**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

** **

**x**          QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

** **

**For the quarterly period ended March 31,2008**

 

**OR**

 

**o**           TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

** **

**For the transition period from                   to                   **

 

**Commission File Number 000-30819**

 

**Particle Drilling Technologies, Inc.**

(Exact name of registrant as specified in its charter)

 

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

 

**5611Baird CourtHouston, Texas 77041**(Address of principal executive offices)(Zip Code)

 

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

 

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

 

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

 

| Large accelerated filer  o                     |   | Accelerated filer x          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

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

 

The number of shares of the registrant’s common stock,$.001 par value, outstanding as of April 30, 2008 was 35,269,089.

 

 

----

 

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

 

**FORM 10-Q FOR THE QUARTER ENDED MARCH 31,2008**

 

**INDEX**

 
| **Part I - Financial Information** | ** **                                                                                                                                                                                |
|-----------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                    |                                                                                                                                                                                      |   |
| Item 1.                                 | Financial Statements                                                                                                                                                                      |   |
|                                    |                                                                                                                                                                                      |   |
|                                    | Consolidated Balance Sheets at March 31, 2008  (Unaudited) and September 30, 2007                                                                                               | 3 |
|                                    |                                                                                                                                                                                      |   |
|                                    | Consolidated Statements of Operations (Unaudited) –  Three and Six Months Ended March 31, 2008 and 2007, and from  June 9, 2003 (date of inception) to March 31, 2008 | 4 |
|                                    |                                                                                                                                                                                      |   |
|                                    | Consolidated Statements of Cash Flows (Unaudited) -  Six Months Ended March 31, 2008 and 2007, and from June 9, 2003  (date of inception) to March 31, 2008                | 5 |
|                                    |                                                                                                                                                                                      |   |
|                                    | Notes to Consolidated Financial Statements  (Unaudited)                                                                                                                                   | 6 |
|                                    |                                                                                                                                                                                      |   |
| Item 2.                                 | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                                                               | 9 |
|                                    |                                                                                                                                                                                      |   |
| Item 3.                                 | Quantitative and Qualitative Disclosures about  Market Risk                                                                                                                               | 14 |
|                                    |                                                                                                                                                                                      |   |
| Item 4.                                 | Controls and Procedures                                                                                                                                                                   | 14 |
|                                    |                                                                                                                                                                                      |   |
| **Part II - Other Information**    | 14                                                                                                                                                                                        |
|                                    |                                                                                                                                                                                      |   |
| Item 4.                                 | Submission of matters to a vote of security holders                                                                                                                                       | 14 |
|                                    |                                                                                                                                                                                      |   |
| Item 6.                                 | Exhibits                                                                                                                                                                                  | 15 |
|                                    |                                                                                                                                                                                      |   |
|                                    | Signatures                                                                                                                                                                                | 16 |

 

2

----

 

**PARTICLE DRILLING TECHNOLOGIES, INC.**

**(a development stage enterprise)**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                    | ** ** | **March 31,  2008** | ** ** | **September 30,  2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                                                                                    | ** ** | **(Unaudited)**          | ** ** | ** **                   | ** ** |
| ** **                                                                                                                                                                                                                                    | ** ** | ** **               | ** ** | ** **                   | ** ** |
| **ASSETS**                                                                                                                                                                                                                                    | ** ** | ** **               | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Current assets:                                                                                                                                                                                                                               |       |                     |       |                         |       |
| Cash and cash  equivalents                                                                                                                                                                                                                    |       | $                        | 743,096    |                         | $          | 4,461,929 |   |
| Assets held for  sale                                                                                                                                                                                                                         |       | 900,000                  |       | 900,000                      |       |
| Prepaid expenses                                                                                                                                                                                                                              |       | 182,128                  |       | 233,174                      |       |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Total current  assets                                                                                                                                                                                                                         |       | 1,825,224                |       | 5,595,103                    |       |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Property,  plant & equipment, net                                                                                                                                                                                                    |       | 583,019                  |       | 867,168                      |       |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Intangibles, net                                                                                                                                                                                                                              |       | 1,370,993                |       | 1,312,246                    |       |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Other assets                                                                                                                                                                                                                                  |       | 41,144                   |       | 52,562                       |       |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Total assets                                                                                                                                                                                                                                  |       | $                        | 3,820,380  |                         | $          | 7,827,079 |   |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                 | ** ** | ** **               | ** ** | ** **                   | ** ** |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Current  liabilities:                                                                                                                                                                                                                         |       |                     |       |                         |       |
| Accounts payable                                                                                                                                                                                                                              |       | $                        | 769,702    |                         | $          | 1,028,999 |   |
| Short-term notes  payable                                                                                                                                                                                                                     |       | 12,814                   |       | 88,258                       |       |
| Current portion  of long-term debt                                                                                                                                                                                                            |       | 13,358                   |       | 13,511                       |       |
| Accrued  liabilities                                                                                                                                                                                                                          |       | 532,445                  |       | 134,988                      |       |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Total current  liabilities                                                                                                                                                                                                                    |       | 1,328,319                |       | 1,265,756                    |       |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Long-term debt                                                                                                                                                                                                                                |       | 17,892                   |       | 24,537                       |       |
| Deferred Rent                                                                                                                                                                                                                                 |       | 106,535                  |       | 45,539                       |       |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Commitments and  contingencies - Note 7                                                                                                                                                                                                       |       |                     |       |                         |       |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Stockholders’  equity:                                                                                                                                                                                                                   |       |                     |       |                         |       |
| Common stock,  $.001 par value, 100,000,000 shares authorized, 34,772,175 shares issued and  31,769,089 shares outstanding at March 31, 2008, and 34,632,987 shares  issued and 31,629,901 shares outstanding at September 30, 2007 |       | 34,773                   |       | 34,634                       |       |
| Additional  paid-in capital                                                                                                                                                                                                                   |       | 39,942,346               |       | 38,510,488                   |       |
| Treasury stock  at cost, 3,003,086 shares                                                                                                                                                                                                     |       | (1,511,817               | )          | (1,511,817                   | )          |
| Deficit  accumulated during the development stage                                                                                                                                                                                             |       | (36,097,668              | )          | (30,542,058                  | )          |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Total  stockholders’ equity                                                                                                                                                                                                              |       | 2,367,634                |       | 6,491,247                    |       |
|                                                                                                                                                                                                                                          |       |                     |       |                         |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                              |       | $                        | 3,820,380  |                         | $          | 7,827,079 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

