UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION




Washington,
D.C. 20549




FORM 10-Q




(Mark
      One)




x
            QUARTERLY REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
the quarterly period ended December 31, 2008




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 of registrant as specified in its charter)




Nevada
            
            20-1563395(State
      or other jurisdiction of
            
            (I.R.S.
      Employerincorporation
      or organization)
            
            Identification
      No.)


5611
Baird Court


Houston,
Texas 77041


(Address
of principal executive offices)


(Zip
Code)


713-223-3031




(Registrant’s
telephone number, including area code)




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 (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x  No o




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




Large
accelerated filer o        
Accelerated filer x           Non-accelerated
filer       o Smaller reporting
company o




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




The
number of shares of the registrant’s common stock, $.001 par value, outstanding
as of February 3, 2009 was 35,740,349.










PARTICLE DRILLING
TECHNOLOGIES, INC.




(a
development stage enterprise)




FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2008




INDEX





Part
      I - Financial Information







Item
      1.
                    
                    Financial
      StatementsConsolidated
      Balance Sheets (Unaudited) at December 31, 2008 and September 30,
      2008
                    
                    3Consolidated
      Statements of Operations (Unaudited) - Three Months Ended December 31,
      2008 and 2007, and from June 9, 2003 (date of inception) to December 31,
      2008
                    
                    4Consolidated
      Statements of Cash Flows (Unaudited) - Three Months Ended December 31,
      2008 and 2007, and from June 9, 2003 (date of inception) to December 31,
      2008
                    
                    5Notes
      to Consolidated Financial Statements (Unaudited)
                    
                    6Item
      2.
                    
                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                    
                    11Item
      3.
                    
                    Quantitative
      and Qualitative Disclosures about Market Risk
                    
                    15Item
      4.
                    
                    Controls
      and Procedures
                    
                    15Part
      II - Other Information
                    
                    15Item
      1A.
                    
                    Risk
      Factors
                    
                    15Item
      6.
                    
                    Exhibits
                    
                    16Signatures
                    
                    17







2


PARTICLE
DRILLING TECHNOLOGIES, INC.


(a
development stage enterprise)


CONSOLIDATED
BALANCE SHEETS




December
      31,
                  2008
                
                
                September 30,
                  2008(Unaudited)ASSETSCurrent
      assets:Cash
      and cash equivalents
                
                $
                1,167,987
                
                
                $
                2,296,143Prepaid
      expenses
                
                
                167,178
                
                
                
                260,686Total
      current assets
                
                
                1,335,165
                
                
                
                2,556,829Property,
      plant & equipment, net
                
                
                453,823
                
                
                
                1,213,918Intangibles,
      net
                
                
                1,655,681
                
                
                
                1,552,266Other
      assets
                
                
                41,144
                
                
                
                41,144Total
      assets
                
                $
                3,485,813
                
                
                $
                5,364,157LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
                
                $
                772,014
                
                
                $
                850,944Short-term
      notes payable
                
                
                48,542
                
                
                
                84,277Current
      portion of long-term debt
                
                
                5,989
                
                
                
                8,651Accrued
      liabilities
                
                
                117,608
                
                
                
                353,881Total
      current liabilities
                
                
                944,153
                
                
                
                1,297,753Long-term
      debt
                
                
                14,310
                
                
                
                15,381Deferred
      rent
                
                
                138,029
                
                
                
                135,531Commitments
      and contingencies - Note 8Stockholders’
      equity:Common
      stock, $.001 par value, 100,000,000 shares authorized, 38,743,435 shares
      issued and 35,740,349 shares outstanding at December 31, 2008, and
      38,767,018 shares issued and 35,763,932 shares outstanding at September
      30, 2008
                
                
                38,744
                
                
                
                38,768Additional
      paid-in capital
                
                
                46,711,173
                
                
                
                46,217,538Treasury
      stock at cost, 3,003,086 shares
                
                
                (1,511,817
                )
                
                
                (1,511,817
                )Deficit
      accumulated during the development stage
                
                
                (42,848,779
                )
                
                
                (40,828,997
                )Total
      stockholders’ equity
                
                
                2,389,321
                
                
                
                3,915,492Total
      liabilities and stockholders’ equity
                
                $
                3,485,813
                
                
                $
                5,364,157




The
accompanying notes are an integral part of these consolidated financial
statements.




3


PARTICLE
DRILLING TECHNOLOGIES, INC.


(a
development stage enterprise)


CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)







Period fromJune 9, 2003(date ofinception) toThree Months EndedDecember 31,
                
                
                December 31,2008
                
                
                2007
                
                
                2008Revenues
                
                $
                —
                
                
                $
                —
                
                
                $
                —Operating
      expenses:Research
      and development
                
                
                965,662
                
                
                
                1,780,812
                
                
                
                22,361,907General
      and administrative
                
                
                1,146,125
                
                
                
                1,479,105
                
                
                
                22,089,353Impairment
      of asset
                
                
                —
                
                
                
                —
                
                
                
                295,260Gain
      on sale of assets
                
                
                (86,971
                )
                
                
                —
                
                
                
                (843,440
                )Total
      operating expenses
                
                
                2,024,816
                
                
                
                3,259,917
                
                
                
                43,903,080Loss
      from operations
                
                
                (2,024,816
                )
                
                
                (3,259,917
                )
                
                
                (43,903,080
                )Other
      income (expenses)Interest
      income
                
                
                6,866
                
                
                
                35,704
                
                
                
                949,457Rental
      income - related party
                
                
                —
                
                
                
                —
                
                
                
                73,727Gain
      on debt extinguishment
                
                
                —
                
                
                
                —
                
                
                
                35,283Gain
      on assignment of lease - related party
                
                
                —
                
                
                
                —
                
                
                
                55,614Interest
      expense
                
                
                (1,832
                )
                
                
                (2,323
                )
                
                
                (59,780
                )Total
      other income
                
                
                5,034
                
                
                
                33,381
                
                
                
                1,054,301Net
      loss
                
                $
                (2,019,782
                )
                
                $
                (3,226,536
                )
                
                $
                (42,848,779
                )Net
      loss per common share, basic and diluted
                
                $
                (0.06
                )
                
                $
                (0.10
                )
                
                $
                (1.79
                )Weighted
      average number of common shares outstanding - basic and
      diluted
                
                
                34,570,348
                
                
                
                30,734,703
                
                
                
                23,920,600





The
accompanying notes are an integral part of these consolidated financial
statements.




