**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**(Mark One)**

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

**Forthe quarterly period ended June 30, 2007**

**OR**

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

**Forthe transition period from                   to                    **

**CommissionFile Number 000-30819**

**Particle Drilling Technologies, Inc.**

**(Exactname of registrant as specified in its charter)**

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

 

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

 

**713-223-3031**

(Registrant’s telephonenumber, including area code)

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe 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” inRule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler 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

Thenumber of shares of the registrant’s common stock, $.001 par value, outstandingas of August 7, 2007 was 30,979,901.

 

----

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

**FORM 10-QFOR THE QUARTER ENDED JUNE 30, 2007**

**INDEX**
| **Part I - Financial Information** |                                                                                                                                                                 | **Page** |
|------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| ** **                         |                                                                                                                                                                 |     |
| Item 1.                            | Financial Statements                                                                                                                                                 |     |   |
|                               |                                                                                                                                                                 |     |   |
|                               | Consolidated Balance Sheets at June 30, 2007  (Unaudited) and September 30, 2006                                                                                     |     | 3 |
|                               |                                                                                                                                                                 |     |   |
|                               | Consolidated Statements of Operations (Unaudited) -  Three and Nine Months Ended June 30, 2007 and 2006, and from June 9, 2003  (date of inception) to June 30, 2007 |     | 4 |
|                               |                                                                                                                                                                 |     |   |
|                               | Consolidated Statements of Stockholders’ Equity  (Unaudited) for the period from September 30, 2006 to June 30, 2007                                            |     | 5 |
|                               |                                                                                                                                                                 |     |   |
|                               | Consolidated Statements of Cash Flows (Unaudited) -  Nine Months Ended June 30, 2007 and 2006, and from June 9, 2003 (date of  inception) to June 30, 2007           |     | 6 |
|                               |                                                                                                                                                                 |     |   |
|                               | Notes to Consolidated Financial Statements (Unaudited)                                                                                                               |     | 7 |
|                               |                                                                                                                                                                 |     |   |
| Item 2.                            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                          |     | 11 |
|                               |                                                                                                                                                                 |     |   |
| Item 3.                            | Quantitative  and Qualitative Disclosures about Market Risk                                                                                                          |     | 15 |
|                               |                                                                                                                                                                 |     |   |
| Item 4.                            | Controls and  Procedures                                                                                                                                             |     | 15 |
|                               |                                                                                                                                                                 |     |   |
| **Part  II - Other Information**   | ** **                                                                                                                                                           | **15**   |
|                               |                                                                                                                                                                 |     |   |
| Item 2.                            | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                         |     | 15 |
|                               |                                                                                                                                                                 |     |   |
| Item 5                             | Other Information                                                                                                                                                    |     | 16 |
|                               |                                                                                                                                                                 |     |   |
| Item  6.                           | Exhibits                                                                                                                                                             |     | 16 |
|                               |                                                                                                                                                                 |     |   |
|                               | Signatures                                                                                                                                                           |     | 17 |

 

 

2

----

**PARTICLEDRILLING TECHNOLOGIES, INC.(a development stage enterprise)CONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                                                                                                         | ** ** | **June 30,  2007** | ** ** | **September 30,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                                                                         | ** ** | **(Unaudited)**         | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| **ASSETS**                                                                                                                                                                                                                         | ** ** | ** **              | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Current assets:                                                                                                                                                                                                                    |       |                    |       |                         |       |
| Cash and cash  equivalents                                                                                                                                                                                                         |       | $                       | 5,976,427  |                         | $          | 2,291,586 |   |
| Short-term  investments                                                                                                                                                                                                            |       | —                  |       | 385,839                      |       |
| Prepaid expenses                                                                                                                                                                                                                   |       | 132,394                 |       | 234,488                      |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Total current  assets                                                                                                                                                                                                              |       | 6,108,821               |       | 2,911,913                    |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Property, plant &  equipment, net                                                                                                                                                                                              |       | 2,008,470               |       | 1,326,713                    |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Intangibles, net                                                                                                                                                                                                                   |       | 1,291,574               |       | 1,230,086                    |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Other assets                                                                                                                                                                                                                       |       | 65,794                  |       | 14,650                       |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Total assets                                                                                                                                                                                                                       |       | $                       | 9,474,659  |                         | $          | 5,483,362 |   |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                     | ** ** | ** **              | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Current liabilities:                                                                                                                                                                                                               |       |                    |       |                         |       |
| Accounts payable                                                                                                                                                                                                                   |       | $                       | 830,831    |                         | $          | 830,552 |   |
| Short-term notes  payable                                                                                                                                                                                                          |       | —                  |       | 179,143                      |       |
| Current portion  of long-term debt                                                                                                                                                                                                 |       | 11,070                  |       | 19,270                       |       |
| Accrued  liabilities                                                                                                                                                                                                               |       | 721,763                 |       | 471,463                      |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Total current  liabilities                                                                                                                                                                                                         |       | 1,563,664               |       | 1,500,428                    |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Long-term debt                                                                                                                                                                                                                     |       | 7,711                   |       | 15,305                       |       |
| Deferred Rent                                                                                                                                                                                                                      |       | 12,000                  |       | —                       |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Commitments and  contingencies - Note 8                                                                                                                                                                                            |       |                    |       |                         |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Stockholders’ equity:                                                                                                                                                                                                         |       |                    |       |                         |       |
| Common stock,  $.001 par value, 100,000,000 shares authorized, 33,682,987 shares issued and  30,679,901 shares outstanding at June 30, 2007, and 28,013,291 shares issued  and 25,010,205 shares outstanding at September 30, 2006 |       | 33,685                  |       | 28,014                       |       |
| Additional  paid-in capital                                                                                                                                                                                                        |       | 37,795,632              |       | 25,239,221                   |       |
| Treasury stock  at cost, 3,003,086 shares at June 30, 2007 and September 30, 2006                                                                                                                                                  |       | (1,511,817              | )          | (1,511,817                   | )          |
| Deficit  accumulated during the development stage                                                                                                                                                                                  |       | (28,426,216             | )          | (19,787,789                  | )          |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Total  stockholders’ equity                                                                                                                                                                                                   |       | 7,891,284               |       | 3,967,629                    |       |
|                                                                                                                                                                                                                               |       |                    |       |                         |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                                                   |       | $                       | 9,474,659  |                         | $          | 5,483,362 |   |

The accompanying notes are anintegral part of these statements.

