**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D. C.  20549**

 

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**FORM 10-K**

 
| **(Mark  one)** | **x**  | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**    |
|-----------------|--------|---------------------------------------------------------------------------------------------------------|
|            |   | **For the fiscal year ended March 31,  2005**                                                      |
|            |   | ** **                                                                                              |
| ** **      | **o**  | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number:  1-8182**

 

**PIONEERDRILLING COMPANY**

(Exact name of registrant as specified in its charter)

 
| **TEXAS**                                                       | ** ** | **74-2088619**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or other jurisdiction  of incorporation or organization) |       | (I.R.S. Employer  Identification Number) |
| ** **                                                      | ** ** | ** **                               |
| **9310 Broadway, Bldg. I  San Antonio, Texas**                  | ** ** | **78217**                                |
| (Address of principal executive offices)                        |       | (Zip Code)                               |

** **

Registrant’s telephone number, including area code:**  (210) 828-7689**

 

Securities registered pursuant to Section 12(b) of the Act:

** **

| **Title of each class**      | ** ** | **Name of each exchange on which registered** |
|------------------------------|------------|-----------------------------------------------|
| Common Stock $0.10 par value |       | American Stock Exchange                       |

 

Securities registered pursuant to Section 12(g) of theAct:  **None**

 

Indicate by check mark whetherthe Registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90days.  Yes ý No o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Securities Exchange Act of 1934). Yes ý No o

 

The aggregate market value ofthe registrant’s voting and nonvoting common equity held by non-affiliates ofthe registrant as of the last business day of the registrant’s most recentlycompleted second fiscal quarter (September 30, 2004) was $189,796,564,based on the last sales price of the registrant’s common stock reported on theAmerican Stock Exchange on that date.

 

As of May 20, 2005,there were 45,931,646 shares of common stock, par value $0.10 per share, of theregistrant issued and outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portions of the proxy statement related to the registrant’s 2005 AnnualMeeting of Shareholders are incorporated by reference into Part III ofthis report.

 

 

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**TABLE OF CONTENTS**

** **
| **PART I**   |                                                                                                                |
|-------------------|---------------------------------------------------------------------------------------------------------------------|
|              |                                                                                                                |   |
| Items 1 and 2.    | Business and  Properties                                                                                            |   |
| Item 3.           | Legal Proceedings                                                                                                   |   |
| Item  4.          | Submission  of Matters to a Vote of Security Holders                                                                |   |
|              |                                                                                                                |   |
| **PART II**  |                                                                                                                |
| ** **        | ** **                                                                                                          | ** ** |
| Item  5.          | Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities |   |
| Item 6.           | Selected Financial  Data                                                                                            |   |
| Item 7.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |   |
| Item  7A.         | Quantitative  and Qualitative Disclosures About Market Risk                                                         |   |
| Item  8.          | Financial  Statements and Supplementary Data                                                                        |   |
| Item  9.          | Changes  in and Disagreements With Accountants on Accounting and Financial Disclosure                               |   |
| Item 9A.          | Controls and  Procedures                                                                                            |   |
|              |                                                                                                                |   |
| **PART III** |                                                                                                                |
|              |                                                                                                                |   |
| Item  10.         | Directors  and Executive Officers of the Registrant                                                                 |   |
| Item 11.          | Executive Compensation                                                                                              |   |
| Item  12.         | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |   |
| Item  13.         | Certain  Relationships and Related Transactions                                                                     |   |
| Item  14.         | Principal  Accountant Fees and Services                                                                             |   |
|              |                                                                                                                |   |
| **PART IV**  | ** **                                                                                                          |
| ** **        | ** **                                                                                                          | ** ** |
| Item 15.          | Exhibits  and Financial Statement Schedules                                                                         |   |

 

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# **PART I**

 

Statements we make in thisAnnual Report on Form 10-K that express a belief, expectation orintention, as well as those that are not historical fact, are forward-lookingstatements under the Private Securities Litigation Reform Act of 1995. Theseforward-looking statements are subject to various risks, uncertainties andassumptions, including those to which we refer under the heading ‘‘CautionaryStatement Concerning Forward-Looking Statements and Risk Factors’’ followingItems 1 and 2 of Part I of this report.

 

## ***Items 1 and 2.     ***Business and Properties

##  

***General***

 

Pioneer Drilling Companyprovides contract land drilling services to independent and major oil and gasexploration and production companies.  Inaddition to our drilling rigs, we provide the drilling crews and most of theancillary equipment needed to operate our drilling rigs. We have focused ouroperations in select oil and natural gas production regions in the UnitedStates.  Our company was incorporated in1979 as the successor to a business that had been operating since 1968.  We conduct our operations through ourprincipal operating subsidiary, Pioneer Drilling Services, Ltd.  Our common stock trades on the American StockExchange under the symbol “PDC.”

 

SinceSeptember 1999, we have significantly expanded our fleet of drilling rigsthrough acquisitions and the construction of new rigs and the refurbishment ofolder rigs we acquired.  The followingtable summarizes acquisitions in which we acquired rigs and related operationssince September 1999:

 
| **Date**            | ** ** | **Acquisition  (1)**                           | ** ** | **Market**       | ** ** | **Number  of  Rigs  Acquired** | ** ** |
|---------------------|------------|------------------------------------------------|------------|------------------|------------|--------------------------------|------------|
| September 1999 |       | Howell Drilling, Inc.                     |       | South Texas      |       | 2                              |       |
| August 2000    |       | Pioneer Drilling Co.                           |       | South Texas      |       | 4                              |       |
| March 2001     |       | Mustang Drilling, Ltd.                         |       | East Texas       |       | 4                              |       |
| May 2002       |       | United Drilling Company                        |       | South Texas      |       | 2                              |       |
| August 2003    |       | Texas Interstate Drilling  Company, L. P.      |       | North Texas      |       | 2                              |       |
| March 2004     |       | Sawyer Drilling &  Service, Inc. |       | East Texas       |       | 7                              |       |
| March 2004     |       | SEDCO Drilling Co., Ltd.                       |       | North Texas      |       | 1                              |       |
| November 2004  |       | Wolverine  Drilling, Inc.                 |       | Rocky Mountains  |       | 7                              |       |
| December 2004  |       | Allen Drilling Company                         |       | Western Oklahoma |       | 5                              |       |

 

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(1)   The August 2000 acquisition of PioneerDrilling Co. involved our acquisition of all the outstanding capital stock ofthat entity.  Each other acquisitionreflected in this table involved our acquisition of assets from the indicatedentity.

 

During that same period, wealso added nine rigs to our fleet through construction of new rigs andconstruction of rigs from new and used components.  In addition, in August 2003, we acquireda rig that had been operating in Trinidad and integrated it into our operationsin Texas.  As of May 20, 2005, ourrig fleet consisted of 50 operating drilling rigs, 15 of which were operatingin South Texas, 17 of which were operating in East Texas, four of which wereoperating in North Texas, five of which were operating in western Oklahoma andnine of which were operating in the Rocky Mountain region.  We are also constructing two additional rigs,which we expect to add to our fleet in June and August of 2005.

 

We conduct our operationsprimarily in South, East and North Texas, western Oklahoma and the RockyMountains.  During fiscal 2005,substantially all the wells we drilled for our customers were drilled in searchof natural gas.  Although we haverecently diversified our operations somewhat with the acquisition of drillingrigs from Wolverine Drilling, with five of those rigs employed in search of oilin the Williston Basin of the Rocky Mountains, our customers remain primarilyfocused on drilling for natural gas. Natural gas reserves are typically found in deep geological formationsand generally require premium equipment and quality crews to drill the wells.

 

For many years, the UnitedStates contract land drilling services industry has been characterized by anoversupply of drilling rigs and a large number of drilling contractors.  Since 1996, however, there has beensignificant consolidation within the industry. We believe continued consolidation in the industry will generate morestability in dayrates, even during industry downturns.  However, although

 

1

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consolidation in the industryis continuing, the industry is still highly fragmented and remains verycompetitive.  For a discussion of marketconditions in our industry, see “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations – Market Conditions in OurIndustry” in Item 7 of Part II of this report.

*** ***

***Our Strategy***

 

Our goal is to continue tobuild on our strong market position and reputation as a quality contractdrilling company in a way that enhances shareholder value.  We intend to accomplish this goal by:

 

•                  continuing to own and operate a high-qualityfleet of land drilling rigs, primarily in active natural gas drilling markets;

 

•                  acquiring high-quality rigs capable ofgenerating our targeted returns on investment;

 

•                  positioning ourselves to maximize rigutilization and dayrates;

 

•                  training and maintaining high-quality,experienced crews; and

 

•                  maintaining the recent improvements in oursafety record.

 

**DrillingEquipment**

 

*General*

* *

A land drilling rig consistsof engines, a hoisting system, a rotating system, pumps and related equipmentto circulate drilling fluid, blowout preventers and related equipment.

 

Diesel or gas engines aretypically the main power sources for a drilling rig.  Power requirements for drilling jobs may varyconsiderably, but most land drilling rigs employ two or more engines togenerate between 500 and 2,000 horsepower, depending on well depth and rigdesign.  Most drilling rigs capable ofdrilling in deep formations, involving depths greater than 15,000 feet, usediesel-electric power units to generate and deliver electric current throughcables to electrical switch gears, then to direct-current electric motorsattached to the equipment in the hoisting, rotating and circulating systems.

 

Drilling rigs use longstrings of drill pipe and drill collars to drill wells.  Drilling rigs are also used to set heavystrings of large-diameter pipe, or casing, inside the borehole.  Because the total weight of the drill stringand the casing can exceed 500,000 pounds, drilling rigs require significanthoisting and braking capacities. Generally, a drilling rig’s hoisting system is made up of a mast, orderrick, a traveling block and hook assembly that attaches to the rotatingsystem, a mechanism known as the drawworks, a drilling line and ancillaryequipment.  The drawworks mechanismconsists of a revolving drum, around which the drilling line is wound, and aseries of shafts, clutches and chain and gear drives for generating speedchanges and reverse motion. The drawworks also houses the main brake, which hasthe capacity to stop and sustain the weights used in the drilling process. Whenheavy loads are being lowered, a hydraulic or electric auxiliary brake assiststhe main brake to absorb the great amount of energy developed by the mass ofthe traveling block, hook assembly, drill pipe, drill collars and drill bit orcasing being lowered into the well.

 

The rotating equipment fromtop to bottom consists of a swivel, the kelly bushing, the kelly, the rotarytable, drill pipe, drill collars and the drill bit.  We refer to the equipment between the swiveland the drill bit as the drill stem.  Theswivel assembly sustains the weight of the drill stem, permits its rotation andaffords a rotating pressure seal and passageway for circulating drilling fluidinto the top of the drill string.  Theswivel also has a large handle that fits inside the hook assembly at the bottomof the traveling block.  Drilling fluidenters the drill stem through a hose, called the rotary hose, attached to theside of the swivel.  The kelly is atriangular, square or hexagonal piece of pipe, usually 40 feet long, thattransmits torque from the rotary table to the drill stem and permits itsvertical movement as it is lowered into the hole.  The bottom end of the kelly fits inside acorresponding triangular, square or hexagonal opening in a device called thekelly bushing.  The kelly bushing, inturn, fits into a part of the rotary table called the master bushing.  As the master bushing rotates, the kellybushing also rotates, turning the kelly, which rotates the drill pipe and thusthe drill bit.  Drilling fluid is pumpedthrough the kelly on its way to the bottom. The rotary table, equipped with its master bushing and kelly bushing,supplies the necessary torque to turn the drill stem.  The drill pipe and drill collars are bothsteel tubes through which drilling fluid can be pumped.  Drill pipe, sometimes called drill string,comes in 30-foot sections, or joints, with threaded sections on each end.  Drill collars are heavier than drill pipe andare also threaded on the ends.  Collarsare used on the bottom of the drill stem to apply weight to the drillingbit.  At the end of the drill stem is thebit, which chews up the formation rock and dislodges it so that drilling fluidcan circulate the fragmented material back up to the surface where thecirculating system filters it out of the fluid.

 

Drilling fluid, often calledmud, is a mixture of clays, chemicals and water or oil, which is carefullyformulated for the particular well being drilled.  Drilling mud accounts for a major portion ofthe equipment and cost of drilling a well. Bulk storage of drilling fluid materials,

 

2

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thepumps and the mud-mixing equipment are placed at the start of the circulatingsystem.  Working mud pits and reservestorage are at the other end of the system. Between these two points the circulating system includes auxiliaryequipment for drilling fluid maintenance and equipment for well pressurecontrol.  Within the system, the drillingmud is typically routed from the mud pits to the mud pump and from the mud pumpthrough a standpipe and the rotary hose to the drill stem.  The drilling mud travels down the drill stemto the bit, up the annular space between the drill stem and the borehole andthrough the blowout preventer stack to the return flow line.  It then travels to a shale shaker for removalof rock cuttings, and then back to the mud pits, which are usually steeltanks.  The reserve pits, usually one ortwo fairly shallow excavations, are used for waste material and excess wateraround the location.

 

There are numerous factorsthat differentiate land drilling rigs, including their power generation systemsand their drilling depth capabilities. The actual drilling depth capability of a rig may be less than or morethan its rated depth capability due to numerous factors, including the size,weight and amount of the drill pipe on the rig. The intended well depth and the drill site conditions determine theamount of drill pipe and other equipment needed to drill a well.  Generally, land rigs operate with crews offive to six persons.

 

*OurFleet of Drilling Rigs*

* *

As of May 26, 2005, ourrig fleet consists of 50 drilling rigs. We own all the rigs in our fleet. The following table sets forthinformation regarding utilization for our fleet of drilling rigs:

 
| ** **                            | ** ** | **Years Ended March 31,** | ** ** |
|---------------------------------------|------------|---------------------------|------------|
| ** **                            | ** ** | **2005**                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| Average number of rigs for the period |       | 40.1                      |       | 27.3 |   | 22.3 |   | 18.0 |   | 10.5 |   | 6.6 |   |
| Average utilization rate              |       | 96                        | %          | 88 | % | 79 | % | 82 | % | 91 | % | 66 | % |

 

The following table setsforth information regarding our drilling fleet:

 
| **Rig  Number** | ** ** | **Rig  Design**    | ** ** | **Approximate  Drilling Depth  Capability  (feet)** | ** ** | **Current  Location** | ** ** | **Type**   | ** ** | **Horsepower** | ** ** |
|-----------------|------------|--------------------|------------|-----------------------------------------------------|------------|-----------------------|------------|------------|------------|----------------|------------|
|            |       |               |       |                                                |       |                  |       |       |       |           |       |
| 1               |       | Cabot 750E         |       | 9,500                                               |       | South Texas           |       | Electric   |       | 750            |       |
| 2               |       | Cabot 750E         |       | 9,500                                               |       | South Texas           |       | Electric   |       | 750            |       |
| 3               |       | National 110 UE    |       | 18,000                                              |       | South Texas           |       | Electric   |       | 1,500          |       |
| 4               |       | RMI 1000 E         |       | 15,000                                              |       | South Texas           |       | Electric   |       | 1,000          |       |
| 5               |       | Brewster N-46      |       | 12,000                                              |       | North Texas           |       | Mechanical |       | 1,000          |       |
| 6               |       | Brewster DH-4610   |       | 13,000                                              |       | East Texas            |       | Mechanical |       | 750            |       |
| 7               |       | National 110 UE    |       | 18,000                                              |       | South Texas           |       | Electric   |       | 1,500          |       |
| 8               |       | National 110 UE    |       | 18,000                                              |       | East Texas            |       | Electric   |       | 1,500          |       |
| 9               |       | Gardner-denver 500 |       | 11,000                                              |       | East Texas            |       | Mechanical |       | 700            |       |
| 10              |       | Brewster N-46      |       | 12,000                                              |       | East Texas            |       | Mechanical |       | 1,000          |       |
| 11              |       | Brewster N-46      |       | 12,000                                              |       | South Texas           |       | Mechanical |       | 1,000          |       |
| 12              |       | IRI Cabot 900      |       | 10,500                                              |       | South Texas           |       | Mechanical |       | 900            |       |
| 14              |       | Brewster N-46      |       | 12,000                                              |       | South Texas           |       | Mechanical |       | 1,000          |       |
| 15              |       | Cabot 750          |       | 9,500                                               |       | South Texas           |       | Mechanical |       | 750            |       |
| 16              |       | Cabot 750          |       | 9,500                                               |       | South Texas           |       | Mechanical |       | 750            |       |
| 17              |       | Ideco 725          |       | 12,000                                              |       | East Texas            |       | Mechanical |       | 800            |       |
| 18              |       | Brewster N-75      |       | 12,000                                              |       | East Texas            |       | Mechanical |       | 1,000          |       |
| 19              |       | Brewster N-75      |       | 12,000                                              |       | East Texas            |       | Mechanical |       | 1,000          |       |
| 20              |       | BDW 800            |       | 13,500                                              |       | East Texas            |       | Mechanical |       | 1,000          |       |
| 21              |       | National 110 UE    |       | 18,000                                              |       | South Texas           |       | Electric   |       | 1,500          |       |
| 22              |       | Ideco 725          |       | 12,000                                              |       | East Texas            |       | Mechanical |       | 800            |       |
| 23              |       | Ideco 725          |       | 12,000                                              |       | North Texas           |       | Mechanical |       | 800            |       |
| 24              |       | National 110 UE    |       | 18,000                                              |       | South Texas           |       | Electric   |       | 1,500          |       |
| 25              |       | National 110 UE    |       | 18,000                                              |       | East Texas            |       | Electric   |       | 1,500          |       |
| 26              |       | Oilwell 840 E      |       | 18,000                                              |       | South Texas           |       | Electric   |       | 1,500          |       |
| 27              |       | IRI Cabot 1200 M   |       | 13,500                                              |       | South Texas           |       | Mechanical |       | 1,300          |       |
| 28              |       | Oilwell 760 E      |       | 15,000                                              |       | South Texas           |       | Electric   |       | 1,000          |       |
| 29              |       | Brewster N-46      |       | 12,000                                              |       | North Texas           |       | Mechanical |       | 1,000          |       |
| 30              |       | Mid Cont U36A      |       | 11,000                                              |       | North Texas           |       | Mechanical |       | 750            |       |