4


PARTICLE
DRILLING TECHNOLOGIES, INC.


(a
development stage enterprise)


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)




Period fromJune 9, 2003(date ofThree Months Ended
                      December
      31,
                    
                    
                    inception
      ) to December 31,2008
                    
                    
                    2007
                    
                    
                    2008Cash
      flows from operating activities:Net
      loss
                    
                    $
                    (2,019,782
                    )
                    
                    $
                    (3,226,536
                    )
                    
                    $
                    (42,848,779
                    )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Gain
      on debt extinguishment
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (35,283
                    )Impairment
      of asset
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    295,260Gain
      on assignment of lease - related party
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (55,614
                    )Gain
      on sale of assets
                    
                    
                    (86,971
                    )
                    
                    
                    —
                    
                    
                    
                    (843,440
                    )Depreciation
      and amortization expense
                    
                    
                    96,262
                    
                    
                    
                    166,855
                    
                    
                    
                    2,683,560Short-term
      note issued for services
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    44,000Common
      stock issued for services
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    931,500Warrants
      issued for services
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    63,829Stock-based
      employee compensation
                    
                    
                    493,611
                    
                    
                    
                    713,958
                    
                    
                    
                    8,305,154Changes
      in operating assets and liabilities:Decrease
      in note receivable
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    385,839(Increase)
      in accounts receivable - related party
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (40,819
                    )(Increase)
      Decrease in prepaid expenses
                    
                    
                    93,508
                    
                    
                    
                    (7,804
                    )
                    
                    
                    198,797Increase
      (Decrease) in accounts payable
                    
                    
                    (78,930
                    )
                    
                    
                    67,551
                    
                    
                    
                    432,076Increase
      (Decrease) in accrued liabilities
                    
                    
                    (236,273
                    )
                    
                    
                    437,060
                    
                    
                    
                    214,405(Increase)
      Decrease in other assets
                    
                    
                    —
                    
                    
                    
                    2,018
                    
                    
                    
                    (26,494
                    )Increase
      in other liabilities
                    
                    
                    2,498
                    
                    
                    
                    35,499
                    
                    
                    
                    138,029Net
      cash used in operating activities
                    
                    
                    (1,736,077
                    )
                    
                    
                    (1,811,399
                    )
                    
                    
                    (30,157,980
                    )Cash
      flows from investing activities:Payments
      to purchase property and equipment
                    
                    
                    (76,575
                    )
                    
                    
                    (26,726
                    )
                    
                    
                    (3,434,077
                    )Proceeds
      from sale of property and equipment
                    
                    
                    840,000
                    
                    
                    
                    —
                    
                    
                    
                    1,712,574Payments
      to purchase intangibles
                    
                    
                    (116,036
                    )
                    
                    
                    (35,294
                    )
                    
                    
                    (1,147,798
                    )Payments
      to purchase other assets
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (419,504
                    )Payments
      issued for note receivable
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (300,783
                    )Payments
      issued for note receivable - related party
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (56,784
                    )Net
      cash provided by (used in) investing activities
                    
                    
                    647,389
                    
                    
                    
                    (62,020
                    )
                    
                    
                    (3,646,372
                    )Cash
      flows from financing activities:Proceeds
      from issuance of common stock
                    
                    
                    —
                    
                    
                    
                    1,200
                    
                    
                    
                    36,839,575Repurchase
      of common stock
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (1,511,817
                    )Proceeds
      from issuance of convertible notes
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    553,500Repayments
      of notes payable
                    
                    
                    (39,468
                    )
                    
                    
                    (40,725
                    )
                    
                    
                    (908,919
                    )Proceeds
      from borrowings under loan agreements - related parties
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    23,195Repayment
      of borrowings under loan agreements - related parties
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (23,195
                    )Net
      cash (used in) provided by financing activities
                    
                    
                    (39,468
                    )
                    
                    
                    (39,525
                    )
                    
                    
                    34,972,339Net
      increase (decrease) in cash and cash equivalents
                    
                    
                    (1,128,156
                    )
                    
                    
                    (1,912,944
                    )
                    
                    
                    1,167,987Cash
      and cash equivalents - beginning of period
                    
                    
                    2,296,143
                    
                    
                    
                    4,461,929
                    
                    
                    
                    —Cash
      and cash equivalents - end of period
                    
                    $
                    1,167,987
                    
                    
                    $
                    2,548,985
                    
                    
                    $
                    1,167,987Supplemental
      disclosures of cash flow information:Cash
      paid for interest
                    
                    $
                    1,832
                    
                    
                    $
                    2,323
                    
                    
                    $
                    59,780Non-cash
      investing and financing activities:Prepaid
      insurance acquired with note payable
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    586,629Common
      stock issued as consideration for account payable
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    6,000Common
      stock issued as consideration for note payable
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    50,000Related
      party note receivable issued for property and equipment
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    56,783Note
      payable converted into common stock
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    553,500Property
      and equipment acquired with assumed liabilities
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    479,610Intangibles
      acquired with assumed liabilities
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    757,792Property
      and equipment acquired with note payable
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    30,487Short-term
      investments reclassified from other assets
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    385,839Property
      and equipment reclassified from other assets
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    19,015




The
accompanying notes are an integral part of these consolidated financial
statements.


5


PARTICLE DRILLING
TECHNOLOGIES, INC.




(a
development stage enterprise)




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




(Unaudited)




1.
            BASIS OF
      PRESENTATION




The
accompanying unaudited interim consolidated financial statements, which include
the accounts of Particle Drilling Technologies, Inc. (which is
referred to herein as “we,” “us,” “our” or the “Company”) and its subsidiary,
have been prepared in accordance with generally accepted accounting principles
in the United States of America (“US GAAP”) and pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with US GAAP have been condensed or omitted in accordance with such
rules and regulations. The information furnished in the unaudited interim
consolidated financial statements includes normal recurring adjustments and
reflects all adjustments, which in the opinion of management are necessary for a
fair presentation of such financial statements. Although management believes the
disclosures and information presented are adequate to make the information not
misleading, these unaudited interim consolidated financial statements should be
read in conjunction with the Company’s September 30, 2008 audited
consolidated financial statements and notes thereto in its Annual Report on
Form 10-K. Operating results for the three months ended December 31, 2008
are not necessarily indicative of the results that may be expected for the year
ending September 30, 2009.




