**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe quarterly period ended December 31, 2005**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from                   to                    **

**CommissionFile Number 000-30819**

**Particle Drilling Technologies, Inc.**

(Exact name of registrantas specified in its charter)

| **Nevada**                                                       |   | **20-1563395**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

**1021 Main Street, Suite 2650Houston, Texas 77002**

(Address of principalexecutive offices)(Zip Code)

**713-223-3031**

(Registrant’s telephonenumber, including area code)

(Former name, formeraddress and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

Large acceleratedfiler o                             Acceleratedfiler x                            Non-acceleratedfiler o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).Yes  o No x

Thenumber of shares of the registrant’s common stock, $.001 par value, outstandingas of February 7, 2006 was 24,654,943.

 

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**PARTICLE DRILLINGTECHNOLOGIES, INC.(a development stage enterprise)**

**FORM 10-QFOR THE QUARTER ENDED DECEMBER 31, 2005**

**INDEX**

| **Part I—Financial Information** |                                                                                                                                                                                                |       |
|--------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Item 1.                                    | Financial Statements (Unaudited)                                                                                                                                                                    |       |   |
|                                       | Consolidated  Balance Sheets (Unaudited) at December 31, 2005 and  September 30, 2005                                                                                                |       | 3 |
|                                       | Consolidated  Statements of Operations (Unaudited)—Three Months Ended December 31,  2005 and 2004, and period from June 9, 2003 (date of inception) to  December 31, 2005  |       | 4 |
|                                       | Consolidated Statements of Cash  Flows (Unaudited)—Three Months Ended December 31, 2005 and 2004, and period  from June 9, 2003 (date of inception) to December 31, 2005        |       | 5 |
|                                       | Notes to Consolidated Financial  Statements (Unaudited)                                                                                                                                             |       | 6 |
| Item 2.                                    | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                                                                                         |       | 16 |
| Item 3.                                    | Quantitative and Qualitative  Disclosures about Market Risk                                                                                                                                         |       | 21 |
| Item 4.                                    | Controls and Procedures                                                                                                                                                                             |       | 21 |
| **Part II—Other Information**    | ** **                                                                                                                                                                                          | ** ** |
| Item 1.                                    | Legal  Proceedings                                                                                                                                                                                  |       | 23 |
| Item 6.                                    | Exhibits                                                                                                                                                                                            |       | 24 |
|                                       | Signatures                                                                                                                                                                                          |       | 25 |

 

2

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**PARTICLE DRILLING TECHNOLOGIES, INC.(a development stage enterprise)**

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

| ** **                                                                                                                                                                       | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                       | ** ** | **2005**              | ** ** | **2005**               | ** ** |
| ** **                                                                                                                                                                       | ** ** | ** **            | ** ** | **(Restated)**         | ** ** |
| **ASSETS**                                                                                                                                                                       |       |                  |       |                   |       |
| Current assets:                                                                                                                                                                  |       |                  |       |                   |       |
| Cash and cash equivalents                                                                                                                                                        |       | $                     | 8,770,182  |                   | $          | 10,504,646 |   |
| Accounts receivable—related party                                                                                                                                           |       | 56,442                |       | 42,330                 |       |
| Prepaid expenses                                                                                                                                                                 |       | 200,605               |       | 229,963                |       |
| Total current assets                                                                                                                                                             |       | 9,027,229             |       | 10,776,939             |       |
| Property, plant & equipment, net                                                                                                                                        |       | 1,163,976             |       | 1,277,982              |       |
| Intangibles, net                                                                                                                                                                 |       | 1,116,344             |       | 1,102,403              |       |
| Other assets                                                                                                                                                                     |       | 391,089               |       | 391,089                |       |
| Total assets                                                                                                                                                                     |       | $                     | 11,698,638 |                   | $          | 13,548,413 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                    |       |                  |       |                   |       |
| Current  liabilities:                                                                                                                                                            |       |                  |       |                   |       |
| Accounts payable                                                                                                                                                                 |       | $                     | 960,208    |                   | $          | 1,056,733 |   |
| Short-term notes payable                                                                                                                                                         |       | 62,972                |       | 79,880                 |       |
| Current portion of long-term debt                                                                                                                                                |       | 10,844                |       | 11,597                 |       |
| Accrued liabilities                                                                                                                                                              |       | 286,328               |       | 242,633                |       |
| Total current liabilities                                                                                                                                                        |       | 1,320,352             |       | 1,390,843              |       |
| Long-term debt                                                                                                                                                                   |       | 7,613                 |       | 9,463                  |       |
| Commitments and  contingencies—see Note 8                                                                                                                                   |       |                  |       |                   |       |
| Stockholders’  equity:                                                                                                                                                      |       |                  |       |                   |       |
| Common stock, $.001 par value, 100,000,000 shares  authorized, 27,441,472 shares issued and 24,441,472 shares outstanding at December 31,  2005 and September 30, 2005 |       | 27,441                |       | 27,441                 |       |
| Additional paid-in capital                                                                                                                                                       |       | 23,609,417            |       | 23,218,868             |       |
| Treasury stock at cost, 3,000,000 shares at December 31,  2005 and September 30, 2005                                                                                  |       | (1,500,000            | )          | (1,500,000             | )          |
| Deficit accumulated during the development stage                                                                                                                                 |       | (11,766,185           | )          | (9,598,202             | )          |
| Total stockholders’ equity                                                                                                                                                  |       | 10,370,673            |       | 12,148,107             |       |
| Total liabilities and stockholders’ equity                                                                                                                                  |       | $                     | 11,698,638 |                   | $          | 13,548,413 |   |

 

The accompanying notes are an integral part of these statements.

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**PARTICLE DRILLING TECHNOLOGIES, INC.(a development stage enterprise)**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

| ** **                                                               | ** ** | ** **                                                           | ** ** | ** **                                                           | ** ** | **Period from**       | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                               | ** ** | ** **                                                           | ** ** | ** **                                                           | ** ** | **June 9, 2003** | ** ** |
| ** **                                                               | ** ** | ** **                                                           | ** ** | ** **                                                           | ** ** | **(date of**          | ** ** |
| ** **                                                               | ** ** | **Three Months Ended**                                     | ** ** | **inception) to**                                               | ** ** |
| ** **                                                               | ** ** | **December 31,**                                                | ** ** | **December 31,**                                                | ** ** |
| ** **                                                               | ** ** | **     2005     ** | ** ** | **     2004     ** | ** ** | **2005**                   | ** ** |
| ** **                                                               | ** ** | ** **                                                           | ** ** | ** **                                                           | ** ** | **(Restated)**             | ** ** |
| Revenues                                                                 |       | $                                                                    | —     |                                                                 | $          | —                     |       | $ | — |   |
| Operating  expenses:                                                     |       |                                                                 |       |                                                                 |       |                       |       |
| Research and development                                                 |       | 1,285,485                                                            |       | 183,156                                                              |       | 4,749,018                  |       |
| General and administrative                                               |       | 990,962                                                              |       | 693,037                                                              |       | 7,359,457                  |       |
| Total operating expenses                                                 |       | 2,276,447                                                            |       | 876,193                                                              |       | 12,108,475                 |       |
| Loss from operations                                                     |       | (2,276,447                                                           | )          | (876,193                                                             | )          | (12,108,475                | )          |
| Other income  (expenses)                                                 |       |                                                                 |       |                                                                 |       |                       |       |
| Interest income                                                          |       | 86,041                                                               |       | —                                                               |       | 295,346                    |       |
| Rental income—related party                                         |       | 23,282                                                               |       | —                                                               |       | 50,444                     |       |
| Gain on debt extinguishment                                              |       | —                                                               |       | —                                                               |       | 35,283                     |       |
| Interest expense                                                         |       | (859                                                                 | )          | (6,552                                                               | )          | (38,783                    | )          |
| Total other income (expenses)                                            |       | 108,464                                                              |       | (6,552                                                               | )          | 342,290                    |       |
| Net loss                                                                 |       | $                                                                    | (2,167,983 | )                                                                    | $          | (882,745                   | )          | $ | (11,766,185 | ) |
| Net loss per common share, basic and diluted                             |       | $                                                                    | (0.09      | )                                                                    | $          | (0.05                      | )          | $ | (0.69 | ) |
| Weighted average number of common shares  outstanding, basic and diluted |       | 24,296,472                                                           |       | 18,299,382                                                           |       | 17,163,174                 |       |

 

The accompanying notes are an integral part of these statements.