3

----

 

**PARTICLEDRILLING TECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

**CONSOLIDATED STATEMENTSOF OPERATIONS**

**(Unaudited)**

** **
| ** **                                                                | ** ** | ** **                                           | ** ** | ** **                                         | ** ** | ** **         | ** ** | ** ** | ** ** | **Period from**       | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------|------------|------------|------------|----------------------------|------------|
| ** **                                                                | ** ** | ** **                                           | ** ** | ** **                                         | ** ** | ** **         | ** ** | ** ** | ** ** | **June 9, 2003** | ** ** |
| ** **                                                                | ** ** | ** **                                           | ** ** | ** **                                         | ** ** | ** **         | ** ** | ** ** | ** ** | **(date of**          | ** ** |
| ** **                                                                | ** ** | ** **                                           | ** ** | ** **                                         | ** ** | ** **         | ** ** | ** ** | ** ** | **inception) to**     | ** ** |
| ** **                                                                | ** ** | **Three Months Ended March 31,** | ** ** | **Six Months Ended March 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                                | ** ** | **2008**                                             | ** ** | **2007**                                           | ** ** | **2008**           | ** ** | **2007**   | ** ** | **2008**                   | ** ** |
| ** **                                                                | ** ** | ** **                                           | ** ** | ** **                                         | ** ** | ** **         | ** ** | ** ** | ** ** | ** **                 | ** ** |
| Revenues                                                                  |       | $                                                    | —     |                                               | $          | —             |       | $          | —     |                       | $          | — |   | $ | — |   |
|                                                                      |       |                                                 |       |                                               |       |               |       |       |       |                       |       |
| Operating  expenses:                                                      |       |                                                 |       |                                               |       |               |       |       |       |                       |       |
| Research and  development                                                 |       | 1,546,200                                            |       | 2,040,316                                          |       | 3,327,012          |       | 3,705,159  |       | 18,649,084                 |       |
| General and  administrative                                               |       | 1,434,859                                            |       | 1,481,607                                          |       | 2,913,964          |       | 2,780,151  |       | 18,806,684                 |       |
| Impairment of  asset                                                      |       | —                                               |       | —                                             |       | —             |       | —     |       | 295,260                    |       |
| Gain on sale of  assets                                                   |       | (641,721                                             | )          | —                                             |       | (641,721           | )          | —     |       | (641,721                   | )          |
|                                                                      |       |                                                 |       |                                               |       |               |       |       |       |                       |       |
| Total operating  expenses                                                 |       | 2,339,338                                            |       | 3,521,923                                          |       | 5,599,255          |       | 6,485,310  |       | 37,109,307                 |       |
|                                                                      |       |                                                 |       |                                               |       |               |       |       |       |                       |       |
| Loss from  operations                                                     |       | (2,339,338                                           | )          | (3,521,923                                         | )          | (5,599,255         | )          | (6,485,310 | )          | (37,109,307                | )          |
|                                                                      |       |                                                 |       |                                               |       |               |       |       |       |                       |       |
| Other income  (expenses)                                                  |       |                                                 |       |                                               |       |               |       |       |       |                       |       |
| Interest income                                                           |       | 11,803                                               |       | 113,834                                            |       | 47,507             |       | 241,732    |       | 902,210                    |       |
| Rental income -  related party                                            |       | —                                               |       | —                                             |       | —             |       | —     |       | 73,727                     |       |
| Gain on debt  extinguishment                                              |       | —                                               |       | —                                             |       | —             |       | —     |       | 35,283                     |       |
| Gain on  assignment of lease - related party                              |       | —                                               |       | —                                             |       | —             |       | —     |       | 55,614                     |       |
| Interest expense                                                          |       | (1,539                                               | )          | (1,710                                             | )          | (3,862             | )          | (4,682     | )          | (55,195                    | )          |
|                                                                      |       |                                                 |       |                                               |       |               |       |       |       |                       |       |
| Total other  income                                                       |       | 10,264                                               |       | 112,124                                            |       | 43,645             |       | 237,050    |       | 1,011,639                  |       |
|                                                                      |       |                                                 |       |                                               |       |               |       |       |       |                       |       |
| Net loss                                                                  |       | $                                                    | (2,329,074 | )                                                  | $          | (3,409,799         | )          | $          | (5,555,610 | )                          | $          | (6,248,260 | ) | $ | (36,097,668 | ) |
|                                                                      |       |                                                 |       |                                               |       |               |       |       |       |                       |       |
| Net loss per  common share, basic and diluted                             |       | $                                                    | (0.08      | )                                                  | $          | (0.11              | )          | $          | (0.18      | )                          | $          | (0.21 | ) | $ | (1.37 | ) |
|                                                                      |       |                                                 |       |                                               |       |               |       |       |       |                       |       |
| Weighted average  number of common shares outstanding - basic and diluted |       | 30,851,502                                           |       | 30,165,484                                         |       | 30,819,479         |       | 29,588,832 |       | 26,432,509                 |       |
|                                                                           |            |                                                      |            |                                                    |            |                    |            |            |            |                            |            |  |  |  |  |  |  |

 

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

 