The
preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from these
estimates.




Certain
reclassifications have been made to conform prior period amounts to the current
period presentation. These reclassifications had no effect on net loss, net loss
per share, or stockholders’ equity.




2.
            GOING
    CONCERN




The
financial statements of the Company have been prepared on the basis of
accounting principles applicable to a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business.  As shown in the consolidated financial statements, for
the three months ended December 31, 2008, the Company reported a net loss of
approximately $2.0 million, as compared to a net loss of approximately $3.2
million for the three months ended December 31, 2007.  The
consolidated financial statements also show an accumulated deficit of
approximately $42.8 million from inception (June 9, 2003) through the period
ended December 31, 2008.




The
Company is currently a development stage company and its continued existence is
dependent upon the Company’s successful development of the PID technology and
its ability to successfully commercialize this technology.  The
Company has yet to generate cash flow from operations, and until revenues
commence, the Company is highly dependent upon debt and equity
funding.  Based on the Company’s current liquidity position, the
Company will need to raise additional capital through debt or equity funding
within the next twelve months.  Management cannot provide any
assurance that any such financing will be available on acceptable terms or at
all.  Should continuing funding requirements not be met, the Company’s
operations may cease to exist.




These
matters raise substantial doubt about the Company’s ability to continue as a
going concern. The financial statements do not include any adjustments relating
to the recoverability and classification of asset carrying amounts or the amount
and classification of liabilities that might result should the Company be unable
to continue as a going concern.




6


3.  
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES




Impairment of Long-Lived
Assets.We evaluate our long-lived assets for indicators of
possible impairment by comparison of the carrying amounts to future net
undiscounted cash flows expected to be generated by such assets when events or
changes in circumstances indicate the carrying amount of an asset may not be
recoverable.  Should an impairment exist, the impairment loss would be
measured based on the excess carrying value of the asset over the asset’s fair
value or discounted estimates of future cash flows.  We also evaluate the
capitalized costs for patents and patent applications filed but not issued for
possible impairments. The evaluation of capitalized costs for patents and patent
applications is based on a subjective cash flow forecast which is subject to
change. We will reassess our cash flow forecast each time there are fundamental
changes in the underlying potential use of the patents or patent applications in
terms of performance, customer acceptance or other factors that may affect such
cash flow forecasts.




New Accounting Pronouncements.In September 2006, the FASB issued Statement of Financial Accounting
Standards, “SFAS” No. 157, Fair Value Measurements
(“SFAS No. 157”).  SFAS No. 157 clarifies the principle that fair
value should be based on the assumptions market participants would use when
pricing an asset or liability and establishes a fair value hierarchy that
prioritizes the information used to develop those assumptions.  Under the
standard, fair value measurements would be separately disclosed by level within
the fair value hierarchy.  SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years, with early adoption permitted. 
The Company has adopted SFAS No. 157 and it has not had a material impact on its
financial position, results of operations or cash flows.




In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (“SFAS No. 159”). SFAS No. 159
permits entities to choose to measure many financial assets and financial
liabilities at fair value. Unrealized gains and losses on items for which the
fair value option has been elected are reported in earnings. SFAS No. 159
is effective for fiscal years beginning after November 15, 2007. The
Company adopted SFAS No. 159 on October 1, 2008 and it has not had a
material impact on its consolidated financial statements.




In
December 2007, the FASB issued SFAS No. 141R, Business Combinations (SFAS
141R), which replaces SFAS 141, Business Combinations. SFAS
141R establishes principles and requirements for determining how an enterprise
recognizes and measures the fair value of certain assets and liabilities
acquired in a business combination, including noncontrolling interests,
contingent consideration, and certain acquired contingencies. SFAS 141R also
requires acquisition-related transaction expenses and restructuring costs be
expensed as incurred rather than capitalized as a component of the business
combination. SFAS 141R will be applicable prospectively to business combinations
beginning in the Company’s 2010 fiscal year.





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements – An Amendment of ARB No. 51 (SFAS160).SFAS160 establishes accounting and reporting standards for
the noncontrolling interest in a subsidiary.SFAS160 also requires that a retained noncontrolling interest upon
the deconsolidation of a subsidiary be initially measured at its fair value.SFAS160 is effective for the
Company’s 2010 fiscal year. Upon adoption ofSFAS160, the Company will be required to report its noncontrolling
interests, if any, as a separate component of shareholders’ equity. The Company
will also be required to present net income allocable to the noncontrolling
interests, if any, and net income attributable to the shareholders of the
Company separately in its consolidated statements of income. Currently,
noncontrolling interests (minority interests) are reported as a liability in a
Company’s statement of financial position and the related income attributable to
minority interests is reflected as an expense in arriving at net income.SFAS160 requires retroactive adoption
of the presentation and disclosure requirements for existing minority interests.
All other requirements ofSFAS160 shall be applied prospectively.  The Company does
not expect the adoption of SFAS No. 160 to significantly impact its
financial position, results of operations or cash flows.





In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities-an amendment of FASB Statement
No. 133 (“SFAS No. 161”). SFAS No. 161 requires enhanced
disclosure related to derivatives and hedging activities and thereby seeks to
improve the transparency of financial reporting. Under SFAS No. 161,
entities are required to provide enhanced disclosures relating to: (a) how and
why an entity uses derivative instruments; (b) how derivative instruments
and related hedge items are accounted for under SFAS No. 133, “Accounting
for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), and
its related interpretations; and (c) how derivative instruments and related
hedged items affect an entity’s financial position, financial performance, and
cash flows. SFAS No. 161 must be applied prospectively to all derivative
instruments and non-derivative instruments that are designated and qualify as
hedging instruments and related hedged items accounted for under SFAS
No. 133 for all financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early application
permitted. The Company does not expect the adoption of SFAS No. 161 to
significantly impact its financial position, results of operations or cash
flows.