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**PARTICLE DRILLINGTECHNOLOGIES, INC.(a development stage enterprise)**

**CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(Unaudited)**

| ** **                                                                   | ** ** | **Three Months Ended  December 31,** | ** ** | **Period from  June 9, 2003  (date of   inception) to  December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                            | ** ** | **2004**                                                                                                 | ** ** | **2005** | ** ** |
| ** **                                                                   | ** ** | ** **                                          | ** ** | ** **                                                                                               | ** ** | **(Restated)** | ** ** |
| Cash flows from operating activities:                                        |       |                                                |       |                                                                                                     |       |   |   |   |   |
| Net loss                                                                     |       | $                                                   | (2,167,983 | )                                                                                                        | $          | (882,745 | ) |   | $ | (11,766,185 | ) |   |
| Adjustments to reconcile  net loss to net cash used in operating activities: |       |                                                |       |                                                                                                     |       |   |   |   |   |
| Gain on debt  extinguishment                                                 |       | —                                              |       | —                                                                                                   |       |   | (35,283 | ) |   |
| Depreciation and  amortization expense                                       |       | 154,571                                             |       | 57,411                                                                                                   |       |   | 693,447 |   |   |
| Short-term note  issued for services                                         |       | —                                              |       | —                                                                                                   |       |   | 44,000 |   |   |
| Common stock  issued for services                                            |       | —                                              |       | 17,500                                                                                                   |       |   | 931,500 |   |   |
| Warrants issued  for services                                                |       | —                                              |       | 57,999                                                                                                   |       |   | 63,829 |   |   |
| Stock-based  employee compensation                                           |       | 390,549                                             |       | 161,800                                                                                                  |       |   | 1,056,263 |   |   |
| Changes in operating  assets and liabilities:                                |       |                                                |       |                                                                                                     |       |   |   |   |   |
| Increase in  accounts receivable—related party                          |       | (14,112                                             | )          | —                                                                                                   |       |   | (56,442 | ) |   |
| (Increase)  decrease in prepaid expenses                                     |       | 29,358                                              |       | (83,041                                                                                                  | )          |   | (88,615 | ) |   |
| Increase  (decrease) in accounts payable                                     |       | (96,525                                             | )          | 256,594                                                                                                  |       |   | 620,270 |   |   |
| Increase  (decrease) in accrued liabilities                                  |       | 43,695                                              |       | (18,226                                                                                                  | )          |   | 286,328 |   |   |
| Net cash used in  operating activities                                       |       | (1,660,447                                          | )          | (432,708                                                                                                 | )          |   | (8,250,888 | ) |   |
| Cash flows from investing activities:                                        |       |                                                |       |                                                                                                     |       |   |   |   |   |
| Payments to  purchase property and equipment                                 |       | (27,947                                             | )          | —                                                                                                   |       |   | (1,211,636 | ) |   |
| Proceeds from sale  of property and equipment                                |       | —                                              |       | —                                                                                                   |       |   | 20,957 |   |   |
| Payments to  purchase intangibles                                            |       | (26,559                                             | )          | (6,304                                                                                                   | )          |   | (457,003 | ) |   |
| Payments to  purchase other assets                                           |       | —                                              |       | —                                                                                                   |       |   | (391,089 | ) |   |
| Payments issued  for note receivable                                         |       | —                                              |       | —                                                                                                   |       |   | (300,783 | ) |   |
| Payments issued  for note receivable—related party                      |       | —                                              |       | —                                                                                                   |       |   | (56,783 | ) |   |
| Net cash used in  investing activities                                       |       | (54,506                                             | )          | (6,304                                                                                                   | )          |   | (2,396,337 | ) |   |
| Cash flows from financing activities:                                        |       |                                                |       |                                                                                                     |       |   |   |   |   |
| Proceeds from  issuance of common stock                                      |       | —                                              |       | 533,334                                                                                                  |       |   | 20,975,766 |   |   |
| Repurchase of  common stock                                                  |       | —                                              |       | —                                                                                                   |       |   | (1,500,000 | ) |   |
| Proceeds from  issuance of convertible notes                                 |       | —                                              |       | —                                                                                                   |       |   | 553,500 |   |   |
| Repayments of  notes payable                                                 |       | (19,511                                             | )          | (85,328                                                                                                  | )          |   | (611,859 | ) |   |
| Proceeds from  borrowings under loan agreements—related parties         |       | —                                              |       | —                                                                                                   |       |   | 23,195 |   |   |
| Repayment of  borrowings under loan agreements—related parties          |       | —                                              |       | —                                                                                                   |       |   | (23,195 | ) |   |
| Net cash provided  by (used in) financing activities                         |       | (19,511                                             | )          | 448,006                                                                                                  |       |   | 19,417,407 |   |   |
| Net increase  (decrease) in cash and cash equivalents                        |       | (1,734,464                                          | )          | 8,994                                                                                                    |       |   | 8,770,182 |   |   |
| Cash and cash  equivalents—beginning of period                          |       | 10,504,646                                          |       | 20,363                                                                                                   |       |   | — |   |   |
| Cash and cash  equivalents—end of period                                |       | $                                                   | 8,770,182  |                                                                                                     | $          | 29,357 |   |   | $ | 8,770,182 |   |   |
| Supplemental disclosures of cash flow information:                           |       |                                                |       |                                                                                                     |       |   |   |   |   |
| Cash paid for  interest                                                      |       | $                                                   | 872        |                                                                                                     | $          | 4,096 |   |   | $ | 39,573 |   |   |
| Non-cash investing and financing activities:                                 |       |                                                |       |                                                                                                     |       |   |   |   |   |
| Prepaid insurance  acquired with note payable                                |       | $                                                   | —     |                                                                                                     | $          | — |   |   | $ | 111,990 |   |   |
| Common stock  issued as consideration for account payable                    |       | —                                              |       | —                                                                                                   |       |   | 6,000 |   |   |
| Common stock  issued as consideration for note payable                       |       | —                                              |       | —                                                                                                   |       |   | 50,000 |   |   |
| Related party note  receivable exchanged for property and equipment          |       | —                                              |       | —                                                                                                   |       |   | 56,783 |   |   |
| Note payable  converted into common stock                                    |       | —                                              |       | —                                                                                                   |       |   | 553,500 |   |   |
| Property and  equipment acquired with assumed liabilities                    |       | —                                              |       | —                                                                                                   |       |   | 479,610 |   |   |
| Intangibles  acquired with assumed liabilities                               |       | —                                              |       | —                                                                                                   |       |   | 757,792 |   |   |

 

The accompanying notes are an integral part of these statements.

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**PARTICLE DRILLINGTECHNOLOGIES, INC.(a development stage enterprise)**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS(Unaudited)**

**1.   BASIS OF PRESENTATION**

The accompanying unaudited interim consolidatedfinancial statements, which include the accounts of Particle DrillingTechnologies, Inc. (which is referred to herein as “we,” “us,” “our” orthe “Company”) and its subsidiary, have been prepared in accordance withgenerally accepted accounting principles in the United States of America (“USGAAP”) and pursuant to the rules and regulations of the Securities andExchange Commission. Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with US GAAP have beencondensed or omitted in accordance with such rules and regulations. Theinformation furnished in the unaudited interim consolidated financialstatements includes normal recurring adjustments and reflects all adjustments,which in the opinion of management are necessary for a fair presentation ofsuch financial statements. Although management believes the disclosures andinformation presented are adequate to make the information not misleading,these unaudited interim consolidated financial statements should be read inconjunction with the Company’s September 30, 2005 audited consolidatedfinancial statements and notes thereto on Form 10-K. Operating results forthe three months ended December 31, 2005 are not necessarily indicative ofthe results that may be expected for the year ending September 30, 2006.

The preparation of financial statements in conformitywith US GAAP requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting periods. Actual resultscould differ from these estimates.

Certain reclassificationshave been made to conform prior period amounts to the current periodpresentation. These reclassifications had no effect on net loss, net loss pershare, or stockholders’ equity.

**2.   RESTATEMENTOF FINANCIAL STATEMENTS**

The historical information in this quarterly report onForm 10-Q for the Consolidated Balance Sheet as of September 30, 2005has been restated. In addition, certain historical information included in theperiod from June 9, 2003 (date of inception) to December 31, 2005 forthe Consolidated Statement of Operations and Consolidated Statement of CashFlows has been restated. These financial statements have been restated afterdetermining that the Company’s policy of recording stock-based employeecompensation upon vesting of the underlying equity award was inconsistent withthe guidelines set forth under Statements of Financial Accounting Standards (“SFAS”)No. 123(R), *Share-Based Payment*.

On February 7, 2006, the Company receivedcomments from the Staff of the Securities and Exchange Commission (“SEC”) toits annual report on Form 10-K for the year ended September 30, 2005that was originally filed on December 14, 2005. As a result of one ofthese comments, the Company undertook a detailed analysis of its policies inconnection with the recording of stock-based employee compensation related toequity incentive awards under SFAS No. 123(R). Following the completion ofthat analysis and further consultation with the Company’s independentregistered public accountants, the Company determined that its policy forrecording equity compensation was inconsistent with the guidance set forthunder SFAS No. 123(R). Historically, the Company has calculated thecompensation expense associated with equity awards using the Black-Scholesmodel and amortized that expense over the service period as the equity awardsvest, commencing with the first vesting dates of the awards. To fully complywith the 

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guidance set forth in SFASNo. 123(R), the Company is now recording such expense on a straight linebasis over the relevant service periods, commencing with the dates of grant ofthe awards. On February 9, 2006, following an analysis of the impact ofthis error on the Company’s previously released financial statements, the AuditCommittee of the Company’s Board of Directors determined that it was necessaryto restate the financial statements contained in the Company’s original annualreport on Form 10-K for the period ended September 30, 2005 originallyfiled with the SEC on December 14, 2005.