3

----

 

**PARTICLE DRILLINGTECHNOLOGIES, INC.(a development stage enterprise)CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**
| ** **                                                                | ** ** | **Three Months Ended June 30,** | ** ** | **Nine Months Ended June 30,** | ** ** | **Period from  June 9, 2003  (date of inception)  to June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2007**                                            | ** ** | **2006**                                           | ** ** | **2007**                                                                                           | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenues                                                                  |       | $                                                   | —     |                                               | $          | —                                                                                             |       | $ | — |   | $ | — |   | $ | — |   |
|                                                                      |       |                                                |       |                                               |       |                                                                                               |       |   |   |   |   |
| Operating  expenses:                                                      |       |                                                |       |                                               |       |                                                                                               |       |   |   |   |   |
| Research and development                                                  |       | 1,289,785                                           |       | 1,735,857                                          |       | 4,994,944                                                                                          |       | 4,469,449 |   | 14,422,915 |   |
| General and administrative                                                |       | 1,180,854                                           |       | 1,157,885                                          |       | 3,961,005                                                                                          |       | 3,530,056 |   | 14,911,104 |   |
|                                                                      |       |                                                |       |                                               |       |                                                                                               |       |   |   |   |   |
| Total operating expenses                                                  |       | 2,470,639                                           |       | 2,893,742                                          |       | 8,955,949                                                                                          |       | 7,999,505 |   | 29,334,019 |   |
|                                                                      |       |                                                |       |                                               |       |                                                                                               |       |   |   |   |   |
| Loss from operations                                                      |       | (2,470,639                                          | )          | (2,893,742                                         | )          | (8,955,949                                                                                         | )          | (7,999,505 | ) | (29,334,019 | ) |
|                                                                      |       |                                                |       |                                               |       |                                                                                               |       |   |   |   |   |
| Other income  (expenses)                                                  |       |                                                |       |                                               |       |                                                                                               |       |   |   |   |   |
| Interest income                                                           |       | 81,034                                              |       | 64,018                                             |       | 322,766                                                                                            |       | 224,314 |   | 792,985 |   |
| Rental income - related party                                             |       | —                                              |       | —                                             |       | —                                                                                             |       | 46,565 |   | 73,727 |   |
| Gain on debt extinguishment                                               |       | —                                              |       | —                                             |       | —                                                                                             |       | — |   | 35,283 |   |
| Gain on assignment of lease - related party                               |       | —                                              |       | —                                             |       | —                                                                                             |       | 55,614 |   | 55,614 |   |
| Interest expense                                                          |       | (562                                                | )          | (821                                               | )          | (5,244                                                                                             | )          | (2,423 | ) | (49,806 | ) |
|                                                                      |       |                                                |       |                                               |       |                                                                                               |       |   |   |   |   |
| Total other income                                                        |       | 80,472                                              |       | 63,197                                             |       | 317,522                                                                                            |       | 324,070 |   | 907,803 |   |
|                                                                      |       |                                                |       |                                               |       |                                                                                               |       |   |   |   |   |
| Net loss                                                                  |       | $                                                   | (2,390,167 | )                                                  | $          | (2,830,545                                                                                         | )          | $ | (8,638,427 | ) | $ | (7,675,435 | ) | $ | (28,426,216 | ) |
|                                                                      |       |                                                |       |                                               |       |                                                                                               |       |   |   |   |   |
| Net loss per  common share, basic and diluted                             |       | $                                                   | (0.08      | )                                                  | $          | (0.11                                                                                              | )          | $ | (0.29 | ) | $ | (0.31 | ) | $ | (1.12 | ) |
|                                                                      |       |                                                |       |                                               |       |                                                                                               |       |   |   |   |   |
| Weighted average number  of common shares outstanding - basic and diluted |       | 30,669,301                                          |       | 24,968,159                                         |       | 29,934,127                                                                                         |       | 24,461,636 |   | 25,333,461 |   |

 

The accompanying notesare an integral part of these statements.

4

----

**PARTICLEDRILLING TECHNOLOGIES, INC.(a development stage enterprise)CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITYFor the Period from September 30, 2006 to June 30, 2007(Unaudited)**
| ** **                                                                                                                  | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Additional  Paid-in** | ** ** | **Deficit  Accumulated  During  Development** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-------------------------|------------|-----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Shares**              | ** ** | **Amount**                                    | ** ** | **Capital**                           | ** ** | **Stage** | ** ** | **(Deficit)** | ** ** |
| Balance,  September 30, 2006                                                                                                |       | 28,013,291            |       | $                       | 28,014     |                    | (3,003,086 | )                                             | $          | (1,511,817                            | )          | $ | 25,239,221 |   | $ | (19,787,789 | ) | $ | 3,967,629 |   |
| Common  stock issued in private placement for cash at $2.35 per share in October  2006, less offering expense of $1,037,509 |       | 5,000,000             |       | 5,000                   |       | —                  |       | —                                        |       | 10,707,491                            |       | — |   | 10,712,491 |   |
| Restricted  stock issued to an employee at $3.08 per share in October 2006                                                  |       | 3,000                 |       | 3                       |       | —                  |       | —                                        |       | (3                                    | )          | — |   | — |   |
| Restricted  stock issued to employees at $2.85 per share in October 2006                                                    |       | 68,250                |       | 68                      |       | —                  |       | —                                        |       | (68                                   | )          | — |   | — |   |
| Common  stock issued upon exercise of warrants at $0.12 per share in October 2006                                           |       | 5,745                 |       | 6                       |       | —                  |       | —                                        |       | (6                                    | )          | — |   | — |   |
| Common  stock issued for cash at $0.12 per share upon exercise of employee stock  options in November 2006                  |       | 6,000                 |       | 6                       |       | —                  |       | —                                        |       | 714                                   |       | — |   | 720 |   |
| Common  stock issued upon cashless exercise of warrants at $0.12 per share in  February 2007                                |       | 5,816                 |       | 6                       |       | —                  |       | —                                        |       | (6                                    | )          | — |   | — |   |
| Common  stock issued upon exercise of warrants at $0.12 per share in February 2007                                          |       | 2,000                 |       | 2                       |       | —                  |       | —                                        |       | 238                                   |       | — |   | 240 |   |
| Common  stock issued upon cashless exercise of warrants at $2.00 per share in March  2007                                   |       | 486,558               |       | 487                     |       | —                  |       | —                                        |       | (487                                  | )          | — |   | — |   |
| Restricted  stock issued to certain Directors at $3.93 per share in March 2007                                              |       | 30,000                |       | 30                      |       | —                  |       | —                                        |       | (30                                   | )          | — |   | — |   |
| Restricted  stock issued to employees at $3.69 per share in April 2007                                                      |       | 4,000                 |       | 4                       |       | —                  |       | —                                        |       | (4                                    | )          | — |   | — |   |
| Restricted  stock cancelled in April 2007                                                                                   |       | (3,375                | )          | (3                      | )          | —                  |       | —                                        |       | 3                                     |       | — |   | — |   |
| Common  stock issued upon cashless exercise of warrants at $0.12 per share in May  2007                                     |       | 24,202                |       | 24                      |       | —                  |       | —                                        |       | (24                                   | )          | — |   | — |   |
| Common  stock issued upon exercise of employee stock options at $0.12 per share in  June 2007                               |       | 37,500                |       | 38                      |       | —                  |       | —                                        |       | 4,462                                 |       | — |   | 4,500 |   |
| Stock-based  employee compensation                                                                                          |       | —                |       | —                  |       | —                  |       | —                                        |       | 1,844,131                             |       | — |   | 1,844,131 |   |
| Net  loss                                                                                                                   |       | —                |       | —                  |       | —                  |       | —                                        |       | —                                |       | (8,638,427 | ) | (8,638,427 | ) |
| Balance,  June 30, 2007                                                                                                     |       | 33,682,987            |       | $                       | 33,685     |                    | (3,003,086 | )                                             | $          | (1,511,817                            | )          | $ | 37,795,632 |   | $ | (28,426,216 | ) | $ | 7,891,284 |   |

 

 

The accompanying notes are an integral part of these statements.

