**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, 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 June 30, 2006**

**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 DrillingTechnologies, Inc.**(Exact name of registrant as specified in its charter)

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

**11757Katy Freeway, Suite 1300Houston, Texas 77079**(Address of principal executive offices)(Zip Code)

**713-223-3031**(Registrant’s telephone number, including area code)

**1021Main Street, Suite 2650Houston, Texas 77002**(Former name, former address and former fiscal year, ifchanged since last report)

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x  No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler o                            Accelerated filer x                      Non-acceleratedfiler o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes  o No x

The number of shares ofthe registrant’s common stock, $.001 par value, outstanding as of August 2,2006 was 25,008,705.

 

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

**FORM 10-QFOR THE QUARTER ENDED JUNE 30, 2006**

**INDEX**

 
| **Part I - Financial Information** |
|------------------------------------|

 
| Item 1.                          |       | Financial Statements (Unaudited)                                                                                                                                     |   |   |
|----------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                             |       |                                                                                                                                                                 |   |   |
|                             |       | Consolidated Balance  Sheets (Unaudited) at June 30, 2006 and September 30, 2005                                                                                     |   | 3      |
|                             |       |                                                                                                                                                                 |   |   |
|                             |       | Consolidated Statements  of Operations (Unaudited) - Three and Nine Months Ended June 30, 2006 and  2005, and from June 9, 2003 (date of inception) to June 30, 2006 |   | 4      |
|                             |       |                                                                                                                                                                 |   |   |
|                             |       | Consolidated Statements  of Cash Flows (Unaudited) - Nine Months Ended June 30, 2006 and 2005, and  from June 9, 2003 (date of inception) to June 30, 2006           |   | 5      |
|                             |       |                                                                                                                                                                 |   |   |
|                             |       | Notes  to Consolidated Financial Statements (Unaudited)                                                                                                              |   | 6      |
|                             |       |                                                                                                                                                                 |   |   |
| Item  2.                         |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                          |   | 9      |
|                             |       |                                                                                                                                                                 |   |   |
| Item 3.                          |       | Quantitative  and Qualitative Disclosures about Market Risk                                                                                                          |   | 14     |
|                             |       |                                                                                                                                                                 |   |   |
| Item 4.                          |       | Controls and  Procedures                                                                                                                                             |   | 14     |
|                             |       |                                                                                                                                                                 |   |   |
| **Part II - Other  Information** | ** ** | **14**                                                                                                                                                               |
|                             |       |                                                                                                                                                                 |   |   |
| Item 1.                          |       | Legal Proceedings                                                                                                                                                    |   | 14     |
|                             |       |                                                                                                                                                                 |   |   |
| Item 2.                          |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                         |   | 15     |
|                             |       |                                                                                                                                                                 |   |   |
| Item  6.                         |       | Exhibits                                                                                                                                                             |   | 16     |
|                             |       |                                                                                                                                                                 |   |   |
|                             |       | Signatures                                                                                                                                                           |   | 17     |

 

2

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**PARTICLE DRILLING TECHNOLOGIES, INC.**

**(a development stage enterprise)**

**CONSOLIDATEDBALANCE SHEETS**
| ** **                                                                                                                                                                                                                         | ** ** | **June 30,  2006** | ** ** | **September 30,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                                                                         | ** ** | **(Unaudited)**         | ** ** | **(Restated)**               | ** ** |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| **ASSETS**                                                                                                                                                                                                                         | ** ** | ** **              | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Current assets:                                                                                                                                                                                                                    |       |                    |       |                         |       |
| Cash and cash  equivalents                                                                                                                                                                                                         |       | $                       | 4,711,810  |                         | $          | 10,504,646 |   |
| Short-term investments                                                                                                                                                                                                             |       | 385,839                 |       | —                       |       |
| Accounts  receivable - related party                                                                                                                                                                                               |       | —                  |       | 42,330                       |       |
| Prepaid expenses                                                                                                                                                                                                                   |       | 71,371                  |       | 229,963                      |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Total current  assets                                                                                                                                                                                                              |       | 5,169,020               |       | 10,776,939                   |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Property, plant &  equipment, net                                                                                                                                                                                              |       | 1,127,031               |       | 1,277,982                    |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Intangibles, net                                                                                                                                                                                                                   |       | 1,208,513               |       | 1,102,403                    |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Other assets                                                                                                                                                                                                                       |       | 33,665                  |       | 391,089                      |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Total assets                                                                                                                                                                                                                       |       | $                       | 7,538,229  |                         | $          | 13,548,413 |   |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                     | ** ** | ** **              | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Current liabilities:                                                                                                                                                                                                               |       |                    |       |                         |       |
| Accounts payable                                                                                                                                                                                                                   |       | $                       | 884,716    |                         | $          | 1,056,733 |   |
| Short-term notes  payable                                                                                                                                                                                                          |       | —                  |       | 79,880                       |       |
| Current portion  of long-term debt                                                                                                                                                                                                 |       | 20,866                  |       | 11,597                       |       |
| Accrued  liabilities                                                                                                                                                                                                               |       | 715,570                 |       | 242,633                      |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Total current  liabilities                                                                                                                                                                                                         |       | 1,621,152               |       | 1,390,843                    |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Long-term debt                                                                                                                                                                                                                     |       | 18,790                  |       | 9,463                        |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Commitments and  contingencies - Note 8                                                                                                                                                                                            |       |                    |       |                         |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Stockholders’ equity:                                                                                                                                                                                                         |       |                    |       |                         |       |
| Common stock,  $.001 par value, 100,000,000 shares authorized, 27,989,291 shares issued and  24,986,205 shares outstanding at June 30, 2006, and 27,441,472 shares issued  and 24,441,472 shares outstanding at September 30, 2005 |       | 27,989                  |       | 27,441                       |       |
| Additional  paid-in capital                                                                                                                                                                                                        |       | 24,655,752              |       | 23,218,868                   |       |
| Treasury stock  at cost, 3,003,086 shares at June 30, 2006 and 3,000,000 shares at September  30, 2005                                                                                                                             |       | (1,511,817              | )          | (1,500,000                   | )          |
| Deficit  accumulated during the development stage                                                                                                                                                                                  |       | (17,273,637             | )          | (9,598,202                   | )          |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Total  stockholders’ equity                                                                                                                                                                                                   |       | 5,898,287               |       | 12,148,107                   |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                                                   |       | $                       | 7,538,229  |                         | $          | 13,548,413 |   |

The accompanying notes are anintegral part of these statements.