4

----

**PARTICLEDRILLING TECHNOLOGIES, INC.**

**(adevelopment stage enterprise)**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 
| ** **                                                                   | ** ** | ** **                                     | ** ** | ** **                             | ** ** | **Period from**       | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------|------------|----------------------------|------------|
| ** **                                                                   | ** ** | ** **                                     | ** ** | ** **                             | ** ** | **June 9, 2003** | ** ** |
| ** **                                                                   | ** ** | ** **                                     | ** ** | ** **                             | ** ** | **(date of**          | ** ** |
| ** **                                                                   | ** ** | **Six Months Ended  March 31,** | ** ** | **inception) to  March 31,** | ** ** |
| ** **                                                                   | ** ** | **2008**                                       | ** ** | **2007**                               | ** ** | **2008**                   | ** ** |
| Cash flows from  operating activities:                                       |       |                                           |       |                                   |       |                       |       |
| Net loss                                                                     |       | $                                              | (5,555,610 | )                                      | $          | (6,248,260                 | )          | $ | (36,097,668 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                           |       |                                   |       |                       |       |
| Gain on debt  extinguishment                                                 |       | —                                         |       | —                                 |       | (35,283                    | )          |
| Impairment of  asset                                                         |       | —                                         |       | —                                 |       | 295,260                    |       |
| Gain on  assignment of lease - related party                                 |       | —                                         |       | —                                 |       | (55,614                    | )          |
| Gain on sale of  assets                                                      |       | (641,721                                       | )          | —                                 |       | (641,721                   | )          |
| Depreciation and  amortization expense                                       |       | 301,824                                        |       | 362,503                                |       | 2,340,640                  |       |
| 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                                           |       | 1,418,797                                      |       | 1,251,144                              |       | 6,619,419                  |       |
| Changes in  operating assets and liabilities:                                |       |                                           |       |                                   |       |                       |       |
| Decrease in note  receivable                                                 |       | —                                         |       | 385,839                                |       | 385,839                    |       |
| (Increase) in  accounts receivable - related party                           |       | —                                         |       | —                                 |       | (40,819                    | )          |
| Decrease in  prepaid expenses                                                |       | 51,046                                         |       | 68,821                                 |       | 183,847                    |       |
| Increase  (Decrease) in accounts payable                                     |       | (259,297                                       | )          | 625,720                                |       | 429,764                    |       |
| Increase in  accrued liabilities                                             |       | 397,457                                        |       | 22,802                                 |       | 629,242                    |       |
| (Increase)  Decrease in other assets                                         |       | 11,418                                         |       | —                                 |       | (26,494                    | )          |
| Increase in  other liabilities                                               |       | 60,996                                         |       | —                                 |       | 106,535                    |       |
|                                                                         |       |                                           |       |                                   |       |                       |       |
| Net cash used in  operating activities                                       |       | (4,215,090                                     | )          | (3,531,431                             | )          | (24,867,724                | )          |
|                                                                         |       |                                           |       |                                   |       |                       |       |
| Cash flows from  investing activities:                                       |       |                                           |       |                                   |       |                       |       |
| Payments to  purchase property and equipment                                 |       | (37,332                                        | )          | (1,225,524                             | )          | (3,354,936                 | )          |
| Proceeds from  sale of property and equipment                                |       | 686,620                                        |       | —                                 |       | 707,577                    |       |
| Payments to  purchase intangibles                                            |       | (83,989                                        | )          | (63,076                                | )          | (825,247                   | )          |
| Payments to  purchase other assets                                           |       | —                                         |       | —                                 |       | (419,504                   | )          |
| Payments issued  for note receivable                                         |       | —                                         |       | —                                 |       | (300,783                   | )          |
| Payments issued  for note receivable - related party                         |       | —                                         |       | —                                 |       | (56,784                    | )          |
|                                                                         |       |                                           |       |                                   |       |                       |       |
| Net cash  provided by (used in) investing activities                         |       | 565,299                                        |       | (1,288,600                             | )          | (4,249,677                 | )          |
|                                                                         |       |                                           |       |                                   |       |                       |       |
| Cash flows from  financing activities:                                       |       |                                           |       |                                   |       |                       |       |
| Proceeds from  issuance of common stock                                      |       | 13,200                                         |       | 10,716,951                             |       | 31,752,510                 |       |
| Repurchase of  common stock                                                  |       | —                                         |       | —                                 |       | (1,511,817                 | )          |
| Proceeds from  issuance of convertible notes                                 |       | —                                         |       | —                                 |       | 553,500                    |       |
| Repayments of  notes payable                                                 |       | (82,242                                        | )          | (163,594                               | )          | (933,696                   | )          |
| Proceeds from  borrowings under loan agreements - related parties            |       | —                                         |       | —                                 |       | 23,195                     |       |
| Repayment of  borrowings under loan agreements - related parties             |       | —                                         |       | —                                 |       | (23,195                    | )          |
|                                                                         |       |                                           |       |                                   |       |                       |       |
| Net cash (used  in) provided by financing activities                         |       | (69,042                                        | )          | 10,553,357                             |       | 29,860,497                 |       |
|                                                                         |       |                                           |       |                                   |       |                       |       |
| Net increase  (decrease) in cash and cash equivalents                        |       | (3,718,833                                     | )          | 5,733,326                              |       | 743,096                    |       |
|                                                                         |       |                                           |       |                                   |       |                       |       |
| Cash and cash  equivalents - beginning of period                             |       | 4,461,929                                      |       | 2,291,586                              |       | —                     |       |
|                                                                         |       |                                           |       |                                   |       |                       |       |
| Cash and cash  equivalents - end of period                                   |       | $                                              | 743,096    |                                   | $          | 8,024,912                  |       | $ | 743,096 |   |
|                                                                         |       |                                           |       |                                   |       |                       |       |
| Supplemental  disclosures of cash flow information:                          |       |                                           |       |                                   |       |                       |       |
| Cash paid for  interest                                                      |       | $                                              | 3,862      |                                   | $          | 4,682                      |       | $ | 55,195 |   |
|                                                                         |       |                                           |       |                                   |       |                       |       |
| Non-cash  investing and financing activities:                                |       |                                           |       |                                   |       |                       |       |
| Prepaid  insurance acquired with note payable                                |       | $                                              | —     |                                   | $          | —                     |       | $ | 478,844 |   |
| Common stock  issued as consideration for account payable                    |       | —                                         |       | —                                 |       | 6,000                      |       |
| Common stock  issued as consideration for note payable                       |       | —                                         |       | —                                 |       | 50,000                     |       |
| Related party  note receivable exchanged for property and equipment          |       | —                                         |       | —                                 |       | 56,783                     |       |
| Note payable  converted into common stock                                    |       | —                                         |       | —                                 |       | 553,500                    |       |
| Property and  equipment acquired with assumed liabilities                    |       | —                                         |       | —                                 |       | 479,610                    |       |
| Intangibles  acquired with assumed liabilities                               |       | —                                         |       | —                                 |       | 757,792                    |       |
| Property and  equipment acquired with note payable                           |       | —                                         |       | —                                 |       | 30,487                     |       |
| Short-term  investments reclassified from other assets                       |       | —                                         |       | —                                 |       | 385,839                    |       |