 

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| **Rig  Number** |   | **Rig  Design** |   | **Approximate  Drilling Depth  Capability  (feet)** |   | **Current  Location** |   | **Type**   |   | **Horsepower** |   |
|-----------------|--------|-----------------|--------|-----------------------------------------------------|--------|-----------------------|--------|------------|--------|----------------|--------|
|            |   |            |   |                                                |   |                  |   |       |   |           |   |
| 31              |   | Brewster N-7    |   | 11,500                                              |   | East Texas            |   | Mechanical |   | 750            |   |
| 32              |   | Brewster N-75   |   | 13,500                                              |   | East Texas            |   | Mechanical |   | 1,000          |   |
| 33              |   | Brewster N-95   |   | 13,500                                              |   | East Texas            |   | Mechanical |   | 1,200          |   |
| 34              |   | All-Rig 900     |   | 12,000                                              |   | East Texas            |   | Mechanical |   | 900            |   |
| 35              |   | RMI 1000        |   | 13,500                                              |   | East Texas            |   | Mechanical |   | 1,000          |   |
| 36              |   | Brewster N-7    |   | 11,500                                              |   | East Texas            |   | Mechanical |   | 750            |   |
| 37              |   | Brewster N-95   |   | 13,500                                              |   | East Texas            |   | Mechanical |   | 1,200          |   |
| 38              |   | Ideco H-1000 E  |   | 11,000                                              |   | Utah                  |   | Electric   |   | 1,000          |   |
| 39              |   | National 370    |   | 7,500                                               |   | North Dakota          |   | Mechanical |   | 550            |   |
| 40              |   | National 370    |   | 8,500                                               |   | North Dakota          |   | Mechanical |   | 550            |   |
| 41              |   | National 610    |   | 11,000                                              |   | Utah                  |   | Mechanical |   | 750            |   |
| 42              |   | Brewster N-46   |   | 12,500                                              |   | North Dakota          |   | Mechanical |   | 1,000          |   |
| 43              |   | National 610    |   | 11,000                                              |   | North Dakota          |   | Mechanical |   | 750            |   |
| 44              |   | National 80B    |   | 15,000                                              |   | North Dakota          |   | Mechanical |   | 1,000          |   |
| 45              |   | Brewster N-4    |   | 7,500                                               |   | North Dakota          |   | Mechanical |   | 500            |   |
| 46              |   | RMI 550         |   | 9,000                                               |   | Oklahoma              |   | Mechanical |   | 550            |   |
| 47              |   | Ideco 525       |   | 8,000                                               |   | Oklahoma              |   | Mechanical |   | 600            |   |
| 48              |   | National 370    |   | 8,500                                               |   | Oklahoma              |   | Mechanical |   | 550            |   |
| 49              |   | Ideco 525       |   | 9,000                                               |   | Oklahoma              |   | Mechanical |   | 600            |   |
| 50              |   | Ideco 725       |   | 11,000                                              |   | Oklahoma              |   | Mechanical |   | 800            |   |
| 54              |   | RMI 1000        |   | 14,000                                              |   | Utah                  |   | Mechanical |   | 1,000          |   |

 

As of May 20, 2005, weowned a fleet of 58 trucks and related transportation equipment that we use totransport our drilling rigs to and from drilling sites.  By owning our own trucks, we reduce the costof rig moves and reduce downtime between rig moves.

 

We believe that our drillingrigs and other related equipment are in good operating condition.  Our employees perform periodic maintenanceand minor repair work on our drilling rigs. We rely on various oilfield service companies for major repair work andoverhaul of our drilling equipment when needed. We also engage in periodic improvement of our drilling equipment.  In the event of major breakdowns ormechanical problems, our rigs could be subject to significant idle time and aresulting loss of revenue if the necessary repair services are not immediatelyavailable.

 

**Drilling Contracts**

 

As a provider of contractland drilling services, our business and the profitability of our operationsdepend on the level of drilling activity by oil and gas exploration andproduction companies operating in the geographic markets where we operate.  The oil and gas exploration and productionindustry is a historically cyclical industry characterized by significantchanges in the levels of exploration and development activities.  During periods of lower levels of drillingactivity, price competition tends to increase and results in decreases in theprofitability of daywork contracts.  Inthis lower level drilling activity and competitive price environment, we may bemore inclined to enter into turnkey and footage contracts that expose us togreater risk of loss without commensurate increases in potential contractprofitability.

 

We obtain our contracts fordrilling oil and gas wells either through competitive bidding or through directnegotiations with customers.  Ourdrilling contracts generally provide for compensation on either a daywork,turnkey or footage basis.  The contractterms we offer generally depend on the complexity and risk of operations, theon-site drilling conditions, the type of equipment used and the anticipatedduration of the work to be performed. Generally, our contracts provide for the drilling of a single well andtypically permit the customer to terminate on short notice, usually on paymentof an agreed fee.

 

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The following table presents,by type of contract, information about the total number of wells we completedfor our customers during each of the last three fiscal years.

 

| ** **            | ** ** | **Year Ended March 31,** | ** ** |
|-----------------------|------------|--------------------------|------------|
| ** **            | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Daywork               |       | 264                      |       | 205 |   | 119 |   |
| Turnkey               |       | 134                      |       | 92 |   | 78 |   |
| Footage               |       | 48                       |       | 13 |   | 5 |   |
| Total number of wells |       | 446                      |       | 310 |   | 202 |   |

 

*DayworkContracts*.  Underdaywork drilling contracts, we provide a drilling rig with required personnelto our customer who supervises the drilling of the well.  We are paid based on a negotiated fixed rateper day while the rig is used.  Dayworkdrilling contracts specify the equipment to be used, the size of the hole andthe depth of the well.  Under a dayworkdrilling contract, the customer bears a large portion of the out-of-pocketdrilling costs and we generally bear no part of the usual risks associated withdrilling, such as time delays and unanticipated costs.

 

*TurnkeyContracts. *Under a turnkeycontract, we agree to drill a well for our customer to a specified depth andunder specified conditions for a fixed price, regardless of the time requiredor the problems encountered in drilling the well.  We provide technical expertise andengineering services, as well as most of the equipment and drilling suppliesrequired to drill the well.  We oftensubcontract for related services, such as the provision of casing crews,cementing and well logging.  Undertypical turnkey drilling arrangements, we do not receive progress payments andare paid by our customer only after we have performed the terms of the drillingcontract in full.

 

The risks to us under aturnkey contract are substantially greater than on a well drilled on a dayworkbasis.  This is primarily because under aturnkey contract we assume most of the risks associated with drillingoperations generally assumed by the operator in a daywork contract, includingthe risk of blowout, loss of hole, stuck drill pipe, machinery breakdowns,abnormal drilling conditions and risks associated with subcontractors’services, supplies, cost escalations and personnel.  We employ or contract for engineeringexpertise to analyze seismic, geologic and drilling data to identify and reducesome of the drilling risks we assume.  Weuse the results of this analysis to evaluate the risks of a proposed contractand seek to account for such risks in our bid preparation.  We believe that our operating experience,qualified drilling personnel, risk management program, internal engineeringexpertise and access to proficient third-party engineering contractors haveallowed us to reduce some of the risks inherent in turnkey drilling operations.We also maintain insurance coverage against some, but not all, drillinghazards.  However, the occurrence ofuninsured or under-insured losses or operating cost overruns on our turnkeyjobs could have a material adverse effect on our financial position and resultsof operations.

 

*FootageContracts*.  Underfootage contracts, we are paid a fixed amount for each foot drilled, regardlessof the time required or the problems encountered in drilling the well.  We typically pay more of the out-of-pocketcosts associated with footage contracts as compared to daywork contracts.  Similar to a turnkey contract, the risks tous on a footage contract are greater because we assume most of the risksassociated with drilling operations generally assumed by the operator in adaywork contract, including the risk of blowout, loss of hole, stuck drillpipe, machinery breakdowns, abnormal drilling conditions and risks associatedwith subcontractors’ services, supplies, cost escalation and personnel.  As with turnkey contracts, we manage thisadditional risk through the use of engineering expertise and bid the footagecontracts accordingly, and we maintain insurance coverage against some, but notall, drilling hazards.  However, theoccurrence of uninsured or under-insured losses or operating cost overruns onour footage jobs could have a material adverse effect on our financial positionand results of operations.

 

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**Customers and Marketing**

 

We market our rigs to anumber of customers.  In fiscal 2005, wedrilled wells for 102 different customers, compared to 83 customers in fiscal2004 and 64 customers in fiscal 2003. The following table shows our three largest customers as a percentage ofour total contract drilling revenue for each of our last three fiscal years.

 

| **Customer**                                  | ** ** | **Total  Contract  Drilling  Revenue  Percentage** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|
| **Fiscal 2005**                               |       |                                               |       |
| Chinn Exploration                             |       | 7                                                  | %          |
| Goodrich Petroleum Corp.                      |       | 5                                                  | %          |
| Medicine Bow Energy Corporation               |       | 5                                                  | %          |
|                                          |       |                                               |       |
| **Fiscal 2004**                               |       |                                               |       |
| Chinn Exploration                             |       | 11                                                 | %          |
| Dale Operating Company                        |       | 6                                                  | %          |
| Medicine Bow Energy Corporation               |       | 5                                                  | %          |
|                                          |       |                                               |       |
| **Fiscal 2003**                               |       |                                               |       |
| Gulf Coast Energy Associates                  |       | 11                                                 | %          |
| Apache Corporation                            |       | 7                                                  | %          |
| Suemaur Exploration & Production,  L.L.C. |       | 5                                                  | %          |

 

We primarily market ourdrilling rigs through employee marketing representatives.  These marketing representatives use personalcontacts and industry periodicals and publications to determine which operatorsare planning to drill oil and gas wells in the near future in our marketareas.  Once we have been placed on the “bidlist” for an operator, we will typically be given the opportunity to bid onmost future wells for that operator in the areas in which we operate.  Our rigs are typically contracted on awell-by-well basis.

 

From time to time we alsoenter into informal, nonbinding commitments with our customers to provide drillingrigs for future periods at specified rates plus fuel and mobilization charges,if applicable, and escalation provisions. This practice is customary in the contract land drilling servicesbusiness during times of tightening rig supply. We currently have thirteen contracts of six months to two years induration, including the contracts for the two rigs currently underconstruction.

 

**Competition**

 

We encounter substantialcompetition from other drilling contractors. Our primary market areas arehighly fragmented and competitive.  Thefact that drilling rigs are mobile and can be moved from one market to anotherin response to market conditions heightens the competition in the industry.

 

The drilling contracts wecompete for are usually awarded on the basis of competitive bids.  Our principal competitors are Grey Wolf, Inc.,Helmerich & Payne, Inc., Nabors Industries, Inc. andPatterson-UTI Energy, Inc.  Webelieve pricing and rig availability are the primary factors our potentialcustomers consider in determining which drilling contractor to select.  In addition, we believe the following factorsare also important:

 

•                  the type and condition of each of thecompeting drilling rigs;

 

•                  the mobility and efficiency of the rigs;

 

•                  the quality of service and experience of therig crews;

 

•                  the safety records of the rigs;

 

•                  the offering of ancillary services; and

 

•                  the ability to provide drilling equipmentadaptable to, and personnel familiar with, new technologies and drillingtechniques.

 

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While we must be competitivein our pricing, our competitive strategy generally emphasizes the quality ofour equipment, the safety record of our rigs and the experience of our rigcrews to differentiate us from our competitors.

 

Contract drilling companiescompete primarily on a regional basis, and the intensity of competition mayvary significantly from region to region at any particular time.  If demand for drilling services improves in aregion where we operate, our competitors might respond by moving in suitablerigs from other regions.  An influx ofrigs from other regions could rapidly intensify competition and make anyimprovement in demand for drilling rigs in a particular region short-lived.

 

Many of our competitors havegreater financial, technical and other resources than we do.  Their greater capabilities in these areas mayenable them to:

 

•                  better withstand industry downturns;

 

•                  compete more effectively on the basis of priceand technology;

 

•                  better retain skilled rig personnel; and

 

•                  build new rigs or acquire and refurbishexisting rigs so as to be able to place rigs into service more quickly than usin periods of high drilling demand.

 

**RawMaterials**

 

The materials and supplies weuse in our drilling operations include fuels to operate our drilling equipment,drilling mud, drill pipe, drill collars, drill bits and cement.  We do not rely on a single source of supplyfor any of these items.  While we are notcurrently experiencing any shortages, from time to time there have beenshortages of drilling equipment and supplies during periods of highdemand.  Shortages could result inincreased prices for drilling equipment or supplies that we may be unable topass on to customers.  In addition,during periods of shortages, the delivery times for equipment and supplies canbe substantially longer.  Any significantdelays in our obtaining drilling equipment or supplies could limit drillingoperations and jeopardize our relations with customers.  In addition, shortages of drilling equipmentor supplies could delay and adversely affect our ability to obtain newcontracts for our rigs, which could have a material adverse effect on ourfinancial condition and results of operations.

 

**OperatingRisks and Insurance**

 

Our operations are subject tothe many hazards inherent in the contract land drilling business, including therisks of:

 

•                  blowouts;

 

•                  fires and explosions;

 

•                  loss of well control;

 

•                  collapse of the borehole;

 

•                  lost or stuck drill strings; and

 

•                  damage or loss from natural disasters.

 

Anyof these hazards can result in substantial liabilities or losses to us from,among other things:

 

•                  suspension of drilling operations;

 

•                  damage to, or destruction of, our property andequipment and that of others;

 

•                  personal injury and loss of life;

 

•                  damage to producing or potentially productiveoil and gas formations through which we drill; and

 

•                  environmental damage.

 

We seek to protect ourselvesfrom some but not all operating hazards through insurance coverage.  However, some risks are either not insurableor insurance is available only at rates that we consider uneconomical.  Those risks include pollution liability inexcess of relatively low limits. Depending on competitive conditions and other factors, we attempt toobtain contractual protection against uninsured operating risks from ourcustomers.  However, customers whoprovide contractual indemnification protection may not in all cases maintainadequate insurance to support their indemnification obligations.  We can offer no assurance that our insuranceor indemnification arrangements will adequately protect us against liability orloss from all the hazards of our operations. The occurrence of a significant event that we have not fully insured orindemnified against or the failure of a customer to meet its indemnificationobligations to us could materially

 

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andadversely affect our results of operations and financial condition.  Furthermore, we may not be able to maintainadequate insurance in the future at rates we consider reasonable.

 

Our current insurancecoverage includes property insurance on our rigs, drilling equipment and realproperty.  Our insurance coverage forproperty damage to our rigs and to our drilling equipment is based on ourestimate, as of October 2005, of the cost of comparable used equipment toreplace the insured property.  The policyprovides for a deductible on rigs of $100,000 per occurrence.  Our third-party liability insurance coverageis $26 million per occurrence and in the aggregate, with a deductible of$260,000 per occurrence.  We believe thatwe are adequately insured for public liability and property damage to otherswith respect to our operations.  However,such insurance may not be sufficient to protect us against liability for allconsequences of well disasters, extensive fire damage or damage to theenvironment.

 

In addition, we generallycarry insurance coverage to protect against certain hazards inherent in ourturnkey and footage contract drilling operations.  This insurance covers “control-of-well,”including blowouts above and below the surface, redrilling, seepage andpollution.  This policy provides coverageof $3 million, $5 million or $10 million, depending on the area in which thewell is drilled and its target depth. This policy also provides care, custody and control insurance, with alimit of $250,000.

