**UNITED STATES SECURITIES AND EXCHANGE**

**COMMISSION**

**Washington, D.C.20549**

**Form 10-K**

| **x**      |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d)** **OF THE SECURITIES  EXCHANGE ACT OF 1934**     |
|------------|--------|--------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                         |   |   |
| ** ** |   | **For the fiscal year ended September 30, 2006**                                                             |
|       |   |                                                                                                         |   |   |
| ** ** |   | **or**                                                                                                       |   |
|       |   |                                                                                                         |   |   |
| **o**      |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d)** **OF THE SECURITIES  EXCHANGE ACT OF 1934** |
| ** ** |   | ** **                                                                                                   |   | ** ** |
| ** ** |   | **For the transition period  from          to**            |
|            |        |                                                                                                              |  |  |  |

**Commission file number: 000-30819**

**Particle Drilling Technologies, Inc.**

(Exact name ofregistrant as specified in its charter)

 

| **Nevada**                                         |   | **20-1563395**                        |
|----------------------------------------------------|--------|---------------------------------------|
| (State of  incorporation)                          |   | (I.R.S. Employer  Identification No.) |
|                                               |   |                                  |
| **11757  Katy Freeway Suite 1300  Houston, Texas** |   | **77079**                             |
| (Address of  principal executive offices)          |   | (Zip Code)                            |

Registrant’s telephone number, including areacode:

**713-223-3031**

Securities registered Pursuant toSection 12(b) of the Act:

**None**

Securities registered Pursuant toSection 12(g) of the Act:

**Common Stock, par value $0.001 pershare**

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the SecuritiesAct.     Yes o No x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) of theAct.    Yes o No x

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports)and (2) has been subject to such filing requirements for the past90 days.     Yes x No o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, andwill not be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to thisForm 10-K.     o

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

| Large accelerated  filer  o |   | Acclerated  filer  x |   | Non-accelerated  filer  o |
|---------------------------------------|--------|--------------------------------|--------|-------------------------------------|

Indicate by check mark if the registrant is a shellcompany (as defined in Rule 12b-2 of theAct).     Yes o No x

The aggregate market value of the voting andnon-voting common equity held by non-affiliates of the registrant wasapproximately $94,679,780 as of March 31, 2006 (based on the last sale price ofsuch stock as quoted on the NASDAQ Capital Market).

As of December 6, 2006, there were30,093,200 shares of the registrant’s common stock, par value$0.001 per share, outstanding.

Documents incorporated by reference: None

 

 

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**TABLE OFCONTENTS**
|      | **PART I**                                                                                                           | 4      |
|-----------|----------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.   | Business                                                                                                             | 4      |
| Item 1A.  | Risk Factors                                                                                                         | 9      |
| Item 1B.  | Unresolved Staff Comments                                                                                            | 11     |
| Item 2.   | Properties                                                                                                           | 11     |
| Item  3.  | Legal  Proceedings                                                                                                   | 12     |
| Item 4.   | Submission of Matters to a Vote of Security Holders                                                                  | 12     |
|      |                                                                                                                 |   |
|      | **PART II**                                                                                                          | 12     |
| Item 5.   | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchasers  of Equity Securities | 13     |
| Item 6.   | Selected Financial Data                                                                                              | 14     |
| Item 7.   | Management’s Discussion and Analysis of Financial  Condition and Results of Operation                           | 15     |
| Item 7A.  | Quantitative and Qualitative Disclosures About Market  Risk                                                          | 20     |
| Item 8.   | Financial Statements and Supplementary Data                                                                          | 20     |
| Item 9.   | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                                | 40     |
| Item 9A.  | Controls and Procedures                                                                                              | 40     |
| Item  9B. | Other  Information                                                                                                   | 40     |
|      |                                                                                                                 |   |
|      | **PART III**                                                                                                         | 41     |
| Item 10.  | Directors, Executive Officers and Corporate Governance                                                               | 41     |
| Item 11.  | Executive Compensation                                                                                               | 45     |
| Item 12.  | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                      | 52     |
| Item 13.  | Certain Relationships and Related Transactions and  Director Independence                                            | 53     |
| Item 14.  | Principal Accounting Fees and Services                                                                               | 54     |
|      |                                                                                                                 |   |
|      | **PART IV**                                                                                                          | 54     |
| Item 15.  | Exhibits and Financial Statement Schedules                                                                           | 54     |

 

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*Unless thecontext otherwise requires, all references in this report to the “Company,” “we,”“us,” or “our” are to Particle Drilling Technologies, Inc. and its subsidiary.*

**PART I**

**Item 1.  Business**

**General**

ParticleDrilling Technologies, Inc., a Nevada corporation, is a holding companyorganized on June 14, 2002 and was formerly known as MedXLink Corp. Wechanged our name to Particle Drilling Technologies, Inc. onJanuary 25, 2005, following the merger on January 14, 2005 of ourwholly-owned subsidiary with and into Particle DrillingTechnologies, Inc., a Delaware corporation (“PDTI”).  Prior to our acquisition of PDTI, we were ashell company. Currently our business consists of one segment and is conductedsoley in the United States. Information about our net loss and total assets islocated under “Item 8. Financial Statements and Supplementary Data.”

PDTIwas formed in March 2004 for the purpose of raising capital and to acquireParticle Drilling, Inc., a Texas corporation. Particle Drilling, Inc.(formerly known as ProDril Acquisition Corp.) was formed in June 2003 forthe purpose of acquiring certain assets, patents and other intellectualproperty, and certain liabilities related to the Particle Impact Drillingtechnology, which we refer to as the “PID technology” or the “PID System.”Particle Drilling, Inc. was merged with and into PDTI in June 2004.

Thepatented PID System utilizes a specially-designed “fit for purpose” drill bitfitted with jetting nozzles and polycrystalline diamond compact cutting structures.We refer to this bit as the “PID bit.” The nozzles in the PID bit serve toaccelerate hardened steel particles entrained with ordinary drilling mud tofracture and remove the formation ahead of the bit. The particles flow back upthe wellbore annulus along with the drilling fluid and formation cuttings tothe surface where the PID System separates and re-circulates the particles. ThePID System is primarily operated utilizing hydraulic energy that is availableon drilling rigs used today in combination with the PID System equipment. Eachparticle is driven into the rock formation at a high velocity and delivers aforce many times greater than the compressional strength of the rock, even informations that exist in the subsurface at elevated hardness and stress.Depending on the volume of particles introduced into the drilling mud, thenumber of particle strikes on the formation is in excess of four million perminute, thereby yielding a higher rate of penetration than conventional drillbits in suitable formations.

Bycomparison, conventional drilling methods rely on mechanical energy created bythe weight and torque applied to a bit, and the amount of total rotationalmechanical energy available on drilling rigs is limited. The result is that thebit gouges out smaller volumes of rock as the compressional strength of therock increases with depth and pressure. We believe the volume of rock excavatedby the PID System is less affected by rock hardness or depth.

ThePID System is designed to entrain, circulate, and recover the particles in themud system without allowing the particles to circulate through the rig pumps.The PID System is designed as a mobile service that will be provided to the oiland gas operator as part of the normal drilling process and is configured toservice a well in progress with minimal interference. Currently, our particleinjection system consists of a stage one and stage two eductor mechanism whichis powered with a 2,200 horsepower quintiplex frac pump.  We have developed two prototype particleinjection systems which are currently being tested for commercialapplication.  While the current particleinjection system is proven and has allowed us to demonstrate the potential ofthe PID technology, it has been unreliable and requires a high level ofmaintenance. Both of the particle injection prototypes currently underdevelopment are significantly cheaper to purchase and to operate.  Further, we expect that the prototypeinjectors will require fewer personnel and can be procured from suppliersoutside the normal oilfield supply chain.  We are also continuing the development of our PID bit and developingalternate sized PID bits in order to further broaden our market opportunities.

ThePID System has demonstrated higher rates of penetration than currentconventional drilling methods. The rate of penetration gains generated by thePID System are expected to result in operators paying less variable drillingcosts (e.g., rig time, labor, fuel, bits, rentals), which are purchased as partof the ordinary drilling cycle. As a result, we believe the PID System canreduce drilling costs and lower finding costs, thus improving the overalleconomics to the oil and gas industry in certain geologic intervals.

**Business Strategy and Plan of Operation**

Webelieve the PID System development has continued to advance significantlyduring 2006, and following our most recent commercial trial in November 2006,is now ready for commercial applications. During the past fiscal year, we hired several industry veterans toassist in the development, commercialization and roll-out of thistechnology.  Further, we have

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successfullyresolved many of the surface equipment issues identified during previous trialsand expect to continuously improve efficiencies as we gain more experience withthe PID System and as we move away from the frac pump driven solution to one ofour prototype particle injection systems. Our operations plan for the remainder of fiscal year 2007 is expected toinclude: (1) completion of PID Unit #2 in the second quarter of fiscal2007; (2) secure additional commercial contracts with potential customers; (3)complete field testing of the prototype particle injection systems;(4) hiring and training additional field and technical personnel; and (5)assembly of additional PID Units.

Ourinitial target customers will continue to be oil and gas operators drillingonshore wells in geologic basins of the U.S. and Canada known to have hard rockand/or highly abrasive formations. We will initially focus our marketing andsales efforts on operators with multi-well drilling programs centered in a fewbasins. Additionally, we will target customers that exhibit a willingnessto embrace emerging technologies.

Weexpect to deliver value to our customers as a specialty service provider usingpatented technology and high quality engineering and field personnel. Based onthe experience of our management team in the oilfield services industry, webelieve that no other company currently attempts to deliver a comparabledrilling service utilizing technology that is similar to the PID System andthat is targeted to serve the hard rock drilling market. Instead, we believe suppliersgenerally design and sell products for hard rock environments that are based onconventional drilling technology.

Weexpect to operate in a fashion more comparable to a directional drilling orwell stimulation service provider in that we will provide our system and fieldpersonnel who will work with exploration and production operators, servicecompanies and drilling contractors to operate our system as an integralcomponent of the drilling operation.  Wewill offer our services on a gain sharing basis whereby the cost saved as aresult of using the PID System will be shared between us and the explorationand production operator. The PID System is expected to result in higher ratesof penetration, thereby reducing drilling costs and lowering finding anddevelopment costs to improve the overall economics of the oil and gas industryin certain geologic intervals. In addition, we believe that our customer’sability to reduce meaningful days on their hard rock intervals will translateinto more efficient rig utilization, which in turn should allow our customersto drill more wells per year per drilling rig. While this gain sharing business model is the preferred way to gainmarket share, we believe that equal or greater returns can be achieved througha more traditional dayrate or fixed fee structure. Initially, we intend toutilize the revenue model most preferred by our potential customer base so longas satisfactory returns are realized.

**Industry**

Oil and natural gas markets have seen a robust pricingenvironment since 2002, with some softening in world oil and U.S. natural gasprices during the second half of 2006. Although daily natural gas prices fell throughout September 2006 becauseof moderate temperatures and high inventories, the prices have recently risensharply.  As of November 10, 2006, theBaker Hughes U.S. land rig count was at 1,586, a 15% increase from a yearearlier.

We believe that continued economic growth, energydemand and the projected oil and gas commodity pricing environment will continueto be robust in 2007.  Drillingactivities in the oilfield service and supply sector are showing no signs ofdecreasing, despite a recent dip in hydrocarbon prices.  We believe that the capacity constrained U.S.land rig market will continue to enjoy robust pricing increases due to highdemand.  As a result, we believe NorthAmerican land drillers and related service providers will continue to benefitfrom the oil and gas demand, hydrocarbon price environment and economic growth.

*The Drilling Industry*— We do not believethe current conventional drilling process using traditional rotary rigequipment and conventional drill bits has fundamentally changed since the firstcommercial applications of the equipment by the Hughes Tool Company in the1920s. Although horizontal drilling and other innovations in the way thesedrilling systems are used have greatly increased well productivity, gains inrates of penetration and absolute drilling efficiency were limited until 1989.At that time, fixed cutter polycrystalline diamond compact bits, or “PDC bits,”became a functional alternative to roller cone bits for a limited but growingsegment of the drilling market. This technology was focused on wells drilled insofter formations as PDC bits could achieve higher rates of penetration andlonger run times, both of which achieved appreciable cost savings by reducingdrilling time. The industry has adopted PDC bits for these specificapplications, although a PDC bit can cost several times more than a comparableroller cone bit.  Despite the increasedeffectiveness of the PDC bit and other technologies, we believe that operatorsand drilling engineers continue to actively seek ways to improve rates ofpenetration, particularly in hard rock and abrasive formations, and are veryreceptive to using promising new technologies to reduce well construction cost.

**ThePID System**

*Particle Recovery System*— The PID Systemutilizes a mobile particle delivery and recovery system capable of operatingwith conventional drilling rigs used in our target markets. Our system isdesigned to entrain, circulate, and recover the

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particles withoutallowing the material to pass through the rig pumps. Previous particle abrasivedrilling systems did not have the ability to circulate, separate, and re-injectthe abrasive or abrading particles and the material passed through the normalrig pumps. An example is the system known as “Abrasive-Jet Drilling” used byGulf Research and Development Co., a division of Gulf Oil Corporation (“Gulf”),in the 1960’s and 1970’s. Gulf made a number of significant advances in thetechnology of delivering particles under pressure for the purpose of increasingrate of penetration.  Basically, the Gulfsystem used fine particle abrasives to abrade the formations in order to removeit. This technology requires very high surface pressures of up to 11,000 psi inorder to give the small particle the velocity to abrade the formation ahead ofthe drill bit.  The PID System utilizeslarger particles at normal rig pressures to fracture the formation ahead of thedrill bit.

*Rig Integration*— The PID System isdesigned to connect to and service an operational well in progress with minimalinterference to normal drilling operations. All PID System equipment is eithermounted on trucks or trailers, and can be substantially installed on a rigduring a scheduled bit trip. A good portion of the PID System is mobilized andrigged up offline so as not to interfere with the drilling operation inprogress. Once the operator is finished with the PID System, it can generallybe taken offline in one to two hours and demobilized with no furtherinterference with the drilling operation. We believe this operationaltransparency is extremely important for industry acceptance of the PID System.

*PID Bit*— We are continuing thedevelopment of our fit-for-purpose PID bit. The PID bit is a fixed-cutter bitdesigned with a PDC cutting structure. To date we have developed and tested a 7 7/8 inch PID bit and a 8 1⁄2 inchPID bit and have now completed the investment casting process on our 7 7/8 inchPID bit so that we can mass produce that size PID bit at a cost that is justless than half the cost of the prototypical PID bit.  Further, we are planning to design, test anditerate a smaller 6 1⁄2 inch PID bit in order to address a market identified by prospectivecustomers.

**RecentTesting of the PID System**

InJuly 2005, we completed a two week test program at the Gas TechnologyInstitute’s Catoosa test drilling facility (“Catoosa”) near Tulsa,Oklahoma.  At Catoosa, we were able toadapt the PID System to an actual drilling rig, run the system under fulloperating conditions and further test and refine procedures and processes foroperating the PID System.  During thistest sequence, we observed drilling penetration rates at or above expectedrates through very hard limestone intervals as well as through softersandstones and shale formations.  We alsoidentified areas for improvement including the shot injector system,maintenance of desired mud properties and system procedures to improveconnection time, shot handling at surface and some test site improvementsrelated to the test well surface casing and rig flow line.  Modifications and improvements were made inorder to continue testing and to log more hours on the PID system at Catoosa inOctober and November 2005.

InNovember 2005, we completed another three weeks of testing at Catoosa and wereable to log more continuous hours on the PID System under various operatingconditions.  The various operatingconditions tested included two PID bit designs; two PID bit sizes; both low andhigh flow rates of drilling fluid ranging from 425 to over 600 GPM, anddifferent shot injection rates.  Allconditions tested were effective at delivering target level rates ofpenetration through very hard and abrasive intervals.  We also developed and tested procedures foritems that did not perform satisfactorily in our prior tests at Catoosa in July2005, including enhancing the shot injection system, reducing the connectiontime and developing improvements in the handling of shot in the wellbore and atthe surface.  The shot injection systemwas improved, and it functioned and performed reliably during this test.

In May2006, we completed our first field trial on a commercial well with GascoEnergy, Inc. This was the first opportunity to run the patented PID System onan actual gas well at depths below 10,000 feet. During this test, we demonstrated that the PID System was capable ofdelivering rates of penetration that were in-line with or greater than ourtarget penetration rate (which is three times faster than conventional drillingtechniques), that we could inject particles while drilling and that we couldsuccessfully recover steel particles from the well bore.   Due to the age and condition of thisparticular drilling rig, we experienced certain rig integration issues whichwere resolved prior to the completion of the first trial; however, while dealingwith many of these rig integration issues, we learned that the steel particlescan be successfully recovered from the well bore even following a complete rigpump shut down.  This was previoiusly aconcern for many of our potential customers and we demonstrated on multipleoccasions during the first field trial that the PID process does notnecessarily damage the wellbore even in situtions where several thousand poundsof steel particles settle on top of the PID bit.

Inorder to achieve continuous PID drilling operations, it is critical tocontinuously inject and recover the injected particles from the well bore,process them and prepare them for reinjection. During the first field trial, the PID System particle recovery unitbecame overrun with steel particles and was no longer capable of recovering theparticles for re-injection and accounted for 90% of the PID System’sdowntime.  Based on this experience andthe likelihood for this particle recovery unit to cause problems on futurewells, we designed a completely new particle recovery unit that was tested inour research facility and then deployed on all subsequent trials.

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The new recoveryunit is now proven and reliable and will be incorporated into all future PIDUnits.

Wewere forced to suspend our commercial field trial attempt in September 2006 dueto the failure of the transmission on our frac pump which is currently used toinject particles into the drilling rig standpipe.  Once our ability to inject particles wasterminated, we were no longer able to continue drilling with the PID System andtherefore our commercial trial was concluded.

InNovember 2006, we completed our second commercial trial with Gasco on a well inNortheastern Utah in the Uinta Basin.  On this trial, we entered the well at a depth of 11,535 feet and drilledapproximately 92 feet in 7 hours during the first day of drilling.  Certain issues with our frac pump driveninjector system limited our drilling performance on the second day and thetrial was concluded after drilling a total of 118 feet.  The subsequent conventional bit averaged 90feet in each 24-hour period during the following five days. With thisexperience behind us, we will look to expand the footage drilled on the nextopportunity with the expectation of saving our customer drilling hours.

Thefrac pump driven injector system works well as long as the frac pump is able todeliver the needed pressure.  The fracpump suffered a high degree of performance related issues on each of the twomost recent commercial trials causing a complete suspension on one test andundesirable downtime on the second test. Specifically, on the most recent trial, the lubrication system for thepump became clogged causing the seals to burn up prematurely.  A different type of lubrication system hasnow been installed on this frac pump which should prevent this issue from re-occuring.

Ourprimary products still need to demonstrate improved reliability in thecommercial market in order to fully realize the potential of the PIDtechnology. Our operations plan calls for further research and development,including the development of different bit sizes and a newer and more efficientand reliable injector systems. Poor performance of our prototype particleinjection systems or other unexpected events while conducting future commercialtrials could further extend the shop and laboratory testing phase, which woulddelay the full commercialization of the PID System and increase the fundsneeded to complete our research and development. This would have the effect ofslowing our advancement as funds otherwise intended to build new PID Systemsand expand our operations may be needed to conduct additional research anddevelopment.

**Competition**

Basedon the experience of our management team in the oilfield services industry andthe exploration and production industry, we believe that no other companycurrently attempts to deliver a comparable drilling service utilizingtechnology that is similar to the PID System and that is targeted to serve thehard rock drilling market.  The oilfieldservices industry in which we compete, however, is highly competitive, and mostof our potential competitors have greater financial resources than we do. Manyof our potential competitors have been in the oilfield service business formany years and have well-established business contacts with exploration andproduction companies. Competitors may enter markets served or proposed to beserved by us, and we may not be able to compete successfully against suchcompanies or have adequate funds to compete effectively.  Recent developments in PDC bits have madethem more durable and capable of drilling in certain hard rock environments;however, many customers operating in our target markets continue to utilizeconvential bits.

**Patents**

Ourpredecessor company acquired the intellectual property and certain assets andassumed certain liabilities underlying the PID technology in January 2004pursuant to certain acquisition agreements in which we agreed to(1) purchase certain of the assets and assume certain of the liabilitiesof ProDril Services Inc. (“PSI”) and ProDril Services International, Ltd. (“PSIL”)related to the PID technology, (2) purchase certain patents related to thePID technology from Curlett Family Limited Partnership, Ltd. (“CFLP”),(3) acquire certain technology licenses from CCORE Technology andLicensing, Ltd. (“CTL”), (4) continue the funding of initial research anddevelopment expenses with respect to the technology acquired, and (5) takesteps towards the commercialization of the PID technology.

Pursuantto such acquisition agreements with CFLP, we acquired from CFLP their entireright, title and interest throughout the world in and to patents related to thePID technology, including all CFLP inventions and the following patents:

·      U.S. Patent No. 6,386,300, issuedMay 14, 2002, entitled “Formation cutting method and system.”

·      U.S. Patent No. 6,581,700, issuedJune 24, 2003, entitled “Formation cutting method and system.”

 

Inaddition to the inventions embodied in the CFLP patents described above, wealso acquired from CFLP, among other things, other patent applications that arepending and certain proprietary know-how pertaining specifically to the PID

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technology.

Thepatent assignment from CFLP is subject to an exclusive license to CFLP to makeand sell or otherwise commercially exploit, for non-oil and gas industryapplications, products developed by CFLP that embody the patents or inventionsassigned to us by CFLP, or our improvements thereto.

In connection with our acquisition of the PID technology, weagreed to make certain royalty payments to PSI and PSIL.  Under our agreement with PSI, we areobligated to pay PSI a royalty on a quarterly basis equal to 18.0% of ourearnings before interest, income taxes, depreciation and amortization (“EBITDA”)derived from the use of the PID technology for such quarter until an aggregateof $67,500,000 has been paid to PSI. Under our agreement with PSIL, we are obligated to pay PSIL a royalty ona quarterly basis equal to 2.0% of our EBITDA derived from the use of the PIDtechnology for such quarter until an aggregate of $7,500,000 has beenpaid.  We have also entered intoadditional royalty agreements that require us to pay a total of 4.0% of ourquarterly gross revenue derived from the use of the PID technology to certainentities from which we acquired the PID technology.  These royalty obligations will have theeffect of limiting our liquidity and our profitability.  As of September 30, 2006, no payments hadbeen made with respect to these royalty obligations.

Wehave continued to enhance and improve upon the PID technology and to developadditional technology and know-how in the application of the PIDtechnology.  The PID technology andrelated technologies remain core to our business, and we have continued to seekpatent protection in the United States and other countries in which we expectthere to be a significant market for application of our technology.

**Researchand Development**

We arein the early phase of commercial deployment and will continue to invest inresearch and development.  Our researchand development program is intended to improve existing products and processes,develop new products and processes, and improve engineering standards andpractices that will serve the changing needs of our customers.  Our expenditures for research and developmentactivities were $5,964,438 in 2006, $2,802,155 in 2005, and $621,752 in 2004.

In our effort to enhance the PID technology, wecontinue to seek less expensive and more efficient ways to inject the steelparticles into the drilling rig standpipe. We have developed two prototype systems to accomplish thisobjective.  Both of these systems arestill in the developmental phase and have yet to be fully tested or used in thefield.  The first system is a canisterstyle injector that consists of a series of steel canisters with fill valvesand dump valves which work in unison to deliver a fixed volume of steelparticles into the drilling mud.  Thesecond system is an extruder design which essentially pushes or forces thesteel particles into the drilling mud through a specially designed metalextrusion mechanism which is procured from one of many manufacturers and islargely an “off the shelf” item.  Both ofthese systems have the potential to significantly reduce the capital cost ofthe PID System improving reliability, while simplifying the injection processand reducing the daily operating cost.

**EnvironmentalRegulations**

We aresubject to numerous and changing local, state, and federal laws and regulationsconcerning the use, storage, treatment, disposal and general handling ofmaterials, some of which may be considered to be hazardous substances andwastes, and restrictions concerning the release of pollutants and contaminantsinto the environment. These laws and regulations may require us to obtain andmaintain certain permits and other authorizations mandating procedures underwhich we must operate and restrict emissions and discharges. Many of these lawsand regulations provide for strict joint and several liabilities for the costsof cleaning up contamination resulting from releases of regulated materials,substances and wastes into the environment. Violation of these laws andregulations as well as terms and conditions of operating permits issued to usmay result in the imposition of administrative, civil, and criminal penaltiesand fines, remedial actions or, in more serious situations, shutdowns orrevocation of permits or authorizations. We believe that future compliance byour operating businesses with existing laws and regulations will not have amaterial adverse effect on us and that future capital expenditures forenvironmental remediation will not be material.

Weregularly monitor and review our operations, procedures and policies forcompliance with environmental laws and regulations and our operating permits. Therecan be no assurance that a review of our past, present or future operations bycourts or federal, state, local or foreign regulatory authorities will notresult in determinations that could have a material adverse effect on us.  In addition, the revocation of any of ourmaterial operating permits, the denial of any material permit application orthe failure to renew any interim permit, could have a material adverse effecton us. In addition, compliance with more stringent environmental laws and regulations,more vigorous enforcement policies, or stricter interpretations of current lawsand regulations, or the occurrence of an industrial accident, could have amaterial adverse effect us.

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**Employees**

As of December 14, 2006, we had 18 employees.  None of our employees are covered bycollective bargaining agreements.  Webelieve that relationships with our employees are satisfactory.

**Website**

Ourwebsite is located at www.particledrilling.com. The filings we make with the Securities and Exchange Commission (“SEC”),such as Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K, and amendments to those reports, are availablefree of charge through our website as soon as reasonably practicable after theyhave been filed with or furnished to the SEC pursuant to Section 13(a) or 15(d)of the Securities and Exchange Act of 1934 (the “1934 Act”).  Forms 3, 4and 5 filed with respect to equity securities under Section 16(a) of the1934 Act are also available on the website.  All of these materials arelocated at the “Investor Relations” link.

Ourwebsite also includes the following corporate governance materials, at the link“Corporate Governance:” the Code of Business Conduct & Ethics, and chartersof each Board committee, including the Audit Committee, the CompensationCommittee, and the Nominating and Corporate Governance Committee. You may alsoobtain a printed copy of any of the materials referenced above by contacting usthrough the website or at the following address: Particle DrillingTechnologies, Inc., 11757 Katy Freeway, Suite 1300, Houston, Texas 77079.

**Item1A.  Risk Factors**

***We have a limited operating history and no revenues and are subject torisks inherent in a new business enterprise. As a result, we have not demonstratedto date that we can fully implement our business plan or that the PIDtechnology will be profitable in a commercial application.***

The business of PDTI was originally established in June 2003to: (1) purchase certain of the assets and assume certain of the liabilities ofPSI and PSIL, related to the PID technology; (2) purchase certain patentsunderlying the PID technology from CFLP; (3) acquire certain technologylicenses related to the PID technology from CTL; (4) continue the funding ofresearch and development expenses with respect to the technology acquired; and(5) take steps towards the commercialization of the PID technology.  To date, the business has not generatedrevenue from its operations.  We may notbe able to fully commercialize our product or generate profitablerevenues.  Additionally, we and ourbusiness have a very limited operating history that investors can analyze toaid them in making an informed judgment as to the merits of an investment in us.  Any investment in us should be considered ahigh risk investment because you will be investing in a company with unforeseencosts, expenses, competition, and other problems to which new ventures areoften subject. In addition, the technology we acquired is still in the earlystage of commercialization and has only limited results in a commercialsetting.  Because we are an early stagecompany, our prospects must be considered in light of the risks, expenses, anddifficulties encountered in establishing a new business in a highly competitiveindustry.

***We have limited sources of liquidity and may not be able to obtainsufficient funding to realize positive cash flows***.

We require substantial capital to pursue our operatingstrategy and execute our business plan. As we have no revenue and therefore limited sources of cash, we willcontinue to rely on external sources for liquidity, and for the foreseeablefuture, our principal source of working capital will be from capital we haveraised through private placements of our securities and other external sources.

Our current monthly operating overhead is approximately$400,000, excluding research and development project costs and non-cashexpenses such as depreciation and stock-based compensation, and we expect thatsuch amount will increase as we expand our operations.  Should we require additional capital, we maynot be able to obtain funds from external sources in sufficient amounts to fundour business plan.

Even if we are able to demonstrate full commercial successwith our products, we may require additional capital in the future to produceour products in sufficient commercial quantities in order for us to realizepositive cash flows.  Any such additionalcapital may lead to additional dilution of our shareholders.  Additionally, it may be difficult for us toraise additional capital in sufficient quantities or at all.