5

----

**PARTICLEDRILLING TECHNOLOGIES, INC.(a development stage enterprise)CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)**
| ** **                                                                   | ** ** | **Nine Months Ended June 30,** | ** ** | **Period from  June 9, 2003  (date of  inception)  to June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                           | ** ** | **2006**                                                                                       | ** ** | **2007** | ** ** |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Cash flows from  operating activities:                                       |       |                                               |       |                                                                                           |       |   |   |
| Net loss                                                                     |       | $                                                  | (8,638,427 | )                                                                                              | $          | (7,675,435 | ) | $ | (28,426,216 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                                               |       |                                                                                           |       |   |   |
| Gain on debt extinguishment                                                  |       | —                                             |       | —                                                                                         |       | (35,283 | ) |
| Gain on assignment of lease - related party                                  |       | —                                             |       | (55,614                                                                                        | )          | (55,614 | ) |
| Depreciation and amortization expense                                        |       | 585,684                                            |       | 504,324                                                                                        |       | 1,812,746 |   |
| 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                                            |       | 1,844,131                                          |       | 1,431,342                                                                                      |       | 4,525,832 |   |
| Changes in operating assets and liabilities:                                 |       |                                               |       |                                                                                           |       |   |   |
| Decrease in note receivable                                                  |       | 385,839                                            |       | —                                                                                         |       | 385,839 |   |
| (Increase) Decrease in accounts receivable - related  party                  |       | —                                             |       | 1,510                                                                                          |       | (42,331 | ) |
| Decrease in prepaid expenses                                                 |       | 102,094                                            |       | 158,592                                                                                        |       | 233,581 |   |
| Increase (Decrease) in accounts payable                                      |       | 279                                                |       | (172,017                                                                                       | )          | 490,893 |   |
| Increase in accrued liabilities                                              |       | 250,300                                            |       | 569,371                                                                                        |       | 818,560 |   |
| (Increase) in other assets                                                   |       | (51,144                                            | )          | —                                                                                         |       | (51,144 | ) |
| Increase in other liabilities                                                |       | 12,000                                             |       | —                                                                                         |       | 12,000 |   |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Net cash used in operating activities                                        |       | (5,509,244                                         | )          | (5,237,927                                                                                     | )          | (19,291,808 | ) |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Cash flows from  investing activities:                                       |       |                                               |       |                                                                                           |       |   |   |
| Payments to purchase property and equipment                                  |       | (1,229,578                                         | )          | (285,022                                                                                       | )          | (3,050,197 | ) |
| Proceeds from sale of property and equipment                                 |       | —                                             |       | —                                                                                         |       | 20,957 |   |
| Payments to purchase intangibles                                             |       | (99,351                                            | )          | (143,973                                                                                       | )          | (707,965 | ) |
| Payments to purchase other assets                                            |       | —                                             |       | (28,416                                                                                        | )          | (419,504 | ) |
| Payments issued for note receivable                                          |       | —                                             |       | —                                                                                         |       | (300,783 | ) |
| Payments issued for note receivable - related party                          |       | —                                             |       | —                                                                                         |       | (56,783 | ) |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Net cash used in investing activities                                        |       | (1,328,929                                         | )          | (457,411                                                                                       | )          | (4,514,275 | ) |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Cash flows from  financing activities:                                       |       |                                               |       |                                                                                           |       |   |   |
| Proceeds from issuance of common stock                                       |       | 10,717,951                                         |       | 6,090                                                                                          |       | 31,699,806 |   |
| Repurchase of common stock                                                   |       | —                                             |       | (11,817                                                                                        | )          | (1,511,817 | ) |
| Proceeds from issuance of convertible notes                                  |       | —                                             |       | —                                                                                         |       | 553,500 |   |
| Repayments of notes payable                                                  |       | (194,937                                           | )          | (91,771                                                                                        | )          | (958,979 | ) |
| Proceeds from borrowings under loan agreements -  related parties            |       | —                                             |       | —                                                                                         |       | 23,195 |   |
| Repayment of borrowings under loan agreements -  related parties             |       | —                                             |       | —                                                                                         |       | (23,195 | ) |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Net cash provided by (used in) financing activities                          |       | 10,523,014                                         |       | (97,498                                                                                        | )          | 29,782,510 |   |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                        |       | 3,684,841                                          |       | (5,792,836                                                                                     | )          | 5,976,427 |   |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Cash and cash  equivalents - beginning of period                             |       | 2,291,586                                          |       | 10,504,646                                                                                     |       | — |   |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Cash and cash  equivalents - end of period                                   |       | $                                                  | 5,976,427  |                                                                                           | $          | 4,711,810 |   | $ | 5,976,427 |   |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Supplemental  disclosures of cash flow information:                          |       |                                               |       |                                                                                           |       |   |   |
| Cash paid for interest                                                       |       | $                                                  | 5,244      |                                                                                           | $          | 2,530 |   | $ | 49,806 |   |
|                                                                         |       |                                               |       |                                                                                           |       |   |   |
| Non-cash  investing and financing activities:                                |       |                                               |       |                                                                                           |       |   |   |
| Prepaid insurance acquired with note payable                                 |       | $                                                  | —     |                                                                                           | $          | — |   | $ | 111,990 |   |
| Common stock issued as consideration for account  payable                    |       | —                                             |       | —                                                                                         |       | 6,000 |   |
| Common stock issued as consideration for note  payable                       |       | —                                             |       | —                                                                                         |       | 50,000 |   |
| Related party note receivable exchanged for property  and equipment          |       | —                                             |       | —                                                                                         |       | 56,783 |   |
| Note payable converted into common stock                                     |       | —                                             |       | —                                                                                         |       | 553,500 |   |
| Property and equipment acquired with assumed  liabilities                    |       | —                                             |       | —                                                                                         |       | 479,610 |   |
| Intangibles acquired with assumed liabilities                                |       | —                                             |       | —                                                                                         |       | 757,792 |   |
| Property and equipment acquired with note payable                            |       | —                                             |       | 30,487                                                                                         |       | 30,487 |   |
| Short-term  investments reclassified from other assets                       |       | —                                             |       | 385,839                                                                                        |       | 385,839 |   |

 

The accompanying notesare an integral part of these statements.