In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. This Statement identifies the sources of
accounting principles and the framework for selecting the principles used in the
preparation of financial statements. This Statement is effective 60 days
following the SEC’s approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, “The Meaning of Present Fairly in Conformity
with Generally Accepted Accounting Principles.” The Company is currently
evaluating the potential impact the new pronouncement will have on its
consolidated financial statements.




In
April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3,
“Determination of the Useful Life of Intangible Assets.” This FSP amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under FASB
Statement No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). The
intent of this FSP is to improve the consistency between the useful life of a
recognized intangible asset under SFAS 142 and the period of expected cash
flows used to measure the fair value of the asset under SFAS 141R, and other
GAAP. This FSP is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods within those fiscal
years. Early adoption is prohibited. The Company is currently evaluating the
potential impact the new pronouncement will have on its consolidated financial
statements.





7




4.
            PROPERTY AND
      EQUIPMENT




The
following is a summary of property and equipment, at cost less accumulated
depreciation, at December 31, 2008 and September 30, 2008:





December
      31, 2008
                    
                    
                    September
      30, 2008Office
      furniture and equipment
                    
                    $
                    268,527
                    
                    
                    $
                    278,350Machines
      and equipment
                    
                    
                    990,391
                    
                    
                    
                    1,813,816Leasehold
      improvements
                    
                    
                    243,164
                    
                    
                    
                    243,164Total
      cost of property and equipment
                    
                    
                    1,502,081
                    
                    
                    
                    2,335,330Less:
      accumulated depreciation
                    
                    
                    (1,048,257
                    )
                    
                    
                    (1,121,412
                    )Total
      property and equipment, net
                    
                    $
                    453,823
                    
                    
                    $
                    1,213,918





In
November 2008, the Company sold its remaining frac pump for net proceeds of
$840,000 for a gain of $90,000.







5.
            NET LOSS PER COMMON
      SHARE




The
Company has presented basic and diluted net loss per share pursuant to SFAS
No. 128, Earnings Per
Share. In accordance with SFAS No. 128, basic and diluted net loss
per share has been computed using the weighted-average number of shares of
common stock outstanding during the period. Dilutive net loss per share would
give effect to the dilutive effect of common stock equivalents consisting of
options and warrants. Potentially dilutive securities have been excluded from
the net loss per common share calculation as the effects would be antidilutive.
Potentially dilutive securities not included in the computation of weighted
average diluted shares of common stock because the impact of these potentially
dilutive securities were antidilutive were none and 1,475,230 shares for the
three months ended December 31, 2008 and 2007, respectively.







6.
            COMMON
      STOCK




At
December 31, 2008, the Company had 35,740,349 shares of common stock outstanding
and had outstanding options and warrants to purchase up to 5,737,341 additional
shares of the Company’s common stock in the aggregate.  During the
three months ended December 31, 2008, there were a total of 23,583 restricted
shares cancelled.




8


7.
            STOCK-BASED EMPLOYEE
      COMPENSATION




In
April 2004, the Board of Directors adopted the 2004 Stock Incentive Plan
(the “2004 Plan”).  The 2004 Plan provides for the issuance of
incentive stock options, non-statutory stock options and restricted stock to
directors, employees and consultants of PDTI. Provisions under the 2004 Plan
allow for the issuance of up to 3,500,000 shares of common stock pursuant to
awards under this plan.  As of  December 31, 2008, the
Company had 3,250 awards available for grant under the 2004 Plan. Under the 2004
Plan, the exercise price of each option is equal to the market value of the
Company’s common stock on the date of grant and the maximum term for the options
is ten years.




In
March 2005, the Board of Directors adopted the 2005 Stock Incentive Plan
(the “2005 Plan”).  The 2005 Plan provides for the issuance of incentive
stock options, non-statutory stock options and restricted stock grants to
directors, employees and consultants of PDTI.  Provisions under the 2005
Plan allow for the issuance of options and restricted stock awards to purchase
or issue up to 2,000,000 shares of common stock.  As of December 31, 2008,
the Company had 52,458 shares of common stock available for issuance pursuant to
awards under the 2005 Plan.  Under the 2005 Plan, the exercise price
of each option is equal to the market value of the Company’s common stock on the
date of grant and the maximum term for the options is ten years.




In March
2007, the shareholders adopted the 2007 Stock Incentive Plan (the “2007
Plan”).  The 2007 Plan provides for the issuance of incentive stock
options, non-statutory stock options and restricted stock to directors,
employees and consultants of PDTI. Provisions under the 2007 Plan allow for the
issuance of up to 1,500,000 shares of common stock pursuant to awards under this
plan.  As of December 31, 2008, the Company had 662,250 awards
available for grant under the 2007 Plan. Under the 2007 Plan, the exercise price
of each option is equal to the market value of the Company’s common stock on the
date of grant and the maximum term for the options is ten years.




Stock-based
employee compensation expense recorded for awards issued under the 2004 Plan,
the 2005 Plan, and the 2007 Plan for the three months ended December 31, 2008
and 2007 was $493,611 and $713,958, respectively.  Stock-based
employee compensation expense recorded for awards issued under the 2004 Plan,
the 2005 Plan, and the 2007 Plan since inception (June 9, 2003) to December
31, 2008 was $8,305,154.  The remaining stock-based compensation
expense to be amortized as of December 31, 2008 is $1,765,829.





The
following table summarizes information about stock options outstanding and
exercisable at December 31, 2008:





Options Outstanding
              
              Options ExercisableRange 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
              
              2,547,700
              
              5.4
      years
              
              $
              0.47
              
              2,547,700
              
              $
              0.47$1.76
      to $6.73
              
              1,410,500
              
              7.2
      years
              
              $
              4.44
              
              1,086,666
              
              4.733,958,200
              
              6.0
      years
              
              $
              1.89
              
              3,634,366
              
              $
              1.76





The
following table summarizes information about warrants outstanding and
exercisable at December 31, 2008:





Warrants Outstanding
              
              Warrants ExercisableRange 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
              
              1,779,141
              
              3.0
      years
              
              $
              1.99
              
              1,779,141
              
              $
              1.99





At
December 31, 2008, the intrinsic value of all outstanding and exercisable
options and warrants was zero.