As a result of the restatement, net loss for the yearended September 30, 2005 was increased by $437,350 resulting in anincrease to the deficit accumulated during the development stage and additionalpaid-in-capital of $437,350 as of September 30, 2005. The ConsolidatedStatements of Operations and the Consolidated Statements of Cash Flowspresented in this report on Form 10-Q compares the three months ended December 31,2005 to the three months ended December 31, 2004. The historicalinformation for the three months ended December 31, 2004 was not affectedby the restatement due to the accounting error described above, and therefore,not restated.

The following are the restated financial statementsfor the year ended September 30, 2005 compared to the previously reportedamounts:

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**RESTATEDCONSOLIDATED BALANCE SHEETAS OF SEPTEMBER 30, 2005(UNAUDITED)**

| ** **                                                                                                                                                                                                                      | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|-----------------|------------|--------------|------------|
| **ASSETS**                                                                                                                                                                                                                      |       |                 |       |            |       |         |       |   |   |
| Current assets:                                                                                                                                                                                                                 |       |                 |       |            |       |         |       |   |   |
| Cash and cash equivalents                                                                                                                                                                                                       |       | $                    | 10,504,646 |            |       | $            | —     |   |   | $ | 10,504,646 |   |
| Accounts receivable—related party                                                                                                                                                                                          |       | 42,330               |       |            | —     |         |       | 42,330 |   |
| Prepaid expenses                                                                                                                                                                                                                |       | 229,963              |       |            | —     |         |       | 229,963 |   |
| Total current assets                                                                                                                                                                                                            |       | 10,776,939           |       |            | —     |         |       | 10,776,939 |   |
| Property, plant & equipment, net                                                                                                                                                                                       |       | 1,277,982            |       |            | —     |         |       | 1,277,982 |   |
| Intangibles, net                                                                                                                                                                                                                |       | 1,102,403            |       |            | —     |         |       | 1,102,403 |   |
| Other assets                                                                                                                                                                                                                    |       | 391,089              |       |            | —     |         |       | 391,089 |   |
| Total assets                                                                                                                                                                                                                    |       | $                    | 13,548,413 |            |       | $            | —     |   |   | $ | 13,548,413 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                   |       |                 |       |            |       |         |       |   |   |
| Current  liabilities:                                                                                                                                                                                                           |       |                 |       |            |       |         |       |   |   |
| Accounts payable                                                                                                                                                                                                                |       | $                    | 1,056,733  |            |       | $            | —     |   |   | $ | 1,056,733 |   |
| Short-term notes payable                                                                                                                                                                                                        |       | 79,880               |       |            | —     |         |       | 79,880 |   |
| Current portion of long-term debt                                                                                                                                                                                               |       | 11,597               |       |            | —     |         |       | 11,597 |   |
| Accrued liabilities                                                                                                                                                                                                             |       | 242,633              |       |            | —     |         |       | 242,633 |   |
| Total current liabilities                                                                                                                                                                                                       |       | 1,390,843            |       |            | —     |         |       | 1,390,843 |   |
| Long-term debt                                                                                                                                                                                                                  |       | 9,463                |       |            | —     |         |       | 9,463 |   |
| Commitments and  Contingencies                                                                                                                                                                                                  |       |                 |       |            |       |         |       |   |   |
| Stockholders’  equity:                                                                                                                                                                                                     |       |                 |       |            |       |         |       |   |   |
| Common stock, $.001 par value, 100,000,000 shares  authorized, 27,441,472 shares issued and 24,441,472 shares outstanding at  September 30, 2005, and 18,095,447 shares issued and outstanding at  September 30, 2004 |       | 27,441               |       |            | —     |         |       | 27,441 |   |
| Additional paid-in capital                                                                                                                                                                                                      |       | 22,781,518           |       |            | 437,350    |         |       | 23,218,868 |   |
| Treasury stock at cost, 3,000,000 shares and -0-  shares at September 30, 2005 and September 30, 2004, respectively                                                                                              |       | (1,500,000           | )          |            | —     |         |       | (1,500,000 | ) |
| Deficit accumulated during the development stage                                                                                                                                                                                |       | (9,160,852           | )          |            | (437,350   | )            |       | (9,598,202 | ) |
| Total stockholders’ equity                                                                                                                                                                                                 |       | 12,148,107           |       |            | —     |         |       | 12,148,107 |   |
| Total liabilities  and stockholders’ equity                                                                                                                                                                                |       | $                    | 13,548,413 |            |       | $            | —     |   |   | $ | 13,548,413 |   |

 

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**RESTATEDCONSOLIDATED STATEMENT OF OPERATIONSFOR THE YEAR ENDED SEPTEMBER 30, 2005(UNAUDITED)**

| ** **                                                                   | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------|------------|-----------------|------------|--------------|------------|
| Revenues                                                                     |       | $                    | —     |            |       | $            | —     |   |   | $ | — |   |
| Operating  expenses:                                                         |       |                 |       |            |       |         |       |   |   |
| Research and development                                                     |       | 2,802,155            |       |            | —     |         |       | 2,802,155 |   |
| General and administrative                                                   |       | 2,744,963            |       |            | 437,350    |         |       | 3,182,313 |   |
| Total operating expenses                                                     |       | 5,547,118            |       |            | 437,350    |         |       | 5,984,468 |   |
| Loss from operations                                                         |       | (5,547,118           | )          |            | (437,350   | )            |       | (5,984,468 | ) |
| Other income  (expenses)                                                     |       |                 |       |            |       |         |       |   |   |
| Interest income                                                              |       | 209,305              |       |            | —     |         |       | 209,305 |   |
| Rental income—related party                                             |       | 27,162               |       |            | —     |         |       | 27,162 |   |
| Gain on debt extinguishment                                                  |       | 35,283               |       |            | —     |         |       | 35,283 |   |
| Interest expense                                                             |       | (11,700              | )          |            | —     |         |       | (11,700 | ) |
| Total other income (expenses)                                                |       | 260,050              |       |            | —     |         |       | 260,050 |   |
| Net loss                                                                     |       | $                    | (5,287,068 | )               |       | $            | (437,350   | ) |   | $ | (5,724,418 | ) |
| Net loss per common share, basic and diluted                                 |       | $                    | (0.24      | )               |       | $            | (0.02      | ) |   | $ | (0.26 | ) |
| Weighted average  number of common shares outstanding—basic and diluted |       | 22,150,365           |       |            | —     |         |       | 22,150,365 |   |

 

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**RESTATEDCONSOLIDATED STATEMENT OF OPERATIONSFOR THE PERIOD FROM JUNE 9, 2003 (DATE OF INCEPTION)TO SEPTEMBER 30, 2005(UNAUDITED)**

| ** **                                                                   | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------|------------|-----------------|------------|--------------|------------|
| Revenues                                                                     |       | $                    | —     |            |       | $            | —     |   |   | $ | — |   |
| Operating  expenses:                                                         |       |                 |       |            |       |         |       |   |   |
| Research and development                                                     |       | 3,463,533            |       |            | —     |         |       | 3,463,533 |   |
| General and administrative                                                   |       | 5,931,145            |       |            | 437,350    |         |       | 6,368,495 |   |
| Total operating expenses                                                     |       | 9,394,678            |       |            | 437,350    |         |       | 9,832,028 |   |
| Loss from operations                                                         |       | (9,394,678           | )          |            | (437,350   | )            |       | (9,832,028 | ) |
| Other income  (expenses)                                                     |       |                 |       |            |       |         |       |   |   |
| Interest income                                                              |       | 209,305              |       |            | —     |         |       | 209,305 |   |
| Rental income—related party                                             |       | 27,162               |       |            | —     |         |       | 27,162 |   |
| Gain on debt extinguishment                                                  |       | 35,283               |       |            | —     |         |       | 35,283 |   |
| Interest expense                                                             |       | (37,924              | )          |            | —     |         |       | (37,924 | ) |
| Total other income (expenses)                                                |       | 233,826              |       |            | —     |         |       | 233,826 |   |
| Net loss                                                                     |       | $                    | (9,160,852 | )               |       | $            | (437,350   | ) |   | $ | (9,598,202 | ) |
| Net loss per common share, basic and diluted                                 |       | $                    | (0.56      | )               |       | $            | (0.02      | ) |   | $ | (0.58 | ) |
| Weighted average  number of common shares outstanding—basic and diluted |       | 16,408,395           |       |            | —     |         |       | 16,408,395 |   |

 