 

5

----

** **

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

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**(Unaudited)**

 

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

 

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

 

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

 

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

 

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

 

The financial statementsof the Company have been prepared on the basis of accounting principlesapplicable to a going concern, which contemplates the realization of assets andthe satisfaction of liabilities in the normal course of business.  As shown in the condensed consolidatedfinancial statements, for the three and six months ended March 31, 2008,the Company reported net losses of approximately $2.3 million and $5.6 million,respectively, as compared to net losses of approximately $3.4 million and $6.2million for the three and six months ended March 31, 2007,respectively.  The condensed consolidatedfinancial statements also show an accumulated deficit of approximately $36.1million from inception (June 9, 2003) through the period ended March 31,2008.  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 currently a development stage companyand its continued existence is dependent upon the Company’s successfuldevelopment of the PID technology and its ability to successfully commercializethis technology.  The Company has yet togenerate cashflow from operations, and until revenues commence, the Company ishighly dependent upon debt and equity funding. Should continuing funding requirements not be met, the Company’soperations may cease to exist. Management cannot provide any assurance that any such financing will beavailable on acceptable terms or at all. On April 21, 2008, the Company completed a subscription rightsoffering to sell 3.5 million common shares at $1.50 per share yielding grossproceeds which totaled approximately $5.25 million, as discussed in Footnote 9.

 

**3.   SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

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

 

6

----

 

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

 

In September 2006,the FASB issued Statement of Financial Accounting Standards, “SFAS” No. 157,*Fair Value Measurements* (“SFAS No. 157”). SFAS No. 157 clarifies the principle that fair value should be based onthe assumptions market participants would use when pricing an asset or liabilityand establishes 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. SFAS No. 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 February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities* (“SFAS No. 159”).SFAS No. 159 permits entities to choose to measure many financial assetsand financial liabilities at fair value. Unrealized gains and losses on itemsfor which the fair value option has been elected are reported in earnings. SFASNo. 159 is effective for fiscal years beginning after November 15,2007. We will adopt SFAS No. 159 on October 1, 2008 and have notyet determined the impact, if any, on our consolidated financial statements.

 

In December 2007,the FASB issued SFAS No. 141R, *BusinessCombinations* (SFAS 141R), which replaces SFAS 141, *Business Combinations*. SFAS 141Restablishes principles and requirements for determining how an enterpriserecognizes and measures the fair value of certain assets and liabilitiesacquired in a business combination, including noncontrolling interests,contingent consideration, and certain acquired contingencies. SFAS 141R alsorequires acquisition-related transaction expenses and restructuring costs beexpensed as incurred rather than capitalized as a component of the businesscombination. SFAS 141R will be applicable prospectively to businesscombinations beginning in the Company’s 2010 fiscal year.

 

In December 2007,the FASB issued SFAS No. 160, *NoncontrollingInterests in Consolidated Financial Statements — An Amendment of ARB No. 51*(SFAS 160). SFAS 160 establishes accounting and reporting standards for thenoncontrolling interest in a subsidiary. SFAS 160 also requires that a retainednoncontrolling interest upon the deconsolidation of a subsidiary be initiallymeasured at its fair value. SFAS 160 is effective for the Company’s 2010 fiscalyear. Upon adoption of SFAS 160, the Company will be required to report itsnoncontrolling interests, if any, as a separate component of shareholders’equity. The Company will also be required to present net income allocable tothe noncontrolling interests, if any, and net income attributable to theshareholders of the Company separately in its consolidated statements ofincome. Currently, noncontrolling interests (minority interests) are reportedas a liability in a Company’s statement of financial position and the relatedincome attributable to minority interests is reflected as an expense inarriving at net income. SFAS 160 requires retroactive adoption of thepresentation and disclosure requirements for existing minority interests. Allother requirements of SFAS 160 shall be applied prospectively.

 

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

 

**4.****     NET LOSS PER COMMON SHARE**

 

The Company has presented basic and diluted net lossper share pursuant to SFAS No. 128, *EarningsPer Share*. In 

 

7

----

 

accordancewith SFAS No. 128, basic and diluted net loss per share has been computedusing the weighted-average number of shares of common stock outstanding duringthe period. Dilutive net loss per share would give effect to the dilutiveeffect of common stock equivalents consisting of options and warrants.Potentially dilutive securities have been excluded from the net loss per commonshare calculation as the effects would be antidilutive. Potentially dilutivesecurities not included in the computation of weighted average diluted sharesof common stock because the impact of these potentially dilutive securitieswere antidilutive were 131,275 and 2,901,623 shares for the three months ended March 31,2008 and 2007, respectively, and 988,584 and 2,577,151 shares for the sixmonths ended March 31, 2008 and 2007, respectively.

 

**5.****     COMMON STOCK**

 

In February 2008, theCompany issued 100,000 shares of its common stock upon an exercise of stockoptions at $0.12 per share.

 

At March 31, 2008, the Company had 31,769,089shares of common stock outstanding and had outstanding options and warrants topurchase up to 5,870,516 additional shares of the Company’s common stock in theaggregate.