3

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**PARTICLEDRILLING TECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

**CONSOLIDATED STATEMENTSOF OPERATIONS**

**(Unaudited)**
| ** **                                                                | ** ** | ** **                                          | ** ** | ** **                                         | ** ** | ** **        | ** ** | ** **     | ** ** | **Period from**       | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|-------------------|------------|----------------|------------|----------------------------|------------|
| ** **                                                                | ** ** | ** **                                          | ** ** | ** **                                         | ** ** | ** **        | ** ** | ** **     | ** ** | **June 9, 2003** | ** ** |
| ** **                                                                | ** ** | ** **                                          | ** ** | ** **                                         | ** ** | ** **        | ** ** | ** **     | ** ** | **(date of**          | ** ** |
| ** **                                                                | ** ** | ** **                                          | ** ** | ** **                                         | ** ** | ** **        | ** ** | ** **     | ** ** | **inception) to**     | ** ** |
| ** **                                                                | ** ** | **Three Months Ended June 30,** | ** ** | **Nine Months Ended June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                                | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006**          | ** ** | **2005**       | ** ** | **2006**                   | ** ** |
| ** **                                                                | ** ** | ** **                                          | ** ** | **(Restated)**                                     | ** ** | ** **        | ** ** | **(Restated)** | ** ** | **(Restated)**             | ** ** |
|                                                                      |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Revenues                                                                  |       | $                                                   | —     |                                               | $          | —            |       | $              | —     |                       | $          | — |   | $ | — |   |
|                                                                      |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Operating expenses:                                                       |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Research and  development                                                 |       | 1,735,857                                           |       | 731,054                                            |       | 4,469,449         |       | 1,721,457      |       | 7,932,982                  |       |
| General and  administrative                                               |       | 1,157,885                                           |       | 984,863                                            |       | 3,530,056         |       | 2,098,850      |       | 9,898,551                  |       |
|                                                                      |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Total operating  expenses                                                 |       | 2,893,742                                           |       | 1,715,917                                          |       | 7,999,505         |       | 3,820,307      |       | 17,831,533                 |       |
|                                                                      |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Loss from  operations                                                     |       | (2,893,742                                          | )          | (1,715,917                                         | )          | (7,999,505        | )          | (3,820,307     | )          | (17,831,533                | )          |
|                                                                      |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Other income (expenses)                                                   |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Interest income                                                           |       | 64,018                                              |       | 80,725                                             |       | 224,314           |       | 126,102        |       | 433,619                    |       |
| Rental income -  related party                                            |       | —                                              |       | 3,880                                              |       | 46,565            |       | 3,880          |       | 73,727                     |       |
| Gain on debt  extinguishment                                              |       | —                                              |       | —                                             |       | —            |       | 26,990         |       | 35,283                     |       |
| Gain on  assignment of lease - related party                              |       | —                                              |       | —                                             |       | 55,614            |       | —         |       | 55,614                     |       |
| Interest expense                                                          |       | (821                                                | )          | (361                                               | )          | (2,423            | )          | (10,813        | )          | (40,347                    | )          |
|                                                                      |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Total other  income                                                       |       | 63,197                                              |       | 84,244                                             |       | 324,070           |       | 146,159        |       | 557,896                    |       |
|                                                                      |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Net loss                                                                  |       | $                                                   | (2,830,545 | )                                                  | $          | (1,631,673        | )          | $              | (7,675,435 | )                          | $          | (3,674,148 | ) | $ | (17,273,637 | ) |
|                                                                      |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Net loss per common  share, basic and diluted                             |       | $                                                   | (0.11      | )                                                  | $          | (0.07             | )          | $              | (0.31      | )                          | $          | (0.17 | ) | $ | (0.94 | ) |
|                                                                      |       |                                                |       |                                               |       |              |       |           |       |                       |       |
| Weighted average number of common shares outstanding - basic and  diluted |       | 24,968,159                                          |       | 24,312,819                                         |       | 24,461,636        |       | 21,385,891     |       | 18,359,429                 |       |

 

The accompanying notesare an integral part of these statements.

4

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**PARTICLEDRILLING TECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                   | ** ** | ** **                                         | ** ** | ** **        | ** ** | **Period from**       | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|-------------------|------------|----------------------------|------------|
| ** **                                                                   | ** ** | ** **                                         | ** ** | ** **        | ** ** | **June 9, 2003** | ** ** |
| ** **                                                                   | ** ** | ** **                                         | ** ** | ** **        | ** ** | **(date of**          | ** ** |
| ** **                                                                   | ** ** | ** **                                         | ** ** | ** **        | ** ** | **inception) to**     | ** ** |
| ** **                                                                   | ** ** | **Nine Months Ended June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                                   | ** ** | **2006**                                           | ** ** | **2005**          | ** ** | **2006**                   | ** ** |
| ** **                                                                   | ** ** | ** **                                         | ** ** | **(Restated)**    | ** ** | **(Restated)**             | ** ** |
|                                                                         |       |                                               |       |              |       |                       |       |
| Cash flows from  operating activities:                                       |       |                                               |       |              |       |                       |       |
| Net loss                                                                     |       | $                                                  | (7,675,435 | )                 | $          | (3,674,148                 | )          | $ | (17,273,637 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                               |       |              |       |                       |       |
| Gain on debt  extinguishment                                                 |       | —                                             |       | (26,990           | )          | (35,283                    | )          |
| Gain on  assignment of lease - related party                                 |       | (55,614                                            | )          | —            |       | (55,614                    | )          |
| Depreciation and  amortization expense                                       |       | 504,324                                            |       | 244,598           |       | 1,043,200                  |       |
| Short-term note  issued for services                                         |       | —                                             |       | —            |       | 44,000                     |       |
| Common stock  issued for services                                            |       | —                                             |       | (66,500           | )          | 931,500                    |       |
| Warrants issued  for services                                                |       | —                                             |       | 57,999            |       | 63,829                     |       |
| Stock-based  employee compensation                                           |       | 1,431,342                                          |       | 302,583           |       | 2,097,056                  |       |
| Changes in  operating assets and liabilities:                                |       |                                               |       |              |       |                       |       |
| (Increase)  decrease in accounts receivable - related party                  |       | 1,510                                              |       | (9,316            | )          | (40,820                    | )          |
| Decrease in  prepaid expenses                                                |       | 158,592                                            |       | 20,606            |       | 40,619                     |       |
| (Decrease) in  accounts payable                                              |       | (172,017                                           | )          | (516,868          | )          | 544,778                    |       |
| Increase in  accrued liabilities                                             |       | 569,371                                            |       | 9,365             |       | 812,004                    |       |
|                                                                         |       |                                               |       |              |       |                       |       |
| Net cash used in  operating activities                                       |       | (5,237,927                                         | )          | (3,658,671        | )          | (11,828,368                | )          |
|                                                                         |       |                                               |       |              |       |                       |       |
| Cash flows from  investing activities:                                       |       |                                               |       |              |       |                       |       |
| Payments to  purchase property and equipment                                 |       | (285,022                                           | )          | (999,651          | )          | (1,468,711                 | )          |
| Proceeds from  sale of property and equipment                                |       | —                                             |       | —            |       | 20,957                     |       |
| Payments to  purchase intangibles                                            |       | (143,973                                           | )          | (35,690           | )          | (574,417                   | )          |
| Payments to  purchase other assets                                           |       | (28,416                                            | )          | (385,839          | )          | (419,505                   | )          |
| Payments issued  for note receivable                                         |       | —                                             |       | —            |       | (300,783                   | )          |
| Payments issued  for note receivable - related party                         |       | —                                             |       | —            |       | (56,783                    | )          |
|                                                                         |       |                                               |       |              |       |                       |       |
| Net cash used in  investing activities                                       |       | (457,411                                           | )          | (1,421,180        | )          | (2,799,242                 | )          |
|                                                                         |       |                                               |       |              |       |                       |       |
| Cash flows from  financing activities:                                       |       |                                               |       |              |       |                       |       |
| Proceeds from  issuance of common stock                                      |       | 6,090                                              |       | 18,647,666        |       | 20,981,856                 |       |
| Repurchase of  common stock                                                  |       | (11,817                                            | )          | (1,500,000        | )          | (1,511,817                 | )          |
| Proceeds from  issuance of convertible notes                                 |       | —                                             |       | —            |       | 553,500                    |       |
| Repayments of  notes payable                                                 |       | (91,771                                            | )          | (302,132          | )          | (684,119                   | )          |
| 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                         |       | (97,498                                            | )          | 16,845,534        |       | 19,339,420                 |       |
|                                                                         |       |                                               |       |              |       |                       |       |
| Net increase (decrease)  in cash and cash equivalents                        |       | (5,792,836                                         | )          | 11,795,683        |       | 4,711,810                  |       |
|                                                                         |       |                                               |       |              |       |                       |       |
| Cash and cash  equivalents - beginning of period                             |       | 10,504,646                                         |       | 20,363            |       | —                     |       |
|                                                                         |       |                                               |       |              |       |                       |       |
| Cash and cash  equivalents - end of period                                   |       | $                                                  | 4,711,810  |              | $          | 11,786,046                 |       | $ | 4,711,810 |   |
|                                                                         |       |                                               |       |              |       |                       |       |
| Supplemental  disclosures of cash flow information:                          |       |                                               |       |              |       |                       |       |
| Cash paid for  interest                                                      |       | $                                                  | 2,530      |              | $          | 12,339                     |       | $ | 41,231 |   |
|                                                                         |       |                                               |       |              |       |                       |       |
| 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                    |       |
| Property and  equipment acquired with note payable                           |       | 30,487                                             |       | —            |       | 30,487                     |       |
| Short-term investments  reclassified from other assets                       |       | 385,839                                            |       | —            |       | 385,839                    |       |

