will not be realized.
  **Liquidity
        and Capital Resources**
  As
        of
        December 31, 2004 and 2003, our cash balance was $267,000 and $1.4 million,
        respectively. The cash balance at December 31, 2003 was generated by an equity
        offering and was utilized to pay debt and to fund operations. We have $185,000
        of debt that becomes due on May 14, 2005, $350,000 of convertible notes that
        becomes due on December 31, 2005 and a $50,000 note that is due on demand.
        In
        addition, we have $200,000 of convertible notes with related parties that
        mature
        on May 31, 2006. Both sets of convertible notes are convertible into common
        stock at the rate of one share for each $2.00 of principal and interest
        outstanding.
   32
  In
        February 2005, we entered into an Agreed Judgment and Order of Severance
        with
        Gryphon as to all breach of contract claims related to our delay in registering
        common stock acquired by Gryphon in October 2003. Under the terms of the
        Agreed
        Judgment, we are obligated to pay liquidated damages of $0.5 million to Gryphon
        on or before September 30, 2005. In March 2005, we agreed to sell our master
        license for the Landers lateral drilling technology and retain a sub-license
        for
        $1.3 million in cash and the release of $270,000 of supplier obligations.
        The
        1.3 million will be collected over the course of 2005.
 
 We
        are
        also subject to significant contingent liabilities as more fully described
        in
        the Notes to the Financial Statements (See Financial Note 17).
  As
        noted
        in the Independent Auditors Report (See Financial Note 2) due to the continued
        substantial operating losses that we have incurred raises substantial doubt
        as
        to our ability to continue as a going concern. We are in an early stage of
        development and are rapidly depleting our cash resources, therefore we have
        determined that we will need to raise additional financing in the short term
        to
        continue in operation and fund future growth. We currently plan to raise
        additional financing in the quarter ending March 31, 2005. The use of stock
        for
        currency in financing or making acquisitions has been heavily curtailed while
        we
        have been under SEC investigation. (See Financial Note 17) If we are unable
        to
        arrange new financing or generate sufficient revenue from new business
        arrangements, we will be unable to continue in our current form and will
        be
        forced to restructure or seek creditor protection.
  **Capital
        Expenditures**
  We
        expect
        to spend approximately one million dollars in 2005 for the building of the
        first
        rig utilizing the AFJ cutting technology. As of December 31, 2004, we had
        no
        commitments towards this project. The project will be financed either through
        the issuance of stock, debt, project equity or from the proceeds of the license
        sold in March of 2005. Capital expenditures for 2004 were $3,705 as compared
        to
        $799,493 from 2003. Capital expenditures for 2003 include the purchase of
        four
        drilling rigs for $737,720.
  **Research
        and Development, Patents and Licenses**
  We
        believe our future success depends on the ability to effectively utilize
        the
        lateral drilling technology obtained in a license granted by Mr. Landers
        and the
        AFJ technology currently under development. See “Patents and Licenses” in the
        Description of Business section of this Form 10-KSB.
   33
  **Item
        7. Financial Statements**
  **Index
        to Financial Statements**
  **Page**Report
                  of Independent Registered Public Accounting Firm
              35Balance
                  Sheet at December 31, 2004
              36Statements
                  of Operations Years ended December 31, 2004 and 2003
              37Statements
                  of Stockholders’ Equity Years ended December 31, 2004 and 2003
              38Statements
                  of Cash Flows Years ended December 31, 2004 and 2003
              40Notes
                  to Financial Statements
              41 -
                  57
  
  34
   
 
 **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
  To
        the
        Board of Directors
 Verdisys,
        Inc.
 Houston,
        Texas
  We
        have
        audited the accompanying balance sheet of Verdisys, Inc. as of December 31,
        2004
        and the related statements of operations, stockholders’ equity (deficit) and
        cash flows for each of the two years then ended. These financial statements
        are
        the responsibility of Verdisys’ management. Our responsibility is to express an
        opinion on these financial statements based on our audits.
  We
        conducted our audits in accordance with standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audits to obtain reasonable assurance about whether the
        financial statements are free of material misstatement. An audit includes
        examining, on a test basis, evidence supporting the amounts and disclosures
        in
        the financial statements. An audit also includes assessing the accounting
        principles used and significant estimates made by management, as well as
        evaluating the overall financial statement presentation. We believe that
        our
        audits provide a reasonable basis for our opinion.
  In
        our
        opinion, the financial statements referred to above present fairly, in all
        material respects, the financial position of Verdisys, Inc. as of December
        31,
        2004 and the results of its operations and cash flows for each of the two
        years
        then ended in conformity with accounting principles generally accepted in
        the
        United States of America.
  The
        accompanying financial statements have been prepared assuming that Verdisys
        will
        continue as a going concern. As discussed in Note 2 to the financial statements,
        Verdisys suffered recurring losses from operations and has a working capital
        deficiency, which raises substantial doubt about its ability to continue
        as a
        going concern. Management’s plans regarding those matters also are described in
        Note 2. The financial statements do not include any adjustments that might
        result from the outcome of this uncertainty.
  As
        described in Note 23, the accompanying financial statements as of December
        31,
        2004 and the year then ended have been restated to reflect the impairment
        of the
        carrying value of the Company's intellectual property as of December 31,
        2004.
  MALONE
        & BAILEY, PC
  www.malone-bailey.com
  Houston,
        Texas
  March
        21,
        2005 (March 29, 2006 as to the effects of the restatement as described in
        Note
        23)
  
  35
   
 **VERDISYS,
        INC.**
 BALANCE
        SHEET
 December
        31, 2004
  **ASSETS**
              
              (Restated)Current
                  AssetsCash
              
              $
              266,917Accounts
                  receivable, net of allowance for doubtful accounts of
                  $30,000
              
              
              58,726Lease
                  receivable
              
              
              125,000License
                  receivable
              
              
              1,300,000Other
                  current assets
              
              
              44,076Total
                  Current Assets
              
              
              1,794,719Equipment,
                  net of accumulated depreciation of $130,467
              
              
              447,401License,
                  net of accumulated amortization of $549,167
              
              
              -Total
                  Assets
              
              $
              2,242,120**LIABILITIES
                  AND STOCKHOLDERS’ DEFICIT**Current
                  LiabilitiesAccounts
                  payable
              
              $
              738,442Accrued
                  expenses
              
              
              1,270,732Deferred
                  revenue
              
              
              254,726Customer
                  deposit
              
              
              276,850Notes
                  payable - related parties, net of unamortized discount of
                  $7,674
              
              
              102,326Notes
                  payable, net of unamortized discount of $74,148
              
              
              400,852Total
                  Current Liabilities
              
              
              3,043,928Long
                  Term LiabilitiesNotes
                  payable - related parties, net of unamortized discount of
                  $50,622
              
              
              149,378Deferred
                  revenue, less current portion
              
              
              81,878Total
                  Liabilities
              
              
              3,275,184Commitments
                  & ContingenciesStockholders’
                  DeficitCommon
                  Stock, $.001 par value, 50,000,000 shares authorized, 33,443,691
                  shares
                  issued and outstanding
              
              
              33,444Additional
                  paid-in capital
              
              
              26,000,119Accumulated
                  deficit
              
              
              (27,066,627
              )Total
                  Stockholders’ Deficit
              
              
              (1,033,064
              )Total
                  Liabilities and Stockholders’ Deficit
              
              $
              2,242,120
  See
        accompanying summary of accounting policies and notes to financial
        statements.
  
  36
   
 **VERDISYS,
        INC.**
 STATEMENTS
        OF OPERATIONS
 Years
        Ended December 31, 2004 and 2003
  **2004**
              
              **2003****Revenue**
              
              (Restated)Satellite
                  Service - third parties
              
              $
              714,634
              
              $
              419,247Drilling
                  ServicesThird
                  parties
              
              
              716,163
              
              
              7,444Related
                  parties
              
              
              22,547
              
              
              458,750Total
                  Revenue
              
              
              1,453,344
              
              
              885,441**Cost
                  of Services Provided**Satellite
                  ServicesThird
                  parties
              
              
              720,912
              
              
              588,498Drilling
                  ServicesThird
                  parties
              
              
              868,160
              
              
              787,560Related
                  parties
              
              
              —
              
              
              226,611Total
                  Cost of Services Provided
              
              
              1,589,072
              
              
              1,602,669**Gross
                  Loss**
              
              
              (135,728
              )
              
              (717,228
              )**Operating
                  Expenses**Selling,
                  general & administrative
              
              
              4,752,391
              
              
              6,614,539Depreciation
                  and amortization
              
              
              512,706
              
              
              219,692Bad
                  debts
              
              
              73,249
              
              
              172,003Asset
                  Impairment
              
              
              3,175,833
              
              
              —**Operating
                  Loss**
              
              
              (8,649,907
              )
              
              (7,723,462
              )**Other
                  (Income) Expense**Debt
                  forgiveness income
              
              
              —
              
              
              (460,235
              )Loss
                  (gain) on sale of property
              
              
              11,237
              
              
              (120,000
              )Interest
                  income
              
              
              (89
              )
              
              (417
              )Interest
                  expense
              
              
              105,053
              
              
              213,235Total
                  other (income) expense
              
              
              116,201
              
              
              (367,417
              )**Net
                  Loss**
              
              $
              (8,766,108
              )
              $
              (7,356,045
              )Basic
                  and diluted net loss per share
              
              $
              (.28
              )
              $
              (.33
              )Weighted
                  average shares outstanding
              
              
              31,415,041
              
              
              22,180,185
  See
        accompanying summary of accounting policies and notes to financial
        statements.
  
  37
   
 **VERDISYS,
        INC.**
 STATEMENT
        OF STOCKHOLDERS’ EQUITY (DEFICIT)
 Years
        Ended December 31, 2003 and 2004 (Restated)
  **Preferred
                  Stock**
              
              **Common
                  Stock****Shares**
              
              **Amount**
              
              **Shares**
              
              **Amount**Balances,
                  December 31, 2002
              
              
              1,410,000
              
              $
              705,000
              
              
              13,553,139
              
              $
              13,553Series
                  B preferred stock exchanged for common stock
              
              
              (1,410,000
              )
              
              (705,000
              )
              
              1,410,000
              
              
              1,410Stock
                  issued for:Cash,
                  net of fundraising costs
              
              
              
              
              
              
              
              
              2,740,733
              
              
              2,741Services
              
              
              
              
              
              
              
              
              4,679,194
              
              
              4,679Accounts
                  payable
              
              
              
              
              
              
              
              
              33,333
              
              
              33Notes
                  payable and accrued interest
              
              
              
              
              
              
              
              
              2,890,688
              
              
              2,891Cash
                  exercise of warrants and options
              
              
              
              
              
              
              
              
              1,995,178
              
              
              1,995Cashless
                  exercise of warrants for note payment
              
              
              
              
              
              
              
              
              200,000
              
              
              200Note
                  payment on lease
              
              
              
              
              
              
              
              
              125,000
              
              
              125Reduction
                  of royalty
              
              
              
              
              
              
              
              
              500,000
              
              
              500RDGI
                  merger
              
              
              
              
              
              
              
              
              1,500,000
              
              
              1,500Fair
                  value of options and warrants issued for servicesContribution
                  to capitalNet
                  lossBalances,
                  December 31, 2003
              
              
              —
              
              
              —
              
              
              29,627,265
              
              
              29,627Stock
                  issued for:Cash,
                  net of fundraising costs
              
              
              
              
              
              
              
              
              829,500
              
              
              830Services
              
              
              
              
              
              
              
              
              47,950
              
              
              48Accounts
                  payable
              
              
              
              
              
              
              
              
              104,000
              
              
              104Notes
                  payable, accrued interest and licensing fees
              
              
              
              
              
              
              
              
              300,000
              
              
              300Cash
                  exercise of warrants and options
              
              
              
              
              
              
              
              
              1,207,198
              
              
              1,207Prior
                  fundraising agreement
              
              
              
              
              
              
              
              
              277,778
              
              
              278Lawsuit
                  settlements
              
              
              
              
              
              
              
              
              1,050,000
              
              
              1,050Fair
                  value of options and warrants issued for servicesNet
                  LossBalances,
                  December 31, 2004
              
              
              —
              
              $
              —
              
              
              33,443,691
              
              $
              33,444
  
  38
   
 **VERDISYS,
        INC.**
 STATEMENT
        OF STOCKHOLDERS’ EQUITY (DEFICIT)
 Years
        Ended December 31, 2003 and 2004 (Restated)
  **Paid-In**
                **Capital**
              
              **Retained**
                **Deficit**
              
              **Totals**Balances,
                  December 31, 2002
              
              $
              6,098,924
              
              $
              (10,944,474
              )
              $
              (4,126,997
              )Series
                  B preferred stock exchanged for common stock
              
              
              703,590Stock
                  issued for:Cash,
                  net of fundraising costs
              
              
              6,559,409
              
              
              
              
              
              6,562,150Services
              
              
              1,619,660
              
              
              
              
              
              1,624,339Accounts
                  payable
              
              
              16,633
              
              
              
              
              
              16,666Notes
                  payable and accrued interest
              
              
              1,503,299
              
              
              
              
              
              1,506,190Cash
                  exercise of warrants and options
              
              
              366,820
              
              
              
              
              
              368,815Cashless
                  exercise of warrants for note payment
              
              
              19,800
              
              
              
              
              
              20,000Note
                  payment on lease
              
              
              249,875
              
              
              
              
              
              250,000Reduction
                  of royalty
              
              
              2,274,500
              
              
              
              
              
              2,275,000RDGI
                  merger
              
              
              (1,500
              )
              
              
              
              
              —Fair
                  value of options and warrants issued for services
              
              
              1,844,311
              
              
              
              
              
              1,844,311Contribution
                  to capital
              
              
              488,000
              
              
              
              
              
              488,000Net
                  loss
              
              
              
              
              
              (7,356,045
              )
              
              (7,356,045
              )Balances,
                  December 31, 2003
              
              
              21,743,321
              
              
              (18,300,519
              )
              
              3,472,429Stock
                  issued for:Cash,
                  net of fundraising costs
              
              
              633,170
              
              
              
              
              
              634,000Services
              
              
              (48
              )
              
              
              
              
              —Accounts
                  payable
              
              
              51,873
              
              
              
              
              
              51,977Notes
                  payable, accrued interest and licensing fees
              
              
              1,919,700
              
              
              
              
              
              1,920,000Cash
                  exercise of warrants and options
              
              
              80,010
              
              
              
              
              
              81,217Prior
                  fundraising agreement
              
              
              (278
              )
              
              
              
              
              —Lawsuit
                  settlements
              
              
              836,950
              
              
              
              
              
              838,000Fair
                  value of options and warrants issued for services
              
              
              735,421
              
              
              
              
              
              735,421Net
                  Loss
              
              
              
              
              
              (8,766,108
              )
              
              (8,766,108
              )Balances,
                  December 31, 2004
              
              $
              26,000,119
              
              $
              (27,066,627
              )
              $
              (1,033,064
              )
  
  39
   
 **VERDISYS,
        INC.**
 STATEMENT
        OF CASH FLOWS
 Years
        Ended December 31, 2004 and 2003
  **2004**
              
              **2003****Cash
                  Flows From Operating Activities**
              
              (Restated)Net
                  loss
              
              $
              (8,766,108
              )
              $
              (7,356,045
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Stock
                  issued for services or litigation
              