 

**6.****     STOCK-BASED EMPLOYEECOMPENSATION**

 

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

 

In March 2005, theBoard of Directors adopted the 2005 Stock Incentive Plan (the “2005 Plan”). The 2005 Plan provides for the issuance of non-statutory stock options andrestricted stock grants to directors, employees and consultants of PDTI. 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 of March 31, 2008, the Company had 4,000 shares of common stockavailable for issuance pursuant to awards under the 2005 Plan.  Under the 2005 Plan, the exercise price ofeach option is equal to the market value of the Company’s common stock on thedate of grant and the maximum term for the options is ten years.

 

In March 2007, theshareholders adopted the 2007 Stock Incentive Plan (the “2007 Plan”).  The 2007 Plan provides for the issuance ofincentive stock options, non-statutory stock options and restricted stock todirectors, employees and consultants of PDTI. Provisions under the 2007 Planallow for the issuance of up to 1,500,000 shares of common stock pursuant toawards under this plan.  As of March 31,2008, the Company had 1,044,250 awards available for grant under the 2007 Plan.Under the 2007 Plan, the exercise price of each option is equal to the marketvalue of the Company’s common stock on the date of grant and the maximum termfor the options is ten years.

 

Stock-based employee compensation expense recorded forawards issued under the 2004 Plan, the 2005 Plan, and the 2007 Plan for thethree months ended March 31, 2008 and 2007 was $704,839 and $623,513,respectively.  Stock-based employeecompensation expense recorded for awards issued under the 2004 Plan, the 2005Plan, and the 2007 Plan for the six months ended March 31, 2008 and 2007was $1,418,797 and $1,251,144, respectively. Stock-based employee compensation expense recorded for awards issuedunder the 2004 Plan, the 2005 Plan, and the 2007 Plan since inception (June 9,2003) to March 31, 2008 was $6,619,419.

 

**7.****     COMMITMENTS AND CONTINGENCIES**

 

In April 2007,we entered into a 60-month lease agreement that commenced in September 2007for a new corporate office and operating facility and delivered to the lessor asecurity deposit of $41,144.  The new facility combines the corporateoffice personnel and the operations personnel into one location at 5611 BairdCourt, Houston, Texas 77041.  The total future minimum lease paymentsunder this lease are $2,034,511.

 

**8.  INCOME TAXES**

 

The Company follows SFAS No. 109Accounting for Income Taxes. This statement requires an asset and liabilityapproach for financial accounting and reporting for income tax purposes.   This statement recognizes the amount oftaxes payable or refundable for the current year and deferred tax liabilitiesand assets for future tax consequences of events that have been recognized inthe consolidated financial statements or tax returns.  Provisions (benefits) for income taxes resultfrom permanent and temporary differences in the recognition of accountingtransactions for tax and financial reporting 

 

8

----

 

purposes.  Valuation allowances are established whennecessary to reduce deferred tax assets to the amount expected to be realized.

 

As discussed in Footnote3, we adopted FIN 48 in the first quarter and, as a result, there was no effecton our consolidated financial statements. FIN 48 prescribes a minimum recognition threshold and measurementmethodology that a tax position taken or expected to be taken in a tax returnis required to meet before being recognized in the financial statements. Italso provides guidance for de-recognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition.  TheCompany recognizes interest and penalties related to unrecognized tax benefitswithin the provision for income taxes on continuing operations in the consolidatedstatements of income. There were no unrecognized tax benefits as of the date ofadoption, nor were there any unrecognized tax benefits that if recognized wouldaffect the tax rate. There were no interest or penalties recognized as of thedate of adoption or for the three months ended March 31, 2008.

 

For the quarter ended March 31,2008, there were no changes in the unrecognized benefits and the Company doesnot anticipate any changes during the remainder of the year.

 

The Company anticipatesrecording no tax benefit for the year, based upon management’s assessment thatthe realization of the anticipated financial loss for the year is not at thispoint reasonably assured; accordingly no benefit has been recorded for thethree months ended March 31, 2008.

 

At March 31, 2008,the Company has cumulative net operating loss carryforwards of approximately$29,500,000 which expire in years 2009 through 2027. No effect has been shownin the consolidated financial statements for the net operating loss carryforwardsas the likelihood of future tax benefit from such net operating losscarryforwards is not determinable at this time. Accordingly, the potential taxbenefits of the net operating loss carryforwards, estimated based upon currenttax rates at March 31, 2008, have been offset by valuation reserves of thesame amount.  The valuation allowanceincreased approximately $2,200,000 from September 30, 2007 to March 31,2008.  We may never realize any futuretax benefit from net operating loss carryforwards.

 

**9.****     SUBSEQUENT EVENTS**

 

On April 21, 2008, the Company completed asubscription rights offering to sell approximately 3.5 million shares of commonstock at $1.50 per share.  Gross proceedstotaled approximately $5.25 million. In the subscription rights offering, allcommon shareholders received one non-transferable right to purchase 0.11025shares of the Company’s common stock for each share that they held of record asof 5:00 p.m., central time, on March 17, 2008.  These subscription rights expired if not exercisedby 5:00 p.m., central time, on April 16, 2008.

 

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

 

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

 

**Overview**

 

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

 

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

 

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

 

9

----

 

In January 2007, we entered into a one-yearagreement with a multi-national independent exploration and production company(the “Operator”), which has been subsequently extended to October 15,2008.  We expect to provide our PIDservices under the terms of this agreement in connection with the Operator’sdrilling program in East Texas. The original agreement anticipated that PIDservices would be conducted on an initial four wells and provides the basis foradditional wells and cooperation between us and the Operator with respect tofinancing of future PID systems by the Operator and an obligation by us toprovide to the Operator preferred access to additional PID systems in thefuture. The compensation under the agreement, if any, is based on ourperformance pursuant to a gain-sharing formula. As is customary within the oilfield service industry, this contract iscancellable by either party at any time.