 

The accompanying notesare an integral part of these statements.

5

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

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

**1.  ****     BASIS OF PRESENTATION**

The accompanyingunaudited interim consolidated financial statements, which include the accountsof Particle Drilling Technologies, Inc. (which is referred to hereinas “we,” “us,” “our” or the “Company”) and its subsidiary, have been preparedin accordance with generally accepted accounting principles in the UnitedStates of America (“US GAAP”) and pursuant to the rules and regulations ofthe Securities and Exchange Commission. Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith US GAAP have been condensed or omitted in accordance with suchrules and regulations. The information furnished in the unaudited interimconsolidated financial statements includes normal recurring adjustments andreflects all adjustments, which in the opinion of management are necessary fora fair presentation of such financial statements. Although management believesthe disclosures and information presented are adequate to make the informationnot misleading, these unaudited interim consolidated financial statementsshould be read in conjunction with the Company’s September 30, 2005audited consolidated financial statements and notes thereto onForm 10-K/A. Operating results for the three months and nine months endedJune 30, 2006 are not necessarily indicative of the results that may beexpected for the year ending September 30, 2006.

The preparation offinancial statements in conformity with US GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting periods. Actual results could 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.  ****       ****FINANCIAL CONDITIONAND MANAGEMENT PLANS**

The financialstatements of the Company have been prepared on the basis of accountingprinciples applicable to a going concern, which contemplates the realization ofassets and the satisfaction of liabilities in the normal course ofbusiness.  As shown in the condensedconsolidated financial statements, for the three and nine months ended June 30,2006, the Company reported net losses of approximately $2.8 million and $7.7million, respectively as compared to net losses of approximately $1.6 and $3.7million for the three and nine months ended June 30, 2005.  The condensed consolidated financialstatements also show an accumulated deficit of approximately $17.3 million frominception (June 9, 2003) through the period ended June 30, 2006.  The financial statements do not include anyadjustments relating to the recoverability and classification of asset carryingamounts or the amount and classification of liabilities that might resultshould the Company be unable to continue as a going concern.

The Company is currentlya development stage company and its continued existence is dependent upon theCompany’s successful development of the PID technology and our ability tosuccessfully commercialize this technology. The Company has yet to generate cashflow from operations, and untilrevenues commence, the Company is highly dependent upon debt and equityfunding.  Should continuing fundingrequirements not be met, the Company’s operations may cease to exist.  Management cannot provide any assurance thatany such financing will be available on acceptable terms or at all.

**3.  ****     RESTATEMENT OF FINANCIALSTATEMENTS**

The historicalinformation in this quarterly report on Form 10-Q for the ConsolidatedBalance Sheet as of September 30, 2005 has been restated. In addition,certain historical information included in the three and nine months ended June30, 2005 and the period from June 9, 2003 (date of inception) to June 30,2006 for the Consolidated Statement of Operations and Consolidated Statement ofCash Flows has been restated. These financial statements have been restatedafter determining 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 received comments from the Staff of the Securities and ExchangeCommission (“SEC”) to its annual report on Form 10-K for the year endedSeptember 30, 2005 that was originally filed on December 14, 2005. Asa result of one of these comments, the Company undertook a detailed analysis ofits policies in connection with the recording of stock-based employee compensationrelated to equity incentive awards under SFAS No. 123(R). Following thecompletion of that analysis and further consultation with the Company’sindependent registered public accountants, the Company determined that itspolicy for recording equity compensation was inconsistent with the guidance setforth under SFAS No. 123(R). Historically, the Company had calculated thecompensation expense associated with equity awards using the Black-Scholesmodel and amortized that expense over the service period as the equity awardsvested, commencing with the first vesting dates of the awards. To fully complywith the guidance set forth in SFAS No. 123(R), the Company is nowrecording such expense on a straight line basis over the relevant serviceperiods, commencing with the dates of grant of the awards. On February 9,2006, following an analysis of the impact of this error on the Company’spreviously released financial statements, the Audit Committee of the Company’sBoard of Directors determined that it was necessary to restate the financialstatements contained in the Company’s original annual report on Form 10-Kfor the period ended September 30, 2005 originally filed with the SEC onDecember 14, 2005.

As a result of therestatement, net loss for the year ended September 30, 2005 was increasedby $437,350 resulting in an increase to the deficit accumulated during thedevelopment stage and additional paid-in-capital of $437,350 as ofSeptember 30, 2005. The Consolidated Statements of Operations presented inthis quarterly report on Form 10-Q compares the three months and ninemonths ended June 30, 2006 and 2005. The Consolidated Statements of Cash flowspresented in this quarterly report on Form 10-Q compares the nine months endedJune 30, 2006 and 2005.  The historical informationfor the three months and nine months ended June 30, 2006 was not affected bythe accounting error described above, and therefore, not restated.

