** **

**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 31,2007**

 

**OR**

 
| **o** | ** ** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|-----------------------------------------------------------------------------------------------|

 

**For the transition periodfrom                   to                   **

 

**Commission File Number 000-30819**

 

**Particle DrillingTechnologies, Inc.**

(Exact name of registrant as specified in its charter)

 

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

 

**5611Baird Court**

**Houston,Texas 77041**

(Address of principalexecutive offices)

(Zip Code)

** **

**713-223-3031**

(Registrant’s telephone number, including area code)

 

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

 

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

 

Large accelerated filer o                            Accelerated filer x                      Non-acceleratedfiler o

 

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

 

The number of shares ofthe registrant’s common stock, $.001 par value, outstanding as of January 31,2008 was 31,645,589.

 

 

----

 

**PARTICLE DRILLING TECHNOLOGIES,INC.**

**(a development stage enterprise)**

 

**FORM 10-Q FOR THE QUARTER ENDED December 31,2007**

 

**INDEX**

 

**Part I - Financial Information**

 
| Item 1.                               |       | Financial Statements                                                                                                                                                                |   |   |
|---------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                  |       |                                                                                                                                                                                |   |   |
|                                  |       | Consolidated  Balance Sheets at December 31, 2007 (Unaudited) and September 30,  2007                                                                                     |   | 3      |
|                                  |       |                                                                                                                                                                                |   |   |
|                                  |       | Consolidated  Statements of Operations (Unaudited) - Three Months Ended December 31,  2007 and 2006, and from June 9, 2003 (date of inception) to  December 31, 2007 |   | 4      |
|                                  |       |                                                                                                                                                                                |   |   |
|                                  |       | Consolidated  Statements of Cash Flows (Unaudited) - Three Months Ended December 31,  2007 and 2006, and from June 9, 2003 (date of inception) to  December 31, 2007 |   | 5      |
|                                  |       |                                                                                                                                                                                |   |   |
|                                  |       | Notes  to Consolidated Financial Statements (Unaudited)                                                                                                                             |   | 6      |
|                                  |       |                                                                                                                                                                                |   |   |
| Item 2.                               |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                         |   | 9      |
|                                  |       |                                                                                                                                                                                |   |   |
| Item 3.                               |       | Quantitative  and Qualitative Disclosures about Market Risk                                                                                                                         |   | 13     |
|                                  |       |                                                                                                                                                                                |   |   |
| Item 4.                               |       | Controls  and Procedures                                                                                                                                                            |   | 13     |
|                                  |       |                                                                                                                                                                                |   |   |
| **Part II  - Other Information** | ** ** | **13**                                                                                                                                                                              |
|                                  |       |                                                                                                                                                                                |   |   |
| Item 2.                               |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                                        |   | 13     |
|                                  |       |                                                                                                                                                                                |   |   |
| Item 6.                               |       | Exhibits                                                                                                                                                                            |   | 13     |
|                                  |       |                                                                                                                                                                                |   |   |
|                                  |       | Signatures                                                                                                                                                                          |   | 15     |

 

2

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**PARTICLEDRILLING TECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                       | ** ** | **December 31,  2007** | ** ** | **September 30,  2007** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                                                                                       | ** ** | **(Unaudited)**             | ** ** | ** **                   | ** ** |
| ** **                                                                                                                                                                                                                                       | ** ** | ** **                  | ** ** | ** **                   | ** ** |
| **ASSETS**                                                                                                                                                                                                                                       | ** ** | ** **                  | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Current assets:                                                                                                                                                                                                                                  |       |                        |       |                         |       |
| Cash and cash  equivalents                                                                                                                                                                                                                       |       | $                           | 2,548,985  |                         | $          | 4,461,929 |   |
| Assets held for  sale                                                                                                                                                                                                                            |       | 900,000                     |       | 900,000                      |       |
| Prepaid expenses                                                                                                                                                                                                                                 |       | 240,978                     |       | 233,174                      |       |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Total current  assets                                                                                                                                                                                                                            |       | 3,689,963                   |       | 5,595,103                    |       |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Property,  plant & equipment, net                                                                                                                                                                                                       |       | 739,660                     |       | 867,168                      |       |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Intangibles, net                                                                                                                                                                                                                                 |       | 1,334,919                   |       | 1,312,246                    |       |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Other assets                                                                                                                                                                                                                                     |       | 50,544                      |       | 52,562                       |       |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Total assets                                                                                                                                                                                                                                     |       | $                           | 5,815,086  |                         | $          | 7,827,079 |   |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                    | ** ** | ** **                  | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Current  liabilities:                                                                                                                                                                                                                            |       |                        |       |                         |       |
| Accounts payable                                                                                                                                                                                                                                 |       | $                           | 1,096,550  |                         | $          | 1,028,999 |   |
| Short-term notes  payable                                                                                                                                                                                                                        |       | 50,842                      |       | 88,258                       |       |
| Current portion  of long-term debt                                                                                                                                                                                                               |       | 13,459                      |       | 13,511                       |       |
| Accrued  liabilities                                                                                                                                                                                                                             |       | 572,048                     |       | 134,988                      |       |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Total current  liabilities                                                                                                                                                                                                                       |       | 1,732,899                   |       | 1,265,756                    |       |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Long-term debt                                                                                                                                                                                                                                   |       | 21,280                      |       | 24,537                       |       |
| Deferred Rent                                                                                                                                                                                                                                    |       | 81,038                      |       | 45,539                       |       |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Commitments and  contingencies - Note 7                                                                                                                                                                                                          |       |                        |       |                         |       |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Stockholders’  equity:                                                                                                                                                                                                                      |       |                        |       |                         |       |
| Common stock,  $.001 par value, 100,000,000 shares authorized, 34,648,675 shares issued and  31,645,589 shares outstanding at December 31, 2007, and 34,632,987  shares issued and 31,629,901 shares outstanding at September 30, 2007 |       | 34,650                      |       | 34,634                       |       |
| Additional  paid-in capital                                                                                                                                                                                                                      |       | 39,225,630                  |       | 38,510,488                   |       |
| Treasury stock  at cost, 3,003,086 shares                                                                                                                                                                                                        |       | (1,511,817                  | )          | (1,511,817                   | )          |
| Deficit  accumulated during the development stage                                                                                                                                                                                                |       | (33,768,594                 | )          | (30,542,058                  | )          |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Total  stockholders’ equity                                                                                                                                                                                                                 |       | 3,979,869                   |       | 6,491,247                    |       |
|                                                                                                                                                                                                                                             |       |                        |       |                         |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                 |       | $                           | 5,815,086  |                         | $          | 7,827,079 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