 

*Researchand development.  *We have made and expect 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 related toresearch 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.  As we havegained more experience with PID drilling and have run the system for longerperiods of time, we have determined that the continuously increasing andfluctuating well pressure encountered on recent trials resulted in unexpectedlevels of maintenance on the frac pump and caused difficulty in maintaining acontinuous flow of particles to the drill bit. While the current particleinjection system has allowed us to demonstrate the potential of the PIDtechnology, it has been unreliable. In April 2007, we began testing anextruder based injection system and the associated pressure diffuser. Thepressure diffuser was determined to be unreliable in July 2007 andtherefore we began testing a pressurized extruder system. In early August 2007,we were able to successfully inject particles, at a controllable rate, intopressures up to 5,200 pounds per square inch. This was the first time that goalwas achieved. The next step in the development required a pressure barrier thatwould allow the pressurized extruder to continuously refill with particles. Weselected a high pressure gate valve to serve as the pressure barrier andsuccessfully tested the gate valve in September 2007 for 3,000 cycles,representing approximately three days of operating time. Following this test,all necessary components needed to build the new particle injection system wereplaced on order. The new injection system was assembled in late December 2007and integrated with our test facility on January 9, 2008.  We tested the subsystems and components thatare integral to the safe operation of the new injection system.  Some refinements and modifications were madeas needed during the initial testing. On January 24, 2008, we completedthe first phase of our in-house test program with good results.  The testing confirmed that the automatedsystem operates as designed as a mechanical means to inject particles intopressurized drilling fluid at the rates needed for commercial use.

 

We completed theconstruction of the new injection system in mid-January 2008 and initiatedour in-house test program in order to learn how the system performed undervarious conditions, including different injection rates, pressure environmentsand flow rates.  Our testing revealed several weak links in some of thesystem’s components which required maintenance, horsepower upgrades or somelevel of modification.  On February 20, 2008, we announced thatcertain modifications made to the system had allowed us to reach a continuousinjection rate of 14 gallons per minute, which is sufficient for fieldoperations.  We intend to continue logging additional hours on the systemto better understand component life and required maintenance schedules beforeconducting the next field trial.

 

As of March 13,2008, we and the Operator had begun discussing specific field trialopportunities, including an area in east Texas outside the Deep Bossier trendwhere the last field trial was conducted. This process continued for a numberof weeks and, after reviewing the specific details of this new area, we haveeliminated it as an application at this time primarily due to limited mud pumpcapacity currently utilized in that area. Following this exercise, in early April 2008, we and the Operatorshifted our focus back to the Deep Bossier trend, and are now planning toconduct another field trial at the next available opportunity.  The field trial is still subject to theOperator’s drilling schedule and therefore the exact date for commencing thenext field operation has not yet been determined at this time. In May 2008,we negotiated a further extension of our contract with the Operator which extendsthe arrangement through October 15, 2008.  The terms and conditionsof the extended contract are consistent with those in the original contractsigned in January 2007.

 

*General and administrative.  *Generaland administrative expenses consist primarily of salaries and benefits, officeexpense, professional services, and other corporate overhead costs. We haveexperienced and expect to continue to experience increases in general andadministrative expenses as a result of: (1) reporting and complianceobligations applicable to publicly-held companies; (2) our continuingefforts to develop, test and prepare the PID technology for commercialization;and (3) the hiring of additional personnel.

 

10

----

 

**Results of Operations**

 

***Three Months Ended March 31, 2008Compared to Three Months Ended March 31, 2007***

 

*Research anddevelopment.  *Research and development expenseswere $1,546,200 and $2,040,316 for the three months ended March 31, 2008and 2007, respectively, representing a decrease of $494,116. This decrease wasprimarily related to higher expenses in the three months ended March 31,2007 from the development of the new particle injection system, construction ofour PID Unit (which expenses have not been capitalized since we have yet toachieve commercial revenues) and higher PID bit expenses.  During the three months ended March 31,2008, these expenses decreased due to the substantial completion of our PIDUnit and new injector system.

 

*General andadministrative.  *General and administrativeexpenses were $1,434,859 and $1,481,607 for the three months ended March 31,2008 and 2007, respectively, representing a decrease of $46,748. While salariesand wages and stock compensation expense increased slightly in the three monthsended March 31, 2008 compared to the three months ended March 31,2007, SEC filing fees, NASDAQ listing fees, legal, and litigation expensesdecreased.

 

*Gain on Sale of Assets.*  Thegain on sale of assets relates to the disposal on our older frac pump, atractor trailor and a machine shop lathe that were sold for net proceeds of$686,620 during the three months ended March 31, 2008.

 

*Other income (expenses).  *Other income was $10,264 and $112,124 for the three monthsended March 31, 2008 and 2007, respectively, representing a decrease inother income of $101,860. The decrease was primarily attributable to thedecrease in interest income associated with a higher cash and cash equivalentsduring the three months ended March 31, 2007 compared to the three monthsended March 31, 2008.

 

***Six Months Ended March 31, 2008Compared to Six Months Ended March 31, 2007***

 

*Research and development. *Researchand development expenses were $3,327,012 and $3,705,159 for the six monthsended March 31, 2008 and 2007, respectively, representing a decrease of$378,147. This decrease was primarily related to higher expenses in the threemonths ended March 31, 2007 from the development of the new particleinjection system, construction of our PID Unit (which expenses have not beencapitalized since we have yet to achieve commercial revenues) and higher PIDbit expenses.  During the six monthsended March 31, 2008, these expenses decreased due to the substantialcompletion of our PID Unit and new injector system.

 

*General and administrative. *Generaland administrative expenses were $2,913,964 and $2,780,151 for the six monthsended March 31, 2008 and 2007, respectively, representing an increase of$133,813.   This increase was primarily the result of increased costsrelated to salaries and wages and stock-based compensation for personnel otherthan research and development personnel during the six months ended March 31,2008.

 

*Gain on Sale of Assets.*  Thegain on sale of assets relates to the disposal on our older frac pump, a tractortrailor and a machine shop lathe that were sold for net proceeds of $686,620during the three months ended March 31, 2008.

 

*Other Income. *Otherincome was $43,645 and $237,050 for the six months ended March 31, 2008and 2007, respectively, representing an increase of $193,405.  Thedecrease was primarily attributable to the decrease in interest incomeassociated with a higher cash and cash equivalents during the six months ended March 31,2007 compared to the six months ended March 31, 2008.