              
              1,573,192
              
              
              1,624,339Release
                  of deferred revenue from litigation settlement
              
              
              (565,750
              )
              
              —Option
                  and warrant expense
              
              
              544,579
              
              
              1,844,311Amortization
                  of note discount
              
              
              58,398
              
              
              —Depreciation
                  and amortization
              
              
              512,706
              
              
              219,692Debt
                  forgiveness income
              
              
              —
              
              
              (460,235
              )Guarantee
                  of third party debt
              
              
              (300,000
              )
              
              300,000Loss
                  (gain) on sale of property
              
              
              11,237
              
              
              (120,000
              )Asset
                  impairment
              
              
              3,175,833
              
              
              —Bad
                  debts
              
              
              73,249
              
              
              172,003Changes
                  in:Accounts
                  receivable
              
              
              32,131
              
              
              (201,747
              )Accounts
                  receivable - related party
              
              
              —
              
              
              (23,960
              )Lease
                  receivable
              
              
              50,000
              
              
              —Employee
                  advances
              
              
              —
              
              
              42,620Accounts
                  payable
              
              
              473,437
              
              
              (277,755
              )Accrued
                  expenses
              
              
              787,767
              
              
              (171,815
              )Deferred
                  revenue
              
              
              15,039
              
              
              724,648Customer
                  deposit
              
              
              208,568
              
              
              68,282Net
                  Cash Used In Operating Activities
              
              
              (2,115,722
              )
              
              (3,615,662
              )**Cash
                  Flows From Investing Activities**Purchase
                  of equipment
              
              
              (3,705
              )
              
              (459,493
              )Cash
                  payments for license
              
              
              —
              
              
              (100,000
              )Proceeds
                  from sale of property
              
              
              12,500
              
              
              120,000Deposit
                  on equipment purchase
              
              
              —
              
              
              (340,000
              )Loan
                  to third party
              
              
              —
              
              
              (100,000
              )Net
                  Cash Provided By (Used In) Investing Activities
              
              
              8,795
              
              
              (879,493
              )**Cash
                  Flows From Financing Activities**Proceeds
                  from sales of common stock
              
              
              634,000
              
              
              6,562,150Proceeds
                  from exercise of options and warrants
              
              
              81,217
              
              
              368,815Proceeds
                  from notes payable, related parties
              
              
              345,000
              
              
              50,000Proceeds
                  from notes payable
              
              
              475,000
              
              
              —Payments
                  on notes payable, related parties
              
              
              (35,000
              )
              
              (363,558
              )Payments
                  on note payable related to license
              
              
              (500,000
              )
              
              (748,760
              )Net
                  Cash Provided By Financing Activities
              
              
              1,000,217
              
              
              5,868,647Net
                  change in cash
              
              
              (1,106,710
              )
              
              1,373,492Cash
                  at beginning of year
              
              
              1,373,627
              
              
              135Cash
                  at end of year
              
              $
              266,917
              
              $
              1,373,627Cash
                  paid during the year for:Interest
              
              $
              —
              
              $
              176,240Income
                  taxes
              
              $
              —
              
              $
              —
  
  40
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  **NOTE
        1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**
  Business .
        Verdisys, Inc. (“Verdisys”) was formed in California on April 7, 1999 as
        TheAgZone, Inc. In January 2001, the name was changed to Verdisys, Inc. In
        May
        2001, Verdisys began selling secure intra-company and wide-area network
        satellite communications systems to energy companies to manage distant oil
        and
        gas producing wells, power distribution and other equipment sites by remote
        computer control. In June 2003, Verdisys began selling a lateral drilling
        technique using high pressure water jetting for the enhancement and production
        of oil and gas reserves using licensed technology acquired in April 2003.
  On
        July
        18, 2003, Verdisys signed an Agreement and Plan of Merger with Reconstruction
        Data Group, Inc. (“RDGI”), a publicly-reporting inactive entity. The
        shareholders of Verdisys received 25,202,539 shares of RDGI in exchange for
        all
        of the 25,202,539 shares of Verdisys then outstanding. Verdisys became a
        wholly-owned subsidiary of RDGI. As of that transfer, Verdisys shareholders
        owned 94.4% of the outstanding stock of the combined entity.
  In
        2004
        and 2003, Verdisys provided lateral drilling services through the utilization
        of
        its drilling rigs by oil and gas operators primarily in Texas and Louisiana.
        Verdisys also provided satellite services to oil and gas companies throughout
        North America and West Africa.
  *Management
        Estimates* .
        The
        preparation of financial statements in conformity with accounting principles
        generally accepted in the United States of America requires management to
        make
        estimates and assumptions that affect the reported amounts of assets,
        liabilities, revenues and expenses, as well as certain financial statement
        disclosures. While management believes that the estimates and assumptions
        used
        in the preparation of the financial statements are appropriate, actual results
        could differ from these estimates.
  *Cash
        Equivalents* .
        Highly
        liquid investments with original maturities of three months or less are
        considered cash equivalents.
  *Revenue
        Recognition* .
        All
        revenue is recognized when persuasive evidence of an arrangement exists,
        the
        service or sale is complete, the price is fixed or determinable and
        collectibility is reasonably assured. Revenue is derived from sales of satellite
        hardware, satellite bandwidth, satellite service and lateral drilling services.
        Revenue from satellite hardware is recognized when the hardware is installed.
        Revenue from satellite bandwidth is recognized evenly over the term of the
        contract. Revenue from satellite service is recognized when the services
        are
        performed. Verdisys provides no warranty but sells commercially obtained
        3 to 12
        month warranties for satellite hardware. Verdisys has a 30 day return policy.
        Revenue for lateral drilling services is recognized when the services are
        performed and collectibility is reasonably assured and when collection is
        uncertain, revenue is recognized when cash is collected.
  *Allowance
        for Doubtful Accounts* .
        Bad
        debt expense is recognized based on management’s estimate of likely losses per
        year, based on past experience and an estimate of current year uncollectible
        amounts.
  *Equipment* .
        Equipment is valued at cost. Maintenance and repairs are charged to expense
        as
        incurred. Renewals and betterments which extend the life or improve existing
        equipment are capitalized. Upon disposition or retirement of equipment, the
        cost
        and related accumulated depreciation are removed and any resulting gain or
        loss
        is reflected in operations. Depreciation is provided using the straight-line
        method over the estimated useful lives of the assets, which are three to
        seven
        years.
  *Impairment
        of Long-Lived Assets* .
        Verdisys reviews the carrying value of its long-lived assets annually or
        whenever events or changes in circumstances indicate that the historical
        cost-carrying value of an asset may no longer be appropriate. Verdisys assesses
        recoverability of the carrying value of the asset by estimating the future
        net
        cash flows expected to result from the asset, including eventual disposition.
        If
        the future net cash flows are less than the carrying value of the asset,
        an
        impairment loss is recorded equal to the difference between the asset’s carrying
        value and fair value.
 
 
  41
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  *Stock
        Options and Warrants.* Verdisys
        accounts for all stock-based employee compensation plans in accordance with
        Statement of Financial Accounting Standard No. 123, *Accounting
        for Stock-Based Compensation* (“SFAS
        No. 123”), which permits the measurement of compensation expense in accordance
        with Accounting Principles Board Opinion 25 *Accounting
        for Stock Issued to Employees* (“APB
        25”). Under APB 25, no stock-based employee compensation cost is reflected in
        net income, as all options granted under those plans had an exercise price
        equal
        to or in excess of the market value of the underlying common stock on the
        date
        of grant. Verdisys accounts for stock-based compensation issued to non-employees
        in accordance with the provisions of SFAS No. 123 and EITF No. 96-18, *Accounting
        for Equity Investments That Are Issued to Non-Employees for Acquiring, or
        in
        Conjunction with Selling Goods or Services* .
        Common
        stock issued to non-employees and consultants is based upon the fair value
        of
        the services received or the fair value of the equity instruments issued
        whichever value is more reliably measurable. The following table illustrates
        the
        effect on net loss and net loss per share if Verdisys had applied the fair
        value
        provisions of SFAS No. 123 to stock-based employee compensation.
  **2004**
              
              **2003**Net
                  loss as reported
              
              $
              (8,766,108
              )
              $
              (7,356,045
              )Less:
                  stock based compensation determined under fair value- based
                  method
              
              
              (2,337,230
              )
              
              (828,737
              )Pro
                  forma net loss
              
              $
              (11,103,338
              )
              $
              (8,184,782
              )Basic
                  and diluted net loss per common share: As reported
              
              $
              (.28
              )
              $
              (.33
              )Pro
                  forma
              
              
              (.35
              )
              
              (.37
              )
  The
        weighted average fair value of the stock options granted during 2004 and
        2003
        was $1.78 and $7.30, respectively. Variables used in the Black-Scholes
        option-pricing model include (1) 1.5% risk-free interest rate, (2) expected
        option life is the actual remaining life of the options as of each year end,
        (3)
        expected volatility is zero, and (4) zero expected dividends.
  *Income
        Taxes* .
        Verdisys utilizes the asset and liability method in accounting for income
        taxes.
        Under this method, deferred tax assets and liabilities are recognized for
        operating loss and tax credit carryforwards and for the future tax consequences
        attributable to differences between the financial statement carrying amounts
        of
        existing assets and liabilities and their respective tax bases. Deferred
        tax
        assets and liabilities are measured using enacted tax rates expected to apply
        to
        taxable income in the year in which those temporary differences are expected
        to
        be recovered or settled. The effect on deferred tax assets and liabilities
        of a
        change in tax rates is recognized in the results of operations in the period
        that includes the enactment date. A valuation allowance is recorded to reduce
        the carrying amounts of deferred tax assets unless it is more likely than
        not
        that such assets will be realized.
  *Earnings
        Per Share* .
        Basic
        earnings per share equals net earnings divided by weighted average shares
        outstanding during the year. Diluted earnings per share includes the impact
        on
        dilution from all contingently issuable shares, including options, warrants
        and
        convertible securities. The common stock equivalents from contingent shares
        are
        determined by the treasury stock method. Verdisys has incurred net losses
        for
        the years ended December 31, 2004 and 2003 and has, therefore, excluded certain
        securities from the computation of diluted earnings per share as the effect
        would be anti-dilutive.
  *Recently
        Issued Accounting Pronouncements* .
        In
        December 2004, the FASB issued SFAS No. 123R, “Accounting for Stock-Based
        Compensation.” SFAS No. 123R establishes standards for the accounting for
        transactions in which an entity exchanges its equity instruments for goods
        or
        services. This Statement focuses primarily on accounting for transactions
        in
        which an entity obtains employee services in share-based payment transactions.
        SFAS No. 123R requires that the fair value of such equity instruments be
        recognized as expense in the historical financial statements as services
        are
        performed. Prior to SFAS No. 123R, only certain pro forma disclosures of
        fair
        value were required. SFAS No. 123R shall be effective for small business
        issuers
        as of the beginning of the first interim or annual reporting period that
        begins
        after December 15, 2005. The impact of the adoption of this new accounting
        pronouncement would be similar to the Company’s calculation of the pro forma
        impact on net income of FAS 123 included in Note 1 above.
  *Reclassifications.* Certain
        amounts in the financial statements of the prior year has been reclassified
        to
        conform to the presentation of the current year for comparative purposes.
 
 
  42
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  **NOTE
        2 - GOING CONCERN**
  As
        shown
        in the accompanying financial statements, Verdisys incurred recurring net
        losses
        of $8,766,108 and $7,356,045 in 2004 and 2003, respectively, has an accumulated
        deficit of $27,066,627 and a working capital deficit of $1,249,209 as of
        December 31, 2004. These conditions create an uncertainty as to Verdisys’
ability to continue as a going concern. Management is trying to raise additional
        capital through sales of common stock or convertible instruments as well
        as
        seeking financing from third parties. The financial statements do not include
        any adjustments that might be necessary if Verdisys is unable to continue
        as a
        going concern.
  **NOTE
        3 - LEASE RECEIVABLE**
  In
        November of 2004, Verdisys sold one of its lateral drilling rigs to an unrelated
        third party under the terms of a seven month direct financing lease. After
        the
        lease payment for the seventh month is earned and received, the customer
        has the
        right to purchase the unit at a nominal cost of $1 on a “as is, where is” basis.
        The monthly payments are $25,000 resulting in a total purchase price of
        $175,000. The net book value of the equipment sold by Verdisys was $148,879.
  At
        December 31, 2004, the receivable consists of five future lease payments.
        Under
        the terms of the lease a $25,000 security deposit was collected, this deposit
        can be applied to the last lease payment. Unearned income under the lease
        as of
        December 31, 2004 was $18,990.
  **NOTE
        4 - EQUIPMENT**
  Equipment
        consisted of the following at December 31, 2004:
  **Description**
              
              **Life**
              
              **Amount**Lateral
                  drilling equipment
              
              
              5
                  years
              
              $
              548,480Computer
                  equipment
              
              
              3
                  years
              
              
              29,388577,868Less:
                  accumulated depreciation
              
              
              
              
              
              (130,467
              )$
              447,401
  Lateral
        drilling equipment consists of three heavy trucks mounted with high powered
        water compressors, flexible hose and other assorted downhole equipment which
        is
        used to conduct the lateral drilling process with high pressure jetting
        technology (see Note 22).
  Depreciation
        expense totaled $159,352 and $23,881 in 2004 and 2003, respectively.
  **NOTE
        5 - LATERAL DRILLING LICENSE & NOTE PAYABLE ON LICENSE TO RELATED PARTY**
  In
        April
        2003, an individual licensed his horizontal drilling technology and equipment
        to
        Verdisys for $2,750,000 plus 10% of related gross revenue from lateral drilling
        operations. Verdisys paid $100,000 upon signing and signed a note payable
        for
        $2,650,000 plus effective interest of 12.14% due in monthly installments
        from
        May 2003 through March 2004.
  
  43
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  In
        July
        2003, Verdisys issued 125,000 shares in exchange for a $250,000 reduction
        of the
        note payable. In August 2003, Verdisys and the licensor amended the agreement
        whereby, in exchange for 500,000 shares of Verdisys common stock and the
        grant
        of a board seat, the licensor agreed to eliminate the 10% royalty and instead
        receive $500 per well serviced. The stock price at the time of the amendment
        was
        $4.55 per share, resulting in a $2,275,000 increase in the carrying value
        of the
        license. Verdisys did not make the December 2003 or January 2004 payment
        on the
        note payable. In February 2004, Verdisys and the licensor agreed to restructure
        the note payments. Verdisys issued the licensor 300,000 shares of common
        stock
        and $500,000 in cash for the unpaid amounts due under the original note.
        The
        300,000 shares had a value of $1,920,000 with approximately $1,185,000 reducing
        the overall note balance and approximately $735,000 recognized as compensation
        expense.
  **NOTE
        6 - ACCRUED EXPENSES**
  Accrued
        expenses at December 31, 2004 consisted of the following:
  **Description**
              
              **Amount**Liquidated
                  damages (see Note 17)
              
              $
              500,000Accrued
                  payroll
              
              
              328,034Litigation
                  settlement (see Note 22)
              
              
              240,000Director
                  fees
              
              
              78,250Interest
              
              
              49,934Other
              
              
              74,514$
              1,270,732
  **NOTE
        7 - DEFERRED REVENUE**
  Verdisys
        bills some of its satellite bandwidth contracts in advance over periods ranging
        from 3 months to 36 months. Verdisys recognizes revenue evenly over the
        contract. Deferred revenue related to satellite services totaled $317,615,
        of
        which $235,737 will be recognized in 2005 and $81,878 will be recognized
        during
        2006.
  Deferred
        revenue also includes the unearned income of $18,989 related to the equipment
        financing lease discussed in Note 3.
  **NOTE
        8 - NOTES PAYABLE, RELATED PARTIES**
  Notes
        payable, related parties at December 31, 2004 consisted of the following:
  One
                  year unsecured notes with officers and directors, 8%, maturing
                  on May 14,
                  2005, issued in connection with 40% warrant coverage to purchase
                  Verdisys
                  common stock at $2.00 per share during the term of the
                  note.
              