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**RESTATEDCONSOLIDATED STATEMENT OFCASH FLOWSFOR THE YEAR ENDED SEPTEMBER 30, 2005(UNAUDITED)**

| ** **                                                                   | ** ** | **As Reported** | ** ** | **Adustments** | ** ** | **Restated** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------|------------|----------------|------------|--------------|------------|
| Cash flows from operating  activities:                                       |       |                 |       |           |       |         |       |   |   |
| Net loss                                                                     |       | $                    | (5,287,068 | )              |       | $            | (437,350   | ) |   | $ | (5,724,418 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities: |       |                 |       |           |       |         |       |   |   |
| Gain on debt extinguishment                                                  |       | (35,283              | )          |           | —     |         |       | (35,283 | ) |
| Depreciation and amortization expense                                        |       | 391,467              |       |           | —     |         |       | 391,467 |   |
| Short-term note issued for services                                          |       | —               |       |           | —     |         |       | — |   |
| Common stock issued for services                                             |       | (66,500              | )          |           | —     |         |       | (66,500 | ) |
| Warrants issued for services                                                 |       | 57,999               |       |           | —     |         |       | 57,999 |   |
| Stock-based employee compensation                                            |       | 177,550              |       |           | 437,350    |         |       | 614,900 |   |
| Changes in  operating assets and liabilities:                                |       |                 |       |           |       |         |       |   |   |
| Increase in accounts receivable—related party                           |       | (42,330              | )          |           | —     |         |       | (42,330 | ) |
| Increase in prepaid expenses                                                 |       | (68,428              | )          |           | —     |         |       | (68,428 | ) |
| (Increase) decrease in other current assets                                  |       | —               |       |           | —     |         |       | — |   |
| Increase in accounts payable                                                 |       | 221,329              |       |           | —     |         |       | 221,329 |   |
| Increase in accrued liabilities                                              |       | 26,080               |       |           | —     |         |       | 26,080 |   |
| Net cash used in operating activities                                        |       | (4,625,184           | )          |           | —     |         |       | (4,625,184 | ) |
| Cash flows from  investing activities:                                       |       |                 |       |           |       |         |       |   |   |
| Payments to purchase property and equipment                                  |       | (1,167,134           | )          |           | —     |         |       | (1,167,134 | ) |
| Proceeds from sale of property and equipment                                 |       | —               |       |           | —     |         |       | — |   |
| Payments to purchase intangibles                                             |       | (170,281             | )          |           | —     |         |       | (170,281 | ) |
| Payments to purchase other assets                                            |       | (385,839             | )          |           | —     |         |       | (385,839 | ) |
| Payments issued for note receivable                                          |       | —               |       |           | —     |         |       | — |   |
| Payments issued for note receivable—related party                       |       | —               |       |           | —     |         |       | — |   |
| Net cash used in investing activities                                        |       | (1,723,254           | )          |           | —     |         |       | (1,723,254 | ) |
| Cash flows from  financing activities:                                       |       |                 |       |           |       |         |       |   |   |
| Proceeds from issuance of common stock                                       |       | 18,647,666           |       |           | —     |         |       | 18,647,666 |   |
| Purchases of common stock                                                    |       | (1,500,000           | )          |           | —     |         |       | (1,500,000 | ) |
| Proceeds from issuance of convertible notes                                  |       | —               |       |           | —     |         |       | — |   |
| Repayments of notes payable                                                  |       | (314,945             | )          |           | —     |         |       | (314,945 | ) |
| Proceeds from borrowings under loan agreements—related  parties         |       | —               |       |           | —     |         |       | — |   |
| Repayment of borrowings under loan agreements—related  parties          |       | —               |       |           | —     |         |       | — |   |
| Net cash provided by financing activities                                    |       | 16,832,721           |       |           | —     |         |       | 16,832,721 |   |
| Net increase in cash and cash equivalents                                    |       | 10,484,283           |       |           | —     |         |       | 10,484,283 |   |
| Cash and cash equivalents—beginning of period                           |       | 20,363               |       |           | —     |         |       | 20,363 |   |
| Cash and cash equivalents—end of period                                 |       | $                    | 10,504,646 |           |       | $            | —     |   |   | $ | 10,504,646 |   |
| Supplemental  disclosures of cash flow information:                          |       |                 |       |           |       |         |       |   |   |
| Cash paid for interest                                                       |       | $                    | 14,004     |           |       | $            | —     |   |   | $ | 14,004 |   |
| Non-cash investing  and financing activities:                                |       |                 |       |           |       |         |       |   |   |
| Prepaid insurance acquired with note payable                                 |       | $                    | 51,000     |           |       | $            | —     |   |   | $ | 51,000 |   |
| Common stock issued as consideration for account  payable                    |       | —               |       |           | —     |         |       | — |   |
| Common stock issued as consideration for note payable                        |       | —               |       |           | —     |         |       | — |   |
| Related party note receivable exchanged for property  and equipment          |       | —               |       |           | —     |         |       | — |   |
| Note payable converted into common stock                                     |       | —               |       |           | —     |         |       | — |   |
| Property and equipment acquired with assumed  liabilities                    |       | —               |       |           | —     |         |       | — |   |
| Intangibles  acquired with assumed liabilities                               |       | —               |       |           | —     |         |       | — |   |

 

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**RESTATEDCONSOLIDATED STATEMENT OFCASH FLOWSFOR THE PERIOD FROM JUNE 9, 2003 (DATE OF INCEPTION)TO SEPTEMBER 30, 2005(UNAUDITED)**

| ** **                                                                   | ** ** | **As Reported** | ** ** | **Adustments** | ** ** | **Restated** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------|------------|----------------|------------|--------------|------------|
| Cash flows from operating activities:                                        |       |                 |       |           |       |         |       |   |   |   |   |
| Net loss                                                                     |       |                 | $          | (9,160,852     | )          |         |       | $ | (437,350 | ) |   | $ | (9,598,202 | ) |
| Adjustments to reconcile net loss to net cash used in  operating activities: |       |                 |       |           |       |         |       |   |   |   |   |
| Gain on debt  extinguishment                                                 |       |                 | (35,283    | )              |       |         | —     |   |   | (35,283 | ) |
| Depreciation and  amortization expense                                       |       |                 | 538,876    |           |       |         | —     |   |   | 538,876 |   |
| Short-term note issued  for services                                         |       |                 | 44,000     |           |       |         | —     |   |   | 44,000 |   |
| Common stock issued for  services                                            |       |                 | 931,500    |           |       |         | —     |   |   | 931,500 |   |
| Warrants issued for  services                                                |       |                 | 63,829     |           |       |         | —     |   |   | 63,829 |   |
| Stock-based employee  compensation                                           |       |                 | 228,364    |           |       |         | 437,350    |   |   | 665,714 |   |
| Changes in operating assets and liabilities:                                 |       |                 |       |           |       |         |       |   |   |   |   |
| Increase in accounts  receivable—related party                          |       |                 | (42,330    | )              |       |         | —     |   |   | (42,330 | ) |
| Increase in prepaid  expenses                                                |       |                 | (117,973   | )              |       |         | —     |   |   | (117,973 | ) |
| (Increase) decrease in  other current assets                                 |       |                 | —     |           |       |         | —     |   |   | — |   |
| Increase in accounts  payable                                                |       |                 | 716,795    |           |       |         | —     |   |   | 716,795 |   |
| Increase in accrued  liabilities                                             |       |                 | 242,633    |           |       |         | —     |   |   | 242,633 |   |
| Net cash used in  operating activities                                       |       |                 | (6,590,441 | )              |       |         | —     |   |   | (6,590,441 | ) |
| Cash flows from investing activities:                                        |       |                 |       |           |       |         |       |   |   |   |   |
| Payments to purchase  property and equipment                                 |       |                 | (1,183,689 | )              |       |         | —     |   |   | (1,183,689 | ) |
| Proceeds from sale of  property and equipment                                |       |                 | 20,957     |           |       |         | —     |   |   | 20,957 |   |
| Payments to purchase  intangibles                                            |       |                 | (430,444   | )              |       |         | —     |   |   | (430,444 | ) |
| Payments to purchase  other assets                                           |       |                 | (391,089   | )              |       |         | —     |   |   | (391,089 | ) |
| Payments issued for note  receivable                                         |       |                 | (300,783   | )              |       |         | —     |   |   | (300,783 | ) |
| Payments issued for note  receivable—related party                      |       |                 | (56,783    | )              |       |         | —     |   |   | (56,783 | ) |
| Net cash used in  investing activities                                       |       |                 | (2,341,831 | )              |       |         | —     |   |   | (2,341,831 | ) |
| Cash flows from financing activities:                                        |       |                 |       |           |       |         |       |   |   |   |   |
| Proceeds from issuance of  common stock                                      |       |                 | 20,975,766 |           |       |         | —     |   |   | 20,975,766 |   |
| Purchases of common stock                                                    |       |                 | (1,500,000 | )              |       |         | —     |   |   | (1,500,000 | ) |
| Proceeds from issuance of  convertible notes                                 |       |                 | 553,500    |           |       |         | —     |   |   | 553,500 |   |
| Repayments of notes  payable                                                 |       |                 | (592,348   | )              |       |         | —     |   |   | (592,348 | ) |
| Proceeds from borrowings  under loan agreements—related parties         |       |                 | 23,195     |           |       |         | —     |   |   | 23,195 |   |
| Repayment of borrowings  under loan agreements—related parties          |       |                 | (23,195    | )              |       |         | —     |   |   | (23,195 | ) |
| Net cash provided by  financing activities                                   |       |                 | 19,436,918 |           |       |         | —     |   |   | 19,436,918 |   |
| Net increase in  cash and cash equivalents                                   |       |                 | 10,504,646 |           |       |         | —     |   |   | 10,504,646 |   |
| Cash and cash  equivalents—beginning of period                          |       |                 | —     |           |       |         | —     |   |   | — |   |
| Cash and cash  equivalents—end of period                                |       |                 | $          | 10,504,646     |       |         |       | $ | — |   |   | $ | 10,504,646 |   |
| Supplemental disclosures of cash flow information:                           |       |                 |       |           |       |         |       |   |   |   |   |
| Cash paid for interest                                                       |       |                 | $          | 38,701         |       |         |       | $ | — |   |   | $ | 38,701 |   |
| Non-cash investing and financing activities:                                 |       |                 |       |           |       |         |       |   |   |   |   |
| Prepaid insurance  acquired with note payable                                |       |                 | $          | 111,990        |       |         |       | $ | — |   |   | $ | 111,990 |   |
| Common stock issued as  consideration for account payable                    |       |                 | 6,000      |           |       |         | —     |   |   | 6,000 |   |
| Common stock issued as  consideration for note payable                       |       |                 | 50,000     |           |       |         | —     |   |   | 50,000 |   |
| Related party note  receivable exchanged for property and equipment          |       |                 | 56,783     |           |       |         | —     |   |   | 56,783 |   |
| Note payable converted  into common stock                                    |       |                 | 553,500    |           |       |         | —     |   |   | 553,500 |   |
| Property and equipment  acquired with assumed liabilities                    |       |                 | 479,610    |           |       |         | —     |   |   | 479,610 |   |
| Intangibles acquired with assumed liabilities                                |       |                 | 757,792    |           |       |         | —     |   |   | 757,792 |   |