 

**Liquidity and Capital Resources**

 

Our principal sources ofliquidity are cash and cash equivalents on hand.  We expect that cash requirements through theend of the fiscal year 2008 will be primarily to fund research and developmentactivities, to continuously improve service capabilities, to expand operations,general and administrative costs and capital expenditures.  As of the date of this report on Form 10-Q,and after the completion of our subscription rights offering, we believe wehave sufficient cash and cash equivalents to meet our working capital andcapital expenditure requirements for at least the next 12 months; however,our continued existence depends on the successful development of the PIDtechnology and our ability to successfully commercialize this technology.  To date we have not yet generated cashflowfrom operations, and until we commence recognizing revenue, we are highlydependent upon debt and equity funding. If we are not able to meet our funding requirements, our operations maycease to exist.  We cannot provide anyassurance that any such funding will be available on acceptable terms or atall.

 

Since inception on June 9,2003 through March 31, 2008, we have financed our operations throughprivate sales of our equity and the issuance of convertible notes payable.  In April 2008, we also competed asubscription rights offering.  Sinceinception through the completion of our subscription rights offering in April 2008,we have raised aggregate net proceeds of $35,397,913 from the private sales ofequity, the issuance of convertible notes payable and the completion of asubscription rights offering.  As of March 31,2008, we had $743,096 in cash and cash equivalents.  In April 2008, we completed a rightsoffering of approximately 3.5 million shares of our common stock for $1.50 pershare, yielding gross proceeds of approximately $5.25 million.  We intend to use the net proceeds of thesubscription rights offering to maintain our current development plan withrespect to the PID technology and for general corporate purposes.

 

11

----

 

*CashFlows 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 six months ended March 31, 2008 were $4,215,090compared to $3,531,431 for the six months ended March 31, 2007.  The increase from fiscal 2007 to fiscal 2008was primarily the result of a decrease in accounts payable between the twoperiods.

 

*CashFlows from Investing Activities. *Cash flow provided by(used in) investing activities for the six months ended March 31, 2008 was$565,299 compared to $(1,288,600) for the six months ended March 31,2007.  The cash flows provided byinvesting activities for the six months ended March 31, 2008 consisted of$686,620 from the sale of our Condor frac pump and other various non-essentialassets.  Also included in cash flowsprovided by investing activities for the six months ended March 31, 2008was $83,989 for costs associated with filing new and protecting existingpatents.  We anticipate that our capitalexpenditures for the next year will continue to be fully funded from ouravailable cash and cash equivalents.

 

*Cash Flow from Financing Activities.  *Netcash (used in) provided by financing activities for the six months ended March 31,2008 was $(69,042) compared to $10,553,357 for the six months ended March 31,2007.  During the six months ended March 31,2007, we completed the sale of five million shares of our common stock toinstitutional and other accredited investors at $2.35 per share and receivedgross proceeds of $11.75 million.  Duringthe six months ended March 31, 2008, the majority of the cash used infinancing activites was for repayments of notes payable.

 

*ContractualObligations*.  In April 2007,we entered into a 60-month lease agreement that commenced in September 2007for a new corporate office and operating facility and delivered to the lessor asecurity deposit of $41,144.  The new facility combines the corporateoffice personnel and the operations personnel into one location at 5611 BairdCourt, Houston, Texas 77041.  The total future minimum lease paymentsunder this lease are $2,034,511.

 
| ** **                                                                          | ** ** | **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) |       | $                                         | 44,064     |   | $ | 26,635 |   | $ | 13,969 |   | $ | 3,460 |   | $ | — |   |
| Purchase  Obligations                                                               |       | 406,215                                   |       | 406,215 |   |   |   |   |   |   |   |
| Operating Lease  Obligations                                                        |       | 2,034,511                                 |       | 400,757 |   | 1,424,272 |   | 209,482 |   | — |   |
|                                                                                |       |                                      |       |   |   |   |   |   |   |   |   |
| Total                                                                               |       | $                                         | 2,484,790  |   | $ | 833,607 |   | $ | 1,438,241 |   | $ | 212,942 |   | $ | — |   |

 

**Off-BalanceSheet Arrangements**

 

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

 

**Critical Accounting Policies**

 

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

 

*Impairment of Long-LivedAssets.  *We evaluate our long-lived assets forindicators of possible impairment by comparison of the carrying amounts tofuture net undiscounted cash flows expected to be generated by such assets whenevents or changes in circumstances indicate the carrying amount of an asset maynot be recoverable.  Should an impairment exist, the impairment loss wouldbe measured based on the excess carrying value of the asset over the asset’sfair value or 

 

12

----

 

discountedestimates of future cash flows.  We also evaluate the capitalized costsfor patents and patent applications filed but not issued for possibleimpairments.  The evaluation ofcapitalized costs for patents and patent applications is based on a subjectivecash flow forecast which is subject to change. 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.

 

*Asset held for sale.*  InJanuary 2007, we purchased a quintaplex frac pump for approximately $1.4million. In September 2007, management decided to place this frac pump onthe market for sale as a result of the development of the new extruder-basedinjection system being constructed that is meant to replace the frac pump basedinjection system. We commenced our selling efforts during September 2007at which time the carrying amount of the frac pump was reclassified as an assetheld for sale, as currently reflected on the accompanying March 31, 2008consolidated balance sheet.   In September 2007,we recognized an impairment on the asset of $295,260, and the net book value ofthe frac pump was reduced to $900,000, reflecting management’s estimate of therealizable value of the frac pump.

 

*Stock-BasedCompensation.  *The Company follows SFAS No. 123(R),*Share-Based Payment*. Thisstatement establishes standards for the accounting for transactions in which anentity exchanges its equity instruments for goods or services. It alsoaddresses transactions in which an entity incurs liabilities in exchange forgoods or services that are based on the fair value of the entity’s equity instrumentsor that may be settled by the issuance of those equity instruments. Thisstatement focuses primarily on accounting for transactions in which an entityobtains employee services in share-based payment transactions. *Research and Development.  *Thecosts of materials and equipment or facilities that are acquired or constructedfor research and development activities and that have alternative future usesare capitalized as tangible assets when acquired or constructed. The cost ofsuch materials consumed in research and development activities and thedepreciation of such equipment or facilities used in those activities areresearch and development costs. However, the costs of materials, equipment, orfacilities acquired or constructed for research and development activities thathave no alternative future uses are considered research and development costsand are expensed at the time the costs are incurred.