9


8.
            COMMITMENTS AND
      CONTINGENCIES




In
April 2007, we entered into a 60-month lease agreement that commenced in
September 2007 for a new corporate office and operating facility and delivered
to the lessor a security deposit of $41,144.  The new facility combines the
corporate office personnel and the operations personnel into one location at
5611 Baird Court, Houston, Texas 77041.  The total future minimum lease
payments under this lease were $1,741,443 at December 31, 2008.




9.  INCOME
TAXES




The
Company follows Statements of Financial Accounting Standards (“SFAS”) No. 109
Accounting for Income Taxes. This statement requires an asset and liability
approach for financial accounting and reporting for income tax
purposes.  This statement recognizes the amount of taxes payable or
refundable for the current year and deferred tax liabilities and assets for
future tax consequences of events that have been recognized in the consolidated
financial statements or tax returns.  Provisions (benefits) for income
taxes result from permanent and temporary differences in the recognition of
accounting transactions for tax and financial reporting
purposes.  Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized.




The
Company adopted FIN 48 in fiscal year 2008 and there was no effect on the
financial statements.  FIN 48 prescribes a minimum recognition
threshold and measurement methodology that a tax position taken or expected to
be taken in a tax return is required to meet before being recognized in the
financial statements. It also provides guidance for de-recognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition.  The Company recognizes interest and penalties
related to unrecognized tax benefits within the provision for income taxes on
continuing operations in the consolidated statements of income. There are no
unrecognized tax benefits as of the date of adoption.  There are no
unrecognized tax benefits that if recognized would affect the tax rate. There is
no interest or penalties recognized as of the date of adoption or for the three
months ended December 31, 2008.





The
Company has filed its income tax return for the tax year ended September 30,
2008.  The tax years ended September 30, 2007, September 30, 2006 and
September 30, 2005 are open for examination by the U.S. and State taxing
authorities.





The
Company anticipates recording no tax benefit for the year, based upon
management’s assessment that the realization of the anticipated financial loss
for the year is not, at this point, reasonably assured; accordingly no benefit
has been recorded for the period ended December 31, 2008.





For the
period ended December 31, 2008, there were permanent and temporary differences
of approximately $3,000 and $(505,000), respectively, which in aggregate
increased the loss for the current year.




At
December 31, 2008, the Company has cumulative net operating loss carryforwards
of approximately $35,985,000 which expire in years 2010 through 2028. No effect
has been shown in the financial statements for the net operating loss
carryforwards as the likelihood of future tax benefit from such net operating
loss carryforwards is not determinable at this time. Accordingly, the potential
tax benefits of the net operating loss carryforwards, estimated based upon
current tax rates at December 31, 2008, have been offset by valuation reserves
of the same amount.  The valuation allowance increased approximately
$510,000 from September 30, 2008 to December 31, 2008.




10




Item
      2:  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations.




The
following discussion of our financial condition and results of operations should
be read together with the unaudited consolidated financial statements and
related notes that are included elsewhere in this report. This discussion may
contain forward-looking statements based upon current expectations that involve
risks and uncertainties that could cause actual results to differ materially
from the forward-looking statements.   Please see
“Forward-Looking Statements” below.




Liquidity
and Capital Resources




Our principal sources of liquidity
are cash and cash equivalents. We are devoting substantially all of our efforts
to product development and commercializing the Particle Impact Drilling ("PID")
technology.   In the course of our development activities, we have
sustained operating losses and expect that such losses could continue through
fiscal 2009. We intend to finance our operations primarily through cash and cash
equivalents on hand, through cash flow from operations if we are able to
successfully engage in commercial operations that generate revenue, and other
potential capital raising transactions. However, we have yet to generate any
revenues, and can provide no assurance of future revenues. To management’s
knowledge, no company has yet marketed a salable product using the technology we
are developing. Even if marketing efforts are successful, substantial time may
pass before revenues are realized.





In
management’s opinion, based on available cash and cash equivalents on hand as of
December 31, 2008, we do not have the ability to maintain sufficient liquidity
to meet our working capital and capital expenditure requirements for the next 12
months.  Management must raise additional outside capital in order to
improve our liquidity position. The equity and debt capital markets have
recently experienced adverse conditions and extreme volatility which may, if
such conditions persist, impair our ability to raise capital on satisfactory
terms, or at all.  Our continued existence depends on our ability to
raise additional outside capital and the successful development of the PID
technology and our ability to successfully commercialize this
technology.  These factors raise substantial doubt regarding our
ability to continue as a going concern.





Since
inception on June 9, 2003 through December 31, 2008, we have financed our
operations through private sales of our equity, a subscription  rights
offering, and the issuance of convertible notes payable, totaling net proceeds
of $35,397,913.  As of December 31, 2008, we had $1,167,987 in cash
and cash equivalents.





Cash Flows from Operating
Activities.Cash flow used for operations is primarily affected by
our research and development progress and business development.  Net
cash flows used in operating activities during the three months ended December
31, 2008 were $1,736,077 compared to $1,811,399 for the three months ended
December 31, 2007.  The decrease from fiscal 2008 to fiscal 2009 was
primarily the result of our decreased level of research and development costs
associated with the construction of the PID System.





Cash Flows from Investing
Activities.Cash flows provided by (used in) investing activities
for the three months ended December 31, 2008 were $647,389 compared to $(62,020)
for the three months ended December 31, 2007.  The cash flows used in
investing activities during the three months ended December 31, 2008 consisted
of  $76,575 for the purchase of property, plant and equipment and
$116,036 for costs associated with filing new and protecting existing
patents.  In addition, we sold our frac pump for net proceeds of
$840,000 during the three months ended December 31, 2008.








Cash Flow from Financing Activities.Net cash used in financing activities for the three months ended
December 31, 2008 was $39,468 compared to $39,525 for the three months ended
December 31, 2007.  During the three months ended December 31, 2008
and 2007, the financing activities consisted primarily of repayments of notes
payable.




11


Contractual
Obligations.  In April 2007, we entered into a 60-month
lease agreement that commenced in September 2007 for a new corporate office and
operating facility and delivered to the lessor a security deposit of
$41,144.  The new facility combines the corporate office personnel and the
operations personnel into one location at 5611 Baird Court, Houston, Texas
77041.  The total future minimum lease payments under this lease are
$1,741,443 at December 31, 2008.