3

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**PARTICLEDRILLING TECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

**CONSOLIDATED STATEMENTSOF OPERATIONS**

**(Unaudited)**

** **
| ** **                                                                | ** ** | **Three Months Ended  December 31,** | ** ** | **Period from  June 9, 2003  (date of  inception) to  December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2007**                                            | ** ** | **2006**                                                                                           | ** ** | **2007** | ** ** |
| ** **                                                                | ** ** | ** **                                          | ** ** | ** **                                                                                         | ** ** | ** ** | ** ** |
| Revenues                                                                  |       | $                                                   | —     |                                                                                               | $          | — |   | $ | — |   |
|                                                                      |       |                                                |       |                                                                                               |       |   |   |
| Operating  expenses:                                                      |       |                                                |       |                                                                                               |       |   |   |
| Research and  development                                                 |       | 1,780,812                                           |       | 1,664,843                                                                                          |       | 17,102,884 |   |
| General and  administrative                                               |       | 1,479,105                                           |       | 1,298,544                                                                                          |       | 17,371,825 |   |
| Impairment of  asset                                                      |       | —                                              |       | —                                                                                             |       | 295,260 |   |
|                                                                      |       |                                                |       |                                                                                               |       |   |   |
| Total operating  expenses                                                 |       | 3,259,917                                           |       | 2,963,387                                                                                          |       | 34,769,969 |   |
|                                                                      |       |                                                |       |                                                                                               |       |   |   |
| Loss from  operations                                                     |       | (3,259,917                                          | )          | (2,963,387                                                                                         | )          | (34,769,969 | ) |
|                                                                      |       |                                                |       |                                                                                               |       |   |   |
| Other income  (expenses)                                                  |       |                                                |       |                                                                                               |       |   |   |
| Interest income                                                           |       | 35,704                                              |       | 127,898                                                                                            |       | 890,407 |   |
| Rental income -  related party                                            |       | —                                              |       | —                                                                                             |       | 73,727 |   |
| Gain on debt  extinguishment                                              |       | —                                              |       | —                                                                                             |       | 35,283 |   |
| Gain on  assignment of lease - related party                              |       | —                                              |       | —                                                                                             |       | 55,614 |   |
| Interest expense                                                          |       | (2,323                                              | )          | (2,972                                                                                             | )          | (53,656 | ) |
|                                                                      |       |                                                |       |                                                                                               |       |   |   |
| Total other  income                                                       |       | 33,381                                              |       | 124,926                                                                                            |       | 1,001,375 |   |
|                                                                      |       |                                                |       |                                                                                               |       |   |   |
| Net loss                                                                  |       | $                                                   | (3,226,536 | )                                                                                                  | $          | (2,838,461 | ) | $ | (33,768,594 | ) |
|                                                                      |       |                                                |       |                                                                                               |       |   |   |
| Net loss per  common share, basic and diluted                             |       | $                                                   | (0.10      | )                                                                                                  | $          | (0.10 | ) | $ | (1.54 | ) |
|                                                                      |       |                                                |       |                                                                                               |       |   |   |
| Weighted average  number of common shares outstanding - basic and diluted |       | 30,734,703                                          |       | 29,094,418                                                                                         |       | 21,900,924 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