6

----

**PARTICLE DRILLINGTECHNOLOGIES, INC.**

**(a development stage enterprise)**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

**1.****  ****        BASISOF PRESENTATION**

The accompanyingunaudited interim consolidated financial statements, which include the accountsof Particle Drilling Technologies, Inc. (which is referred to hereinas “we,” “us,” “our” or the “Company”) and its subsidiary, have been preparedin accordance with generally accepted accounting principles in the UnitedStates of America (“US GAAP”) and pursuant to the rules and regulations ofthe Securities and Exchange Commission. Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith US GAAP have been condensed or omitted in accordance with such rules andregulations. The information furnished in the unaudited interim consolidatedfinancial statements includes normal recurring adjustments and reflects alladjustments, which in the opinion of management are necessary for a fairpresentation of such financial statements. Although management believes thedisclosures and information presented are adequate to make the information notmisleading, these unaudited interim consolidated financial statements should beread in conjunction with the Company’s September 30, 2006 auditedconsolidated financial statements and notes thereto in its Annual Report onForm 10-K. Operating results for the three months and nine months endedJune 30, 2007 are not necessarily indicative of the results that may be expectedfor the year ending September 30, 2007.

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

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

**2.  ****       ****FINANCIALCONDITION AND MANAGEMENT PLANS**

Thefinancial statements of the Company have been prepared on the basis ofaccounting principles applicable to a going concern, which contemplates therealization of assets and the satisfaction of liabilities in the normal courseof business.  As shown in the condensedconsolidated financial statements, for the three and nine months ended June 30,2007, the Company reported net losses of approximately $2.4 million and $8.6million, respectively, as compared to net losses of approximately $2.8 millionand $7.7 million for the three and nine months ended June 30, 2006,respectively.  The condensed consolidatedfinancial statements also show an accumulated deficit of approximately $28.4million from inception (June 9, 2003) through the period ended June 30,2007.  The financial statements do notinclude any adjustments relating to the recoverability and classification ofasset carrying amounts or the amount and classification of liabilities thatmight result should the Company be unable to continue as a going concern.

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

**3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

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

7

----

 

*NewAccounting Pronouncements**.  ***In July 2006, the FASB issued FASB Interpretation No. 48, *Accounting for Uncertainty in Income Taxes — An Interpretationof FASB Statement No. 109*(“FIN 48”).  FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with SFAS No. 109, *Accounting for Income**Taxes.*  It prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return.  This new standard also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition.  The provisions of FIN 48 are to be applied toall tax positions upon initial adoption of this standard.  Only taxpositions that meet the more-likely-than-not recognition threshold at the effectivedate may be recognized or continue to be recognized upon adoption of FIN48.  The cumulative effect of applying the provisions of FIN 48 should bereported as an adjustment to the opening balance of retained earnings (or otherappropriate components of equity or net assets in the statement of financialposition) for that fiscal year.  The provisions of FIN 48 are effectivefor fiscal years beginning after December 15, 2006.  Earlier applicationis permitted as long as the enterprise has not yet issued financial statements,including interim financial statements, in the period of adoption.  TheCompany is in the process of assessing the impact of the adoption of Fin 48.

In September 2006,the FASB issued SFAS No. 157, Fair Value Measurements.  SFAS No. 157clarifies the principle that fair value should be based on the assumptionsmarket participants would use when pricing an asset or liability andestablishes a fair value hierarchy that prioritizes the information used todevelop those assumptions.  Under the standard, fair value measurementswould be separately disclosed by level within the fair value hierarchy.  SFASNo. 157 is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears, with early adoption permitted.  The Company believes that theadoption of SFAS No. 157 will not have a material impact on its financialposition, results of operations or cash flows.

In September 2006,the FASB issued FSP No. AUG AIR-1, Accounting for Planned Major MaintenanceActivities.  FSP No. AUG AIR-1 prohibits the use of the accrue-in-advancemethod for accounting for major maintenance activities and confirms theacceptable methods of accounting for planned major maintenanceactivities.  FSP No. AUG AIR-1 is effective the first fiscal yearbeginning after December 15, 2006.  The Company believes that the adoptionof FSP No. AUG AIR-1 will not have a material impact on its financial position,results of operations or cash flows.

InSeptember 2006, the SEC issued SAB 108, “Considering the Effects of PriorYear Misstatements when Quantifying Misstatements in Current Year FinancialStatements”(“ SAB 108”)*.*SAB 108provides interpretive guidance on how the effects of the carryover or reversalof prior year misstatements should be considered in quantifying a current yearmisstatement. The pronouncement prescribes an approach whereby the effect ofall unrecorded identified errors should be considered on all of the financialstatements rather than just either the effect on the balance sheet or theincome statement. The Company adopted the provisions of SAB 108 beginning infiscal 2007. The adoption of SAB 108 did not have a material impact on theCompany’s Consolidated Financial Statements.

In February 2007,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 159, *TheFair Value Option for Financial Assets and Financial Liabilities*(“SFASNo. 159”). SFAS No. 159 permits entities to choose to measure manyfinancial assets and financial liabilities at fair value. Unrealized gains andlosses on items for which the fair value option has been elected are reportedin earnings. SFAS No. 159 is effective for fiscal years beginning afterNovember 15, 2007. We will adopt SFAS No. 159 on October 1, 2008 andhave not yet determined the impact, if any, on our consolidated financialstatements.

**4.  ****     REVERSE ACQUISITION WITHMEDXLINK, CORP**

On July 14, 2004,MedXLink, Corp. (“MXLK”, or the “Parent”), a Nevada corporation and an inactivepublicly-traded company, entered into an Agreement and Plan of Reorganizationwith Particle Drilling Technologies, Inc., a Delaware corporation (“PDTI-DE”),whereby MXLK agreed to acquire PDTI-DE by merging PDTI Acquisition Corp. (“MergerSub”), a newly formed Delaware corporation and wholly owned subsidiary of MXLK,with and into PDTI-DE and issued common stock of MXLK in exchange for all theoutstanding shares of PDTI-DE. On January 14, 2005, MXLK closed itsacquisition of PDTI-DE and issued 16,698,094 shares of common stock (including3,381,538 shares of common stock issued upon conversion of the same number ofshares of Series A Convertible Preferred Stock of PDTI-DE) to holders ofcommon stock of PDTI-DE and reserved for issuance (1) 228,000 shares ofcommon stock pursuant to outstanding warrants to purchase common stock ofPDTI-DE, and (2) 3,205,000 shares of common stock pursuant to outstandingoptions to purchase common stock of PDTI-DE. In addition, 1,342,404 issued andoutstanding shares of common stock of the Parent were cancelled for noadditional cash consideration in connection with the Merger. Following themerger, the Parent had 18,248,094 shares of common stock issued and outstanding(which included 3,381,538 shares of common stock issued upon conversion of thesame number of shares of Series A Convertible Preferred Stock of PDTI-DE)and an additional 3,433,000 shares of common

8

----

stock reserved for issuance upon exercise of warrantsand options as described above. Following the merger, PDTI-DE continued as thesurviving corporation under the name of Particle DrillingTechnologies, Inc. as a subsidiary of Parent, the Parent changed its nameto Particle Drilling Technologies, Inc., and its stock trading symbolchanged from MXLK.OB to PDRT.OB. On June 28, 2005, the Company’s shares ofcommon stock began trading on The NASDAQ Capital Market® under the symbol PDRT.