 

**Employees**

 

We currently haveapproximately 1,370 employees. Approximately 186 of these employees are salaried administrative orsupervisory employees.  The rest of ouremployees are hourly employees who operate or maintain our drilling rigs andrig-hauling trucks.  The number of hourlyemployees fluctuates depending on the number of drilling projects we areengaged in at any particular time.  Noneof our employment arrangements are subject to collective bargainingarrangements.

 

Our operations require theservices of employees having the technical training and experience necessary toobtain the proper operational results.  Asa result, our operations depend, to a considerable extent, on the continuingavailability of such personnel.  Althoughwe have not encountered material difficulty in hiring and retaining qualifiedrig crews, shortages of qualified personnel are occurring in our industry.  If we should suffer any material loss ofpersonnel to competitors or be unable to employ additional or replacementpersonnel with the requisite level of training and experience to adequatelyoperate our equipment, our operations could be materially and adverselyaffected.  While we believe our wagerates are competitive and our relationships with our employees aresatisfactory, a significant increase in the wages paid by other employers couldresult in a reduction in our workforce, increases in wage rates, or both.  The occurrence of either of these events fora significant period of time could have a material and adverse effect on ourfinancial condition and results of operations.

 

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**Facilities**

 

**We own our headquartersbuilding in San Antonio, Texas and our office building in Kenmare, NorthDakota.  We also own:**

 

**•**                  a15-acre division office, rig storage and maintenance yard in Corpus Christi,Texas;

 

**•**                  asix-acre division office, storage and maintenance yard in Henderson, Texas;

 

**•**                  a4-acre trucking department office, storage and maintenance yard in Kilgore,Texas;

 

**•**                  a17-acre rig storage and maintenance yard in Woodward, Oklahoma; and

 

**•**                  a4.7-acre division rig storage and maintenance yard in Kenmare, North Dakota.

 

**We lease:**

 

**•**                  a43-acre division office and storage yard in Decatur, Texas, at a cost of $800per month, pursuant to a lease extending through September 2006;

 

**•**                  atrucking department office, storage and maintenance yard in Alice, Texas, at acost of $4,500 per month, pursuant to a lease extending through July 2006;

 

**•**                  adivision office in Denver, Colorado, at a cost of $1,210 per month, pursuant toa lease extending through June 2005;

 

**•**                  ayard office in Kenmare, North Dakota, at a cost of $700 per month, pursuant toa lease extending through March 31, 2006; and

 

**•**                  partof a 2.2-acre division office and storage yard in Vernal, Utah, at a cost of$2,000 per month, pursuant to a lease extending through October 2005.

 

**Infour to six months, we will take over the entire division office and storageyard in Vernal, Utah and will enter into a two year lease at a cost of $6,000per month.**

 

**In July 2005,we will be moving our corporate headquarters to new office space in SanAntonio, Texas.  We have entered into a102-month lease with monthly payments of approximately $12,300 for the firsttwo years increasing to an average of approximately $20,000 per monththereafter.  We plan to sell our currentcorporate headquarters building in San Antonio, Texas.**

 

**GovernmentalRegulation**

 

Our operations are subject tostringent laws and regulations relating to containment, disposal andcontrolling the discharge of hazardous oilfield waste and other non-hazardouswaste material into the environment, requiring removal and cleanup undercertain circumstances, or otherwise relating to the protection of theenvironment.  In addition, our operationsare often conducted in or near ecologically sensitive areas, such as wetlands,which are subject to special protective measures and which may expose us toadditional operating costs and liabilities for accidental discharges of oil,natural gas, drilling fluids or contaminated water or for noncompliance withother aspects of applicable laws.  We arealso subject to the requirements of the federal Occupational Safety and HealthAct (“OSHA”) and comparable state statutes. The OSHA hazard communication standard, the Environmental ProtectionAgency “community right-to-know” regulations under Title III of the FederalSuperfund Amendment and Reauthorization Act and comparable state statutesrequire us to organize and report information about the hazardous materials weuse in our operations to employees, state and local government authorities andlocal citizens.

 

Environmental laws andregulations are complex and subject to frequent change.  In some cases, they can impose liability forthe entire cost of cleanup on any responsible party without regard tonegligence or fault and can impose liability on us for the conduct of others orconditions others have caused, or for our acts that complied with allapplicable requirements when we performed them. We may also be exposed to environmental or other liabilities originatingfrom businesses and assets that we purchased from others.  Compliance with applicable environmental lawsand regulations has not, to date, materially affected our capital expenditures,earnings or competitive position, although compliance measures have added toour costs of operating drilling equipment in some instances.  We do not expect to incur material capitalexpenditures in our next fiscal year in order to comply with currentenvironment control regulations. However, our compliance with amended, new or more stringentrequirements, stricter interpretations of existing requirements or the futurediscovery of contamination may require us to make material expenditures orsubject us to liabilities that we currently do not anticipate.

 

9

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In addition, our business dependson the demand for land drilling services from the oil and gas industry and,therefore, is affected by tax, environmental and other laws relating to the oiland gas industry generally, by changes in those laws and by changes in relatedadministrative regulations.  It ispossible that these laws and regulations may in the future add significantly toour operating costs or those of our customers or otherwise directly orindirectly affect our operations.

 

**Available Information**

 

Our website address is www.pioneerdrlg.com.  We make available on this website under “InvestorRelations-SEC Filings,” free of charge, our annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K andamendments to those reports as soon as reasonably practicable after weelectronically file those materials with, or furnish those materials to, theSEC.

 

**CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS AND RISKFACTORS**

 

We are including thefollowing discussion to inform our existing and potential security holdersgenerally of some of the risks and uncertainties that can affect our companyand to take advantage of the “safe harbor” protection for forward-lookingstatements that applicable federal securities law affords.

 

Fromtime to time, our management or persons acting on our behalf makeforward-looking statements to inform existing and potential security holdersabout our company.  These statements mayinclude projections and estimates concerning the timing and success of specificprojects and our future backlog, revenues, income and capital spending.  Forward-looking statements are generallyaccompanied by words such as “estimate,” “project,” “predict,” “believe,” “expect,”“anticipate,” “plan,” “intend,” “seek,” “will,” “should,” “goal” or other wordsthat convey the uncertainty of future events or outcomes. These forward-lookingstatements speak only as of the date on which they are first made, which in thecase of forward-looking statements made in this report is the date of thisreport.   Sometimes we will specifically describe astatement as being a forward-looking statement and refer to this cautionarystatement.

 

In addition, variousstatements that this Annual Report on Form 10-K contains, including thosethat express a belief, expectation or intention, as well as those that are notstatements of historical fact, are forward-looking statements.  Those forward-looking statements appear inItems 1 and 2 – “Business and Properties” and Item 3 – “Legal Proceedings” in Part Iof this report and in Item 5 – “Market for Registrant’s Common Equity, RelatedStockholder Matters and Issuer Purchases of Equity Securities,” and in Item 7 –“Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” Item 7A – “Quantitative and Qualitative Disclosures About MarketRisk” and in the Notes to Consolidated Financial Statements we have included inItem 8 of Part II of this report and elsewhere in this report.  These forward-looking statements speak onlyas of the date of this report.  Wedisclaim any obligation to update these statements, and we caution you not torely on them unduly.  We have based theseforward-looking statements on our current expectations and assumptions aboutfuture events.  While our managementconsiders these expectations and assumptions to be reasonable, they areinherently subject to significant business, economic, competitive, regulatoryand other risks, contingencies and uncertainties, most of which are difficultto predict and many of which are beyond our control.  These risks, contingencies and uncertaintiesrelate to, among other matters, the following:

 

•                  general economic and business conditions andindustry trends;

 

•                  the continued strength of the contract landdrilling industry in the geographic areas where we operate;

 

•                  levels and volatility of oil and gas prices;

 

•                  decisions about onshore exploration anddevelopment projects to be made by oil and gas companies;

 

•                  the highly competitive nature of our business;

 

•                  the success or failure of our acquisitionstrategy, including our ability to finance acquisitions and manage growth;

 

•                  our future financial performance, includingavailability, terms and deployment of capital;

 

•                  the continued availability of qualifiedpersonnel; and

 

•                  changes in, or our failure or inability tocomply with, governmental regulations, including those relating to theenvironment.

 

We believe the items we haveoutlined above are important factors that could cause our actual results todiffer materially from those expressed in a forward-looking statement containedin this report or elsewhere.  We havediscussed many of these factors in more detail elsewhere in this report.  These factors are not necessarily all theimportant factors that could affect us. Unpredictable or unknown factors we have not discussed in this reportcould also have material adverse effects on actual results of matters that arethe subject of our forward-looking statements. We do not intend to update our description of important factors eachtime a potential important factor arises. We advise our security holders that they should (1) be aware thatimportant factors not referred to above could affect the

 

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accuracyof our forward-looking statements and (2) use caution and common sensewhen considering our forward-looking statements.  Also, please read the risk factors set forthbelow.

 

**RisksRelating to the Oil and Gas Industry**

 

*Wederive all our revenues from companies in the oil and gas exploration and productionindustry, a historically cyclical industry with levels of activity that aresignificantly affected by the levels and volatility of oil and gas prices.*

 

Asa provider of contract land drilling services, our business depends on thelevel of drilling activity by oil and gas exploration and production companiesoperating in the geographic markets where we operate. The oil and gasexploration and production industry is a historically cyclical industrycharacterized by significant changes in the levels of exploration anddevelopment activities.  Oil and gasprices, and market expectations of potential changes in those prices,significantly affect the levels of those activities. Worldwide political,economic and military events have contributed to oil and gas price volatilityand are likely to continue to do so in the future.  Any prolonged reduction in the overall levelof exploration and development activities, whether resulting from changes inoil and gas prices or otherwise, can materially and adversely affect us in manyways by negatively impacting:

 

•                  our revenues, cash flows and profitability;

 

•                  the fair market value of our rig fleet;

 

•                  our ability to maintain or increase ourborrowing capacity;

 

•                  our ability to obtain additional capital tofinance our business and make acquisitions, and the cost of that capital; and

 

•                  our ability to retain skilled rig personnelwhom we would need in the event of an upturn in the demand for our services.

 

Dependingon the market prices of oil and gas, oil and gas exploration and productioncompanies may cancel or curtail their drilling programs, thereby reducingdemand for our services.  Oil and gasprices have been volatile historically and, we believe, will continue to be soin the future.  Many factors beyond ourcontrol affect oil and gas prices, including:

 

•                  weather conditions in the United States andelsewhere;

 

•                  economic conditions in the United States andelsewhere;

 

•                  actions by OPEC, the Organization of PetroleumExporting Countries;

 

•                  political instability in the Middle East andother major oil and gas producing regions;

 

•                  governmental regulations, both domestic andforeign;

 

•                  domestic and foreign tax policy;

 

•                  the pace adopted by foreign governments forthe exploration, development and production of their national reserves;

 

•                  the price of foreign imports of oil and gas;

 

•                  the cost of exploring for, producing anddelivering oil and gas;

 

•                  the discovery rate of new oil and gasreserves;

 

•                  the rate of decline of existing and new oiland gas reserves;

 

•                  available pipeline and other oil and gastransportation capacity;

 

•                  the ability of oil and gas companies to raisecapital; and

 

•                  the overall supply and demand for oil and gas.

 

**RisksRelating to Our Business**

 

*Wehave a history of losses and may experience losses in the future.*

 

Wehave a history of losses.  We incurrednet losses of $1.8 million, $5.1 million and $0.4 million in the fiscal yearsended March 31, 2004, 2003 and 2000, respectively.  Our profitability in the future will dependon many factors, but largely on utilization rates and dayrates for our drillingrigs.  Our current utilization rates anddayrates may decline and we may experience losses in the future.

 

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*Ouracquisition strategy involves various risks*.

 

Asa key component of our business strategy, we have pursued and intend tocontinue to pursue acquisitions of complementary assets and businesses.    For example, since March 31, 2003, ourrig fleet has increased from 24 to 50 drilling rigs, primarily as a result ofacquisitions.  Certain risks are inherentin an acquisition strategy, such as increasing leverage and debt servicerequirements and combining disparate company cultures and facilities, whichcould adversely affect our operating results. The success of any completed acquisition will depend in part on ourability to integrate effectively the acquired business into ouroperations.  The process of integratingan acquired business may involve unforeseen difficulties and may require adisproportionate amount of management attention and financial and otherresources.  Possible future acquisitionsmay be for purchase prices significantly higher than those we paid for recentacquisitions.  We may be unable tocontinue to identify additional suitable acquisition opportunities, negotiateacceptable terms, obtain financing for acquisitions on satisfactory terms orsuccessfully acquire identified targets. Our failure to achieve consolidation savings, to incorporate theacquired businesses and assets into our existing operations successfully or tominimize any unforeseen operational difficulties could have a material adverseeffect on our financial condition and results of operations.

 

Inaddition, we may not have sufficient capital resources to complete additionalacquisitions.  Historically, we havefunded the growth of our rig fleet through a combination of debt and equityfinancing.  We may incur substantialadditional indebtedness to finance future acquisitions and also may issue equitysecurities or convertible securities in connection with such acquisitions.  Debt service requirements could represent asignificant burden on our results of operations and financial condition and theissuance of additional equity could be dilutive to our existingstockholders.  Furthermore, we may not beable to obtain additional financing on satisfactory terms.

 

*Weoperate in a highly competitive, fragmented industry in which price competitionis intense.*

 

Weencounter substantial competition from other drilling contractors. Our primarymarket areas of are highly fragmented and competitive.  The fact that drilling rigs are mobile andcan be moved from one market to another in response to market conditionsheightens the competition in the industry.

 

Thedrilling contracts we compete for are usually awarded on the basis ofcompetitive bids.  We believe pricing andrig availability are the primary factors our potential customers consider indetermining which drilling contractor to select.  In addition, we believe the following factorsare also important:

 

•                  the type and condition of each of thecompeting drilling rigs;

 

•                  the mobility and efficiency of the rigs;

 

•                  the quality of service and experience of therig crews;

 

•                  the safety records of the rigs;

 

•                  the offering of ancillary services; and

 

•                  the ability to provide drilling equipmentadaptable to, and personnel familiar with, new technologies and drillingtechniques.

 

Whilewe must be competitive in our pricing, our competitive strategy generally emphasizesthe quality of our equipment, the safety record of our rigs and the quality ofservice and experience of our rig crews to differentiate us from ourcompetitors.  This strategy is lesseffective as lower demand for drilling services intensifies price competitionand makes it more difficult for us to compete on the basis of factors otherthan price.  In all of the markets inwhich we compete, an over-supply of rigs can cause greater price competition.

 

Contractdrilling companies compete primarily on a regional basis, and the intensity ofcompetition may vary significantly from region to region at any particulartime.  If demand for drilling servicesimproves in a region where we operate, our competitors might respond by movingin suitable rigs from other regions.  Aninflux of rigs from other regions could rapidly intensify competition andreduce profitability and make any improvement in demand for drilling rigsshort-lived.

 

*Weface competition from many competitors with greater resources.*

 

Manyof our competitors have greater financial, technical and other resources thanwe do.  Their greater capabilities inthese areas may enable them to:

 

•                  better withstand industry downturns;

 

•                  compete more effectively on the basis of priceand technology;

 

•                  retain skilled rig personnel; and

 

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•                  build new rigs or acquire and refurbishexisting rigs so as to be able to place rigs into service more quickly than usin periods of high drilling demand.

 

*Unexpectedcost overruns on our turnkey drilling jobs and our footage contracts couldadversely affect our financial position and our results of operation.*

 

Wehave historically derived a significant portion of our revenues from turnkeydrilling contracts and we expect that they will represent a significantcomponent of our future revenues.  Theoccurrence of uninsured or under-insured losses or operating cost overruns onour turnkey jobs could have a material adverse effect on our financial positionand results of operations.  Under atypical turnkey drilling contract, we agree to drill a well for our customer toa specified depth and under specified conditions for a fixed price.  We provide technical expertise andengineering services, as well as most of the equipment and drilling suppliesrequired to drill the well.  We oftensubcontract for related services, such as the provision of casing crews,cementing and well logging.  Undertypical turnkey drilling arrangements, we do not receive progress payments andare paid by our customer only after we have performed the terms of the drillingcontract in full.  For these reasons, therisk to us under a turnkey drilling contract is substantially greater than fora well drilled on a daywork basis, because we must assume most of the risksassociated with drilling operations that the operator generally assumes under adaywork contract, including the risks of blowout, loss of hole, stuck drillpipe, machinery breakdowns, abnormal drilling conditions and risks associatedwith subcontractors’ services, supplies, cost escalations and personnel.  Similar to our turnkey contracts, under afootage contract we assume most of the risks associated with drillingoperations that the operator generally assumes under a daywork contract.