4

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**PARTICLEDRILLING TECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended  December 31,** | ** ** | **Period from  June 9, 2003  (date of  inception) to  December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                            | ** ** | **2006**                                                                                           | ** ** | **2007** | ** ** |
|                                                                         |       |                                                |       |                                                                                               |       |   |   |
| Cash flows from  operating activities:                                       |       |                                                |       |                                                                                               |       |   |   |
| Net loss                                                                     |       | $                                                   | (3,226,536 | )                                                                                                  | $          | (2,838,461 | ) | $ | (33,768,594 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities: |       |                                                |       |                                                                                               |       |   |   |
| Gain on debt  extinguishment                                                 |       | —                                              |       | —                                                                                             |       | (35,283 | ) |
| Impairment of  asset                                                         |       | —                                              |       | —                                                                                             |       | 295,260 |   |
| Gain on  assignment of lease - related party                                 |       | —                                              |       | —                                                                                             |       | (54,103 | ) |
| Depreciation and  amortization expense                                       |       | 166,855                                             |       | 188,307                                                                                            |       | 2,205,671 |   |
| Short-term note  issued for services                                         |       | —                                              |       | —                                                                                             |       | 44,000 |   |
| Common stock  issued for services                                            |       | —                                              |       | —                                                                                             |       | 931,500 |   |
| Warrants issued  for services                                                |       | —                                              |       | —                                                                                             |       | 63,829 |   |
| Stock-based  employee compensation                                           |       | 713,958                                             |       | 627,627                                                                                            |       | 5,914,580 |   |
| Changes in  operating assets and liabilities:                                |       |                                                |       |                                                                                               |       |   |   |
| Decrease in note  receivable                                                 |       | —                                              |       | 385,839                                                                                            |       | 385,839 |   |
| (Increase) in  accounts receivable - related party                           |       | —                                              |       | —                                                                                             |       | (42,330 | ) |
| (Increase)  Decrease in prepaid expenses                                     |       | (7,804                                              | )          | 20,771                                                                                             |       | 124,997 |   |
| Increase  (Decrease) in accounts payable                                     |       | 67,551                                              |       | (26,055                                                                                            | )          | 756,612 |   |
| Increase  (Decrease) in accrued liabilities                                  |       | 437,060                                             |       | (41,236                                                                                            | )          | 668,845 |   |
| (Increase)  Decrease in other assets                                         |       | 2,018                                               |       | —                                                                                             |       | (35,894 | ) |
| Increase in  other liabilities                                               |       | 35,499                                              |       | —                                                                                             |       | 81,038 |   |
|                                                                         |       |                                                |       |                                                                                               |       |   |   |
| Net cash used in  operating activities                                       |       | (1,811,399                                          | )          | (1,683,208                                                                                         | )          | (22,464,033 | ) |
|                                                                         |       |                                                |       |                                                                                               |       |   |   |
| Cash flows from  investing activities:                                       |       |                                                |       |                                                                                               |       |   |   |
| Payments to  purchase property and equipment                                 |       | (26,726                                             | )          | (52,556                                                                                            | )          | (3,344,330 | ) |
| Proceeds from  sale of property and equipment                                |       | —                                              |       | —                                                                                             |       | 20,957 |   |
| Payments to  purchase intangibles                                            |       | (35,294                                             | )          | (40,205                                                                                            | )          | (776,552 | ) |
| 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 used in  investing activities                                       |       | (62,020                                             | )          | (92,761                                                                                            | )          | (4,876,996 | ) |
|                                                                         |       |                                                |       |                                                                                               |       |   |   |
| Cash flows from  financing activities:                                       |       |                                                |       |                                                                                               |       |   |   |
| Proceeds from  issuance of common stock                                      |       | 1,200                                               |       | 10,753,770                                                                                         |       | 31,740,510 |   |
| Repurchase of  common stock                                                  |       | —                                              |       | —                                                                                             |       | (1,511,817 | ) |
| Proceeds from  issuance of convertible notes                                 |       | —                                              |       | —                                                                                             |       | 553,500 |   |
| Repayments of  notes payable                                                 |       | (40,725                                             | )          | (81,166                                                                                            | )          | (892,179 | ) |
| Proceeds from  borrowings under loan agreements - related parties            |       | —                                              |       | —                                                                                             |       | 23,195 |   |
| Repayment of  borrowings under loan agreements - related parties             |       | —                                              |       | —                                                                                             |       | (23,195 | ) |
|                                                                         |       |                                                |       |                                                                                               |       |   |   |
| Net cash (used  in) provided by financing activities                         |       | (39,525                                             | )          | 10,672,604                                                                                         |       | 29,890,014 |   |
|                                                                         |       |                                                |       |                                                                                               |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                        |       | (1,912,944                                          | )          | 8,896,635                                                                                          |       | 2,548,985 |   |
|                                                                         |       |                                                |       |                                                                                               |       |   |   |
| Cash and cash  equivalents - beginning of period                             |       | 4,461,929                                           |       | 2,291,586                                                                                          |       | — |   |
|                                                                         |       |                                                |       |                                                                                               |       |   |   |
| Cash and cash  equivalents - end of period                                   |       | $                                                   | 2,548,985  |                                                                                               | $          | 11,188,221 |   | $ | 2,548,985 |   |
|                                                                         |       |                                                |       |                                                                                               |       |   |   |
| Supplemental disclosures  of cash flow information:                          |       |                                                |       |                                                                                               |       |   |   |
| Cash paid for  interest                                                      |       | $                                                   | 2,323      |                                                                                               | $          | 2,972 |   | $ | 54,145 |   |
|                                                                         |       |                                                |       |                                                                                               |       |   |   |
| Non-cash  investing and financing activities:                                |       |                                                |       |                                                                                               |       |   |   |
| Prepaid  insurance acquired with note payable                                |       | $                                                   | —     |                                                                                               | $          | — |   | $ | 478,844 |   |
| Common stock  issued as consideration for account payable                    |       | —                                              |       | —                                                                                             |       | 6,000 |   |
| Common stock  issued as consideration for note payable                       |       | —                                              |       | —                                                                                             |       | 50,000 |   |
| Related party  note receivable exchanged for property and equipment          |       | —                                              |       | —                                                                                             |       | 56,783 |   |
| Note payable  converted into common stock                                    |       | —                                              |       | —                                                                                             |       | 553,500 |   |
| Property and  equipment acquired with assumed liabilities                    |       | —                                              |       | —                                                                                             |       | 479,610 |   |
| Intangibles  acquired with assumed liabilities                               |       | —                                              |       | —                                                                                             |       | 757,792 |   |
| Property and  equipment acquired with note payable                           |       | —                                              |       | —                                                                                             |       | 30,487 |   |
| Short-term  investments reclassified from other assets                       |       | —                                              |       | —                                                                                             |       | 385,839 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

5

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**PARTICLE DRILLINGTECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**(Unaudited)**

 

**1.****              BASIS OFPRESENTATION**

 

The accompanying unaudited interim consolidatedfinancial statements, which include the accounts of Particle DrillingTechnologies, Inc. (which is referred to herein as “we,” “us,” “our” orthe “Company”) and its subsidiary, have been prepared in accordance withgenerally accepted accounting principles in the United States of America (“USGAAP”) and pursuant to the rules and regulations of the Securities andExchange Commission. Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with US GAAP have beencondensed or omitted in accordance with such rules and regulations. Theinformation furnished in the unaudited interim consolidated financialstatements includes normal recurring adjustments and reflects all adjustments,which in the opinion of management are necessary for a fair presentation ofsuch financial statements. Although management believes the disclosures andinformation presented are adequate to make the information not misleading,these unaudited interim consolidated financial statements should be read inconjunction with the Company’s September 30, 2007 audited consolidatedfinancial statements and notes thereto in its Annual Report on Form 10-K.Operating results for the three months ended December 31, 2007 are notnecessarily indicative of the results that may be expected for the year ending September 30,2008.