**5.  ****     NET LOSS PER COMMON SHARE**

The Company has presentedbasic and diluted net loss per share pursuant to SFAS No. 128, *Earnings Per Share*. In accordance withSFAS No. 128, basic and diluted net loss per share has been computed usingthe weighted-average number of shares of common stock outstanding during theperiod. Dilutive net loss per share would give effect to the dilutive effect ofcommon stock equivalents consisting of options and warrants. Potentiallydilutive securities have been excluded from the net loss per common sharecalculation as the effects would be antidilutive. Potentially dilutivesecurities not included in the computation of weighted average diluted sharesof common stock because the impact of these potentially dilutive securitieswere antidilutive were 2,498,200 and 2,349,650 shares for the three monthsended June 30, 2007 and 2006, respectively, and 2,485,717 and 2,303,555 sharesfor the nine months ended June 30, 2007 and 2006, respectively.

**6.  ****     COMMON STOCK**

InOctober 2006, the Company issued 5,745 shares of its common stock upon a netcashless exercise of warrants at $0.12 per share.

InOctober 2006, the Company issued 71,250 shares of its restricted stock toseveral of its employees.

InOctober 2006, the Company issued 5,000,000 shares of its common stock from aprivate placement at $2.35 per share.

In November 2006, theCompany issued 6,000 shares of its common stock for cash upon exercise ofoptions at $0.12 per share.

InFebruary 2007, the Company issued 5,816 shares of its common stock upon a netcashless exercise of warrants at $0.12 per share.

InFebruary 2007, the Company issued 2,000 shares of its common stock upon a cashexercise of warrants at $0.12 per share.

InMarch 2007, the Company issued 486,558 shares of its common stock upon a netcashless exercise of warrants at $2.00 per share.

InMarch 2007, the Company issued 30,000 shares of its restricted stock to severalof its directors.

InApril 2007, the Company issued 4,000 shares of its restricted stock to anemployee.

InApril 2007, the Company cancelled 3,375 shares of its restricted stock thatwere previously issued to several of its employees.

InMay 2007, the Company issued 24,202 shares of its common stock upon a netcashless exercise of warrants at $0.12 per share.

InJune 2007, the Company issued 37,500 shares of its common stock upon exerciseof stock options at $0.12 per share.

At June 30, 2007, theCompany had 30,679,901 shares of common stock outstanding and had outstandingoptions and warrants to purchase up to 6,177,016 additional shares of theCompany’s common stock in the aggregate.

**7.  ****     STOCK-BASED EMPLOYEECOMPENSATION**

In April 2004, theBoard of Directors adopted the 2004 Stock Incentive Plan (the “2004 Plan”). The2004 Plan provides for the issuance of incentive stock options, non-statutorystock options and restricted stock grants to directors, employees and

9

----

consultants of the Company. Provisions under the 2004Plan allowed for the issuance of up to 3,500,000 shares of common stockpursuant to awards under the 2004 Plan. As of June 30, 2007, the Company had6,250 shares of common stock available for issuance pursuant to awards underthe 2004 Plan.

In March 2005, theBoard of Directors adopted the 2005 Stock Option Plan (the “2005 Plan”). The2005 Plan provides for the issuance of non-statutory stock options andrestricted stock grants to directors, employees and consultants of the Company.Provisions under the 2005 Plan allow for the issuance of options and restrictedstock awards to purchase or issue up to 2,000,000 shares of common stock. As ofJune 30, 2007, the Company had 329,250 shares of common stock available forissuance pursuant to awards under the 2005 Plan.

In March 2007, theshareholders approved the 2007 Stock Incentive Plan (the “2007 Plan”). The 2007Plan provides for the issuance of incentive stock options, non-statutory stockoptions and restricted stock grants to directors, employees and consultants ofthe Company. Provisions under the 2007 Plan allow for the issuance of optionsand restricted stock awards to purchase or issue up to 1,500,000 shares ofcommon stock. As of June 30, 2007, the Company had 1,500,000 shares of commonstock available for issuance pursuant to awards under the 2007 Plan.

Stock-based employeecompensation expense recorded for awards issued under the 2004 Plan, the 2005Plan, and the 2007 Plan for the three months ended June 30, 2007 and 2006 was$592,987 and $544,178, respectively. Stock-based employee compensation expenserecorded for awards issued under the 2004 Plan, the 2005 Plan, and the 2007Plan for the nine months ended June 30, 2007 and 2006 was $1,844,131 and$1,431,342, respectively. Stock-based employee compensation expense recordedfor awards issued under the 2004 Plan, the 2005 Plan, and the 2007 Plan sinceinception (June 9, 2003) to June 30, 2007 was $4,525,832.

**8.  ****     COMMITMENTS AND CONTINGENCIES**

The lease for ourcommercial operating facility expired on June 30, 2007.  Currently, the Company is renting thefacility on a month-to-month basis.

In April 2006, theCompany entered into a thirteen (13) month lease agreement for new corporateoffices that commenced in May 2006. We moved our previous corporate officesthat were located at 1021 Main Street, Suite 2650, Houston, Texas 77002,to 11757 Katy Freeway, Suite 1300, Houston, Texas 77079. In April 2006, wedelivered to the lessor a security deposit of $9,400. This lease expired on May31, 2007, and the Company is renting the offices on a month-to-month basis.

InApril 2007, the Company entered into a 60 month lease agreement for a newcorporate office and operating facility and delivered to the lessor a securitydeposit of $41,144.  The new facility will combine the corporate officepersonnel and the operations personnel into one location at 5611 Baird Court,Houston, Texas 77041.  The Company isexpected to commence the new lease on or around September 1, 2007. The totalfuture minimum lease payments under this lease are $2,213,786.

**9.  INCOMETAXES**

The Company reports itsincome taxes in accordance with SFAS No. 109, *Accounting for Income Taxes*, which calls for the utilizationof the asset and liability method of accounting for income taxes. Under thismethod, deferred taxes are determined based on differences between financialreporting and tax bases of assets and liabilities and are measured using theenacted marginal tax rates and laws that will be in effect when the differencesreverse. Temporary differences have been created for all stock option plans andare included in our SFAS No. 109 computation. For the quarter ended June30, 2007, there were permanent and temporary differences of approximately$17,000 and $1,581,000, respectively. At June 30, 2007, we had cumulative netoperating loss carryforwards of approximately $23,603,000, which expire inyears 2007 through 2025. No effect has been shown in the consolidated financialstatements for the net operating loss carryforwards as the likelihood of futuretax benefit from such net operating loss carryforwards is not determinable atthis time. Accordingly, the potential tax benefits of the net operating losscarryforwards, estimated based upon tax rates at June 30, 2007, have beenoffset by valuation reserves of the same amount.