***The PID System is a new technology and it may not be fully accepted inthe marketplace to the degree anticipated by management.***

The PID technology has only been used or deployed in limitedcommercial gas wells.  Market acceptanceof our products will largely depend upon our ability to demonstrate the PIDSystem’s efficiency, cost effectiveness, safety features and ease of use.  We may not be able to demonstrate that thePID System can effectively be deployed on a significant number of

9

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commercial oil and gas wells in a safe and cost-effective manner.  The use of the PID technology will alsodepend upon concerted sales efforts by our management team.  The PID System may never be fully accepted inthe market in preference to other competing technologies that currently existor that may subsequently be developed. If our products are not fully accepted by the marketplace, we may notrealize sufficient revenues or cash flow to execute our operations plan and wemay be forced to pursue a different strategy or liquidate our company.

In order to enter the oilfield services market on a fullscale basis, we must successfully complete additional research and development,the cost of which may exceed the amounts we have budgeted in our operationsplan.  Any such cost overruns couldexhaust our available capital and force us to raise additional capital, whichcapital may not be available or may lead to additional dilution of ourshareholders.

Our primary products must demonstrate satisfactoryperformance in a significant number of oil and gas wells.  Our operations plan calls for furtherresearch and development, including the development of different bit sizes anda newer and more efficient and reliable particle injection system.  Poor performance of the PID bit or othercomponents of the PID System while conducting commercial trials could revealadditional unidentified issues and further extend the shop and laboratorytesting phase, which could further delay the full commercialization of the PIDSystem and increase the funds needed to complete our research anddevelopment.  Further, in order to fullyimplement our business plan we will be required to hire and train a substantialnumber of new employees.  Currently, theoilfield industry is strained and operating at near full capacity from a humanresource perspective, which could limit our ability to hire and train adequatequalified personnel.  These circumstanceswould have the effect of slowing our advancement as funds otherwise intended tobuild new PID Systems and expand our operations may be needed to conductadditional research or procure and train adequate human resources.

Regardless of the success of the initial research anddevelopment, we will require additional research and development and capitalspending to continuously improve our service capabilities and expand ouroperations.  In addition, regardless ofthe amount of research and development completed by us, our products may neverbe fully adopted in a significant number of oil and gas wells.

***We are obligated to make certain royalty payments that will limit ourprofitability.***

In connection with our acquisition of the PID technology, weagreed to make certain royalty payments to PSI and PSIL.  Under our agreement with PSI, we areobligated to pay PSI a royalty on a quarterly basis equal to 18.0% of ourearnings before interest, income taxes, depreciation and amortization (“EBITDA”)derived from the use of the PID technology for such quarter until an aggregateof $67,500,000 has been paid to PSI. Under our agreement with PSIL, we are obligated to pay PSIL a royalty ona quarterly basis equal to 2.0% of our EBITDA derived from the use of the PIDtechnology for such quarter until an aggregate of $7,500,000 has beenpaid.  We have also entered intoadditional royalty agreements that require us to pay a total of 4.0% of ourquarterly gross revenue derived from the use of the PID technology to certainentities from which we acquired the PID technology.  These royalty obligations will have theeffect of limiting our liquidity and our profitability.

***We rely on the intellectual property rights we acquired to the PIDtechnology and we may not be able to successfully protect or defend our intellectualproperty rights. Our competitive position depends to a significant extent onour ability to assert and defend our intellectual property rights in order torestrict other competitors from offering similar services.***

Our success depends on certain patents and patentapplications that we purchased from CFLP, CTL, PSI and PSIL, along with otherproprietary intellectual property rights we have developed or intend todevelop.  We rely on a combination ofnondisclosure and other contractual arrangements and trade secret, patent,copyright, and trademark laws to protect our proprietary rights and theproprietary rights of third parties from whom we license intellectualproperty.  The steps we have taken toprotect our rights may not be adequate to deter misappropriation of ourproprietary information.  We also may notbe able to detect unauthorized use of and take appropriate steps to enforce ourintellectual property rights.  In addition,the laws of some foreign countries may not protect our proprietary rights asfully or in the same manner as do the laws of the United States.  Also, despite the steps taken by us toprotect our proprietary rights, others may develop technologies similar orsuperior to the PID technology and/or design around the proprietary rights weown.

We are also subject to the risk of litigation alleginginfringement of third-party intellectual property rights.  Any such claims could require us to spendsignificant sums in litigation, pay damages, develop non-infringingintellectual property or acquire licenses to the intellectual property which isthe subject of the asserted infringement. If we are unable to successfully enforce our intellectual propertyrights, or if claims are successfully brought against us for infringing theintellectual property rights of others, such events could cause us to paysubstantial damages, cause us to lose a key competitive advantage, force us toconduct additional research to develop non-infringing technology or cause us tohave to pursue a different business

10

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strategy.

***We may face intense competition in our industry from companies with amore established reputation and greater financial resources than us.***

The oilfield services industry in which we compete is highlycompetitive, and most of our potential competitors have greater financialresources than we do.  Many of ourpotential competitors have been in the oilfield drilling business for manyyears and have well-established business contacts with exploration andproduction companies.  Competitors mayenter markets served or proposed to be served by us, and we may not be able tocompete successfully against such companies or have adequate funds to competeeffectively.

***Our stockholders may experience substantial dilution as a result of theexercise of outstanding options and warrants to purchase our common stock orfuture issuances of additional shares of our common stock, any of which couldhave an adverse effect on the market price of our common stock.***

In connection with our acquisition of our subsidiary,Particle Drilling Technologies, Inc., a Delaware corporation, we assumedwarrants to purchase 119,141 shares of common stock and options issued underPDTI’s 2004 Incentive Stock Plan to purchase 3,104,000 shares of commonstock.  In connection with the privateplacement of our common stock in February 2005, we granted the placement agentwarrants to purchase 1,500,000 shares of our common stock, of which 1,140,000are still outstanding.  In connectionwith the private placement of our common stock in October 2006, we granted theinvestors warrants to purchase 1,500,000 shares of our common stock.  Since our acquisition of PDTI, we have issuedoptions to purchase an additional 1,310,250 shares of our common stock.  The common stock issuable upon exercise ofthese options and warrants represents approximately 24% of our outstandingshares of common stock on a fully-diluted basis.  The exercise of these options and warrantswould result in substantial dilution to our existing stockholders and any salesof these shares of common stock, or the perception that these sales mightoccur, could lower the market price of our common stock.

We may also issue additional shares of our common stock orother securities that are convertible into or exercisable for common stock inconnection with the hiring of personnel, future acquisitions, future publicofferings or private placements of our securities for capital raising purposes,or for other business purposes.  Futuresales of substantial amounts of our common stock, or the perception that salescould occur, could have a material adverse effect on the market price of ourcommon stock.

***Our common stock has experienced, and may continue to experience, pricevolatility.  The limited trading volumeof our common stock may contribute to this price volatility.***

The trading price of our common stock has been, and maycontinue to be, highly volatile.  Webelieve this volatility is due to, among other things, our lack of revenues,current expectations of our future financial performance and the volatility ofthe stock market in general.

Moreover, our common stock, which began trading on TheNASDAQ Capital Market® on June 28,2005, does not have substantial trading volume. During the year ended September 30, 2006, the average daily tradingvolume of our common stock as reported by The NASDAQ Capital Market® wasapproximately 122,000 shares, which represents less than 1% of our outstandingshares of common stock.  As a result,relatively small trades of our common stock may have a significant impact onthe price of our common stock and, therefore, may contribute to the pricevolatility of our common stock.

Because of the limited trading volume in our common stockand the price volatility of our common stock, you may be unable to sell yourshares of common stock when you desire or at the price you desire.  Moreover, the inability to sell your sharesin a declining market because of such illiquidity or at a price you desire maysubstantially increase your risk of loss.

***We presently do not intend to pay cash dividends on our common stock.***

We currently anticipate that no cash dividends will be paidon our common stock in the foreseeable future. While our dividend policy will be based on the operating results andcapital needs of the business, we anticipate that all earnings, if any, will beretained to finance the future expansion of our company.

**Item1B.  Unresolved Staff Comments**

NoneApplicable

**Item2.  Properties**

Ourprincipal executive and administrative office facility is leased in Houston,Texas at 11757 Katy Freeway, Houston,

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Texas 77079. Wealso lease an 11,000 square foot operating facility at 7407 Wright Road,Houston, Texas 77041.

Webelieve that our properties are generally in good condition, are wellmaintained, and are generally suitable and adequate to conduct our business.

**Item3.  Legal Proceedings**

OnFebruary 17, 2006, PDTI closed a settlement agreement, entered into on February8, 2006, related to certain litigation styled Cause No. 2004-63506, *Particle Drilling Technologies, Inc. vs. Harry B.Curlett, Curlett Family Limited Partnership, Ltd., CCore Technology andLicensing, Ltd., and Deep Heat Energy Corporation,* in the 333rd 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.

Alsoas part of the settlement agreement, PDTI and Curlett Family LimitedPartnership, Ltd. (“CFLP”) amended the Exclusive License Agreement between PDTI’spredecessor, ProDril Acquisition Company, and CFLP, dated June 1, 2003, tolimit the parties’ respective obligations to share information with each otherand to terminate as of February 18, 2006, the parties’ respective rights to theother party’s improvements to the PID Technology.  The settlement agreement provided that theparties would integrate these amendments into an Amended Exclusive LicenseAgreement by March 10, 2006.

Duringefforts to draft an Amended Exclusive License Agreement reflecting theamendments made in the settlement agreement, CFLP took the position that PDTIhas a greater obligation to share information with it than provided in theamendments and that CFLP has greater rights in PDTI’s improvements thanprovided in the amendments.  On March 20,2006, PDTI and CFLP unsuccessfully mediated their dispute over these issues butnonetheless put in place a process through which they believed that they couldresolve that dispute.  Prior to theconclusion of that process, however, CFLP filed the lawsuit describedhereafter.

OnMarch 24, 2006, CFLP filed Civil Action No. 4:06-CV-01012, Curlett FamilyLimited Partnership, Ltd. v. Particle Drilling Technologies, Inc., a DelawareCorporation, and Particle Drilling Technologies, Inc., a Nevada Corporation, inthe United States 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 per month.

OnJune 15, 2006, the Court granted a summary judgment in favor PDTI and againstCFLP thereby disposing of all of CFLP’s claims against PDTI and granting PDTIdeclaratory relief as to the Exclusive License Agreement, as amended by thesettlement agreement.  Thereafter, PDTIrequested that the Court make an award against CFLP for a part of PDTI’sattorneys’ fees and expenses incurred in the lawsuit.  On July 26, 2006, the Court ordered that PDTIrecover $26,525 in attorneys’ fees and $2,750 in expenses from CFLP.

OnJuly 26, 2006, the Court signed a Judgment incorporating its orders on thesummary judgment and attorneys’ fee issues. Under the Judgment, (1) CFLP takes nothing by its claims against PDTI,and PDTI recovers all taxable costs from CFLP; (2) after February 17, 2006,CFLP has no license rights to any of PDTI’s improvements to the LicensedPatents under the Exclusive License Agreement, as amended by the settlementagreement, without qualification as to when PDTI made or acquired thoseimprovements; (3) PDTI has no obligation to share any information with CFLP ordisclose any information to CFLP except for information in the public domainthat it is otherwise obligated to provide under the Exclusive License Agreementas amended by the settlement agreement; and (4) PDTI recovers from CFLPattorneys’ fees in the amount of $26,525 and expenses in the amount of $2,750with interest thereon as provided by law and its taxable costs.  CFLP has filed notice of its intention toappeal the Court’s summary judgment against it to the United States Court ofAppeals for the Fifth Circuit.

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

Nomatters were submitted during the fourth quarter of 2006 to a vote of theholders of our common stock, through the solicitation of proxies or otherwise.

 

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**PART II**

**Item 5.  Market for Registrant’s Common Equity,Related Stockholder Matters and Issuer Purchases of Equity Securities**

**MarketInformation**

Ourcommon stock trades on the NASDAQ Capital Market under the symbol PDRT.  Prior to June 28, 2005, shares of ourcommon stock were traded on the OTC Bulletin Board.  The following table sets forth the high andlow bid prices per share of our common stock for the fiscal years endedSeptember 30, 2006 and 2005.  All pricesquoted from the time when our common stock was traded on the OTC Bulletin Boardreflect inter-dealer prices, without retail mark-up, mark-down or commissionand may not necessarily represent actual transactions.

|                | ** ** | **High**                                                    | ** ** | **Low**                                                     | ** ** |
|----------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| **2005**       |       |                                                        |       |                                                        |       |
| First Quarter  |       | $         3.57 |       | $         3.39 |       |
| Second Quarter |       | $         6.09 |       | $         5.69 |       |
| Third Quarter  |       | $         6.15 |       | $         5.91 |       |
| Fourth Quarter |       | $         6.00 |       | $         3.25 |       |
|           |       |                                                        |       |                                                        |       |
| **2006**       |       |                                                        |       |                                                        |       |
| First Quarter  |       | $         6.03 |       | $         3.58 |       |
| Second Quarter |       | $         7.50 |       | $         4.42 |       |
| Third Quarter  |       | $         6.22 |       | $         2.93 |       |
| Fourth Quarter |       | $         3.94 |       | $         2.50 |       |

 

**Holders**

Theapproximate number of holders of record of the shares of our common stock was266 as of December 6, 2006.

**Dividends**

Holdersof shares of common stock will be entitled to receive cash dividends when, asand if declared by our Board of Directors, out of funds legally available forpayment thereof. However, if dividends are not declared by our Board ofDirectors, no dividends shall be paid. We have not paid any dividends on ourcommon stock during our two most recent fiscal years.

We donot anticipate that any cash dividends will be paid in the foreseeable future.While our dividend policy will be based on the operating results and capitalneeds of the business, we anticipate that all earnings, if any, will beretained to finance our future expansion. Therefore, prospective investors whoanticipate the need for immediate income by way of cash dividends from theirinvestment should not purchase our securities.

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

The followingtable summarizes as of September 30, 2006, certain information regarding equitycompensation to our employees, officers, directors and other persons under ourequity compensation plans:

 
| **Plan category**                                       | ** ** | **Number of securities**

**to be issued upon**

**exercise of**

**outstanding options,**

**warrants and rights** | ** ** | **Weighted-average**

**exercise**

**price of**

**outstanding**

**options,**

**warrants and rights**                                           | ** ** | **Number of securities**

**remaining available for**

**future issuance under**

**equity compensation**

**plans (excluding**

**securities reflected in**

**column (a))** | ** ** |
|--------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **(a)**                                                                                                                                                          | ** ** | **(b)**                                                                                                                                                           | ** ** | **(c)**                                                                                                                                                                                                                              | ** ** |   |
| Equity compensation  plans approved by security holders      |       | —                                                                                                                                                           |       | —                                                                                                                                                            |       | —                                                                                                                                                                                                                               |       |   |
| Equity compensation  plans not approved by security holders* |       | 5,532,121                                                                                                                                                        |       | $                          1.72 |       | 599,250                                                                                                                                                                                                                              |       |   |
|                                                         |       |                                                                                                                                                             |       |                                                                                                                                                              |       |                                                                                                                                                                                                                                 |       |   |
| Total                                                        |       | 5,532,121                                                                                                                                                        |       | $                          1.72 |       | 599,250                                                                                                                                                                                                                              |       |   |
|                                                              |            |                                                                                                                                                                  |            |                                                                                                                                                                   |            |                                                                                                                                                                                                                                      |            |  |  |  |  |  |  |  |  |

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*                    Thefollowing equity compensation plans have not been approved by security holders:

·    In April 2004, the Board of Directors ofParticle Drilling, Inc. approved and adopted the 2004 Stock Plan.  The stockholders of PDTI adopted this plan inAugust 2004.  This plan provides for theissuance of incentive stock

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options,non-statutory stock options and restricted stock grants to our directors,employees and consultants.  This planprovides for the issuance of options and restricted stock awards to purchase orissue up to 3,500,000 shares of common stock. Awards may be granted at not less than the fair market value (as definedin this plan) on the date such awards are granted.  The options expire ten years from the dategranted unless otherwise specified in the award agreement.

·    In March 2005, our Board of Directorsapproved and adopted the Particle Drilling Technologies, Inc. 2005 StockIncentive Plan.  This plan provides forthe issuance of incentive stock options, non-statutory stock options andrestricted stock grants to our directors, employees and consultants.  This plan provides for the issuance ofoptions and restricted stock awards to purchase or issue up to 2,000,000 sharesof common stock.  Awards may be grantedat not less than the fair market value (as defined in this plan) on the datethe awards are granted.  The optionsexpire ten years after date of grant unless otherwise specified in the awardagreement.

·    On April 30, 2004, Particle Drilling, Inc.granted warrants to ten consultants as consideration for services provided toParticle Drilling, Inc.  Pursuant tothese warrants, the ten consultants have the right to purchase up to anaggregate of 58,000 shares of common stock of Particle Drilling, Inc.(consisting of warrants to purchase 25,000 shares, 6,000 shares, 6,000 shares,5,000 shares, 5,000 shares, 5,000 shares, and 2,000 shares).  On June 17, 2004, Particle Drilling, Inc.granted warrants to an additional consultant for services provided to ParticleDrilling, Inc., pursuant to which such consultant has the right to purchase upto 10,000 shares of common stock of Particle Drilling, Inc.  The warrants described in this paragraph havean exercise price of $0.12 and a maximum term of five years from the dategranted.  All of these warrants wereconverted into warrants to purchase common stock of PDTI in connection with themerger of Particle Drilling, Inc. into PDTI, and were then assumed by ourcompany in connection with our acquisition of PDTI.

·    On November 1, 2004, PDTI granted warrantsto two consultants as consideration for services provided to PDTI, pursuant towhich such consultants have the right to purchase up to 10,000 shares and 2,500shares, respectively, of common stock of PDTI. The warrants described in this paragraph have an exercise price of $3.00per share and maximum term of five years from the date granted.  In connection with our acquisition of PDTI,we assumed these warrants.

·    On January 11, 2005, PDTI granted warrantsto eight parties affiliated with the placement agent as compensation for theirservices in connection with the private placement of PDTI Series A preferredstock in January 2005.  Pursuant to thesewarrants, the parties affiliated with the placement agent have the right topurchase up to an aggregate of 44,641 shares of our common stock (consisting ofwarrants to purchase 32,641 shares, 10,000 shares, and 2,000 shares).  The warrants described in this paragraph havean exercise price of $2.00 and a maximum term of five years from the dategranted.  In connection with ouracquisition of PDTI, we assumed these warrants.

·    On February 9, 2005, we granted warrants toseven parties affiliated with the placement agent in connection with theprivate placement of our common stock in February 2005 as consideration forservices provided to us.  Pursuant tothese warrants, the parties affiliated with the placement agent have the rightto purchase up to an aggregate of 1,140,000 shares of our common stock(consisting of warrants to purchase 800,000 shares, 135,000 shares, 135,500shares, 30,000 shares, 25,000 shares and 15,000 shares).  The warrants described in this paragraph havean exercise price of $2.00 per share and a maximum term of ten years from thedate granted.

**Unregistered Sales of EquitySecurities**

OnAugust 9, 2006, a holder of an outstanding warrant exercised its right topurchase 2,000 shares of our common stock at $0.12 per share on a cashlessexercise basis.  The fair market value ofour common stock on the date of exercise was $3.05.  As a result of this exercise, we issued 2,000shares of our common stock to the holder of this warrant.

Theshares of our common stock issued upon exercise of the warrant described abovewere issued in an exchange between us and our existing security holders inwhich no commission or other remuneration was paid or given directly orindirectly for soliciting such exchange. As a result, the issuance of such shares of common stock was exempt fromregistration pursuant to Section 3(a)(9) under the Securities Act of 1933.

**Item6.  Selected Financial Data**

Thefollowing table sets forth selected financial data of the Company derived fromour consolidated financial statements. The selected financial data should beread in conjunction with the Company’s consolidated financial statements andnotes thereto, included elsewhere in this report.
| ** **                        | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** | **Period from**                                                                        | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| ** **                        | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** | **June 9, 2003**                                                                  | ** ** |
| ** **                        | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** | **(date of**                                                                           | ** ** |
| ** **                        | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** | **inception) to**                                                                      | ** ** |
| ** **                        | ** ** | **Year Ended September 30,**                                                 | ** ** | **September 30,**                                                                      | ** ** |
| ** **                        | ** ** | **2006**                                                                                    | ** ** | **2005**                                                                                    | ** ** | **2004**                                                                                    | ** ** | **2003**                                                                                    | ** ** |
| ** **                        | ** ** | **(Restated)**                                                                              | ** ** |
| **Statement of Operations Data:** | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** | ** **                                                                                  | ** ** |
| Revenues                          |       | $              — |       | $              — |       | $              — |       | $              — |       |
| Operating expenses:               |       | —                                                                                      |       | —                                                                                      |       | —                                                                                      |       | —                                                                                      |       |

 

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| Research and development                             |       | 5,964,438                                                                            |       | 2,802,155                                                                |       | 621,752                                                                  |       | 39,626                                                 |       |
|------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| General and  administrative                          |       | 4,581,604                                                                            |       | 3,182,313                                                                |       | 2,683,024                                                                |       | 503,158                                                |       |
| Loss from operations                                 |       | (10,546,042                                                                          | )          | (5,984,468                                                               | )          | (3,304,776                                                               | )          | (542,784                                               | )          |
| Other income (expenses)                              |       | 356,455                                                                              |       | 260,050                                                                  |       | (26,224                                                                  | )          | —                                                 |       |
| Net loss                                             |       | $  (10,189,587                                                             | )          | $  (5,724,418                                                  | )          | $  (3,331,000                                                  |       | $  (542,784                                  | )          |
| ** **                                           | ** ** | ** **                                                                           | ** ** | ** **                                                               | ** ** | ** **                                                               | ** ** | ** **                                             | ** ** |
| **Basic and Diluted Net Loss Per  Share:**           | ** ** | ** **                                                                           | ** ** | ** **                                                               | ** ** | ** **                                                               | ** ** | ** **                                             | ** ** |
| Loss from operations                                 |       | $             (0.43 | )          | $           (0.27 | )          | $           (0.25 | )          | $        (0.07 | )          |
| Net loss                                             |       | $             (0.42 | )          | $           (0.26 | )          | $           (0.25 | )          | $        (0.07 | )          |
| Weighted average shares  outstanding                 |       | 24,520,619                                                                           |       | 22,150,365                                                               |       | 13,364,183                                                               |       | 7,741,646                                              |       |
|                                                 |       |                                                                                 |       |                                                                     |       |                                                                     |       |                                                   |       |
| **Cash Flow Data:**                                  | ** ** | ** **                                                                           | ** ** | ** **                                                               | ** ** | ** **                                                               | ** ** | ** **                                             | ** ** |
| Net cash used in  operating activities               |       | $    (7,192,123                                                  | )          | $  (4,625,184                                                  | )          | $  (1,714,691                                                  | )          | $  (250,566                                  | )          |
| Net cash used in  investing activities               |       | (843,515                                                                             | )          | (1,723,254                                                               | )          | (267,546                                                                 | )          | (351,031                                               | )          |
| Net cash (used in)  provided by financing activities |       | (177,422                                                                             | )          | 16,832,721                                                               |       | 1,999,098                                                                |       | 605,099                                                |       |
| ** **                                           | ** ** | ** **                                                                           | ** ** | ** **                                                               | ** ** | ** **                                                               | ** ** | ** **                                             | ** ** |
| **Balance Sheet Data (at end of  period):**          | ** ** | ** **                                                                           | ** ** | ** **                                                               | ** ** | ** **                                                               | ** ** | ** **                                             | ** ** |
| Cash and cash  equivalents                           |       | $     2,291,586                                             |       | $  10,504,646                                                  |       | $        20,363                  |       | $        3,502 |       |
| Working capital surplus  (deficiency)                |       | 1,411,485                                                                            |       | 9,386,096                                                                |       | (1,301,027                                                               | )          | (5,575                                                 | )          |
| Total assets                                         |       | 5,483,362                                                                            |       | 13,548,413                                                               |       | 1,570,585                                                                |       | 362,033                                                |       |
| Long-term debt                                       |       | 15,305                                                                               |       | 9,463                                                                    |       | 20,201                                                                   |       | —                                                 |       |
| Total stockholders’ equity                      |       | 3,967,629                                                                            |       | 12,148,107                                                               |       | 118,459                                                                  |       | 69,120                                                 |       |

 

**Item7.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

Thefollowing discussion of our financial condition and results of operationsshould be read together with the unaudited consolidated financial statements andrelated notes that are included elsewhere in this report.

**Overview**

OnJanuary 14, 2005, we acquired Particle DrillingTechnologies, Inc., a privately-held Delaware corporation (“PDTI”). As aresult of this acquisition, our company, which previously had no materialoperations, acquired the business of PDTI and we are now engaged in thedevelopment of the Particle Impact Drilling System, a patented systemutilizing a specially designed “fit for purpose” drill bit fitted with jettingnozzles and polycrystalline diamond compact cutting structures for use in theoil and gas drilling industry.

We area development-stage company and have a limited operating history. Ourpredecessor company for financial reporting purposes was formed on June 9,2003 to acquire the technology related to the Particle Impact DrillingSystem (the “PID technology”). We are still developing this technology, and todate, we have not generated any revenues from our operations. As we continue toexecute our operations plan, we expect our development and operating expensesto increase.

*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) being subject to reporting and complianceobligations applicable to publicly-held companies; (2) our continuingefforts to develop, test and prepare the PID technology for commercialization;and (3) the hiring of additional personnel.

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***Comparison of Year Ended September 30, 2006 with YearEnded September 30, 2005***

*Research and development.*    Researchand development expenses were $5,964,438 and $2,802,155 for the years endedSeptember 30, 2006 and 2005, respectively, representing an increase of$3,162,283.  During the fiscal year endedSeptember 30, 2006, we conducted a test program with the PID System at Castoosain November 2005 resulting in costs of approximately $385,000.  A commercial trial with a customer in May2006 resulted in job differential time charges of approximately $135,000, and asecond attempted commercial trial with the same customer in September 2006resulted in a job differential time charge of approximately $81,000. TheCompany incurred other field charges of approximately $511,000 associated withthe two customer trials.  Further, duringthe period from October 2005 to September 30, 2006, we incurred approximately$1.6 million related to the design, engineering, construction and testing oftwo alternative particle injection systems.  Research and development costs also increased as a result of furtherdevelopment, testing and iterations to the PID drill bit and a completere-design of the PID particle recovery unit. Lastly, as a result of the shift from laboratory testing to fieldtesting, our employee related costs increased by $1.7 million, including anincrease of approximately $700,000 related to stock based compensation charges.

*General and administrative.*    Generaland administrative expenses were $4,581,604 and $3,182,313 for the years endedSeptember 30, 2006 and 2005, respectively, representing an increase of$1,399,291.  Employee related costsincreased approximately $420,000, including an increase of approximately$200,000 related to stock based compensation charges.  Additional charges for services related todirectors’ compensation increased approximately $610,000, which includes anincrease of approximately $480,000 in stock based compensation charges.  Other increases are primarily related toreporting and compliance obligations applicable to publicly-held companies,legal fees associated with litigation defense, legal fees associated with therestatement of the companies financial results and recruiting fees incurred to hirea new President and CEO and certain other key employees.

*Other income.*    Otherincome was $356,455 and $260,050 for the years ended September 30, 2006and 2005, respectively, representing an increase in other income of$96,405.  The increase was primarilyattributable to interest income, rental income and the gains on the assignmentof a lease in fiscal 2006.  Interestincome was due to the interest earned on the investment of funds received inour private placement in February 2005.

***Comparison of Year Ended September 30, 2005 with YearEnded September 30, 2004***

*Research and development.*    Researchand development expenses were $2,802,155 and $621,752 for the years endedSeptember 30, 2005 and 2004, respectively, representing an increase of $2,180,403.  We had only a limited ability to develop thePID technology due to our lack of funds available during the year endedSeptember 30, 2004.  As a result of thecompletion of our private placement in February 2005, we continued to usesubstantial resources during fiscal 2005 to develop and test the PIDtechnology, including a test program conducted at TerraTek during March andJune 2005 and a test program conducted at Catoosa during July and November2005.  In fiscal 2005, research anddevelopement expenses also increased due to direct costs associated with thedevelopment of the injector system and PID bits of $1,508,430 while no suchcomparable costs were incurred in fiscal 2004. Indirect cost, or overhead, relating to research and development increased$671,973 during fiscal 2005 compared to fiscal 2004.  We hired additional employees, made certainmodifications to our research facility and had an increase in depreciationexpense as a result of additional property purchased during fiscal 2005.