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**4.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

*Impairmentof Long-Lived Assets.  *We evaluate our long-livedassets for indicators of possible impairment by comparison of the carryingamounts to future net undiscounted cash flows expected to be generated by suchassets when events or changes in circumstances indicate the carrying amount of anasset may not be recoverable.  Should an impairment exist, the impairmentloss would be measured based on the excess carrying value of the asset over theasset’s fair value or discounted estimates of future cash flows.  We alsoevaluate the capitalized costs for patents and patent applications filed butnot issued for possible impairments. We have not identified any such impairmentlosses to date. The evaluation of capitalized costs for patents and patentapplications is based on a subjective cash flow forecast which is subject tochange. We will reassess our cash flow forecast each time there are fundamentalchanges in the underlying potential use of the patents or patent applicationsin terms of performance, customer acceptance or other factors that may affectsuch cash flow forecasts.

*New Accounting Pronouncements**.  ***In July 2006, the FASB issued FASBInterpretation No. 48, *Accounting forUncertainty in Income Taxes - An Interpretation of FASB Statement No. 109*(“FIN48”).  FIN 48 clarifies the accountingfor uncertainty in income taxes recognized in an enterprise’s financialstatements in accordance with SFAS No. 109, *Accountingfor Income*Taxes*.*  It prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return.  This new standard also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition.  Theprovisions of FIN 48 are to be applied to all tax positions upon initialadoption of this standard.  Only taxpositions that meet the more-likely-than-not recognition threshold at theeffective date may be recognized or continue to be recognized upon adoption ofFIN 48.  The cumulative effect ofapplying the provisions of FIN 48 should be reported as an adjustment to theopening balance of retained earnings (or other appropriate components of equityor net assets in the statement of financial position) for that fiscalyear.  The provisions of FIN 48 areeffective for fiscal years beginning after December 15, 2006.  Earlier application is permitted as long asthe enterprise has not yet issued financial statements, including interimfinancial statements, in the period of adoption.  We believe that the adoption of FIN 48 willnot have a material impact on our financial position, results of operations orcash flows.

**5.  ****     REVERSE ACQUISITION WITHMEDXLINK, 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 noadditional cash consideration in connection with the Merger. Following themerger, the Parent had 18,248,094 shares of common stock issued and outstanding(which included 3,381,538 shares of common stock issued upon conversion of thesame number of shares of Series A Convertible Preferred Stock of PDTI-DE)and an additional 3,433,000 shares of common stock reserved for issuance uponexercise of warrants and options as described above. Following the merger,PDTI-DE continued as the surviving corporation under the name ofParticle Drilling Technologies, Inc. as a subsidiary of Parent, theParent changed its name to Particle Drilling Technologies, Inc., andits stock trading symbol changed from MXLK.OB to PDRT.OB. On June 28,2005, the Company’s shares of common stock began trading on The NASDAQ CapitalMarket® under the symbol PDRT.

**6.  ****     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 not included in the computation of weighted average diluted sharesof common stock were 2,349,650 and 2,004,223 shares for the three months endedJune 30, 2006 and 2005, respectively, and 2,303,555 and 1,903,001 shares for thenine months ended June 30, 2006 and 2005, respectively.

**7.  ****     COMMON STOCK**

InJanuary 2006, the Company issued 53,750 shares of its common stock for cashupon exercise of options at $0.12 per share.

InJanuary 2006, the Company issued 9,721 shares of its common stock upon a netcashless exercise of warrants at $2.00 per share.

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InJanuary 2006, the Company issued 150,000 shares of its restricted stock to itsChief Executive Officer.

InFebruary 2006, the Company issued 176,458 shares of its common stock upon a netcashless exercise of warrants at $2.00 per share.

InFebruary 2006, the Company issued 20,000 shares of its restricted stock to oneof its employees.

InMarch 2006, the Company issued 66,000 shares of its common stock upon a netcashless exercise of warrants at $2.00 per share.

InApril 2006, the Company issued 12,500 shares of its restricted stock to one ofits employees.

InApril 2006, the Company issued 29,390 shares of its common stock upon a netcashless exercise of warrants at $.12 per share.

InJune 2006, the Company issued 30,000 shares of its restricted stock to itsBoard of Directors.

InJune 2006, the Company repurchased 3,086 shares of its common stock from one ofits employees.

At June 30, 2006, theCompany had 24,986,205 shares of common stock outstanding and has outstandingoptions and warrants to purchase up to 5,641,641 additional shares of theCompany’s common stock in the aggregate.

**8.  ****     STOCK-BASED EMPLOYEECOMPENSATION**

In April 2004, theBoard of Directors adopted the 2004 Stock Incentive Plan (the “2004 Plan”). The2004 Plan provides for the issuance of incentive stock options, non-statutorystock options and restricted stock grants to directors, employees andconsultants of the Company. Provisions under the 2004 Plan allowed for theissuance of up to 3,500,000 shares of common stock pursuant to awards under the2004 Plan. As of June 30, 2006, the Company had 66,250 shares of common stockavailable for issuance pursuant to awards under the 2004 Plan.

In March 2005, theBoard of Directors adopted the 2005 Stock Incentive Plan (the “2005 Plan”). The2005 Plan provides for the issuance of incentive stock options, non-statutorystock options and restricted stock grants to directors, employees andconsultants of the Company. Provisions under the 2005 Plan allow for theissuance of options and restricted stock awards to purchase or issue up to2,000,000 shares of common stock. As of June 30, 2006, the Company had 448,000shares of common stock available for issuance pursuant to awards under the 2005Plan.

Stock-based employeecompensation expense recorded for awards issued under the 2004 Plan and the2005 Plan for the three months ended June 30, 2006 and 2005 was $544,178 and$140,783, respectively. Stock-based employee compensation expense recorded forawards issued under the 2004 Plan and the 2005 Plan for the nine months endedJune 30, 2006 and 2005 was $1,431,342 and $302,583, respectively. Stock-basedemployee compensation expense recorded for awards issued under the 2004 Planand the 2005 Plan since inception (June 9, 2003) to June 30, 2006 was$2,097,056.

**9.  ****     COMMITMENTS AND CONTINGENCIES**

In March 2006, weassigned our commitments under the previous lease for our corporate officesthat were located at 1021 Main Street, Suite 2650, Houston, Texas 77002 toEnergy XXI Services, LLC, an affiliate of John D. Schiller, our former interimPresident and Chief Executive Officer and currently one of our directors, andof Steve Weyel, who is also currently one of our directors. The ExploitationCompany, LLP, also an affiliate of Messrs. Schiller and Weyel, had previouslysubleased a portion of that corporate office space pursuant to a SubleaseAgreement, which agreement was cancelled in connection with the assignment ofthe office lease to Energy XXI Services, LLC.