 

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

 

Certain reclassifications have been made to conformprior period amounts to the current period presentation. Thesereclassifications had no effect on net loss, net loss per share, orstockholders’ equity.

 

**2.****              GOINGCONCERN**

 

The financial statements of the Company have beenprepared on the basis of accounting principles applicable to a going concern,which contemplates the realization of assets and the satisfaction ofliabilities in the normal course of business. As shown in the condensed consolidated financial statements, for thethree months ended December 31, 2007, the Company reported a net loss ofapproximately $3.2 million, as compared to a net loss of approximately $2.8million for the three months ended December 31, 2006.  The condensed consolidated financialstatements also show an accumulated deficit of approximately $33.8 million frominception (June 9, 2003) through the period ended December 31, 2007.

 

The Company is currently a development stage companyand its continued existence is dependent upon the Company’s successfuldevelopment of the PID technology and its ability to successfully commercializethis technology.  The Company has yet togenerate cashflow from operations, and until revenues commence, the Company ishighly dependent upon debt and equity funding. Based on the Company’s current liquidity position, the Company will needto raise additional capital through debt or equity funding within the next 12months.  Management cannot provide anyassurance that any such financing will be available on acceptable terms or atall.  Should continuing funding requirementsnot be met, the Company’s operations may cease to exist.

 

These matters raise substantial doubt about theCompany’s ability to continue as a going concern. The financial statements donot include any adjustments relating to the recoverability and classificationof asset carrying amounts or the amount and classification of liabilities thatmight result should the Company be unable to continue as a going concern.

 

**3.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

*Impairment of Long-LivedAssets.  *We evaluate our long-lived assets forindicators of possible impairment by comparison of the carrying amounts tofuture net undiscounted cash flows expected to be generated by such assets whenevents or changes in circumstances indicate the carrying amount of an asset maynot be recoverable.  Should an impairment exist, the impairment loss wouldbe measured based on the excess carrying value of the asset over the asset’sfair value or discounted estimates of future cash flows.  We also evaluatethe capitalized costs for patents and patent applications filed but not issuedfor possible impairments. The evaluation of capitalized costs for patents andpatent applications is based on a subjective cash flow forecast which issubject to change. We will reassess our cash flow forecast each time there arefundamental changes in the underlying potential use of the patents or patentapplications in terms of performance, customer acceptance or other factors thatmay affect such cash flow forecasts.

 

6

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*New Accounting Pronouncements.* In June 2006, the Financial AccountingStandards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”),Accounting for Uncertainty in Income Taxes. FIN 48 prescribes detailed guidancefor the financial statement recognition, measurement and disclosure ofuncertain tax positions recognized in an enterprise’s financial statements inaccordance with FASB Statement No. 109, Accounting for Income Taxes. Taxpositions must meet a more-likely-than-not recognition threshold at theeffective date to be recognized upon the adoption of FIN 48 and in subsequentperiods. FIN 48 will be effective for fiscal years beginning after December 15,2006 (our fiscal year 2008) and the provisions of FIN 48 will be applied to alltax positions under Statement No. 109 upon initial adoption.  We have adopted FIN 48 and there was noeffect on our financial statements as a result of its implementation.

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS No. 157”).  SFAS No. 157 clarifies the principle thatfair value should be based on the assumptions market participants would usewhen pricing an asset or liability and establishes a fair value hierarchy thatprioritizes the information used to develop those assumptions.  Under thestandard, fair value measurements would be separately disclosed by level withinthe 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 SFAS No. 157 will not have amaterial impact on its financial position, results of operations or cash flows.

 

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities* (“SFAS No. 159”).SFAS No. 159 permits entities to choose to measure many financial assetsand financial liabilities at fair value. Unrealized gains and losses on itemsfor which the fair value option has been elected are reported in earnings. SFASNo. 159 is effective for fiscal years beginning after November 15,2007. We will adopt SFAS No. 159 on October 1, 2008 and have notyet determined the impact, if any, on our consolidated financial statements.

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 141R, *Business Combinations* (SFAS 141R), whichreplaces SFAS 141, *Business Combinations*.SFAS 141R establishes principles and requirements for determining how anenterprise recognizes and measures the fair value of certain assets andliabilities acquired in a business combination, including noncontrollinginterests, contingent consideration, and certain acquired contingencies. SFAS141R also requires acquisition-related transaction expenses and restructuringcosts be expensed as incurred rather than capitalized as a component of thebusiness combination. SFAS 141R will be applicable prospectively to businesscombinations beginning in the Company’s 2010 fiscal year.