*General and administrative.*    Generaland administrative expenses were $3,182,313 and $2,683,024 for the years endedSeptember 30, 2005 and 2004, respectively, representing an increase of$499,289.  The increase is primarilyrelated to reporting and compliance obligations applicable to publicly-heldcompanies and stock-based compensation.

*Other income (expenses).*    Otherincome (expenses) were $260,050 and ($26,224) for the years endedSeptember 30, 2005 and 2004, respectively, representing an increase in otherincome of $286,274.  The increase wasprimarily attributable to interest income, rental income and the gains on debtextinguishment during fiscal 2005. Interest income was due to the interest earned on the investment offunds received in our private placement in February 2005.  In addition, we recognized $7,761 each monthin rental income from Energy XXI Services, LLC, an affiliate of John D.Schiller (our former interim President and Chief Executive Officer untilNovember 15, 2005, and currently one of our directors).  Such monthly rental payments did not beginuntil December 2005.  Gains on debtextinguishment were due to settlements on a note payable and certain accountspayable that were related to the liabilities we assumed in connection with ouracquisition of the PID technology.

**Liquidityand Capital Resources**

Ourprincipal sources of liquidity are cash and cash equivalents.  Cash requirements through the end of thefiscal year 2007 are primarily to fund research and development activities, tocontinuously improve service capabilities, expand operations, general andadministrative costs and capital expenditures. We believe we have sufficient resources to meet our working capital andcapital expenditure requirements for at least the next 12 months; however,our continued existence depends on the successful development of the PIDtechnology and our ability to successfully commercialize this technology.

Sinceinception on June 9, 2003 through September 30, 2006, we havefinanced our operations through private sales of our equity and the issuance ofconvertible notes payable, totaling net proceeds of $19,436,918.  As of September 30, 2006,

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we had $2,291,586in cash and cash equivalents.  In October2006, we completed a private sale of five million shares of our equity for$2.35 per share and warrants to purchase 1.5 million shares at $3.25 per share,yielding gross proceeds of $11,750,000.

*Cash Flows from Operating Activities. *Cash flow used for operations isprimarily affected by our research and development progress and businessdevelopment.  Net cash flows used inoperating activities during the year ended September 30, 2006 were $7,192,123compared to $4,625,184 for fiscal 2005. The increase from fiscal 2005 to fiscal 2006 was the result of our increasedspending on research and development and our increased level of general andadministrative cost as discussed above.

*Cash Flows from Investing Activities. *Cashflow used in investing activities for the year ended September 30, 2006 was$843,515 compared to $1,723,254 in 2005. During the year ended September 30, 2006, we decreased capitalspending for our research and development activities primarily as a result ofthe frac pump and tractor purchased in May 2005 for $820,000.  We placed a down payment on a similar fracpump in 2006 in the amount of $320,499. The remaining balance of approximately $930,000 is expected to be paidin fiscal 2007.  We anticipate that ourcapital expenditures for the next year will continue to be fully funded fromour available cash and cash equivalents.

*Cash Flow from Financing Activities.  *Netcash provided by (used in) financing activities for year endedSeptember 30, 2006 was ($177,422) compared to $16,832,721 in 2005.  The majority of the cash used in financingactivities in 2006 was a result of the repayments of notes payable, whereas themajority of the cash provided by financing activities in fiscal 2005 was aresult of the private placement of common stock in February 2005.

*ContractualObligations*.  In March 2005, we delivered to the lessorof our then current corporate offices at 1021 Main Street, Suite 2650, Houston,Texas 77002, a security deposit of $350,000 in the form of an irrevocableletter of credit. Our future annual minimum lease payments were $186,256. InAugust 2005, we expanded the corporate office facility an additional 1,086square feet for a total of 11,396 square feet. The future annual minimum leasepayments for the additional space were $18,758. In March 2006, we assigned ourcommitments under this office lease to Energy XXI Services, LLC, an affiliateof John D. Schiller, our former interim President and Chief Executive Officerand currently one of our directors, and of Steve Weyel, currently one of ourdirectors. The Exploitation Company, LLP had previously subleased a portion ofthat corporate office space pursuant to a Sublease Agreement, which agreementwas cancelled in connection with the assignment of the office lease to EnergyXXI Services, LLC. Furthermore, Energy XXI Services, LLC assumed the obligationunder the lease to provide a security deposit of $350,000 and we were releasedfrom the irrevocable letter of credit we had previously provided. We will notincur any future obligations for lease payments under this office lease.

InApril 2006, we entered into a thirteen month lease agreement for our newcorporate offices at 11757 Katy Freeway, Suite 1300, Houston, Texas 77079, thatcommenced in May 2006. In connection with the execution of this new leaseagreement, we delivered to the lessor a security deposit of $9,400. Our futureminimum lease payments are $90,240 for the remainder of calendar year 2006 and2007.

InJune 2006, we extended the lease for our commercial operating facilitythat expired June 30, 2006 for one additional year. The lease for ourcommercial operating facility will expire June 30, 2007. The futureminimum lease payments under this lease are $45,000 for the remainder ofcalendar year 2006 and 2007.

InJuly 2006, we entered into a contract to purchase a quintaplex frac pump to beused with PID Unit #2 which is currently under construction. In connection withthis contract, we paid $320,499 as a deposit and will pay another $930,000during the assembly phase and upon completion.
| ** **                                                                          | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**                                                    | ** ** | **Total**                                 | ** ** | **Less than 1**

**year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **More than 5**

**years** | ** ** |
|                                                                                |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-Term Debt  Obligation and Short Term Notes Payable (including current portion) |       | $    213,718          |       | $    198,413 |   | $      15,305 |   | $             — |   | $             — |   |
| Equipment Purchase  Commitment                                                      |       | 930,000                                   |       | 930,000 |   |   |   |   |   |   |   |
| Operating Lease  Obligations                                                        |       | 135,240                                   |       | 135,240 |   | — |   | — |   | — |   |
|                                                                                |       |                                      |       |   |   |   |   |   |   |   |   |
| Total                                                                               |       | $ 1,278,958                          |       | $ 1,263,653 |   | $      15,305 |   | $             — |   | $             — |   |

 

**Off-BalanceSheet Arrangements**

Inconnection with the acquisition of the PID technology in January 2004,PDTI entered into a Royalty Agreement with ProDril Services, Incorporated (“PSI”)pursuant to which we are obligated to pay PSI a royalty on a quarterly basisequal to 18% of our earnings before interest, income taxes, depreciation andamortization (“EBITDA”) derived from the use of the PID technology, until anaggregate of $67,500,000 has been paid. PDTI also entered into a RoyaltyAgreement in January 2004 with ProDril Services, International, Ltd. (“PSIL”)pursuant to which we are obligated to pay PSIL a royalty on

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a quarterly basisequal to 2% of our EBITDA derived from the use of the PID technology, until anaggregate of $7,500,000 has been paid. In addition, we are obligated to payCCORE Technology and Licensing, Ltd. (“CTL”), PSI and PSIL a royalty equal to1.6%, 1.2% and 1.2%, respectively, of our quarterly gross revenue, derived fromthe use of the PID technology.  As ofSeptember 30, 2006, we had no revenues or EBITDA; therefore no royaltieshave been paid or accrued.

**CriticalAccounting Policies**

Thediscussion and analysis of our financial condition and results of operations isbased on our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America. The preparation of these consolidated financial statements requiresus to make estimates and judgments that affect the reported amounts of assets,liabilities and expenses. We base our estimates on historical experience and onvarious other assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Actual results may differ from these estimates underdifferent assumptions or conditions. We believe the following criticalaccounting policies affect our most significant judgments and estimates used inthe preparation of our consolidated financial statements.

*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 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 the patentsor patent applications in terms of performance, customer acceptance or otherfactors that may affect such cash flow forecasts.

*Stock-BasedCompensation*.   In December 2004, theFinancial Accounting Standards Board (“FASB”) issued a revision to SFASNo. 123, *Share-Based Payment*, SFAS No.123(R).  This statement establishesstandards for the accounting for transactions in which an entity exchanges itsequity instruments for goods or services. It also addresses transactions inwhich an entity incurs liabilities in exchange for goods or services that arebased on the fair value of the entity’s equity instruments or that may besettled by the issuance of those equity instruments. This statement focusesprimarily on accounting for transactions in which an entity obtains employeeservices in share-based payment transactions. This statement does not changethe accounting guidance for share-based payment transactions with parties otherthan employees provided in SFAS No. 123 as originally issued. Thisstatement is effective for new awards and those modified, repurchased orcancelled in interim or annual reporting periods beginning after June 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.

*Income Taxes.*  We report our incometaxes in accordance with SFAS 109, *Accounting for IncomeTaxes*, which calls for the utilization of the asset and liabilitymethod of accounting for income taxes. Under this method, deferred taxes are determined based on differencesbetween financial reporting and tax bases of assets and liabilities and aremeasured using the enacted marginal tax rates and laws that will be in effectwhen the differences reverse.  Temporarydifferences have been created for all stock option plans and are included inour SFAS 109 computation.  AtSeptember 30, 2006, we had cumulative

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net operating losscarryforwards of approximately $16,082,000, which expire in years 2007 through2025.  No effect has been shown in theconsolidated financial statements for the net operating loss carryforwards asthe likelihood of future tax benefit from such net operating loss carryforwardsis not determinable at this time.  Accordingly, the potential tax benefits of thenet operating loss carryforwards, estimated based upon tax rates atSeptember 30, 2006, have been offset by valuation reserves of the sameamount.

**RecentAccounting Pronouncements**

InOctober 2005, the Financial Accounting Standards Board (“FASB”) issued FASBStaff Position (“FSP”) 13-1, Accounting for Rental Costs Incurred During aConstruction Period, to address the accounting for rental costs associated withoperating leases that are incurred during a construction period.  FSP 13-1 requires rental costs associatedwith ground or building operating leases that are incurred during aconstruction period to be recognized as rental expense.  FSP 13-1 is effective in fiscal yearsbeginning after December 31, 2005.  TheCompany believes that the adoption of FSP 13-1 will not have a material impactthe Company’s financial position, results of operations or cash flows.

InFebruary 2006, the FASB issued SFAS No. 155, Accounting for Certain HybridFinancial Instruments — An Amendment of FASB Statements No. 133 and140.  SFAS No. 155 provides entities withrelief from having to separately determine the fair value of an embeddedderivative that would otherwise be required to be bifurcated from its hostcontract in accordance with SFAS No. 133. SFAS No. 155 allows an entity to make an irrevocable election to measuresuch a hybrid financial instrument at fair value in its entirety, with changesin fair value recognized in earnings. SFAS No. 155 is effective for all financial instruments acquired, issuedor subject to a remeasurement event occurring after the beginning of an entity’sfirst fiscal year that begins after September 15, 2006.  The Company believes that the adoption ofSFAS No. 155 will not have a material impact the Company’s financial position,results of operations or cash flows.

InMarch 2006, the FASB issued SFAS No. 156, Accounting for Servicing of FinancialAssets — An Amendment to FASB Statement No. 140.  Once effective, SFAS No. 156 will requireentities to recognize a servicing asset or liability each time they undertakean obligation to service a financial asset by entering into a servicingcontract in certain situations.  Thisstatement also requires all separately recognized servicing assets and servicingliabilities to be initially measured at fair value and permits a choice ofeither the amortization or fair value measurement method for subsequentmeasurement.  The effective date of thisstatement is for annual periods beginning after September 15, 2006, withearlier adoption permitted as of the beginning of an entity’s fiscal yearprovided the entity has not issued any financial statements for that year.  The Company does not believe that it willhave a material impact on its financial position, results of operations or cashflows.

In July2006, the FASB issued FASB Interpretation (“FIN”) No. 48, Accounting forUncertainty in Income Taxes - An Interpretation of FASB Statement No. 109.  FIN No. 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, Accounting for 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 No. 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 No. 48.  The cumulative effect ofapplying the provisions of FIN No. 48 should be reported as an adjustment tothe opening balance of retained earnings (or other appropriate components ofequity or net assets in the statement of financial position) for that fiscalyear.  The provisions of FIN No. 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.  The Company believes that the adoption of FINNo. 48 will not have a material impact on its financial position, results ofoperations or cash flows.

InJuly 2006, the FASB issued FSP No. FAS 13-2, Accounting for a Change orProjected Change in the Timing of Cash Flows Relating to Income Taxes Generatedby a Leveraged Lease Transaction.  FSPNo. FAS 13-2 requires that changes in the projected timing of income tax cashflows generated by a leveraged lease transaction be recognized as a gain orloss in the

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year in whichchange occurs.  The pretax gain or lossis required to be included in the same line item in which the leveraged leaseincome is recognized, with the tax effect being included in the provision forincome taxes.  FSP No. FAS 13-2 iseffective for fiscal years beginning after December 15, 2006.  The Company believes that the adoption of FSPNo. FAS 13-2 will not have a material impact on its financial position, resultsof operations or cash flows.

InSeptember 2006, the FASB issued SFAS No. 157, Fair Value Measurements.  SFAS No. 157 clarifies the principlethat fair value should be based on the assumptions market participants woulduse when pricing an asset or liability and establishes a fair value hierarchythat prioritizes the information used to develop those assumptions.  Under the standard, fair value measurementswould be separately disclosed by level within the fair value hierarchy.  SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years, with early adoption permitted.  The Company believes that the adoption ofSFAS No. 157 will not have a material impact on its financial position, resultsof operations or cash flows.

InSeptember 2006, the FASB issued SFAS No. 158, Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plan — an amendment of FASB StatementNo. 87, 88, 106 and 132(R).  SFAS No. 158requires an employer to recognize the overfunded or underfunded status of adefined benefit postretirement plan as an asset or liability in its statementof financial position and recognize changes in the funded status in the year inwhich the changes occur.  SFAS No. 158 iseffective for fiscal years ending after December 15, 2006.  The Company believes that the adoption of SFASNo. 158 will not have a material impact on its financial position, results ofoperations or cash flows.

InSeptember 2006, the FASB issued FSP No. AUG AIR-1, Accounting for Planned MajorMaintenance Activities.  FSP No. AUGAIR-1 prohibits the use of the accrue-in-advance method for accounting formajor maintenance activities and confirms the acceptable methods of accountingfor planned major maintenance activities. FSP No. AUG AIR-1 is effective the first fiscal year beginning afterDecember 15, 2006.  The Company believesthat the adoption of FSP No. AUG AIR-1 will not have a material impact on itsfinancial position, results of operations or cash flows.

In September 2006, the SEC issued SAB 108, “Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements”**(“SAB 108”)*.*SAB 108 provides interpretiveguidance on how the effects of the carryover or reversal of prior yearmisstatements should be considered in quantifying a current year misstatement.The pronouncement prescribes an approach whereby the effect of all unrecordedidentified errors should be considered on all of the financial statementsrather than just either the effect on the balance sheet or the incomestatement. The Company will adopt the provisions of SAB 108 beginning in fiscal2007. The adoption of SAB 108is not expected to have a material impact on theCompany’s Consolidated Financial Statements.

**Forward-LookingStatements**

Statementsin this annual report on Form 10-K that are not historical facts(including any statements concerning plans and objectives of management forfuture operations or economic performance, or assumptions or forecasts relatedthereto) are forward-looking statements subject to Section 27A of the SecuritiesAct of 1933 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 representativesmay from time to time make other oral or written statements that are alsoforward-looking statements.

Theseforward-looking statements are made based upon our management’s current plans,expectations, estimates, assumptions and beliefs concerning future eventsimpacting us and therefore involve a number of risks and uncertainties.  We caution that forward-looking statementsare not guarantees and that actual results could differ materially from thoseexpressed or implied in the forward-looking statements as a result of certainfactors, including but not limited to dependence upon energy industry spending,the volatility of oil and gas prices, weather interruptions, the results oftesting of our products, the availability of capital resources and the otherfactors described under “Item 1A. Risk Factors”.  We undertake no obligation to update anyforward-looking statements except as required by law.

**Item7A.  Quantitative and QualitativeDisclosures About Market Risk**

Webelieve that we do not have any material exposure to financial market risk andwe do not enter into foreign currency or interest rate transactions.

**Item8.  Financial Statements andSupplementary Data**

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**PARTICLEDRILLING TECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

 

**Index to Consolidated Financial Statements**
| Management’s Report on  Internal Control over Financial Reporting                                                                                                                   |   |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                                                                                                     |   |   |
| Reports of Independent Registered Public Accounting  Firms                                                                                                                               |   |   |
|                                                                                                                                                                                     |   |   |
| Consolidated  Balance Sheets as of September 30, 2006 and 2005                                                                                                                           |   |   |
|                                                                                                                                                                                     |   |   |
| Consolidated Statements of Operations for the years  ended September 30, 2006, 2005, and 2004, and for the period from June 9,  2003 (date of inception) to September 30, 2006           |   |   |
|                                                                                                                                                                                     |   |   |
| Consolidated Statements of Stockholders’ Equity for  the years ended September 30, 2006, 2005, 2004 and for the period from June  9, 2003 (date of inception) to September 30, 2006 |   |   |
|                                                                                                                                                                                     |   |   |
| Consolidated Statements of Cash Flows for the years  ended September 30, 2006, 2005, 2004, and for the period from June 9, 2003  (date of inception) to September 30, 2006               |   |   |
|                                                                                                                                                                                     |   |   |
| Notes to Consolidated Financial Statements                                                                                                                                               |   |   |

 

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**MANAGEMENT’S REPORT ON INTERNAL CONTROL OVERFINANCIAL REPORTING**

Our company’s management is responsible forestablishing and maintaining adequate internal control over financialreporting, as such term is defined in Exchange Act Rule 13a-15(f).  Internal control over financial reporting isa process designed to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of our consolidated financialstatements for external purposes in accordance with generally acceptedaccounting principles.  Under thesupervision and with the participation of our company’s management, includingthe Chief Executive Officer and the Chief Financial Officer, we conducted anevaluation of the effectiveness of our internal control over financialreporting based on the framework in *InternalControl — Integrated Framework*issued by the Committee ofSponsoring Organizations of the Treadway Commission.

Our internal control over financial reporting includesthose policies and procedures that: (1) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect the transactionsand dispositions of our assets; (2) provide reasonable assurance thattransactions are recorded as necessary to permit preparation of ourconsolidated financial statements in accordance with generally acceptedaccounting principles, and that our receipts and expenditures are being madeonly in accordance with authorizations of our management and directors; and(3) provide reasonable assurance regarding prevention or timely detectionof unauthorized acquisition, use or disposition of our assets that could have amaterial effect on our consolidated financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Based on our evaluation under the framework in *Internal Control — Integrated Framework,*themanagement of our company concluded that our internal control over financialreporting was effective as of September 30, 2006.

Theassessment by the management of our company of the effectiveness of ourinternal control over financial reporting as of September 30, 2006 has beenaudited by UHYLLP, an independent registered public accounting firm, as stated intheir report that follows.

 
| /s/ J. CHRIS BOSWELL                                                                                        |   |   |
|-------------------------------------------------------------------------------------------------------------|--------|--------|
| Senior Vice President  and                                                                                  |
| Chief Financial Officer                                                                                     |
|                                                                                                        |
| /s/ Jim B.  Terry                |   |   |
| President and                                                                                               |
| Chief Executive Officer                                                                                     |
|                                                                                                        |
| Houston, Texas                                                                                              |
| December 14, 2006                                                                                           |

 

 

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**Reportof Independent Registered Public Accounting Firm**

Tothe Board of Directors and Stockholders

ParticleDrilling Technologies, Inc.

Houston, Texas

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting appearing on page 24, that Particle Drilling Technologies, Inc. andsubsidiaries (the “Company”) maintained effective internal control overfinancial reporting as of September 30, 2006, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (2) provide reasonable assurance that transactions are recordedas necessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures ofthe company are being made only in accordance with authorizations of managementand directors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

In our opinion, management’s assessment that ParticleDrilling Technologies, Inc. and subsidiaries maintained effective internalcontrol over financial reporting as of September 30, 2006, is fairly stated, inall material respects, based on criteria established in InternalControl—Integrated Framework issued by COSO. Also, in our opinion, ParticleDrilling Technologies, Inc. and subsidiaries maintained, in all materialrespects, effective internal control over financial reporting as of September30, 2006, based on criteria established in Internal Control—IntegratedFramework issued by COSO.  We have alsoaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated balance sheet of ParticleDrilling Technologies, Inc. and subsidiaries as of September 30, 2006, and therelated consolidated statements of operations, stockholders’ equity, and cashflows for the year ended September 30, 2006, and for the period from June 9,2003 (date of inception) to September 30, 2006 and our report dated December 14,2006 expressed an unqualified opinion on those consolidated financialstatements.

 
| /s/ UHY, LLP      |   |   |
|-------------------|--------|--------|
|              |   |   |
| Houston, Texas    |   |   |
| December 14, 2006 |   |   |

 

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**Reportof Independent Registered Public Accounting Firm**

To the Board of Directorsand Stockholders

Particle DrillingTechnologies, Inc.

Houston,Texas

Wehave audited the accompanying consolidated balance sheet of Particle DrillingTechnologies, Inc. (a development stage company) as of September 30, 2006, andthe related consolidated statements of operations, stockholders’ equity, andcash flows for the year ended September 30, 2006, and for the period from June9, 2003 (date of inception) to September 30, 2006. These consolidated financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audit.  Thecumulative statements of operations, stockholders’ equity, and cash flows forthe period June 9, 2003 (date of inception) to September 30, 2005 includeamounts for the period from June 9, 2003 (date of inception) to September 30,2003 and for each of the years in the two year period ending September 30, 2005which were audited by other auditors whose report has been furnished to us, andour opinion, insofar as it relates to the amounts included for the period June9, 2003 through September 30, 2005 is based solely on the report of otherauditors. The report of the other auditors includes an explanatory paragraphwhich states that the financial statements as of and for the year ended September30, 2005 and cumulative amounts since inception to September 30, 2005 have beenrestated.

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audits to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation.  We believe that our audits provide a reasonablebasis for our opinion.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofParticle Drilling Technologies, Inc. as of September 30, 2006, and theconsolidated results of their operations and their cash flows for the yearended September 30, 2006,  and for theperiods from June 9, 2003 (date of inception) to September 30, 2006, inconformity with accounting principles generally accepted in the United Statesof America.

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of the Company’sinternal control over financial reporting as of September 30, 2006, based onthe criteria established in Internal Control — Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission and ourreport dated December 14, 2006 expressed an unqualified opinion on management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting and an unqualified opinion on the effectiveness of theCompany’s internal control over financial reporting.

 
| /s/ UHY, LLP      |   |   |
|-------------------|--------|--------|
|              |   |   |
| Houston, Texas    |   |   |
| December 14, 2006 |   |   |

 

24

----

 

**Reportof Independent Registered Public Accounting Firm**

Tothe Board of Directors and Stockholders

ParticleDrilling Technologies, Inc.

Houston, Texas

We have audited the accompanying consolidated balancesheet of Particle Drilling Technologies, Inc. (a development stage company) asof September 30, 2005, and the related consolidated statements of operations,stockholders’ equity, and cash flows for the years ended September 30, 2005 and2004, and for the period June 9, 2003 (date of inception) to September 30,2005. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of Particle Drilling Technologies, Inc. as of September 30,2005, and the consolidated results of their operations and their cash flows forthe years ended September 30, 2005 and 2004, and for the periods from June 9,2003 (date of inception) to September 30, 2005, in conformity with accountingprinciples generally accepted in the United States of America.

As discussed in Note 2 to the consolidated financialstatements, the accompanying consolidated financial statements have beenrestated.

 
| /s/ UHY Mann Frankfort Stein & Lipp CPAs, LLP                               |   |   |
|---------------------------------------------------------------------------------|--------|--------|
|                                                                            |   |   |
| Houston, Texas                                                                  |   |   |
| December 14, 2005,  except for Note 2 as to which the date is February 14, 2006 |   |   |

** **

25

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**PARTICLE DRILLING TECHNOLOGIES, INC.**

**(a development stage enterprise)**

**CONSOLIDATEDBALANCE SHEETS**
| ** **                                                                                                                                                                                                                              | ** ** | **September 30,  2006** | ** ** | **September 30,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                                                                              | ** ** | ** **                   | ** ** | **(Restated)**               | ** ** |
| **ASSETS**                                                                                                                                                                                                                              | ** ** | ** **                   | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Current assets:                                                                                                                                                                                                                         |       |                         |       |                         |       |
| Cash and cash equivalents                                                                                                                                                                                                               |       | $                            | 2,291,586  |                         | $          | 10,504,646 |   |
| Short term investments                                                                                                                                                                                                                  |       | 385,839                      |       | —                       |       |
| Accounts receivable - related party                                                                                                                                                                                                     |       | —                       |       | 42,330                       |       |
| Prepaid expenses                                                                                                                                                                                                                        |       | 234,488                      |       | 229,963                      |       |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Total current assets                                                                                                                                                                                                                    |       | 2,911,913                    |       | 10,776,939                   |       |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Property, plant  & equipment, net                                                                                                                                                                                                   |       | 1,326,713                    |       | 1,277,982                    |       |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Intangibles, net                                                                                                                                                                                                                        |       | 1,230,086                    |       | 1,102,403                    |       |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Other assets                                                                                                                                                                                                                            |       | 14,650                       |       | 391,089                      |       |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Total assets                                                                                                                                                                                                                            |       | $                            | 5,483,362  |                         | $          | 13,548,413 |   |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                           | ** ** | ** **                   | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Current  liabilities:                                                                                                                                                                                                                   |       |                         |       |                         |       |
| Accounts payable                                                                                                                                                                                                                        |       | $                            | 830,552    |                         | $          | 1,056,733 |   |
| Short-term notes payable                                                                                                                                                                                                                |       | 179,143                      |       | 79,880                       |       |
| Current portion of long-term debt                                                                                                                                                                                                       |       | 19,270                       |       | 11,597                       |       |
| Accrued liabilities                                                                                                                                                                                                                     |       | 471,463                      |       | 242,633                      |       |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Total current liabilities                                                                                                                                                                                                               |       | 1,500,428                    |       | 1,390,843                    |       |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Long-term debt                                                                                                                                                                                                                          |       | 15,305                       |       | 9,463                        |       |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Commitments and  contingencies - See Note 13                                                                                                                                                                                            |       | —                       |       | —                       |       |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Stockholders’  equity:                                                                                                                                                                                                             |       |                         |       |                         |       |
| Common stock, $.001 par value, 100,000,000 shares  authorized, 28,013,291 shares issued and 25,010,205 shares outstanding at  September 30, 2006, and 27,441,472 shares issued and 24,441,472 shares  outstanding at September 30, 2005 |       | 28,014                       |       | 27,441                       |       |
| Additional paid-in capital                                                                                                                                                                                                              |       | 25,239,221                   |       | 23,218,868                   |       |
| Treasury stock at cost, 3,003,086 shares and  3,000,000 shares at September 30, 2006 and September 30, 2005, respectively                                                                                                               |       | (1,511,817                   | )          | (1,500,000                   | )          |
| Deficit accumulated during the development stage                                                                                                                                                                                        |       | (19,787,789                  | )          | (9,598,202                   | )          |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Total stockholders’ equity                                                                                                                                                                                                         |       | 3,967,629                    |       | 12,148,107                   |       |
|                                                                                                                                                                                                                                    |       |                         |       |                         |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                        |       | $                            | 5,483,362  |                         | $          | 13,548,413 |   |

 

The accompanying notes are an integral part ofthese statements.