              $
              110,000Convertible
                  promissory notes with related individual and entity, 8%, maturing
                  on May
                  31, 2006, issued in connection with 100% warrant coverage to purchase
                  Verdisys common stock at $.001 per share until October 26, 2005,
                  conversion rate of one share of common stock for every $2.00 of
                  outstanding principal and unpaid interest.
              
              
              200,000Less:
                  discount for warrants
              
              
              58,296251,704Less:
                  current maturities
              
              
              102,326Long-term
                  debt, related parties
              
              $
              149,378
  
  44
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  **NOTE
        9 - NOTES PAYABLE**
  Notes
        payable at December 31, 2004 consisted of the following:
  One
                  year unsecured notes, 8%, maturing on May 14, 2005, issued in connection
                  with 40% warrant coverage to purchase Verdisys common stock at
                  $2.00 per
                  share during the term of the note.
              
              $
              75,000Convertible
                  promissory notes, 8%, maturing on December 31, 2005, issued in
                  connection
                  with 100% warrant coverage to purchase Verdisys common stock until
                  December 31, 2005, conversion rate of one share of common stock
                  for every
                  $2.00 of outstanding principal and unpaid interest.
              
              
              350,000Note
                  payable, individual, 10%, due on demand
              
              
              50,000Less:
                  discount for warrants
              
              
              74,148$
              400,852
  **NOTE
        10 - RELATED PARTY REVENUES**
  Energy
        2000 NGC, Inc. (“Energy 2000”) is a subsidiary of Berg McAfee Energy, LLC, which
        is a wholly owned subsidiary of Berg McAfee Companies. Berg McAfee Companies
        are
        beneficial owners of more than 25% of Verdisys and Eric McAfee is a former
        Vice
        Chairman of the board and Chief Executive Officer of Verdisys. In April 2003,
        Verdisys signed a drilling service contract with Energy 2000, whereby Energy
        2000 would have paid Verdisys a minimum of $1,800,000 for lateral drilling
        of 45
        wells. This contract was a fixed amount due to Verdisys dependent upon the
        number of wells drilled and offshoot lateral bores drilled. In addition,
        Verdisys would receive an 80 percent interest in the net operating income
        after
        payback from these properties and also be reimbursed for 20 percent of its
        field
        costs. In September, 2003 Verdisys entered into another contract with Energy
        2000 for an additional 57 wells with terms similar to the original contract.
        This contract was suspended for lack of payment.
  Natural
        Gas Systems, Inc. (“NGS”) is an independent company with substantial
        shareholdings owned by Eric McAfee. In September 2003, Verdisys signed a
        drilling service contract with NGS, whereby NGS would have paid Verdisys
        a
        minimum of $7,800,000 for lateral drilling of 120 wells. This contract was
        a
        fixed amount due to Verdisys dependent upon the number of wells drilled and
        offshoot lateral bores drilled. In addition, Verdisys would receive a 70
        percent
        interest in the net operating income after payback from these properties.
        This
        contract was renegotiated in February 2004 to a smaller agreement with an
        initial four well commitment and removed the Verdisys’ rights to
        post-production. The contract was subsequently suspended.
  Verdisys
        billed $666,250 and $153,960 to Energy 2000 and NGS, respectively, for services
        performed in 2003. Verdisys received $397,500 and $130,000, respectively.
        However, Verdisys has inadequate documentation to substantiate whether some
        of
        the services were performed. For Energy 2000, Verdisys was able to substantiate
        $328,750 of revenue leaving $68,750 in deferred revenue. Verdisys billed
        $20,547
        and $2,000 to Energy 2000 and NGS, respectively, for expenses incurred in
        2004.
        The amount billed to Energy 2000 was deemed uncollectible and the amount
        billed
        to NGS was collected. As of December 31, 2004, deferred revenues from related
        parties totaled $0. In October 2004, Verdisys entered into an agreement with
        Berg McAfee Companies, Energy 2000 and Eric McAfee to settle several outstanding
        legal issues. Under the agreement, Verdisys is entitled to retain the $68,750
        and Energy 2000 has waived all claims to the funds.
 
 
  45
   **VERDISYS,
        INC.**
 **NOTES TO
        FINANCIAL STATEMENTS**
  **NOTE
        11 - INCOME TAXES**
 
 During
        2004 and 2003, Verdisys incurred net losses and, therefore, had no tax
        liability. The net deferred tax asset generated by the loss carry-forward
        has
        been fully reserved. The cumulative net operating loss carry-forward is
        approximately $18,000,000 at December 31, 2004, and will expire in the years
        2019 through 2024.
 
 At
        December 31, 2004, deferred tax assets consisted of the following:
 
 Deferred
                  tax assetsNet
                  operating losses
              
              $
              6,300,000Less:
                  valuation allowance
              
              
              (6,300,000
              )Net
                  deferred tax asset
              
              $
              0
 
 The
        change in the valuation allowance for the years ended December 31, 2004 and
        2003
        totaled $1,800,000 and $4,383,879, respectively.
 
 **NOTE
        12 - PREFERRED STOCK**
  650,000
        and 760,000 shares of Series B preferred stock were issued in 2001 and 2002,
        respectively, for $.50 per share. In early 2003, Verdisys converted all
        1,410,000 shares of Series B convertible preferred stock into 1,410,000 shares
        of common stock.
  There
        are
        currently no preferred shares issued or outstanding. Verdisys currently has
        no
        authorized preferred stock.
  **NOTE
        13 - COMMON STOCK**
  In
        the
        second quarter of 2003, Verdisys sold 1,239,000 shares of common stock in
        private placements for between $.50 and $.75 per share for total proceeds
        of
        $779,250 before $15,100 costs of fundraising.
  In
        the
        second quarter of 2003, Verdisys converted $1,506,190 of notes payable and
        accrued interest to investors to 2,890,688 shares of common stock.
  In
        the
        second quarter of 2003, director and employee options were exercised at $.10
        per
        share for 2,409,291 shares of common stock. In lieu of cash, Verdisys agreed
        to
        expense the exercise price as compensation of $240,929.
  In
        the
        second quarter of 2003, warrants were exercised for 1,580,000 shares of common
        stock. $56,500 in cash was received for the exercise of 430,000 warrants,
        accounts payable was reduced by $95,000 for the exercise of 950,000 warrants
        and
        notes payable to investor was reduced by $20,000 for the exercise of 200,000
        warrants.
  In
        April
        2003, Verdisys issued 2,000,000 shares of common stock purportedly to acquire
        the assets of QuikView, Inc. The shares were valued at $1,000,000 and have
        been
        accounted for as expense.
  In
        June
        2003, 100,000 shares valued at $75,000 were issued to a consultant.
  In
        May
        2003, Verdisys issued 33,333 shares of stock for a $16,666 reduction in accounts
        payable.
  On
        July
        18, 2003, Verdisys signed an Agreement and Plan of Merger with RDGI, a
        publicly-reporting inactive entity. The shareholders of Verdisys received
        25,103,223 shares of RDGI in exchange for all of the 25,202,539 shares of
        Verdisys then outstanding. RDGI was renamed Verdisys and the former Verdisys
        Entity was extinguished. As of that transfer, Verdisys shareholders owned
        94.4%
        of the outstanding stock and RDGI shareholders owned 1,500,000 shares or
        1.6% of
        the combined entity.
  In
        July
        and August 2003, Verdisys sold 609,000 shares of common stock at $2.00 per
        share
        in a private placement for total proceeds of $1,218,000. Offering costs
        consisted of 59,400 shares of restricted common stock and 9,501 warrants
        exercisable at $2.00 per share anytime through September 5, 2008.
  In
        the
        third quarter of 2003, warrants were exercised for 269,547 shares of common
        stock. $177,751 in cash was received for the exercise.
 
  46
   **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  In
        the
        third quarter of 2003, Verdisys issued 625,000 shares of common stock to
        the
        licensor of the lateral drilling license. 125,000 shares were for a reduction
        of
        the note payable by $250,000 and 500,000 were for an amendment to the royalty
        agreement. The 500,000 shares were valued at $2,275,000.
  In
        September 2003, 144,903 shares granted in 2001, but never recorded, were
        issued
        to former employees and valued at the 2001 value of $52,160.
  In
        October 2003, Verdisys sold 833,333 shares of common stock to Gryphon Master
        Fund, L.P. (“Gryphon”) at $6.00 per share for $5,000,000 total proceeds.
        Offering costs associated with the sale were $420,000 in cash, 83,334 warrants
        at $6.00 per share that expire October 24, 2008, 9,501 warrants at $2.00
        per
        share that expire in September 2008 and 20,000 shares of common stock. The
        warrants are exercisable at any time prior to October 24, 2008 by paying
        cash at
        the exercise price or by electing a cashless exercise. In October 2004, Verdisys
        issued 277,778 additional shares of common stock for no additional compensation
        as the 30 day average closing price of Verdisys’ common stock dropped below
        $6.00 per share in the ten months subsequent to the agreement. After this
        issuance, a total of 1,111,111 common shares were issued for an effective
        average price of $4.50 per share.
  In
        the
        fourth quarter of 2003, Verdisys issued 25,000 shares of common stock valued
        at
        $256,250 to a consultant for services.
  In
        the
        fourth quarter 2003, warrants were exercised for 245,631 shares of common
        stock
        and options were exercised for 100,000 shares of common stock for $29,564
        and
        $10,000, respectively.
  In
        February 2004, Verdisys issued 300,000 shares of common stock as part of
        a
        renegotiation of a note associated with the lateral drilling license and
        the
        license agreement. The shares had a value of $1,920,000 with $1,184,808 reducing
        the note balance and $735,192 recognized as expense.
  In
        the
        first quarter of 2004, warrants were exercised for 779,957 shares of common
        stock and options were exercised for 25,000 shares of common stock for $38,494
        and $2,500, respectively. The exercised warrants included a cashless exercise
        of
        400,000 warrants for 395,022 shares of common stock.
  In
        the
        second quarter of 2004, warrants were exercised for 57,658 shares of common
        stock and options were exercised for 344,583 shares of common stock for $5,766
        and $34,458, respectively.
  From
        May
        through June 2004, Verdisys sold 179,500 shares of common stock at a price
        of
        $2.00 per share in a private placement for total proceeds of $359,000. Two
        year
        warrants to purchase 71,800 shares of common stock at a price of $2.00 per
        share
        were issued in connection with the private placement. The proceeds were
        allocated between the common stock and the warrants based on their respective
        relative fair values. Offering costs consisted of 17,950 shares of common
        stock
        and 7,180 warrants exercisable at $2.00 per share until August 23, 2006.
  During
        the third quarter of 2004, Verdisys issued 30,000 shares of common stock
        for
        commissions on a future fundraising effort. Verdisys also issued 300,000
        shares
        of common stock for a lawsuit settlement valued at $213,000.
  During
        the fourth quarter of 2004, Verdisys issued 104,000 shares of common stock
        in
        payment of consulting services valued at $52,000. Verdisys also sold 250,000
        shares of common stock at a price of $0.30 per share in the fourth quarter
        to
        settle a dispute with a former consultant.
  In
        October 2004, Verdisys issued 750,000 shares of common stock in a move to
        settle
        outstanding litigation matters. In a Settlement Agreement and Mutual Release
        (“Agreement) between Edge Capital Group, Inc. (“Edge”), Eric McAfee and
        Verdisys, the parties would release each other from any claims upon the
        completion of the terms of the Agreement (see Note 17). One of the provisions
        under the Agreement was that 250,000 shares of Verdisys common stock were
        issued
        to Edge and 500,000 shares of Verdisys common stock were issued to Eric McAfee.
  During
        the fourth quarter of 2004, Verdisys sold 400,000 shares of common stock
        at a
        price of $0.50 per share to Berg McAfee. The sale had a provision that allows
        the buyer to re-price the shares to the extent Verdisys offers more favorable
        terms to third parties prior to March 31, 2005. This provision will result
        in
        the issuance of two year warrants to purchase 400,000 shares of Verdisys
        common
        stock at a price of $1.00 per share.
 
 
  47
   **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  **NOTE
        14 - STOCK OPTIONS AND WARRANTS**
  *Options*
  In
        April
        2003, Verdisys granted options to purchase 780,000 shares of common stock
        to an
        employee, options to purchase 250,000 shares of common stock to non-employee
        directors and options to purchase 250,000 shares of common stock to an employee
        director. The options all have an exercise price of $0.10 per share and a
        ten
        year term. The market value at time of grant was $0.50 per share resulting
        in an
        intrinsic value of $512,000. 30,000 options vest monthly over four months,
        750,000 options vest quarterly over three years and 500,000 options vest
        quarterly over one year.
  In
        August
        2003, Verdisys granted options to purchase 100,000 shares of common stock
        to an
        employee at an exercise price of $4.10 per share, the market price at the
        date
        of grant. The options vest quarterly over one year and have a five year term.
  In
        December 2003, Verdisys granted options to purchase 500,000 shares of common
        stock to an officer/director with an exercise price of $9.55 per share, the
        market price at the date of grant. The options have a ten year term. 50,000
        vest
        immediately, 50,000 were to vest by December 31, 2003 if Verdisys could collect
        all of the Edge disputed accounts receivable by December 31, 2003 and the
        remaining 400,000 options vest evenly over 12 months in 2004. Because Verdisys
        was unable to collect the accounts receivable from Edge, 50,000 of the 500,000
        options were forfeited.
  Verdisys
        recorded expense of $714,524 for the intrinsic value associated with options
        vesting in 2003. The expense is included in selling, general &
administrative expense on the statement of operations.
  In
        January 2004, Verdisys granted options to purchase 230,000 shares of common
        stock to officers and options to purchase 80,000 shares of common stock to
        non-employee directors at an exercise price of $4.28 per share, the market
        price
        at the date of grant. The options have a ten year term. The options granted
        to
        the officers vest quarterly over one year, while the options granted to the
        directors vested immediately.
  In
        May
        2004, Verdisys granted options to purchase 72,000 shares of common stock
        to
        non-employee directors at an exercise price of $2.20 per share, the market
        price
        at the date of grant. The options vest quarterly over one year and have a
        ten
        year term.
  In
        July
        2004, Verdisys granted options to purchase 770,000 shares of common stock
        to
        officers at an exercise price of $0.90 per share, the market price at the
        date
        of grant. The options vest quarterly over three years and have a ten year
        term.
  Verdisys
        recorded expense of $245,829 for the intrinsic value associated with options
        vesting in 2004. The expense is included in selling, general &
administrative expense on the statement of operations.
  *Warrants*
  Verdisys
        issues warrant to non-employees from time to time. The board of directors
        has
        discretion as to the terms under which the warrants are issued. All warrants
        vest immediately unless specifically noted in warrant agreements.
  In
        April
        2003, Verdisys issued warrants to purchase 200,000 shares of common stock
        at
        $0.10 per share. Half of the warrants expire in January 2007 and the remainder
        expires in January 2008. The warrants have a fair value of $80,000 which
        was
        expensed when the warrants were granted.
  During
        the summer of 2003, Verdisys negotiated settlements the two original founders
        for various debts recorded on the books at $576,000 by paying cash of $28,000
        and issuing warrants to purchase 150,000 shares of common stock at $0.10
        per
        share. The warrants were valued at $0.40 or $60,000, resulting in a contribution
        to capital of $488,000 (see Note 19).
  During
        the fall of 2003, Verdisys issued warrants to purchase 92,835 shares of common
        stock, 83,334 at $6.00 per share that expire October 2008 and 9,501 at $2.00
        per
        share that expire September 2008. The warrants were issued in connection
        with
        raising the $5,000,000 from Gryphon (see Note 13) and their fair value of
        $822,738 was treated as a cost of fundraising.
  Verdisys
        issued warrants to purchase 2,644,438 shares of common stock in 2003 at an
        exercise price $0.10 per share. The fair value of $1,050,687 has been expensed
        accordingly in 2003.
 