 

Althoughwe attempt to obtain insurance coverage to reduce certain of the risks inherentin our turnkey and footage drilling operations, adequate coverage may beunavailable in the future and we might have to bear the full cost of suchrisks, which could have an adverse effect on our financial condition andresults of operation.

 

*Ouroperations involve operating hazards, which if not insured or indemnifiedagainst, could adversely affect our results of operations and financialcondition.*

 

Ouroperations are subject to the many hazards inherent in the contract landdrilling business, including the risks of:

 

•                  blowouts;

 

•                  fires and explosions;

 

•                  loss of well control;

 

•                  collapse of the borehole;

 

•                  lost or stuck drill strings; and

 

•                  damage or loss from natural disasters.

 

Any of these hazards canresult in substantial liabilities or losses to us from, among other things:

 

•                  suspension of drilling operations;

 

•                  damage to, or destruction of, our property andequipment and that of others;

 

•                  personal injury and loss of life;

 

•                  damage to producing or potentially productiveoil and gas formations through which we drill; and

 

•                  environmental damage.

 

We seek to protect ourselves from some but not all operating hazardsthrough insurance coverage. However, some risks are either not insurable orinsurance is available only at rates that we consider uneconomical.  Those risks include pollution liability inexcess of relatively low limits. Depending on competitive conditions and other factors, we attempt toobtain contractual protection against uninsured operating risks from ourcustomers.  However, customers whoprovide contractual indemnification protection may not in all cases maintainadequate insurance to support their indemnification obligations.  Our insurance or indemnification arrangementsmay not adequately protect us against liability or loss from all the hazards ofour operations. The occurrence of a significant event that we have not fullyinsured or indemnified against or the failure of a customer to meet its indemnificationobligations to us could materially and adversely affect our results ofoperations and financial condition. Furthermore, we may be unable to maintain adequate insurance in thefuture at rates we consider reasonable.

 

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*We faceincreased exposure to operating difficulties because we primarily focus ondrilling for natural gas.*

 

Most of ourdrilling contracts are with exploration and production companies in search ofnatural gas.  Drilling on land fornatural gas generally occurs at deeper drilling depths than drilling foroil.  Although deep-depth drillingexposes us to risk similar to risks encountered in shallow-depth drilling, themagnitude of the risk for deep-depth drilling is greater because of the highercosts and greater complexities involved in drilling deep wells.  We generally do not insure risks related tooperating difficulties other than blowouts. If we do not adequately insure the increased risk from blowouts or ifour contractual indemnification rights are insufficient or unfulfilled, ourprofitability and other results of operation and our financial condition couldbe adversely affected in the event we encounter blowouts or other significantoperating difficulties while drilling at deeper depths.

 

*Ourcurrent primary focus on drilling for natural gas could place us at acompetitive disadvantage if we changed our primary focus to drilling for oil.*

 

Ourrig fleet consists of rigs capable of drilling on land at drilling depths of6,000 to 18,000 feet because most of our contracts are with customers drillingin search of natural gas, which generally occurs at deeper drilling depths thandrilling in search of oil, which often occurs at drilling depths less than6,000 feet.  Generally, larger drillingrigs capable of deep drilling generally incur higher mobilization costs thansmaller drilling rigs drilling at shallower depths.  If our primary focus shifts from drilling forcustomers in search of natural gas to drilling for customers in search of oil,the majority of our rig fleet would be disadvantaged in competing for new oildrilling projects as compared to competitors that primarily use shallowerdrilling depth rigs when drilling in search of oil.

 

*Ouroperations are subject to various laws and governmental regulations that couldrestrict our future operations and increase our operating costs.*

 

Manyaspects of our operations are subject to various federal, state and local lawsand governmental regulations, including laws and regulations governing:

 

•                  environmental quality;

 

•                  pollution control;

 

•                  remediation of contamination;

 

•                  preservation of natural resources; and

 

•                  worker safety.

 

Ouroperations are subject to stringent laws and regulations relating tocontainment, disposal and controlling the discharge of hazardous oilfield wasteand other nonhazardous waste material into the environment, requiring removaland cleanup under certain circumstances, or otherwise relating to theprotection of the environment.  Inaddition, our operations are often conducted in or near ecologically sensitiveareas, such as wetlands, which are subject to special protective measures andwhich may expose us to additional operating costs and liabilities foraccidental discharges of oil, gas, drilling fluids or contaminated water or fornoncompliance with other aspects of applicable laws.  We are also subject to the requirements ofOSHA and comparable state statutes.  TheOSHA hazard communication standard, the Environmental Protection Agency “communityright-to-know” regulations under Title III of the Federal SuperfundAmendment and Reauthorization Act and comparable state statutes require us toorganize and report information about the hazardous materials we use in ouroperations to employees, state and local government authorities and localcitizens.

 

Environmentallaws and regulations are complex and subject to frequent change.  In some cases, they can impose liability forthe entire cost of cleanup on any responsible party without regard tonegligence or fault and can impose liability on us for the conduct of others orconditions others have caused, or for our acts that complied with allapplicable requirements when we performed them. We may also be exposed to environmental or other liabilities originatingfrom businesses and assets which we purchased from others. Our compliance withamended, new or more stringent requirements, stricter interpretations ofexisting requirements or the future discovery of contamination may require usto make material expenditures or subject us to liabilities that we currently donot anticipate.

 

Inaddition, our business depends on the demand for land drilling services fromthe oil and gas industry and, therefore, is affected by tax, environmental andother laws relating to the oil and gas industry generally, by changes in thoselaws and by changes in related administrative regulations.  It is also possible that these laws andregulations may in the future add significantly to our operating costs or thoseof our customers or otherwise directly or indirectly affect our operations.

 

*Wecould be adversely affected if shortages of equipment, supplies or personneloccur.*

 

Fromtime to time there have been shortages of drilling equipment and suppliesduring periods of high demand which we believe could reoccur.  Shortages could result in increased pricesfor drilling equipment or supplies that we may be unable to pass on tocustomers.  In

 

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addition, during periods ofshortages, the delivery times for equipment and supplies can be substantiallylonger.  Any significant delays in ourobtaining drilling equipment or supplies could limit drilling operations andjeopardize our relations with customers. In addition, shortages of drilling equipment or supplies could delay andadversely affect our ability to obtain new contracts for our rigs, which couldhave a material adverse effect on our financial condition and results ofoperations.

 

Ouroperations require the services of employees having the technical training andexperience necessary to obtain the proper operational results.  As a result, our operations depend, to aconsiderable extent, on the continuing availability of such personnel.  Shortages of qualified personnel areoccurring in our industry. If we should suffer any material loss of personnelto competitors or be unable to employ additional or replacement personnel withthe requisite level of training and experience to adequately operate ourequipment, our operations could be materially and adversely affected.  A significant increase in the wages paid byother employers could result in a reduction in our workforce, increases in wagerates, or both.  The occurrence of eitherof these events for a significant period of time could have a material andadverse effect on our financial condition and results of operations.

 

**RiskRelating to Our Capitalization and Organizational Documents**

 

*Ourlargest shareholder and our management control approximately 20% of our commonstock, and their interests may conflict with those of our other shareholders.*

 

Asof May 20, 2005, our largest shareholder, Chesapeake Energy Corporation,beneficially owned 16.78% of our outstanding common stock, and together withour officers and directors as a group beneficially owned a total of 20.46% ofour outstanding common stock.  For eachshareholder or group of shareholders, beneficial ownership includes shares ofour common stock issuable on exercise of outstanding stock options held by thatshareholder or group of shareholders.  Insome circumstances, if these shareholders were to act in concert, they would beable to exercise substantial control over our affairs.  The interests of Chesapeake and these otherpersons with respect to matters potentially or actually involving or affectingus, such as future acquisitions, financings and other corporate opportunitiesand attempts to acquire us, may conflict with the interests of our othershareholders.

 

 *Limited trading volume ofour common stock may contribute to its price volatility.*

 

Ourcommon stock is traded on the American Stock Exchange.  During the period from January 1, 2005through May 20, 2005, the average daily trading volume of our common stockas reported by the American Stock Exchange was****366,154shares.  There can be no assurance that amore active trading market in our common stock will develop.  As a result, relatively small trades may havea significant impact on the price of our common stock and, therefore, maycontribute to the price volatility of our common stock.  As a result, our common stock may be subjectto greater price volatility than the stock market as a whole and comparablesecurities of other contract drilling service providers.

 

Themarket price of our common stock has been, and may continue to be,volatile.  For example, during our 2005fiscal year, the trading price of our common stock ranged from $5.60 to $14.21per share.

 

Becauseof the limited trading market of our common stock and the price volatility ofour common stock, you may be unable to sell shares of common stock when youdesire or at a price you desire.  Theinability to sell your shares in a declining market because of such illiquidityor at a price you desire may substantially increase your risk of loss.

 

*Underour existing dividend policy, we do not pay dividends on our common stock.*

 

Wehave not paid or declared any dividends on our common stock and currentlyintend to retain any earnings to fund our working capital needs and growthopportunities.  Any future dividends willbe at the discretion of our board of directors after taking into accountvarious factors it deems relevant, including our financial condition andperformance, cash needs, income tax consequences and the restrictions imposedby the Texas Business Corporation Act and other applicable laws and by ourcredit facilities.  Our debt arrangementsinclude provisions that generally prohibit us from paying dividends on ourcapital stock, including our common stock.

 

*Wemay issue preferred stock whose terms could adversely affect the voting poweror value of our common stock.*

 

Ourarticles of incorporation authorize us to issue, without the approval of ourshareholders, one or more classes or series of preferred stock having suchdesignations, preferences, limitations and relative rights, includingpreferences over our common stock respecting dividends and distributions, asour board of directors may determine. The terms of one or more classes or series of preferred stock couldadversely impact the voting power or value of our common stock.  For example, we might grant holders ofpreferred stock the right to elect some number of our directors in all eventsor on the happening of specified events or the right to veto specifiedtransactions.  Similarly, the repurchaseor redemption rights or liquidation preferences we might assign to holders ofpreferred stock could affect the residual value of the common stock.

 

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*Provisionsin our organizational documents could delay or prevent a change in control ofour company, even if that change would be beneficial to our shareholders.*

 

Theexistence of some provisions in our organizational documents could delay orprevent a change in control of our company, even if that change would be beneficialto our shareholders.  Our articles ofincorporation and bylaws contain provisions that may make acquiring control ofour company difficult, including:

 

•                  provisions regulating the ability of ourshareholders to bring matters for action at annual meetings of ourshareholders;

 

•                  limitations on the ability of our shareholdersto call a special meeting and act by written consent;

 

•                  provisions dividing our board of directorsinto three classes elected for staggered terms; and

 

•                  the authorization given to our board ofdirectors to issue and set the terms of preferred stock.

 

## ***Item3.***       LegalProceedings

##  

Dueto the nature of our business, we are, from time to time, involved in routinelitigation or subject to disputes or claims related to our business activities,including workers’ compensation claims and employment-related disputes.  In the opinion of our management, none of thepending litigation, disputes or claims against us will have a material adverseeffect on our financial condition or results of operations.

 

## ***Item 4.      ***Submission of Matters to a Vote of Security Holders

##  

We did not submit any matterto a vote of our security holders during the fourth quarter of fiscal 2005.

 

# **PART II**

#  

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

##  

As of May 20, 2005,****45,931,646 shares of our common stock were outstanding,held by approximately****561shareholders of record. The number of record holders does not necessarily bearany relationship to the number of beneficial owners of our common stock.

 

Our common stock trades onthe American Stock Exchange under the symbol “PDC.”  The following table sets forth, for each ofthe periods indicated, the high and low sales prices per share on the AmericanStock Exchange:

 

| ** **                            | ** ** | **Low** | ** ** | **High** | ** ** |
|---------------------------------------|------------|---------|------------|----------|------------|
| **Fiscal Year Ended March 31, 2005:** |       |    |       |     |       |
| First Quarter                         |       | $       | 5.60       |     | $          | 7.99 |   |
| Second Quarter                        |       | 6.75    |       | 8.90     |       |
| Third Quarter                         |       | 7.63    |       | 10.50    |       |
| Fourth Quarter                        |       | 9.05    |       | 14.21    |       |
|                                  |       |    |       |     |       |
| **Fiscal Year Ended March 31, 2004:** |       |    |       |     |       |
| First Quarter                         |       | $       | 3.57       |     | $          | 5.24 |   |
| Second Quarter                        |       | 3.65    |       | 4.99     |       |
| Third Quarter                         |       | 3.30    |       | 5.20     |       |
| Fourth Quarter                        |       | 4.75    |       | 7.35     |       |

 

The last reported sales pricefor our common stock on the American Stock Exchange on May 27, 2005 was$14.00 per share.

 

We have not paid or declaredany dividends on our common stock and currently intend to retain earnings tofund our working capital needs and growth opportunities.  Any future dividends will be at thediscretion of our board of directors after taking into account various factorsit deems relevant, including our financial condition and performance, cashneeds, income tax consequences and the restrictions Texas and other applicablelaws and our credit facilities then impose. Our debt arrangements include provisions that generally prohibit us frompaying dividends, other than dividends on our preferred stock.  We currently have no preferred stockoutstanding.

 

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***Equity Compensation Plan Information***

 

Thefollowing table provides information on our equity compensation plans as of March 31,2005:

 
| **Plan category**                                           | ** ** | **Number of securities to be  issued upon exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price per share  of outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under equity  compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| * *                                                    | * *   | **(a)**                                                                                            | * *   | **(b)**                                                                                      | * *   | **(c)**                                                                                                                                              | * *   |
| Equity compensation plans approved by  security holders     |       | 2,005,000                                                                                          |       | $                                                                                            | 5.30       |                                                                                                                                                 | 1,906,413  |   |
|                                                        |       |                                                                                               |       |                                                                                         |       |                                                                                                                                                 |       |
| Equity compensation plans not approved by  security holders |       | —                                                                                             |       | —                                                                                       |       | —                                                                                                                                               |       |
| Total                                                       |       | 2,005,000                                                                                          |       | $                                                                                            | 5.30       |                                                                                                                                                 | 1,906,413  |   |

 

## ***Recent Sales ofUnregistered Securities***

##  

On August 11, 2004, theentire $28,000,000 in aggregate principal amount of our 6.75% convertiblesubordinated debentures held by WEDGE Energy Services, L.L.C. and William H.White was converted in accordance with the terms of those debentures into6,496,519 shares of our common stock.  Weissued those shares without registration under the Securities Act of 1933 inreliance on the exemption that Section 4(2) of that Act provides fortransactions not involving any public offering.

 

## ***Item6.      ***Selected Financial Data

##  

The following informationderives from our audited financial statements. You should review this information in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inItem 7 of this report and the historical financial statements and related notesthis report contains.

 
| ** **                                                                    | ** ** | **Years Ended March 31,**                    | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                    | ** ** | **(In thousands, except per share amounts)** | ** ** |
|                                                                          |       |                                         |       |   |   |   |   |   |   |   |   |
| Contract drilling revenues                                                    |       | $                                            | 185,246    |   | $ | 107,876 |   | $ | 80,183 |   | $ | 68,627 |   | $ | 50,345 |   |
| Income (loss) from operations                                                 |       | 18,774                                       |       | 438 |   | (4,943 | ) | 11,201 |   | 3,803 |   |
| Income (loss) before income taxes                                             |       | 17,161                                       |       | (2,216 | ) | (7,305 | ) | 9,737 |   | 3,838 |   |
| Preferred dividends                                                           |       | —                                       |       | — |   | — |   | 93 |   | 275 |   |
| Net earnings (loss) applicable to common stockholders                         |       | 10,812                                       |       | (1,790 | ) | (5,086 | ) | 6,225 |   | 2,428 |   |
| Earnings (loss) per common share-basic                                        |       | 0.31                                         |       | (0.08 | ) | (0.31 | ) | 0.41 |   | 0.22 |   |
| Earnings (loss) per common share-diluted                                      |       | 0.30                                         |       | (0.08 | ) | (0.31 | ) | 0.35 |   | 0.19 |   |
| Long-term debt and capital lease  obligations, excluding current installments |       | 13,445                                       |       | 44,892 |   | 45,855 |   | 26,119 |   | 10,056 |   |
| Shareholders' equity                                                          |       | 221,615                                      |       | 70,836 |   | 47,672 |   | 33,343 |   | 17,827 |   |
| Total assets                                                                  |       | 276,009                                      |       | 143,731 |   | 119,694 |   | 83,450 |   | 56,493 |   |
| Capital expenditures                                                          |       | 80,388                                       |       | 44,845 |   | 33,589 |   | 27,597 |   | 41,628 |   |
|                                                                               |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Refer to Note 2 of theconsolidated financial statements for information on acquisitions.