Payments
      Due by PeriodContractual
      Obligations
                
                Total
                
                
                Less
      than 1
                  year
                
                
                1
      - 3 years
                
                
                3
      - 5 years
                
                
                More
      than 5
                  yearsLong-Term
      Debt Obligation and Short Term Notes Payable(including
      current portion)
                
                $
                68,841
                
                
                $
                54,531
                
                
                $
                14,310
                
                
                $
                —
                
                
                $
                —Purchase
      Obligations
                
                
                10,585
                
                
                
                10,585
                
                
                
                —
                
                
                
                —
                
                
                
                —Operating
      Lease Obligations
                
                
                1,741,443
                
                
                
                436,757
                
                
                
                1,304,686
                
                
                
                —
                
                
                
                —Total
                
                $
                1,820,869
                
                
                $
                501,873
                
                
                $
                1,318,996
                
                
                $
                —
                
                
                $
                —





Overview




On
January 14, 2005, we acquired Particle Drilling
Technologies, Inc., a privately-held Delaware corporation (“PDTI”). As a
result of this acquisition, our company, which previously had no material
operations, acquired the business of PDTI and we are now engaged in the
development of the Particle Impact Drilling System, a patented system
utilizing a specially designed “fit for purpose” drill bit fitted with jetting
nozzles and polycrystalline diamond compact cutting structures for use in the
oil and gas drilling industry.




We are a
development-stage company and have a limited operating history. Our predecessor
company for financial reporting purposes was formed on June 9, 2003 to
acquire the technology related to the Particle Impact Drilling System (the
“PID System” or “PID technology”). We are still developing this technology, and
to date, we have not generated any revenues from our
operations.  Currently, we have limited liquidity and therefore our
business activities have been curtailed.  We are currently reviewing
strategic alternatives and hope that any such transaction would assist us in
accelerating the commercialization of our technology.  Our Board of
Directors has determined it would be in the best interest of our company and its
shareholders to evaluate all available strategic alternatives, including a
strategic industry joint venture, technology licensing arrangement, sale of the
company, and other available alternatives.  If we are able to identify
a strategic partner that can provide additional capital, resources, test
facilities and drilling opportunities, we will continue to execute our
operations plan which will likely result in increases to our development and
operating expenses.




In
management’s opinion, based on available cash and cash equivalents on hand as of
December 31, 2008, we do not have the ability to maintain sufficient liquidity
to meet our working capital and capital expenditure requirements for the next 12
months.  Management must raise additional outside capital in order to
improve our liquidity position. The equity and debt capital markets have
recently experienced adverse conditions and extreme volatility which may, if
such conditions persist, impair our ability to raise capital on satisfactory
terms, or at all.  Our continued existence depends on our ability to
raise additional outside capital and the successful development of the PID
technology and our ability to successfully commercialize this
technology.




The PID
System is expected to result in higher rates of penetration than current
conventional drilling methods, thereby reducing drilling costs and lowering
finding and development costs to improve the overall economics to the oil and
gas industry in certain geologic intervals.




On
December 8, 2008, we announced that we have entered into an agreement with a
fully integrated, multi-national energy company (the “Operator”). The contract
has a total potential value to us of up to $818,000 in connection with the
performance of up to three field trials.  Pursuant to this contract,
the Operator will provide us funding to develop and manufacture one or more
smaller bit designs apart from those bits we normally use, and for us to provide
those bits along with our patented PID System in connection with as many as
three trials at one of the Operator’s drilling areas in the onshore United
States. The contract specifies that an initial $350,000 will be paid in advance
of the first field trial.  The initial term of the agreement runs from
December 1, 2008 through November 30, 2010, but is terminable by the Operator at
any time.  At any time within two years following the completion of
the initial field trial, the Operator has preferred access to the initial two
PID Systems for a 2-year period, subject to the satisfaction of certain minimum
utilization requirements.  Currently, we only have one prototype PID
System.





12


Research and
development.We have made and expect to continue to make
substantial investments in research and development activities in order to
develop and market the PID technology subject to the availability of cash
resources.  Research and development costs consist primarily of
general and administrative and operating expenses related to research and
development activities. We expense research and development costs as incurred
except for property, plant and equipment related to research and development
activity that have an alternative future use. Property, plant and equipment for
research and development activity that have an alternative future use are
capitalized and the related depreciation is expensed as research and development
costs.




Our primary
products still need to demonstrate commercial reliability in order to fully
realize the potential of the PID technology. Further, we believe we need to
obtain a better understanding of the drill bit cutting pattern in order to
further improve the drilling performance.   We have constructed a
small drill bit test facility to allow us to better evaluate the bottom hole
pattern, the development of a new smaller PID bit, testing of that bit and a
field trial using the preferred bit design.  Poor performance of our
new particle injection system or other unexpected events while conducting future
commercial trials could further extend the shop and laboratory testing phase,
which would delay the full commercialization of the PID System and increase the
funds needed to complete our research and development. This would have the
effect of slowing our advancement as funds otherwise intended to build new PID
Systems and expand our operations may be needed to conduct additional research
and development.





General and
administrative.General and administrative expenses consist
primarily of salaries and benefits, office expense, professional services, and
other corporate overhead costs. We have experienced and expect to continue to
experience increases in general and administrative expenses as a result of:
(1) reporting and compliance obligations applicable to publicly-held
companies; (2) our continuing efforts to develop, test and prepare the PID
technology for commercialization; and (3) the hiring of additional
personnel.




Results
      of Operations




Three
      Months Ended December 31, 2008 Compared to Three Months Ended December 31,
      2007




Research and
development.Research and development expenses were $965,662
and $1,780,812 for the three months ended December 31, 2008 and 2007,
respectively, representing a decrease of $815,150. The decrease in research and
development expenses for the three months ended December 31, 2008 as compared to
the three months ended December 31, 2007 is attributed to much higher costs
associated with the construction of the PID unit in the prior year.




General and
administrative.General and administrative expenses were
$1,146,125 and $1,479,105 for the three months ended December 31, 2008 and 2007,
respectively, representing a decrease of $332,980. This decrease was primarily
the result of decreased costs related to stock-based compensation expense and
bonus expense.




Gain on sale of assets.Gain on sale of assets were $86,971 and $-0-  for the three
months ended December 31, 2008 and 2007, respectively, representing an increase
of $86,971. The majority of the gain was from the sale of our frac pump in
November 2008.  The gain from the sale of the frac pump was $90,000
and this amount was offset by several small losses from the sale of several
non-core assets.