26

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**PARTICLE DRILLING TECHNOLOGIES, INC.**

**(a development stage enterprise)**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**
| ** **                                                                     | ** ** | ** **                                  | ** **  | ** **             | ** ** | ** ** | ** ** | **Period from  June 9, 2003  (date of  inception) to** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------|-------------|------------------------|------------|------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **Year Ended September 30,** | ** **  | **September 30,** | ** ** |
| ** **                                                                     | ** ** | **2006**                                    | ** **  | **2005**               | ** ** | **2004**   | ** ** | **2006**                                                                        | ** ** |
| ** **                                                                     | ** ** | ** **                                  | ** **  | **(Restated)**         | ** ** | ** ** | ** ** | ** **                                                                      | ** ** |
| Revenues                                                                       |       | $                                           | —      |                   | $          | —     |       | $                                                                               | —     |   | $ | — |   |
|                                                                           |       |                                        |        |                   |       |       |       |                                                                            |       |
| Operating  expenses:                                                           |       |                                        |        |                   |       |       |       |                                                                            |       |
| Research and development                                                       |       | 5,964,438                                   |        | 2,802,155              |       | 621,752    |       | 9,427,971                                                                       |       |
| General and administrative                                                     |       | 4,581,604                                   |        | 3,182,313              |       | 2,683,024  |       | 10,950,099                                                                      |       |
|                                                                           |       |                                        |        |                   |       |       |       |                                                                            |       |
| Total operating expenses                                                       |       | 10,546,042                                  |        | 5,984,468              |       | 3,304,776  |       | 20,378,070                                                                      |       |
|                                                                           |       |                                        |        |                   |       |       |       |                                                                            |       |
| Loss from operations                                                           |       | (10,546,042                                 | )           | (5,984,468             | )          | (3,304,776 | )          | (20,378,070                                                                     | )          |
|                                                                           |       |                                        |        |                   |       |       |       |                                                                            |       |
| Other income (expenses)                                                        |       |                                        |        |                   |       |       |       |                                                                            |       |
| Interest income                                                                |       | 260,914                                     |        | 209,305                |       | —     |       | 470,219                                                                         |       |
| Rental income - related party                                                  |       | 46,565                                      |        | 27,162                 |       | —     |       | 73,727                                                                          |       |
| Gain on debt extinguishment                                                    |       | —                                      |        | 35,283                 |       | —     |       | 35,283                                                                          |       |
| Other                                                                          |       | 55,614                                      |        | —                 |       | —     |       | 55,614                                                                          |       |
| Interest expense                                                               |       | (6,638                                      | )           | (11,700                | )          | (26,224    | )          | (44,562                                                                         | )          |
|                                                                           |       |                                        |        |                   |       |       |       |                                                                            |       |
| Total other income (expenses)                                                  |       | 356,455                                     |        | 260,050                |       | (26,224    | )          | 590,281                                                                         |       |
|                                                                           |       |                                        |        |                   |       |       |       |                                                                            |       |
| Net loss                                                                       |       | $                                           | (10,189,587 | )                      | $          | (5,724,418 | )          | $                                                                               | (3,331,000 | ) | $ | (19,787,789 | ) |
|                                                                           |       |                                        |        |                   |       |       |       |                                                                            |       |
| Net loss per  common share, basic and diluted                                  |       | $                                           | (0.42       | )                      | $          | (0.26      | )          | $                                                                               | (0.25      | ) | $ | (1.05 | ) |
|                                                                           |       |                                        |        |                   |       |       |       |                                                                            |       |
| Weighted average number  of common shares outstanding — basic and diluted |       | 24,520,619                                  |        | 22,150,365             |       | 13,364,183 |       | 18,841,589                                                                      |       |

 

The accompanying notes are an integral part ofthese statements.

27

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**PARTICLEDRILLING TECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY**

**Forthe Period from June 9, 2003 (date of inception)**

**to September 30, 2006**
| ** **                                                                                                                                   | ** ** | ** **            | ** ** | ** **              | ** ** | ** **  | ** ** | ** **      | ** ** | ** **     | ** ** | **Deficit**     | ** ** | ** **             | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-------------|------------|-----------------|------------|----------------|------------|-----------------|------------|------------------------|------------|
| ** **                                                                                                                                   | ** ** | ** **            | ** ** | ** **              | ** ** | ** **  | ** ** | ** **      | ** ** | ** **     | ** ** | **Accumulated** | ** ** | **Total**              | ** ** |
| ** **                                                                                                                                   | ** ** | ** **            | ** ** | ** **              | ** ** | ** **  | ** ** | ** **      | ** ** | **Additional** | ** ** | **During**      | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                                                                   | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Paid-in** | ** ** | **Development** | ** ** | **Equity**     | ** ** |
| ** **                                                                                                                                   | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Shares**  | ** ** | **Amount**      | ** ** | **Capital**    | ** ** | **Stage**       | ** ** | **(Deficit)**          | ** ** |
| Retroactive  restatement of stockholders’ equity prior to merger for recapitalization                                                   |       | 1,550,000             |       | $                       | 1,550      |        | —     |            | $          | —         |       | $               | (1,550     | )                      | $          | — |   | $ | — |   |
| Common  stock issued to founders at $0.001 per share in June 2003                                                                            |       | 9,000,000             |       | 9,000                   |       | —      |       | —          |       | —         |       | —          |       | 9,000                  |       |
| Common  stock issued in private placement for cash at $2.00 per share from June 2003  to September 2003, less offering expense of $436,096   |       | 504,500               |       | 505                     |       | —      |       | —          |       | 572,399        |       | —          |       | 572,904                |       |
| Common  stock issued for services provided at $2.00 per share in July 2003                                                                   |       | 15,000                |       | 15                      |       | —      |       | —          |       | 29,985         |       | —          |       | 30,000                 |       |
| Net  loss                                                                                                                                    |       | —                |       | —                  |       | —      |       | —          |       | —         |       | (542,784        | )          | (542,784               | )          |
| Balance,  September 30, 2003                                                                                                                 |       | 11,069,500            |       | 11,070                  |       | —      |       | —          |       | 600,834        |       | (542,784        | )          | 69,120                 |       |
| Common  stock issued in private placement for cash at $2.00 per share from October  2003 to February 2004, less offering expense of $166,322 |       | 196,800               |       | 197                     |       | —      |       | —          |       | 227,080        |       | —          |       | 227,277                |       |
| Common  stock issued for services provided at $2.00 per share in October 2003                                                                |       | 27,000                |       | 27                      |       | —      |       | —          |       | 53,973         |       | —          |       | 54,000                 |       |
| Common  stock issued for cash at $2.00 per share from October 2003 to March 2004                                                             |       | 325,000               |       | 325                     |       | —      |       | —          |       | 649,675        |       | —          |       | 650,000                |       |
| Common  stock issued for cash at $1.82 per share in October 2003                                                                             |       | 2,750                 |       | 2                       |       | —      |       | —          |       | 4,998          |       | —          |       | 5,000                  |       |
| Common  stock issued in exchange for note payable at $2.00 per share in January 2004                                                         |       | 25,000                |       | 25                      |       | —      |       | —          |       | 49,975         |       | —          |       | 50,000                 |       |
| Common  stock issued for services provided at $2.00 per share in January 2004                                                                |       | 12,000                |       | 12                      |       | —      |       | —          |       | 23,988         |       | —          |       | 24,000                 |       |
| Common  stock issued for cash at $0.72 per share in March 2004                                                                               |       | 69,508                |       | 70                      |       | —      |       | —          |       | 49,930         |       | —          |       | 50,000                 |       |
| Common  stock issued for cash at $0.97 per share in March 2004                                                                               |       | 15,480                |       | 15                      |       | —      |       | —          |       | 14,985         |       | —          |       | 15,000                 |       |
| Common  stock issued for cash at $0.75 per share in March 2004                                                                               |       | 35,000                |       | 35                      |       | —      |       | —          |       | 26,215         |       | —          |       | 26,250                 |       |
| Common  stock issued for services provided at $2.00 per share in March 2004                                                                  |       | 70,000                |       | 70                      |       | —      |       | —          |       | 139,930        |       | —          |       | 140,000                |       |
| Common  stock issued for services provided at $2.00 per share in March 2004                                                                  |       | 75,000                |       | 75                      |       | —      |       | —          |       | 149,925        |       | —          |       | 150,000                |       |
| Common  stock issued for cash at $0.74 per share in April 2004                                                                               |       | 23,500                |       | 23                      |       | —      |       | —          |       | 17,477         |       | —          |       | 17,500                 |       |
| Common  stock issued in exchange of accounts payable at $0.12 per share upon exercise  of warrants in April 2004                             |       | 50,000                |       | 50                      |       | —      |       | —          |       | 6,850          |       | —          |       | 6,900                  |       |
| Common  stock issued for cash at $0.12 per share upon exercise of warrants from April  2004 to June 2004                                     |       | 113,909               |       | 114                     |       | —      |       | —          |       | 15,605         |       | —          |       | 15,719                 |       |
| Common  stock issued for cash at $0.12 per share upon exercise of employee stock  options in June 2004                                       |       | 200,000               |       | 200                     |       | —      |       | —          |       | 32,062         |       | —          |       | 32,262                 |       |
| Common  stock issued in connection with advisory agreement at $0.12 per share in June  2004                                                  |       | 5,000,000             |       | 5,000                   |       | —      |       | —          |       | 595,000        |       | —          |       | 600,000                |       |
| Common  stock issued at $1.50 per share upon conversion of note payable in June 2004,  less offering expense                                 |       | 410,000               |       | 410                     |       | —      |       | —          |       | 553,090        |       | —          |       | 553,500                |       |
| Common  stock issued in private placement for cash at $2.00 per share from July 2004  to September 2004, less offering expense               |       | 375,000               |       | 375                     |       | —      |       | —          |       | 717,125        |       | —          |       | 717,500                |       |
| Fair  value of common stock warrants issued for services                                                                                     |       | —                |       | —                  |       | —      |       | —          |       | 2,880          |       | —          |       | 2,880                  |       |
| Stock-based  employee compensation                                                                                                           |       | —                |       | —                  |       | —      |       | —          |       | 42,551         |       | —          |       | 42,551                 |       |
| Net  loss                                                                                                                                    |       | —                |       | —                  |       | —      |       | —          |       | —         |       | (3,331,000      | )          | (3,331,000             | )          |
| Balance, September 30, 2004                                                                                                                  |       | 18,095,447            |       | 18,095                  |       | —      |       | —          |       | 3,974,148      |       | (3,873,784      | )          | 118,459                |       |
| Common  stock issued in private placement for cash at $2.00 per share from October  2004 to February 2005, less offering expense             |       | 850,000               |       | 850                     |       | —      |       | —          |       | 1,581,585      |       | —          |       | 1,582,435              |       |
| Common  stock issued for services provided at $1.75 per share in October 2004                                                                |       | 10,000                |       | 10                      |       | —      |       | —          |       | 17,490         |       | —          |       | 17,500                 |       |
| Common  stock issued upon cashless exercise of warrants at $0.12 per share in  December 2004                                                 |       | 9,314                 |       | 10                      |       | —      |       | —          |       | (10            | )          | —          |       | —                 |       |
| Common  stock issued for cash at $0.01 per share upon exercise of warrants in  December 2004                                                 |       | 33,333                |       | 33                      |       | —      |       | —          |       | 302            |       | —          |       | 335                    |       |
| Common  stock cancelled at $0.12 per share in January 2005                                                                                   |       | (700,000              | )          | (700                    | )          | —      |       | —          |       | (83,300        | )          | —          |       | (84,000                | )          |
| Common  stock cancelled at $0.001 per share in January 2005                                                                                  |       | (50,000               | )          | (50                     | )          | —      |       | —          |       | 50             |       | —          |       | —                 |       |
| Common  stock issued in private placement for cash at $2.00 per share in February  2005, less offering expense                               |       | 9,000,000             |       | 9,000                   |       | —      |       | —          |       | 14,605,332     |       | —          |       | 14,614,332             |       |
| Repurchase  of common stock at $0.50 per share in February 2005                                                                              |       | —                |       | —                  |       | (3,000,000  | )          | (1,500,000      | )          | —         |       | —          |       | (1,500,000             | )          |
| Restricted  stock issued to employees at $4.90 per share in May 2005                                                                         |       | 140,000               |       | 140                     |       | —      |       | —          |       | (140           | )          | —          |       | —                 |       |
| Restricted  stock issued to employees at $5.45 per share in May 2005                                                                         |       | 5,000                 |       | 5                       |       | —      |       | —          |       | (5             | )          | —          |       | —                 |       |
| Common  stock issued upon cashless exercise of warrants at $0.12 per share in August  2005                                                   |       | 48,378                |       | 48                      |       | —      |       | —          |       | (48            | )          | —          |       | —                 |       |
| Fair  value of common stock warrants issued for services                                                                                     |       | —                |       | —                  |       | —      |       | —          |       | 2,508,564      |       |            |       | 2,508,564              |       |
| Stock-based  employee compensation                                                                                                           |       | —                |       | —                  |       | —      |       | —          |       | 614,900        |       |            |       | 614,900                |       |
| Net  loss                                                                                                                                    |       | —                |       | —                  |       | —      |       | —          |       | —         |       | (5,724,418      | )          | (5,724,418             | )          |
| Balance, September 30, 2005                                                                                                                  |       | 27,441,472            |       | $                       | 27,441     |        | (3,000,000 | )               | $          | (1,500,000     | )          | $               | 23,218,868 |                   | $          | (9,598,202 | ) | $ | 12,148,107 |   |
| Comon  stock issued for cash at $0.12 per share upon exercise of employee stock  options in January 2006                                     |       | 53,750                |       | 54                      |       |        |       |            |       | 6,396          |       |            |       | 6,450                  |       |
| Common  stock issued upon cashless exercise of warrants at $2.00 per share in  February 2006                                                 |       | 9,721                 |       | 10                      |       |        |       |            |       | (10            | )          |            |       |                   |       |
| Restricted  stock issued to employee at $6.73 per share in January 2006                                                                      |       | 150,000               |       | 150                     |       |        |       |            |       | (150           | )          |            |       |                   |       |
| Common  stock issued upon cashless exercise of warrants at $2.00 per share in  February 2006                                                 |       | 176,458               |       | 176                     |       |        |       |            |       | (176           | )          |            |       |                   |       |
| Restricted  stock issued to employee at $5.87 per share in February 2006                                                                     |       | 20,000                |       | 20                      |       |        |       |            |       | (20            | )          |            |       |                   |       |
| Common  stock issued upon cashless exercise of warrants at $2.00 per share in March  2006                                                    |       | 66,000                |       | 66                      |       |        |       |            |       | (66            | )          |            |       |                   |       |
| Repurchase  of common stock at $3.85 per share in June 2006                                                                                  |       |                  |       |                    |       | (3,086      | )          | (11,817         | )          |           |       |            |       | (11,817                | )          |
| Restriced  stock issued to employee at $5.73 per share in June 2006                                                                          |       | 12,500                |       | 13                      |       |        |       |            |       | (13            | )          |            |       |                   |       |
| Restriced  stock issued to employee at $3.40 per share in June 2006                                                                          |       | 5,000                 |       | 5                       |       |        |       |            |       | (5             | )          |            |       |                   |       |
| Restriced  stock issued to employee at $3.40 per share in June 2006                                                                          |       | 10,000                |       | 10                      |       |        |       |            |       | (10            | )          |            |       |                   |       |
| Restriced  stock issued to employee at $3.40 per share in June 2006                                                                          |       | 5,000                 |       | 5                       |       |        |       |            |       | (5             | )          |            |       |                   |       |
| Restriced  stock issued to employee at $3.40 per share in June 2006                                                                          |       | 5,000                 |       | 5                       |       |        |       |            |       | (5             | )          |            |       |                   |       |
| Restriced  stock issued to employee at $3.40 per share in June 2006                                                                          |       | 5,000                 |       | 5                       |       |        |       |            |       | (5             | )          |            |       |                   |       |
| Common  stock issued upon cashless exercise of warrants at $2.00 per share in April  2006                                                    |       | 29,390                |       | 29                      |       |        |       |            |       | (29            | )          |            |       |                   |       |
| Common  stock issued for cash at $0.12 per share upon exercise of employee stock  options in July 2006                                       |       | 14,500                |       | 15                      |       |        |       |            |       | (15            | )          |            |       |                   |       |
| Restriced  stock issued to employee at $3.51 per share in July 2006                                                                          |       | 7,500                 |       | 8                       |       |        |       |            |       | (8             | )          |            |       |                   |       |
| Common  stock issued upon exercise of warrants at $2.00 per share in August 2006                                                             |       | 2,000                 |       | 2                       |       |        |       |            |       | (2             | )          |            |       |                   |       |
| Stock-based  employee compensation                                                                                                           |       | —                |       | —                  |       | —      |       | —          |       | 2,014,476      |       |            |       | 2,014,476              |       |
| Net  loss                                                                                                                                    |       | —                |       | —                  |       | —      |       | —          |       | —         |       | (10,189,587     | )          | (10,189,587            | )          |
| Balance, September 30, 2006                                                                                                                  |       | 28,013,291            |       | $                       | 28,014     |        | (3,003,086 | )               | $          | (1,511,817     | )          | $               | 25,239,221 |                   | $          | (19,787,789 | ) | $ | 3,967,629 |   |

 

The accompanying notes are an integral part of these statements.

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**PARTICLE DRILLINGTECHNOLOGIES, INC.(a development stage enterprise)CONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                   | ** ** | ** **                                  | ** **  | ** **     | ** ** | ** **             | ** ** | **Period from  June 9, 2003  (date of  inception) to** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------|-------------|----------------|------------|------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **Year Ended September 30,** | ** **  | ** **     | ** ** | **September 30,** | ** ** |
| ** **                                                                   | ** ** | **2006**                                    | ** **  | **2005**       | ** ** | **2004**               | ** ** | **2006**                                                                        | ** ** |
| ** **                                                                   | ** ** | ** **                                  | ** **  | **(Restated)** | ** ** | ** **             | ** ** | ** **                                                                      | ** ** |
| Cash flows from  operating activities:                                       |       |                                        |        |           |       |                   |       |                                                                            |       |
| Net loss                                                                     |       | $                                           | (10,189,587 | )              | $          | (5,724,418             | )          | $                                                                               | (3,331,000 | ) | $ | (19,787,789 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                        |        |           |       |                   |       |                                                                            |       |
| Gain on debt  extinguishment                                                 |       | —                                      |        | (35,283        | )          | —                 |       | (35,283                                                                         | )          |
| Other                                                                        |       | (54,103                                     | )           | —         |       | —                 |       | (54,103                                                                         | )          |
| Depreciation and  amortization expense                                       |       | 688,185                                     |        | 391,467        |       | 147,409                |       | 1,227,062                                                                       |       |
| Short-term note  issued for services                                         |       | —                                      |        | —         |       | 44,000                 |       | 44,000                                                                          |       |
| Common stock  issued for services                                            |       | —                                      |        | (66,500        | )          | 968,000                |       | 931,500                                                                         |       |
| Warrants issued  for services                                                |       | —                                      |        | 57,999         |       | 5,830                  |       | 63,829                                                                          |       |
| Stock-based  employee compensation                                           |       | 2,014,476                                   |        | 614,900        |       | 50,814                 |       | 2,680,190                                                                       |       |
| Changes in  operating assets and liabilities:                                |       |                                        |        |           |       |                   |       |                                                                            |       |
| (Increase)  Decrease in accounts receivable — related party             |       | —                                      |        | (42,330        | )          | —                 |       | (42,330                                                                         | )          |
| (Increase)  Decrease in prepaid expenses                                     |       | 249,460                                     |        | (68,428        | )          | (49,545                | )          | 131,487                                                                         |       |
| Decrease in  other current assets                                            |       | —                                      |        | —         |       | 7,500                  |       | —                                                                          |       |
| Increase  (Decrease) in accounts payable                                     |       | (226,181                                    | )           | 221,329        |       | 362,527                |       | 490,614                                                                         |       |
| Increase in  accrued liabilities                                             |       | 325,627                                     |        | 26,080         |       | 79,774                 |       | 568,260                                                                         |       |
|                                                                         |       |                                        |        |           |       |                   |       |                                                                            |       |
| Net cash used in  operating activities                                       |       | (7,192,123                                  | )           | (4,625,184     | )          | (1,714,691             | )          | (13,782,564                                                                     | )          |
|                                                                         |       |                                        |        |           |       |                   |       |                                                                            |       |
| Cash flows from  investing activities:                                       |       |                                        |        |           |       |                   |       |                                                                            |       |
| Payments to  purchase property and equipment                                 |       | (636,930                                    | )           | (1,167,134     | )          | (16,555                | )          | (1,820,619                                                                      | )          |
| Proceeds from  sale of property and equipment                                |       | —                                      |        | —         |       | 20,957                 |       | 20,957                                                                          |       |
| Payments to  purchase intangibles                                            |       | (178,170                                    | )           | (170,281       | )          | (185,468               | )          | (608,614                                                                        | )          |
| Payments to  purchase other assets                                           |       | (28,415                                     | )           | (385,839       | )          | (5,250                 | )          | (419,504                                                                        | )          |
| Payments issued  for note receivable                                         |       | —                                      |        | —         |       | (24,447                | )          | (300,783                                                                        | )          |
| Payments issued  for note receivable — related party                    |       | —                                      |        | —         |       | (56,783                | )          | (56,783                                                                         | )          |
|                                                                         |       |                                        |        |           |       |                   |       |                                                                            |       |
| Net cash used in  investing activities                                       |       | (843,515                                    | )           | (1,723,254     | )          | (267,546               | )          | (3,185,346                                                                      | )          |
|                                                                         |       |                                        |        |           |       |                   |       |                                                                            |       |
| Cash flows from  financing activities:                                       |       |                                        |        |           |       |                   |       |                                                                            |       |
| Proceeds from  issuance of common stock                                      |       | 6,089                                       |        | 18,647,666     |       | 1,746,196              |       | 20,981,855                                                                      |       |
| Repurchase of  common stock                                                  |       | (11,817                                     | )           | (1,500,000     | )          | —                 |       | (1,511,817                                                                      | )          |
| Proceeds from  issuance of convertible notes                                 |       | —                                      |        | —         |       | 553,500                |       | 553,500                                                                         |       |
| Repayments of  notes payable                                                 |       | (171,694                                    | )           | (314,945       | )          | (277,403               | )          | (764,042                                                                        | )          |
| Proceeds from  borrowings under loan agreements — related parties       |       | —                                      |        | —         |       | —                 |       | 23,195                                                                          |       |
| Repayment of  borrowings under loan agreements — related parties        |       | —                                      |        | —         |       | (23,195                | )          | (23,195                                                                         | )          |
|                                                                         |       |                                        |        |           |       |                   |       |                                                                            |       |
| Net cash  provided (used in) by financing activities                         |       | (177,422                                    | )           | 16,832,721     |       | 1,999,098              |       | 19,259,496                                                                      |       |
|                                                                         |       |                                        |        |           |       |                   |       |                                                                            |       |
| Net increase (decrease)  in cash and cash equivalents                        |       | (8,213,060                                  | )           | 10,484,283     |       | 16,861                 |       | 2,291,586                                                                       |       |
|                                                                         |       |                                        |        |           |       |                   |       |                                                                            |       |
| Cash and cash  equivalents — beginning of period                        |       | 10,504,646                                  |        | 20,363         |       | 3,502                  |       | —                                                                          |       |
| Cash and cash  equivalents - end of period                                   |       | $                                           | 2,291,586   |           | $          | 10,504,646             |       | $                                                                               | 20,363     |   | $ | 2,291,586 |   |
|                                                                         |       |                                        |        |           |       |                   |       |                                                                            |       |
| Supplemental  disclosures of cash flow information:                          |       |                                        |        |           |       |                   |       |                                                                            |       |
| Cash paid for  interest                                                      |       | $                                           | 12,339      |           | $          | 14,004                 |       | $                                                                               | 24,697     |   | $ | 51,040 |   |
|                                                                         |       |                                        |        |           |       |                   |       |                                                                            |       |
| Non-cash investing and  financing activities:                                |       |                                        |        |           |       |                   |       |                                                                            |       |
| Prepaid  insurance acquired with note payable                                |       | $                                           | 253,985     |           | $          | 51,000                 |       | $                                                                               | 60,990     |   | $ | 365,975 |   |
| Common stock  issued as consideration for account payable                    |       | —                                      |        | —         |       | 6,000                  |       | 6,000                                                                           |       |
| Common stock  issued as consideration for note payable                       |       | —                                      |        | —         |       | 50,000                 |       | 50,000                                                                          |       |
| Related party  note receivable exchanged for property and equipment          |       | —                                      |        | —         |       | 56,783                 |       | 56,783                                                                          |       |
| Note payable  converted into common stock                                    |       | —                                      |        | —         |       | 553,500                |       | 553,500                                                                         |       |
| Property and  equipment acquired with assumed liabilities                    |       | —                                      |        | —         |       | 479,610                |       | 479,610                                                                         |       |
| Intangibles  acquired with assumed liabilities                               |       | —                                      |        | —         |       | 757,792                |       | 757,792                                                                         |       |
| Property and  equipment acquired with note payable                           |       | 30,487                                      |        | —         |       | —                 |       | 30,487                                                                          |       |
| Short-term  investment reclassified from other assets                        |       | 385,839                                     |        | —         |       | —                 |       | 385,839                                                                         |       |
| Property and equipment  reclassified from other assets                       |       | 19,015                                      |        | —         |       | —                 |       | 19,015                                                                          |       |

 

The accompanying notes are anintegral part of these statements.

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**PARTICLEDRILLING TECHNOLOGIES, INC.(a development stage enterprise)NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS**

**1. ORGANIZATION AND NATURE OF BUSINESS**

Particle Drilling Technologies, Inc. (“PDTI”or the “Company”)is a Nevada corporation, formerly named MedXLink, Corp. (“MXLK”).  On January 14, 2005, Particle DrillingTechnologies, Inc., a Delaware corporation (“PDTI-DE”) merged with a subsidiaryof MXLK in a stock-for-stock transaction as a result of a merger and plan ofreorganization agreement between MXLK and PDTI-DE.  Pursuant to the above merger, MXLK assumedPDTI-DE’s operations and business plan and changed its name to ParticleDrilling Technologies, Inc.

PDTIis a development stage company engaged in the development of a proprietarydrilling system (“Particle Impact Drilling” or “PID”).  The PID technology is designed to increasethe rate-of-penetration in the drilling process, particularly in hard rockdrilling environments.  PDTI intends todevelop and exploit this technology by commercializing the PID system in theoil and gas industry.

PDTIis devoting substantially all of its efforts to product development,commercializing the technology and recruiting personnel. PDTI has substantiallyfunded its operations with proceeds from the issuance of common stock.  In the course of the development activities,PDTI has sustained operating losses and expects such losses to continue intofiscal 2007.  PDTI will finance itsoperations primarily through cash and cash equivalents on hand, futurefinancing from the issuance of debt or equity instruments and through thegeneration of revenues if commercial operations get underway.  However, the Company has yet to generate anyrevenues, and has no assurance of future revenues.  To management’s knowledge, no company has yetmarketed a salable product using the technology that is being developed by theCompany.  Even if marketing efforts aresuccessful, substantial time may pass before revenues are realized.  In management’s opinion, based on availablecash and cash equivalents on hand, PDTI has sufficient liquidity to meet itsworking capital and capital expenditure requirements for at least the nexttwelve months.

**2.  RESTATEMENT OF FINANCIAL STATEMENTS**

The historical information for the year endedSeptember 30, 2005, and for the period from June 9, 2003 (date of inception) toSeptember 30, 2005, have been restated after determining that the Company’spolicy of recording stock-based employee compensation upon vesting of theunderlying equity award was inconsistent with the guidelines set forth underStatements of Financial Accounting Standards (“SFAS”) No. 123(R), *Share-Based Payment*.

As a result of the restatement, net loss for the yearended September 30, 2005 and for the period from June 9, 2003 (date ofinception) to September 30, 2005 was increased by $437,350.

**3. SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

**Basisof Presentation**

Theaccompanying consolidated financial statements have been prepared in conformitywith accounting principles generally accepted in the United States ofAmerica.  Certain reclassifications havebeen made to conform prior period amounts to the current periodpresentation.  These reclassificationshad no effect on net loss, net loss per share or stockholders’ equity.

**ReverseAcquisition**

Forthe purposes of these consolidated financial statements, the merger of PDTI-DEinto MXLK was treated as a reverse acquisition. Pursuant to the guidance in Appendix B of SEC Accounting DisclosureRules and Practices Official Text, the merger of a private operating companyinto a non-operating public shell corporation with nominal net assets typicallyresults in the owners and management of the private company having actual oreffective operating control of the combined company after the transaction, withthe shareholders of the former public shell continuing only as passiveinvestors.  These transactions areconsidered by the staff of the Securities and Exchange Commission to be capitaltransactions in substance, rather than business combinations.  That is, the transaction is equivalent to theissuance of stock by the private company for the net monetary assets of theshell corporation, accompanied by a recapitalization.  Accordingly, the reverse acquisition has beenaccounted for as a recapitalization.  Foraccounting purposes, PDTI is considered the acquirer in the reverseacquisition.  The historical consolidatedfinancial statements are those of PDTI. Net loss per share for periods prior to the merger are restated toreflect the number of equivalent shares received by the acquiring company.

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**Principlesof Consolidation**

Theaccompanying consolidated financial statements include the accounts of theCompany and its subsidiary.  Allsignificant intercompany balances and transactions have been eliminated.

**Useof Estimates**

Thepreparation of consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities, disclosure of contingent assets and liabilities atthe date of the consolidated financial statements and the reported amounts ofrevenues and expenses during the reporting periods.  Actual results could differ from theseestimates.

**CashEquivalents**

Cashequivalents include highly liquid investments with a maturity of three monthsor less when acquired.

**FairValue of Financial Instruments**

Weinvest cash in excess of operating requirements in U.S. Money MarketFunds.  The carrying amounts reported inthe consolidated balance sheets for current assets and current liabilitiesapproximate fair value due to the short maturity of these items.