10

----

 

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

The following discussionof our financial condition and results of operations should be read togetherwith the unaudited consolidated financial statements and related notes that areincluded elsewhere in this report. This discussion may contain forward-lookingstatements based upon current expectations that involve risks and uncertaintiesthat could cause actual results to differ materially from the forward-lookingstatements.   Please see “Forward-LookingStatements” below.

**Overview**

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

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

In January 2007, weentered into a one-year agreement with a multi-national independent explorationand production company (the “Operator”). Pursuant to this agreement, we willprovide our PID services in connection with the Operator’s drilling program inEast Texas. The agreement anticipates that PID services will be conducted on aninitial four wells and provides the basis for additional wells and cooperationbetween us and the Operator with respect to financing of future PID systems bythe Operator and an obligation by us to provide to the Operator preferredaccess to additional PID systems in the future. The compensation under thisagreement, if any, is based on our performance pursuant to a gain-sharingformula.  As is customary within theoilfield service industry, this contract is cancellable by either party at anytime.

In addition, in January2007, we entered into another one-year agreement with Gasco Production Company,(“Gasco”).  Pursuant to this agreement,we will provide our PID services in connection with the drilling program atGasco’s Riverband Project of the Uinta Basin in Utah.   The compensation under this agreement, ifany, is based on our performance pursuant to a gain-sharing formula.  As is customary within the oilfield serviceindustry, this contract is cancellable by either party at any time.

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

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.  The preferredalternative to the current system is an extruder based system which has beenpurchased and is currently undergoing testing and modification.  Should the extruder system prove unable tomeet our objectives, we have also developed two prototype systems which areslightly more complex and expensive but we believe should also be capable ofmeeting our objectives.

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

11

----

 

**Resultsof Operations**

***Three Months Ended June 30, 2007 Compared to Three MonthsEnded June 30, 2006***

*Researchand development.  *Research and developmentexpenses were $1,289,785 and $1,735,857 for the three months ended June 30,2007 and 2006, respectively, representing a decrease of $446,072. This decreasewas primarily related to our first commercial trial that was completed in thethird fiscal quarter of 2006 and consulting costs incurred during the thirdfiscal quarter of 2006 related to the prototype canister injection system.  These expenses were not recurring during thethree months ended June 30, 2007.  Inaddition, there was less employee stock compensation expense and bonus expenserelated to research and development personnel during the three months endedJune 30, 2007 compared to the three months ended June 30, 2006.

*Generaland administrative.  *General and administrativeexpenses were $1,180,854 and $1,157,885 for the three months ended June 30,2007 and 2006, respectively, representing an increase of $22,969. This increasewas primarily the result of increased costs related to bonus accruals andstock-based compensation for personnel other than research and developmentpersonnel during the three months ended June 30, 2007 compared to the threemonths ended June 30, 2006.  Thisincrease was primarily related to the issuance of new stock options and thehiring of additional personnel.

*Otherincome (expenses).  *Other income was $80,472 and$63,197 for the three months ended June 30, 2007 and 2006, respectively,representing an increase of $17,275. The increase was primarily attributable tointerest income from a larger balance of cash and cash equivalents in the threemonths ended June 30, 2007 compared to the three months ended June 30, 2006.

***Nine Months Ended June 30, 2007 Compared to Nine MonthsEnded June 30, 2006***

*Researchand development. *Research and development expenses were$4,994,944 and $4,469,449 for the nine months ended June 30, 2007 and2006, respectively, representing an increase of $525,495. This increase wasprimarily the result of the continuing development of a new particle injectorsystem, construction of our second PID Unit, and construction of additional PIDbits.

*Generaland administrative. *General and administrative expenseswere $3,961,005 and $3,530,056 for the nine months ended June 30, 2007 and2006, respectively, representing an increase of $430,949.   Thisincrease was primarily the result of increased costs related to salaries andwages and stock-based compensation for personnel other than research anddevelopment personnel during the nine months ended June 30, 2007 due to thehiring of additional personnel in fiscal 2007.

*OtherIncome. *Other income was $317,522 and $324,070 for thenine months ended June 30, 2007 and 2006, respectively, representing a decreaseof $6,548.  The decrease was primarily attributable to the gain onassignment of a lease and the rental income from a related party during thenine months ended June 30, 2006 which was offset by increased interest incomefrom a larger cash and cash equivalents balance during the nine months endedJune 30, 2007 compared to the nine months ended June 30, 2006.

**Liquidityand Capital Resources**

Ourprincipal sources of liquidity are available cash and cash equivalents.  We expect that cash requirements through theend of the fiscal year 2007 will be primarily to fund research and developmentactivities, improve service capabilities, expand operations, and for generaland administrative related services.  Webelieve we have sufficient cash and cash equivalents to meet our workingcapital and capital expenditure requirements for at least the next12 months; however, our continued existence depends on the successfuldevelopment of the PID technology and our ability to successfully commercializethis technology.  To date we have not yetgenerated cashflow from operations, and until we commence recognizing revenue,we are highly dependent upon debt and equity funding.  If we are not able to meet our funding requirements,our operations may cease to exist.  Wecannot provide any assurance that any such funding will be available onacceptable terms or at all.

Sinceinception on June 9, 2003 through June 30, 2007, we have financed ouroperations through private sales of our equity and the issuance of convertiblenotes payable, totaling net proceeds of $30,144,409.  As of June 30, 2007, we had $5,976,427 incash and cash equivalents.  In October2006, we completed a private sale of five million shares of our common stockfor $2.35 per share and warrants to purchase 1.5 million shares at $3.25 pershare, yielding gross proceeds of $11,750,000. The 1.5 million warrants became exercisable on April 22, 2007 and mayonly be exercised on a cash basis.

12

----

*Cash Flows from Operating Activities. *Cash flow used for operations isprimarily affected by our research and development progress and businessdevelopment.  Net cash flows used inoperating activities during the nine months ended June 30, 2007 were $5,509,244compared to $5,237,927 for the nine months ended June 30, 2006.  The increase from fiscal 2006 to fiscal 2007was the result of our increased spending on research and development and ourincreased level of general and administrative cost as discussed above.

*Cash Flows from Investing Activities. *Cashflows used in investing activities for the nine months ended June 30, 2007 were$1,328,929 compared to $457,411 for the nine months ended June 30, 2006.  The cash flows used in investing activitiesconsist of  $1,229,578 for the purchaseof property, plant and equipment, the majority of which was used for thepurchase of a quintiplex frac pump.  Alsoincluded in cash flows used in investing activities for the nine months endedJune 30, 2007 are $99,351 for costs associated with filing new and protectingexisting patents.  We anticipate that ourcapital expenditures for the next year will continue to be fully funded fromour available cash and cash equivalents.

*Cash Flow from Financing Activities. *Net cash provided by (used in) financing activities forthe nine months ended June 30, 2007 was $10,523,014 compared to ($97,498) forthe nine months ended June 30, 2006.  OnOctober 19, 2006, we completed the sale of five million shares of our commonstock to institutional and other accredited investors at $2.35 per share. Wereceived gross proceeds of $11.75 million, which we are using to manufactureadditional PID Systems, to hire and train qualified personnel, to fund a newparticle injection system, to fund additional research and development, forgeneral corporate purposes and for expenses associated with the offering.  In addition, the investors received warrantsto purchase 1.5 million shares of our common stock with an exercise price of$3.25 per share. The warrants became exercisable commencing on April 22, 2007and will expire on October 19, 2011. We have valued these warrants at$2,835,000 using the Black-Scholes option pricing model and this amount wascharged to shareholders equity.