Other income (expenses).Other income was $5,034 and $33,381 for the three months ended December
31, 2008 and 2007, respectively, representing a decrease in other income of
$28,347. The decrease was primarily attributable to the decrease in cash and
cash equivalents between the two periods resulting in substantially less
interest income.




Off-Balance Sheet Arrangements





In
connection 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 basis
equal to 18% of our earnings before interest, income taxes, depreciation and
amortization (“EBITDA”) derived from the use of the PID technology, until an
aggregate of $67,500,000 has been paid. PDTI also entered into a Royalty
Agreement in January 2004 with ProDril Services, International, Ltd.
(“PSIL”) pursuant to which we are obligated to pay PSIL a royalty on a quarterly
basis equal to 2% of our EBITDA derived from the use of the PID technology,
until an aggregate of $7,500,000 has been paid. In addition, we are obligated to
pay CCORE Technology and Licensing, Ltd. (“CTL”), PSI and PSIL a royalty equal
to 1.6%, 1.2% and 1.2%, respectively, of our quarterly gross revenue, derived
from the use of the PID technology.  As of December 31, 2008, we had
no revenues or EBITDA; therefore no royalties have been paid or
accrued.





13


Critical
      Accounting Policies




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




Impairment of Long-Lived
Assets.We evaluate our long-lived assets for indicators of
possible impairment by comparison of the carrying amounts to future net
undiscounted cash flows expected to be generated by such assets when events or
changes in circumstances indicate the carrying amount of an asset may not be
recoverable.  Should an impairment exist, the impairment loss would be
measured based on the excess carrying value of the asset over the asset’s fair
value or discounted estimates of future cash flows.  We also evaluate the
capitalized costs for patents and patent applications filed but not issued for
possible impairments.  The evaluation of capitalized costs for patents
and patent applications is based on a subjective cash flow forecast which is
subject to change.  We will reassess our cash flow forecast each time
there are fundamental changes in the underlying potential use of the patents or
patent applications in terms of performance, customer acceptance or other
factors that may affect such cash flow forecasts.




Stock-Based
Compensation.In December 2004, the Financial Accounting
Standards Board (“FASB”) issued a revision to SFAS No. 123, Share-Based Payment. This
statement establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or
services that are based on the fair value of the entity’s equity instruments or
that may be settled by the issuance of those equity instruments. This statement
focuses primarily on accounting for transactions in which an entity obtains
employee services in share-based payment transactions. This statement does not
change the accounting guidance for share-based payment transactions with parties
other than employees provided in SFAS No. 123 as originally issued. This
statement is effective for new awards and those modified, repurchased or
cancelled in interim or annual reporting periods beginning after June 15,
2005. We early adopted this standard upon inception.




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




Income Taxes.We follow SFAS No. 109, Accounting for Income Taxes.
This statement requires an asset and liability approach for financial accounting
and reporting for income tax purposes.  This statement recognizes the
amount of taxes payable or refundable for the current year and deferred tax
liabilities and assets for future tax consequences of events that have been
recognized in the consolidated financial statements or tax
returns.  Provisions (benefits) for income taxes result from permanent
and temporary differences in the recognition of accounting transactions for tax
and financial reporting purposes.  Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized.




We
adopted FIN 48 in fiscal year 2008 and there was no effect on our financial
statements.  FIN 48 prescribes a minimum recognition threshold and
measurement methodology that a tax position taken or expected to be taken in a
tax return is required to meet before being recognized in the financial
statements. It also provides guidance for derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition.  The Company recognizes interest and penalties related to
unrecognized tax benefits within the provision for income taxes on continuing
operations in the consolidated statements of income. There are no unrecognized
tax benefits as of the date of adoption.  There are no unrecognized tax
benefits that if recognized would affect the tax rate. There is no interest or
penalties recognized as of the date of adoption or for the three months ended
December 31, 2008.





We filed
our income tax return for the tax year ended September 30, 2008.  The
tax years ended September 30, 2007, 2006 and 2005 are open for examination by
the U.S. and State taxing authorities.





We
anticipate recording no tax benefit for the year, based upon management’s
assessment that the realization of the anticipated financial loss for the year
is not at this point reasonably assured; accordingly no benefit has been
recorded for the three months ended December 31, 2008.





Net Loss per Share.We have presented basic and diluted net loss per share pursuant to SFAS
No. 128, Earnings Per
Share. In accordance with SFAS No. 128, basic and diluted net loss
per share has been computed using the weighted-average number of shares of
common stock outstanding during the period. Dilutive net loss per share would
give effect to the dilutive effect of common stock equivalents consisting of
options and warrants. Potentially dilutive securities have been excluded from
the net loss per common share calculation as the effects would be antidilutive.
Potentially dilutive securities not included in the computation of weighted
average diluted shares of common stock because the impact of these potentially
dilutive securities were antidilutive were none and 1,475,230 shares for the
three months ended December 31, 2008 and 2007, respectively.




14


Forward-Looking
      Statements




Statements
in this quarterly report on Form 10-Q that are not historical facts
(including any statements concerning plans and objectives of management for
future operations or economic performance, or assumptions or forecasts related
thereto) are forward-looking statements subject to Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. These statements can be identified by the use of forward-looking
terminology including “forecast,” “may,” “believe,” “expect,” “anticipate,”
“estimate,” “continue” or other similar words. These statements discuss future
expectations, contain projections of results of operations or of financial
condition or state other “forward-looking” information. We and our
representatives may from time to time make other oral or written statements that
are also forward-looking statements.




These
forward-looking statements are made based upon our management’s current plans,
expectations, estimates, assumptions and beliefs concerning future events
impacting us and therefore involve a number of risks and
uncertainties.  We caution that forward-looking statements are not
guarantees and that actual results could differ materially from those expressed
or implied in the forward-looking statements as a result of certain factors,
including but not limited to dependence upon energy industry spending, the
volatility of oil and gas prices, weather interruptions, the results of testing
of our products, the availability of capital resources and the other factors
described under “Item 1A. Risk Factors” in our annual report on Form 10-K for
the year ended September 30, 2008 filed with the SEC on December 15, 2008 and in
this quarterly report on Form 10-Q.  We undertake no obligation to
update any forward-looking statements except as required by law.