 
  48
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  In
        2003,
        previously expired warrants to purchase 232,334 shares of common stock were
        extended and exercised. At the time of the extension Verdisys stock was selling
        for $0.50 per share in private placements and the warrant was exercised at
        $0.75
        per share. Using the minimum value method, the modification resulted in no
        additional compensation expense.
  In
        May
        2004, Verdisys borrowed $185,000 under one year promissory notes issued to
        certain private investors with interest of 8%. Warrants to purchase 37,000
        shares of our common stock at $2.00 per share were issued in connection with
        the
        notes (see Notes 8 and 9). The warrants have a term of one year. The notes
        have
        been discounted for the relative fair value of the warrants.
  From
        May
        to June 2004, Verdisys issued warrants to purchase 71,800 shares of common
        stock
        at $2.00 per share in connection with the private placement that raised $359,000
        (see Note 13). An additional warrant to purchase 7,180 shares of common stock
        at
        $2.00 per share was issued as part of the offering costs of the private
        placement. The warrants have a term of two years.
  In
        July
        2004, Verdisys issued $200,000 in convertible notes to third party lenders
        and
        warrants to purchase 100,000 shares of common stock at an exercise price
        of
        $0.001 per share. The warrants have a term of one year. We also issued $150,000
        in convertible notes to third party lenders and warrants to purchase 75,000
        shares of common stock at an exercise price of $0.01 per share. The warrants
        have a term of two years. The notes have been discounted for the relative
        fair
        value of the warrants (see Note 9).
  In
        August
        2004, Verdisys issued warrants to purchase 140,000 shares of common stock
        at
        $0.80 per share to certain subcontractors. The warrants vest at the rate
        of 20%
        immediately and then 20% every 90 days thereafter until fully vested. The
        warrants have a term of two years. The fair value of $98,000 was expensed
        in
        2004.
  In
        October 2004, Verdisys issued $200,000 in convertible notes to Berg McAfee
        Company and Eric McAfee ($100,000 each) and warrants to purchase 100,000
        shares
        of common stock at $0.001 per share (see Note 8). The warrants have a term
        of
        one year. The notes have been discounted for the relative fair value of the
        warrants.
  In
        October 2004, Verdisys issued warrants to purchase 250,000 shares of common
        stock at $0.50 per share to Alberta Energy Holdings (“Alberta”) as part of a
        licensing agreement (see Note 17). The warrants have a term of three years.
        The
        fair value of $199,750 was expensed in 2004.
  Summary
        information regarding options and warrants is as follows:
  **Options**
              
              **Weighted**
                **Average**
                **Share Price**
              
              **Warrants**
              
              **Weighted**
                **Average**
                **Share Price**Outstanding
                  at December 31, 2002
              
              
              9,502,189
              
              $
              0.10
              
              
              3,550,909
              
              $
              0.33Year
                  ended December 31, 2003:Granted
              
              
              1,880,000
              
              
              2.83
              
              
              3,319,607
              
              
              0.26Exercised
              
              
              (2,509,291
              )
              
              0.10
              
              
              (2,092,961
              )
              
              0.10Forfeited
              
              
              (4,760,522
              )
              
              0.23
              
              
              (352,840
              )
              
              0.31Outstanding
                  at December 31, 2003
              
              
              4,112,376
              
              
              1.35
              
              
              4,424,715
              
              
              0.38Year
                  ended December 31, 2004:Granted
              
              
              1,152,000
              
              
              1.89
              
              
              780,980
              
              
              0.48Exercised
              
              
              (369,583
              )
              
              0.10
              
              
              (837,605
              )
              
              0.10Forfeited
              
              
              (2,481,113
              )
              
              1.47
              
              
              (573,871
              )
              
              0.18Outstanding
                  at December 31, 2004
              
              
              2,413,680
              
              $
              1.67
              
              
              3,794,219
              
              $
              0.49
 
 
  49
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  Options
        outstanding and exercisable as of December 31, 2004:
  **Outstanding**
              
              **Exercisable****Exercise Price**
              
              **Number**
                **of
                  Shares**
              
              **Remaining**
                **life**
              
              **Number**
                **of
                  Shares**$  0.10
              
              
              5,000
              
              
              6
                  years
              
              
              5,0000.10
              
              
              118,556
              
              
              7
                  years
              
              
              118,5560.10
              
              
              954,792
              
              
              8
                  years
              
              
              685,7909.55
              
              
              183,332
              
              
              9
                  years
              
              
              183,3324.28
              
              
              310,000
              
              
              9
                  years
              
              
              252,5002.20
              
              
              72,000
              
              
              9
                  years
              
              
              36,0000.90
              
              
              770,000
              
              
              10
                  years
              
              
              128,3332,413,680
              
              
              
              
              
              1,409,511
  Warrants
        outstanding and exercisable as of December 31, 2004:
  **Outstanding**
              
              **Exercisable****Exercise Price**
              
              **Number**
                **of
                  Shares**
              
              **Remaining**
                **life**
              
              **Number
                  of**
                **Shares**$  0.00 -
                  0.15
              
              
              1,150,000
              
              
              1
                  years
              
              
              1,150,0002.00
              
              
              378,482
              
              
              1
                  years
              
              
              378,4820.01
                  - 0.50
              
              
              260,889
              
              
              2
                  years
              
              
              218,8891.00
              
              
              85,000
              
              
              2
                  years
              
              
              85,0002.00
              
              
              16,180
              
              
              2
                  years
              
              
              16,1800.10
                  - 0.50
              
              
              1,810,833
              
              
              3
                  years
              
              
              1,810,8332.00
              
              
              9,501
              
              
              4
                  years
              
              
              9,5016.00
              
              
              83,334
              
              
              4
                  years
              
              
              83,3343,794,219
              
              
              
              
              
              3,752,219
  **NOTE
        15 - CONCENTRATIONS**
  One
        customer accounted for 14% and 38% of total revenues in 2004 and 2003,
        respectively. Related parties accounted for 2% and 52% of total revenues
        in 2004
        and 2003, respectively.
  Verdisys
        at times has cash in bank in excess of Federal Deposit Insurance Corporation
        (“FDIC”) insurance limits. At December 31, 2004, Verdisys had $160,262 in cash
        in excess of FDIC insurance limits.
  Verdisys
        performs ongoing credit evaluations of its customers’ financial condition and
        does not generally require collateral from them.
 
 
  50
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  **NOTE
        16 - COMMITMENTS & CONTINGENCIES**
  In
        August
        2003, Verdisys obtained a 75% net revenue interest in property located in
        Monroe, Louisiana from a third party in exchange for agreeing to perform
        lateral
        drilling services on the property. In October 2003, Verdisys assigned the
        net
        revenue interest to Edge for $200,000. Edge only paid Verdisys $120,000.
        Verdisys agreed to refund the money to Edge if Verdisys did not deliver a
        lease
        between Edge and the original owner within 90 days if Edge desired. As of
        December 31, 2004, Verdisys had not delivered the necessary lease and Edge
        had
        the right under the agreement to request a refund of the $120,000 (see Note
        20).
        Effective January 19, 2005, Verdisys, Edge and certain other parties entered
        in
        a settlement agreement and mutual release to fully settle and resolve disputes
        among the parties. Under the settlement, Verdisys will retain the $120,000
        already received and both Edge and Verdisys will drop their claims in the
        dispute. See Note 22 for further details.
  Under
        the
        terms of the Landers lateral drilling license (see Note 5), Verdisys is
        obligated to pay a royalty of $500 for every well in which that technology
        is
        utilized. The Landers license expires upon the expiration of the underlying
        patents, the earliest date being October 2013.
  Under
        the
        terms of an exclusive worldwide licensing agreement for the application of
        Abrasive Fluid Jet (“AFJ”) cutting technique, Verdisys agreed to pay Alberta a
        $10,000 per month consulting fee for six months beginning on November 30,
        2004.
        In addition, royalties are payable by Verdisys at the rate of $1,000 per
        well
        for services billed at $40,000 or less and for services above $40,000, a
        royalty
        of 2% per well is payable quarterly. As specific phases of the AFJ process
        are
        successfully applied, Alberta is entitled to receive four tranches of warrants
        to purchase 250,000 shares of common stock. The first tranche has already
        been
        issued (see note 14). The warrants have a three year term, with an exercise
        price of $0.62 per share for the pending tranches. The agreement also provides
        for the mutual sharing of the proceeds from the sale of the technology with
        Verdisys, subject to a maximum of $10 million. The AFJ license is for a term
        of
        ten years and automatically extends for additional two-year terms.
  Three
        of
        Verdisys’ employees are under employment agreements. One agreement was entered
        into June 2003 and provides for a base salary of $150,000 in year one, $180,000
        in year two and $210,000 in year three. The other agreements have a one year
        term but provide for one year renewals. One of the agreements is for a minimum
        base salary of $185,000, while the other agreement provides for a $20,000
        escalation for two years from the original base salary of $175,000 in 2004.
  **NOTE
        17 - LITIGATION**
  *Lawsuits
        involving Edge Capital Group, Inc. (Settled)*
  Effective
        January 19, 2005, Edge, certain entities affiliated with Edge, Eric McAfee
        (Verdisys’ former Vice Chairman) and Verdisys, entered into a Settlement
        Agreement and Mutual Release to fully settle and resolve the disputes between
        Edge and its affiliated entities, Mr. McAfee, Verdisys’ directors and Verdisys
        (see Note 22). The settlement removed Verdisys’ liability for a $300,000
        guarantee and deferred revenue of $497,000. In July 2003, Verdisys guaranteed
        Edge’s purchase of oil and gas properties from another entity for $450,000. Edge
        paid $150,000 and signed a note payable for $300,000 due in 2004. Edge defaulted
        on the note and had requested Verdisys to pay the amounts due. In June 2003,
        Verdisys signed an agreement to drill wells for Edge and Edge paid $497,000
        in
        2003. Edged had disputed whether services were actually performed and requested
        the $497,000 to be returned to their third party financing source but did
        not
        initiate any court action. Verdisys had inadequate documentation to substantiate
        what services were actually performed, so the revenue was deferred in 2003.
 
 
  51
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  Verdisys
        had initiated a lawsuit against Edge that requested a declaratory judgment
        that
        a purported agreement between Verdisys and Edge was not enforceable. It was
        filed in Montgomery County, Texas in February 2004. The lawsuit arose from
        Edge’s contention that one of Verdisys’ ex-officers committed the company to
        purchase certain oil and gas properties from Edge. Edge had filed a counterclaim
        against Verdisys and asserted claims against Dan Williams (Verdisys’ former
        President and CEO), Eric McAfee, Ron Robinson (Verdisys former CEO and current
        Board member), Andrew Wilson (Verdisys former CFO) and Verdisys current Board
        members Joseph Penbera, Frederick Ruiz, James Woodward and John Block. Edge
        has
        also made claims against Solarcom, L.L.C., DeLage Landen Financial Services,
        Inc., Andrew Wilson and Allen Voight. Edge had sought to enforce the agreement
        Verdisys challenged and alleged several causes of action including claims
        for
        fraud, breach of contract, negligence and conspiracy. Edge had asserted actual
        damages in excess of $85 million and had claimed punitive damages as well.
  Edge
        and
        one of its apparent owners, Frazier Ltd., initiated a lawsuit in Summin County,
        Ohio against Verdisys, Solarcom, L.L.C., DeLage Landen Financial Services,
        Inc.
        and Firstmerit Bank, N.A. that sought an injunction against the draw against
        a
        letter of credit pledged as collateral for a credit advanced to Edge. Edge
        asserted that its transaction with Verdisys was the product of fraud and
        that
        its creditor, DeLage Landen as assignee from Solarcom, should not be allowed
        to
        draw against Edge’s letter of credit from Firstmerit. The Ohio state court
        denied Edge’s request for a temporary injunction. The pleadings in the Ohio
        action did not include any claim for damages from Verdisys.
  *Class
        Action Lawsuit (Settled)*
  In
        March
        2005, Verdisys entered into an agreement, subject to court approval, to settle
        the class action lawsuit brought by former shareholders in March 2004 in
        the
        U.S. District Court for the Southern District. Under terms of the agreement,
        Verdisys will issue to the class 1,150,000 shares of common stock and pay
        up to
        $55,000 in legal and administrative fees for the plaintiffs. The lawsuit
        alleged
        that Verdisys and its former CEO, Dan Williams, and Verdisys’ former CFO, Andrew
        Wilson, violated Sections 10(b) and 20(a) of the Securities Exchange Act
        of
        1934, and Rule 10b-5 promulgated thereunder. The lawsuit alleged that defendants
        made material misstatements about Verdisys’ financial results. More
        specifically, the Complaints alleged that defendants failed to disclose and
        indicate: (1) that Verdisys had materially overstated its net income and
        earnings per share; (2) that Verdisys prematurely recognized revenue from
        contracts between Verdisys, Edge Capital and Energy 2000 in violation of
        GAAP
        and its own revenue recognition policy; (3) that Verdisys lacked adequate
        internal controls and was therefore unable to ascertain the true financial
        condition of the company; and (4) that as a result of recognizing revenue
        prematurely, Verdisys’ financial results were inflated at all relevant times.
        Verdisys had filed a motion to dismiss all actions in the litigation against
        it.
  *Securities
        and Exchange Commission Investigation Inquiries*
  Verdisys
        received notice in January 2004 that the Securities and Exchange Commission
        (“SEC”) has initiated a formal investigation into its reporting practices and
        public statements about Verdisys in 2003.
  The
        SEC
        has requested substantiation and documentary evidence from Verdisys concerning
        the performance of certain lateral drilling services by subcontractors in
        the
        period from May 2003 to September 2003, supervision of such services by
        Verdisys’ executive management at the time, revenue recognition related to the
        performance of such services, the third quarter 2003 earnings restatement,
        public statements concerning the services performed, and related matters.
        The
        SEC has also requested information and documentary evidence related to Verdisys’
acquisition of certain assets of QuikView, Inc., a related party company,
        in
        June, 2003. In its letters to Verdisys requesting documents, the SEC stated
        that
        the staff’s inquiry should not be construed as an indication that any violations
        of securities laws have occurred or as an adverse reflection on any persons,
        company or security.
 