*ContractualObligations*.  In April2006, we entered into a thirteen month lease agreement for our new corporateoffices at 11757 Katy Freeway, Suite 1300, Houston, Texas 77079, that commencedin May 2006. In connection with the execution of this new lease agreement, wedelivered to the lessor a security deposit of $9,400. This lease expired on May31, 2007, and we are renting the offices on a month-to-month basis.

The lease for ourcommercial operating facility expired on June 30, 2007.  Currently, we are renting the facility on amonth-to-month basis.

InApril 2007, we entered into a 60 month lease agreement for a new corporateoffice and operating facility and delivered to the lessor a security deposit of$41,144.  The new facility will combine the corporate office personnel andthe operations personnel into one location at 5611 Baird Court, Houston, Texas77041.  The Company is expected tocommence the new lease on or around September 1, 2007.  The total future minimum lease payments underthis lease are $2,213,786.
| ** **                                                                          | ** ** | **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) |       | $                                         | 18,781     |   | $ | 11,070 |   | $ | 7,711 |   | $ | — |   | $ | — |   |
| Purchase  Obligations                                                               |       | 21,180                                    |       | 21,180 |   |   |   |   |   |   |   |
| Operating Lease  Obligations*                                                       |       | 2,213,786                                 |       | 239,068 |   | 1,346,272 |   | 628,446 |   | — |   |
| Total                                                                               |       | $                                         | 2,253,747  |   | $ | 271,318 |   | $ | 1,353,983 |   | $ | 628,446 |   | $ | — |   |

*Operating Lease Obligations include the future minimum lease payments for thenew corporate office and operating facility that was executed in April 2007.

**Off-BalanceSheet Arrangements**

Inconnection with the acquisition of the PID technology in January 2004,PDTI entered into a Royalty Agreement with ProDril Services, Incorporated (“PSI”)pursuant to which we are obligated to pay PSI a royalty on a quarterly basisequal to 18% of our earnings before interest, income taxes, depreciation andamortization (“EBITDA”) derived from the use of the PID technology, until anaggregate of $67,500,000 has been paid. PDTI also entered into a RoyaltyAgreement in January 2004 with ProDril Services, International, Ltd. (“PSIL”)pursuant to which we are obligated to pay PSIL a royalty on a quarterly basisequal to 2% of our EBITDA derived from the use of the PID technology, until anaggregate of $7,500,000 has been paid. In addition, we are obligated to payCCORE Technology and Licensing, Ltd. (“CTL”), PSI and PSIL a royalty equal to1.6%, 1.2% and 1.2%, respectively, of our quarterly gross revenue, derived fromthe use of the PID technology.  As ofJune 30, 2007, we had no revenues or EBITDA; therefore no royalties have beenpaid or accrued.

**CriticalAccounting Policies**

The discussion andanalysis of our financial condition and results of operations is based on ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America. Thepreparation of these consolidated financial statements requires us to makeestimates and judgments that affect 

13

----

the reported amounts of assets, liabilities andexpenses. We base our estimates on historical experience and on various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates under different assumptions orconditions. We believe the following critical accounting policies affect ourmost significant judgments and estimates used in the preparation of ourconsolidated financial statements.

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

*Impairmentof Long-Lived Assets.  *We evaluate our long-livedassets for indicators of possible impairment by comparison of the carryingamounts to future net undiscounted cash flows expected to be generated by suchassets when events or changes in circumstances indicate the carrying amount ofan asset may not be recoverable.  Should an impairment exist, theimpairment loss would be measured based on the excess carrying value of theasset over the asset’s fair value or discounted estimates of future cashflows.  We also evaluate the capitalized costs for patents and patentapplications filed but not issued for possible impairments. We have notidentified any such impairment losses to date. The evaluation of capitalized costs for patents and patent applicationsis based on a subjective cash flow forecast which is subject to change.  We will reassess our cash flow forecast eachtime there are fundamental changes in the underlying potential use of thepatents or patent applications in terms of performance, customer acceptance orother factors that may affect such cash flow forecasts.

*Stock-BasedCompensation.  *In December 2004, theFinancial Accounting Standards Board (“FASB”) issued a revision to SFASNo. 123, *Share-Based Payment*.This statement establishes standards for the accounting for transactions inwhich an entity 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.

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

*IncomeTaxes.  *The Company reports its income taxes inaccordance with SFAS No. 109, *Accountingfor Income Taxes*, which calls for the utilization of the asset andliability method of accounting for income taxes. Under this method, deferredtaxes are determined based on differences between financial reporting and taxbases of assets and liabilities and are measured using the enacted marginal taxrates and laws that will be in effect when the differences reverse. Temporarydifferences have been created for all stock option plans and are included inour SFAS No. 109 computation. For the nine months ended June 30, 2007,there were permanent and temporary differences of approximately $17,000 and$1,581,000, respectively. At June 30, 2007, we had cumulative net operatingloss carryforwards of approximately $23,603,000, which expire in years 2007through 2025. No effect has been shown in the consolidated financial statementsfor the net operating loss carryforwards as the likelihood of future taxbenefit from such net operating loss carryforwards is not determinable at thistime. Accordingly, the potential tax benefits of the net operating losscarryforwards, estimated based upon tax rates at June 30, 2007, have beenoffset by valuation reserves of the same amount.

*NetLoss per Share.  *The Company has presented basicand diluted net loss per share pursuant to SFAS No. 128, *Earnings Per Share*. In accordance withSFAS No. 128, basic and diluted net loss per share has been computed usingthe 

14

----

weighted-average number of shares of common stockoutstanding during the period. Dilutive net loss per share would give effect tothe dilutive effect of common stock equivalents consisting of options andwarrants. Potentially dilutive securities have been excluded from the net lossper common share calculation as the effects would be antidilutive. Potentiallydilutive securities not included in the computation of weighted average dilutedshares of common stock because the impact of these potentially dilutivesecurities were antidilutive were 2,498,200 and 2,349,650 shares for the threemonths ended June 30, 2007 and 2006, respectively, and 2,485,717 and 2,303,555shares for the nine months ended June 30, 2007 and 2006, respectively.

**Forward-LookingStatements**

Statements in thisquarterly report on Form 10-Q that are not historical facts (including anystatements concerning plans and objectives of management for future operationsor economic performance, or assumptions or forecasts related thereto) areforward-looking statements subject to Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934. Thesestatements can be identified by the use of forward-looking terminologyincluding “forecast,” “may,” “believe,” “expect,” “anticipate,” “estimate,” “continue”or other similar words. These statements discuss future expectations, containprojections of results of operations or of financial condition or state other “forward-looking”information. We and our representatives may from time to time make other oralor written statements that are also forward-looking statements.