**Concentrationof Credit Risk**

Financialinstruments that potentially subject PDTI to a concentration of credit riskconsist of cash and cash equivalents. Cash and cash equivalents are depositedin demand in one financial institution in the United States.  Deposits held with financial institutions mayexceed the amount of insurance provided on such deposits.  PDTI has not experienced any material losseson its deposits of cash and cash equivalents.

**Propertyand Equipment**

Propertyand equipment are stated at cost. Depreciation is calculated using the straight-line method over theestimated useful lives of the assets, which ranges from three to fiveyears.  Leasehold improvements areamortized using the straight-line method over the estimated useful lives of theassets or the term of the lease, whichever is shorter.  Whenever assets are retired or otherwisedisposed of, the cost and related accumulated depreciation are removed from theaccounts, and any resulting gain or loss is recognized in income for theperiod.  The cost of maintenance andrepairs is expensed as incurred and any significant improvements that extendthe useful life of the assets are capitalized.

**IntangibleAssets**

Anintangible asset that is acquired either individually or with a group of otherassets (but not those acquired in a business combination) is initiallyrecognized and measured based on its fair value.  The costs of a group of assets acquired in atransaction other than a business combination are allocated to the individualassets acquired based on their relative fair values and are not consideredgoodwill.  The cost is measured based onthe fair value of the consideration given or the fair value of the net assetsacquired, whichever is more reliably measurable.  Intangible assets are amortized on astraight-line basis over the best estimate of their useful lives.  The amortization period and amortizationmethod are reviewed annually at each fiscal year-end.  Additional patent and application costs arecapitalized, and amortized over their useful lives once the patents are issued.

**Impairmentof Long-Lived Assets**

PDTIevaluates its long-lived assets for indicators of possible impairment bycomparison of the carrying amounts to future net undiscounted cash flowsexpected to be generated by such assets when events or changes in circumstancesindicate the carrying amount of an asset may not be recoverable.  Should 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.  PDTI also evaluates the capitalized costs forpatents and patent applications filed but not issued for possible impairments.PDTI has not identified any such impairment losses to date.

**OfferingExpense**

Offeringexpenses consist primarily of placement fees and expenses, professional feesand printing costs.  These expenses arecharged against the related proceeds from the sale of Company stock in theperiods in which they occur or charged to expense in the event of a terminatedoffering.

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**IncomeTaxes**

TheCompany follows Statements of Financial Accounting Standards (“SFAS”) No. 109*Accounting for Income Taxes*. Thisstatement requires an asset and liability approach for financial accounting andreporting for income tax purposes.  Thisstatement recognizes the amount of taxes payable or refundable for the currentyear and deferred tax liabilities and assets for future tax consequences ofevents that have been recognized in the consolidated financial statements ortax returns.  Provisions (benefits) forincome taxes result from permanent and temporary differences in the recognitionof accounting transactions for tax and financial reporting purposes.  Valuation allowances are established whennecessary to reduce deferred tax assets to the amount expected to be realized.

**Stock-BasedCompensation**

TheCompany follows SFAS No. 123(R), *Share-BasedPayment.*  This statementestablishes standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services.  It also addresses transactions in which anentity incurs liabilities in exchange for goods or services that are based onthe fair value of the entities equity instruments or that may be settled by theissuance of those equity instruments. This statement focuses primarily on accounting for transactions in whichan entity obtains employee services in share-based payment transactions.  This statement does not change the accountingguidance for share-based payment transactions with parties other than employeesprovided in SFAS No. 123 as originally issued.

**Researchand Development**

Thecosts of materials and equipment or facilities that are acquired or constructedfor research and development activities and that have alternative future usesare capitalized as tangible assets when acquired or constructed.  The cost of such materials consumed in researchand development activities and the depreciation of such equipment or facilitiesused in those activities are research and development costs.  However, the costs of materials, equipment,or facilities acquired or constructed for research and development activitiesthat have no alternative future uses are considered research and developmentcosts and are expensed at the time the costs are incurred.

**NetLoss Per Share**

TheCompany has presented basic and diluted net loss per share pursuant SFASNo. 128, *Earnings Per Share*.  In accordance with SFAS No. 128, basicand diluted net loss per share has been computed using the weighted-averagenumber of shares of common stock outstanding during the period.  Dilutive net loss per share would give affectto the dilutive effect of common stock equivalents consisting of options andwarrants.  Potentially dilutivesecurities have been excluded from the net loss per common share calculation asthe effects would be antidilutive. Potentially dilutive securities for the years ended September 30,2006, 2005 and 2004 that have been excluded are $1,276,624, $991,711 and $98,771,respectively.

Thefollowing is the calculation of basic and diluted weighted average sharesoutstanding and net loss per share for each of the years and periods endingSeptember 30:
| ** **                                       | ** ** | ** **                                  | ** **  | ** **             | ** ** | ** ** | ** ** | **Period from**       | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|-------------|------------------------|------------|------------|------------|----------------------------|------------|
| ** **                                       | ** ** | ** **                                  | ** **  | ** **             | ** ** | ** ** | ** ** | **June 9, 2003** | ** ** |
| ** **                                       | ** ** | ** **                                  | ** **  | ** **             | ** ** | ** ** | ** ** | **(date of**          | ** ** |
| ** **                                       | ** ** | **Year Ended September 30,** | ** **  | **inception) to** | ** ** |
| ** **                                       | ** ** | ** **                                  | ** **  | ** **             | ** ** | ** ** | ** ** | **September 30,**     | ** ** |
| ** **                                       | ** ** | **2006**                                    | ** **  | **2005**               | ** ** | **2004**   | ** ** | **2006**                   | ** ** |
| ** **                                       | ** ** | ** **                                  | ** **  | **(Restated)**         | ** ** | ** ** | ** ** | ** **                 | ** ** |
| Net loss  (numerator):                           |       |                                        |        |                   |       |       |       |                       |       |
| Net loss — basic and diluted                |       | $                                           | (10,189,587 | )                      | $          | (5,724,418 | )          | $                          | (3,331,000 | ) | $ | (19,787,789 | ) |
|                                             |       |                                        |        |                   |       |       |       |                       |       |
| Weighted average  shares (denominator):          |       |                                        |        |                   |       |       |       |                       |       |
| Weighted average shares — basic and diluted |       | 24,520,619                                  |        | 22,150,365             |       | 13,364,183 |       | 18,841,589                 |       |
|                                             |       |                                        |        |                   |       |       |       |                       |       |
| Net loss per  share:                             |       |                                        |        |                   |       |       |       |                       |       |
| Basic and  diluted                               |       | $                                           | (0.42       | )                      | $          | (0.26      | )          | $                          | (0.25      | ) | $ | (1.05 | ) |

 

**RecentAccounting Pronouncements**

InOctober 2005, the Financial Accounting Standards Board (“FASB”) issued FASBStaff Position (“FSP”) 13-1, Accounting for Rental Costs Incurred During aConstruction Period, to address the accounting for rental costs associated with

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operating leasesthat are incurred during a construction period. FSP 13-1 requires rental costs associated with ground or buildingoperating leases that are incurred during a construction period to berecognized as rental expense.  FSP 13-1is effective in fiscal years beginning after December 31, 2005.  The Company believes that the adoption of FSP13-1 will not have a material impact the Company’s financial position, resultsof operations or cash flows.

InFebruary 2006, the FASB issued SFAS No. 155, Accounting for Certain HybridFinancial Instruments — An Amendment of FASB Statements No. 133 and140.  SFAS No. 155 provides entities withrelief from having to separately determine the fair value of an embeddedderivative that would otherwise be required to be bifurcated from its hostcontract in accordance with SFAS No. 133. SFAS No. 155 allows an entity to make an irrevocable election to measuresuch a hybrid financial instrument at fair value in its entirety, with changesin fair value recognized in earnings. SFAS No. 155 is effective for all financial instruments acquired, issuedor subject to a remeasurement event occurring after the beginning of an entity’sfirst fiscal year that begins after September 15, 2006.  The Company believes that the adoption ofSFAS No. 155 will not have a material impact the Company’s financial position,results of operations or cash flows.

InMarch 2006, the FASB issued SFAS No. 156, Accounting for Servicing of FinancialAssets — An Amendment to FASB Statement No. 140.  Once effective, SFAS No. 156 will requireentities to recognize a servicing asset or liability each time they undertakean obligation to service a financial asset by entering into a servicingcontract in certain situations.  Thisstatement also requires all separately recognized servicing assets andservicing liabilities to be initially measured at fair value and permits a choiceof either the amortization or fair value measurement method for subsequentmeasurement.  The effective date of thisstatement is for annual periods beginning after September 15, 2006, withearlier adoption permitted as of the beginning of an entity’s fiscal yearprovided the entity has not issued any financial statements for that year.  The Company does not believe that it willhave a material impact on its financial position, results of operations or cashflows.

InJuly 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, Accounting for Uncertaintyin Income Taxes — An Interpretation of FASB Statement No. 109.  FIN No. 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, Accounting for 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 No. 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 No. 48.  The cumulative effect ofapplying the provisions of FIN No. 48 should be reported as an adjustment tothe opening balance of retained earnings (or other appropriate components ofequity or net assets in the statement of financial position) for that fiscalyear.  The provisions of FIN No. 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.  The Company believes that the adoption of FINNo. 48 will not have a material impact on its financial position, results ofoperations or cash flows.

InJuly 2006, the FASB issued FSP No. FAS 13-2, Accounting for a Change orProjected Change in the Timing of Cash Flows Relating to Income Taxes Generatedby a Leveraged Lease Transaction.  FSPNo. FAS 13-2 requires that changes in the projected timing of income tax cashflows generated by a leveraged lease transaction be recognized as a gain orloss in the year in which change occurs. The pretax gain or loss is required to be included in the same line itemin which the leveraged lease income is recognized, with the tax effect beingincluded in the provision for income taxes. FSP No. FAS 13-2 is effective for fiscal years beginning after December15, 2006.  The Company believes that theadoption of FSP No. FAS 13-2 will not have a material impact on its financialposition, results of operations or cash flows.

InSeptember 2006, the FASB issued SFAS No. 157, Fair Value Measurements.  SFAS No. 157 clarifies the principlethat fair value should be based on the assumptions market participants woulduse when pricing an asset or liability and establishes a fair value hierarchythat prioritizes the information used to develop those assumptions.  Under the standard, fair value measurementswould be separately disclosed by level within the fair value hierarchy.  SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years, with early adoption permitted.  The Company believes that the adoption of SFASNo. 157 will not have a material impact on its financial position, results ofoperations or cash flows.

InSeptember 2006, the FASB issued SFAS No. 158, Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plan — an amendment of FASB StatementNo. 87, 88, 106 and 132(R).  SFAS No. 158requires an employer to recognize the overfunded or underfunded status of adefined benefit postretirement plan as an asset or liability in its statementof financial position and recognize changes in the funded status in the year inwhich the changes occur.  SFAS No. 158 is

33

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effective forfiscal years ending after December 15, 2006. The Company believes that the adoption of SFAS No. 158 will not have amaterial impact on its financial position, results of operations or cash flows.

InSeptember 2006, the FASB issued FSP No. AUG AIR-1, Accounting for Planned MajorMaintenance Activities.  FSP No. AUGAIR-1 prohibits the use of the accrue-in-advance method for accounting formajor maintenance activities and confirms the acceptable methods of accountingfor planned major maintenance activities. FSP No. AUG AIR-1 is effective the first fiscal year beginning afterDecember 15, 2006.  The Company believesthat the adoption of FSP No. AUG AIR-1 will not have a material impact on itsfinancial position, results of operations or cash flows.

In September 2006, the SEC issued SAB 108, “Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements”**(“SAB 108”)*.*SAB 108 provides interpretiveguidance on how the effects of the carryover or reversal of prior yearmisstatements should be considered in quantifying a current year misstatement.The pronouncement prescribes an approach whereby the effect of all unrecordedidentified errors should be considered on all of the financial statementsrather than just either the effect on the balance sheet or the incomestatement. The Company will adopt the provisions of SAB 108 beginning in fiscal2007. The adoption of SAB 108is not expected to have a material impact on theCompany’s Consolidated Financial Statements.

**4. PROPERTY AND EQUIPMENT**

Thefollowing is a summary of property and equipment, at cost less accumulateddepreciation, at September 30:

|                                      | ** ** | **2006**   | ** ** | **2005**  | ** ** |
|--------------------------------------|------------|------------|------------|-----------|------------|
|                                 |       |       |       |      |       |
| Office furniture  and equipment      |       | $          | 227,372    |      | $          | 200,360 |   |
| Machines and  equipment              |       | 1,869,586  |       | 1,530,665 |       |
|                                 |       |       |       |      |       |
| Total cost of property and equipment |       | 2,096,958  |       | 1,731,025 |       |
|                                 |       |       |       |      |       |
| Construction in  Progress            |       | 320,499    |       | —    |       |
|                                 |       |       |       |      |       |
| Less: accumulated  depreciation      |       | (1,090,744 | )          | (453,043  | )          |
|                                 |       |       |       |      |       |
| Total property  and equipment, net   |       | $          | 1,326,713  |      | $          | 1,277,982 |   |

 

Forthe years ended September 30, 2006, 2005 and 2004, depreciation expensetotaled $637,701, $340,977 and $112,066, respectively.

**5. INTANGIBLE ASSETS**

Thefollowing is a summary of intangibles, at cost less accumulated amortization,at September 30:

|                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
|                            |       |     |       |     |       |
| Intangibles, at  cost           |       | $        | 1,366,403  |     | $          | 1,188,236 |   |
| Less:  accumulated amortization |       | (136,317 | )          | (85,833  | )          |
|                            |       |     |       |     |       |
| Total  intangibles, net         |       | $        | 1,230,086  |     | $          | 1,102,403 |   |

 

Duringfiscal years 2006 and 2005, the Company incurred direct cost of $178,163 and$170,281, respectively, for patents filed but not issued.

Theestimated amortization expense for each of the five succeeding years followingSeptember 30, 2006 is $50,000.

Forthe years ended September 30, 2006, 2005 and 2004, amortization expensetotaled $50,484, $50,490 and $35,343, respectively.

**6. SHORT-TERM NOTES**

Thefollowing is a table of PDTI’s short-term obligations at September 30:

34

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|                                                                                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                           |       |     |       |     |       |
| Short-term note  at 6.13% interest, unsecured with monthly principal and interest payments of  $26,117         |       | 179,143  |       | —   |       |
|                                                                                                           |       |     |       |     |       |
| Short-term note  at prime plus 2% interest, unsecured with monthly principal payments of  $5,000 plus interest |       | —   |       | 40,000   |       |
|                                                                                                           |       |     |       |     |       |
| Short-term note  at 6.5% interest, unsecured with monthly principal and interest payments of  $5,821           |       | —   |       | 39,880   |       |
|                                                                                                           |       |     |       |     |       |
| Total short-term  notes payable                                                                                |       | $        | 179,143    |     | $          | 79,880 |   |
|                                                                                                                |            |          |            |          |            |  |  |

 

**7.  ACCRUED LIABILITIES**

Accrued liabilities consist of thefollowing at September 30:

|                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
|                              |       |     |       |     |       |
| Payroll and  related expenses     |       | $        | 352,592    |     | $          | 4,449 |   |
| General and  administrative       |       | —   |       | 21,846   |       |
| Rent                              |       | —   |       | 57,450   |       |
| Professional  fees                |       | 26,907   |       | 2,154    |       |
| Audit fees                        |       | 8,624    |       | 112,000  |       |
| Research and  development expense |       | 67,476   |       | 33,243   |       |
| Accrued capital  costs            |       | 15,864   |       | 11,491   |       |
|                              |       |     |       |     |       |
| Total accrued  liabilities        |       | $        | 471,463    |     | $          | 242,633 |   |

 

**8. LONG-TERM DEBT**

Long-term debt consists of the followingat September 30:

|                                                                                                                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                              |       |     |       |     |       |
| Note payable to  a bank in monthly installments of $974, including interest at 6.25%, due in  July 2007, secured by a vehicle     |       | $        | 9,473      |     | $          | 21,060 |   |
|                                                                                                                              |       |     |       |     |       |
| Note payable to  a bank in monthly installments of $954, including interest at 7.90%, due in  February 2009, secured by a vehicle |       | 25,102   |       | —   |       |
|                                                                                                                              |       |     |       |     |       |
| Less: current  portion                                                                                                            |       | (19,270  | )          | (11,597  | )          |
|                                                                                                                              |       |     |       |     |       |
| Total long-term  debt                                                                                                             |       | $        | 15,305     |     | $          | 9,463 |   |

 

**9. COMMON STOCK**

Allcommon stock sold or issued in exchange for services included an anti-dilutionprovision with the exception of the founders’ shares, the 5,000,000 shares ofcommon stock issued in June 2004 to PDTI’s financial advisors, and shares ofcommon stock issued in exchange for warrants. In June 2004, all shareholders whose shares included an anti-dilutionprovision agreed to exchange the anti-dilution provision for registrationrights, thereby eliminating the anti-dilution provision.

At September 30, 2006 and 2005, the Company had25,010,205 and 24,441,472 shares of common stock outstanding,respectively.  Common stock reserved forissuance consists of the following at September 30:

|                                                      | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                 |       |      |       |      |       |
| Exercise of  stock options                           |       | 4,267,000 |       | 3,915,000 |       |
| Exercise of  warrants                                |       | 1,265,141 |       | 1,678,000 |       |
| Future grants of  stock options and restricted stock |       | 599,250   |       | 1,230,000 |       |
|                                                 |       |      |       |      |       |
| Total common  stock reserved for issuance            |       | 6,131,391 |       | 6,823,000 |       |

 

35

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**10. TREASURY STOCK**

In June 2006, the Board of Directors authorized therepurchase of 3,086 shares of the Company’s common stock at $3.83 per sharefrom Thomas Hardisty, PDTI’s Vice President and Director of BusinessDevelopment.  As of the year ended 2006and 2005, the Company had a treasury stock balance of $1,511,817 and $1,500,000respectively.

During the year ended September 30, 2006, we made thefollowing 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** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | ** **                                                     | ** ** | ** **                                                 | ** ** | ** **                                                                                                                                   | ** ** | ** **                                                                                                                                                                                                  | ** ** |
| October 1, 2005  to   September 30, 2006(1) |       | 3,086                                                          |       | $                                                          | 3.83       |                                                                                                                                         | —     |                                                                                                                                                                                                        | —     |   |
|                                        |       |                                                           |       |                                                       |       |                                                                                                                                         |       |                                                                                                                                                                                                        |       |
| Total                                       |       | 3,086                                                          |       |                                                       |       | —                                                                                                                                       |       | —                                                                                                                                                                                                      |       |
|                                             |            |                                                                |            |                                                            |            |                                                                                                                                              |            |                                                                                                                                                                                                             |            |  |

----

(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.

**11. STOCK OPTIONS AND WARRANTS**

**StockOptions**

InMarch 2005, the Board of Directors adopted the 2005 Stock Incentive Plan(the “2005 Plan”).  The 2005 Plan provides the issuance of incentive stockoptions, non-statutory stock options and restricted stock grants to directors,employees and consultants of PDTI.  Provisions under the 2005 Plan allowfor the issuance of options and restricted stock awards to purchase or issue upto 2,000,000 shares of common stock.  As of September 30, 2006, theCompany had 488,000 shares of common stock available for issuance pursuant to awardsunder the 2005 Plan.  Under the 2005Plan, the exercise price of each option equals the market value of the Company’scommon stock on the date of grant and the maximum term for the options is tenyears.

InApril 2004, the Board of Directors adopted the 2004 Stock Incentive Plan(the “2004 Plan”).  The 2004 Planprovides the issuance of incentive stock options, non-statutory stock optionsand restricted stock to directors, employees and consultants of PDTI.Provisions under the 2004 Plan allow for the issuance of up to 3,500,000 sharesof common stock pursuant to awards under this plan.  As of September 30, 2006, the Companyhad 111,250 awards available for grant under the 2004 Plan. Under the 2004Plan, the exercise price of each option equals the market value of the Company’scommon stock on the date of grant and the maximum term for the options is tenyears.

Stock-basedemployee compensation expense recorded for awards issued under the 2004 Planand the 2005 Plan for the years ended September 20, 2006 and 2005 was$2,014,476 and $614,900, respectively. Stock-based employee compensation expense for awards issued under the2004 Plan and the 2005 Plan since inception (June 9, 2003) to September 30,2006 was $2,680,551.

**Warrants**

InOctober 2004, PDTI issued warrants to purchase 33,333 shares of theCompany’s common stock at $0.01 per share.  The warrants were issued to afinancial advisor for services provided.  The Company recorded an expenseof $58,000 using the Black-Scholes option pricing model.

Inconnection with a private placement that commenced in April 2004 andcompleted in January 2005, PDTI issued warrants, in January 2005, topurchase 65,500 shares of the Company’s common stock to certain personsassociated with the Placement Agent of this private placement.  Offeringexpense recorded for these warrants was $80,565.  The related expense wasa direct cost of the associated financing and was therefore charged directly tostockholders’ equity.  Each warrant has an exercise price of $2.00 pershare with a maximum term of five years.  The fair value of each warrantgranted is estimated as of the grant date using the Black-Scholes optionpricing model.

36

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Inconnection with a private placement that was completed February 9, 2005,PDTI issued warrants, in February 2005, to purchase 1,500,000 shares ofthe Company’s common stock to certain persons associated with the PlacementAgent of this private placement.  Offering expense recorded for thesewarrants was $2,370,000.  The related expense was a direct cost of the associatedfinancing and was therefore charged directly to stockholders’ equity. Each warrant has an exercise price of $2.00 per share with a maximum term often years.  The fair value of each warrant granted is estimated as of thegrant date using the Black-Scholes option pricing model.

Duringfiscal year 2004, PDTI issued warrants to purchase 323,909 of the Company’scommon stock to consultants. The exercise price of each warrant equals themarket value of the Company’s common stock on the date of grant and the maximumterm for the warrants is five years. For the fiscal year endedSeptember 30, 2004, compensation expense recorded for these warrants was$5,830.

TheCompany did not have any stock option or stock warrant activity for the periodfrom June 9, 2003 (date of inception) to September 30, 2003;therefore, no compensation expense was recorded for this period.

**SummarizedInformation for Stock Options and Warrants**

Thefollowing is a summary of all stock option and warrant activity for fiscalyears 2006 and 2005:

|                                    | ** ** | **Number of  Shares  Underlying  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Shares  Underlying  Warrants** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------|------------|
| Outstanding at  September 30, 2004 |       | 2,655,000                                       |       | $                                      | 0.12       |                                             | 160,000    |                                   | $          | 0.12 |   |
|                               |       |                                            |       |                                   |       |                                             |       |                                   |       |
| Granted                            |       | 1,270,000                                       |       | 3.60                                   |       | 1,611,333                                        |       | 1.97                                   |       |
| Exercised                          |       | —                                          |       | —                                 |       | (91,025                                          | )          | 0.08                                   |       |
| Forfeited                          |       | (10,000                                         | )          | 4.90                                   |       | (2,308                                           | )          | 0.12                                   |       |
|                               |       |                                            |       |                                   |       |                                             |       |                                   |       |
| Outstanding at  September 30, 2005 |       | 3,915,000                                       |       | $                                      | 1.24       |                                             | 1,678,000  |                                   | $          | 1.90 |   |
|                               |       |                                            |       |                                   |       |                                             |       |                                   |       |
| Granted                            |       | 616,500                                         |       | 4.81                                   |       | —                                           |       | —                                 |       |
| Exercised                          |       | (68,750                                         | )          | 0.12                                   |       | (412,859                                         | )          | 1.85                                   |       |
| Forfeited                          |       | (195,750                                        | )          | 3.86                                   |       | —                                           |       | —                                 |       |
|                               |       |                                            |       |                                   |       |                                             |       |                                   |       |
| Outstanding at  September 30, 2006 |       | 4,267,000                                       |       | $                                      | 1.66       |                                             | 1,265,141  |                                   | $          | 1.91 |   |
|                               |       |                                            |       |                                   |       |                                             |       |                                   |       |
| Exercisable at  September 30, 2006 |       | 2,980,000                                       |       | $                                      | 0.79       |                                             | 1,265,141  |                                   | $          | 1.91 |   |
|                               |       |                                            |       |                                   |       |                                             |       |                                   |       |

 

Theweighted average fair value of an option to purchase one share of common stockgranted during fiscal years 2006 and 2005 was $3.49 and $2.37,respectively.  The fair value of eachstock option and warrant granted is estimated as of the date of grant using theBlack-Scholes option pricing model with the following weighted averageassumptions:

| ** **               | ** ** | **Weighted Average  Assumption for  Options Granted** | ** ** | **Weighted Average  Assumption for  Warrants Granted** | ** ** |
|--------------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                             | ** ** | **2005**                                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|                     |       |                                                                 |       |                                                                  |       |   |   |   |   |
| Risk-free  interest rate |       | 4.4%                                                                 |       | 4.0%                                                                  |       | N/A |   | 3.9% |   |
|                     |       |                                                                 |       |                                                                  |       |   |   |   |   |
| Expected  volatility     |       | 75.0%                                                                |       | 40.4%                                                                 |       | N/A |   | 69.8% |   |
|                     |       |                                                                 |       |                                                                  |       |   |   |   |   |
| Dividend yield           |       | None                                                                 |       | None                                                                  |       | N/A |   | None |   |
|                     |       |                                                                 |       |                                                                  |       |   |   |   |   |
| Expected life            |       | 9.3 years                                                            |       | 7.8 years                                                             |       | N/A |   | 9.6 years |   |

 

The following table summarizesinformation about stock options outstanding and exercisable at September 30,2006:
| **Options Outstanding**           | ** ** | **Options Exercisable**                    | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|
| **Range of  Exercise Price** | ** ** | **Number of  Shares  Underlying  Options** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Shares  Underlying  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                                   |       |                                            |       |   |   |   |   |   |   |   |   |
| $0.12 to $1.75                         |       | 3,110,000                                       |       | 7.6 years |   | $ | 0.44 |   | 2,747,500 |   | $ | 0.44 |   |
| $4.50 to $6.73                         |       | 1,157,000                                       |       | 9.0 years |   | $ | 4.89 |   | 232,500 |   | 4.90 |   |
|                                   |       | 4,267,000                                       |       | 8.0 years |   | $ | 1.66 |   | 2,980,000 |   | $ | 0.79 |   |

 

37

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The following table summarizesinformation about warrants outstanding and exercisable at September 30, 2006:
| **Warrants Outstanding**          | ** ** | **Warrants Exercisable**                    | ** ** |
|----------------------------------------|------------|--------------------------------------------------|------------|
| **Range of  Exercise Price** | ** ** | **Number of  Shares  Underlying  Warrants** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Shares  Underlying  Warrants** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                                   |       |                                             |       |   |   |   |   |   |   |   |   |
| $0.12 to $3.00                         |       | 1,265,141                                        |       | 7.8 years |   | $ | 1.91 |   | 1,265,141 |   | $ | 1.91 |   |
|                                        |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

The following table presents informationabout stock options and warrants granted during the year where the exerciseprice of some stock options and warrants differed from the market price of theCompany’s stock on the grant date:

|                                          | ** ** | **Number of  Shares  Underlying  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Shares  Underlying  Warrants** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------|------------|
|                                     |       |                                            |       |                                   |       |                                             |       |                                   |       |
| Year ended  September 30, 2006           |       |                                            |       |                                   |       |                                             |       |                                   |       |
| Exercise price equals market value       |       | 616,500                                         |       | $                                      | 4.89       |                                             | —     |                                   | $          | — |   |
| Exercise price greater than market value |       | —                                          |       | —                                 |       | —                                           |       | —                                 |       |
| Exercise price less than market value    |       | —                                          |       | —                                 |       | —                                           |       | —                                 |       |
|                                     |       |                                            |       |                                   |       |                                             |       |                                   |       |
|                                     |       | 616,500                                         |       | $                                      | 4.89       |                                             | —     |                                   | $          | — |   |
|                                     |       |                                            |       |                                   |       |                                             |       |                                   |       |
| Year ended  September 30, 2005           |       |                                            |       |                                   |       |                                             |       |                                   |       |
| Exercise price equals market value       |       | 1,270,000                                       |       | $                                      | 3.60       |                                             | 1,565,500  |                                   | $          | 2.00 |   |
| Exercise price greater than market value |       | —                                          |       | —                                 |       | 12,500                                           |       | 3.00                                   |       |
| Exercise price less than market value    |       | —                                          |       | —                                 |       | 33,333                                           |       | 0.01                                   |       |
|                                     |       |                                            |       |                                   |       |                                             |       |                                   |       |
|                                     |       | 1,270,000                                       |       | $                                      | 3.60       |                                             | 1,611,333  |                                   | $          | 1.97 |   |

 

**12. INCOME TAXES**

Forthe period ended September 30, 2006, there were permanent and temporary differencesof approximately $100,000 and $1,008,000, respectively, which decreased the taxloss for the current year.