 
  52
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  Since
        December 2003, Verdisys has taken several steps to address issues related
        to the
        SEC’s inquiries, including the termination and replacement of the previous Chief
        Executive Officer and Chief Operating Officer and the reassignment of its
        Chief
        Financial Officer. Two directors have resigned from the Verdisys’ board and
        Verdisys has appointed a new CFO. Internal controls have been strengthened
        overall, particularly with respect to the public release of Verdisys information
        and the recognition of revenue. Verdisys had also initiated an internal
        investigation of the matters of concern to the SEC. Consequently, Verdisys
        restated its second and third quarter financial statements for fiscal year
        2003
        and deferred all revenue related to the aforementioned period until such
        time
        that it can substantiate whether or not the services were performed.
  Verdisys
        is cooperating fully with the SEC, including the provision of numerous documents
        and voluntary testimony by its current executives. In December 2004, the
        staff
        of the SEC notified Verdisys that it was considering recommending that the
        SEC
        bring a civil injunction (including a possible permanent injunction and a
        civil
        penalty) against Verdisys alleging violations of provisions of the Sections
        10(b), 13(b)(2)(A), 13(b)(2)(B) and 15(d) of the Securities Exchange Act
        of 1934
        and rules promulgated thereunder in connection with the purchase and sale
        of
        securities of Verdisys, recordkeeping, internal controls, certification and
        disclosure obligations. Verdisys was notified of its right to make a Wells
        submission. Verdisys has provided information to the SEC setting forth the
        specific steps it has taken to upgrade the quality and effectiveness of its
        board of directors, replace the previous management team with industry experts,
        improve its recordkeeping, internal and disclosure controls, and revenue
        recognition procedures. Although Verdisys is working to bring the matter
        to a
        prompt conclusion, it cannot make any assurance that the investigation will
        be
        resolved positively or that it will not have negative effects on Verdisys’
limited resources or its ability to raise capital and use its stock as
        acquisition currency during the period of the investigation.
  *Claims
        by Investor (Partially Settled)*
  In
        February 2005, Verdisys entered into an Agreed Judgment and Order of Severance
        with Gryphon Master Fund, L.P. (“Gryphon”) as to all breach of contract claims
        related to Verdisys’ delay in registering common stock acquired by Gryphon in
        October 2003 (see Note 22). Under the terms of the Agreed Judgment, Verdisys
        is
        obligated to pay liquidated damages of $500,000 to Gryphon on or before
        September 30, 2005 (see Note 6). Additionally, Gryphon has agreed to abate
        their
        remaining claims and related discovery in the lawsuit against Verdisys until
        after September 30, 2005. Verdisys agreed to register the shares issued to
        Gryphon on or before March 2004 or be subject to certain liquidated damages.
        Gryphon made a claim against Verdisys for the maximum liquidated damages
        in an
        amount of $400,000. Gryphon has also claimed it has sustained actual damages
        in
        excess of $6.2 million. In July 2004, Gryphon filed a lawsuit in the state
        district court in Dallas County, Texas against Verdisys, alleging, among
        other
        things, breach of contract and securities fraud by Verdisys. In connection
        with
        the lawsuit, Gryphon requested liquidated damages, actual damages, punitive
        damages, interest, costs and attorneys’ fees among other claims Verdisys intends
        to vigorously defend itself in this matter with respect to the remaining
        claims
        of Gryphon. If Gryphon prevails, it may obtain significant damages that may
        have
        a material adverse effect on Verdisys’ financial condition.
  *Claims
        by Former CEO*
  In
        July
        2004, Verdisys was informed that a former Chief Executive Officer of Verdisys
        filed a lawsuit against Verdisys for breach of contract and wrongful discharge.
        The lawsuit seeks relief in excess of $500,000 related to an alleged employment
        agreement and also seeks damages related to an excess of 4 million stock
        options
        claimed due pursuant to the alleged agreement. The lawsuit was filed in state
        court in San Diego, California. Verdisys intends to vigorously defend itself
        in
        this matter. If the plaintiff prevails, it may obtain significant damages
        that
        may have a material adverse effect on Verdisys’ financial condition.
 
 
  53
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  *Energy
        2000 (Settled)*
  In
        October 2004, Verdisys entered into an agreement with Berg McAfee Companies,
        Energy 2000 and Eric McAfee (collectively, “McAfee Group”) to settle several
        outstanding legal issues. Energy 2000 has agreed to settle a finders fee
        and
        lateral drilling services dispute by delivering 300,000 shares of NGS stock
        into
        escrow for Verdisys. Due to uncertainties on the liquidity of the shares,
        Verdisys has assigned no value to them as of December 31, 2004. Furthermore,
        to
        settle the “Lawsuits involving Edge Capital Group, Inc.”, the McAfee Group
        exchanged into escrow 500,000 shares of NGS stock for 500,000 shares of Verdisys
        common stock. In January 2005, the McAfee Group replaced the 500,000 shares
        of
        NGS stock with $625,000 in cash. Verdisys submitted that cash and an additional
        250,000 shares of Verdisys common stock to Edge as part of the settlement.
        Verdisys also has agreed to dismiss the QuikView, Inc. lawsuit, which it
        had
        filed against certain individuals.
  *General* **
  Verdisys
        has never been in bankruptcy, receivership or any similar legal proceeding.
        Other than the aforementioned legal matters, Verdisys is not aware of any
        other
        threatened legal proceedings. The foregoing is also true with respect to
        each
        officer, director and control shareholder as well as any entity owned by
        any
        officer, director and control shareholder, over the last five years.
  As
        part
        of its regular operations, Verdisys may become party to various pending or
        threatened claims, lawsuits and administrative proceedings seeking damages
        or
        other remedies concerning its’ commercial operations, products, employees and
        other matters. Although Verdisys can give no assurance about the outcome
        of
        these or any other pending legal and administrative proceedings and the effect
        such outcomes may have on the company, except as described above, Verdisys
        believes that any ultimate liability resulting from the outcome of such
        proceedings, to the extent not otherwise provided for or covered by insurance,
        will not have a material adverse effect on Verdisys’ financial condition or
        results of operations.
  **NOTE
        18 - NON-CASH TRANSACTIONS ON CASH FLOW STATEMENT**
  **2004**
              
              **2003**Seller
                  financed purchase of license with note
              
              $
              1,184,808
              
              $
              2,650,000Stock
                  issued for license amendment
              
              
              —
              
              
              2,275,000Stock
                  issued for reduction of note payable on license
              
              
              —
              
              
              250,000Contributions
                  to capital by founders for debt forgiveness
              
              
              —
              
              
              488,000Conversion
                  of notes payable to common stock
              
              
              —
              
              
              1,245,000Conversion
                  of accrued interest on notes payable to common stock
              
              
              —
              
              
              261,190Conversion
                  of Series B preferred stock to common stock
              
              
              —
              
              
              705,000Stock
                  issued for accounts payable
              
              
              51,977
              
              
              16,666Warrants
                  exercised with notes payable
              
              
              —
              
              
              20,000Warrants
                  issued with notes payable
              
              
              190,842
              
              
              —
  **NOTE
        19 - DEBT FORGIVENESS INCOME & CONTRIBUTION TO CAPITAL**
  During
        2003, Verdisys negotiated settlements with 9 vendors for various debts
        originally recorded on the books at $520,501 for $43,600 cash and 33,333
        shares
        of stock valued at $.50 or $16,666 resulting in debt forgiveness income of
        $460,235. During the same period, Verdisys negotiated settlements with the
        two
        original founders for various debts recorded on the books at $576,000 for
        $28,000 cash and 150,000 warrants exercisable at $.10 and valued at $.40
        or
        $60,000 resulting in a contribution to capital of $488,000.
 
 
  54
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  **NOTE
        20 - GAIN ON SALE OF PROPERTY**
  In
        August
        2003, Verdisys obtained a 75% net revenue interest in property located in
        Monroe, Louisiana from a third party in exchange for agreeing to perform
        lateral
        drilling services on the property. In October 2003, Verdisys assigned the
        net
        revenue interest to Edge for $200,000. Edge paid Verdisys $120,000 and agreed
        to
        pay the balance of $80,000 by March 31, 2004. Verdisys agreed to refund the
        money to Edge if Verdisys did not deliver a lease between Edge and the original
        owner within 90 days if Edge desired. Verdisys recognized a $120,000 gain
        for
        the monies received due to a $0 cost basis by Verdisys. The $80,000 was not
        collected and under terms of the Settlement Agreement and Mutual Release
        entered
        into with Edge effective January 19, 2005, Verdisys has relinquished its
        right
        to these funds. See Note 22 for further detail.
  
 **NOTE
        21 - BUSINESS SEGMENTS**
  Verdisys
        has two reportable segments: (1) lateral drilling and (2) satellite service.
        A
        reportable segment is a business unit that has a distinct type of business
        based
        upon the type and nature of services and products offered.
  Verdisys
        evaluates performance and allocates resources based on profit or loss from
        operations before other income or expense and income taxes. The accounting
        policies of the reportable segments are the same as those described in the
        summary of significant accounting policies. The table below reports certain
        financial information by reportable segment:
  **For the Years Ended December 31,****2004**
              
              **2003**Revenues
                  from external customers
              
              (Restated)Lateral
                  drilling
              
              $
              738,710
              
              $
              466,194Satellite
                  service
              
              
              714,634
              
              
              419,247$
              1,453,344
              
              $
              885,441Depreciation
                  and amortizationLateral
                  drilling
              
              $
              499,631
              
              $
              215,258Corporate
              
              
              13,075
              
              
              4,434$
              512,706
              
              $
              219,692Operating
                  loss1Lateral
                  drilling
              
              $
              (1,521,185
              )
              $
              (935,238
              )Satellite
                  service
              
              
              (195,521
              )
              
              (169,251
              )Corporate
              
              
              (6,933,201
              )
              
              (6,618,973
              )$
              (8,649,907
              )
              $
              (7,723,462
              )Acquisition
                  of equipmentLateral
                  drilling
              
              $
              —
              
              $
              767,420Corporate
              
              
              3,705
              
              
              32,073$
              3,705
              
              $
              799,493
 _____________________________
 1
              -
                  Operating loss is total operating revenue less operating expenses,
                  selling
                  general & administrative expenses, depreciation and amortization, bad
                  debts and does not include other income and expense or income taxes.
  
  55
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  One
        customer of Verdisys lateral drilling, Maxim Energy, represented approximately
        14% of total revenue in 2004. Energy 2000, a customer of Verdisys lateral
        drilling and a related party, represented approximately 38% of total revenue
        in
        2003.
  Verdisys
        assets at December 31, 2004 were as follows:
  (Restated)Lateral
                  drilling
              
              $
              1,854,643Satellite
                  service
              
              
              73,936Corporate
              
              
              313,541$
              2,242,120
  All
        of
        Verdisys’ long-term assets are attributable to North America. The following
        table sets forth financial information with respect to Verdisys’ revenues by
        geographic area:
  **2004**
              
              **2003**United
                  States
              
              $1,279,053
              
              $885,441Africa
              
              
              174,291
              
              
              —$
              1,453,344
              
              $
              885,441
  **NOTE
        22 - SUBSEQUENT EVENTS**
  In
        January and February 2005, Verdisys issued 433,000 shares of common stock
        for
        $216,500 in a private placement for $0.50 per share. Two year warrants to
        purchase 433,000 common shares at $1.00 per share were attached to the common
        stock. Offering costs consisted of 15,800 shares of common stock and warrants
        to
        purchase 15,800 shares of common stock at $1.00 per share.
  In
        January 2005, we issued 16,000 shares of common stock for the payment of
        leasing
        fees valued at approximately $8,000 and 10,666 shares of common stock to
        settle
        unpaid compensation issues with two former AgZone employees. Verdisys also
        issued 388,502 shares of common stock under a program to compensate our
        directors, employees, contractors and former employees for unpaid wages,
        commissions and director fees accrued in 2004.
  Effective
        January 19, 2005, Verdisys, Edge, certain entities affiliated with Edge and
        Eric
        McAfee entered into a settlement agreement and mutual release to fully settle
        and resolve the disputes. As part of the settlement, Verdisys issued an
        aggregate of 750,000 shares of common stock along with warrants to purchase
        750,000 shares of common stock to Edge. 250,000 shares were issued during
        October 2004 and the remaining 500,000 shares were issued in 2005 and were
        valued at $240,000. In addition, Verdisys agreed to provide Edge a drilling
        rig
        to provide certain lateral drilling services in return for a fee per well
        and a
        share of the revenues generated from each well drilled. Upon closing of the
        settlement, Verdisys will sublicense the lateral drilling technology to Edge
        for
        certain limited purposes. As part of the settlement, the parties to the
        agreement have agreed to a mutual release and to dismiss all pending claims
        and
        litigation upon performance of the obligations in the settlement agreement.
        If
        the remaining obligations under the settlement agreement are not performed,
        this
        would cause the release to not be effective and could lead to the underlying
        lawsuit being reinstituted. The settlement agreement has been reflected in
        the
        2004 Statement of Operations, but had less than a $1,000 of impact as the
        settlement costs were offset by the write-off of previously accrued liabilities.
  In
        February 2005, Verdisys entered into an Agreed Judgment and Order of Severance
        with Gryphon as to all breach of contract claims related to Verdisys’ delay in
        registering common stock acquired by Gryphon in October 2003. Under the terms
        of
        the Agreed Judgment, Verdisys is obligated to pay liquidated damages of $500,000
        to Gryphon on or before September 30, 2005. Additionally, Gryphon has agreed
        to
        abate their remaining claims and related discovery in the lawsuit against
        Verdisys until after September 30, 2005.
 