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 160, *Noncontrolling Interests in Consolidated FinancialStatements – An Amendment of ARB No. 51* (SFAS 160). SFAS 160establishes accounting and reporting standards for the noncontrolling interestin a subsidiary. SFAS 160 also requires that a retained noncontrolling interestupon the deconsolidation of a subsidiary be initially measured at its fairvalue. SFAS 160 is effective for the Company’s 2010 fiscal year. Upon adoptionof SFAS 160, the Company will be required to report its noncontrollinginterests as a separate component of shareholders’ equity. The Company willalso be required to present net income allocable to the noncontrollinginterests and net income attributable to the shareholders of the Companyseparately in its consolidated statements of income. Currently, noncontrollinginterests (minority interests) are reported as a liability in the Company’sstatement of financial position and the related income attributable to minorityinterests is reflected as an expense in arriving at net income. SFAS 160requires retroactive adoption of the presentation and disclosure requirementsfor existing minority interests. All other requirements of SFAS 160 shall beapplied prospectively.

 

**4.****              NET LOSS PER COMMONSHARE**

 

The Company has presented basic and diluted net lossper share pursuant to SFAS No. 128, *EarningsPer Share*. In accordance with SFAS No. 128, basic and dilutednet loss per share has been computed using the weighted-average number ofshares of common stock outstanding during the period. Dilutive net loss pershare would give effect to the dilutive effect of common stock equivalentsconsisting of options and warrants. Potentially dilutive securities have beenexcluded from the net loss per common share calculation as the effects would beantidilutive. Potentially dilutive securities not included in the computationof weighted average diluted shares of common stock because the impact of thesepotentially dilutive securities were antidilutive were 1,475,230 and 2,054,643shares for the three months ended December 31, 2007 and 2006,respectively.

 

**5.     COMMON STOCK**

 

In December 2007, theCompany issued 688 shares of its common stock upon a net cashless exercise ofwarrants at $2.00 per share.

 

7

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In December 2007, theCompany issued 10,000 shares of its common stock upon a cash exercise ofwarrants at $0.12 per share.

 

At December 31, 2007, the Company had 31,645,589shares of common stock outstanding and had outstanding options and warrants topurchase up to 5,863,516 additional shares of the Company’s common stock in theaggregate.

 

**6.     STOCK-BASED EMPLOYEE COMPENSATION**

 

In April 2004, theBoard of Directors adopted the 2004 Stock Incentive Plan (the “2004Plan”).  The 2004 Plan provides for theissuance of incentive stock options, non-statutory stock options and restrictedstock to directors, employees and consultants of PDTI. Provisions under the2004 Plan allow for the issuance of up to 3,500,000 shares of common stockpursuant to awards under this plan.  Asof  December 31, 2007, the Companyhad 1,250 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’scommon stock on the date of grant and the maximum term for the options is tenyears.

 

In March 2005, theBoard of Directors adopted the 2005 Stock Incentive Plan (the “2005Plan”).  The 2005 Plan provides for 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 December 31, 2007, theCompany had 9,000 shares of common stock available for issuance pursuant toawards under the 2005 Plan.  Under the2005 Plan, the exercise price of each option is equal to the market value ofthe Company’s common stock on the date of grant and the maximum term for theoptions is ten years.

 

In March 2007, theshareholders adopted the 2007 Stock Incentive Plan (the “2007 Plan”).  The 2007 Plan provides for the issuance ofincentive stock options, non-statutory stock options and restricted stock to directors,employees and consultants of PDTI. Provisions under the 2007 Plan allow for theissuance of up to 1,500,000 shares of common stock pursuant to awards underthis plan.  As of December 31, 2007,the Company had 1,179,250 awards available for grant under the 2007 Plan. Underthe 2007 Plan, the exercise price of each option is equal to the market valueof the Company’s common stock on the date of grant and the maximum term for theoptions is ten years.

 

Stock-based employee compensation expense recorded forawards issued under the 2004 Plan, the 2005 Plan, and the 2007 Plan for thethree months ended December 31, 2007 and 2006 was $713,958 and $627,627,respectively.  Stock-based employeecompensation expense recorded for awards issued under the 2004 Plan, the 2005Plan, and the 2007 Plan since inception (June 9, 2003) toDecember 31, 2007 was $5,914,580.

 

**7.     COMMITMENTS AND CONTINGENCIES**

 

InApril 2007, we entered into a 60-month lease agreement that commenced inSeptember 2007 for a new corporate office and operating facility anddelivered to the lessor a security deposit of $41,144.  The new facilitycombines the corporate office personnel and the operations personnel into onelocation at 5611 Baird Court, Houston, Texas 77041.  The total futureminimum lease payments under this lease are $2,114,201.

 

**8.     INCOMETAXES**

 

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

 

As discussed in Footnote3, we adopted FIN 48 and, as a result, there was no effect on our financialstatements.  FIN 48 prescribes a minimumrecognition threshold and measurement methodology that a tax position taken orexpected to be taken in a tax return is required to meet before beingrecognized in the financial statements. It also provides guidance forderecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition.  The Company recognizes interest andpenalties related to unrecognized tax benefits within the provision for incometaxes on continuing operations in the consolidated statements of income. Thereare no unrecognized tax benefits as of the date of adoption.  There are nounrecognized tax benefits that if recognized would affect the tax rate. Thereis no interest or penalties recognized as of the date of adoption or for thethree months ended December 31, 2007.

 

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

 

The Company anticipatesrecording no tax benefit for the year, based upon management’s assessment thatthe realization of the anticipated financial loss for the year is not at thispoint reasonably assured; accordingly no benefit has been recorded for thethree months ended 12/31/07.

 

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

 

The following discussion of our financial conditionand results of operations should be read together with the unauditedconsolidated financial statements and related notes that are included elsewherein this report. This discussion may contain forward-looking statements basedupon current expectations that involve risks and uncertainties that could causeactual results to differ materially from the forward-looking statements.   Please see “Forward-Looking Statements”below.