AtSeptember 30, 2006, the Company has cumulative net operating loss carryforwardsof approximately $18,567,696 which expire in years 2007 through 2025.  No effect has been shown in the consolidatedfinancial statements for the net operating loss carryforwards as the likelihoodof future tax benefit from such net operating loss carryforwards is notdeterminable at this time.  Accordingly,the potential tax benefits of the net operating loss carryforwards, estimatedbased upon current tax rates at September 30, 2006, have been offset byvaluation reserves of the same amount. The valuation allowance increased $3,430,454 from September 30,2005 to September 30, 2006.

Deferredtax assets consisted of the following at September 30:

|                                 | ** ** | **2006**   | ** ** | **2005**       | ** ** |
|---------------------------------|------------|------------|------------|----------------|------------|
| ** **                      | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| Deferred tax  asset:            |       |       |       |           |       |
| Net operating loss carryforward |       | $          | 6,313,017  |           | $          | 3,225,244 |   |
| Intangibles                     |       | 31,296     |       | 31,296         |       |
| Stock warrants exercised        |       | 834,807    |       | 834,807        |       |
| Stock-based compensation        |       | 817,109    |       | 190,401        |       |
| Deferred tax  liability:        |       |       |       |           |       |
| Stock Warrants                  |       | (203,351   | )          | —         |       |
| Intangibles                     |       | (201,212   | )          | (55,002        | )          |
| Property and equipment          |       | (39,382    | )          | (104,916       | )          |
|                            |       |       |       |           |       |
| Deferred tax asset              |       | 7,552,284  |       | 4,121,830      |       |
|                            |       |       |       |           |       |
| Valuation  allowance            |       | (7,552,284 | )          | (4,121,830     | )          |
|                            |       |       |       |           |       |
| Net deferred tax  asset         |       | $          | —     |           | $          | — |   |

 

38

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Due to the losses that haveoccurred since the Company’s inception, no statutory rate reconciliation of theCompany’s tax rate is disclosed nor discussed within this footnote.

**13.COMMITMENTS AND CONTINGENCIES**

**LeaseCommitments**

Rent expense with respect to our lease commitmentsfor the year ended September 30, 2006 was $135,240.  The Company is obligated undernon-cancellable operating leases for PDTI’s office space and commercialoperating facility in Houston, Texas. Future minimum payments required under these leases as of September 30,2006 are as follows:

| Year Ending September 30: | ** ** | ** ** | ** ** |
|------------------------------------------|------------|------------|------------|
| 2007                                     |       | $          | 135,240    |   |
| 2008                                     |       | —     |       |
| 2009                                     |       | —     |       |
| 2010                                     |       | —     |       |
| 2011                                     |       | —     |       |
|                                     |       |       |       |
| Total minimum  lease payments            |       | $          | 135,240    |   |

 

**RoyaltyAgreements**

InJanuary 2004, PDTI entered into a Royalty Agreement with PSI whereby PDTIwill be required to pay PSI a royalty on a quarterly basis equal to 18% of theearnings 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 aRoyalty Agreement in January 2004 with PSIL whereby PDTI will be requiredto pay PSIL a royalty on a quarterly basis equal to 2% of EBITDA derived fromthe use of the PID technology, until an aggregate of $7,500,000 has beenpaid.  In addition, PDTI will be requiredto pay CCORE, PSI and PSIL a royalty equal to 1.6%, 1.2% and 1.2%,respectively, of PDTI’s quarterly gross revenue derived from the use of the PIDtechnology.  PDTI has no revenues orEBITDA; therefore no royalties have been paid or accrued as ofSeptember 30, 2006.

**CapitalCommitments**

TheCompany placed a down payment on a new frac pump in fiscal 2006 in the amountof $320,499.  The remaining balance ofapproximately $930,000 is expected to be paid in fiscal 2007.

**Litigation**

TheCompany may in the future be involved as a party to various legal proceedings,which are incidental to the ordinary course of business.  The Company regularly analyzes currentinformation and, as necesay, provides accruals for probable liabilities on theeventual disposition of these matters. In the opinion of management and legal counsel, as of September 30,2006, there were no threatened or pending legal matters that would have amaterial impact on the Company's results of operations, financial position orcash flows.

**14. SUBSEQUENT EVENTS**

OnOctober 19, 2006, the Company completed the sale of 5.0 million shares of itscommon stock to institutional and other accredited investors at $2.35 pershare. The Company received gross proceeds of $11.75 million, which we intendto use to manufacture additional PID Systems, to hire and train qualifiedpersonnel, to fund the development of a new particle injection system, to fundadditional research and development, for general corporate purposes and forexpenses associated with the offering.

Inaddition, the investors received warrants to purchase 1.5 million shares of theCompany’s common stock with an exercise price of $3.25 per share. The warrantswill be exercisable commencing on April 22, 2007 and will expire on October 19,2011. The Company has valued these warrants at $2,835,000 using theblack-scholes option pricing model and this amount will be charged toshareholders equity in the first quarter of fiscal 2007.

39

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**PARTICLEDRILLING TECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

**SUPPLEMENTALINFORMATION TO CONSOLIDATED FINANCIAL STATEMENTS**

**SUMMARIZEDQUARTERLY FINANCIAL DATA**

**(Unaudited)**

 
| ** **                              | ** ** | **Fiscal 2006 Quarter Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------------------|------------|
| ** **                              | ** ** | **December 31**                         | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September 30** | ** ** | **Year** | ** ** |
|                                    |       |                                         |       |   |   |   |   |   |   |   |   |
| Year ended September  30, 2006:         |       |                                         |       |   |   |   |   |   |   |   |   |
| Revenues                                |       | $                                            | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Gross profit                            |       | —                                       |       | — |   | — |   | — |   | — |   |
| Loss from  operations                   |       | (2,276,447                                   | )          | (2,829,316 | ) | (2,893,742 | ) | (2,546,537 | ) | (10,546,042 | ) |
| Net loss                                |       | (2,167,983                                   | )          | (2,676,907 | ) | (2,830,545 | ) | (2,514,152 | ) | (10,189,587 | ) |
| Net loss per  share - basic and diluted |       | $                                            | (0.09      | ) | $ | (0.11 | ) | $ | (0.11 | ) | $ | (0.11 | ) | $ | (0.42 | ) |

 

 
| ** **                              | ** ** | **Fiscal 2005 Quarter Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------------------|------------|
| ** **                              | ** ** | **December 31**                         | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September 30** | ** ** | **Year** | ** ** |
| ** **                              | ** ** | ** **                                   | ** ** | ** ** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Year ended September  30, 2005:         |       |                                         |       |   |   |   |   |   |   |   |   |
| Revenues                                |       | $                                            | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Gross profit                            |       | —                                       |       | — |   | — |   | — |   | — |   |
| Loss from  operations                   |       | (876,193                                     | )          | (1,228,197 | ) | (1,715,917 | ) | (2,164,161 | ) | (5,984,468 | ) |
| Net loss                                |       | (882,745                                     | )          | (1,159,730 | ) | (1,631,673 | ) | (2,050,270 | ) | (5,724,418 | ) |
| Net loss per share -  basic and diluted |       | $                                            | (0.05      | ) | $ | (0.05 | ) | $ | (0.07 | ) | $ | (0.09 | ) | $ | (0.26 | ) |

 

**Item9.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

None

**Item9A.  Controls and Procedures**

**DisclosureControls and Procedures**

As ofthe end of the period covered by this report, we carried out an evaluation,under the supervision and with the participation of our principal executive andprincipal financial officers, of the effectiveness of the design and operationof our disclosure controls and procedures (as defined in Rule 13a-15(e) of theSecurities Exchange Act of 1934).  Basedupon that evaluation, our principal executive and principal financial officersconcluded that our disclosure controls and procedures were effective as ofSeptember 30, 2006.

**Management’sReport on Internal Control over Financial Reporting and Report of IndependentRegistered Public Accounting Firm**

Theinformation required to be furnished pursuant to this item is set forth under thecaptions “Management’s Report on Internal Control over Financial Reporting” and“Report of Independent Registered Public Accounting Firm” in Item 8 of thisreport.

**Changesin Internal Control over Financial Reporting**

As ofthe end of the period covered by this report, we carried out an evaluation,under the supervision and with the participation of our principal executive andprincipal financial officers, of our internal control over financial reportingto determine whether any changes occurred during the fourth quarter of fiscal2006 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.  Based on that evaluation, there were nochanges in our internal control over financial reporting or in other factorsthat have materially affected or are reasonably likely to materially affect ourinternal control over financial reporting.

**Item9B.  Other Information**

NoneApplicable

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**PART III**

**Item10.   Directors and Executive Officers of the Registrant**

Thefollowing table shows information regarding our directors and executiveofficers. All of the persons named below other than Mr. Weyel became officersand directors of our company in January 2005, following our acquisition ofPDTI.  Mr. Weyel became a director of ourcompany in May 2005.

 
| **Name**                    | ** ** | **Age**    | ** ** | **Position with PDTI**                                        | ** ** |
|-----------------------------|------------|------------|------------|---------------------------------------------------------------|------------|
| ** **                  | ** ** | ** ** | ** ** | ** **                                                    | ** ** |
| Ken R. LeSuer               |       | 70         |       | Chairman of the Board and Director                            |       |
| Jim B. Terry                |       | 53         |       | President, Chief Executive Officer and Director               |       |
| J. Chris Boswell            |       | 45         |       | Senior Vice President, Chief Financial Officer and  Treasurer |       |
| Thomas E.  Hardisty         |       | 45         |       | Senior Vice President of Corporate Development and  Secretary |       |
| Gordon Tibbitts             |       | 59         |       | Vice President of Technology                                  |       |
| John D.  Schiller, Jr. |       | 47         |       | Director                                                      |       |
| Michael S.  Mathews         |       | 66         |       | Director                                                      |       |
| Hugh A. Menown              |       | 48         |       | Director                                                      |       |
| Steve A. Weyel              |       | 52         |       | Director                                                      |       |

 

**KenR. LeSuer**  was electedChairman of PDTI in December 2004 after serving as Vice Chairman of PDTIsince June 2004. Mr. LeSuer retired in 1999 as Vice Chairman ofHalliburton Company. Since his retirement from Halliburton in 1999,Mr. LeSuer has been a private investor. Prior to becoming the ViceChairman of Halliburton in May 1997, Mr. LeSuer served as both thePresident and CEO of Halliburton Energy Services from March 1994 to September 1996and as President and CEO of Halliburton Energy Group from September 1996to May 1997. He also served as President and CEO of three Halliburtonunits during his tenure. Mr. LeSuer began his career with Halliburton asan engineer-in-training in 1959. From 1965 through 1982, he served inmanagerial positions in Asia Pacific and Europe/Africa and was serving as vicepresident of Europe/Africa before returning to Duncan, Oklahoma to assume theposition of vice president of International Operations in 1982.

Mr. LeSuer isa member of the Texas A&M University Petroleum Engineering Industry Board,as well as the TAMU Dwight Look College of Engineering External Advisory andDevelopment Council. He has served as Vice President Services Division of theInternational Association of Drilling Contractors, and is or at one time was amember of numerous petroleum and geological engineering societies, includingthe Society of Petroleum Engineers, the American Petroleum Institute, theNational Ocean Industries Association, and the Petroleum Equipment SuppliersAssociation. Mr. LeSuer received his bachelor’s degree in petroleumengineering from Texas A&M University in 1959. Mr. LeSuer is also adirector of Horizon Offshore, Inc. (NNM: HOFF).

**JimB. Terry**  has served asour President and Chief Executive Officer since January 23, 2006. FromJanuary 2003 until September 2005, Mr. Terry served as VicePresident, Drilling Services for Weatherford International, one of the largestglobal providers of innovative mechanical solutions, technology and servicesfor the drilling and production sectors of the oil and gas industry, where heled the effort to consolidate, develop and improve the performance of wellconstruction products and services by strategically aligning synergisticproduct lines in order to improve both their financial and operationalperformance. His duties at Weatherford included responsibility for all phasesof new product and service development from inception throughcommercialization, which in some cases included securing project funding fromcustomers. From September 2005 to January 2006, Mr. Terry served as aconsultant to the oil and gas drilling services industry.

FromMarch 1994 until January 2003, Mr. Terry was employed byHalliburton Company, the last three of those years as Director—Advanced WellConstruction Systems where he was the lead inventor of a step change advancedwell construction system. During this time, he was responsible for all phasesof this project which included research and development, engineering, prototyping,field trials and commercialization. During his first six years at Halliburton,he served in various management capacities ranging from new productintroduction to regional operations management. During this time he wasresponsible for, among other things, much of Halliburton’s consolidation effortfollowing its acquisition of Smith International’s Drilling Services Division.

Prior to joiningHalliburton in March 1994, Mr. Terry served as Regional VicePresident for Smith International in Singapore. He was responsible for all ofSmith’s activities in the Asia Pacific, Middle East and East Africa regions.

Mr. Terry beganhis career at Eastman Whipstock, which was acquired by Baker Hughes in 1990.Following Baker Hughes’ acquisition of Eastman Whipstock in 1990, Mr. Terryjoined Smith International.

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Mr. Terrygraduated in 1978 from San Francisco State University with a BA in Business andis a member of the Society of Petroleum Engineers.

**J.Chris Boswell** hasserved as Senior Vice President and Chief Financial Officer of PDTI sinceJune 2004. Mr. Boswell had previously served as Director and SeniorVice President and Chief Financial Officer of Particle Drilling, Inc. fromAugust 2003 until it was merged into PDTI in June 2004. He alsoserved as a Director of PDTI from June 2004 until March 2006. FromOctober 2002 until August 2003, Mr. Boswell was a privateinvestor. Mr. Boswell has over 20 years of experience in financialmanagement focused in the energy industry and began his career as a CertifiedPublic Accountant at Arthur Andersen & Co. and later served inmanagement positions with Price Waterhouse in Houston, Texas. He served asSenior Vice President and Chief Financial Officer of Petroleum Geo-Services ASA(“PGS”) from December 1995 until October 2002. PGS grew from a smallenterprise in 1994 when Mr. Boswell joined the company to a$1 billion annual revenue enterprise with a peak enterprise value of$6 billion. Subsequent to Mr. Boswell’s departure and following achange of control within PGS, the new management of PGS filed for bankruptcyprotection in July 2003 in order to restructure PGS’s debt portfolio. Therestructuring was successfully completed and PGS emerged from bankruptcy inOctober 2003. In all, during his tenure as CFO at PGS, Mr. Boswelldirected financings for over $3 billion of capital expenditures tofacilitate PGS’ growth. Additionally during 1995, Mr. Boswell and othersenior executives at PGS developed the concept to create a unique oil and gascompany using a non-exclusive license in PGS’ seismic data library as seedcapital. This company became Spinnaker Exploration company (NYSE: SKE), whichwas recently sold to Norsk Hydro ASA (NYSE:NHY) for approximately $2.45billion. Mr. Boswell is a 1984 graduate of the University of Texas atAustin.

**ThomasE. Hardisty**has served as Senior Vice President, CorporateDevelopment of PDTI since June 2004. Mr. Hardisty had previouslyserved as Director and Senior Vice President, Corporate Development of ParticleDrilling, Inc. from June 2003 until it was merged into PDTI inJune 2004. He also served as a Director of PDTI from June 2004 until March2006. Mr. Hardisty has over 21 years of experience in the oil and gasindustry, primarily in the area of land management, contracts and corporatedevelopment, and is co-founder of the company. From January 2001 untilJune 2003, Mr. Hardisty was Vice President, Land of ShorelinePartners LLC, an independent exploration company and from January 2000until January 2001, Vice President, Land of Benz Resources LLC, aconsulting firm charged with managing certain exploration properties acquiredby Harken Energy Corporation. From May 1999 until January 2000,Mr. Hardisty was a Land Manager for Texstar Energy Inc. responsiblefor divesting certain of the company’s exploration projects in the Texas GulfCoast and Mississippi areas. From 1994 until May 1999, Mr. Hardistywas Division Landman for PetroCorp Inc. responsible for company landpositions, contract negotiations and partner relations in exploration anddevelopment projects in PetroCorp’s Gulf Coast, Rockies and Canada Division.From 1984 until 1994, Mr. Hardisty was a land consultant and later SeniorProject Manager for Roger A. Soape Inc. in Houston, Texas.Mr. Hardisty graduated from the University of Texas at Austin in 1984 witha BBA in Petroleum Land Management. He is a member of the American Associationof Drilling Engineers (AADE), International Association of Drilling Contractors(IADC), the American Association of Professional Landmen (AAPL) and the HoustonAssociation of Professional Landmen (HAPL). Mr. Hardisty formerly servedas a Director of HAPL and is past Chairman of the HAPL Ethics Committee andpast Chairman of HAPL Membership Committee.

**Gordon Tibbitts** has served as VicePresident of Technology of PDTI since June 2004, and served as VicePresident of Technology of Particle Drilling, Inc. from June 2003until it was merged into PDTI in June 2004. Prior to joining ParticleDrilling, Inc., Mr. Tibbitts was Vice President of Technology forProDril Services Inc. from October 2002 until June 2003. FromApril 2000 until October 2002, Mr. Tibbitts was an in-houseengineering consultant on drilling and coring activities for TerraTek Drilling &Completions Research Laboratory. Mr. Tibbitts was employed fromMay 1999 until April 2000 by Pro Steel Inc as Chief OperatingOfficer. Prior to that time and for the majority of his career,Mr. Tibbitts worked for Hughes Christensen, one of the world’s largestmakers of oil and gas drilling bits. While at Hughes Christensen,Mr. Tibbitts held the title of Director of Research and Development from1987 until October 1998 and was responsible for managing and directingworld-wide research, development, and technical support through research groupsin Houston, Salt Lake City and Tulsa. He directed and managed the building of aworld-class drilling research laboratory in Houston and a drilling operation inOklahoma dedicated to field-testing and development of downhole tools.Mr. Tibbitts has over 30 years of experience in the upstream oil andgas industry, including 17 years in engineering, research, and developmentmanagement. Mr. Tibbitts holds over 70 patents related to drilling,coring, and diamond cutting tools. His work has been published by the Societyof Petroleum Engineers, International Association of Drilling Contractors,Society of Core Analysts, and the Journal of Petroleum Technology.Mr. Tibbitts graduated from the University of Utah with a Bachelors degreein Mechanical Engineering.

**JohnD. Schiller, Jr.** has served as a Director of PDTI since June 2004. He served asinterim President and Chief Executive Officer of PDTI from December 2004to November 15, 2005. Mr. Schiller is currently Chairman and CEO ofEnergy XXI (Bermuda) Limited. Prior to his current job he was President and CEOof Energy XXI, Panama, a private E&P company involved in worldwideacquisition & exploitation of oil and gas properties. In addition, heis majority owner of The

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Exploitation Company,LLP, a petroleum consulting firm established in October 2004 that providesassistance in locating and acquiring oil and gas properties. FromDecember 2003 until June 2004, Mr. Schiller was a privateinvestor. Mr. Schiller resigned from Devon Energy in December 2003where he was Vice President, Exploration & Production withresponsibility for Devon’s domestic & international activities. Beforejoining Devon Energy he was Executive Vice President, Exploration &Production for Ocean Energy, Inc. until Ocean was acquired by Devon inApril 2003. While at Ocean, he was responsible for Ocean’s worldwideexploration, production and drilling activities.

Mr. Schillerjoined Ocean Energy from Seagull Energy, where he served as Senior VicePresident of Operations before the two companies merged in March of 1999.He joined Seagull Energy from Burlington Resources, where he served in avariety of operational and management positions over a period of 14 years,including Production Manager and Engineering Manager for the Gulf of MexicoDivision. Prior to this assignment, he managed the corporate acquisition groupfor Burlington Resources.

Mr. Schillerbegan his career with Superior Oil in 1981. He spent five years as a staffengineer working properties in the Gulf of Mexico and south Louisiana.

Mr. Schillergraduated with honors from Texas A&M University with a Bachelor of Sciencein Petroleum Engineering and is a member of the Texas A&M PetroleumEngineering Industry Board. He is a member of the Society of PetroleumEngineers, Independent Petroleum Association of America, American PetroleumInstitute, American Association of Drilling Engineers and the Houston ProducersForum.

**MichaelMathews**  has served asa Director of PDTI since June 2004. Mr. Mathews is managing directorof Westgate Capital Co., a firm he founded in 1993 to identify and structureinvestment opportunities on behalf of private investors. Mr. Mathewsserved on the Board of Petroleum Geo-Services (PGS) from 1993 until September 2002.From 1998 to 2002, he served as Vice Chairman of PGS and held the position asChairman of the Compensation Committee and was a member of the Audit Committee.From 1989 to 1992, Mr. Mathews served as managing director of BradfordVentures Ltd., a private investment firm involved in equity investments,including acquisitions. Prior to 1989, he was president of DNC CapitalCorporation and senior vice president and director of its parent, DNC AmericaBanking Corp., the US subsidiary of Den Norske Credit Bank Group, where hedirected merchant banking and investment activity in North America and foundedand acted as senior advisor to Nordic Investors Limited, N.V., a privateventure capital fund. Previously, Mr. Mathews was a Vice President inCorporate Finance at Smith Barney and prior to that he was an associate withthe New York law firm of White & Case. Mr. Mathews received anA.B. from Princeton University in 1962 and received a J.D. from the Universityof Michigan Law School in 1965. Mr. Mathews is also a Director and serveson the Audit Committee and as Chairman of the Governance Committee ofInterpool Inc. (NYSE: IPX), and Director and Vice Chairman of Apptix ASA(OSE: APP).

**HughA. Menown**  hasserved as a Director of PDTI since June 2004. Mr. Menown has over25 years of experience in mergers & acquisitions, auditing andmanagerial finance, and is currently an independent consultant. FromJune 1999 through December 2005, Mr. Menown worked with QuantaServices, Inc. (“Quanta”) (NYSE: PWR) as a financial consultant.Mr. Menown performed due diligence on a number of Quanta’s acquisitionsand has served as Chief Financial Officer for two of their operating companies,most recently North Houston Pole Line, L.P. located in Houston, Texas. Prior toserving as a financial consultant to Quanta, Mr. Menown was a Partner inthe Houston office of PricewaterhouseCoopers, LLP where he led the TransactionServices Practice providing due diligence, mergers & acquisitionadvisory and strategic consulting to numerous clients in various industries.Mr. Menown also worked in the Business Assurance Practice providing auditand related services to clients. Mr. Menown is a Certified PublicAccountant.

**SteveA. Weyel**  hasserved as a Director of PDTI since May 2005. Since July 2005,Mr. Weyel has served as President and Chief Operating Officer ofEnergy XXI (Bermuda) Limited. Previously, Mr. Weyel co-founded andwas a principal, and President and Chief Operating Officer of EnerVen LLC, aprivately-held company with strategic ventures in the energy industry. EnerVen’sbusinesses include the start-up of WesCo LLC, a gas compression servicescompany, and EnerVen Compression Services, a joint venture company withEnogex Inc., an unregulated subsidiary of OGE Energy Corp. (NYSE: OGE),providing compression asset rentals. Mr. Weyel was a principal of EnerVenLLC commencing in 2001 and sold his membership interests in EnerVen inSeptember 2005 and resigned as an officer and director of EnerVen at that time.

From 1999 until heco-founded EnerVen in 2001, Mr. Weyel was President of InterGen NorthAmerica, a Shell—Bechtel joint venture in the gas and power business. WhilePresident of InterGen, Mr. Weyel was responsible for the acquisition andmanagement of gas assets, including gas storage, mid-stream gas assets and over15,000 miles of regulated pipelines, development of greenfield merchant powerprojects, and board-level oversight of InterGen’s equity ownership in CoralMarketing and Trading.

Mr. Weyel wasemployed by Dynegy Corporation (previously known as Natural Gas Clearinghouseand then NGC Corporation) from 1994 to 1999. While at Dynegy, he served inseveral senior executive leadership roles, including Senior VicePresident—Power Development from 1998 to 1999. Mr. Weyel began his career withBaker Hughes in 1976 and rotated through a variety of assignments, includingresponsibility for Baker Production Service’s operations in North and South

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America. In 1985 heformed a start-up technology and engineering driven oilfield services company,Resource Technology Corporation (“RTC”), evaluating oil and gas reserves aroundthe world. RTC’s assets and ongoing operations were later sold to John WoodGroup PLC in 1993.

Mr. Weyel is a1976 graduate of Texas A&M University and received his MBA from theUniversity of Texas at Austin in 1989.

***Audit Committee.***   Our Boardof Directors has a separately-designated standing Audit Committee, whichcommittee consists of Messrs. Menown, Mathews and Weyel. Mr. Menownserves as Chairman of the Audit Committee. The Board of Directors has made thefollowing determinations related to the Audit Committee:

·       Messrs. Menown,Mathews and Weyel satisfy the independence requirements as defined by theNASDAQ rules and as set forth in Rule 10A-3 under the SecuritiesExchange Act of 1934.

·       Each member of the AuditCommittee is “financially literate” as the Board of Directors, in its businessjudgment, interprets such qualification.

·       Mr. Menown qualifiesas an “audit committee financial expert” based on the definition and additionalexpertise factors outlined by the Securities and Exchange Commission.Mr. Menown acquired the attributes to qualify as an “audit committeefinancial expert” through his experience as a Partner with PricewaterhouseCoopersLLP where he had extensive exposure to and obtained a working knowledge ofgenerally accepted accounting principles and financial statements.Mr. Menown is also a Certified Public Accountant.

Our AuditCommittee reviews, acts on and reports to the Board of Directors with respectto various auditing and accounting matters, including the selection of ourindependent auditors, the scope of the annual audits, fees to be paid to theauditors, the performance of our independent auditors and our accountingpractices. The Audit Committee operates pursuant to a written charter, whichwas adopted February 3, 2005 and amended on May 31, 2005.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Section 16(a) ofthe Securities Exchange Act of 1934 requires our officers, directors andpersons who own more than 10% of our common stock to file reports of ownershipand changes in ownership concerning the common stock with the Commission and tofurnish us with copies of all Section 16(a) forms they file.

Based solely upona review of Forms 3 and 4 and amendments thereto furnished to us pursuant toRule 16a-3(e) under the Securities Exchange Act of 1934 during the fiscal yearended September 30, 2006 and Forms 5 and amendments thereto furnished to uswith respect to the fiscal year ended September 30, 2006, and anyrepresentations furnished to us that no Form 5 is required, we believe that allsuch forms required to be filed were timely filed, as necessary, by theofficers, directors and security holders required to file the same during thefiscal year ended September 30, 2006, except a late Form 4 filed by Mr. PrentisTomlinson on February 27, 2006.  Mr.Tomlinson, who was a 10% shareholder of our company during the fiscal yearended September 30, 2006, engaged in a series of sales transactions pursuant towhich he sold shares of common stock of our company in open market or privatetransactions on January 27, 2006, January 30, 2006, January 31, 2006, February1, 2006, February 2, 2006, February 3, 2006 and February 6, 2006.  Each of these transactions should have beenreported on a Form 4 before the end of the second business day following theday on which the transaction was executed. Mr. Tomlinson did not file a Form 4 reporting these transactions untilhe filed a Form 4 on February 27, 2006 reporting all of thesetransactions.  As a result, Mr. Tomlinsondid not timely file at least three reports on Form 4.

**Code ofEthics**

Our Board ofDirectors has adopted a code of ethics (we call it our “Code of Business Conductand Ethics”) that governs the business conduct and ethics of our directors, allof our employees and our executive officers, including our chief executiveofficer, our chief financial officer and our chief accounting officer.  Our code of ethics has been posted on ourcompany’s internet website at www.particledrilling.com.  In addition, we will provide a printed copyof our code of conduct without charge to any stockholder making a writtenrequest to Corporate Secretary, Particle Drilling Technologies, Inc., 11757Katy Freeway, Suite 1300, Houston, Texas 77079. It is our intention to disclose on our internet website within fourbusiness days of any amendment or waiver:

·       the date and nature of anyamendment we make to any provision of our code of conduct that applies to ourchief executive officer, our chief financial officer and our chief accountingofficer and that relates to any element of the code of ethics definitionenumerated in Item 406(b) of Regulation S-K; and

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·       information related to anywaiver, including any implicit waiver, we grant to our chief executive officer,our chief financial officer and our chief accounting officer that relates toany element of the code of ethics definition enumerated in Item 406(b) ofRegulation S-K.