 
  56
   
 **VERDISYS,
        INC.**
  **NOTES TO
        FINANCIAL STATEMENTS**
  On
        March
        8, 2005, Verdisys entered in an Assignment of License Agreement with Maxim
        TEP,
        Inc. (“Maxim”). The President and Chief Executive Officer of Maxim is Dan
        Williams, a former president and CEO of Verdisys. Verdisys and Carl Landers
        entered into a license agreement on April 23, 2003 for the exclusive use
        of the
        Landers horizontal drilling process (see Note 5). Under the Assignment, Verdisys
        assigned to Maxim its rights in the license; all current and future negotiations
        for assignments, sublicenses or territorial royalty pertaining to the license
        and two lateral drilling rigs. The first rig is to be delivered upon payment
        of
        the first installment by Maxim and the second rig is to be delivered no later
        than June 30, 2005. As consideration, Maxim agreed to pay Verdisys a total
        of
        $1.3 million in cash and release a $270,000 credit obligation owed by Verdisys
        to Maxim. The cash payments will be made in four installments: $300,000 on
        March
        9, 2005; $100,000 on March 18, 2005; $500,000 on June 3, 2005 and $400,000
        on
        September 2, 2005. Verdisys will retain a non-exclusive sublicense interest
        as
        long as Verdisys pays all required royalties on which the Landers horizontal
        technology is utilized.
  In
        March
        2005, Verdisys, Inc, entered into an agreement, subject to court approval,
        to
        settle the class action lawsuit brought by former shareholders in March 2004
        in
        the U.S. District Court for the Southern District. Under the terms of the
        agreement, Verdisys would issue to the class 1,150,000 shares of common stock
        and pay up to $55,000 in legal and administrative fees for the plaintiffs.
  **NOTE
        23 - RESTATEMENT**
 The
          2004 financial statements originally included the value of the
          intellectual property at cost because the net present value of the future
          cash flows exceeded the acquisition cost. During 2005, Blast agreed to
          sell the lateral drilling license for $1.3 million in cash over a period of
          time. Subsequently, Verdisys determined that the asset valuation
          conclusions were incorrect and that the sales agreement established the
          asset
          value of the intellectual property. Consequently, the value of the lateral
          drilling license was written down with a non-cash impairment charge of
          approximately $3.2 million and the financial statements were
          restated.
 
 The
        accounts affected by the restatement are:
 
 **As
                    reported**
                
                **Adjustments**
                
                **As
                    restated**License
                
                $
                5,025,000
                
                $
                (5,025,000
                )
                
                -Accumulated
                    amortization
                
                
                (549,167
                )
                
                549,167
                
                
                -Net
                    Book Value
                
                
                4,475,833
                
                
                (4,475,833
                )
                
                -Asset
                    impairment expense
                
                
                -
                
                
                3,175,833
                
                
                3,175,833License
                    receivable
                
                
                -
                
                
                1,300,000
                
                
                1,300,000Basic
                    and diluted loss per share
                
                
                (0.18
                )
                
                
                
                
                (0.28
                )
 
 
  57
  **Item
        8. Changes In / Disagreements with Accountants on Accounting and Financial
        Disclosure**
  None.
  **Item
        8a. Controls and Procedures**
  Our
          management, including the Principal Executive Officer and Principal Financial
          Officer, have conducted an evaluation of the effectiveness of disclosure
          controls and procedures pursuant to Exchange Act Rule 13a-15. This evaluation
          was conducted as of December 31, 2004. Based on that evaluation, the Principal
          Executive Officer and Principal Financial Officer originally concluded
          that the disclosure controls and procedures were effective in ensuring that
          (i) information required to be disclosed by Verdisys in the reports that
          it
          files or submits under the Exchange Act is accumulated and communicated
          to
          Verdisys management, including the Principal Executive Officer and Principal
          Financial Officer, as appropriate to allow timely decisions regarding required
          disclosure, and (ii) information required to be filed in the reports it
          files or
          submits is recorded, processed, summarized and reported, within the time
          periods
          specified in the SEC’s rules and forms. As of March 23, 2006, it
          was
          determined the controls and procedures were not effective because the impairment
          charge was not recognized and disclosed .
          The
          Company has instituted a procedure to thoroughly review the carrying value
          of its assets relative to indicated market value to determine whether the
          asset
          should be impaired. There have been no changes in internal controls or
          in other
          factors that occurred during the last fiscal quarter that has materially
          affected, or is reasonably likely to materially affect our internal controls
          over financial reporting.
 
  The
        Audit
        Committee, along with management, has reinforced internal controls and has
        implemented stringent policies regarding business engagements and activities.
        These policies and procedures cover the areas of approval and authority limits,
        segregation of duties, internal audit procedures, revenue recognition,
        contractual commitments, documentation and customer acceptance, and staggered
        levels of internal checks and balances. Operating documents, such as the
        “Verdisys Accounting Operations Manual,” “Employee Handbook” and “Approval
        Authorities” have been revised and adopted to describe such policies and train
        personnel. Since the earnings restatement in November 2003, the Committee
        has
        increased the frequency of its meetings and has directly reviewed and approved
        internal policies and procedures. They have also been directly involved in
        recruiting key personnel, namely a new CFO, a new controller and meeting
        with
        our auditors.
 
 **Audit
        Committee Report**
  The
        Audit
        Committee has reviewed and discussed the audited financial statements with
        management. The Audit Committee has discussed with the independent auditors
        the
        matters required to be discussed by SAS 61, as may be modified or supplemented.
        The Audit Committee has received the written disclosures and the letter from
        the
        independent accountants required by Independence Standards Board Standard
        No. 1,
        as may be modified or supplemented, and has discussed with the independent
        accountant the independent accountant’s independence. Based on the review and
        discussions conducted by the Audit Committee, the Audit Committee recommended
        to
        the Board of Directors that the audited financial statements be included
        in our
        Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004
        for
        filing with the Commission.
  Joseph
        J.
        Penbera, PhD - Chairman
 John
        R.
        Block
 O.
        James
        Woodward III
  **Sarbanes-Oxley
        Act**
  While
        the
        effective date of Section 404 of the Sarbanes-Oxley Act for non-accelerated
        filers like us has been delayed until fiscal years ending on or after July
        15,
        2006, our Board and management remain committed to implementation. We have
        already completed several steps such as an audit committee charter.
   58
  **Part
        III**
  **Item
        9. Directors and Executive Officers**
  The
        names
        of our directors and executive officers and certain additional information
        with
        respect to each of them are set forth below. The dates set forth under “Year
        First Became Director” below indicate the year in which our directors first
        became a director of our predecessor in interest, Verdisys, Inc.
  **Name**
              
              **Age**
              
              **Current
                  Position**
              
              **Year First**
                **Became**
                **Director**David
                  M. Adams
              
              53
              
              PresidentCo-Chief
                  Executive Officer
              
              N/AJohn
                  O’Keefe
              
              56
              
              Co-Chief
                  Executive OfficerChief
                  Financial Officer
              
              N/AJohn
                  R. Block
              
              70
              
              Director1
              
              2000Joseph
                  J. Penbera, Ph.D.
              
              57
              
              Director1
              
              1999Ronald
                  J. Robinson, Ph.D.
              
              59
              
              Director
              
              2002Frederick
                  R. Ruiz
              
              61
              
              Director
              
              1999O.
                  James Woodward, III
              
              69
              
              Chairman
                  of the Board1
              
              1999
 _________________________
 1   -
        Member
        of Audit Committee
  Statements
        below pertaining to the time at which an individual became one of our directors,
        executive officers or founders refers to the time at which the respective
        individual achieved his respective status with us or our predecessor in
        interest, Verdisys, Inc.
  ***David
        M. Adams*** has
        served as our President and COO since January 2004, and became Co-Chief
        Executive Officer in May 2004. From 1989 to 2000, Mr. Adams served as General
        Manager of Baker Hughes, E&P Solutions, and from 2001 to 2004; he served as
        President and General Manager of Subsea Mudlift Drilling Co., LLC, a subsidiary
        of Hydril Co., LP. Mr. Adams has a degree in petroleum engineering from the
        University of Texas and is a registered Professional Engineer.
  ***John
        O’Keefe*** has
        served as our Executive Vice President and CFO since January 2004 and became
        Co-Chief Executive Officer in May 2004. From 1999 to 2000, Mr. O’Keefe served as
        Vice President of Investor Relations of Santa Fe Snyder, and from 2000 to
        2003,
        he served as Executive Vice President and CFO of Ivanhoe Energy. Mr. O’Keefe has
        a B.A. in Business from the University of Portsmouth, is a Chartered Accountant
        and graduated from the Program for Management Development (PMD) from the
        Harvard
        Graduate School of Business in 1985 under sponsorship of Sun Oil Co.
 
 ***John
        R. Block*** has
        served as a director on our Board since May 2000. He currently serves as
        President of the Food Distributors International, an organization that
        represents the wholesale grocery and foodservice distribution industry. Prior
        to
        that, Mr. Block served as Secretary of Agriculture for the U.S. Department
        of
        Agriculture from 1981 to 1986. He currently serves as a director of John
        Deere
        and Co. and Hormel Foods Corp.
  ***Joseph
        J. Penbera, Ph.D.*** co-founded our company and has served as a director on our Board since its
        inception in April 1999. Since 1985, he has been a Professor of Business
        at
        California State University, Fresno, where he previously served as Dean of
        the
        Craig School of Business. Dr. Penbera was Senior Economist at Westamerica
        Bank,
        Regency Bancorp and California Bank from 1999 to 2002. Dr. Penbera is on
        the
        board of directors of Gottschalks, Inc., a publicly traded regional department
        store and Rug Doctor, Inc. Dr. Penbera received his Ph.D. from American
        University, his M.P.A. from Bernard Baruch School and his B.A. from Rutgers
        University.
  ***Ronald
        J. Robinson, Ph.D.*** was
        appointed as our interim President and CEO in December 2003 and has served
        as
        Chairman of our Board since January 2002. With the appointment of David Adams
        as
        President and Co-Chief Executive Officer, John O’Keefe as Co-Chief Executive
        Officer and Jim Woodward as Chairman of the Board, Dr. Robinson now serves
        only
        as Director. From 1996 to 2001, Dr. Robinson served as president of Texaco
        Technologies, a subsidiary of Chevron Texaco. From 2001 to 2003, Dr. Robinson
        was head of the Petroleum Engineering Department at Texas A&M University.
        Dr. Robinson currently serves as a director of Ensyn Group Inc. Dr. Robinson
        received his Ph.D. in Petroleum Engineering from Texas A&M University, an
        M.S. in Physics from Baylor University and a B.S. in Physics and Mathematics
        from the University of Southern Colorado.
  
 
  59
  ***Frederick
        R. Ruiz*** has
        served as a director on our Board since its inception in April 1999. He
        co-founded and is Chairman of the Board of Ruiz Food Products, Inc., a privately
        held frozen food company. Mr. Ruiz currently serves as a director of McClatchy
        Newspapers, Inc. and Gottschalks, Inc., each of which are publicly traded,
        the
        California Chamber of Commerce and the Hispanic College Fund. During 2004,
        Mr.
        Ruiz was named to the California University System Board of Regents.
  ***O.
        James Woodward III*** has
        served as a director on our Board since its inception in April 1999 and was
        elected Chairman of the Board in May 2004. From 1992 to 1999, Mr. Woodward
        was
        an attorney in private practice in Fresno, California. From 1995 to 2000,
        he was
        Chairman of MJ Construction Co., a Fresno, California based construction
        company, and from 2001 to 2003, he served as a consultant in Fresno, California.
        Mr. Woodward has been in private practice as an attorney since 2003 and is
        currently Of Counsel with Baker, Manock and Jensen. He currently serves on
        the
        board of directors of Gottschalks, Inc. Mr. Woodward received his M.B.A.
        from
        Stanford Graduate School of Business and his J.D. from the University of
        California, Berkeley Law School.
  All
        directors will serve in such capacity until the next annual meeting of our
        shareholders and until their successors have been elected and qualified.
        The
        officers serve at the discretion of our directors. There are no familial
        relationships among our officers and directors, nor are there any arrangements
        or understanding between any of our directors or officers or any other person
        pursuant to which any officer or director was or is to be selected as an
        officer
        or director.
  No
        non-compete or non-disclosure agreements exist between our management and
        any
        prior or current employer.
  Our
        directors are aware of no petitions or receivership actions having been filed
        or
        court appointed as to our business activities, officers, directors, or key
        personnel.
  We
        have
        not, nor anticipate, making loans to any of our officers, directors, key
        personnel, 10% stockholders, relatives thereof, or controllable entities.
        None
        of our officers, directors, key personnel, or 10% stockholders has guaranteed
        or
        co-signed any bank debt, obligation, or any other indebtedness pertaining
        to us.
  **Audit
        Committee**
  Our
        Board
        of Directors has established an Audit Committee. The Audit Committee meets
        with
        management and our independent auditors to determine the adequacy of internal
        controls and other financial reporting matters. In addition, the committee
        provides an avenue for communication between the independent auditors, financial
        management and the Board. Our Board of Directors have determined that for
        the
        purpose of and pursuant to the instructions of item 401(e) of regulation
        S-B
        titled Audit Committee Financial Expert, Joseph J. Penbera, PhD possesses
        the
        attributes of an audit committee financial expert. Dr. Penbera is one of
        our
        Board members and is the Chairman of the Audit Committee. Dr. Penbera is
        independent as defined by item 401(e)(ii) of regulation S-B. He receives
        compensation for board service only and is not otherwise an affiliated person.
 
 **Code
        of Ethics**
  We
        have
        adopted a code of ethics that applies to our senior officers such as the
        principal executive officer, principal financial officer, principal accounting
        officer and persons performing similar functions. A code of ethics relates
        to
        written standards that are reasonably designed to deter wrongdoing and to
        promote;
  •
              Honest
                  and ethical conduct, including the ethical handling of actual or
                  apparent
                  conflicts of interest between personal and professional relationships;
  •
              Full,
                  fair, accurate, timely and understandable disclosure in reports
                  and
                  documents that are filed with, or submitted to, the SEC and in
                  other
                  public communications made by an issuer;
  •
              Compliance
                  with applicable governmental laws, rules and regulations;
  •
              The
                  prompt internal reporting of violations of the code to an appropriate
                  person or persons identified in the code; and
  •
              Accountability
                  for adherence to the code.
  Our
        code
        of ethics was filed as Exhibit 14.1 of our 10-KSB for the year ended December
        31, 2003. Our code of ethics is posted on our website at www.verdisys.com .
        We will
        provide to any person without charge, upon written request to our corporate
        secretary at our principal executive office, a copy of our code of ethics.
  
  60
  **Item
        10. Executive Compensation**
  Dr.
        Robinson served as interim CEO from January to May 2004 and President for
        a
        brief period in January 2004 until Messrs. Adams and O’Keefe were elevated to
        Co-CEOs. Other than for Dr. Robinson, Mr. Adams and Mr. O’Keefe, we have no
        other person that is a named executive officer as of December 31, 2004.
  **Compensation
        Summary**
  The
        following table provides certain summary information concerning compensation
        for
        the last three fiscal years earned by or paid to our Chief Executive Officers
        and each of our other executive officers who had compensation in excess of
        $100,000 during the last fiscal year (collectively, the “Named Executive
        Officers”).
  **SUMMARY
        COMPENSATION TABLE**
  **Annual
                  Compensation**
              
              **Award(s)**
              
              **Payouts****Position**
              
              **Year**
              
              **Salary**
                **($)**
              
              **Bonus**
                **($)**
              
              **Other
                  Annual**
                **Compensation****(1)**
                **($)**
              
              **Restricted**
                **Stock**
                **Award
                  (s)**
                **($)**
              
              **Securities**
                **Underlying**
                **Options/SARs**
                **(#)**
              
              **LTIP**
                **Payouts**
                **($)**
              
              **All
                  Other**
                **Compensation**
                **($)****Ronald
                  J. Robinson**
              
              
              2004
              
              
              90,000
              
              
              0
              
              
              10,000
              
              
              0
              
              
              12,000
              
              
              0
              
              
              0Former
              
              
              2003
              
              
              70,000
              
              
              0
              
              
              0
              
              
              0
              
              
              700,000
              
              
              0
              
              
              0Interim
                  CEO
              
              
              2002
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              50,000
              
              
              0
              
              
              0**David
                  M. Adams**
              
              
              2004
              
              
              181,146
              
              
              50,000
              
              
              0
              
              
              0
              
              
              500,000
              
              
              0
              
              
              0Co-CEO
              
              
              2003
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0COO
              
              
              2002
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0**John
                  O’Keefe**
              
              
              2004
              
              
              172,570
              
              
              40,000
              
              
              0
              
              
              0
              
              
              500,000
              
              
              0
              
              
              0Co-CEO
              
              
              2003
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0CFO
              
              
              2002
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0
              
              
              0
 _________________________
 During
        the periods indicated, perquisites for each individual named in the Summary
        Compensation Table aggregated less than 10% of the total annual salary and
        bonus
        reported for such individual in the Summary Compensation Table. Accordingly,
        no
        such amounts are included in the Summary Compensation Table.
 