 

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## ***Item 7***.                     Management’s Discussion and Analysis of Financial Conditionand Results of Operations

##  

*Statements we make in the following discussion that express a belief,expectation or intention, as well as those which are not historical fact, areforward-looking statements that are subject to risks, uncertainties andassumptions.  Our actual results,performance or achievements, or industry results, could differ materially fromthose we express in the following discussion as a result of a variety offactors, including general economic and business conditions and industrytrends, the continued strength or weakness of the contract land drillingindustry in the geographic areas in which we operate, decisions about onshoreexploration and development projects to be made by oil and gas companies, thehighly competitive nature of our business, our future financial performance,including availability, terms and deployment of capital, the continuedavailability of qualified personnel, and changes in, or our failure or inabilityto comply with, government regulations, including those relating to theenvironment.*

 

**Company Overview**

 

PioneerDrilling Company provides contract land drilling services to independent andmajor oil and gas exploration and production companies.  In addition to our drilling rigs, we providethe drilling crews and most of the ancillary equipment needed to operate ourdrilling rigs.  We have focused ouroperations in selected oil and natural gas production regions in the UnitedStates.  Our company was incorporated in1979 as the successor to a business that had been operating since 1968.  We conduct our operations through ourprincipal operating subsidiary, Pioneer Drilling Services, Ltd.  We are an oil and gas services company.  We do not invest in oil and natural gasproperties.  The drilling activity of ourcustomers is highly dependent on the current price of oil and natural gas.

 

Ourbusiness strategy is to own and operate a high-quality fleet of land drillingrigs in active drilling markets, and position ourselves to maximize rigutilization and dayrates and to enhance shareholdervalue.  We intend to continue makingadditions to our drilling fleet, either through acquisitions of businesses orselected assets or through the construction of new or refurbished drillingrigs.

 

SinceSeptember 1999, we have significantly expanded our fleet of drilling rigsthrough acquisitions and the construction of new and refurbished rigs.  As of March 31, 2005 our rig fleetconsisted of 50 land drilling rigs that drill in depth ranges between 6,000 and18,000 feet.  Fifteen of our rigs areoperating in South Texas, 17 in East Texas, four in North Texas, five inwestern Oklahoma and nine in the Rocky Mountains. We actively market all ofthese rigs.  We completed construction ofour 50th rig in late March 2005 and began moving it to itsfirst drilling location.  We anticipatecontinued growth of our rig fleet in fiscal year 2006.  We are currently constructing two 1000horsepower electric rigs from new and used components.

 

Weearn our revenues by drilling oil and gas wells for our customers.  We obtain our contracts for drilling oil andgas wells either through competitive bidding or through direct negotiationswith customers.  Our drilling contractsgenerally provide for compensation on either a daywork,turnkey or footage basis.  Contract termsgenerally depend on the complexity and risk of operations, the on-site drillingconditions, the type of equipment used and the anticipated duration of the workto be performed.  Generally, ourcontracts provide for the drilling of a single well and typically permit thecustomer to terminate on short notice. However, we currently have thirteencontracts with terms of six months to two years in duration, including thecontracts for the two rigs currently under construction.

 

Asignificant performance measurement in our industry is rig utilization.  We compute rig utilization rates by dividingrevenue days by total available days during a period.  Total available days are the number ofcalendar days during the period that we have owned the rig.  Revenue days for each rig are days when therig is earning revenues under a contract, which is usually a period from thedate the rig begins moving to the drilling location until the rig is releasedfrom the contract.

 

Forthe three years ended March 31, 2005, our rig utilization, revenue daysand number of rigs were as follows:

 
| ** **        | ** ** | **Years Ended March 31,** | ** ** |
|-------------------|------------|--------------------------------|------------|
| ** **        | ** ** | **2005**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Utilization Rates |       | 96                             | %          | 88 | % | 79 | % |
| Revenue Days      |       | 13,894                         |       | 8,764 |   | 6,419 |   |
| Number of rigs    |       | 50                             |       | 35 |   | 24 |   |

 

Thereasons for the increase in the number of revenue days in 2005 over 2004 and2003 are the increase in size of our rig fleet and the improvement in ouroverall rig utilization rate due to improved market conditions.  For 2006, we anticipate continued growth inrevenue days and utilization rates comparable to 2005.

 

Inaddition to high commodity prices, we attribute our relatively high utilizationrates to a strong sales effort, quality equipment, good field and operationspersonnel, a disciplined safety approach, and our generally successfulperformance of turnkey operations. Turnkey contracts currently account for approximately 12% of ourcontracts.  Turnkey contracts provide uswith the opportunity to keep our rigs working in periods of lower demand andimprove our profitability, but at an increased risk.  During periods of reduced demand for drilling

 

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rigs, turnkey operating profit per revenue day has been greater than daywork operating profit; however, occasionally, a turnkeycontract will be unprofitable if the contract cannot be completed successfullywithout unanticipated complications.

 

Wedevote substantial resources to maintaining and upgrading our rig fleet.  During fiscal 2004, we removed three rigsfrom service for approximately three weeks each, to perform upgrades.  In the short term, these actions resulted infewer revenue days and slightly lower utilization; however, in the long term,we believe the upgrades will help the marketability of the rigs and improvetheir operating performance.  We arecurrently performing or have recently performed, between contracts or asnecessary, safety and equipment upgrades to the eight rigs we acquired in March 2004and the 12 rigs we acquired in November and December 2004.

 

***MarketConditions in Our Industry***

 

TheUnited States contract land drilling services industry is highly cyclical.  Volatility in oil and gas prices can producewide swings in the levels of overall drilling activity in the markets we serveand affect the demand for our drilling services and the dayrateswe can charge for our rigs.  Theavailability of financing sources, past trends in oil and gas prices and theoutlook for future oil and gas prices strongly influence the number of wellsoil and gas exploration and production companies decide to drill.

 

Forthe three months ended March 31, 2005, the average weekly spot price forWest Texas Intermediate crude oil was $49.87, the average weekly spot price forHenry Hub natural gas was $6.39 and the average weekly Baker Hughes land rigcount was 1,153.  On May 20, 2005, thespot price for West Texas Intermediate crude oil was $46.80, the spot price forHenry Hub natural gas was $6.36 and the Baker Hughes land rig count was 1,202,a 14% increase from 1,056 on May 21, 2004.

 

Theaverage weekly spot prices of West Texas Intermediate crude oil and Henry Hubnatural gas and the average weekly domestic land rig count, per the BakerHughes land rig count, for each of the previous six years ended March 31,2005 were: 

 
| ** **                    | ** ** | **Years Ended March 31,** | ** ** |
|-------------------------------|------------|--------------------------------|------------|
| ** **                    | ** ** | **2005**                       | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| Oil (West Texas Intermediate) |       | $                              | 45.04      |   | $ | 31.47 |   | $ | 29.27 |   | $ | 24.31 |   | $ | 30.40 |   | $ | 23.23 |   |
| Natural Gas (Henry Hub)       |       | $                              | 5.99       |   | $ | 5.27 |   | $ | 4.24 |   | $ | 2.96 |   | $ | 5.27 |   | $ | 2.46 |   |
| U.S. Land Rig Count           |       | 1,110                          |       | 964 |   | 723 |   | 912 |   | 841 |   | 550 |   |

 

Duringfiscal 2005, 2004 and 2003, substantially all the wells we drilled for ourcustomers were drilled in search of natural gas because of the depth capacityof our rigs and the natural gas rich areas in which we operate.  Although we have recently diversified ouroperations somewhat with the November 2004 acquisition of seven drillingrigs from Wolverine Drilling, with six of those rigs employed in search of oilin the Williston Basin of the Rocky Mountains, our customers remain primarilyfocused on drilling for natural gas. Natural gas reserves are typically found in deeper geological formationsand generally require premium equipment and quality crews to drill the wells.

 

***CriticalAccounting Policies and Estimates***

 

***Revenue and cost recognition*****– We earn our revenues by drilling oil and gaswells for our customers under daywork, turnkey orfootage contracts, which usually provide for the drilling of a singlewell.  We recognize revenues on daywork contracts for the days completed based on the dayrate each contract specifies.  We recognize revenues from our turnkey andfootage contracts on the percentage-of-completion method based on our estimateof the number of days to complete each contract.  Contract drilling in progress representsrevenues we have recognized in excess of amounts billed on contracts inprogress.** Individual contracts are usually completed inless than 60 days.  The risks to us undera turnkey contract, and to a lesser extent under footage contracts, aresubstantially greater than on a contract drilled on a dayworkbasis. Under a turnkey contract, we assume most of the risks associated withdrilling operations that are generally assumed by the operator in a daywork contract, including the risks of blowout, loss ofhole, stuck drill pipe, machinery breakdowns and abnormal drilling conditions,as well as risks associated with subcontractors’ services, supplies, costescalations and personnel operations.

 

Ourmanagement has determined that it is appropriate to use thepercentage-of-completion method as defined in SOP 81-1 to recognize revenue onour turnkey and footage contracts. Although our turnkey and footage contracts do not have express termsthat provide us with rights to receive payment for the work that we performprior to drilling wells to the agreed-on depth, we use this method because, asprovided in applicable accounting literature, we believe we achieve acontinuous sale for our work-in-progress and believe, under applicable statelaw, we ultimately could recover the fair value of our work-in-progress even inthe event we were unable to drill to the agreed-on depth in breach of theapplicable contract.  However, in theevent we were unable to drill to the agreed on depth in breach of the contract,ultimate recovery of that value would be subject to negotiations with thecustomer and the possibility of litigation.

 

Ifa customer defaults on its payment obligation to us under a turnkey or footagecontract, we would need to rely on applicable law to enforce our lien rights,because our turnkey and footage contracts do not expressly grant to us asecurity interest in the work we have completed under the contract and we haveno ownership rights in the work-in-progress or completed drilling work, exceptany rights arising

 

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under the applicable lien statute on foreclosure.  If we were unable to drill to the agreed ondepth in breach of the contract, we also would need to rely on equitableremedies outside of the contract, including *quantum meruit*, available in applicable courts torecover the fair value of our work-in-progress under a turnkey or footagecontract.

 

Weaccrue estimated contract costs on turnkey and footage contracts for each dayof work completed based on our estimate of the total costs to complete thecontract divided by our estimate of the number of days to complete thecontract.  Contract costs include labor,materials, supplies, repairs and maintenance, operating overhead allocationsand allocations of depreciation and amortization expense.  In addition, the occurrence of uninsured orunder-insured losses or operating cost overruns on our turnkey and footagecontracts could have a material adverse effect on our financial position andresults of operations.* *Therefore, our actual resultscould differ significantly if our cost estimates are later revised from ouroriginal estimates for contracts in progress at the end of a reporting periodwhich were not completed prior to the release of our financial statements.

 

***Asset impairments*** – We assess the impairment of property andequipment whenever events or circumstances indicate that the carrying value maynot be recoverable.  Factors that weconsider important and which could trigger an impairment review would be ourcustomers’ financial condition and any significant negative industry oreconomic trends.  More specifically,among other things, we consider our contract revenue rates, our rigutilizations rates, cash flows from our drilling rigs, current oil and gasprices, industry analysts’ outlook for the industry and their view of ourcustomers’ access to debt or equity, discussions with major industry suppliers,discussions with officers of our primary lender regarding their experiences andexpectations for oil and gas operators in our areas of operations and thetrends in the price of used drilling equipment observed by our management.  If a review of our drilling rigs indicates thatour carrying value exceeds the estimated undiscounted future net cash flows, weare required under applicable accounting standards to write down the drillingequipment to its fair market value.  Aone percent write-down in the cost of our drilling equipment, at March 31,2005, would have resulted in a corresponding decrease in our net earnings ofapproximately $1,427,000 for our fiscal year ended March 31, 2005.

 

***Deferred taxes*******– We provide deferred taxes for net operatingloss carryforwards and for the basis difference inour property and equipment between financial reporting and tax reportingpurposes.  For property and equipment,basis differences arise from differences in depreciation periods and methodsand the value of assets acquired in a business acquisition where we acquire anentity rather than just its assets.  Forfinancial reporting purposes, we depreciate the various components of ourdrilling rigs over eight to 15 years and refurbishments over three years, whilefederal income tax rules require that we depreciate drilling rigs andrefurbishments over five years. Therefore, in the first five years of our ownership of a drilling rig,our tax depreciation exceeds our financial reporting depreciation, resulting inour providing deferred taxes on this depreciation difference.  After five years, financial reportingdepreciation exceeds tax depreciation, and the deferred tax liability begins toreverse.

 

***Accounting estimates*** – We consider the recognition of revenues andcosts on turnkey and footage contracts critical accounting estimates.  On these types of contracts, we are requiredto estimate the number of days it will require for us to complete the contractand our total cost to complete the contract. Our actual costs could substantially exceed our estimated costs if weencounter problems such as lost circulation, stuck drill pipe or an undergroundblowout on contracts still in progress subsequent to the release of thefinancial statements.

 

Wereceive payment under turnkey and footage contracts when we deliver to ourcustomer a well completed to the depth specified in the contract, unless thecustomer authorizes us to drill to a shallower depth. Since 1995, when currentmanagement joined our company, we have completed all our turnkey or footagecontracts.  Although our initial costestimates for turnkey and footage contracts do not include cost estimates forrisks such as stuck drill pipe or loss of circulation, we believe that ourexperienced management team, our knowledge of geologic formations in our areasof operations, the condition of our drilling equipment and our experiencedcrews enable us to make reasonably dependable cost estimates and completecontracts according to our drilling plan. While we do bear the risk of loss for cost overruns and other eventsthat are not specifically provided for in our initial cost estimates, ourpricing of turnkey and footage contracts takes such risks intoconsideration.  When we encounter, duringthe course of our drilling operations, conditions unforeseen in the preparationof our original cost estimate, we immediately increase our cost estimate tocomplete the contracts.  If we anticipatea loss on a contract in progress at the end of a reporting period due to a changein our cost estimate, we immediately accrue the entire amount of the estimatedloss including all costs that are included in our revised estimated cost tocomplete that contract in our consolidated statement of operations for thatreporting period.  During fiscal year2005, we experienced losses on 17 of the 182 turnkey and footage contractscompleted, with losses exceeding $25,000 on ten contracts and losses exceeding$100,000 on four contracts.  We are morelikely to encounter losses on turnkey and footage contracts in years in whichrevenue rates are lower for all types of contracts.  During periods of reduced demand for drillingrigs, our overall profitability on turnkey and footage contracts hashistorically exceeded our profitability on dayworkcontracts.

 

Revenuesand costs during a reporting period could be affected for contracts in progressat the end of a reporting period which have not been completed before ourfinancial statements for that period are released.  All of our turnkey contracts in progress at March 31,2005 were completed prior to the release of the financial statements includedin this report.  At March 31, 2005our contract drilling in progress totaled approximately $5,365,000.  Of that amount accrued, turnkey and footagecontract revenues were approximately $2,344,000.  The remaining balance of approximately$3,021,000 relates to the revenue recognized but not yet billed on daywork contracts in progress at March 31, 2005.  At March 31, 2004, drilling in progresstotaled $9,131,000 of which $7,683,000 related to turnkey contracts and$1,488,000 related to daywork contracts.

 

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Weestimate an allowance for doubtful accounts based on the creditworthiness ofour customers as well as general economic conditions.  We evaluate the creditworthiness of ourcustomers based on information obtained from major industry suppliers, currentprices of oil and gas and any past experience we have with the customer.  Consequently, an adverse change in thosefactors could affect our estimate of our allowance for doubtful accounts.  In some instances, we require new customersto establish escrow accounts or make prepayments.  We typically invoice our customers at 15-dayintervals during the performance of daywork contractsand upon completion of the daywork contract.  Turnkey and footage contracts are invoicedupon completion of the contract.  Ourtypical contract provides for payment of invoices in 10 to 30 days.  We generally do not extend payment termsbeyond 30 days and have not extended payment terms beyond 60 days for any ofour contracts in the last three fiscal years. We established an allowance for doubtful accounts of $352,000 at March 31,2005, an increase of $242,000 from $110,000 at March 31, 2004.

 

Another critical estimate is our determination of the useful lives ofour depreciable assets, which directly affects our determination ofdepreciation expense and deferred taxes. A decrease in the useful life of our drilling equipment would increasedepreciation expense and reduce deferred taxes. We provide for depreciation of our drilling, transportation and otherequipment on a straight-line method over useful lives that we have estimatedand that range from three to 15 years. We record the same depreciation expense whether a rig is idle orworking.  Our estimates of the usefullives of our drilling, transportation and other equipment are based on our morethan 35 years of experience in the drilling industry with similar equipment.

 

Our other accrued expenses as of March 31, 2005 include an accrualof approximately $1,334,000 for costs incurred under the self-insurance portionof our health insurance and under our workers’ compensation insurance.  We have a deductible of (1) $100,000 percovered individual per year under the health insurance and (2) $250,000 peroccurrence under our workers’ compensation insurance, except in North Dakotawhere the deductible is $100,000.  Weaccrue for these costs as claims are incurred based on cost estimates establishedfor each claim by the insurance companies providing the administrative servicesfor processing the claims, including an estimate for incurred but not reportedclaims, estimates for claims paid directly by us, our estimate of theadministrative costs associated with these claims and our historical experiencewith these types of claims.  Managementevaluates these cost estimates by the insurance companies based on historicalclaim information and adjusts the accrued claim costs if deemed necessary.