 

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**3.   RECENTACCOUNTING PRONOUNCEMENTS**

In May 2005, theFinancial Accounting Standards Board issued Statements of Financial AccountingStandards (“SFAS”) No. 154, *AccountingChanges and Error Corrections*. This new standard replaces AccountingPrincipals Board Opinion (“APB”) No. 20, *AccountingChanges,* and SFAS No. 3, *ReportingAccounting Changes in Interim Financial Statements*. This statementchanges the requirements for the accounting for and reporting of a change inaccounting principle and applies to all voluntary changes in accountingprinciple. It also applies to changes required by an accounting pronouncementin the unusual instance that the pronouncement does not include specifictransition provisions. When a pronouncement includes specific transition provisions,those provisions should be followed. APB No. 20 required that mostvoluntary changes in accounting principle be recognized by including in netincome of the period of the change the cumulative effect of changing to the newaccounting principle. This statement requires retrospective application toprior period financial statements of changes in accounting principle, unless itis impracticable to determine either the period-specific effects or thecumulative effect of the change. The provisions of SFAS No. 154 areeffective for fiscal years beginning after December 15, 2005. As such weare required to adopt SFAS No. 154 by October 1, 2006. We do notexpect this statement to have a material impact on our consolidated financialstatements.

**4.   REVERSEACQUISITION WITH MEDXLINK, CORP**

On July 14, 2004,MedXLink, Corp. (“MXLK”, or the “Parent”), a Nevada corporation and an inactivepublicly-traded company, entered into an Agreement and Plan of Reorganizationwith Particle Drilling Technologies, Inc., a Delaware corporation, (“PDTI-DE”),whereby MXLK agreed to acquire PDTI-DE by merging PDTI Acquisition Corp. (“MergerSub”), a newly formed Delaware corporation and wholly owned subsidiary of MXLK,with and into PDTI-DE and issued common stock of MXLK in exchange for all theoutstanding shares of PDTI-DE. On January 14, 2005, MXLK closed itsacquisition of PDTI-DE and issued 16,698,094 shares of common stock (including3,381,538 shares of common stock issued upon conversion of the same number ofshares of Series A Convertible Preferred Stock of PDTI-DE) to holders ofcommon stock of PDTI-DE and reserved for issuance (1) 228,000 shares ofcommon stock pursuant to outstanding warrants to purchase common stock ofPDTI-DE, and (2) 3,205,000 shares of common stock pursuant to outstandingoptions to purchase common stock of PDTI-DE. In addition, 1,342,404 issued andoutstanding shares of common stock of the Parent were cancelled for noconsideration in connection with the Merger. Following the merger, the Parenthad 18,248,094 shares of common stock issued and outstanding (which included3,381,538 shares of common stock issued upon conversion of the same number ofshares of Series A Convertible Preferred Stock of PDTI-DE) and anadditional 3,433,000 shares of common stock reserved for issuance upon exerciseof warrants and options as described above. Following the merger, PDTI-DEcontinued as the surviving corporation under the name of Particle DrillingTechnologies, Inc. as a subsidiary of Parent, the Parent changed its nameto Particle Drilling Technologies, Inc., and its stock trading symbolchanged from MXLK.OB to PDRT.OB. On June 28, 2005, the Company’s shares ofcommon stock began trading on The NASDAQ Capital Market® under the symbol PDRT.

**5.   NET LOSS PER COMMON SHARE**

The Company has presentedbasic and diluted net loss per share pursuant to SFAS No. 128, *Earnings Per Share*. In accordance withSFAS No. 128, basic and diluted net loss per share has been computed usingthe weighted-average number of shares of common stock outstanding during theperiod. Dilutive net loss per share would give affect to the dilutive effect ofcommon stock equivalents consisting of options and warrants. Potentiallydilutive securities have been excluded from the net loss per common sharecalculation as the effects would be antidilutive. Potentially dilutivesecurities totaling 2,701,790 and 1,734,228 for the periods ended December 31,2005 and 2004, respectively, were not included in the computation of 

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weightedaverage diluted shares of common stock because the impact of these potentiallydilutive securities were antidilutive.

**6.   COMMON STOCK**

At December 31, 2005,the Company had 24,441,472 shares of common stock outstanding and has issuedoptions and warrants to purchase up to 5,849,500 additional shares of theCompany’s common stock in the aggregate.

**7.   STOCK-BASEDEMPLOYEE COMPENSATION**

In April 2004, the Board of Directors adopted the2004 Stock Incentive Plan (the “2004 Plan”). The 2004 Plan provides for theissuance of incentive stock options, non-statutory stock options and restrictedstock grants to directors, employees and consultants of the Company. Provisionsunder the 2004 Plan allowed for the issuance of up to 3,500,000 shares ofcommon stock pursuant to awards under this Plan. As of December 31, 2005,the Company had 40,000 shares of common stock available for issuance pursuantto awards under the 2004 Plan.

In March 2005, the Board of Directors adopted the2005 Stock Incentive Plan (the “2005 Plan”). The 2005 Plan provides for theissuance of incentive stock options, non-statutory stock options and restrictedstock grants to directors, employees and consultants of the Company. Provisionsunder the 2005 Plan allow for the issuance of options and restricted stockawards to purchase or issue up to 2,000,000 shares of common stock. As of December 31,2005, the Company had 943,500 shares of common stock available for issuancepursuant to awards under the 2005 Plan.

Stock-based employeecompensation expense recorded for awards issued under the 2004 Plan and the2005 Plan for the three months ended December 31, 2005 and 2004 was$390,549 and $161,800, respectively. Stock-based employee compensation expenserecorded for awards issued under the 2004 Plan and the 2005 Plan sinceinception (June 9, 2003) to December 31, 2005 was $1,056,263.

**8.   COMMITMENTS AND CONTINGINCIES**

In March 2005, the Company entered into a fiveyear lease agreement for a new corporate office and delivered to the lessor asecurity deposit of $350,000 in the form of an irrevocable letter of credit,which is included in other assets on our balance sheet. In June 2005, theCompany moved its corporate offices from 808 Travis Street, Suite 850,Houston, Texas, 77002 to 1021 Main Street, Suite 2650, Houston, Texas,77002. The future annual minimum lease payments are $186,256. In August 2005,we expanded the corporate office facility an additional 1,086 square feet for atotal of 11,396 square feet. The future annual minimum lease payments for theadditional space will be $18,758.

In June 2005, weextended the lease for our commercial operating facility that expired June 30,2005 for one additional year. The lease for our commercial operating facilitywill expire June 30, 2006. The future minimum lease payments under thislease are $28,800.

**9.   RELATED PARTY TRANSACTIONS**

In March 2005, weentered into a five year sublease agreement with Energy XXI, an affiliate ofJohn D. Schiller, our former interim President and Chief Executive Officeruntil November 15, 2005 and currently one of our directors, pursuant towhich Energy XXI subleased from us approximately 5,200 square feet of ourcorporate office space, beginning in June 2005. In July 2005, Mr. SteveWeyel, one of our directors, became an executive officer of Energy XXI. Futureannual minimum rental income associated with the sublease is $93,128. Totalfuture minimum rental income associated with the sublease for the full term ofthe lease is $438,479.

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**10.   INCOME TAXES**

The Company reports itsincome taxes in accordance with SFAS No. 109, *Accounting for Income Taxes*, which calls for the utilizationof the asset and liability method of accounting for income taxes. Under thismethod, deferred taxes are determined based on differences between financialreporting and tax bases of assets and liabilities and are measured using theenacted marginal tax rates and laws that will be in effect when the differencesreverse. Temporary differences have been created for all stock option plans andare included in our SFAS No. 109 computation. For the quarter ended December 31,2005, there were permanent and temporary differences of approximately $55,000and $50,000, respectively. At December 31, 2005, we had cumulative netoperating loss carryforwards of approximately $9,064,000, which expire in years2006 through 2024. No effect has been shown in the consolidated financialstatements for the net operating loss carryforwards as the likelihood of futuretax benefit from such net operating loss carryforwards is not determinable atthis time. Accordingly, the potential tax benefits of the net operating losscarryforwards, estimated based upon tax rates at December 31, 2005, havebeen offset by valuation reserves of the same amount.