 

**Liquidity and Capital Resources**

 

Our principal sources ofliquidity are available cash and cash equivalents.  We expect that cash requirements through theend of the fiscal year 2008 will be primarily to fund research and developmentactivities, improve service capabilities, expand operations, and for generaland administrative related services. Based on our current liquidity position, we will need to raiseadditional capital through debt or equity funding within the next 12 months.Should there be any unexpected delays in the development of the new particleinjection system, management intends to reduce certain overhead and researchand development costs as compared to previous years and complete the sale ofvarious non-core assets.  Our continued existence depends on thesuccessful development of the PID technology and our ability to successfullycommercialize this technology.  To date wehave not yet generated cashflow from operations, and until we commencerecognizing revenue, we are highly dependent upon debt and equity funding.  If we are not able to meet our fundingrequirements, our operations may cease to exist.  We cannot provide any assurance that any suchfunding will be available on acceptable terms or at all.

 

Since inception onJune 9, 2003 through December 31, 2007, we have financed ouroperations through private sales of our equity and the issuance of convertiblenotes payable, totaling net proceeds of $30,147,913.  As of December 31, 2007, we had$2,548,985 in cash and cash equivalents.

 

*CashFlows from Operating Activities. *Cash flow used for operations is primarilyaffected by our research and development progress and businessdevelopment.  Net cash flows used in operatingactivities during the three months ended December 31, 2007 were $1,811,399compared to $1,683,208 for the three months ended December 31, 2006.  The increase from fiscal 2006 to fiscal 2007was primarily the result of our increased level of general and administrativecosts as discussed above.

 

*CashFlows from Investing Activities. *Cash flows used in investing activities for the threemonths ended December 31, 2007 were $62,020 compared to $92,761 for thethree months ended December 31, 2006. The cash flows used in investing activities during the period consistof  $26,726 for the purchase of property,plant and equipment and $35,294 for costs associated with filing new andprotecting existing patents.  Weanticipate that our capital expenditures for the next year will continue to befully funded from our available cash and cash equivalents.

 

*Cash Flow from Financing Activities.  *Netcash provided by (used in) financing activities for the three months ended December 31,2007 was $(39,525) compared to $10,672,604 for the three months ended December 31,2006.  During the three months ended December 31,2007, the financing ativities consisted primarily of repayments of notespayable.  During the three months ended December 31,2006, the financing activities consisted of repayments of notes payable as wellas the completion of the sale of five million shares of our common stock toinstitutional and other accredited investors at $2.35 per share in which wereceived gross proceeds of $11.75 million.

 

*ContractualObligations*.  In April 2007,we entered into a 60-month lease agreement that commenced in September 2007for a new corporate office and operating facility and delivered to the lessor asecurity deposit of $41,144.  The new facility combines the corporateoffice personnel and the operations personnel into one location at 5611 BairdCourt, Houston, Texas 77041.  The total future minimum lease paymentsunder this lease are $2,114,201.

 
| ** **                                                                          | ** ** | **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) |       | $                                         | 85,581     |   | $ | 65,287 |   | $ | 15,891 |   | $ | 4,403 |   | $ | — |   |
| Purchase  Obligations                                                               |       | 10,288                                    |       | 10,288 |   | — |   | — |   | — |   |
| Operating Lease  Obligations                                                        |       | 2,114,201                                 |       | 372,757 |   | 1,406,272 |   | 335,172 |   | — |   |
|                                                                                |       |                                      |       |   |   |   |   |   |   |   |   |
| Total                                                                               |       | $                                         | 2,210,070  |   | $ | 448,332 |   | $ | 1,422,163 |   | $ | 339,575 |   | $ | — |   |

 

9

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**Overview**

 

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

 

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

 

In January 2007, we entered into a one-yearagreement with a multi-national independent exploration and production company(the “Operator”), which was subsequently extended to April 15, 2008.Pursuant to this agreement, we will provide our PID services in connection withthe Operator’s drilling program in East Texas. The agreement anticipates thatPID services will be conducted on an initial four wells and provides the basisfor additional wells and cooperation between us and the Operator with respectto financing of future PID systems by the Operator and an obligation by us toprovide to the Operator preferred access to additional PID systems in thefuture. The compensation under this agreement, if any, is based on ourperformance pursuant to a gain-sharing formula. As is customary within the oilfield service industry, this contract iscancellable by either party at any time.

 

*Researchand development.  *We have made and expect to continue to makesubstantial investments in research and development activities in order todevelop and market the PID technology. Research and development costs consistprimarily of general and administrative and operating expenses related toresearch and development activities. We expense research and development costsas incurred except for property, plant and equipment related to research anddevelopment activity that have an alternative future use. Property, plant andequipment for research and development activity that have an alternative futureuse are capitalized and the related depreciation is expensed as research anddevelopment costs.

 

After conductingfour full scale field trials, we believe that all components of the PID systemare now functioning satisfactorily with the exception of the frac pump driveninjection system.  While some minormodifications will be made to the PID bit in order to further improveperformance, most of our focus is now directed towards implementation of a newparticle injection system.  As we havegained more experience with PID drilling and have run the system for longerperiods of time, we have determined that the continuously increasing andfluctuating well pressure encountered on recent trials resulted in unexpectedlevels of maintenance on the frac pump and caused difficulty in maintaining acontinuous flow of particles to the drill bit. While the current particleinjection system has allowed us to demonstrate the potential of the PIDtechnology, it has been unreliable. In April 2007, we began testing anextruder based injection system and the associated pressure diffuser. Thepressure diffuser was determined to be unreliable in July and therefore webegan testing a pressurized extruder system. In early August 2007, we wereable to successfully inject particles, at a controllable rate, into pressuresup to 5,200 pounds per square inch (“psi”). This was the first time that goalwas achieved. The next step in the development required a pressure barrier thatwould allow the pressurized extruder to continuously refill with particles. Weselected a high pressure gate valve to serve as the pressure barrier andsuccessfully tested the gate valve in September 2007 for 3,000 cycles,representing approximately three days of operating time. Following this test,all necessary components needed to build the new particle injection system wereplaced on order. The new injection system was assembled in lateDecember 2007 and integrated with our test facility on January 9,2008.  We tested the subsystems andcomponents that are integral to the safe operation of the new injectionsystem.  Some refinements and modificationswere made as needed during the initial testing. On January 24, 2008, wecompleted the first phase of our in-house test program with good results.  The testing confirmed that the automatedsystem operates as designed as a mechanical means to inject particles intopressurized drilling fluid at the rates needed for commercial use.