 

***Liquidityand Capital Resources***

 

***Sources of Capital Resources***

 

Ourrig fleet has grown from eight rigs in August 2000 to 50 rigs as of March 31,2005.  We have financed this growth witha combination of debt and equity financing. We have raised additional equity or used equity for growth eight timessince January 2000 and have increased our long-term debt fromapproximately $3,909,000 at June 30, 2000 to approximately $18,200,000 at March 31,2005.  We plan to continue to grow ourrig fleet.  At March 31, 2005, ourtotal debt to total capital was approximately 7.6%.  Due to the volatility in our industry, we arereluctant to take on substantial additional debt in excess of the $20,000,000of remaining availability under our acquisition credit facility.  However, our ability to continue funding ourgrowth through the issuance of shares of our common stock is uncertain, as ourcommon stock is not heavily traded and the market price for our common stockhas been volatile in recent periods.

 

OnFebruary 20, 2004, we sold 4,400,000 shares of our common stock at $5.40per share in a private placement to accredited investors for $23,760,000 inproceeds, before related offering expenses.

 

OnAugust 11, 2004, the entire $28,000,000 in aggregate principal amount ofour 6.75% convertible subordinated debentures held by WEDGE Energy Services, L.L.C. and William H. White was converted in accordancewith the terms of those debentures into 6,496,519 shares of our common stock.

 

OnAugust 11, 2004, we also sold 4,000,000 shares of our common stock atapproximately $6.61 per share, net of underwriters’ commissions, pursuant to apublic offering we registered with the SEC. On August 31, 2004, we sold600,000 additional shares of our common stock at approximately $6.61 per share,net of underwriters’ commissions, pursuant to the underwriters’ exercise of anover-allotment option granted in connection with that public offering.

 

OnMarch 22, 2005, we sold 6,945,000 shares of our common stock, includingshares we sold pursuant to the underwriters’ exercise of an over-allotmentoption, at approximately $11.78 per share, net of underwriters’ commissions,pursuant to a public offering we registered with the SEC.

 

OnOctober 29, 2004, we entered into a $47,000,000 credit facility with agroup of lenders consisting of a $7,000,000 revolving line and letter of creditfacility and a $40,000,000 acquisition facility for the acquisition of drillingrigs, rig transportation equipment and associated equipment. Frost NationalBank is the administrative agent and lead arranger under the new creditfacility, and the lenders include Frost National Bank, the Bank of Scotland andZions First National Bank. Borrowings under the newcredit facility bear interest at a rate equal to Frost National Bank’s primerate (5.75% at March 31, 2005) and are secured by most of our assets,including all our drilling rigs, associated equipment and receivables. Asdescribed below, we borrowed the entire $40,000,000 available under theacquisition facility and we have used approximately $2,825,000 of availabilityunder the revolving line and letter of credit facility through the issuance ofletters of credit in the ordinary course of

 

21

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business.On March 29, 2005, we repaid $20,000,000 of the borrowings under theacquisition facility.  On May 11, 2005,the lenders agreed to an amendment to the acquisition facility to provide uswith the ability to draw an additional $20,000,000 for future acquisitions.  The remaining approximately $20,0000,000 and$4,175,000 of availability under the acquisition facility and the revolvingline and letter of credit facility, respectively, should remain available to usuntil those facilities mature in October 2006 and October 2005,respectively.

 

***Uses of Capital Resources***

 

Inlate May 2004 and late December 2004, we completed constructing, primarilyfrom used components, two 1000 horsepower electric drilling rigs, at a cost ofapproximately $5,000,000 and $6,500,000, respectively.  In late March 2005, we completed theconstruction, primarily from used components, of a 1000 horsepower mechanicalrig, at a cost of approximately $5,700,000.

 

InNovember 2004, we acquired a fleet of seven drilling rigs and relatedequipment from Wolverine Drilling, obtained noncompetitionagreements from the two stockholders of Wolverine Drilling and purchased a4.7-acre rig storage and maintenance yard in Kenmare, North Dakota for totalconsideration of $28,000,000 in cash. In December 2004, we acquired afleet of five drilling rigs and related equipment and a 17-acre rig storage andmaintenance yard located in Woodward, Oklahoma from Allen Drilling for totalconsideration of $7,200,000 in cash. We also obtained a noncompetitionagreement from the President of Allen Drilling for additional consideration tobe paid over the next five years. We funded the purchase price for each ofthese acquisitions with borrowings under our new credit facility aggregating$35,200,000.

 

Wehave also begun constructing, from new and used components, two 1000 horsepowerelectric rigs at an estimated cost of $6,500,000 each. We expect to place oneof these rigs in service in June 2005 and the second in August 2005.  As of March 31, 2005, we have incurredapproximately $3,300,000 of construction costs on these rigs.

 

Forfiscal year 2006, we project regular rig capital expenditures to beapproximately $20,200,000, rig upgrade expenditures to be approximately$9,000,000, transportation equipment capital expenditures of approximately$2,900,000 and other capital expenditures of approximately $1,400,000.  These capital expenditures are expected to befunded primarily from operating cash flow in excess of cash flow necessary tomeet routine contractual obligations.

 

Forthe years ended March 31, 2005 and 2004, the additions to our property andequipment consisted of the following:

 
| ** **               | ** ** | **Years Ended March 31,** | ** ** |
|--------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **2005**                       | ** ** | **2004** | ** ** |
|                     |       |                           |       |   |   |
| Drilling rigs (1)        |       | $                              | 53,341,420 |   | $ | 34,961,004 |   |
| Other drilling equipment |       | 22,674,774                     |       | 7,642,968 |   |
| Transportation equipment |       | 2,717,181                      |       | 2,160,838 |   |
| Other                    |       | 1,655,108                      |       | 79,935 |   |
|                     |       | $                              | 80,388,483 |   | $ | 44,844,745 |   |

 

----

(1) Includes capitalized interest costs of$86,819 in 2005 and $106,395 in 2004.

 

***Working Capital***

 

Ourworking capital increased to $76,326,669 at March 31, 2005 from $6,028,018at March 31, 2004.  Our currentratio, which we calculate by dividing our current assets by our currentliabilities, was 3.70 at March 31, 2005 compared to 1.27 at March 31,2004.  The principal reason for theincrease in our working capital at March 31, 2005 was the approximately$61,300,000 in proceeds, after the payment of $20,000,000 of long-term debt,from the shares of common stock we sold in a public offering on March 22,2005.  Approximately $13,000,000 of theproceeds from that offering will be used for the construction of the two rigsdescribed above.  We anticipate that theremaining proceeds will be used for future rig and equipment acquisitions.

 

Ouroperations have historically generated sufficient cash flow to meet ourrequirements for debt service and equipment expenditures (excluding rig andother major equipment acquisitions). However, during periods when a higher percentage of our contracts areturnkey and footage contracts, our short-term working capital needs couldincrease.  The significant improvement inoperating cash flow for the year ended March 31, 2005 over March 31,2004 is due primarily to the approximately $12,600,000 overall improvement innet earnings, components of which are discussed in “Results ofOperations.”  That improvement was net ofapproximately $6,900,000 in noncash depreciation andamortization expense.  If necessary, wecan defer rig upgrades to improve our cash position.  We believe our cash generated by operationsand our ability to borrow the currently unused portion of our line of creditand letter of credit facility of approximately $4,175,000, which takes intoaccount reductions for approximately $2,825,000 of outstanding letters ofcredit as of March 31, 2005, should allow us to meet our routine financialobligations for the foreseeable future.

 

22

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Thechanges in the components of our working capital were as follows:

 
| ** **                 | ** ** | **March 31,** | ** ** |
|----------------------------|------------|--------------------|------------|
| ** **                 | ** ** | **2005**           | ** ** | **2004** | ** ** | **Change** | ** ** |
| Cash and cash equivalents  |       | $                  | 69,673,279 |   | $ | 1,815,759 |   | $ | 67,857,520 |   |
| Marketable securities      |       | 1,000,000          |       | 4,550,000 |   | (3,550,000 | ) |
| Receivables                |       | 26,108,291         |       | 10,901,991 |   | 15,206,300 |   |
| Contract drilling          |       | 5,364,529          |       | 9,130,794 |   | (3,766,265 | ) |
| Deferred tax receivable    |       | 569,548            |       | 285,384 |   | 284,164 |   |
| Prepaid expenses           |       | 1,876,843          |       | 1,336,337 |   | 540,506 |   |
| Current assets             |       | 104,592,490        |       | 28,020,265 |   | 76,572,225 |   |
|                       |       |               |       |   |   |   |   |
| Current debt               |       | 5,415,001          |       | 4,423,306 |   | 991,695 |   |
| Accounts payable           |       | 15,621,647         |       | 13,270,989 |   | 2,350,658 |   |
| Accrued payroll            |       | 2,706,623          |       | 1,499,151 |   | 1,207,472 |   |
| Income tax payable         |       | 195,949            |       | — |   | 195,949 |   |
| Prepaid drilling contracts |       | 172,750            |       | — |   | 172,750 |   |
| Accrued expenses           |       | 4,153,851          |       | 2,798,801 |   | 1,355,050 |   |
|                       |       | 28,265,821         |       | 21,992,247 |   | 6,273,574 |   |
|                       |       |               |       |   |   |   |   |
| Working capital            |       | $                  | 76,326,669 |   | $ | 6,028,018 |   | $ | 70,298,651 |   |

 

Thelarge cash balance at March 31, 2005 was due to our sale of shares ofcommon stock on March 22, 2005 for net proceeds of approximately$81,300,000, of which $20,000,000 was used to reduce long-term debt and$61,300,000 was in the March 31, 2005 cash balance.

 

Theincrease in our receivables at March 31, 2005 from March 31, 2004 wasdue to our operating 15 additional rigs in the quarter ended March 31,2005, and an improvement in utilization and revenue rates in the fourth quarterof fiscal year 2005 over fiscal year 2004.

 

Substantiallyall our prepaid expenses at March 31, 2005 consisted of prepaidinsurance.  The increase in prepaidinsurance was primarily due to the increase in the size of our drilling rigfleet from 35 rigs at March 31, 2004 to 50 rigs at March 31, 2005.

 

Theincrease in payables at March 31, 2005 from March 31, 2004 wasprimarily due to the increase in the size of our drilling rig fleet.

 

Theincrease in accrued payroll was primarily due to the approximately 49% increasein our number of employees and the increase in the number of payroll daysincluded in the accrual from nine days at March 31, 2004 to ten days at March 31,2005.

 

Thetotal increase in accrued expenses at March 31, 2005 from March 31,2004 was due to an increase of approximately $685,000 in the accrual for ourinsurance deductibles and additional insurance premiums, an increase in bonusaccruals of approximately $525,000, an increase in vacation pay accruals ofapproximately $101,000 and an increase in accrued property taxes ofapproximately $171,000 due to increases in rig valuations and the size of ourrig fleet.  These increases were offsetby a decrease of approximately $127,000 in other accrued expense items.

 

Although,we have not been required to make income tax payments for the last three years,it is likely we will be in a current taxable position during fiscal year 2006due to improving market conditions and the reversal of deferred taxliabilities.

 

23

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***Long-term Debt***

 

Ourlong-term debt at March 31, 2005 and 2004 consisted of the following:

 
| ** **                                                                                                                                                                                                                          | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                                                                                                                                                                                                |       |       |       |       |       |
| Indebtedness incurred under $47,000,000  credit facility, secured by drilling equipment, due in monthly payments of  $388,889 plus interest at prime (5.75% at March 31, 2005), with final  maturity on December 1, 2007  |       | $          | 18,077,778 |       | $          | — |   |
|                                                                                                                                                                                                                                |       |       |       |       |       |
| Convertible subordinated debentures due July 2007  at 6.75% (1)                                                                                                                                                                |       | —     |       | 28,000,000 |       |
|                                                                                                                                                                                                                                |       |       |       |       |       |
| Note payable to Merrill Lynch Capital,  secured by drilling equipment, due in monthly payments of $172,619 plus  interest at a floating rate equal to the three month LIBOR rate plus 385  basis points, due December 2007 (2) |       | —     |       | 13,119,048 |       |
|                                                                                                                                                                                                                                |       |       |       |       |       |
| Note payable to Frost National Bank,  secured by drilling equipment, due in monthly payments of $107,143 plus  interest at prime plus 1.00%, due August 2007 (2)                                                               |       | —     |       | 4,392,174  |       |
|                                                                                                                                                                                                                                |       |       |       |       |       |
| Note payable to Frost National Bank,  secured by drilling equipment, due in monthly payments of $42,401, including  interest at prime plus 1.0%, beginning April 15, 2004, due March 15,  2007 (2)                        |       | —     |       | 3,000,000  |       |
|                                                                                                                                                                                                                                |       | 18,077,778 |       | 48,511,222 |       |
|                                                                                                                                                                                                                                |       |       |       |       |       |
| Less current installments                                                                                                                                                                                                           |       | (4,666,667 | )          | (3,724,302 | )          |
|                                                                                                                                                                                                                                |       | $          | 13,411,111 |       | $          | 44,786,920 |   |

 

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(1)          Wedge Energy Services, LLC (“WEDGE”) held $27,000,000 of the convertiblesubordinated debentures and William H. White, a former director of our company,held $1,000,000 of the convertible subordinated debentures.  The convertible subordinate debentures wereconverted into 6,496,519 shares of our common stock on August 11, 2004.

 

(2)          These notes were repaid in August and September 2004 withproceeds from our August 2004 common stock offering.

 

*ContractualObligations*

 

Wedo not have any routine purchase obligations. However, as of March 31, 2005, we were in the process ofconstructing two drilling rigs, as described above.  The following table excludes interestpayments on long-term debt and capital lease obligations.  The following table includes all of ourcontractual obligations of the type specified below at March 31, 2005:

 
| ** **                   | ** ** | **Payments Due by Period** | ** ** |
|------------------------------|------------|----------------------------|------------|
| **Contractual  Obligations** | ** ** | **Total**                  | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **4-5  years** | ** ** | **More than 5  years** | ** ** |
|                         |       |                       |       |   |   |   |   |   |   |   |   |
| Long-Term Debt Obligations   |       | $                          | 18,077,778 |   | $ | 4,666,667 |   | $ | 13,411,111 |   | $ | — |   | $ | — |   |
| Capital Lease Obligations    |       | 100,265                    |       | 66,359 |   | 33,906 |   | — |   | — |   |
| Operating Lease Obligations  |       | 1,991,934                  |       | 224,873 |   | 391,427 |   | 472,196 |   | 903,438 |   |
| Total                        |       | $                          | 20,169,977 |   | $ | 4,957,899 |   | $ | 13,836,444 |   | $ | 472,196 |   | $ | 903,438 |   |

 

24

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***Debt Requirements***

 

The$18,077,778 amount of indebtedness outstanding under the acquisition facilityportion of our new credit facility is due in monthly installments of $388,889plus interest, based on a 72-month amortization schedule, with all remainingunpaid principal being due on December 1, 2007. All the indebtedness underthe acquisition facility bears interest at Frost National Bank’s prime rate(5.75% as of March 31, 2005).

 

Thesum of (1) the draws under and (2) the amount of all outstanding lettersof credit issued for our account under the revolving line and letter of creditfacility portion of our new credit facility are limited to 75% of our eligibleaccounts receivable, not to exceed $7,000,000. Therefore, if 75% of oureligible accounts receivable was less than $7,000,000, our ability to drawunder this line would be reduced. At March 31, 2005, we had no outstandingadvances under this line of credit, outstanding letters of credit were$2,825,000 and 75% of our eligible accounts receivable was approximately$19,084,000. The letters of credit are issued to three workers’ compensationinsurance companies to secure possible future claims under the deductibles onthese policies. It is our practice to pay any amounts due under thesedeductibles as they are incurred. Therefore, we do not anticipate that thelenders will be required to fund any draws under these letters of credit. Thetermination date of the revolving line and letter of credit facility portion ofour new credit facility is October 28, 2005.

 

Ournew credit facility contains various covenants pertaining to a debt to totalcapitalization ratio, operating leverage ratio and fixed charge coverage ratioand restricts us from paying dividends. We determine compliance with the ratioson a quarterly basis, based on the previous four quarters. Events of default,which could trigger an early repayment requirement, include, among others:

 

•                  our failure to makerequired payments;

 

•                  any sale of assets by usnot permitted by the credit facility;

 

•                  our failure to comply withfinancial covenants related to a debt to total capitalization ratio not toexceed 0.3 to 1, an operating leverage ratio not to exceed 3 to 1, and a fixedcharge coverage ratio of not less than 1.5 to 1;

 

•                  our incurrence of additionalindebtedness in excess of $3,000,000 not already allowed by the creditfacility;

 

•                  any event which results ina change in the ownership of at least 40% of all classes of our outstandingcapital stock; and

 

•                  any payment of cashdividends on our common stock.