**11.   SUBSEQUENT EVENTS**

On January 23, 2006, the Company appointed Jim B.Terry to serve as its President and Chief Executive Officer. Mr. Terryreplaced J. Chris Boswell who had served as the Company’s interim President andChief Executive Officer since November 15, 2005. Mr. Boswell willcontinue to serve the Company as its Senior Vice President and Chief FinancialOfficer.

In connection with the commencement of Mr. Terry’semployment as the Company’s President and Chief Executive Officer, the Companygranted to Mr. Terry (1) options to purchase 150,000 shares of commonstock at $6.73 per share, which options vest in one-third increments on anannual basis beginning on January 23, 2007, and (2) 150,000 shares ofrestricted common stock, the forfeiture restrictions of which lapse inone-third increments on an annual basis beginning on January 23, 2007.

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**Item2:        Management’s Discussion andAnalysis of Financial Condition and Results of Operations.**

The following discussionof our financial condition and results of operations should be read togetherwith the unaudited consolidated financial statements and related notes that areincluded elsewhere in this report. This discussion may contain forward-lookingstatements based upon current expectations that involve risks and uncertaintiesthat could cause actual results to differ materially from the forward-lookingstatements. We undertake no obligation to update any forward-looking statementsexcept as required by law.

**Overview**

On January 14, 2005, we acquiredParticle Drilling Technologies, Inc., a privately-held Delawarecorporation (“PDTI”). As a result of this acquisition, our company, whichpreviously had no material operations, acquired the business of PDTI and we arenow engaged in the development of the Particle Impact Drilling System, apatented system utilizing a specially designed “fit for purpose” drill bitfitted with jetting nozzles and polycrystalline diamond compact cuttingstructures for use in the oil and gas drilling industry.

We are a development-stage company and have a limitedoperating history. Our predecessor company for financial reporting purposes wasformed on June 9, 2003 to acquire the technology related to theParticle Impact Drilling System (the “PID technology”). We are stilldeveloping this technology, and to date, we have not generated any revenuesfrom our operations. As we continue to execute our operations plan, we expectour development and operating expenses to increase.

*Researchand development.**  *Wehave made and expect to continue to make substantial investments in researchand development activities in order to develop and market our PID technology.Research and development costs consist primarily of general and administrativeand operating expenses related to research and development activities. Weexpense research and development costs as incurred except for property, plant andequipment related to research and development activity that have an alternativefuture use. Property, plant and equipment for research and development activitythat have an alternative future use are capitalized and the relateddepreciation is expensed as research and development costs.

In our continuing effort to enhance the PIDtechnology, we have retained Beeken TechQuest, Ltd. (Beeken) to develop a moreefficient and cost effective shot injector system. Beeken is led by Dr. B.N.Murali, formerly the Vice President of Technology for Halliburton EnergyServices. During his last nine years at Halliburton, Dr. Murali was incharge of developing new technology for all product service lines. Beeken isdesigning a system to replace the existing shot injection system with asimpler, less expensive approach. This system has the potential to reduce thecost of the PID System while providing redundant injection capability.

*General and administrative.**  *General and administrative expensesconsist primarily of salaries and benefits, office expense, professionalservices, and other corporate overhead costs. We have experienced and expect tocontinue to experience increases in general and administrative expenses as aresult of: (1) becoming subject to reporting and compliance obligationsapplicable to publicly-held companies in January 2005; (2) stock-basedcompensation accounted for under Statements of Financial Accounting Standards (“SFAS”)No. 123(R), *Share-Based Payment*;(3) our continuing efforts to develop, test and prepare the PID technologyfor commercialization; and (4) the hiring of additional personnel.

**Results of Operations**

***Quarter Ended December 31, 2005 Compared toQuarter Ended December 31, 2004***

*Researchand development.**  *Researchand development expenses were $1,285,485 and $183,156 for the three monthsended December 31, 2005 and 2004, respectively, representing an increaseof $1,102,329. 

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We had only a limitedability to develop the technology due to our lack of funds available during thethree months ended December 31, 2004. As a result of the completion of ourprivate placement in February 2005, we have continued to use substantialresources during the three months ended December 31, 2005 to develop thePID technology. In particular, during the three months ended December 31,2005, we incurred $344,078 in connection with our most recent field test atCatoosa and $135,806 for drill bit development. No such costs were incurredduring the three months ended December 31, 2004. Further, our costsrelated to our ongoing injector development program increased $140,682 duringthe three months ended December 31, 2005 compared to the three monthsended December 31, 2004. Salaries and general overhead for research anddevelopment activities increased $481,763 during the three months ended December 31,2005 compared to the three months ended December 31, 2004 as a result ofour increased research and development activities and increased stock-basedcompensation.

*Generaland administrative.**  *Generaland administrative expenses were $990,962 and $693,037 for the three monthsended December 31, 2005 and 2004, respectively, representing an increaseof $297,925. This increase was primarily the result of increased costs relatedto reporting and compliance obligations applicable to publicly-held companies,which commenced for the Company (for financial reporting purposes) in January 2005,and stock-based compensation.

*Other income (expenses).**  *Other income (expenses) were$108,464 and ($6,552) for the three months ended December 31, 2005 and2004, respectively, representing an increase in other income of $115,016. Theincrease was primarily attributable to interest income and rental income duringthe three months ended December 31, 2005. Interest income was due to theinterest earned on the investment of funds received in our private placement inFebruary 2005. In addition, we record $7,761 each month in rental incomedue from Energy XXI, an affiliate of Messrs. Schiller and Weyel.

**Liquidity and Capital Resources**

Our principal sources of liquidity are cash and cashequivalents. Cash requirements through the end of the fiscal year 2006 areprimarily to fund research and development activities, to continuously improveservice capabilities, expand operations, general and administrative costs andcapital expenditures. We believe we have sufficient resources to meet ourworking capital and capital expenditure requirements for at least the next12 months; however, our continued existence depends on the successfuldevelopment of the PID technology and our ability to successfully commercializethis technology.

Since inception on June 9, 2003 through December 31,2005, we have financed our operations through private sales of our equity andthe issuance of convertible notes payable, totaling net proceeds of $19,417,407.As of December 31, 2005, we had $8,770,182 in cash and cash equivalents.

On February 9, 2005, we sold 9,000,000 shares ofour common stock at $2.00 per share in a private placement and received grossproceeds of $18,000,000. We paid commissions to the placement agent in theamount of $600,000, $100,000 for reimbursable expenses, and legal fees relatedto this offering of $315,767. In connection with this private placement, weissued ten year warrants to persons associated with the placement agent topurchase 1,500,000 shares of our common stock in the aggregate at $2.00 pershare. In addition, we used $1,500,000 of these proceeds to repurchase 3,000,000shares of our common stock from Prentis B. Tomlinson (PDTI’s former Presidentand Chief Executive Officer until December 2, 2004). These shares werepurchased as treasury stock and recorded at cost.

*CashFlows from Operations.**  *Cashflows used for operations are primarily affected by our research anddevelopment progress and business development. Net cash flows used foroperations during the three months ended December 31, 2005 were$1,660,447, compared to $432,708 for the three months ended December 31,2004. The increase from the three months ended December 31, 2004 to thethree months ended December 31, 2005 was the result of our successfulfundraising efforts in February 2005, allowing us 

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more cash resources toincrease the planned development expenditures for the PID technology. Inparticular, during the three months ended December 31, 2005, we incurred$344,078 in connection with our most recent field test at Catoosa. Further, weincurred $188,625 of costs related to our new injector development. No suchcosts were incurred during the three months ended December 31, 2004. Ourworking capital since inception (June 9, 2003) has been fully funded fromcash flows from financing activities.

*CashFlows from Investing Activities.**  *Our capital spending for the threemonths ended December 31, 2005 was $54,506 compared to $6,304 for thethree months ended December 31, 2004. During the three months ended December 31,2005, we used capital expenditures for our research and development activitiesin accordance with our 2006 capital budget. Our capital spending sinceinception (June 9, 2003) has been fully funded from cash flows fromfinancing activities. We anticipate that our capital expenditures for the nextseveral months will continue to be fully funded from our available cash andcash equivalents.

*CashFlows from Financing Activities.**  *Net cash provided by (used in)financing activities for three months ended December 31, 2005 and 2004 was($19,511) and $448,006, respectively. During the three months ended December 31,2004, we received net proceeds of $533,334 from the issuance of common stockand used $85,328 to repay note payables. During the three months ended December 31,2005, we used $19,511 to repay note payables.

*ContractualObligations.**  *Ourcontractual obligations at December 31, 2005 are set forth in the tablebelow. Our long-term debt obligation (including current portion of long-termdebt) is related to equipment that was financed for a three year period,beginning in July 2004, and is secured by the same equipment. Ouroperating lease obligations consist of our corporate office and commercialoperating facility that are both located in Houston, Texas.