 
  61
   
 **Option
        Grants**
  The
        following table provides certain information with respect to options granted
        to
        our Named Executive Officers named in the Summary Compensation Table during
        the
        fiscal year ended December 31, 2004 under our stock option plan:
  **OPTION
        GRANTS IN 2004**
  **Name**
              
              **Number
                  of**
                **Securities**
                **Underlying**
                **Options**
                **Granted**
              
              **Percent**
                **of
                  Total**
                **Granted to**
                **Employees**
                **in
                  Fiscal**
                **Year**
              
              **Exercise**
                **Price**
              
              **Market**
                **Price**
                **on**
                **Date
                  of**
                **Grant**
              
              **Expiration**
                **Date**Ronald
                  J. Robinson
              
              
              12,000
              
              
              1
              %
              $
              4.28
              
              $
              4.28
              
              
              1/21/2014David
                  M. Adams
              
              
              150,000
              
              
              13
              %
              $
              4.28
              
              $
              4.28
              
              
              1/21/2014350,000
              
              
              30
              %
              $
              0.90
              
              $
              0.90
              
              
              7/29/2014John
                  O’Keefe
              
              
              80,000
              
              
              7
              %
              $
              4.28
              
              $
              4.28
              
              
              1/21/2014420,000
              
              
              36
              %
              $
              0.90
              
              $
              0.90
              
              
              7/29/2014
  **Option
        Exercises and Values**
  The
        following table sets forth the information concerning option exercises and
        the
        value of unexercised options held by our Named Executive Officers named in
        the
        Summary Compensation Table as of the end of the last fiscal year.
  **AGGREGATED
        OPTION EXERCISES IN 2004**
 **AND
        OPTION VALUES AT DECEMBER 31, 2004**
  **Number
                  of Securities**
                **Underlying
                  Unexercised**
                **Options
                  Held at**
                **December
                  31, 2004**
              
              **Value
                  of Unexercised**
                **In-The-Money**
                **Options Held at**
                **December
                  31, 2004****Name**
              
              **Shares**
                **Acquired on**
                **Exercise**
              
              **Value**
                **Realized**
              
              **Exercisable**
              
              **Unexercisable**
              
              **Exercisable**
              
              **Unexercisable**Ronald
                  J. Robinson
              
              
              None
              
              
              None
              
              
              189,332
              
              
              6,000
              
              $
              0
              
              $
              0David
                  M. Adams
              
              
              None
              
              
              None
              
              
              170,834
              
              
              329,166
              
              $
              0
              
              $
              0John
                  O’Keefe
              
              
              None
              
              
              None
              
              
              130,000
              
              
              370,000
              
              $
              0
              
              $
              0
  Note:
  Value
        of
        Unexercised In-The-Money Options Held at December 31, 2004 computed based
        on the
        difference between aggregate fair market value and aggregate exercise price.
        The
        fair market value of our common stock on December 31, 2004 was $0.47, based
        on
        the closing price on the OTC Bulletin Board .
  **Compensation
        of Directors**
  We
        pay
        our directors fees for attendance at board and other committee meetings in
        the
        form of cash compensation or similar remuneration, and reimburse them for
        any
        out-of-pocket expenses incurred by them in connection with our business.
  Currently,
        each independent director earns compensation of $1,000 per month with an
        additional $1,000 per month for chairing a committee with the exception of
        the
        audit committee chair who receives an additional $2,000 per month and the
        chairman of the board who receives an additional $3,000 per month. Meeting
        fees
        accrue at a rate of $1,000 per day for regularly scheduled Board meetings.
        Currently, only the chairman of the board is receiving cash payments towards
        fees earned. All independent directors receive options to purchase 12,000
        shares
        per year.
  62
  **Employment
        Agreements**
  *Ronald
        J. Robinson* **
  In
        July
        2003, we entered into an advisory agreement with Dr. Robinson, and we amended
        the agreement in December 2003. Pursuant to the agreement, as amended, Dr.
        Robinson agreed to serve as our interim President and CEO until a suitable
        replacement was found. For his services as interim President and CEO, he
        received an option to purchase 500,000 shares of our common stock pursuant
        to a
        12 month vesting schedule (except with respect to 50,000 shares that were
        tied
        to certain revenue milestones for the fourth quarter of 2003 and which
        milestones were not met), and he receives monthly compensation of $20,000
        and a
        monthly office allowance of $2,500. Dr. Robinson also served as Chairman
        of the
        Board. In January 2004, David Adams was selected to serve as President thus
        terminating Dr. Robinson’s service as interim President.
 
 *David
        M. Adams* **
  In
        January 2004, we entered into an employment agreement with David Adams. The
        term
        of the agreement is for one year, and it may be renewed at the pleasure of
        both
        parties. Pursuant to the agreement, Mr. Adams serves as our President and
        COO in
        exchange for a base salary of $185,000 per year. Mr. Adams also received
        an
        option to purchase 150,000 shares of common stock to vest quarterly over
        the
        initial term of the employment agreement. Mr. Adams also received a signing
        bonus in the amount of $50,000 on the effective date of the employment
        agreement, and is entitled to participate in our annual incentive compensation
        program with a potential bonus being up to fifty percent of his base salary.
  *John
        O’Keefe* **
  In
        January 2004, we entered into an employment agreement with John O’Keefe. The
        term of the agreement is for one year, and it may be renewed at the pleasure
        of
        both parties. Pursuant to the agreement, Mr. O’Keefe serves in the position of
        Executive Vice President and Chief Financial Officer in exchange for a base
        annual salary of $175,000 for the first twelve months of his employment,
        $195,000 for the second year of employment and $215,000 for the third year
        of
        employment. Mr. O’Keefe also received an option to purchase 80,000 shares of
        common stock to vest quarterly over the initial term of the employment
        agreement. Mr. O’Keefe received a one time payment of $40,000 as a sign-on bonus
        and is entitled to participate in our annual compensation program with a
        potential bonus being up to fifty percent of his base salary.
  **Item
        11. Security Ownership of Certain Beneficial Owners and Management**
  The
        following table presents certain information regarding the beneficial ownership
        of our common stock as of February 28, 2005 by (i) each person who is known
        by
        us to own beneficially more than 5% of the outstanding shares of our common
        stock, (ii) each of our directors, (iii) our Named Executive Officers, and
        (iv)
        all directors and executive officers as a group. Each of the persons listed
        in
        the table has sole voting and investment power with respect to the shares
        listed.
   63
  **Common
        Stock**
  **Name
                  and Address of Beneficial Owner**
              
              **Amount and Nature**
                **of
                  Beneficial Owner**
              
              **Percentage**
                **of Class (1)**Berg
                  McAfee Companies (2)
              
              
              10,040,752
              (3)
              
              28.0
              %100600
                  N. De Anza Blvd., #250Cupertino,
                  California 95014Eric
                  McAfee
              
              
              1,825,400
              (4)(5)
              
              5.2
              %100600
                  N. De Anza Blvd, #250Cupertino,
                  California 95014David
                  M. Adams
              
              
              333,332
              (6)
              
              *President
                  and co-CEOJohn
                  O’Keefe
              
              
              283,334
              (7)
              
              *Co-CEO
                  & CFOJohn
                  R. Block
              
              
              194,000
              (8)
              
              *DirectorJoseph
                  J. Penbera
              
              
              1,012,952
              (9)
              
              2.9
              %DirectorRonald
                  J. Robinson
              
              
              550,332
              (10)
              
              1.6
              %DirectorFrederick
                  R. Ruiz
              
              
              401,366
              (11)
              
              1.1
              %DirectorO.
                  James Woodward III
              
              
              240,500
              (12)
              
              *DirectorTotal
                  Shares of 5% or more Beneficial Ownership
              
              
              11,866,152
              (13)
              
              32.8
              %Total
                  Shares of Officers and Directors as a group
              
              
              3,015,816
              
              
              8.4
              %
 _________________________
 ***   *Less
        than 1%*
 
 *Notes:*
  *(1)*
              *Each
                  beneficial owner’s percentage ownership is based upon 34,973,673 shares of
                  common stock outstanding as of February 28, 2005 and assumes the
                  exercise
                  or conversion of**all**options, warrants and other convertible securities held by such
                  person and
                  that are exercisable or convertible within 60 days after February
                  28,
                  2005.*
  *(2)*
              *Berg
                  McAfee Companies is controlled by Clyde Berg and Eric McAfee. Mr.
                  McAfee
                  is our former Vice-Chairman.*
  *(3)*
              *Includes
                  820,014 shares issuable upon exercise of warrants and 52,067 shares
                  issuable upon conversion of convertible debt.*
  *(4)*
              *Includes
                  250,000 shares issuable upon exercise of warrants and 52,067 shares
                  issuable upon conversion of convertible debt.*
  *(5)*
              *Does
                  not include shares beneficially owned by Berg McAfee.*
  *(6)*
              *Includes
                  266,666 shares issuable upon exercise of options and 5,000 shares
                  issuable
                  upon exercise of warrants*
  *(7)*
              *Includes
                  220,000 shares issuable upon exercise of options and 5,000 shares
                  issuable
                  upon exercise of warrants.*
  *(8)*
              *Includes
                  82,000 shares issuable upon exercise of options and 2,000 shares
                  issuable
                  upon exercise of warrants.*
  *(9)*
              *Includes
                  82,000 shares issuable upon exercise of options and 5,000 shares
                  issuable
                  upon exercise of warrants.*
  *(10)*
              *Includes
                  195,332 shares issuable upon exercise of options.*
  64
   *(11)*
              *Includes
                  82,000 shares issuable upon exercise of options and 5,000 shares
                  issuable
                  upon exercise of warrants.*
  *(12)*
              *Includes
                  94,000 shares issuable upon exercise of options.*
  *(13)*
              *Includes
                  shares beneficially owned by Berg McAfee and Eric McAfee.*
  **Holders**
  As
        of
        February 28, 2005 we had 34,973,673 shares of common stock issued and
        outstanding and held by approximately 500 shareholders.
  **Item
        12. Certain Relationships and Related Transactions**
  *Energy
        2000 NGC, Inc. and Natural Gas Systems, Inc.* **
  Energy
        2000 NGC, Inc. (“Energy 2000”) is a subsidiary of Berg McAfee Energy, LLC, which
        is a wholly owned subsidiary of Berg McAfee Companies (“Berg McAfee”). Berg
        McAfee has a more than 25% beneficial interest in us. Natural Gas Systems,
        Inc.
        (“NGS”) is an independent company with substantial shareholdings owned by Eric
        McAfee, a 50% owner of Berg McAfee and one of our former directors. Energy
        2000
        and NGS are beneficially owned 80% and 23% respectively by Berg McAfee or
        Eric
        McAfee personally.
  We
        billed
        $666,250 and $153,960 to Energy 2000 and NGS, respectively, for services
        performed in 2003. We received $397,500 and $130,000, respectively. However,
        for
        Energy 2000 we had inadequate documentation to substantiate whether some
        of the
        services were performed. For Energy 2000, we were able to substantiate $328,750
        of revenue leaving $68,750 in deferred revenue. We billed $20,457 and $2,000
        to
        Energy 2000 and NGS, respectively, for expenses incurred in 2004. The amount
        billed to Energy 2000 was deemed uncollectible and the amount billed to NGS
        was
        collected. At December 31, 2004, we have no receivables or deferred revenues
        from related parties.
  In
        September 2003, we signed a drilling service contract with NGS, whereby NGS
        would have paid us a minimum of $7,800,000 for the lateral drilling of 120
        wells. This contract was for a fixed amount with the total price dependent
        upon
        the number of wells serviced and offshoot lateral bores drilled. In addition,
        we
        would receive a 70 percent interest in the net operating income after payback
        from these properties.
  In
        April
        2003, we signed a drilling service contract with Energy 2000, whereby Energy
        2000 would have paid us a minimum of $1,800,000 for the lateral drilling
        of 45
        wells. This contract was for a fixed amount, dependent upon the number of
        wells
        serviced and offshoot lateral bores drilled. In addition, we would receive
        an 80
        percent interest in the net operating income after payback from these properties
        and also be reimbursed for 20 percent of its field costs. In September, 2003
        we
        entered into another contract with Energy 2000 for an additional 57 wells
        with
        terms similar to the original contract. These contracts have been suspended
        for
        lack of payment.
 