 

Thelimitation on additional indebtedness described above has not affected ouroperations or liquidity and we do not expect it to affect our future operationsor liquidity, as we expect to continue to generate adequate cash flow fromoperations to fund our anticipated working capital and other normal cash flowrequirements.

 

***Resultsof Operations***

 

Ouroperations consist of drilling oil and gas wells for our customers under daywork, turnkey, or footage contracts usually on awell-to-well basis.  Dayworkcontracts are the least complex for us to perform and involve the leastrisk.  Turnkey contracts are the mostdifficult to perform and involve much greater risk but provide the opportunityfor higher operating profits.

 

***Daywork******Contracts*****.**  Under daywork drilling contracts, we provide a drilling rig withrequired personnel to our customer, who supervises the drilling of thewell.  We are paid based on a negotiatedfixed rate per day while the rig is used. During the mobilization period we typically earn a fixed amount ofrevenue based on the mobilization rate stated in the contract.  We attempt to set the mobilization rate at anamount equal to our external costs for the move plus our internal costs duringthe mobilization period.  We beginearning our contracted daywork rate when we begindrilling the well.  Occasionally, inperiods of increased demand, some of our contracts will provide for thetrucking costs to be paid by the customer and we will receive a reduced dayrate during the mobilization period.

 

***Turnkey Contracts.**** *Under a turnkeycontract, we agree to drill a well for our customer to a specified depth andunder specified conditions for a fixed price, regardless of the time requiredor the problems encountered in drilling the well.  We provide technical expertise andengineering services, as well as most of the equipment and drilling suppliesrequired to drill the well.  We oftensubcontract for related services, such as the provision of casing crews, cementingand well logging.  Under typical turnkeydrilling arrangements, we do not receive progress payments and are entitled tobe paid by our customer only after we have performed the terms of the drillingcontract in full.  The risks under aturnkey contract are greater than those under a dayworkcontract, because under a turnkey contract we assume most of the risksassociated with drilling operations that the operator generally assumes under adaywork contract.

 

25

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***Footage Contracts*****.**  Underfootage contracts, we are paid a fixed amount for each foot drilled, regardlessof the time required or the problems encountered in drilling the well.  We typically pay more of the out-of-pocketcosts associated with footage contracts as compared to dayworkcontracts.  Similar to turnkey contracts,under a footage contract we assume most of the risks associated with drillingoperations that the operator generally assumes under a dayworkcontract.

 

Wehave a history of losses.  We incurrednet losses of approximately $1,800,000, $5,100,000 and $400,000 in the fiscalyears ended March 31, 2004, 2003 and 2000, respectively.  Our profitability in the future will dependon many factors, but largely on utilization rates and dayratesfor our drilling rigs.

 

Thecurrent demand for drilling rigs greatly influences the types of contracts weare able to obtain.  As the demand forrigs increases, daywork rates move up and we are ableto switch primarily to daywork contracts.

 

Forthe years ended March 31, 2005, 2004 and 2003, the percentages of ourdrilling revenues by type of contract were as follows:

 
| ** **         | ** ** | **Years Ended March 31,** | ** ** |
|--------------------|------------|--------------------------------|------------|
| ** **         | ** ** | **2005**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Daywork  Contracts |       | 52                             | %          | 47 | % | 41 | % |
| Turnkey Contracts  |       | 43                             | %          | 50 | % | 58 | % |
| Footage Contracts  |       | 5                              | %          | 3 | % | 1 | % |

 

Whiledemand for drilling rigs has been increasing, we continue to bid on turnkeycontracts in an effort to meet our customer demand and maintain rigutilization.  With the improvements in daywork contract rates, we anticipate a gradual decline inthe number of turnkey contracts.  We had6 turnkey contracts in progress at March 31, 2005 compared to 16 turnkeycontracts in progress at March 31, 2004. We also had 6 footage contracts in progress at March 31, 2005compared to none in progress at March 31, 2004.

 

Inour years ended March 31, 2005 and 2004, we recognized revenues ofapproximately $4,885,000 and $924,000, respectively, and recorded contractdrilling costs of approximately $3,263,000 and $745,000, respectively,excluding depreciation, on contracts with Chesapeake Energy Corporation.  At March 31, 2005, Chesapeake owned16.78% of our outstanding common stock.

 

26

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***Statements of Operations Analysis***

 

The following table provides information about our operations for theyears ended March 31, 2005, March 31, 2004, and March 31, 2003.

 
| ** **                                | ** ** | **Years Ended March 31,** | ** **  |
|-------------------------------------------|------------|--------------------------------|-------------|
| ** **                                | ** ** | **2005**                       | ** **  | **2004** | ** ** | **2003** | ** ** |
| Contract drilling revenues:               |       |                           |        |   |   |   |   |
| Daywork  contracts                        |       | $                              | 95,997,451  |   | $ | 50,144,773 |   | $ | 33,203,385 |   |
| Turnkey contracts                         |       | 80,210,813                     |        | 54,234,756 |   | 45,889,585 |   |
| Footage contracts                         |       | 9,038,184                      |        | 3,496,004 |   | 1,090,516 |   |
| Total contract drilling revenues          |       | $                              | 185,246,448 |   | $ | 107,875,533 |   | $ | 80,183,486 |   |
| Contract drilling costs:                  |       |                           |        |   |   |   |   |
| Daywork  contracts                        |       | $                              | 68,415,608  |   | $ | 42,903,525 |   | $ | 29,289,493 |   |
| Turnkey contracts                         |       | 63,421,106                     |        | 42,761,928 |   | 40,482,547 |   |
| Footage contracts                         |       | 6,646,045                      |        | 2,838,649 |   | 1,051,270 |   |
| Total contract drilling costs             |       | $                              | 138,482,759 |   | $ | 88,504,102 |   | $ | 70,823,310 |   |
|                                      |       |                           |        |   |   |   |   |
| Depreciation and amortization             |       | $                              | 23,090,909  |   | $ | 16,160,494 |   | $ | 11,960,387 |   |
| General and administrative expense        |       | $                              | 4,657,013   |   | $ | 2,772,730 |   | $ | 2,232,390 |   |
| Revenue days by type of contract:         |       |                           |        |   |   |   |   |
| Daywork  contracts                        |       | 8,685                          |        | 5,626 |   | 3,681 |   |
| Turnkey contracts                         |       | 4,471                          |        | 2,827 |   | 2,619 |   |
| Footage contracts                         |       | 738                            |        | 311 |   | 119 |   |
| Total Revenue days                        |       | 13,894                         |        | 8,764 |   | 6,419 |   |
|                                      |       |                           |        |   |   |   |   |
| Contract drilling revenue per revenue day |       | $                              | 13,333      |   | $ | 12,309 |   | $ | 12,492 |   |
| Contract drilling cost per revenue day    |       | $                              | 9,967       |   | $ | 10,099 |   | $ | 11,033 |   |
| Rig utilization rates                     |       | 96                             | %           | 88 | % | 79 | % |
| Average number of rigs during the period  |       | 40.1                           |        | 27.3 |   | 22.3 |   |
|                                      |       |                           |        |   |   |   |   |

 

Ourcontract drilling revenues grew by approximately $77,000,000, or 72%, in fiscalyear 2005 from fiscal year 2004, primarily due to the 59% increase in revenuedays (approximately $63,000,000) and the approximately $1,000 increase inrevenue per revenue day (approximately $14,000,000), which was attributable toimproving market conditions in our industry.

 

Ourcontract drilling revenues grew by approximately $28,000,000, or 35%, in fiscalyear 2004 from fiscal year 2003, primarily due to a 37% increase in revenuedays, which was mostly attributable to the 22% increase in the average numberof rigs in our rig fleet, and a 9% increase in rig utilization.  The $183 per day decrease in average contractdrilling revenue is due to the decrease in turnkey and footage revenue days asa percentage of total revenue days.

 

Ourcontract drilling costs in fiscal year 2005 grew by approximately $50,000,000,or 56%, primarily due to the increases in 2005 in revenue days and rigutilization referred to above.  The $132decrease in average cost per revenue day was primarily due to the greaterincrease in daywork revenue days (3,059 days) infiscal 2005 over the increase in turnkey and footage revenue days (2,071).  Under dayworkcontracts, our customer provides supplies and materials, such as fuel, drillbits, casing and drilling fluids, which we are required to provide underturnkey contracts.

 

Ourcontract drilling costs grew by approximately $18,000,000, or 25%, in fiscalyear 2004 from fiscal year 2003 due to the increase in revenue days and rigutilization. The increase in daywork revenue days by1,945 revenue days in fiscal year 2004 resulted in a $934 decrease in contractdrilling costs per revenue day because costs associated with the drilling of daywork contracts is less than costs associated withturnkey and footage contracts which only increased by 400 revenue days infiscal year 2004.

 

Ourdepreciation and amortization expense in 2005 increased by approximately$7,000,000, or 43%, from 2004. Depreciation and amortization expense in 2004increased approximately $4,000,000, or 35%, from 2003.  The increase in 2005 over 2004 resulted fromour addition of 15 drilling rigs and related equipment in 2005.  The increase in 2004 over 2003 resulted fromour addition of 11 drilling rigs and related equipment during 2004.

 

Ourgeneral and administrative expenses increased by approximately $1,900,000, or68%, in fiscal year 2005 from fiscal year 2004. The increase resulted from increased payroll costs, professional andconsulting costs, insurance costs and director fees.  Payroll related costs

 

27

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increased by approximately $894,000 due to pay increases, staffadditions and an approximately $610,000 increase in bonus costs.  Professional and consulting costs increasedapproximately $587,000, with much of this increase due to the implementation ofSarbanes-Oxley compliance procedures. Director fees increased approximately $142,000.  Insurance costs increased approximately$89,000, due to an increase in the cost of director and officer liabilityinsurance coverage.

 

Ourgeneral and administrative expenses increased by approximately $541,000, or24%, in fiscal year 2004 from fiscal year 2003. The increase resulted from increased payroll costs, employment fees,loan fees, insurance costs and director fees. In 2004, payroll costs increased by approximately $310,000 due to payraises and the increase from 12 to 17 employees in our corporate office.  Employment and loan fees increased by $61,000due to the employee additions and fees associated with the Merrill LynchCapital loan.  In addition, ourdirectors’ and officers’ liability and employment practices insurance increasedby approximately $60,000 and directors’ fees increased by approximately$93,000.

 

Ourcontract land drilling operations are subject to various federal and state lawsand regulations designed to protect the environment.  Maintaining compliance with these regulationsis part of our day-to-day operating procedures. We monitor each of our yard facilities and each of our rig locations ona day-to-day basis for potential environmental spill risks.  In addition, we maintain a spill preventioncontrol and countermeasures plan for each yard facility and each riglocation.  The costs of these proceduresrepresent only a small portion of our routine employee training, equipmentmaintenance and job site maintenance costs. We estimate the annual compliance costs for this program isapproximately $212,000.  We are not awareof any potential clean-up obligations that would have a material adverse effecton our financial condition or results of operations.

 

Oureffective income tax rates of 37.0%, 19.2% and 30.4% for 2005, 2004 and 2003,respectively, differ from the federal statutory rate of 34% due to permanentdifferences.  Permanent differences arecosts included in results of operations in the accompanying financialstatements which are not fully deductible for federal income tax purposes.  At March 31, 2005, we had a netoperating loss carryforwards for income tax purposesof approximately $16,500,000, of which approximately $6,600,000 will expire in2023 and $9,900,000 in 2024.  We feelthat it is more likely than not that we will realize the benefits of thesedeductible differences.  Therefore, wehave established a deferred tax asset applicable to these net operating loss carryforwards of approximately $4,300,000.

 

**Inflation**

 

Asa result of the relatively low levels of inflation during the past two years,inflation did not significantly affect our results of operations in any of theperiods reported.

 

**Off Balance Sheet Arrangements**

 

Wedo not currently have any off balance sheet arrangements.

 

**Recently Issued Accounting Standards**

 

In December 2004, the FASBissued SFAS No. 123 (revised 2004), *Share-Based Payment.*  SFAS No. 123R is arevision of FASB  SFAS No.123, *Accounting for Stock-Based Compensation*and supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees,*and its related implementationguidance.  SFASNo. 123R established standards for the accounting for transactions in which anentity exchanges its equity instruments for goods or services.  It also addresses transactions in which anentity incurs liabilities in exchange for goods or services that are based onthe fair value of the entity’s equity instruments or that may be settled by theissuance of those equity instruments.  SFAS No. 123R focuses primarily on accounting for transactionsin which an entity obtains employee services in share-based paymenttransactions.  SFASNo. 123R requires a public entity to measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award (with limited exceptions).  That cost will be recognized over the periodduring which an employee is required to provide service in exchange for theaward.  The provisions of SFAS No. 123R are effective for public entities that do notfile as small business issuers as of the beginning of the first annualreporting period that begins after June 15, 2005.  We are currently evaluating the negativeimpact SFAS No. 123R will have on our financialposition and results of operations in fiscal year 2007.  The negative impact will be created due tothe fact that we previously issued employee stock options for which no expensehas been recognized, as these options will not be fully vested as of theeffective date of SFAS No. 123R.

 

## ***Item 7A.***           Quantitative and Qualitative Disclosures About Market Risk

##  

Weare subject to market risk exposure related to changes in interest rates onmost of our outstanding debt.  At March 31,2005, we had outstanding debt of approximately $18,078,000 that was subject tovariable interest rates, based on Frost National Bank’s prime interestrate.  An increase or decrease of 1% inthat interest rate would have a corresponding decrease or increase in our netincome (loss) of approximately $120,000 annually.  We did not enter into this debt arrangementfor trading purposes.

 

28

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***Item 8.*****                   ****Financial Statements andSupplementary Data**

 

PIONEERDRILLING COMPANY

 

INDEXTO CONSOLIDATED FINANCIAL STATEMENTS

 
| Reports  of Independent Registered Public Accounting Firm                                                                              |   |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                   |   |
| Consolidated Balance Sheets  as of March 31, 2005 and 2004                                                                        |   |
|                                                                                                                                   |   |
| Consolidated  Statements of Operations for the Years Ended March 31, 2005, 2004 and  2003                                         |   |
|                                                                                                                                   |   |
| Consolidated  Statements of Shareholders’ Equity and Comprehensive Income for the Years  Ended March 31, 2005, 2004 and 2003 |   |
|                                                                                                                                   |   |
| Consolidated  Statements of Cash Flows for the Years Ended March 31, 2005, 2004 and  2003                                         |   |
|                                                                                                                                   |   |
| Notes to  Consolidated Financial Statements                                                                                            |   |

 

29

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and ShareholdersPioneer Drilling Company:

 

We have audited the accompanying consolidated balance sheets of PioneerDrilling Company and subsidiaries as of March 31, 2005 and 2004, and therelated consolidated statements of operations, stockholders’ equity, and cashflows for each of the years in the three-year period ended March 31, 2005.In connection with our audits of the consolidatedfinancial statements, we also have audited the financial statement schedule II.  These consolidated financial statements andfinancial statement schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement.  Anaudit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of PioneerDrilling Company and subsidiaries as of March 31, 2005 and 2004, and theresults of their operations and their cash flows for each of the years in thethree-year period ended March 31, 2005, in conformity with U.S. generallyaccepted accounting principles.  Also inour opinion, the related financial statement schedule, when considered inrelation to the basic consolidatedfinancial statements taken as a whole, present fairly, in all materialrespects, the information set forth therein.

 

We also have audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the effectiveness ofPioneer Drilling Company’s internal control over financial reporting as of March 31,2005, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO), and our report dated May 27, 2005expressed an unqualified opinion on management’s assessment of, and theeffective operation of, internal control over financial reporting.

 

 

KPMGLLP

 

SanAntonio, TexasMay 27, 2005

 

30

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# **REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

#  

TheBoard of Directors and Stockholders

PioneerDrilling Company:

 

Wehave audited management’s assessment, included in Management’s Report onInternal Control over Financial Reporting in Item 9A of Pioneer DrillingCompany’s Annual Report on Form 10-K for the year ended March 31,2005, that Pioneer Drilling Company and subsidiaries maintained effectiveinternal control over financial reporting as of March 31, 2005, based on**criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO)*.*PioneerDrilling Company’s management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of theCompany’s internal control over financial reporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of the Company’sinternal control over financial reporting, evaluating management’s assessment,testing and evaluating the design and operating effectiveness of the Company’sinternal control over financial reporting, and performing such other proceduresas we considered necessary in the circumstances. We believe that our auditprovides a reasonable basis for our opinion.