In March 2005, we entered into a five year leaseagreement for new corporate offices that commenced in June 2005. We movedour previous corporate offices that were located at 808 Travis Street, Suite 850,Houston, Texas 77002 to 1021 Main Street, Suite 2650, Houston, Texas 77002.In March 2005, we delivered to the lessor a security deposit of $350,000in the form of an irrevocable letter of credit. Our future annual minimum leasepayments are $186,256. In August 2005, we expanded the corporate officefacility an additional 1,086 square feet for a total of 11,396 square feet. Thefuture annual minimum lease payments for the additional space will be $18,758.

In June 2005,we extended the commercial operating lease that expired June 30, 2005 forone additional year. The commercial operating lease will expire June 30,2006. The future minimum lease payments under this lease are $28,800.

| ** **                                             | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**                       | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less than 1  year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **More than 5  years** | ** ** |
| Long-Term Debt  Obligation (including current portion) |       | $                                         | 18,457     |   |   | $ | 10,844 |   |   | $ | 7,613 |   | $ | — |   |   | $ | — |   |   |
| Operating Lease  Obligations                           |       | 1,005,799                                 |       |   | 233,814 |   |   | 615,042 |   | 156,943 |   |   | — |   |   |
| Total                                                  |       | $                                         | 1,024,256  |   |   | $ | 244,658 |   |   | $ | 622,655 |   | $ | 156,943 |   |   | $ | — |   |   |
|                                                        |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Off-Balance Sheet Arrangements**

In connection with theacquisition of the PID technology in January 2004, PDTI entered into aRoyalty Agreement with ProDril Services, Incorporated (“PSI”) pursuant to whichwe are obligated to pay PSI a royalty on a quarterly basis equal to 18% of ourearnings before interest, income taxes, depreciation and amortization (“EBITDA”)derived from the use of the PID technology, until an aggregate of $67,500,000has been paid. PDTI also entered into a Royalty Agreement in January 2004with ProDril 

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Services,International, Ltd. (“PSIL”) pursuant to which we are obligated to pay PSIL aroyalty on a quarterly basis equal to 2% of our EBITDA derived from the use ofthe PID technology, until an aggregate of $7,500,000 has been paid. Inaddition, we are obligated to pay CCORE Technology and Licensing, Ltd. (“CTL”),PSI and PSIL a royalty equal to 1.6%, 1.2% and 1.2%, respectively, of ourquarterly gross revenue, derived from the use of the PID technology. As of December 31,2005, we had no revenues or EBITDA; therefore no royalties have been paid oraccrued.

**Related Party Transactions**

In March 2005, we entered into a five yearsublease agreement with Energy XXI, an affiliate of John D. Schiller, ourformer interim President and Chief Executive Officer until November 15,2005 and currently one of our directors, pursuant to which Energy XXI subleasedfrom us approximately 5,200 square feet of our corporate office space,beginning in June 2005. In July 2005, Mr. Steve Weyel, one ofour directors, became an executive officer of Energy XXI. Future annual minimumrental income associated with the sublease is $93,128. Total future minimumrental income associated with the sublease for the full term of the lease is$438,479.

We believe that thetransaction described above was negotiated on an arm’s length basis and thatthe terms of the transaction was at least as favorable to us as those thatcould have been obtained from an unaffiliated third party.

**Critical Accounting Policies**

The discussion and analysis of our financial conditionand results of operations is based on our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these consolidatedfinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities and expenses. We base our estimateson historical experience and on various other assumptions that we believe to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions. We believe the followingcritical accounting policies affect our most significant judgments andestimates used in the preparation of our consolidated financial statements.

*ReverseAcquisition.**  *Theacquisition of PDTI in January 2005 was accounted for as a reverseacquisition. Pursuant to the guidance in Appendix B of SEC AccountingDisclosure Rules and Practices Official Text, we believe the acquisitionof PDTI was a merger of a private operating company into a non-operating publicshell corporation with nominal net assets which typically results in the ownersand management of the private company having actual or effective operatingcontrol of the combined company after the transaction, with the shareholders ofthe former public shell continuing only as passive investors. Thesetransactions are considered by the staff of the Securities and ExchangeCommission to be capital transactions in substance, rather than businesscombinations. That is, the transaction is equivalent to the issuance of stockby the private company for the net monetary assets of the shell corporation,accompanied by a recapitalization. Accordingly, the reverse acquisition hasbeen accounted for as a recapitalization. For accounting purposes, PDTI isconsidered the acquirer in the reverse acquisition. The historical financialstatements are those of PDTI. Net loss per share for periods prior to themerger in January 2005 is restated to reflect the number of equivalentshares received by the acquiring company.

*Impairmentof Long-Lived Assets.**  *Weevaluate our long-lived assets for indicators of possible impairment bycomparison of the carrying amounts to future net undiscounted cash flowsexpected to be generated by such assets when events or changes in circumstancesindicate the carrying amount of an asset may not be recoverable. Should animpairment exist, the impairment loss would be measured based on the 

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excess carrying value ofthe asset over the asset’s fair value or discounted estimates of future cashflows. We also evaluate the capitalized costs for patents and patentapplications filed but not issued for possible impairments. We have notidentified any such impairment losses to date.

*Stock-BasedCompensation.**  *InDecember 2004, the Financial Accounting Standards Board (“FASB”) issued arevision to SFAS No. 123, *Share-BasedPayment*. This statement establishes standards for the accounting fortransactions in which an entity exchanges its equity instruments for goods orservices. It also addresses transactions in which an entity incurs liabilitiesin exchange for goods or services that are based on the fair value of theentity’s equity instruments or that may be settled by the issuance of thoseequity instruments. This statement focuses primarily on accounting fortransactions in which an entity obtains employee services in share-basedpayment transactions. This statement does not change the accounting guidancefor share-based payment transactions with parties other than employees providedin SFAS No. 123 as originally issued. This statement is effective for newawards and those modified, repurchased or cancelled in interim or annualreporting periods beginning after June 15, 2005. We early adopted thisstandard upon inception.

*Researchand Development.**  *Thecosts of materials and equipment or facilities that are acquired or constructedfor research and development activities and that have alternative future usesare capitalized as tangible assets when acquired or constructed. The cost ofsuch materials consumed in research and development activities and thedepreciation of such equipment or facilities used in those activities areresearch and development costs. However, the costs of materials, equipment, orfacilities acquired or constructed for research and development activities thathave no alternative future uses are considered research and development costsand are expensed at the time the costs are incurred.

*IncomeTaxes.**  *TheCompany reports its income taxes in accordance with SFAS No. 109, *Accounting for Income Taxes*, which callsfor the utilization of the asset and liability method of accounting for incometaxes. Under this method, deferred taxes are determined based on differencesbetween financial reporting and tax bases of assets and liabilities and aremeasured using the enacted marginal tax rates and laws that will be in effectwhen the differences reverse. Temporary differences have been created for allstock option plans and are included in our SFAS No. 109 computation. Forthe quarter ended December 31, 2005, there were permanent and temporarydifferences of approximately $55,000 and $50,000, respectively. At December 31,2005, we had cumulative net operating loss carryforwards of approximately$9,064,000, which expire in years 2006 through 2024. No effect has been shownin the consolidated financial statements for the net operating losscarryforwards as the likelihood of future tax benefit from such net operating losscarryforwards is not determinable at this time. Accordingly, the potential taxbenefits of the net operating loss carryforwards, estimated based upon taxrates at December 31, 2005, have been offset by valuation reserves of thesame amount.

*Net Loss per Share.**  *The Company has presented basic anddiluted net loss per share pursuant to SFAS No. 128, *Earnings Per Share*. In accordance withSFAS No. 128, basic and diluted net loss per share has been computed usingthe weighted-average number of shares of common stock outstanding during theperiod. Dilutive net loss per share would give affect to the dilutive effect ofcommon stock equivalents consisting of options and warrants. Potentiallydilutive securities have been excluded from the net loss per common sharecalculation as the effects would be antidilutive. Potentially dilutivesecurities totaling 2,701,790 and 1,734,228 for the periods ended December 31,2005 and 2004, respectively, were not included in the computation of weightedaverage diluted common shares because the impact of these potentially dilutivesecurities were antidilutive.

**Recent Accounting Pronouncements**

In May 2005, theFinancial Accounting Standards Board issued SFAS No. 154, *Accounting Changes and Error Corrections*. Thisnew standard replaces Accounting Principals Board Opinion (“APB”) No. 20, 

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*Accounting Changes,* and SFAS No. 3, *Reporting Accounting Changes in Interim FinancialStatements*. This statement changes the requirements for theaccounting for and reporting of a change in accounting principle and applies toall voluntary changes in accounting principle. It also applies to changesrequired by an accounting pronouncement in the unusual instance that thepronouncement does not include specific transition provisions. When apronouncement includes specific transition provisions, those provisions shouldbe followed. APB No. 20 required that most voluntary changes in accountingprinciple be recognized by including in net income of the period of the changethe cumulative effect of changing to the new accounting principle. Thisstatement requires retrospective application to prior period financialstatements of changes in accounting principle, unless it is impracticable todetermine either the period-specific effects or the cumulative effect of thechange. The provisions of SFAS No. 154 are effective for fiscal yearsbeginning after December 15, 2005. As such we are required to adopt SFAS No. 154by October 1, 2006. We do not expect this statement to have a materialimpact on our consolidated financial statements.