Theseforward-looking statements are made based upon our management’s current plans,expectations, estimates, assumptions and beliefs concerning future eventsimpacting us and therefore involve a number of risks and uncertainties.  We caution that forward-looking statementsare not guarantees and that actual results could differ materially from thoseexpressed or implied in the forward-looking statements as a result of certainfactors, including but not limited to dependence upon energy industry spending,the volatility of oil and gas prices, weather interruptions, the results oftesting of our products, the availability of capital resources and the otherfactors described under “Item 1A. Risk Factors” in our annual report on Form10-K for the year ended September 30, 2006 filed with the SEC on December 14,2006.  We undertake no obligation toupdate any forward-looking statements except as required by law.

**Item 3.**                          Quantitativeand Qualitative Disclosures about Market Risk

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

**Item 4.**                          Controlsand Procedures

As required byRule 13a-15(b) of the Securities Exchange Act of 1934, an evaluation wasperformed under the supervision and with the participation of our ChiefExecutive Officer and Chief Financial Officer of the effectiveness of thedesign and operation of our “disclosure controls and procedures” (as definedunder Rule 13a-15(e) and Rule 15d-15(e)) as of the end of the period covered bythis Quarterly Report on Form 10-Q filed with the SEC. Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective as of June 30, 2007.

There was no change inour internal control over financial reporting during our third quarter offiscal 2007 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**Part II—Other Information**

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

On May 1, 2007,a holder of outstanding warrants exercised its right to purchase 25,000 sharesof our common stock at $2.00 per share on a cashless exercise basis.  The fair market value of our common stock onthe date of exercise was $3.76.  As aresult of this cashless exercise, we issued 24,202 shares of our common stock tothe holder of this warrant and withheld issuing 798 shares of our common stockin satisfaction of the exercise price under the warrant.

The shares ofour common stock issued upon exercise of the warrant described above wereissued in an exchange between us and our existing security holders in which nocommission or other remuneration was paid or given directly or indirectly forsoliciting such exchange.  As a result, the issuance of such shares ofcommon stock was exempt from registration pursuant to Section 3(a)(9) under theSecurities Act of 1933.

15

----

 

**Item 5.**                       OtherInformation

On August 7, 2007, theCompensation Committee of our Board of Directors approved, awards of 500,000shares of restricted stock in the aggregate to our Chief Executive Officer, Mr.Jim B. Terry.  The forms of the award agreementsare filed with this Quarterly Report on Form 10-Q as Exhibits 10.1, 10.2 and10.3 and are incorporated herein by reference. The forfeiture restrictions with respect to these awards lapse asfollows:

•                                           with respect to 129,250 shares,the restrictions lapse on the date we file our first quarterly or annual reportwith the U.S. Securities and Exchange Commission in which we report AdjustedEBITDA (as defined in the award agreement) for a fiscal quarter that is greaterthan $0;

•                                           with respect to 200,000 shares,the restrictions lapse on the date we consummate a strategic transaction with athird party that the Compensation Committee of our Board of Directors, in itssole discretion, determines satisfies certain criteria described in the awardagreement; and

•                                           with respect to 170,750 shares,the restrictions lapse on the date we file our first quarterly or annual reportwith the U.S. Securities and Exchange Commission in which we report, for twoconsecutive fiscal quarters, cumulative revenues in an amount equal to orgreater than $1.0 million, in the aggregate.

In addition, on August 7, 2007,we entered into an amendment to the Employment Agreement with Mr. Terry.  The amendment is filed with this QuarterlyReport on Form 10-Q as Exhibit 10.4 and is incorporated herein by reference.  The purpose of the amendment to Mr. Terry’sEmployment Agreement was to provide that in the event any payment ordistribution to Mr. Terry is subject to the excise tax imposed by Section 4999of the Internal Revenue Code or any interest or penalties with respect to suchexcise tax, we have agreed to make an additional payment to Mr. Terry in anamount such that after payment by Mr. Terry of all taxes (including such excisetax imposed on such additional payment), Mr. Terry will retain an amount of suchpayment equal to the amount of the excise tax imposed upon such payment.

We had previously disclosed inour Current Report on Form 8-K filed with the Securities and ExchangeCommission on May 11, 2007 that Mr. Steve Weyel had indicated his intention to resignfrom our board of directors upon the later to occur of (1) our board ofdirectors has elected a nominee to replace Mr. Weyel or (2) July 1, 2007.  On August 7, 2007, Mr. Weyel notified us ofhis resignation from our board of directors, effective immediately.  The Nominating and Corporate GovernanceCommittee of our board of directors has commenced a search process to recommendto the board of directors a nominee to replace Mr. Weyel, however, noreplacement has been identified by the Nominating and Corporate GovernanceCommittee to date.

**Item 6.**                          Exhibits

Exhibits:
| Exhibit  No. | ** ** | **Description**                                                                                                                                                      |
|--------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                                 |
| 10.1         |       | Restricted Stock Award dated August 7, 2007 to Mr.  Jim B. Terry (2005 Stock Incentive plan)                                                                         |
|         |       |                                                                                                                                                                 |
| 10.2         |       | Restricted Stock Award dated August 7, 2007 to Mr.  Jim B. Terry (2007 Stock Incentive plan)                                                                         |
|         |       |                                                                                                                                                                 |
| 10.3         |       | First amendment to Employment Agreement by and  between Particle Drilling Technologies, Inc. and Jim B. Terry dated August 7,  2007                                  |
|         |       |                                                                                                                                                                 |
| 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.** |

----

*                    Filed herewith

**             Furnishedherewith

16

----

 

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                            |   | PARTICLE DRILLING TECHNOLOGIES, INC.                                                                                              |
|----------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------|
|                       |   | (Registrant)                                                                                                                           |
|                       |   |                                                                                                                                   |
|                       |   |                                                                                                                                   |
| Date:  August 7, 2007 |   | /s/ J. CHRIS BOSWELL                                                                                                                   |
|                       |   | J. Chris Boswell                                                                                                                       |
|                       |   | Senior Vice President and Chief Financial Officer  (authorized officer, principal financial officer and principal accounting  officer) |

 

17

----

**EXHIBIT INDEX**
| Exhibit  No. | ** ** | **Description**                                                                                                                                                      |
|--------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1         |       | Restricted Stock Award dated August 7, 2007 to Mr.  Jim B. Terry (2005 Stock Incentive plan)                                                                         |
|         |       |                                                                                                                                                                 |
| 10.2         |       | Restricted Stock Award dated August 7, 2007 to Mr.  Jim B. Terry (2007 Stock Incentive plan)                                                                         |
|         |       |                                                                                                                                                                 |
| 10.3         |       | First amendment to Employment Agreement by and  between Particle Drilling Technologies, Inc. and Jim B. Terry dated August 7,  2007                                  |
|         |       |                                                                                                                                                                 |
| 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.** |

----

*                    Filed herewith

**             Furnishedherewith

 

18

----