In June 2006, weextended the lease for our commercial operating facility that expiredJune 30, 2006 for one additional year. The lease for our commercialoperating facility will expire June 30, 2007. The future minimum leasepayments under this lease are $60,000.

In April 2006, theCompany entered into a thirteen (13) month lease agreement for new corporateoffices that commenced in May 2006. We moved our previous corporate officesthat were located at 1021 Main Street, Suite 2650, Houston, Texas 77002,to 11757 Katy Freeway, Suite 1300, Houston, Texas 77079. In April 2006, wedelivered to the lessor a security deposit of $9,400. Our future annual minimumlease payments as of June 30, 2006 are $123,140.

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**10.  ****                      RELATEDPARTY TRANSACTIONS**

In March 2005, weentered into a five year sublease agreement with The Exploitation Company, LLP,an affiliate of John D. Schiller, our former interim President and ChiefExecutive Officer until November 15, 2005 and currently one of ourdirectors, pursuant to which The Exploitation Company, LLP subleased from usapproximately 5,200 square feet of our corporate office space, beginning inJune 2005. In July 2005, Mr. Steve Weyel, one of our directors,became an executive officer of The Exploitation Company, LLP.

In March 2006, weassigned our commitments under the previous lease for our corporate officesthat were located at 1021 Main Street, Suite 2650, Houston, Texas 77002 toEnergy XXI Services, LLC. We agreed with The Exploitation Company, LLP toterminate the sublease agreement in connection with the assignment of thecorporate office lease to Energy XXI Services, LLC.

**11.  INCOMETAXES**

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 June30, 2006, there were permanent and temporary differences of approximately$85,000 and $462,000, respectively. At June 30, 2006, we had cumulative netoperating loss carryforwards of approximately $14,129,000, which expire inyears 2007 through 2025. 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 June 30, 2006, have beenoffset by valuation reserves of the same amount.

**Item 2:  Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

The following discussion ofour financial condition and results of operations should be read together withthe 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 acquired Particle Drilling Technologies, Inc., a privately-heldDelaware corporation (“PDTI”). As a result of this acquisition, our company,which previously had no material operations, acquired the business of PDTI andwe are now engaged in the development of the Particle Impact DrillingSystem, a patented system utilizing a specially designed “fit for purpose”drill bit fitted with jetting nozzles and polycrystalline diamond compactcutting structures for use in the oil and gas drilling industry.

We are adevelopment-stage company and have a limited operating history. Our predecessorcompany for financial reporting purposes was formed on June 9, 2003 toacquire the technology related to the Particle Impact Drilling System (the“PID technology”). We are still developing this technology, and to date, wehave not generated any revenues from our operations. As we continue to executeour operations plan, we expect our development and operating expenses toincrease.

*Researchand development.  *We have made and expect tocontinue to make substantial investments in research and development activitiesin order to develop and market the PID technology. Research and developmentcosts consist primarily of general and administrative and operating expensesrelated to research and development activities. We expense research anddevelopment costs as incurred except for property, plant and equipment relatedto research and development activity that have an alternative future use.Property, plant and equipment for research and development activity that havean alternative future use are capitalized and the related depreciation isexpensed as research and development costs.

*Generaland administrative.  *General and administrativeexpenses consist primarily of salaries and benefits, office expense,professional services, and other corporate overhead costs. We have experiencedand expect to continue to experience increases in general and administrativeexpenses as a result of: (1) becoming subject to reporting and complianceobligations applicable to publicly-held companies in January 2005;(2) our continuing efforts to develop, test and prepare the PID technologyfor commercialization; and (3) the hiring of additional personnel.

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**Resultsof Operations**

***Three Months Ended June 30, 2006 Compared to Three MonthsEnded June 30, 2005***

*Researchand development.  *Research and developmentexpenses were $1,735,857 and $731,054 for the three months ended June 30, 2006and 2005, respectively, representing an increase of $1,004,803. This increasewas primarily the result of the development of a new particle injector system,increased compensation due to the hiring of additional personnel, bonusaccruals and stock-based compensation for research and development personnel duringthe three months ended June 30, 2006.  Inaddition, we incurred approximately $315,124 for supplies, transportation andother operational costs in connection with our first commercial trial, whichincludes a $135,469 payment to the operator as a result of downtime.

*Generaland administrative.  *General and administrativeexpenses were $1,157,885 and $984,863 for the three months ended June 30, 2006and 2005, respectively, representing an increase of $173,022. This increase wasprimarily the result of increased costs related to bonus accruals andstock-based compensation during the three months ended June 30, 2006.  In addition, there was a decrease in SEC andstock market fees in the three months ended June 30, 2006 compared to the sameperiod in 2005 as a result of our filing of a registration statement with theSEC and the initial listing for trading of our common stock on The NASDAQCapital Market® during the three months ended June 30,2005.

*Otherincome (expenses).  *Other income was $63,197 and$84,244 for the three months ended June 30, 2006 and 2005, respectively,representing a decrease in other income of $21,047. The decrease during thethree months ended June 30, 2006 was primarily attributable to: (1) rentalincome from our sublease agreement with The Exploitation Company, LLP thatcommenced in June 2005 and was terminated in March 2006; and (2) the decreasein earnings on investments because our cash and cash equivalents have decreaseddue to funding of operations.

***Nine Months Ended June 30, 2006 Compared to Nine MonthsEnded June 30, 2005***

*Researchand development. *Research and development expenses were$4,469,449 and $1,721,457 for the nine months ended June 30, 2006 and 2005,respectively, representing an increase of $2,747,992. This increase wasprimarily the result of the development of a new particle injector system,increased compensation due to the hiring of additional personnel, bonusaccruals and stock-based compensation for research and development personnelduring the nine months ended June 30, 2006. During the nine months ended June 30, 2006, we also incurred $371,736 inconnection with our field test at Catoosa which occurred during the firstquarter of fiscal 2006.  In addition, weincurred approximately $315,124 for supplies, transportation and otheroperational costs in connection with our first commercial trial, which includesa $135,469 payment to the operator as a result of downtime.

*Generaland administrative. *General and administrative expenseswere $3,530,056 and $2,098,850 for the nine months ended June 30, 2006 and2005, respectively, representing an increase of $1,431,206.   Thisincrease was primarily the result of increased costs related to bonus accrualsand stock-based compensation during the nine months ended June 30, 2006.  In addition, our general and administrativeexpenses increased during the nine months ended June 30, 2006 as a result ofour reporting and compliance obligations applicable to publicly-held companies,which commenced for us (for financial reporting purposes) during the secondquarter of fiscal 2005. Lastly, we incurred substantial legal cost during thethree months ended March 31, 2006 in connection with our settlement agreementand the related litigation which was settled in March 2006.