 

SinceJanuary 25, 2008, we have been endurance testing the new injectionsystem.  During the endurance testing,we  identified one issue in particularthat needs to be addressed before the system can be deemed field ready.  This relates to decreasing the time requiredto fill the upper chamber where particles are introduced at atmosphericconditions and then pressurized before filling the lower chamber.  It is necessary to decrease the “fill time”in order to maintain the desired high volumes of particle injection.  The Company is in the process of testing andimplementing solutions to address this issue. Once the Company is satisfied withthe results of this test program, the Company intends to announce a field trialschedule schedule

 

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The PID System hasdemonstrated higher rates of penetration than current conventional drillingmethods. The rate of penetration gains generated by the PID System are expectedto result in operators paying less variable drilling costs (e.g., rig time,labor, fuel, bits, rentals), which are purchased as part of the ordinarydrilling cycle. As a result, we believe the PID System can reduce drillingcosts and lower finding costs, thus improving the overall economics to the oiland gas industry in certain geologic intervals.

 

*General andadministrative.  *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) reporting and compliance obligationsapplicable to publicly-held companies; (2) our continuing efforts todevelop, test and prepare the PID technology for commercialization; and (3) thehiring of additional personnel.

 

**Results of Operations**

 

***Three Months Ended December 31, 2007Compared to Three Months Ended December 31, 2006***

 

*Research anddevelopment.  *Research and development expenseswere $1,780,812 and $1,664,843 for the three months ended December 31,2007 and 2006, respectively, representing an increase of $115,969. While theresearch and development direct costs remained constant between the twoperiods, the increase was primarily the result of repairs and maintenanceexpense associated with the frac pump.

 

*General andadministrative.  *General and administrativeexpenses were $1,479,105 and $1,298,544 for the three months ended December 31,2007 and 2006, respectively, representing an increase of $180,561. Thisincrease was primarily the result of increased costs related to stock-basedcompensation expense, legal expenses, and litigation expense associated withthe arbitration between our Company and the frac pump manufacturer.

 

*Other income (expenses).  *Other income was $33,381 and $124,926 for the three monthsended December 31, 2007 and 2006, respectively, representing a decrease inother income of $91,545. The decrease was primarily attributable to thedecrease in cash and cash equivalents between the two periods resulting insubstantially less interest income.

 

**Off-BalanceSheet Arrangements**

 

In connection with theacquisition of the PID technology in January 2004, PDTI entered into aRoyalty Agreement with ProDril Services, Incorporated (“PSI”) pursuant to whichwe are obligated to pay PSI a royalty on a quarterly basis equal to 18% of ourearnings before interest, income taxes, depreciation and amortization (“EBITDA”)derived from the use of the PID technology, until an aggregate of $67,500,000has been paid. PDTI also entered into a Royalty Agreement in January 2004with ProDril Services, International, Ltd. (“PSIL”) pursuant to which we areobligated to pay PSIL a royalty on a quarterly basis equal to 2% of our EBITDAderived from the use of the PID technology, until an aggregate of $7,500,000has been paid. In addition, we are obligated to pay CCORE Technology andLicensing, 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 PIDtechnology.  As of December 31,2007, we had no revenues or EBITDA; therefore no royalties have been paid oraccrued.

 

**Critical Accounting Policies**

 

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

 

*Impairment of Long-LivedAssets.  *We evaluate our long-lived assets forindicators of possible impairment by comparison of the carrying amounts tofuture net undiscounted cash flows expected to be generated by such assets whenevents or changes in circumstances indicate the carrying amount of an asset maynot be recoverable.  Should an impairment exist, the impairment loss wouldbe measured based on the excess carrying value of the asset over the asset’sfair value or discounted estimates of future cash flows.  We also evaluatethe capitalized costs for patents and patent applications filed but not issuedfor possible impairments.  The evaluationof capitalized costs for patents and patent applications is based on asubjective cash flow forecast which is subject to change.  We will reassess our cash flow forecast eachtime there are fundamental changes in the underlying potential use of thepatents or patent applications in terms of performance, customer 

 

11

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acceptance or other factors that may affect such cashflow forecasts.

 

*Asset held for sale.*  InJanuary 2007, we purchased a quintaplex frac pump for approximately $1.4million. In September 2007, management decided to place this frac pump onthe market for sale as a result of the development of the new extruder-basedinjection system being constructed that is meant to replace the frac pump basedinjection system. We commenced our selling efforts during September 2007at which time the carrying amount of the frac pump was reclassified as an assetheld for sale, as currently reflected on the accompanying December 31,2007 consolidated balance sheet. We recognized an impairment on the asset of$295,260, and the net book value of the frac pump was reduced to $900,000,reflecting management’s estimate of the realizable value of the frac pump.