Item 3.
            Quantitative and Qualitative
      Disclosures about Market
Risk




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




Item 4.
            Controls and
      Procedures




As
required by Rule 13a-15(b) of the Securities Exchange Act of 1934, an evaluation
was performed under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer of the effectiveness of the design
and operation of our “disclosure controls and procedures” (as defined under Rule
13a-15(e) and Rule 15d-15(e)) as of the end of the period covered by this
Quarterly Report on Form 10-Q filed with the SEC. Based upon that evaluation,
our Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of December 31,
2008.




There was
no change in our internal control over financial reporting during our first
quarter of fiscal 2009 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.




Part II—Other
      Information




Item
    1A.
            Risk
    Factors




We
may be delisted from The NASDAQ Capital Market for failure to satisfy the
continued listing requirements.





Our
common stock currently trades on The NASDAQ Capital Market.  If we
fail to meet any of the continued listing standards of The NASDAQ Capital
Market, our common stock will be delisted.  NASDAQ’s continued listing
standards include specifically enumerated criteria, such as a $1.00 minimum
closing bid price, shareholders’ equity of $2.5 million or market value of
publicly held shares of $35 million or net income from continuing operations of
at least $500,000 in the latest fiscal year or in two of the last three fiscal
years, 500,000 shares of common stock publicly held and market value of publicly
held shares of at least $1 million, as well as additional or more stringent
criteria that may be applied in the exercise of NASDAQ’s discretionary authority
to maintain the quality of and public confidence in the NASDAQ market, prevent
fraudulent and manipulative practices, promote just and equitable principles of
trade, and protect investors and the public interest




15


The
closing price of our common stock on February 2, 2009 was $0.11 per
share.  As a result, we currently fail to satisfy the continuing
listing standard related to a $1.00 minimum closing bid price.  NASDAQ
granted temporary relief from this requirement and the market value of publicly
held shares requirement until January 19, 2009 in a release dated October 16,
2008.  In a release dated December 19, 2009, NASDAQ extended this
temporary relief until April 20, 2009.  We cannot assure you that
NASDAQ will continue to extend this temporary relief from the continued listing
requirements or that our stock price will return to compliance with the minimum
closing bid price requirement.




Furthermore,
as of December 31, 2008, our stockholders’ equity fell below the minimum
continued listing standard of $2.5 million.  Prior to that date, the
market value of our publicly held shares of common stock had fallen below $35
million and we have not recognized any net income in the preceding three fiscal
years.  As a result, we are currently not in compliance with the
continued listing standards of the NASDAQ Capital Market.  The
temporary relief described above does not provide relief from these continued
listing standards.  If we are unable to regain compliance with these
continued listing requirements, our common stock could be delisted from The
NASDAQ Capital Market.  We can give no assurance that NASDAQ will not
in the future seek to delist us for our failure to meet the enumerated
conditions for continued listing.




If
our common stock were delisted from The NASDAQ Capital Market, you may find it
difficult to dispose of your shares.





If our
common stock were to be delisted from The NASDAQ Capital Market, trading of our
common stock most likely will be conducted in the over-the-counter market on an
electronic bulletin board established for unlisted securities such as the “pink
sheets” or the OTC Bulletin Board.  Such trading will reduce the
market liquidity of our common stock.  As a result, an investor would
find it more difficult to dispose of, or obtain accurate quotations for the
price of, our common stock.  In addition, if our common stock is
delisted, we will find it more difficult to obtain additional financing in the
future




If our
common stock is delisted from The NASDAQ Capital Market and the trading price
remains below $5.00 per share, trading in our common stock might also become
subject to the requirements of certain rules promulgated under the Securities
Exchange Act of 1934, which require additional disclosure by broker-dealers in
connection with any trade involving a stock defined as a “penny stock”
(generally, any equity security not listed on a national securities exchange or
quoted on NASDAQ that has a market price of less than $5.00 per share, subject
to certain exceptions).  Many brokerage firms are reluctant to
recommend low-priced stocks to their clients.  Moreover, various
regulations and policies restrict the ability of shareholders to borrow against
or “margin” low-priced stocks, and declines in the stock price below certain
levels may trigger unexpected margin calls.  Additionally, because
brokers’ commissions on low-priced stocks generally represent a higher
percentage of the stock price than commissions on higher priced stocks, the
current price of the common stock can result in an individual shareholder paying
transaction costs that represent a higher percentage of total share value than
would be the case if our share price were higher.  This factor may
also limit the willingness of investors to purchase our common
stock.  Finally, the additional burdens imposed upon broker-dealers by
these requirements could discourage broker-dealers from facilitating trades in
our common stock, which could severely limit the market liquidity of the stock
and the ability of investors to trade our common stock.




Item 6.
            Exhibits




Exhibits:




Exhibit
                        No.
                      
                      Description10.1
                      
                      Development
      Agreement, dated December 4, 2008, by and between the Company
      and  Shell Exploration and Production Company and certain of its
      affiliates.*31.1
                      
                      Certification
      of the Chief Executive Officer pursuant to
      Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of
      1934.*31.2
                      
                      Certification
      of the Interim Chief Financial Officer pursuant to
      Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of
      1934.*32.1
                      
                      Certification
      of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.**32.2
                      
                      Certification
      of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.**




*
            Filed
    herewith


**
            Furnished
      herewith




16





SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.




PARTICLE DRILLING
      TECHNOLOGIES, INC.(Registrant)Date:
       February 9, 2009
            /s/
      JASON D. DAVISJason
      D. DavisVice
      President and Interim Chief Financial Officer
              (authorized
      officer, principal financial officer and
              principal
      accounting officer)





17


EXHIBIT INDEX




Exhibit
                No.
              
              Description10.1
              
              Development
      Agreement, dated December 4, 2008, by and between the Company
      and  Shell Exploration and Production Company and certain of its
      affiliates.*31.1
              
              Certification
      of the Chief Executive Officer pursuant to
      Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of
      1934.*31.2
              
              Certification
      of the Interim Chief Financial Officer pursuant to
      Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of
      1934.*32.1
              
              Certification
      of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.**32.2
              
              Certification
      of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.**




*
            Filed
    herewith


**
            Furnished
      herewith