*OtherIncome. *Other income was $324,070 and $146,159 for thenine months ended June 30, 2006 and 2005, respectively, representing anincrease of $177,911.  This increase was primarily the result of anincrease in interest income, rental income, and a gain on assignment of leaseduring the nine months ended June 30, 2006. The increase in interest income forthe nine months ended June 30, 2006 relates to the investment of the proceedsreceived from the private placement of our common stock during February 2005.The increase in rental income during the nine months ended June 30, 2006 isattributable from our sublease agreement with The Exploitation Company, LLPthat commenced in June 2005 and was terminated in March 2006. During the ninemonths ended June 30, 2006, we recorded a gain on assignment of lease relatedto the assignment of our corporate offices located at 1021 Main Street, Suite2650, Houston, Texas 77002 to Energy XXI Service, LLC in March 2006.

**Liquidityand Capital Resources**

Our principal sources ofliquidity are cash and cash equivalents. Cash requirements through the end ofthe fiscal year 2006 are primarily to fund research and development activities,to continue to improve service capabilities, to expand operations, general andadministrative costs and capital expenditures. Our continued existence dependson the successful development of the PID technology and our ability tosuccessfully commercialize this technology. Depending on the timing of these two events, we will need to seekadditional funding through the sale or licensing of assets or through issuancesof debt or equity securities.  We anticipate that we will need additionalfunding during the next 12 months and would seek to raise such funds throughpublic or private equity financing, bank debt financing, or from other sources.Adequate funds may not be available when needed, and if we raiseadditional funds by issuing equity securities, existing stockholdersmay be diluted.

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Since inception onJune 9, 2003 through June 30, 2006, we have financed our operationsthrough private sales of our equity and the issuance of convertible notespayable, totaling net proceeds of $21,558,551. As of June 30, 2006, we had$5,097,649 in cash and short term investments.

There are no assurancesthat the Company will be successful in achieving profitable operations,additional financing, or continue as a going concern.

*CashFlows from Operations.  *Cash flows used foroperations are primarily affected by our research and development progress andbusiness development. Net cash flows used for operations during the nine monthsended June 30, 2006 were $5,237,927, compared to $3,658,671 for the nine monthsended June 30, 2005. The increase from the nine months ended June 30, 2005 tothe nine months ended June 30, 2006 was the result of increased cash due to thehiring of additional personnel and professional fees relating to being apublicly traded company.  During the ninemonths ended June 30, 2006, we also incurred costs in the amount of $371,736 inconnection with our field test at Catoosa which occurred during the firstquarter of fiscal 2006.  No such costswere incurred during the nine months ended June 30, 2005. In addition, weincurred approximately $315,124 for supplies, transportation and otheroperational costs in connection with our first commercial trial, which includesa $135,469 payment to the operator as a result of downtime. Our working capitalsince inception (June 9, 2003) has been fully funded from cash flows fromfinancing activities.

*CashFlows from Investing Activities.  *Our capitalspending for the nine months ended June 30, 2006 was $285,022 compared to$999,651 for the nine months ended June 30, 2005. During the nine months endedJune 30, 2006, we used capital expenditures for our research and developmentactivities in accordance with our 2006 capital budget.  During the nine months ended June 30, 2005,in addition to capital expenditures for our research and development activitiesin accordance with our 2005 capital budget, we used $389,983 to purchase otherassets.  This was primarily related to a $350,000 deposit supporting aletter of credit we established in connection with our former corporate officelease. Our capital spending since inception (June 9, 2003) has been fullyfunded from cash flows from financing activities. We anticipate that ourcapital expenditures for the next several months will continue to be fullyfunded from our available cash and cash equivalents, and short terminvestments.

*CashFlows from Financing Activities.  *Net cashprovided by (used in) financing activities for the nine months ended June 30,2006 and 2005 was ($97,498) and $16,845,534, respectively. During the ninemonths ended June 30, 2005, we received net proceeds of $18,647,666 from theissuance of common stock and used $1,500,000 to repurchase 3,000,000 sharesfrom a shareholder, and $302,132 to repay notes payable.  During the nine months ended June 30, 2006,we used $91,771 to repay note payables.

*ContractualObligations*.In March 2005, we delivered to the lessor of our corporate offices at 1021 MainStreet, Suite 2650, Houston, Texas 77002, a security deposit of $350,000 in theform of an irrevocable letter of credit. Our future annual minimum leasepayments were $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 were $18,758. InMarch 2006, we assigned our commitments under this office lease to Energy XXIServices, LLC, an affiliate of John D. Schiller, our former interim Presidentand Chief Executive Officer and currently one of our directors, and of SteveWeyel, currently one of our directors. The Exploitation Company, LLP hadpreviously subleased a portion of that corporate office space pursuant to aSublease Agreement, which agreement was cancelled in connection with theassignment of the office lease to Energy XXI Services, LLC. Furthermore, EnergyXXI Services, LLC assumed the obligation under the lease to provide a securitydeposit of $350,000 and we were released from the irrevocable letter of creditwe had previously provided. We will not incur any future obligations for leasepayments under this office lease.

In April 2006, we enteredinto a thirteen month lease agreement for our new corporate offices at 11757Katy Freeway, Suite 1300, Houston, Texas 77079, that commenced in May 2006. Inconnection with the execution of this new lease agreement, we delivered to thelessor a security deposit of $9,400. Our future annual minimum lease paymentsare $123,140.

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In June 2006, weextended the lease for our commercial operating facility that expiredJune 30, 2006 for one additional year. The lease for our commercialoperating facility will expire June 30, 2007. The future minimum leasepayments under this lease are $60,000.

**Off-BalanceSheet 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 Services, International, Ltd. (“PSIL”) pursuant to which we are obligatedto pay PSIL a royalty on a quarterly basis equal to 2% of our EBITDA derivedfrom the use of the PID technology, until an aggregate of $7,500,000 has beenpaid. In addition, we are obligated to pay CCORE Technology and Licensing, Ltd.(“CTL”), PSI and PSIL a royalty equal to 1.6%, 1.2% and 1.2%, respectively, ofour quarterly gross revenue, derived from the use of the PID technology. As ofJune 30, 2006, we had no revenues or EBITDA; therefore no royalties have beenpaid or accrued.

**RelatedParty Transactions**

In March 2005, weentered into a five year sublease agreement with The Exploitation Company, LLP,an affiliate of John D. Schiller, our former interim President and ChiefExecutive Officer and currently one of our directors, pursuant to which TheExploitation Company, LLP subleased from us approximately 5,200 square feet ofour corporate office space, beginning in June 2005. In July 2005,Mr. Steve Weyel, one of our directors, became an executive officer of TheExploitation Company, LLP.

In March 2006, weassigned our commitments under the previous lease for our corporate officesthat were located at 1021 Main Street, Suite 2650, Houston, Texas 77002 toEnergy XXI Services, LLC. We agreed with The Exploitation Company, LLP toterminate the sublease agreement in connection with the assignment of thecorporate office lease to Energy XXI Services, LLC.

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.