**Item11.   Executive and Director Compensation**

**Executive Compensation**

Thefollowing summary compensation table sets forth information concerningcompensation earned in the fiscal years ended September 30, 2006 and 2005by our chief executive officer and our three other executive officers.  During the fiscal year ended September 30,2004 and from October 1, 2004 until January 14, 2005, our sole executiveofficer and director was Dean Becker. During that time, Mr. Becker did not receive any compensation from ourcompany.  In addition, prior to ouracquisition of PDTI in January 2005, none of our current officers and directorsreceived any compensation from our company. In connection with our acquisition of PDTI in January 2005, the officersand directors of PDTI became the officers and directors of our company.  In connection with our acquisition of PDTI inJanuary 2005, Mr. Becker resigned from his positions as an officer and directorof our company.

**SummaryCompensation Table**
| **Name and Principal Position**                | ** ** | **Fiscal**

**Year** | ** ** | **Salary**

**($)** | ** ** | **Bonus**

**($)** | ** ** | **Restricted**

**Stock**

**Awards ($)** | ** ** | **Securities**

**Underlying**

**Options (#)** | ** ** | **All Other**

**Compensation ($)** | ** ** |
|---------------------------------------------------------------|------------|----------------------|------------|---------------------|------------|--------------------|------------|------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------|------------|
|                                                          |       |                 |       |                |       |               |       |                                           |       |                                                 |       |                                          |       |
| Jim B. Terry(1)                                               |       | 2006                 |       | 166,154             |       | 75,000             |       | 1,009,500                                      | (6)        | 150,000                                              |       | 3,046                                         | (9)        |
| President and Chief Executive Officer                         |       |                 |       |                |       |               |       |                                           |       |                                                 |       |                                          |       |
| John D.  Schiller, Jr. (2)                                    |       | 2006                 |       | —              |       | —             |       | —                                         |       | —                                               |       | —                                        |       |
| Interim President and Chief Executive Officer                 |       | 2005                 |       | —              |       | —             |       | 294,000                                        | (7)        | 250,000                                              |       | —                                        |       |
| J. Chris Boswell  (2) (3)                                     |       | 2006                 |       | 207,265             |       | 40,000             |       | —                                         |       | —                                               |       | 4,952                                         | (9)        |
| Senior Vice President, Chief Financial Officer and Treasurer  |       | 2005                 |       | 130,313             |       | —             |       | 147,000                                        | (8)        | 160,000                                              |       | 1,762                                         | (9)        |
| Thomas E.  Hardisty (4)                                       |       | 2006                 |       | 170,502             |       | 40,000             |       | —                                         |       | —                                               |       | 4,060                                         | (9)        |
| Senior Vice President of Corporate Development and  Secretary |       | 2005                 |       | 108,594             |       | —             |       | 147,000                                        | (8)        | 160,000                                              |       | 1,949                                         | (9)        |
| Gordon Tibbitts  (5)                                          |       | 2006                 |       | 142,168             |       | 40,000             |       | —                                         |       | —                                               |       | 3,000                                         | (9)        |
| Vice President  of Technology                                 |       | 2005                 |       | 94,115              |       | —             |       | —                                         |       | —                                               |       | 1,221                                         | (9)        |

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(1)             Assumedposition with our company on January 23, 2006.

(2)             Mr.Schiller assumed the position of interim President and Chief Executive Officer ofour company in January 2005 and served until November 15, 2005.  Prior to our acquisition of PDTI, Mr.Schiller served as interim President and Chief Executive Officer of PDTIcommencing on December 2, 2004.  Mr.Schiller did not receive a salary while he served as interim Chief ExecutiveOfficer of PDTI or our company.  FromNovember 15, 2005 until January 23, 2006, Mr. Boswell served as interimPresident and Chief Executive Officer of our company.

(3)             Assumedposition with our company in January 2005.  Mr. Boswell served as Senior Vice Presidentand Chief Financial Officer of PDTI prior to our acquisition of PDTI on January14, 2005.  Mr. Boswell received a salaryfrom PDTI of $90,000 during fiscal 2004 and $52,500 from October 1, 2004 toJanuary 14, 2005 while serving as Chief Financial Officer of PDTI.

(4)             Assumedposition with our company in January 2005. Mr. Hardisty served as Senior Vice President of Corporate Development ofPDTI prior to our acquisition of PDTI on January 14, 2005.  Mr. Hardisty received a salary from PDTI of$103,500 during fiscal 2004 and $40,250 from October 1, 2004 to January 14,2005 while serving as Senior Vice President of Corporate Development of PDTI.

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(5)             Assumedposition with our company in January 2005. Mr. Tibbitts served as Vice President of Technology of PDTI prior to ouracquisition of PDTI on January 14, 2005. Mr. Tibbitts received a salary from PDTI of $130,000 during fiscal 2004and $37,917 from October 1, 2004 to January 14, 2005 while serving as SeniorVice President of Technology of PDTI. During fiscal 2004, Mr. Tibbitts also received a retention bonus fromPDTI of $65,000.

(6)             Represents150,000 shares of restricted stock valued at $6.73 per share, the closing priceof our common stock on the NASDAQ Capital Market on January 23, 2006, the dayof the grant.  On September 30, 2006, therestricted stock held by Mr. Terry had a value of $388,500 based on the closingprice of our common stock of $2.59 per share on the NASDAQ Capital Market.  The restricted stock granted to Mr. Terryvests 33% on each anniversary of the date of grant.  We do not currently pay dividends on ourcommon stock; however, we would pay dividends on the restricted stock shouldour dividend policy change.

(7)             Represents60,000 shares of restricted stock valued at $5.00 per share, the closing priceof our common stock on the OTC Bulletin Board on May 20, 2005, the day of thegrant.  On September 30, 2005, therestricted stock held by Mr. Schiller had a value of $264,000 based on theclosing price of our common stock of $4.40 per share on the NASDAQ CapitalMarket.  The restricted stock granted toMr. Schiller vests 33% on each anniversary of the date of grant.  We do not currently pay dividends on ourcommon stock; however, we would pay dividends on the restricted stock shouldour dividend policy change.

(8)             Represents30,000 shares of restricted stock valued at $5.00 per share, the closing priceof our common stock on the OTC Bulletin Board on May 20, 2005, the day of thegrant.  On September 30, 2005, therestricted stock held by each of Messrs. Boswell and Hardisty had a value of$132,000 based on the closing price of our common stock of $4.40 per share onthe NASDAQ Capital Market.  Therestricted stock granted to Messrs. Boswell and Hardisty vests 33% on eachanniversary of the date of grant.  We donot currently pay dividends on our common stock; however, we would paydividends on the restricted stock should our dividend policy change.

(9)             Representscompany matching contributions pursuant to our 401(k) plan and the dollar valueof insurance premiums paid by our company with respect to term life insurancefor the benefit of the named executive officer.

**StockOptions Granted During Fiscal 2006**
| **Individual Grants** | ** ** | ** **                                                      | ** ** |
|----------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                 | ** ** | **Number of**

**Securities**

**Underlying**

**Options** | ** ** | **% of Total**

**Options**

**Granted to**

**Employees**

**in Fiscal** | ** ** | **Exercise**

**Price Per** | ** ** | **Expiration** | ** ** | **Potential Realizable**

**Value at Assumed**

**Annual Rates of Stock**

**Price Appreciation for**

**Option Terms(4) ($)** | ** ** |
| **Name**                   | ** ** | **Granted (#)**                                            | ** ** | **2006 (3)** | ** ** | **Share ($)** | ** ** | **Date** | ** ** | **5%** | ** ** | **10%** | ** ** |
|                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |
| Jim B. Terry               |       | 150,000                                                         | (1)        | 24 | % | 6.73 |   | 01/23/2016 |   | 114,000 |   | 182,000 |   |
|                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |
| J. Chris Boswell           |       | —                                                          |       | — |   | — |   | — |   | — |   | — |   |
|                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |
| John D. Schiller           |       | —                                                          |       | — |   | — |   | — |   | — |   | — |   |
|                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |
| Gordon Tibbitts            |       | 70,000                                                          | (2)        | 11 | % | 4.50 |   | 10/3/2015 |   | 224,000 |   | 389,000 |   |
|                       |       |                                                            |       |   |   |   |   |   |   |   |   |   |   |
| Thomas E. Hardisty         |       | —                                                          |       | — |   | — |   | — |   | — |   | — |   |

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(1)             Optionsvest in one-third increments on each anniversary of January 23, 2006, thegrant date.

(2)             Options vest inone-third increments on each anniversary of October 3, 2005, the grant date.

(3)             Wegranted options to purchase 616,500 shares of our common stock in the aggregateduring fiscal 2006.

(4)             Calculatedbased upon the indicated rates of appreciation, compounded annually, from thedate of grant to the end of each option term. Actual gains, if any, on stockoption exercises and common stock holdings are dependent upon the futureperformance of our common stock and overall market conditions. There can be noassurance that the amounts reflected in this table will be achieved. Thecalculation does not take into account the effects, if any, of provisions ofour option plans governing termination of options upon employment termination,transferability or vesting.

**AggregatedOption Exercises During Fiscal 2006 and Fiscal Year-End Option Values**
| ** **             | ** ** | **Shares**

**Acquired on** | ** ** | **Value**             | ** ** | **Number of Securities**

**Underlying Unexercised**

**Options at**

**September 30, 2006 (#)** | ** ** | **Value of Unexercised**

**In-the-Money Options**

**at September 30, 2006 ($) (1)** | ** ** |
|------------------------|------------|----------------------------------|------------|-----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
| **Name**               | ** ** | **Exercise (#)**            | ** ** | **Realized ($)** | ** ** | **Exercisable**                                                                                                                     | ** ** | **Unexercisable**                                                                                                             | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Jim B. Terry           |       | —                           |       | —                |       | —                                                                                                                              |       | 150,000                                                                                                                       |       | — |   | — |   |
|                   |       |                             |       |                  |       |                                                                                                                                |       |                                                                                                                          |       |   |   |   |   |
| J. Chris Boswell       |       | —                           |       | —                |       | 573,333                                                                                                                             |       | 346,667                                                                                                                       |       | 1,284,400 |   | 592,800 |   |
|                   |       |                             |       |                  |       |                                                                                                                                |       |                                                                                                                          |       |   |   |   |   |
| John D.  Schiller, Jr. |       | —                           |       | —                |       | 583,333                                                                                                                             |       | 181,667                                                                                                                       |       | 370,000 |   | — |   |
|                   |       |                             |       |                  |       |                                                                                                                                |       |                                                                                                                          |       |   |   |   |   |
| Thomas E. Hardisty     |       | —                           |       | —                |       | 503,333                                                                                                                             |       | 256,667                                                                                                                       |       | 1,111,500 |   | 370,500 |   |
|                   |       |                             |       |                  |       |                                                                                                                                |       |                                                                                                                          |       |   |   |   |   |
| Gordon Tibbitts        |       | —                           |       | —                |       | 225,000                                                                                                                             |       | 195,000                                                                                                                       |       | 555,750 |   | 308,750 |   |

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(1)             Thevalue of each unexercised in-the-money stock option is equal to the differencebetween the closing price of our common stock as reported on the NASDAQ CapitalMarket on September 30, 2006 of $2.59 per share and the exercise price of theoption.

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**Compensation of Directors**

Certain of ourdirectors, who are also officers, do not receive any compensation for theirservices as members of our Board of Directors. We reimburse our directors fortravel and lodging expenses in connection with their attendance at board andcommittee meetings.

Our Board ofDirectors adopted our current Board Compensation Package effective as ofJune 1, 2005. Under the Board Compensation Package, our non-employeedirectors will receive an annual retainer of $20,000 and $1,500 for each formalBoard meeting attended. In addition, each non-employee director who is also acommittee member will receive an annual committee retainer fee of $2,500 and$750 for each formal committee meeting attended. Each non-employee director whois also a committee chair will receive an additional annual retainer of $2,500.The Board Compensation Package also provides for annual equity compensation foreach non-employee director consisting of 5,000 shares of our restricted commonstock and an option for 15,000 shares of our common stock. In addition, any newnon-employee directors will be granted an option for 25,000 shares of ourcommon stock as a one time award upon joining the Board of Directors. Inaddition to receiving the compensation described above as a director, theChairman of the Board will receive an annual retainer of $2,500, as well as anannual award of 5,000 shares of our restricted common stock and an option for15,000 shares of our common stock. All option awards will be non-qualifiedstock options and, together will all awards of restricted stock, will be issuedpursuant to our equity compensation plans in effect at the time of the awardand will be exercisable for a ten-year period from the date of grant of theaward. The restricted stock and option awards will vest in 50% installments oneach anniversary of the date of grant of the award.

In May 2006,the Compensation Committee granted options to our non-employee directors topurchase an aggregate of 90,000 shares of our common stock as follows:

·       15,000 options to purchaseshares of common stock to each of Messrs. Weyel, Schiller, Mathews andMenown on May 20, 2006, with 50% vesting on each anniversary of the dateof grant and an exercise price of $3.40, for annual director fees; and

·       30,000 options to purchaseshares of common stock to Mr. LeSuer on May 20, 2006, with 50%vesting on each anniversary of the date of grant and an exercise price of$3.40, for annual director fee as Chairman of the Board.

In May 2006,the Compensation Committee granted to our non-employee directors an aggregateof 30,000 restricted shares of our common stock as follows:

·       5,000 shares of restrictedcommon stock to each of Messrs. Weyel, Schiller, Mathews and Menown onMay 20, 2006, with 50% vesting on each anniversary of the date of grant,for annual director fees; and

·       10,000 shares of restrictedcommon stock to Mr. LeSuer, on May 20, 2006, with 50% vesting on eachanniversary of the date of grant, for annual director fee as Chairman of theBoard.

We made paymentsof $51,194, $65,818, $59,579, $62,279 and $41,625 to Messrs. LeSuer,Mathews, Menown, Schiller and Weyel, respectively, for meeting fees in fiscal2006.

**Employment Agreements**

Set forth below isa summary of the material terms of our employment agreements with our executiveofficers. Mr. Tibbitts’ employment agreement was made with PDTI and wasassumed by our company in connection with our acquisition of PDTI.

*JimB. Terry.*   Mr. Terry entered into anemployment agreement effective as of January 23, 2006. This agreement hasa three-year term that is automatically extended for successive one-yearperiods following the end of the initial three-year term unless otherwiseterminated by delivery of written notice by either party no less than 90 daysprior to the first day of any one-year extension period. The agreement providesthat Mr. Terry will serve as our Chief Executive Officer and President.Under the terms of the agreement, Mr. Terry will receive an annual basesalary of $240,000, which may be further increased at the sole discretion ofthe Compensation Committee. We may decrease Mr. Terry’s base salary onlywith the prior written consent

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of Mr. Terry.Mr. Terry is also eligible to participate in our annual bonus incentiveplan as approved by the Compensation Committee or the Board of Directors inamounts approved by and based on criteria established by the CompensationCommittee. Mr. Terry will also be eligible to participate, in the solediscretion of the Compensation Committee, in any long-term incentivearrangements we make available to our executive officers from time to time.Finally, Mr. Terry will receive certain perquisites, includingreimbursement in accordance with our standard policies and procedures ofbusiness and business-related business expenses and dues and fees to industryand professional organizations, four weeks of paid vacation each calendar year,and participation by Mr. Terry and his spouse and dependents in allbenefits, plans and programs available to our executive employees. We have alsoagreed to use reasonable efforts to obtain life insurance for Mr. Terry inthe amount of $500,000.

During the term ofthe agreement, we may terminate Mr. Terry’s employment at any time uponhis (1) death, (2) disability, (3) for cause, or (4) forany other reason whatsoever in the sole discretion of the Board of Directors.If we desire to terminate Mr. Terry’s employment at any time prior toexpiration of the term of his employment, we must provide written notice toMr. Terry indicating that we have elected to terminate his employment andstating the effective date of termination and the reason for such termination.Mr. Terry may terminate his employment (1) as a result of a change induties (as such term is defined in the employment agreement) after first givingus written notice of the specific occurrence that resulted in the change induties and if such occurrence remains uncorrected for 10 days followingdelivery of such notice, or (2) at any time for any reason whatsoever. IfMr. Terry desires to terminate his employment at any time prior toexpiration of the term of his employment, he must provide 30-days written noticeto us indicating that he has elected to terminate his employment and statingthe effective date of termination and the reason for such termination.

In the eventMr. Terry’s employment terminates upon expiration of the term of theemployment agreement or if Mr. Terry’s employment is terminated by eitherMr. Terry or our company for any reason other than an InvoluntaryTermination (as defined below), all compensation and benefits to Mr. Terryunder the agreement will terminate contemporaneously with the termination ofhis employment. For purposes of the agreement, an “Involuntary Termination”means any termination of Mr. Terry’s employment with our company which:

·       does not result from anexpiration of the term of the employment agreement;

·       does not result from aresignation by Mr. Terry (except as otherwise provided below);

·       does not result from atermination for cause of Mr. Terry;

·       does not result fromMr. Terry’s death or disability; or

·       results from a resignationby Mr. Terry on or before the date which is 60 days after the date uponwhich Mr. Terry receives notice of a change of duties (as defined in theagreement).

Except as providedin the following sentence, in the event Mr. Terry’s employment is subjectto an Involuntary Termination, we shall pay to Mr. Terry a lump sum cashpayment within 30 days of termination equal to two times his annual base salaryin effect at the time of termination. If Mr. Terry’s employment is subjectto an Involuntary Termination that occurs at any time during the periodbeginning 60 days prior to the date a definitive agreement concerning a Changeof Control (as defined below) is executed and ending on the one-yearanniversary of the consummation of such Change of Control (such period being a “Changeof Control Period”), Mr. Terry will be entitled to receive a lump sum cashpayment within 30 days of termination equal to two times the sum of his annualbase salary in effect at the time of termination and the average of the bonuseshe received in the two preceding fiscal years (as calculated in accordance withthe agreement). If Mr. Terry’s employment is subject to an InvoluntaryTermination during a Change of Control Period or as a result of his death ordisability, we have also agreed to accelerate the vesting of all options topurchase common stock granted to Mr. Terry and to remove the restrictionson vesting or forfeiture of all restricted stock and all other accrued benefitsunder any nonqualified deferred compensation plans granted to Mr. Terry.Finally, Mr. Terry and his dependents will be eligible to receive COBRAcontinuation coverage under our group health plans for a period of up to twoyears following any Involuntary Termination of his employment, in accordancewith and to the extent provided by COBRA.

For purposes ofthe agreement, a “Change of Control” means:

·       a merger of our companywith another entity, a consolidation involving our company or the sale of allor substantially all of our assets to another entity if, in any such case,(A) the holders of our equity securities immediately prior to suchtransaction do not beneficially own after such transaction 50% or more of thevotes to elect directors generally in substantially the same proportions thatthey owned securities of our company prior to such transaction, or (B) thepersons who were members of our Board of Directors immediately prior to suchtransaction do not constitute at least a majority of the board of directors ofthe resulting entity after such transaction;

·       a dissolution orliquidation of our company;

·       when any person or entityacquires or gains ownership or control of more than 50% of the combined votingpower of the outstanding securities of our company; or

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·       as a result of or inconnection with a contested election of directors, the persons who were membersof our Board of Directors immediately before such election cease to constitutea majority of our Board of Directors.

In the eventMr. Terry is a “disqualified individual” (as defined inSection 280G(c) of the Internal Revenue Code) and the payments andbenefits that Mr. Terry has the right to receive would constitute a “parachutepayment” (as defined in Section 280G(b)(2) of the Internal RevenueCode), then the benefits provided under the agreement will be either(1) reduced to an amount so that no portion of such amounts and benefitsreceived by Mr. Terry will be subject to the excise tax imposed bySection 4999 of the Internal Revenue Code or (2) paid in full,whichever produces the better net after-tax position to Mr. Terry.

The agreement alsocontains customary confidentiality, nondisclosure and proprietary rightsprovisions. In addition, during his employment and for a period of two yearsfollowing the termination of Mr. Terry’s employment for any reason,Mr. Terry is prohibited from participating in the ownership, management,operation or control in any business that conducts a business similar to thatconducted by us or provides or sells a service or product that is the same,substantially similar to or otherwise competitive with the products andservices provided or sold by our company in any of the business territoriesthat we conduct business from time to time, subject to certain limitedexceptions. During that same period, Mr. Terry may not solicit, amongothers, customers, suppliers and employees of our company.

In connection withthe commencement of Mr. Terry’s employment as our President and ChiefExecutive Officer on January 23, 2006, we granted to Mr. Terry(1) options to purchase 150,000 shares of common stock at $6.73 per share,which options vest in one-third increments on an annual basis beginning onJanuary 23, 2007, and (2) 150,000 shares of restricted common stock,the forfeiture restrictions of which lapse in one-third increments on an annualbasis beginning on January 23, 2007.

*J.Chris Boswell.*   Mr. Boswell entered into anemployment agreement that was effective as of February 1, 2006. Thisagreement, which replaced his previous employment agreement, has a three-yearterm that is automatically extended for successive one-year periods followingthe end of the initial three-year term unless otherwise terminated by deliveryof written notice by either party no less than 90 days prior to the first dayof any one-year extension period. The agreement provides that Mr. Boswell willserve as Chief Financial Officer and Senior Vice President. Under the terms ofthe agreement, Mr. Boswell will receive an annual base salary of $220,000,which may be further increased at the sole discretion of the CompensationCommittee. We may decrease Mr. Boswell’s base salary only with the priorwritten consent of Mr. Boswell. Mr. Boswell is also eligible toparticipate in our annual bonus incentive plan as approved by the CompensationCommittee or the Board of Directors in amounts approved by and based oncriteria established by the Compensation Committee. Mr. Boswell will alsobe eligible to participate, in the sole discretion of the CompensationCommittee, in any long-term incentive arrangements we make available to ourexecutive officers from time to time. Finally, Mr. Boswell will receivecertain perquisites, including reimbursement in accordance with our standardpolicies and procedures of business and business-related business expenses anddues and fees to industry and professional organizations, four weeks of paidvacation each calendar year, and participation by Mr. Boswell and hisspouse and dependents in all benefits, plans and programs available to ourexecutive employees. We have also agreed to use reasonable efforts to obtainlife insurance for Mr. Boswell in the amount of $500,000.

During the term ofthe agreement, we may terminate Mr. Boswell’s employment at any time uponhis (1) death, (2) disability, (3) for cause, or (4) forany other reason whatsoever in the sole discretion of the Board of Directors.If we desire to terminate Mr. Boswell’s employment at any time prior toexpiration of the term of his employment, we must provide written notice toMr. Boswell indicating that we have elected to terminate his employmentand stating the effective date of termination and the reason for suchtermination. Mr. Boswell may terminate his employment (1) as a resultof a change in duties (as such term is defined in the employment agreement)after first giving us written notice of the specific occurrence that resultedin the change in duties and if such occurrence remains uncorrected for 10 daysfollowing delivery of such notice, or (2) at any time for any reasonwhatsoever. If Mr. Boswell desires to terminate his employment at any timeprior to expiration of the term of his employment, he must provide 30-dayswritten notice to us indicating that he has elected to terminate his employmentand stating the effective date of termination and the reason for suchtermination.

In the eventMr. Boswell’s employment terminates upon expiration of the term of theemployment agreement or if Mr. Boswell’s employment is terminated byeither Mr. Boswell or our company for any reason other than an InvoluntaryTermination (as defined below), all compensation and benefits to

Mr. Boswell underthe agreement will terminate contemporaneously with the termination of hisemployment. For purposes of the agreement, an “Involuntary Termination” meansany termination of Mr. Boswell’s employment with our company which:

·       does not result from anexpiration of the term of the employment agreement;

·       does not result from aresignation by Mr. Boswell (except as otherwise provided below);

·       does not result from atermination for cause of Mr. Boswell;

·       does not result fromMr. Boswell’s death or disability; or

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·       results from a resignationby Mr. Boswell on or before the date which is 60 days after the date uponwhich Mr. Boswell receives notice of a change of duties (as defined in theagreement).

Except as providedin the following sentence, in the event Mr. Boswell’s employment issubject to an Involuntary Termination, we shall pay to Mr. Boswell a lumpsum cash payment within 30 days of termination equal to the greater of(1) two times his annual base salary in effect at the time of termination,or (2) $600,000. If Mr. Boswell’s employment is subject to anInvoluntary Termination that occurs at any time during the period beginning 60days prior to the date a definitive agreement concerning a Change of Control(as defined below) is executed and ending on the one-year anniversary of theconsummation of such Change of Control (such period being a “Change of ControlPeriod”), Mr. Boswell will be entitled to receive a lump sum cash paymentwithin 30 days of termination equal to the greater of (1) two times thesum of his annual base salary in effect at the time of termination and theaverage of the bonuses he received in the two preceding fiscal years (ascalculated in accordance with the agreement), or (2) $600,000, whichamount will be increased to $950,000 if Mr. Boswell is not provided withan opportunity to sell the shares of our common stock then held byMr. Boswell at a purchase price of $4.00 or more per share in connectionwith a Change of Control transaction. If Mr. Boswell’s employment issubject to an Involuntary Termination during a Change of Control Period or as aresult of his death or disability, we have also agreed to accelerate thevesting of all options to purchase common stock granted to Mr. Boswell andto remove the restrictions on vesting or forfeiture of all restricted stock andall other accrued benefits under any nonqualified deferred compensation plansgranted to Mr. Boswell. Finally, Mr. Boswell and his dependents willbe eligible to receive COBRA continuation coverage under our group health plansfor a period of up to two years following any Involuntary Termination of hisemployment, in accordance with and to the extent provided by COBRA.

For purposes ofthe agreement, a “Change of Control” has the same meaning as set forth inMr. Terry’s employment agreement.

In the event thatany payment or distribution to Mr. Boswell is subject to the excise taximposed by Section 4999 of the Internal Revenue Code or any interest orpenalties with respect to such excise tax, we have agreed to make an additionalpayment to Mr. Boswell in an amount such that after payment byMr. Boswell of all taxes (including such excise tax imposed on suchadditional payment), Mr. Boswell will retain an amount of such paymentequal to the amount of the excise tax imposed upon such payment.

The agreement alsocontains customary confidentiality, nondisclosure and proprietary rightsprovisions. In addition, during his employment and for a period of two yearsfollowing the termination of Mr. Boswell’s employment for any reason,Mr. Boswell is prohibited from participating in the ownership, management,operation or control in any business that either (1) conducts a businesssimilar to the particle impact drilling system business conducted by us (or anyother line of business involving technological processes that we have eitherdeveloped or acquired) or (2) provides or sells a service or product thatis the same, substantially similar to or otherwise competitive with theproducts and services related to the particle impact drilling system businessconducted by us (or any other line of business involving technologicalprocesses that we have either developed or acquired) in any of the businessterritories that we conduct business from time to time, subject to certainlimited exceptions. During that same period, Mr. Boswell may not solicit,among others, customers, suppliers and employees of our company.

*ThomasE. Hardisty.*   Mr. Hardisty entered into anemployment agreement that was effective as of February 1, 2006. Thisagreement, which replaced his previous employment agreement, has a three-yearterm that is automatically extended for successive one-year periods followingthe end of the initial three-year term unless otherwise terminated by deliveryof written notice by either party no less than 90 days prior to the first dayof any one-year extension period. The agreement provides that Mr. Hardistywill serve as a Senior Vice President. Under the terms of the agreement,Mr. Hardisty will receive an annual base salary of $180,000, which may befurther increased at the sole discretion of the Compensation Committee. We maydecrease Mr. Hardisty’s base salary only with the prior written consent ofMr. Hardisty. Mr. Hardisty is also eligible to participate in ourannual bonus incentive plan as approved by the Compensation Committee or theBoard of Directors in amounts approved by and based on criteria established bythe Compensation Committee. Mr. Hardisty will also be eligible toparticipate, in the sole discretion of the Compensation Committee, in anylong-term incentive arrangements we make available to our executive officersfrom time to time. Finally, Mr. Hardisty will receive certain perquisites,including reimbursement in accordance with our standard policies and proceduresof business and business-related business expenses and dues and fees toindustry and professional organizations, four weeks of paid vacation eachcalendar year, and participation by Mr. Hardisty and his spouse anddependents in all benefits, plans and programs available to our executiveemployees. We have also agreed to use reasonable efforts to obtain lifeinsurance for Mr. Hardisty in the amount of $500,000.

During the term ofthe agreement, we may terminate Mr. Hardisty’s employment at any time uponhis (1) death, (2) disability, (3) for cause, or (4) forany other reason whatsoever in the sole discretion of the Board of Directors.If we desire to terminate Mr. Hardisty’s employment at any time prior toexpiration of the term of his employment, we must provide written notice toMr. Hardisty indicating that we have elected to terminate his employmentand stating the effective date of termination and the reason for suchtermination. Mr. Hardisty may terminate his employment (1) as aresult of a

 

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change in duties (as such term is defined in theemployment agreement) after first giving us written notice of the specificoccurrence that resulted in the change in duties and if such occurrence remainsuncorrected for 10 days following delivery of such notice, or (2) at anytime for any reason whatsoever. If Mr. Hardisty desires to terminate hisemployment at any time prior to expiration of the term of his employment, hemust provide 30-days written notice to us indicating that he has elected toterminate his employment and stating the effective date of termination and thereason for such termination.