 

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

 

As discussed in Footnote3, we adopted FIN 48 in the first quarter and, as a result, there was no effecton our consolidated financial statements. FIN 48 prescribes a minimum recognition threshold and measurementmethodology that a tax position taken or expected to be taken in a tax returnis required to meet before being recognized in the financial statements. Italso provides guidance for de-recognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition.  TheCompany recognizes interest and penalties related to unrecognized tax benefitswithin the provision for income taxes on continuing operations in theconsolidated statements of income. There were no unrecognized tax benefits asof the date of adoption, nor were there any unrecognized tax benefits that ifrecognized would affect the tax rate. There were no interest or penaltiesrecognized as of the date of adoption or for the three months ended March 31,2008.

 

For the quarter ended March 31,2008, there were no changes in the unrecognized benefits and the Company doesnot anticipate any changes during the remainder of the year.

 

The Company anticipatesrecording no tax benefit for the year, based upon management’s assessment thatthe realization of the anticipated financial loss for the year is not at thispoint reasonably assured; accordingly no benefit has been recorded for thethree months ended March 31, 2008.

 

At March 31, 2008,the Company has cumulative net operating loss carryforwards of approximately$29,500,000 which expire in years 2009 through 2027. No effect has been shownin the consolidated financial statements for the net operating losscarryforwards as the likelihood of future tax benefit from such net operatingloss carryforwards is not determinable at this time. Accordingly, the potentialtax benefits of the net operating loss carryforwards, estimated based uponcurrent tax rates at March 31, 2008, have been offset by valuationreserves of the same amount.  Thevaluation allowance increased approximately $2,200,000 from September 30,2007 to March 31, 2008.  We maynever realize any future tax benefit from these net operating losscarryforwards.

 

*Net Loss per Share.  *TheCompany has presented basic and diluted net loss per share pursuant to SFAS No. 128,

 

13

----

 

*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 shares ofcommon stock because the impact of these potentially dilutive securities wereantidilutive were 131,275 and 2,901,623 shares for the three months ended March 31,2008 and 2007, respectively, and 988,584 and 2,294,032 shares for the sixmonths ended March 31, 2008 and 2007, respectively.

 

**Forward-Looking Statements**

 

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

 

These forward-lookingstatements are made based upon our management’s current plans, expectations,estimates, assumptions and beliefs concerning future events impacting us andtherefore involve a number of risks and uncertainties.  We caution that forward-looking statementsare not guarantees and that actual results could differ materially from thoseexpressed or implied in the forward-looking statements as a result of certainfactors, including but not limited to dependence upon energy industry spending,the volatility of oil and gas prices, weather interruptions, the results oftesting of our products, the availability of capital resources and the otherfactors described under “Item 1A. Risk Factors” in our annual report on Form 10-Kfor the year ended September 30, 2007 filed with the SEC on December 13,2007.  We undertake no obligation toupdate any forward-looking statements except as required by law.

 

**Item 3.****         Quantitative andQualitative Disclosures about Market Risk**

 

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

 

**Item 4.****         Controls and Procedures**

 

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

 

There was no change in our internal control overfinancial reporting during our second quarter of fiscal 2008 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**Part II—Other Information**

 

**Item 4.****        ****Submissionof Matters to a Vote of Security Holders**

 

On March 5, 2008, atthe 2008 Annual Meeting of Shareholders, our shareholders voted to approve anamendment to our Articles of Incorporation, elect six directors to our board ofdirectors, and to ratify the selection of UHY LLP as our independentaccountants.

 

The results of the voteby the shareholders on the proposal to approve the amendment to our Articles ofIncorporation were as follows:

 

Votes For:17,084,926    Votes Against:1,420,714     Abstentions: 30,568    Broker Non-Votes: 8,940,696

 

The results of theelection of the directors by the shareholders were as follows:

 

14

----

 
| **Name**                    | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|-----------------------------|------------|--------------------|------------|-------------------------|------------|
| Kenneth R.  LeSuer          |       | 27,350,684         |       | 126,220                 |       |
| Jim B. Terry                |       | 27,362,684         |       | 114,220                 |       |
| John D.  Schiller, Jr. |       | 27,350,684         |       | 126,220                 |       |
| Michael S.  Mathews         |       | 27,362,784         |       | 114,120                 |       |
| Hugh A. Menown              |       | 27,350,784         |       | 126,120                 |       |
| Byron Dunn                  |       | 27,358,684         |       | 118,220                 |       |

 

The results of the voteby the shareholders on the proposal to ratify the selection of UHY LLP as theCompany’s independent accountants were as follows:

 

Votes For:27,281,114    Votes Against: 123,815     Abstentions: 71,975

 

**Item 6.****         Exhibits**

 

Exhibits:

 
| Exhibit  No. | ** ** | **Description** |
|--------------|------------|-----------------|
|         |       |            |
| 3.1          |       |            | Amendment to the Articles of Incorporation* |
|         |       |            |   |
| 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.** |

 

----

*                 Filedherewith

**    Furnished herewith

 

15

----

 

**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:  May 9, 2008 | /s/ J. CHRIS BOSWELL                                                                                                                   |
|                         | J. Chris Boswell                                                                                                                       |
|                         | Senior Vice President and Chief Financial Officer  (authorized officer, principal financial officer and  principal accounting officer) |

 

16

----

 

**EXHIBIT INDEX**

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                      |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                 |
| 3.1              |       | Amendment to the Articles of Incorporation*                                                                                                                          |
|             |       |                                                                                                                                                                 |
| 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.** |

 

----

*                 Filedherewith

**    Furnished herewith

 

17

----