**Forward-Looking Statements**

Statements in this quarterly report on Form 10-Qthat are not historical facts (including any statements concerning plans andobjectives of management for future operations or economic performance, orassumptions or forecasts related thereto) are forward-looking statementssubject to Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. These statements can be identified bythe use of forward-looking terminology including “forecast,” “may,” “believe,” “expect,”“anticipate,” “estimate,” “continue” or other similar words. These statementsdiscuss future expectations, contain projections of results of operations or offinancial condition or state other “forward-looking” information. We and ourrepresentatives may from time to time make other oral or written statementsthat are also forward-looking statements.

These forward-lookingstatements are made based upon our management’s current plans, expectations,estimates, assumptions and beliefs concerning future events impacting us andtherefore involve a number of risks and uncertainties. We caution thatforward-looking statements are not guarantees and that actual results coulddiffer materially from those expressed or implied in the forward-lookingstatements as a result of certain factors, including but not limited todependence upon energy industry spending, the volatility of oil and gas prices,weather interruptions, the results of testing of our products, the availabilityof capital resources and the other factors described under “Item 1A. RiskFactors” in our annual report on Form 10-K for the year ended September 30,2005 and filed with the SEC on December 14, 2005. We undertake noobligation to update any forward-looking statements except as required by law.

**Item3.        Quantitative and QualitativeDisclosures about Market Risk**

We believe that we do nothave any material exposure to financial market risk and we do not enter intoforeign currency or interest rate transactions.

**Item4.        Controls and Procedures**

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in our reportsunder the Securities Exchange Act of 1934 is recorded, processed, summarizedand reported within the time periods specified in the rules and formspromulgated by the Securities and Exchange Commission (“SEC”), and that suchinformation is accumulated and communicated to management, including our ChiefExecutive Officer and Chief Financial Officer, to allow timely decisionsregarding required disclosure. The design of any system of control is based inpart upon certain assumptions about the likelihood of future events, and therecan be no assurance that any design will succeed in achieving our statedpurpose under all potential future conditions. As required by 

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Rule 13a-15(b) ofthe Securities Exchange Act of 1934, an evaluation was performed under thesupervision and with the participation of our Chief Executive Officer and ChiefFinancial Officer of the effectiveness of the design and operation of our “disclosurecontrols and procedures” (as defined under Rule 13a-15(e) and Rule 15d-15(e))as of the end of the period covered by this quarterly report on Form 10-Qfiled with the SEC. Based upon that evaluation and in connection with theirdetermination that the matters described immediately below relating to therestatement of our historical financial information, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures, as of December 31, 2005, were effective in timely alertingthem to material company information required to be included in our periodicfilings with the SEC.

Our Chief Executive Officer and Chief FinancialOfficer reviewed with members of our Audit Committee whether the restatement ofour financial results for our fiscal quarter ended June 30, 2005 and yearended September 30, 2005 affected their conclusions that our disclosurecontrols and procedures, as of December 31, 2005, were effective in timelyalerting them to material company information required to be included in ourperiodic filings with the SEC. In connection with their review, our ChiefExecutive Officer and Chief Financial Officer noted that our decision torestate our fiscal quarter ended June 30, 2005 and year ended September 30,2005 financial results did not call into question whether the relevantinformation was recorded, processed, summarized or reported within the timeperiods specified in the SEC’s rules and forms. It also did not involveany issue about whether information required to be disclosed in this quarterlyreport on Form 10-Q was accumulated and communicated to our ChiefExecutive Officer and Chief Financial Officer to allow timely decisionsregarding required disclosure. Rather, the restatements resulted fromreconsideration of our policy for recording stock-based employee compensationexpense in connection with preparing responses to a comment letter that wereceived from the Staff of the SEC on our annual report on Form 10-Kfor the year ended September 30, 2005. Our Chief Executive Officer andChief Financial Officer did not find that management’s ultimate determinationthat its prior policy of recording stock-based compensation expense wasinconsistent with generally accepted accounting principles raised any questionabout whether our disclosure controls and procedures were effective to ensurethat required information was disclosed to them as appropriate to allow timelydecisions regarding required disclosure. Therefore, based on that review, ourChief Executive Officer and Chief Financial Officer determined that their priorconclusions, that our disclosure controls and procedures were effective as of December 31,2005, had not changed.

There was no change in our internal control overfinancial reporting during our first quarter of fiscal 2006 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

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**Part II—Other Information**

**Item 1.**                        LegalProceedings

PDTI filed a lawsuit in District Court in HarrisCounty, Texas in November 2004 styled *Particle DrillingTechnologies, Inc. vs. PSI Distribution Incorporated, Harry B. Curlett,Curlett Family Limited Partnership, Ltd., CCore Technology and Licensing, Ltd.,Deep Heat Energy Corporation, and Energeo, LP* to recover certaintangible and intangible assets that PDTI believes should have been transferredas part of the Acquisition Agreement among PSI, the Curlett Group (as definedbelow) and the predecessor company of PDTI. It was pursuant to this acquisitionthat PDTI acquired its intellectual property rights to the PID technology. In January 2005,PDTI reached a settlement with one of the defendants, PSID, whereby PDTI agreedto hold PSID harmless with regard to this lawsuit in exchange for PSID’sagreement to re-affirm and ratify the Acquisition Agreement. Further, PDTIobtained in this settlement any rights, claims and causes of action that PSIDmay have to pursue damages or to recover assets from the other parties named inthe lawsuit.

*On December 6,2004*and December 30, 2005, PDTI receivedresponses to the above-referenced lawsuit from certain of the defendants,namely Harry B. Curlett, CFLP, CTL and Deep Heat Energy Corporation, which werefer to as the “Curlett Group,” in which the Curlett Group asserted acounterclaim against PDTI claiming, among other things, that PDTI (1) owesMr. Curlett $40,000 plus default interest at 18% per annum under apromissory note and certain fees incurred in connection with collection underthe note; (2) committed a breach of contract in connection with theAcquisition Agreement referenced in the preceding paragraph and the closing ofthat agreement in January 2004; (3) engaged in economic duress andfraud in the inducement in connection with the negotiation and closing of theAcquisition Agreement; (4) committed fraud in connection with thattransaction; and (5) interfered with alleged prospective businessrelationships of CFLP. The counterclaim requests damages of, among otherthings, judgment on the $40,000 principal amount of the promissory note plusaccrued default interest and costs of collection, actual damages of not lessthan $100 million for breach of contract, fraud and interference, exemplarydamages of not less than $200 million, specific performance of the licenseagreement for non-oil and gas applications of the PID technology and adeclaratory judgment rescinding the Acquisition Agreement.

By filing this lawsuit, weseek to recover the intellectual property related to the PID technology as itapplies to non-oil and gas applications. We believe the counterclaim made bythe Curlett Group is without merit. We intend to vigorously pursue our claimsin this case and shall vigorously defend the alleged counterclaims by theCurlett Group. Discovery in this litigation is ongoing, however, and ourposition with regard to the merits of the various claims and defenses maychange as additional information is adduced through the discovery process. Theoutcome of all litigation is inherently uncertain; as a result, we do not knowat this time whether or not we will recover any of the intellectual propertythat we seek to recover in our original petition or if any or all of the remediesrequested by the Curlett Group in their counterclaim will be awarded. If themonetary damages requested in this counterclaim were granted in a judgmentagainst us, such damages would severely impair our ability to continue as agoing concern. Furthermore, if the request for rescission of the AcquisitionAgreement that closed in January 2004 is granted as requested by thecounterclaim, such a judgment could have the effect of causing us to lose allintellectual property ownership rights to the PID technology.

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**Item 6.**                        Exhibits

Exhibits:

| Exhibit  No. | ** ** | ** ** | ** ** | **Description**                                                                                                                                                      |
|--------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1         |       |       |       | Certification of  the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of  the Securities Exchange Act of 1934.*                               |
| 31.2         |       |       |       | Certification of  the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of  the Securities Exchange Act of 1934.*                               |
| 32.1         |       |       |       | Certification of  the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.** |
| 32.2         |       |       |       | Certification of  the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.** |

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*       Filedherewith

**    Furnishedherewith

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

|                                     | PARTICLE DRILLING TECHNOLOGIES, INC.                                                                                              |
|-------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|
|                                | (Registrant)                                                                                                                           |
| Date:   February 14, 2006 | /s/ J. CHRIS BOSWELL                                                                                                                   |
|                                | J. Chris Boswell                                                                                                                       |
|                                | Senior Vice President and Chief Financial Officer  (authorized officer, principal financial officer and principal accounting  officer) |

 

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**EXHIBIT INDEX**

| Exhibit   No. | ** ** | ** **                                                                                                                                                           | ** ** | **Description** |
|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 31.1               |       | Certification of the  Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of  the Securities Exchange Act of 1934.*                               |
| 31.2               |       | Certification of  the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of  the Securities Exchange Act of 1934.*                               |
| 32.1               |       | Certification of  the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.** |
| 32.2               |       | Certification of the  Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.** |
|                    |            |                                                                                                                                                                      |            |                 |  |

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*                    Filed herewith

**             Furnished herewith

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