In the eventMr. Hardisty’s employment terminates upon expiration of the term of theemployment agreement or if Mr. Hardisty’s employment is terminated by eitherMr. Hardisty or our company for any reason other than an InvoluntaryTermination (as defined below), all compensation and benefits toMr. Hardisty under the agreement will terminate contemporaneously with thetermination of his employment. For purposes of the agreement, an “InvoluntaryTermination” means any termination of Mr. Hardisty’s employment with ourcompany which:

·       does not result from anexpiration of the term of the employment agreement;

·       does not result from aresignation by Mr. Hardisty (except as otherwise provided below);

·       does not result from atermination for cause of Mr. Hardisty;

·       does not result fromMr. Hardisty’s death or disability; or

·       results from a resignationby Mr. Hardisty on or before the date which is 60 days after the date uponwhich Mr. Hardisty receives notice of a change of duties (as defined inthe agreement).

Except as providedin the following sentence, in the event Mr. Hardisty’s employment issubject to an Involuntary Termination, we shall pay to Mr. Hardisty a lumpsum cash payment within 30 days of termination equal to the greater of(1) two times his annual base salary in effect at the time of termination,or (2) $450,000. If Mr. Hardisty’s employment is subject to anInvoluntary Termination that occurs at any time during the period beginning 60days prior to the date a definitive agreement concerning a Change of Control(as defined below) is executed and ending on the one-year anniversary of theconsummation of such Change of Control (such period being a “Change of ControlPeriod”), Mr. Hardisty will be entitled to receive a lump sum cash paymentwithin 30 days of termination equal to the greater of (1) two times thesum of his annual base salary in effect at the time of termination and theaverage of the bonuses he received in the two preceding fiscal years (ascalculated in accordance with the agreement), or (2) $450,000, whichamount will be increased to $650,000 if Mr. Hardisty is not provided withan opportunity to sell the shares of our common stock then held byMr. Hardisty at a purchase price of $4.00 or more per share in connectionwith a Change of Control transaction. If Mr. Hardisty’s employment issubject to an Involuntary Termination during a Change of Control Period or as aresult of his death or disability, we have also agreed to accelerate thevesting of all options to purchase common stock granted to Mr. Hardistyand to remove the restrictions on vesting or forfeiture of all restricted stockand all other accrued benefits under any nonqualified deferred compensationplans granted to Mr. Hardisty. Finally, Mr. Hardisty and hisdependents will be eligible to receive COBRA continuation coverage under ourgroup health plans for a period of up to two years following any InvoluntaryTermination of his employment, in accordance with and to the extent provided byCOBRA.

For purposes ofthe agreement, a “Change of Control” has the same meaning as set forth inMr. Terry’s employment agreement.

In the event thatany payment or distribution to Mr. Hardisty is subject to the excise taximposed by Section 4999 of the Internal Revenue Code or any interest orpenalties with respect to such excise tax, we have agreed to make an additionalpayment to Mr. Hardisty in an amount such that after payment by Mr. Hardistyof all taxes (including such excise tax imposed on such additional payment),Mr. Hardisty will retain an amount of such payment equal to the amount ofthe excise tax imposed upon such payment.

The agreement alsocontains customary confidentiality, nondisclosure and proprietary rightsprovisions. In addition, during his employment and for a period of two yearsfollowing the termination of Mr. Hardisty’s employment for any reason,Mr. Hardisty is prohibited from participating in the ownership,management, operation or control in any business that conducts a businesssimilar to that conducted by us or provides or sells a service or product thatis the same, substantially similar to or otherwise competitive with theproducts and services provided or sold by our company in any of the businessterritories that we conduct business from time to time, subject to certainlimited exceptions. During that same period, Mr. Hardisty may not solicit,among others, customers, suppliers and employees of our company.

*GordonTibbitts*   Mr. Tibbitts entered into anemployment agreement effective as of August 1, 2003. The agreement has aninitial term of one year and automatically renews each August 1st for anaddition twelve month period. The agreement provides that Mr. Tibbitts willserve as Vice President—Technology. Mr. Tibbitts receives an annual basesalary of $130,000 and is eligible to participate in company benefits andinsurance packages. We also agreed to provide Mr. Tibbitts with the use 

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of office and communication equipment normal for theoperation of a satellite office in Salt Lake City, Utah. Mr. Tibbitts alsowas entitled to receive a retention bonus of $65,000 in 2004 in connection withthe closing of PDI’s acquisition of the PID technology. This retention bonuswas paid in February 2005. Mr. Tibbitts will also be eligible toreceive a bonus at such time and in such amount as determined by the Board ofDirectors of the company.

During the term ofthe agreement, we may terminate Mr. Tibbitts’ employment at any time forcause, and Mr. Tibbitts may terminate the agreement for any reason uponwritten notice delivered no less than 15 days and no more than 60 days prior tothe date of termination. The employment agreement with Mr. Tibbitts alsocontains customary nondisclosure and proprietary rights provisions.

**CompensationCommittee Interlocks and Insider Participation**

During the fiscalyear ended September 30, 2006, Messrs. LeSuer, Mathews and Menown served on theCompensation Committee of our Board of Directors. None of Messrs. LeSuer,Mathews nor Menown has ever been an officer or employee of Particle DrillingTechnologies, Inc. None of our executive officers serve as a member of theBoard of Directors or compensation committee of any entity that has any executiveofficer serving as a member of our Board of Directors or CompensationCommittee.

**Item 12.**                   SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters

Thefollowing table sets forth the number of shares of common stock of the companybeneficially owned as of December 14, 2006 by (1) those persons or anygroup (as that term is used in Section 13(d)(3) of the Securities Exchange Actof 1934) known by our company to beneficially own more than 5% of our commonstock, (2) each named executive officer and director of our company, and(3) all directors and executive officers of our company as a group. Forpurposes of this table, beneficial ownership is determined in accordance withRule 13d-3 promulgated under the Securities Exchange Act of 1934. Thefollowing table includes shares of restricted stock of our company held by ourexecutive officers and directors over which they have voting power but noinvestment power. The following percentage information is calculated based on30,093,200 shares of common stock that were outstanding as of December 14,2006. Except as indicated below, the stockholders listed possess sole votingand investment power with respect to the shares beneficially owned by thatperson.

| Prentis B.  Tomlinson, Jr.(2)                       | 2,094,237 | (4)      | 6.8    | % |
|----------------------------------------------------------|-----------|----------|--------|---|
| LC Capital  Master Fund, Ltd.(3)                         | 1,734,300 |     | 5.8    | % |
| Greywolf Capital  Management LP                          | 1,650,000 | (13)     | 5.5    | % |
| John D.  Schiller, Jr. (1)                          | 1,648,333 | (5)      | 5.4    | % |
| Jim B. Terry                                             | 225,000   | (6)      |   | * |
| Thomas E.  Hardisty                                      | 1,376,419 | (7)      | 4.5    | % |
| J. Chris Boswell  (1)                                    | 1,692,473 | (8)      | 5.5    | % |
| Gordon Tibbitts                                          | 225,000   | (9)      |   | * |
| Ken R. LeSuer                                            | 135,000   | (10)     |   | * |
| Michael S.  Mathews                                      | 67,500    | (11)     |   | * |
| Hugh A. Menown                                           | 67,500    | (11)     |   | * |
| Steve Weyel                                              | 22,500    | (12)     |   | * |
| Directors and  executive officers as a group (9 persons) | 5,459,726 | (5)-(12) | 17.0   | % |

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*                    Lessthan 1%

(1)             Address:c/o Particle Drilling Technologies, Inc., 11757 Katy Freeway Houston,Texas 77079

(2)             Address:1825 I Street, NW, Suite 400, Washington, D.C. 20006.

(3)             Address:c/o Lampe Conway, 680 Fifth Avenue, Suite 1202, New York, New York 10019.Richard F. Conway has sole voting and investment power with respect to theshares of common stock held by LC Capital Master Fund, Ltd.

(4)             Includes600,000 shares of common stock that Mr. Tomlinson may purchase uponexercise of stock options that are currently vested or will become vestedwithin 60 days of the date of this Form 10-K.

(5)             Includes65,000 shares of restricted stock and 583,333 shares of common stock thatMr. Schiller may purchase upon exercise of stock options that arecurrently vested or will become vested within 60 days of the date of thisForm 10-K.

(6)             Includes175,000 shares of restricted stock.

(7)             Includes33,086 shares of restricted stock and 503,333 shares of common stock thatMr. Hardisty may purchase upon exercise of stock options that arecurrently vested or will become vested within 60 days of the date of thisForm 10-K.

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(8)             Includes30,000 shares of restricted stock and 573,333 shares of common stock thatMr. Boswell may purchase upon exercise of stock options that are currentlyvested or will become vested within 60 days of the date of this Form 10-K.

(9)             Includes225,000 shares of common stock that Mr. Tibbitts may purchase uponexercise of stock options that are currently vested or will become vestedwithin 60 days of this Form 10-K.

(10)       Includes20,000 shares of restricted stock and 100,000 shares of common stock thatMr. LeSuer may purchase upon exercise of stock options that are currentlyvested or will become vested within 60 days of this Form 10-K.

(11)       Includes10,000 shares of restricted stock and 32,500 shares of common stock that eachof Messrs. Mathews and Menown may purchase upon exercise of stock optionsthat are currently vested or will become vested within 60 days of this Form10-K.

(12)       Consistsof 10,000 shares of restricted stock and 12,500 shares of common stock that Mr.Weyel may purchase upon exercise of stock options that are currently vested orwill become vested within 60 days of this Form 10-K.

(13)       Theshares of common stock shown above for Greywolf Management LP (“InvestmentManager”) are owned directly by Greywolf Capital Partners II LP (“GreywolfCapital II”) (561,500 shares) and by Greywolf Capital Overseas Fund (“GreywolfOverseas”) (1,088,500 shares). Greywolf Advisors LLC (the “General Partner”), asgeneral partner to Greywolf Capital II, may be deemed to be the beneficialowner of all such shares owned by Greywolf Capital II. The Investment Manager,as investment manager of Greywolf Overseas and Greywolf Capital II, may bedeemed to be the beneficial owner of all such shares owned by Greywolf Overseasand Greywolf Capital II. Greywolf GP LLC (the “Investment Manager General Partner”),as general partner of the Investment Manager, may be deemed to be the beneficialowner of all such shares owned by Greywolf Capital II and Greywolf Overseas.Jonathan Savitz (“Savitz”), as the senior managing member of the GeneralPartner and as the sole managing member of the Investment Manager General Partner,may be deemed to be the beneficial owner of all such shares owned by GreywolfCapital II and Greywolf Overseas. Each of the General Partner, the InvestmentManager, the Investment Manager General Partner and Savitz hereby disclaims anybeneficial ownership of any such shares. The address of the principal businessoffice of (i) Greywolf Capital II, General Partner, Investment Manager andInvestment Manager General Partner is 4 Manhattanville Road, Suite 201,Purchase, NY 10577 and (ii) Greywolf Overseas is 6 Front Street, Hamilton, HM11Bermuda.

**Item13.**                   CertainRelationships and Related Transactions and Director Independence

**Transactions with Related Persons**

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 ourdirectors, 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 and, as a result, were fully released by the lessorfrom our prior office lease.  Messrs.Schiller and Weyel are directors and executive officers of Energy XXIServices.  We agreed with The ExploitationCompany, LLP to terminate the sublease agreement in connection with theassignment of the corporate office lease to Energy XXI Services, LLC.  During the term of the sublease agreement, wereceived approximately $74,000 of rental income from The Exploitation Company.

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

**Director Independence**

Our Board ofDirectors has determined that Messrs. LeSuer, Schiller, Mathews, Menown andWeyel are “independent” as that term is defined by the rules of theNASDAQ.  Prior to December 12, 2006, ourBoard of Directors had determined that Mr. Schiller was not independent.  This was because Mr. Schiller served asinterim President and Chief Executive Officer of our company and PDTI fromDecember 2004 until November 14, 2005. During that time, Mr. Schiller received compensation in the form of additionalgrants of restricted stock for serving as an interim executive officer.  Because of recent modifications to the rulesrelated to the definition of an independent director under NASDAQ rules, ourBoard of Directors re-evaluated this determination with respect to Mr. Schillerin December 2006.  As a result of thisevaluation, our Board of Directors determined that Mr. Schiller is now anindependent director under the rules and regulations of the NASDAQ.  In making the independence determinationswith respect to our directors, our Board of Directors considered transactionsand relationships between each director or his immediate family and ourcompany, including those reported above under “—Transactions with RelatedPersons.”  The purpose of this review wasto determine whether any such relationships or transactions were material and,therefore, inconsistent with a determination that the director isindependent.  The Board of Directorsconcluded that any such relationships and transactions were not material andthat any such transactions were at arm’s-length.  As a result of this review, the Board ofDirectors affirmatively determined based on its understanding of suchtransactions and relationships that the directors named above are independentof the Company under the standards set forth by NASDAQ.

During the fiscalyear ended September 30, 2006, each of the directors who served on the AuditCommittee, the Compensation Committee and the Nominating Committee weredetermined to have been independent directors by our Board of Directors.

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**Item 14.**                   PrincipalAccountant Fees and Services

**AuditFees**

The aggregate feesbilled for professional services rendered for the audit of our consolidatedfinancial statements, audit of internal control over financial reporting,issuance of consents and the reviews of financial statements included in ourquarterly reports on Form 10-Q for the fiscal years endedSeptember 30, 2006 and 2005 were $122,694 and $233,000, respectively. Ouraudit committee pre-approved all fees for professional services for the auditof our consolidated financial statements for the fiscal year endedSeptember 30, 2006.

**AuditRelated Fees**

There were noaudit related services provided by our independent registered public accountingfirm for the fiscal years ended September 30, 2006 and 2005.

**Tax Fees**

There were no taxservices provide by our independent registered public accounting firm for thefiscal years ended September 30, 2006 and 2005.

**AllOther Fees**

There were noother services provide by our independent registered public accounting firm forthe fiscal years ended September 30, 2006 and 2005.

The AuditCommittee is responsible for approving in advance any audit services and allpermitted audit-related services, tax services, and other non-audit services tobe performed by the independent registered public accounting firm. The AuditCommittee may delegate its pre-approval authority for these services to one ormore members, whose decisions shall be presented to the full Audit Committee atits scheduled meetings. Each of these services must receive specificpre-approval by the Audit Committee unless the Audit Committee has providedgeneral pre-approval for such category of services in accordance with policiesand procedures that comply with applicable laws and regulations.

**PART IV**

**Item15.**                   Exhibitsand Financial Statement Schedules

(a) List ofdocuments filed as part of this Annual Report:

(1) Consolidated Financial Statements

All of our consolidated financial statements are setforth under Item 8 of this Annual Report on Form 10-K.

(2) FinancialStatement Schedules:

Financial statementschedules listed under SEC rules but not included in this report are omittedbecause they are not applicable or the required information is provided in thenotes to our consolidated financial statements.

(3) Exhibits

See Exhibit Index

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**SIGNATURES**

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the Registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized, on the fourteenth day of December, 2006.
|        | PARTICLE DRILLING TECHNOLOGIES, INC |
|--------|-------------------------------------|
|   |                                |
|   | By                                  | /s/ J. CHRIS BOSWELL |   |
|   |                                | J. Chris Boswell |
|   |                                | Chief Financial Officer |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities indicated and on the fourteenth day of December, 2006.

| **Signature**           |   | **Title**                                                       |
|-------------------------|--------|-----------------------------------------------------------------|
|                    |   |                                                            |
| /s/ KENNETH R.  LESUER  |   | Chairman of the Board and Director                              |
| Kenneth R.  LeSuer      |   |                                                            |
|                    |   |                                                            |
| /s/ JIM TERRY           |   | President and Chief Executive Officer                           |
| Jim Terry               |   | (principal executive officer)                                   |
|                    |   |                                                            |
| /s/ J. CHRIS  BOSWELL   |   | Senior Vice President, and Chief Financial Officer              |
| J. Chris Boswell        |   | (principal financial officer and principal  accounting officer) |
|                    |   |                                                            |
| /s/ THOMAS E.  HARDISTY |   | Senior Vice President of Corporate Development and  Director    |
| Thomas E.  Hardisty     |   |                                                            |
|                    |   |                                                            |
| /s/ JOHN D.  SCHILLER   |   | Director                                                        |
| John. D.  Schiller      |   |                                                            |
|                    |   |                                                            |
| /s/ MICHAEL S.  MATHEWS |   | Director                                                        |
| Michael S.  Mathews     |   |                                                            |
|                    |   |                                                            |
| /s/ HUGH A.  MENOWN     |   | Director                                                        |
| Hugh A. Menown          |   |                                                            |
|                    |   |                                                            |
| /s/ STEVE A.  WEYEL     |   | Director                                                        |
| Steve A. Weyel          |   |                                                            |

 

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**EXHIBITINDEX**
| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|--------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **   | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | ** ** | ** ** | ** ** | ** ** |
| 2.1     |       | Acquisition Agreement dated as of January 20,  2004 among Particle Drilling, Inc., ProDril Partners L.L.C.,  ProDril Services Incorporated, Mr. Harry B. Curlett, CCORE  Technology and Licensing,  Ltd. and Curlett Family Limited  Partnership, Ltd. (Incorporated herein by reference to Exhibit 10.3  to our current report filed on Form 8-K dated January 20, 2005.)                                                                                                     |
| 2.2     |       | Acquisition Agreement dated as of January 20,  2004 among Particle Drilling, Inc., ProDril Partners L.L.C., ProDril  Services International Limited, Mr. Harry B. Curlett, CCORE  Technology and Licensing, Ltd. and Curlett Family Limited Partnership, Ltd.  (Incorporated herein by reference to Exhibit 10.4 to our current report  on Form 8-K dated January 20, 2005).                                                                                                                  |
| 2.3     |       | Agreement and Plan of Reorganization dated  July 14, 2004 by and among MedXLink Corp., a Nevada corporation,  PDTI Acquisition Corp., a Delaware corporation, Dean Becker, Particle  Drilling Technologies,  Inc., a Delaware corporation, ProDril  Partners L.L.C., a Texas limited liability company, and Thomas E.  Hardisty. (Incorporated herein by reference to Exhibit 2.1 to our  current report filed on Form 8-K dated July 14, 2004.)                                    |
| 2.4     |       | Amendment No. 1 to the Agreement and Plan of  Reorganization dated January 10, 2005 by and among MedXLink Corp.,  a Nevada corporation, PDTI Acquisition Corp., a Delaware corporation,  Dean Becker, Particle Drilling Technologies, Inc., a Delaware  corporation, ProDril Partners L.L.C., a Texas limited liability company,  and Thomas E. Hardisty. (Incorporated herein by reference to  Exhibit 99.1 to our current report filed on Form 8-K dated  January 12, 2005.) |
| 2.5     |       | Plan of Merger and Merger Agreement, dated  January 19, 2005, between Particle Drilling Technologies, Inc. and  MedXLink Corp. (Incorporated herein by reference to Exhibit 2.3 to our  current report filed on Form 8-K dated January 31, 2005.)                                                                                                                                                                                                                                                       |
| 3.1     |       | Articles of Incorporation of MedePort, Inc.  (Incorporated herein by reference to Exhibit 3.1 to our current report  filed on Form 8-K dated January 20, 2005.)                                                                                                                                                                                                                                                                                                                                              |
| 3.2     |       | Articles of Amendment to the Articles of  Incorporation of MedePort, Inc. (Incorporated herein by reference to  Exhibit 3.2 to our current report filed on Form 8-K dated  January 20, 2005.)                                                                                                                                                                                                                                                                                                                |
| 3.3     |       | Articles of Merger dated January 25, 2005  changing the name of the Company to Particle Drilling Technologies, Inc.  (Incorporated herein by reference to Exhibit 3.3 to our Registration  Statement on Form S-1 (Registration No. 333-123925 filed on April 7, 2005.)                                                                                                                                                                                                                                                 |
| 3.4     |       | Bylaws of the Company (Incorporated herein by  reference to Exhibit 3.3 to our current report filed on Form 8-K  dated January 20, 2005.)                                                                                                                                                                                                                                                                                                                                                                         |
| 10.1†   |       | Particle Drilling, Inc. 2004 Stock Incentive  Plan. (Incorporated herein by reference to Exhibit 10.5 to our current  report filed on Form 8-K dated January 20, 2005.)                                                                                                                                                                                                                                                                                                                                      |
| 10.2†   |       | Particle Drilling Technologies, Inc. 2005 Stock  Incentive Plan. (Incorporated herein by reference to Exhibit 99.1 to our  current report filed on Form 8-K dated April 4, 2005.)                                                                                                                                                                                                                                                                                                                            |
| 10.3†   |       | Form of Incentive Stock Option Agreement.  (Incorporated herein by reference to Exhibit 10.6 to our current report  filed on Form 8-K dated January 20, 2005.)                                                                                                                                                                                                                                                                                                                                                    |
| 10.4†   |       | Form of Non-Statutory Stock Option Agreement.  (Incorporated herein by reference to Exhibit 10.7 to our current report  filed on Form 8-K dated January 20, 2005.)                                                                                                                                                                                                                                                                                                                                                |
| 10.5†   |       | Employment Agreement by and between Particle  Drilling Technologies, Inc. and Jim B. Terry (Incorporated by reference to  Exhibit 10.1 to our current report on Form 8-K filed with the Securities and  Exchange Commission on January 25, 2006)                                                                                                                                                                                                                                                                                 |
| 10.6†   |       | form of Non-Statutory Stock Option Agreement  (employees) (Incorporated by reference to Exhibit 10.2 to our current report  on Form 8-K filed with the Securities and Exchange Commission on January 25,  2006)                                                                                                                                                                                                                                                                                                                  |
| 10.7†   |       | form of Restricted Stock Agreement (employees)  (Incorporated by reference to Exhibit 10.3 to our current report on Form 8-K  filed with the Securities and Exchange Commission on January 25, 2006)                                                                                                                                                                                                                                                                                                                             |
| 10.8†   |       | Employment Agreement by and between Particle  Drilling Technologies, Inc. and Jon Christopher Boswell (Incorporated by  reference to Exhibit 10.4 to our current report on Form 8-K filed with the  Securities and Exchange Commission on January 25, 2006)                                                                                                                                                                                                                                                                      |
| 10.9†   |       | Employment Agreement by and between Particle  Drilling Technologies, Inc. and Thomas E. Hardisty (Incorporated by reference  to Exhibit 10.5 to our current report on Form 8-K filed with the Securities  and Exchange Commission on January 25, 2006)                                                                                                                                                                                                                                                                           |
| 10.10†  |       | Employment Agreement dated August 1, 2003  between ProDril Acquisition Company and Gordon Tibbitts. (Incorporated herein  by reference to Exhibit 10.10 to our current report filed on  Form 8-K dated January 20, 2005.)                                                                                                                                                                                                                                                                                    |
| 10.11†  |       | Letter agreement dated December 2, 2004 between  Particle Drilling Technologies, Inc. and Prentis Tomlinson, Jr.  (Incorporated herein by reference to Exhibit 10.11 to our current report  filed on Form 8-K dated January 20, 2005.)                                                                                                                                                                                                                                                             |
| 10.12   |       | Securities Purchase Agreement, dated as of  February 9, 2005, by and among Particle Drilling Technologies, Inc.  and the Purchasers listed on Schedule I thereto. (Incorporated herein by  reference to Exhibit 10.1 to our current report filed on Form 8-K  dated February 10, 2005.)                                                                                                                                                                                                            |
| 10.13   |       | Registration Rights Agreement, dated as of  February 9, 2005, by and among Particle Drilling Technologies, Inc.  and each of the Purchasers. (Incorporated herein by reference to  Exhibit 10.2 to our current report filed on Form 8-K dated  February 10, 2005.)                                                                                                                                                                                                                                      |

 

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| 10.14      |   | Common Stock Purchase Warrant issued by Particle  Drilling Technologies, Inc. to Rita Barr (with attached schedule of  substantially identical Common Stock Purchase Warrants not filed with the  Securities and Exchange Commission). (Incorporated herein by reference to  Exhibit 10.3 to our current report filed on Form 8-K dated  February 10, 2005.)                                                                   |
|------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15      |   | Stock Purchase Agreement, dated as of  February 8, 2005, by and between Particle Drilling  Technologies, Inc. and Prentis B. Tomlinson, Jr. (Incorporated  herein by reference to Exhibit 10.4 to our current report filed on  Form 8-K dated February 10, 2005.)                                                                                                                                               |
| 10.16      |   | Form of Common Stock Purchase Warrant issued by  Particle Drilling Technologies, Inc. to Tejas Securities  Group, Inc. (Incorporated herein by reference to Exhibit 10.5 to  our current report filed on Form 8-K dated February 10, 2005.)                                                                                                                                                                               |
| 10.17      |   | Assignment and Assumption Agreement dated  January 20, 2004 among Curlett Family Limited Partnership, Ltd., ProDril  Services Incorporated, Harry B. Curlett, CCORE Technology and Licensing,  Ltd. ProDril Services International Limited and Particle Drilling, Inc.  (Incorporated by reference to Exhibit 10.14 to Amendment No. 1 to our  Registration Statement on Form S-1 (Registration No. 333-123925) filed on May  20, 2005.) |
| 10.18      |   | Royalty Agreement dated January 20, 2004  between Particle Drilling, Inc. and ProDril Services Incorporated.  (Incorporated by reference to Exhibit 10.15 to Amendment No. 1 to our  Registration Statement on Form S-1 (Registration No. 333-123925) filed on May  20, 2005.)                                                                                                                                                                |
| 10.19      |   | Royalty Agreement dated January 20, 2004  between Particle Drilling, Inc. and ProDril Services International Limited.  (Incorporated by reference to Exhibit 10.16 to Amendment No. 1 to our  Registration Statement on Form S-1 (Registration No. 333-123925) filed on May  20, 2005.)                                                                                                                                                       |
| 10.20      |   | Sublease Agreement dated March 21, 2005 between  Particle Drilling Technologies, Inc. and The Exploitation Company, LLP.  (Incorporated by reference to Exhibit 10.17 to Amendment No. 2 to our Registration  Statement on Form S-1 (Registration No. 333-123925) filed on June 27, 2005.)                                                                                                                                                    |
| 10.21      |   | Securities Purchase Agreement, dated as of October  19, 2006, by and among Particle Drilling Technologies, Inc. and the  Purchasers listed on Schedule I thereto. (Incorporated herein by reference to  Exhibit 10.1 to our current report filed on Form 8-K dated October  19, 2006.)                                                                                                                                                   |
| 10.22      |   | Registration Rights Agreement, dated as of October  19, 2006, by and among Particle Drilling Technologies, Inc. and each of the  purchasers. (Incorporated herein by reference to Exhibit 10.2 to our  current report filed on Form 8-K dated October 19, 2006.)                                                                                                                                                                         |
| 10.23      |   | Common Stock Purchase Warrant issued by Particle  Drilling Technologies, Inc. to Milfam I, LP (with attached schedule of substantially  identical Common Stock Purchase Warrants not filed with the Securities and  Exchange Commission). (Incorporated herein by reference to Exhibit 10.3  to our current report filed on Form 8-K dated October 19, 2006.)                                                                            |
| 14.1  |   | Particle Drilling Technologies, Inc. Code of  Business Conduct and Ethics. (Incorporated herein by reference to Exhibit  14.1 to our current report filed on Form 8-K dated February 9, 2005.)                                                                                                                                                                                                                                                     |
| 16.1  |   | Letter of Chisholm, Bierwolf &  Nilson, LLC. (Incorporated herein by reference to Exhibit 16.1 to  our current report filed on Form 8-K dated April 4, 2005.)                                                                                                                                                                                                                                                         |
| 16.2  |   | Letter of UHY Mann Frankfort Stein & Lipp CPAs,  LLP (Incorporated herein by reference to Exhibit 16.1 to our current report  filed on Form 8-K dated August 7, 2006.)                                                                                                                                                                                                                                                                         |
| 21.1*      |   | Subsidiaries of Particle Drilling Technologies, Inc.                                                                                                                                                                                                                                                                                                                                                                                               |
| 23.1*      |   | Consent of UHY, LLP.                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 23.2*      |   | Consent of UHY Mann Frankfort Stein & Lipp CPAs,  LLP                                                                                                                                                                                                                                                                                                                                                                                          |
| 31.1*      |   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                           |
| 32.1*      |   | Certification pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                           |
| 32.2*      |   | Certification pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                           |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                               |

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*                    Filedherewith

†                     Managementcontract or compensatory plan or arrangement

 

 

 

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