**CriticalAccounting Policies**

The discussion andanalysis of our financial condition and results of operations is based on ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America. Thepreparation of these consolidated financial statements requires us to makeestimates and judgments that affect the reported amounts of assets, liabilitiesand expenses. We base our estimates on historical experience and on variousother assumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates under different assumptions orconditions. We believe the following critical accounting policies affect ourmost significant judgments and estimates used in the preparation of ourconsolidated financial statements.

*ReverseAcquisition.  *The acquisition of PDTI inJanuary 2005 was accounted for as a reverse acquisition. Pursuant to theguidance in Appendix B of SEC Accounting Disclosure Rules and PracticesOfficial Text, we believe the acquisition of PDTI was a merger of a privateoperating company into a non-operating public shell corporation with nominalnet assets which typically results in the owners and management of the privatecompany having actual or effective operating control of the combined companyafter the transaction, with the shareholders of the former public shellcontinuing only as passive investors. These transactions are considered by thestaff of the Securities and Exchange Commission to be capital transactions insubstance, rather than business combinations. That is, the transaction isequivalent to the issuance of stock by the private company for the net monetaryassets of the shell corporation, accompanied by a recapitalization.Accordingly, the reverse acquisition has been accounted for as arecapitalization. For accounting purposes, PDTI is considered the acquirer inthe reverse acquisition. The historical financial statements are those of PDTI.Net loss per share for periods prior to the merger in January 2005 isrestated to reflect the number of equivalent shares received by the acquiringcompany.

*Impairmentof Long-Lived Assets.  *We evaluate our long-livedassets for indicators of possible impairment by comparison of the carryingamounts to future net undiscounted cash flows expected to be generated by suchassets when events or changes in circumstances indicate the carrying amount ofan asset may not be recoverable.  Should an impairment exist, theimpairment loss would be measured based on the excess carrying value of theasset over the asset’s fair value or discounted estimates of future cashflows.  We also evaluate the capitalized costs for patents and patentapplications filed but 

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not issued for possible impairments. We have notidentified any such impairment losses to date. The evaluation of capitalized costs for patents and patent applicationsis based on a subjective cash flow forecast which is subject to change.  We will reassess our cash flow forecast eachtime there are fundamental changes in the underlying potential use of thepatents or patent applications in terms of performance, customer acceptance orother factors that may affect such cash flow forecasts.

*Stock-BasedCompensation.  *In December 2004, the FinancialAccounting Standards Board (“FASB”) issued a revision to SFAS No. 123, *Share-Based Payment*. This statementestablishes standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services. It also addressestransactions in which an entity incurs liabilities in exchange for goods orservices that are based on the fair value of the entity’s equity instruments orthat may be settled by the issuance of those equity instruments. This statementfocuses primarily on accounting for transactions in which an entity obtainsemployee services in share-based payment transactions. This statement does notchange the accounting guidance for share-based payment transactions withparties other than employees provided in SFAS No. 123 as originallyissued. This statement is effective for new awards and those modified,repurchased or cancelled in interim or annual reporting periods beginning afterJune 15, 2005. We early adopted this standard upon inception.

*Researchand Development.  *The costs of materials andequipment or facilities that are acquired or constructed for research anddevelopment activities and that have alternative future uses are capitalized astangible assets when acquired or constructed. The cost of such materialsconsumed in research and development activities and the depreciation of suchequipment or facilities used in those activities are research and developmentcosts. However, the costs of materials, equipment, or facilities acquired orconstructed for research and development activities that have no alternativefuture uses are considered research and development costs and are expensed atthe time the costs are incurred.

*IncomeTaxes.  *The Company reports its income taxes inaccordance with SFAS No. 109, *Accountingfor Income Taxes*, which calls for the utilization of the asset andliability method of accounting for income taxes. Under this method, deferredtaxes are determined based on differences between financial reporting and taxbases of assets and liabilities and are measured using the enacted marginal taxrates and laws that will be in effect when the differences reverse. Temporarydifferences have been created for all stock option plans and are included inour SFAS No. 109 computation. For the quarter ended June 30, 2006, therewere permanent and temporary differences of approximately $85,000 and $462,000,respectively. At June 30, 2006, we had cumulative net operating losscarryforwards of approximately $14,129,000, which expire in years 2007 through2025. No effect has been shown in the consolidated financial statements for thenet operating loss carryforwards as the likelihood of future tax benefit fromsuch net operating loss carryforwards is not determinable at this time.Accordingly, the potential tax benefits of the net operating losscarryforwards, estimated based upon tax rates at June 30, 2006, have beenoffset by valuation reserves of the same amount.

*NetLoss per Share.  *The Company has presented basicand 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 not included in the computation of weighted average diluted sharesof common stock because the impact of these potentially dilutive securitieswere anti-dilutive were 2,349,650 and 1,858,347 shares for the three monthsended June 30, 2006 and 2005, respectively, and 2,303,555 and 1,903,001 sharesfor the nine months ended June 30, 2006 and 2005, respectively.

**Forward-LookingStatements**

Statements in thisquarterly report on Form 10-Q that are not historical facts (including anystatements concerning plans and objectives of management for future operationsor economic performance, or assumptions or forecasts related thereto) areforward-looking statements subject to Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934. Thesestatements can be identified by the use of forward-looking terminologyincluding “forecast,” “may,” “believe,” “expect,” “anticipate,” “estimate,” “continue”or other similar words. These statements discuss future expectations, containprojections of results of operations or of financial condition or state other “forward-looking”information. We and our representatives may from time to time make other oralor written statements that 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 Amendment No. 1 to our annual report on Form 10-K/A for theyear ended September 30, 2005 and filed with the SEC on February 15, 

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2006. We undertake no obligation to update anyforward-looking statements except as required by law.

**Item 3.****                          Quantitativeand Qualitative Disclosures 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.

**Item 4.****                          Controlsand Procedures**

As required byRule 13a-15(b) of the Securities Exchange Act of 1934, an evaluation wasperformed under the supervision and with the participation of our ChiefExecutive Officer and Chief Financial Officer of the effectiveness of thedesign and operation of our “disclosure controls and procedures” (as definedunder Rule 13a-15(e) and Rule 15d-15(e)) as of the end of the period covered bythis Quarterly Report on Form 10-Q filed with the SEC. Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective as of June 30, 2006.

There was no change inour internal control over financial reporting during our third quarter offiscal 2006 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**Part II—Other Information**

**Item 1.****                          LegalProceedings**

On February 17, 2006, PDTI closed a settlementagreement, entered into on February 8, 2006, related to certain litigationstyled Cause No. 2004-63506, *ParticleDrilling Technologies, Inc. vs. Harry B. Curlett, Curlett Family LimitedPartnership, Ltd., CCore Technology and Licensing, Ltd., and Deep Heat EnergyCorporation,* in the333rd Judicial District Court of Harris County,Texas.  As part of the settlementagreement, all parties released all claims against each other, and, on February21, 2006, the Court dismissed all claims among the parties with prejudice.  The Court’s dismissal became final on March24, 2006, thereby concluding the litigation.