 

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

 

*Research andDevelopment.  *The costs of materials and equipmentor facilities that are acquired or constructed for research and developmentactivities and that have alternative future uses are capitalized as tangibleassets when acquired or constructed. The cost of such materials consumed inresearch and development activities and the depreciation of such equipment orfacilities used in those activities are research and development costs.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 follow SFAS No. 109, *Accounting for Income Taxes.* This statement requires anasset and liability approach for financial accounting and reporting for incometax purposes.  This statement recognizesthe amount of taxes payable or refundable for the current year and deferred taxliabilities and assets for future tax consequences of events that have beenrecognized in the consolidated financial statements or tax returns.  Provisions (benefits) for income taxes resultfrom permanent and temporary differences in the recognition of accountingtransactions for tax and financial reporting purposes.  Valuation allowances are established whennecessary to reduce deferred tax assets to the amount expected to be realized.

 

As discussed in Footnote3, we adopted FIN 48 and, as a result, there was no effect on our financialstatements. As discussed in Footnote 3, we adopted FIN 48 and, as a result,there was no effect on our financial statements.  FIN 48 prescribes a minimum recognition thresholdand measurement methodology that a tax position taken or expected to be takenin a tax return is required to meet before being recognized in the financialstatements. It also provides guidance for derecognition, classification,interest and penalties, accounting in interim periods, disclosure, andtransition.  The Company recognizes interest and penalties related tounrecognized tax benefits within the provision for income taxes on continuingoperations in the consolidated statements of income. There are no unrecognizedtax benefits as of the date of adoption.  There are no unrecognized taxbenefits that if recognized would affect the tax rate. There is no interest orpenalties recognized as of the date of adoption or for the three months endedDecember 31, 2007.

 

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

 

The Company anticipatesrecording no tax benefit for the year, based upon management’s assessment thatthe realization of the anticipated financial loss for the year is not at thispoint reasonably assured; accordingly no benefit has been recorded for thethree months ended 12/31/07.

 

*Net Loss per Share.  *TheCompany has presented basic and diluted net loss per share pursuant to SFAS No. 128,*Earnings Per Share*. In accordancewith SFAS No. 128, basic and diluted net loss per share has been computedusing the weighted-average number of shares of common stock outstanding duringthe period. Dilutive net loss per share would give effect to the dilutiveeffect of common stock equivalents consisting of options and warrants.Potentially dilutive securities have been excluded from the net loss per commonshare calculation as the effects would be antidilutive. Potentially dilutivesecurities not included in the computation of weighted average diluted sharesof common stock because the impact of these potentially dilutive securitieswere antidilutive were 1,475,230 and 2,054,643 shares for the three monthsended December 31, 2007 and 2006, respectively.

 

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**Forward-Looking Statements**

 

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

 

These forward-lookingstatements are made based upon our management’s current plans, expectations,estimates, assumptions and beliefs concerning future events impacting us andtherefore involve a number of risks and uncertainties.  We caution 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” in our annual report on Form 10-Kfor the year ended September 30, 2007 filed with the SEC onDecember 13, 2007.  We undertake noobligation to update any forward-looking statements except as required by law.

 

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

 

We believe that we do not have any material exposureto financial market risk and we do not enter into foreign currency or interestrate transactions.

 

**Item4.        Controls and Procedures**

 

As required by Rule 13a-15(b) of the SecuritiesExchange Act of 1934, an evaluation was performed under the supervision andwith the participation of our Chief Executive Officer and Chief FinancialOfficer of the effectiveness of the design and operation of our “disclosurecontrols and procedures” (as defined under Rule 13a-15(e) and Rule 15d-15(e))as of the end of the period covered by this Quarterly Report on Form 10-Qfiled with the SEC. Based upon that evaluation, our Chief Executive Officer andChief Financial Officer concluded that our disclosure controls and procedureswere effective as of December 31, 2007.

 

There was no change in our internal control overfinancial reporting during our first quarter of fiscal 2008 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**Part II—Other Information**

 

**Item2.****        Unregistered Sales of EquitySecurities and Use of Proceeds**

 

On December 1, 2007, a holder of outstanding warrantsexercised its right to purchase 2,000 shares of our common stock at $2.00 pershare on a cashless exercise basis.  Thefair market value of our common stock on the date of exercise was $3.05.  As a result of this cashless exercise, weissued 688 shares of our common stock to the holder of this warrant andwithheld issuing 1,312 shares of our common stock in satisfaction of theexercise price under the warrant.

 

The shares of our common stock issued upon exercise of thewarrant described above were issued in an exchange between us and our existingsecurity holders in which no commission or other remuneration was paid or givendirectly or indirectly for soliciting such exchange.  As a result, theissuance of such shares of common stock was exempt from registration pursuantto Section 3(a)(9) under the Securities Act of 1933.

 

On December 20, 2007, a holder of outstanding warrantsexercised its right to purchase 10,000 shares of our common stock at $0.12 pershare on a cash exercise basis.  The fairmarket value of our common stock on the date of exercise was $2.70.  The shares of common stock issued uponexercise of this warrant were issued pursuant to the exemption fromregistration afforded by Section 4(2) of the Securities Act.

 

**Item6.****         Exhibits**

 

Exhibits:

 

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

 

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*                    Filed herewith

**             Furnished herewith

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                                   | PARTICLE DRILLING TECHNOLOGIES, INC.                                                                                              |
|-----------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|
|                              | (Registrant)                                                                                                                           |
|                              |                                                                                                                                   |
|                              |                                                                                                                                   |
| Date:  February 7, 2008 | /s/ J. CHRIS BOSWELL                                                                                                                   |
|                              | J. Chris Boswell                                                                                                                       |
|                              | Senior Vice President and Chief Financial Officer  (authorized officer, principal financial officer and  principal accounting officer) |

 

15

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**EXHIBITINDEX**

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

 

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*                    Filedherewith

**             Furnishedherewith

 

16

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