 Lateral
        drilling services for these two customers ceased in December 2003 because
        of a
        change in Verdisys management.
  *Berg
        McAfee Companies* **
  In
        addition to the transactions involving Energy 2000 and NGS, we had an additional
        transaction with Berg McAfee. In December 2004, Berg McAfee purchased 400,000
        shares of our common stock at a price of $0.50 per share in a private
        transaction. In October 2004, Berg McAfee loaned us $100,000 under the terms
        of
        a convertible promissory note bearing interest at 8% and maturing May 31,
        2006.
        In connection with the note, we issued warrants to purchase 50,000 shares
        of
        common stock at $2.00 per share during the term of the note to Berg McAfee.
   65
  *Eric
        McAfee* **
  In
        addition to the transactions involving Energy 2000, NGS and Berg McAfee,
        we had
        the additional transactions with Eric McAfee.
  On
        January 19, 2005, we entered into a settlement agreement and mutual release
        with
        Eric McAfee, Edge Capital Group, Inc. (“Edge”) and certain entities affiliated
        with Robert Frazier, Sr. As part of the settlement, Mr. McAfee paid us $625,000
        and gave us 300,000 shares of NGS common stock in exchange for 500,000 shares
        of
        our common stock. Mr. McAfee has signed a Funding Agreement to acknowledge
        an
        obligation to Verdisys of $375,000, currently secured by the 300,000 shares
        of
        NGS common stock. The $625,000 in cash was then distributed to Edge along
        with
        750,000 shares of our common stock. At the closing of the settlement agreement,
        the parties have agreed to a mutual release and have agreed to dismiss all
        pending claims and litigation between them.
  In
        October 2004, Mr. McAfee loaned us $100,000 under the terms of a convertible
        promissory note bearing interest at 8% and maturing May 31, 2006. In connection
        with the note, we issued warrants to purchase 50,000 shares of common stock
        at
        $2.00 per share during the term of the note to Mr. McAfee.
  We
        had a
        consulting agreement with Mr. McAfee for $10,000 per month through April
        30,
        2005, with $120,000 due during 2004 and $40,000 in 2005. This agreement was
        cancelled upon his resignation as a director.
  In
        April
        2003, we issued 2,000,000 shares of our common stock for what management
        believed was satellite communications management software pursuant to an
        asset
        purchase agreement with a related party. Management in place as of August
        2003
        maintained the software was not useful and impaired it as of June 30, 2003.
        Eric
        McAfee, a principal to the counterparty in the transaction, acquired 11.5%
        of
        the 2,000,000 shares. In June 2004, we filed a lawsuit against Eric McAfee,
        Mark
        Crone and QuikView Inc. in an attempt to negate the transaction. In November
        2004, we dismissed the lawsuit against all defendants with prejudice.
  In
        April
        2003, Mr. McAfee was granted options to purchase 50,000 shares of our common
        stock for his role as a director. The options had an exercise price of $0.10
        per
        share, but where granted when the market value was $0.50 per share. The options
        vested quarterly over one year and have a ten year term. Mr. McAfee’s role as a
        director terminated effective March 2, 2004.
  *Directors
        and Officers* **
  In
        July
        2004, we granted options to purchase 350,000 shares of our common stock to
        David
        M. Adams and options to purchase 420,000 shares of our common stock to John
        O’Keefe. Mr. Adams is our president and co-CEO, while Mr. O’Keefe is our co-CEO
        and CFO. The options have a ten year term and are exercisable at $0.90 per
        share, the market price at date of grant. The options vest quarterly over
        three
        years.
  In
        May
        2004, we granted options to purchase 12,000 shares of our common stock to
        the
        following directors; John R. Block, Joseph J. Penbera, Frederick R. Ruiz
        and
        Ronald J. Robinson. We also granted options to purchase 24,000 shares of
        our
        common stock to O. James Woodward III, another director. The options have
        a ten
        year term and are exercisable at $2.20 per share, the market price at date
        of
        grant. The options vest quarterly over one year.
  In
        May
        2004, Messrs. Adams, O’Keefe, Penbera and Ruiz loaned $25,000 to us, while Mr.
        Block loaned $10,000. The notes bear interest at 8% and mature on May 14,
        2005.
        In connection with the notes we issued warrants to purchase 5,000 shares
        of
        common stock to Messrs. Adams, O’Keefe, Penbera and Ruiz and warrants to
        purchase 2,000 shares of common stock to Mr. Block. The warrants are exercisable
        at $2.00 per share.
  In
        January 2004, we granted options to purchase 150,000 shares of our common
        stock
        to Mr. Adams and options to purchase 80,000 shares of our common stock to
        Mr.
        O’Keefe. We also granted options to purchase 20,000 shares of our common stock
        to the following directors; Messrs. Block, Penbera, Ruiz and Woodward. The
        options have a ten year term and are exercisable at $4.28 per share, the
        market
        price at date of grant. The options granted to the officers vest quarterly
        over
        one year, while the options granted to the directors vested immediately.
  In
        January 2004, we entered into an employment agreement with Mr. O’Keefe to serve
        as CFO. The agreement stipulates compensation of $175,000 in year one, $195,000
        in year two and $215,000 in year three. The agreement renews annually.
  In
        December 2003, we entered into an employment agreement with Mr. Adams to
        serve
        as CEO. The agreement provides for a base salary of not less than $185,000.
        The
        agreement renews annually.
   66
  In
        December 2003, we granted options to purchase 500,000 shares of our common
        stock
        to Ronald J. Robinson, our then chairman of the board and interim CEO. The
        options have a ten year term and are exercisable at $9.55 per share, the
        market
        price at date of grant. 50,000 vested immediately, 50,000 were performance
        options and did not vest, and the remaining 400,000 options vest evenly over
        12
        months in 2004.
  In
        April
        2003, we granted options to purchase 50,000 shares of our common stock to
        each
        of our directors. The directors awarded options were Messrs. Block, Penbera,
        Robinson, Ruiz and Woodward. We also granted options to purchase 200,000
        shares
        of our common stock to our interim CEO, Mr. Robinson. The options all have
        an
        exercise price of $0.10 per share and were granted at a time when the market
        value was $0.50 per share. The options vest quarterly over one year and have
        a
        ten year term.
   67
  **Item
        13. Exhibits and Reports on Form 10-KSB**
  ***(a)
        Exhibits*** **
  Index
        of Exhibits
  Verdisys,
        Inc. includes by reference, unless otherwise indicated, the following exhibits:
  **Number**
              
              **Description**2.1
              
              Agreement
                  and Plan of Reorganization, dated April 24, 2003, as amended June
                  30,
                  2003; Filed July 18, 2003 with the SEC, Report on Form
                  8-K3.1
              
              Restated
                  Articles of Incorporation dated July 15, 2003 Filed June 29, 2004
                  with the
                  SEC, Form SB-23.2
              
              Bylaws,
                  as amended September 25, 2003 Filed June 29, 2004 with the SEC,
                  Form
                  SB-24.1
              
              Form
                  of Subscription Agreement Filed August 11, 2004 with the SEC, Form
                  10-QSB4.2
              
              Form
                  of Warrant Agreement Filed August 11, 2004 with the SEC, Form
                  10-QSB4.3
              
              Form
                  of Promissory Note Filed August 11, 2004 with the SEC, Form
                  10-QSB4.4
              
              Form
                  of Convertible Promissory Note Filed August 11, 2004 with the SEC,
                  Form
                  10-QSB4.5
              
              Form
                  of Registration Rights Agreement Filed August 11, 2004 with the
                  SEC, Form
                  10-QSB10.1
              
              Employment
                  Agreement - John O’Keefe, dated January 6, 2004 Filed April 15, 2004 with
                  the SEC, Form 10-KSB10.2
              
              Employment
                  Agreement - David Adams, dated December 31, 2003 Filed April 15,
                  2004 with
                  the SEC, Form 10-KSB10.3
              
              Advisor
                  Agreement - Dr. Ron Robinson, amended December 11, 2003 Filed April
                  15,
                  2004 with the SEC, Form 10-KSB10.4
              
              Employment
                  Agreement - Andrew Wilson, dated June 2003 Filed November 20, 2003
                  with
                  the SEC, Form 10-QSB, as amended10.5
              
              License
                  Agreement - Carl W. Landers, dated April 24, 2003; Filed October
                  6, 2003
                  with the SEC, Report on Form 8-K10.6
              
              Amendment
                  to License Agreement - Carl W. Landers, dated September 4, 2003;
                  Filed
                  October 6, 2003 with the SEC, Report on Form
                  8-K
 
 10.7
              
              Second
                  Amendment to License Agreement - Carl W. Landers, dated February
                  28, 2004;
                  Filed February 28, 2004 with the SEC, Report on Form
                  8-K10.8
              
              Technology
                  Report, “Landers Technology”, dated October 13, 2003 Filed November 20,
                  2003 with the SEC, Form 10-QSB, as amended10.9
              
              Subscription
                  Agreement, Gryphon Master Fund, L.P., dated October 23, 2003 and
                  Registration Rights Agreement dated October 24, 2003 Filed October
                  27,
                  2003 with the SEC, Report on Form
                  8-K
 
  68
  
 **Number**
              
              **Description**10.10
              
              Form
                  of Registration Rights Agreement, re: Private Placement Offering
                  July/August 2003 Filed December 3, 2003 with the SEC, Form 10-QSB,
                  as
                  amended10.11
              
              Alternative
                  Form of Registration Rights Agreement, re: Offering July/August
                  2003 Filed
                  December 3, 2003 with the SEC, Form 10-QSB, as amended10.12
              
              Placement
                  Agency Agreement, Stonegate Securities, Inc., dated August 26,
                  2003 Filed
                  November 20, 2003 with the SEC, Form 10-QSB, as amended10.13
              
              Independent
                  Contractor Agreement, Terronne Petroleum Corporation, dated August
                  1, 2003
                  Filed November 20, 2003 with the SEC, Form 10-QSB, as
                  amended10.14
              
              Master
                  Services Contract, Esperada Energy Partners, L.L.C., dated March
                  2004
                  Filed April 15, 2004 with the SEC, Form 10-KSB10.15
              
              Services
                  Contract, Maxim Energy, Inc., dated March 2004 Filed April 15,
                  2004 with
                  the SEC, Form 10-KSB10.16
              
              Services
                  Contract, Natural Gas Systems, dated January 2004 Filed April 15,
                  2004
                  with the SEC, Form 10-KSB10.17
              
              Contract
                  - Natural Gas Systems, “Delhi Field”, dated September 22, 2003; Filed
                  November 20, 2003 with the SEC, Form 10-QSB, as amended10.18
              
              Services
                  Contract, Amvest Osage, Inc.; dated January 2004 Filed April 15,
                  2004 with
                  the SEC, Form 10-KSB10.19
              
              Acknowledge
                  of amounts owed at September 30, 2003 re. Edge Capital Group contract
                  dated June 16, 2003 Filed November 20, 2003 with the SEC, Form
                  10-QSB, as
                  amended10.20
              
              Contract
                  - Edge Capital Group, “Franklin Field”, dated September 27, 2003 Filed
                  November 20, 2003 with the SEC, Form 10-QSB, as amended10.21
              
              Contract
                  - Edge Capital Group, “Monroe Field”, dated June 16, 2003 Filed August 20,
                  2003 with the SEC, Form 10-QSB, as amended10.22
              
              Addendum
                  to Contract, Edge Capital Group, “Monroe Field”, dated November 19, 2003
                  Filed November 20, 2003 with the SEC, Form 10-QSB, as
                  amended10.23
              
              Contract
                  - Noble Energy, re: Satellite Services, dated September 17, 2003
                  Filed
                  November 20, 2003 with the SEC, Form 10-QSB, as amended10.24
              
              Contract
                  - Apache Corp., re: Satellite Services, dated September 11, 2002
                  Filed
                  November 20, 2003 with the SEC, Form 10-QSB, as amended10.25
              
              Contract
                  - Energy 2000 NGC, “Monroe Field”, dated April 30, 2000 Filed August 20,
                  2003 with the SEC, Form 10-QSB, as amended10.26
              
              Verdisys,
                  Inc. 2003 Stock Option Plan; Filed November 20, 2003 with the SEC,
                  Form
                  10-QSB, as amended10.27
              
              Master
                  Service Contract - BlueRidge Gas Partners, LLC - June 23, 2004
                  Filed
                  August 11, 2004 with the SEC, Form 10-QSB10.28
              
              Master
                  Service Contract - VJI Natural Resources, LLC - July 20, 2004 Filed
                  August
                  11, 2004 with the SEC, Form 10-QSB
  
  69
    **Number**
              
              **Description**10.29
              
              Contract/Order
                  - U. S. Department of Energy - June 4, 2004 and Letter of Intent,
                  Radial
                  Drilling Optimization Services - April 14, 2004 Filed August 11,
                  2004 with
                  the SEC, Form 10-QSB10.30
              
              Contract
                  - License Agreement between Alberta Energy Holdings, Inc. and Verdisys,
                  Inc. for Abrasive Fluid Jet Technology, dated October 27, 2004
                  Filed
                  November 15, 2004 with the SEC, Form 10-QSB10.31
              
              Contract
                  - Agreement among Verdisys, Berg McAfee Companies, Energy 2000
                  NGC, and
                  Eric McAfee Filed November 15, 2004 with the SEC, Form
                  10-QSB10.32
              
              Settlement
                  Agreement and Mutual Release dated as of January 19, 2005 by and
                  among
                  Verdisys, Inc., Eric McAfee, Edge Capital Group, Inc. and certain
                  entities
                  affiliated with Robert Frazier, Sr. Filed February 4, 2005 with
                  the SEC,
                  Form 8-K10.33
              
              Assignment
                  of License Agreement dated March 8, 2005 by and among Verdisys,
                  Inc. and
                  Maxim TEP, Inc. Filed March 14, 2004 with the SEC, Form
                  8-K*31.1
              
              Certification
                  of Principal Executive Officer pursuant to Section 302*31.2
              
              Certification
                  of Principal Accounting Officer pursuant to Section 302*32.1
              
              Certification
                  of Principal Executive Officer pursuant to Section 1350*32.2
              
              Certification
                  of Principal Accounting Officer pursuant to Section
                  1350
 _________________________
 *   Filed
        herewith
  ***(b)
        Reports on Form 8-K***
  During
        the quarter ending December 31, 2004, we had no filings on Form 8-K with
        the
        Securities and Exchange Commission.
  **Item
        14. Principal Accountants Fees and Services**
  **Audit
        Fees**
  The
        aggregate fees billed for each of the last two fiscal years for professional
        services rendered by the principal accountant for the audit of our annual
        financial statements and for services provided by the accountant in connection
        with statutory and regulatory filings or engagements for the last two fiscal
        years were: $95,970 in Fiscal Year 2004 and $58,000 in Fiscal Year 2003.
  **Audit-Related
        Fees**
  No
        aggregate fees were billed in each of the last two fiscal years for assurance
        and related services by the principal accountant that are reasonably related
        to
        the performance of the audit or review of our financial statements, and are
        not
        reported under the prior caption Audit Fees.
  **Tax
        Fees**
  No
        aggregate fees were billed in each of the last two fiscal years for professional
        services rendered by the principal accountant for tax compliance, tax advice,
        and tax planning.
  **All
        Other Fees**
  No
        other
        services were provided, nor aggregate fees billed, other then such services
        or
        fees which have been previously disclosed herein.
  Our
        Audit
        Committee has approved all of the services performed by our principal accountant
        for the fiscal year ending December 31, 2004.
 
 
  70
   
 **Signatures**
  In
        accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
        this report to be signed on its behalf by the undersigned, thereunto duly
        authorized.
  Verdisys,
                  Inc.(Registrant)By:
              /s/
                  David M. AdamsDavid
                  M. AdamsCo-Chief
                  Executive OfficerPrincipal
                  Executive OfficerDate:
                  June 2, 2006
  In
        accordance with the Exchange Act, this report has been signed below by the
        following persons on behalf of the registrant and in the capacities and on
        the
        dates indicated.
  By:
              /s/
                  David M. Adams
              By:
              /s/
                  John O’KeefeDavid
                  M. Adams
              
              John
                  O’KeefePresident
              
              Co-Chief
                  Executive OfficerCo-Chief
                  Executive Officer
              
              Chief
                  Financial OfficerPrincipal
                  Executive Officer
              
              Principal
                  Accounting OfficerDate:
                  June 2, 2006
              Date:
                  June 2, 2006By:
              /s/
                  John R. Block
              By:
              /s/
                  Joseph J. Penbera, Ph.D.John
                  R. Block
              
              Joseph
                  J. Penbera, Ph.D.Director
              
              DirectorDate:
                  June 2, 2006
              Date:
                  June 2, 2006By:
              /s/
                  Ronald J. Robinson, Ph.D.
              By:
              /s/
                  Frederick R. RuizRonald
                  J. Robinson, Ph.D.
              
              Frederick
                  R. RuizDirector
              
              DirectorDate:
                  June 2, 2006
              Date:
                  June 2, 2006By:
              /s/
                  O. James Woodward IIIO.
                  James Woodward IIIDirectorDate:
                  June 2, 2006