Also as part of the settlement agreement, PDTI andCurlett Family Limited Partnership, Ltd. (“CFLP”) amended the Exclusive LicenseAgreement between PDTI’s predecessor, ProDril Acquisition Company, and CFLP,dated June 1, 2003, to limit the parties’ respective obligations to shareinformation with each other and to terminate as of February 18, 2006, theparties’ respective rights to the other party’s improvements to the PIDTechnology.  The settlement agreementprovided that the parties would integrate these amendments into an AmendedExclusive License Agreement by March 10, 2006.

During efforts to draft an Amended Exclusive LicenseAgreement reflecting the amendments made in the settlement agreement, CFLP tookthe position that PDTI has a greater obligation to share information with itthan provided in the amendments and that CFLP has greater rights in PDTI’simprovements than provided in the amendments. On March 20, 2006, PDTI and CFLP unsuccessfully mediated their disputeover these issues but nonetheless put in place a process through which theybelieved that they could resolve that dispute. Prior to the conclusion of that process, however, CFLP filed the lawsuitdescribed hereafter.

On March 24, 2006, CFLP filed Civil Action No.4:06-CV-01012, *Curlett Family Limited Partnership, Ltd. v.Particle Drilling Technologies, Inc., a Delaware Corporation, and ParticleDrilling Technologies, Inc., a Nevada Corporation*, in the UnitedStates District Court for the Southern District of Texas, HoustonDivision.  In that lawsuit, CFLPrequested the Court to construe the Exclusive License Agreement, as amended bythe settlement agreement, as imposing a greater obligation on PDTI to shareinformation with CFLP than PDTI believes exists and as giving CFLP greaterrights in PDTI’s improvements than PDTI believes exists.  In addition, CFLP claimed that PDTI breachedthe settlement agreement and exclusive license agreement and sought specificperformance of those agreements and lost profits damages of $26,000,000 permonth.

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On June 15, 2006, the Court granted a summary judgmentin favor PDTI and against CFLP thereby disposing of all of CFLP’s claimsagainst PDTI and granting PDTI declaratory relief as to the Exclusive LicenseAgreement, as amended by the settlement agreement.  Thereafter, PDTI requested that the Courtmake an award against CFLP for a part of PDTI’s attorneys’ fees and expensesincurred in the lawsuit.  On July 26,2006, the Court ordered that PDTI recover $26,525 in attorneys’ fees and $2,750in expenses from CFLP.

On July 26, 2006, the Court signed a Judgmentincorporating its orders on the summary judgment and attorneys’ feeissues.  Under the Judgment, (1) CFLPtakes nothing by its claims against PDTI, and PDTI recovers all taxable costsfrom CFLP; (2) after February 17, 2006, CFLP has no license rights to any ofPDTI’s improvements to the Licensed Patents under the Exclusive LicenseAgreement, as amended by the settlement agreement, without qualification as towhen PDTI made or acquired those improvements; (3) PDTI has no obligation toshare any information with CFLP or disclose any information to CFLP except forinformation in the public domain that it is otherwise obligated to provideunder the Exclusive License Agreement as amended by the settlement agreement;and (4) PDTI recovers from CFLP attorneys’ fees in the amount of $26,525 and expensesin the amount of $2,750 with interest thereon as provided by law and itstaxable costs.  CFLP has filed notice ofits intention to appeal the Court’s summary judgment against it to the UnitedStates Court of Appeals for the Fifth Circuit.

**Item 2.****                          UnregisteredSales of Equity Securities and Use of Proceeds**

On April 4, 2006, a holder of an outstanding warrantexercised its right to purchase 30,000 shares of our common stock at $0.12 pershare on a cashless exercise basis.  Thefair market value of our common stock on the date of exercise was $5.90.  As a result of this cashless exercise, weissued 29,390 shares of our common stock to the holder of this warrant andwithheld issuing 610 shares of our common stock in satisfaction of the exerciseprice under the warrant.

The shares of our common stock issued upon exercise ofthe warrant described above were issued in an exchange between us and ourexisting security holders in which no commission or other remuneration was paidor given directly or indirectly for soliciting such exchange.  As a result, the issuance of such shares ofcommon stock was exempt from registration pursuant to Section 3(a)(9) under theSecurities Act of 1933.

During the three months ended June 30, 2006, we madethe following repurchases of shares of our common stock:
| Period                      | ** ** | **Total   Number of   Shares   Purchased** | ** ** | **Average   Price   Paid per   Share** | ** ** | **Total Number of   Shares Purchased as  Part of Publicly   Announced Plans or  Programs** | ** ** | **Maximum Number   (or Approximate   Dollar Value) of   Shares that May   Yet Be Purchased   Under the Plans or  Programs** | ** ** |
|-----------------------------|------------|----------------------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                  | ** ** | ** **                                                     | ** ** | ** **                                                 | ** ** | ** **                                                                                                                                   | ** ** | ** **                                                                                                                                                                                                  | ** ** |
| April 1 to April  30, 2006  |       | —                                                         |       | —                                                     |       | —                                                                                                                                       |       | —                                                                                                                                                                                                      |       |
|                        |       |                                                           |       |                                                       |       |                                                                                                                                         |       |                                                                                                                                                                                                        |       |
| May 1 to May 31,  2006      |       | —                                                         |       | —                                                     |       | —                                                                                                                                       |       | —                                                                                                                                                                                                      |       |
|                        |       |                                                           |       |                                                       |       |                                                                                                                                         |       |                                                                                                                                                                                                        |       |
| June 1 to June  30, 2006(1) |       | 3,086                                                          |       | $                                                          | 3.83       |                                                                                                                                         | —     |                                                                                                                                                                                                        | —     |   |
|                        |       |                                                           |       |                                                       |       |                                                                                                                                         |       |                                                                                                                                                                                                        |       |
| Total                       |       | 3,086                                                          |       |                                                       |       | —                                                                                                                                       |       | —                                                                                                                                                                                                      |       |
|                             |            |                                                                |            |                                                            |            |                                                                                                                                              |            |                                                                                                                                                                                                             |            |  |

 

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(1)                                  Shareswere purchased from an officer of the Company to pay for taxes that arose as aresult of the partial vesting of previously issued shares of restricted stock.

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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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*                    Filed herewith

**             Furnished herewith

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                            | PARTICLE DRILLING TECHNOLOGIES, INC.                                                                                                |
|----------------------------|------------------------------------------------------------------------------------------------------------------------------------------|
|                       | (Registrant)                                                                                                                             |
|                       |                                                                                                                                     |
|                       |                                                                                                                                     |
| Date:  August 9, 2006 | /s/ J. CHRIS BOSWELL                                                                                                                     |   |
|                       | J. Chris Boswell                                                                                                                         |
|                       | Senior Vice President and Chief Financial Officer   (authorized officer, principal financial officer and   principal accounting officer) |

 

**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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*                    Filedherewith

**             Furnishedherewith

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