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal control over financial reporting includes thosepolicies and procedures that (1) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

Inour opinion, management’s assessment that Pioneer Drilling Company maintainedeffective internal control over financial reporting as of March 31, 2005,is fairly stated, in all material respects, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO)*.*Also,in our opinion, Pioneer Drilling Company maintained, in all material respects,effective internal control over financial reporting as of March 31, 2005,based on criteria established in Internal Control—Integrated Framework issuedby the Committee of Sponsoring Organizations of the TreadwayCommission (COSO).

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets ofPioneer Drilling Company and subsidiaries as of March 31, 2005 and 2004,and the related consolidated statements of operations, stockholders’ equity,and cash flows for each of the years in the three-year period ended March 31,2005, and our report dated May 27, 2005**expressed an unqualified opinion on those consolidated financialstatements*.*

 

 
| KPMG  LLP           |
|---------------------|
|                |
|                |
| San  Antonio, Texas |
| May 27,  2005  |

 

31

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**PIONEER DRILLING COMPANY ANDSUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                                                                                | ** ** | **March 31,** | ** **  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|
| ** **                                                                                                                                                                                | ** ** | **2005**           | ** **  | **2004** | ** ** |
| ASSETS                                                                                                                                                                                    |       |               |        |   |   |
| Current assets:                                                                                                                                                                           |       |               |        |   |   |
| Cash and cash equivalents                                                                                                                                                                 |       | $                  | 69,673,279  |   | $ | 1,815,759 |   |
| Marketable securities                                                                                                                                                                     |       | 1,000,000          |        | 4,550,000 |   |
| Receivables:                                                                                                                                                                              |       |               |        |   |   |
| Trade, net                                                                                                                                                                                |       | 26,108,291         |        | 10,901,991 |   |
| Contract drilling in progress                                                                                                                                                             |       | 5,364,529          |        | 9,130,794 |   |
| Current deferred income taxes                                                                                                                                                             |       | 569,548            |        | 285,384 |   |
| Prepaid expenses                                                                                                                                                                          |       | 1,876,843          |        | 1,336,337 |   |
| Total current assets                                                                                                                                                                      |       | 104,592,490        |        | 28,020,265 |   |
| Property and equipment, at cost:                                                                                                                                                          |       |               |        |   |   |
| Drilling rigs and equipment                                                                                                                                                               |       | 216,286,747        |        | 145,758,913 |   |
| Transportation equipment                                                                                                                                                                  |       | 6,469,519          |        | 4,282,349 |   |
| Land, buildings and other                                                                                                                                                                 |       | 2,691,673          |        | 1,145,288 |   |
|                                                                                                                                                                                      |       | 225,447,939        |        | 151,186,550 |   |
| Less accumulated depreciation and  amortization                                                                                                                                           |       | 54,881,488         |        | 35,844,938 |   |
| Net property and equipment                                                                                                                                                                |       | 170,566,451        |        | 115,341,612 |   |
| Intangible and other assets                                                                                                                                                               |       | 850,381            |        | 369,278 |   |
| Total assets                                                                                                                                                                              |       | $                  | 276,009,322 |   | $ | 143,731,155 |   |
|                                                                                                                                                                                      |       |               |        |   |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                                 |       |               |        |   |   |
| Current liabilities:                                                                                                                                                                      |       |               |        |   |   |
| Notes payable                                                                                                                                                                             |       | $                  | 681,975     |   | $ | 558,070 |   |
| Current installments of long-term debt                                                                                                                                                    |       | 4,666,667          |        | 3,724,302 |   |
| Current installments of capital lease  obligations                                                                                                                                        |       | 66,359             |        | 140,934 |   |
| Accounts payable                                                                                                                                                                          |       | 15,621,647         |        | 13,270,989 |   |
| Income tax payable                                                                                                                                                                        |       | 195,949            |        | — |   |
| Prepaid drilling contracts                                                                                                                                                                |       | 172,750            |        | — |   |
| Accrued expenses:                                                                                                                                                                         |       |               |        |   |   |
| Payroll and payroll taxes                                                                                                                                                                 |       | 2,706,623          |        | 1,499,151 |   |
| Other                                                                                                                                                                                     |       | 4,153,851          |        | 2,798,801 |   |
| Total current liabilities                                                                                                                                                                 |       | 28,265,821         |        | 21,992,247 |   |
| Long-term debt, less current installments                                                                                                                                                 |       | 13,411,111         |        | 44,786,920 |   |
| Capital lease obligations, less current  installments                                                                                                                                     |       | 33,906             |        | 104,754 |   |
| Non-current liability                                                                                                                                                                     |       | 400,000            |        | — |   |
| Deferred income taxes                                                                                                                                                                     |       | 12,283,070         |        | 6,010,916 |   |
| Total liabilities                                                                                                                                                                         |       | 54,393,908         |        | 72,894,837 |   |
| Commitments and contingencies                                                                                                                                                             |       | —             |        | — |   |
| Shareholders’ equity:                                                                                                                                                                |       |               |        |   |   |
| Preferred stock, 10,000,000 shares  authorized; none issued and outstanding                                                                                                               |       | —             |        | — |   |
| Common stock $.10 par value; 100,000,000  shares authorized; 45,893,311 shares and 27,300,126 shares issued and  outstanding at March 31, 2005 and March 31, 2004, respectively |       | 4,589,331          |        | 2,730,012 |   |
| Additional paid-in capital                                                                                                                                                                |       | 220,232,520        |        | 82,124,368 |   |
| Accumulated deficit                                                                                                                                                                       |       | (3,206,437         | )           | (14,018,062 | ) |
| Total shareholders’ equity                                                                                                                                                           |       | 221,615,414        |        | 70,836,318 |   |
| Total liabilities and shareholders’ equity                                                                                                                                           |       | $                  | 276,009,322 |   | $ | 143,731,155 |   |

 

See accompanying notes to consolidated financial statements.

 

32

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**PIONEER DRILLING COMPANY AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                               | ** ** | **Years Ended March 31,** | ** **  |
|----------------------------------------------------------|------------|--------------------------------|-------------|
| ** **                                               | ** ** | **2005**                       | ** **  | **2004** | ** ** | **2003** | ** ** |
|                                                     |       |                           |        |   |   |   |   |
| Contract drilling revenues                               |       | $                              | 185,246,448 |   | $ | 107,875,533 |   | $ | 80,183,486 |   |
|                                                     |       |                           |        |   |   |   |   |
| Costs and expenses:                                      |       |                           |        |   |   |   |   |
| Contract drilling                                        |       | 138,482,759                    |        | 88,504,102 |   | 70,823,310 |   |
| Depreciation and amortization                            |       | 23,090,909                     |        | 16,160,494 |   | 11,960,387 |   |
| General and administrative                               |       | 4,657,013                      |        | 2,772,730 |   | 2,232,390 |   |
| Bad debt expense                                         |       | 242,000                        |        | — |   | 110,000 |   |
|                                                     |       |                           |        |   |   |   |   |
| Total operating costs and expenses                       |       | 166,472,681                    |        | 107,437,326 |   | 85,126,087 |   |
| Income (loss) from operations                            |       | 18,773,767                     |        | 438,207 |   | (4,942,601 | ) |
|                                                     |       |                           |        |   |   |   |   |
| Other income (expense):                                  |       |                           |        |   |   |   |   |
| Interest expense                                         |       | (1,722,393                     | )           | (2,807,822 | ) | (2,698,529 | ) |
| Interest income                                          |       | 173,318                        |        | 101,584 |   | 94,235 |   |
| Other                                                    |       | 37,267                         |        | 51,675 |   | 37,614 |   |
| Loss from early extinguishment of debt                   |       | (100,833                       | )           | — |   | 203,887 |   |
| Total other income (expense)                             |       | (1,612,641                     | )           | (2,654,563 | ) | (2,362,793 | ) |
|                                                     |       |                           |        |   |   |   |   |
| Income (loss) before income taxes                        |       | 17,161,126                     |        | (2,216,356 | ) | (7,305,394 | ) |
| Income tax (expense) benefit                             |       | (6,349,501                     | )           | 426,299 |   | 2,219,776 |   |
|                                                     |       |                           |        |   |   |   |   |
| Net earnings (loss)                                      |       | $                              | 10,811,625  |   | $ | (1,790,057 | ) | $ | (5,085,618 | ) |
|                                                     |       |                           |        |   |   |   |   |
| Earnings (loss) per common share - Basic                 |       | $                              | 0.31        |   | $ | (0.08 | ) | $ | (0.31 | ) |
|                                                     |       |                           |        |   |   |   |   |
| Earnings (loss) per common share - Diluted               |       | $                              | 0.30        |   | $ | (0.08 | ) | $ | (0.31 | ) |
|                                                     |       |                           |        |   |   |   |   |
| Weighted average number of shares  outstanding - Basic   |       | 34,543,695                     |        | 22,585,612 |   | 16,163,098 |   |
|                                                     |       |                           |        |   |   |   |   |
| Weighted average number of shares  outstanding - Diluted |       | 37,577,927                     |        | 22,585,612 |   | 16,163,098 |   |

 

*Seeaccompanying notes to consolidated financial statements.*

 

33

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**PIONEER DRILLING COMPANY AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF SHAREHOL****DERS’ EQUITY ANDCOMPREHENSIVE INCOME**

 
| ** **                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **      | ** ** | **Accumulated**   | ** ** | ** **             | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **      | ** ** | **Other**         | ** ** | **Total**              | ** ** |
| ** **                                                                     | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Paid In**    | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** |
| ** **                                                                     | ** ** | **Common** | ** ** | **Common** | ** ** | **Capital**    | ** ** | **Deficit**     | ** ** | **Income**        | ** ** | **Equity**             | ** ** |
| ** **                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **      | ** ** | ** **        | ** ** | ** **             | ** ** |
| Balance  as of March 31, 2002                                             |       | 15,922,459 |       | $          | 1,592,245  |           | $          | 38,783,731      |       | $                 | (7,142,387 | )                      | $          | 109,416 |   | $ | 33,343,005 |   |
| Comprehensive  income:                                                         |       |       |       |       |       |           |       |            |       |              |       |                   |       |
| Net  loss                                                                      |       | —     |       | —     |       | —         |       | (5,085,618      | )          | —            |       | (5,085,618             | )          |
| Net  unrealized change in securites available for sale,  net of tax of $56,366 |       | —     |       | —     |       | —         |       | —          |       | (109,416          | )          | (109,416               | )          |
| Total  comprehensive loss                                                      |       | —     |       | —     |       | —         |       | —          |       | —            |       | (5,195,034             | )          |
| Issuance  of common stock for:                                                 |       |       |       |       |       |           |       |            |       |              |       |                   |       |
| Sale,  net of related expenses of $657,499                                     |       | 5,333,333  |       | 533,334    |       | 18,809,167     |       | —          |       | —            |       | 19,342,501             |       |
| Exercise  of options and related tax benefits of $2,720                        |       | 445,000    |       | 44,500     |       | 137,290        |       | —          |       | —            |       | 181,790                |       |
| Preferred  stock dividend                                                      |       | —     |       | —     |       | —         |       | —          |       | —            |       | —                 |       |
| Balance  as of March 31, 2003                                             |       | 21,700,792 |       | 2,170,079  |       | 57,730,188     |       | (12,228,005     | )          | —            |       | 47,672,262             |       |
| Comprehensive  income:                                                         |       |       |       |       |       |           |       |            |       |              |       |                   |       |
| Net  loss                                                                      |       | —     |       | —     |       | —         |       | (1,790,057      | )          | —            |       | (1,790,057             | )          |
| Total  comprehensive loss                                                      |       | —     |       | —     |       | —         |       | —          |       | —            |       | (1,790,057             | )          |
| Issuance  of common stock for:                                                 |       |       |       |       |       |           |       |            |       |              |       |                   |       |
| Sale,  net of related expenses of $1,654,753                                   |       | 4,400,000  |       | 440,000    |       | 21,665,247     |       | —          |       | —            |       | 22,105,247             |       |
| Equipment  acquisitions                                                        |       | 477,000    |       | 47,700     |       | 2,074,950      |       | —          |       | —            |       | 2,122,650              |       |
| Exercise  of options and related income tax benefits of $52,423                |       | 722,334    |       | 72,233     |       | 653,983        |       | —          |       | —            |       | 726,216                |       |
| Balance  as of March 31, 2004                                             |       | 27,300,126 |       | 2,730,012  |       | 82,124,368     |       | (14,018,062     | )          | —            |       | 70,836,318             |       |
| Comprehensive  income:                                                         |       |       |       |       |       |           |       |            |       |              |       |                   |       |
| Net  earnings                                                                  |       | —     |       | —     |       | —         |       | 10,811,625      |       | —            |       | 10,811,625             |       |
| Total  comprehensive income                                                    |       | —     |       | —     |       | —         |       | —          |       | —            |       | 10,811,625             |       |
| Issuance  of common stock for:                                                 |       |       |       |       |       |           |       |            |       |              |       |                   |       |
| Sale,  net of related expenses of $5,807,193                                   |       | 11,545,000 |       | 1,154,500  |       | 109,854,558    |       | —          |       | —            |       | 111,009,058            |       |
| Debenture  conversion                                                          |       | 6,496,519  |       | 649,652    |       | 27,350,348     |       | —          |       | —            |       | 28,000,000             |       |
| Exercise  of options and related income tax benefits of $204,964               |       | 551,666    |       | 55,167     |       | 903,246        |       | —          |       | —            |       | 958,413                |       |
| Balance  as of March 31, 2005                                             |       | 45,893,311 |       | $          | 4,589,331  |           | $          | 220,232,520     |       | $                 | (3,206,437 | )                      | $          | — |   | $ | 221,615,414 |   |

 

*See accompanying notes to consolidated financial statements.*

 

34

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**PIONEER DRILLING COMPANY ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

 
| ** **                                                                                                          | ** ** | **Years Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                          | ** ** | **2005**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash flows from operating activities:                                                                               |       |                           |       |   |   |   |   |
| Net earnings (loss)                                                                                                 |       | $                              | 10,811,627 |   | $ | (1,790,057 | ) | $ | (5,085,618 | ) |
| Adjustments to reconcile net earnings  (loss) to net cash provided by operating activities:                         |       |                           |       |   |   |   |   |
| Depreciation and amortization                                                                                       |       | 23,090,909                     |       | 16,160,494 |   | 11,960,387 |   |
| Allowance for doubtful accounts                                                                                     |       | 242,000                        |       | — |   | 110,000 |   |
| Gain on sale of securities                                                                                          |       | —                         |       | — |   | (203,887 | ) |
| Loss on dispositions of property and  equipment                                                                     |       | 696,345                        |       | 816,104 |   | 279,054 |   |
| Change in deferred income taxes                                                                                     |       | 5,987,991                      |       | 119,038 |   | (1,511,744 | ) |
| Changes in current assets and liabilities:                                                                          |       |                           |       |   |   |   |   |
| Receivables                                                                                                         |       | (11,682,035                    | )          | (11,103,862 | ) | 242,126 |   |
| Prepaid expenses                                                                                                    |       | (540,507                       | )          | (422,150 | ) | (279,440 | ) |
| Accounts payable                                                                                                    |       | 2,350,658                      |       | (935,597 | ) | 7,699,417 |   |
| Income tax payable                                                                                                  |       | 195,949                        |       | — |   | — |   |
| Prepaid drilling contracts                                                                                          |       | 172,750                        |       | — |   | — |   |
| Federal income taxes                                                                                                |       | —                         |       | 444,900 |   | 435,168 |   |
| Accrued expenses                                                                                                    |       | 2,462,523                      |       | 1,576,096 |   | 743,814 |   |
| Net cash provided by operating activities                                                                           |       | 33,788,210                     |       | 4,864,966 |   | 14,389,277 |   |
|                                                                                                                |       |                           |       |   |   |   |   |
| Cash flows from financing activities:                                                                               |       |                           |       |   |   |   |   |
| Proceeds from notes payable                                                                                         |       | 41,354,367                     |       | 4,110,019 |   | 23,573,501 |   |
| Proceeds from subordinated debenture                                                                                |       | —                         |       | — |   | 10,000,000 |   |
| Increase in other assets                                                                                            |       | (123,263                       | )          | (40,000 | ) | (253,698 | ) |
| Proceeds from exercise of options                                                                                   |       | 958,412                        |       | 673,794 |   | 181,790 |   |
| Proceeds from common stock, net of offering  cost of $5,807,193 in 2005, of $1,654,753 in 2004 and $657,499 in 2003 |       | 111,009,058                    |       | 22,105,247 |   | 19,342,501 |   |
| Payments of debt                                                                                                    |       | (43,809,329                    | )          | (4,048,744 | ) | (18,714,311 | ) |
| Net cash provided by financing activities                                                                           |       | 109,389,245                    |       | 22,800,316 |   | 34,129,783 |   |
| Cash flows from investing activities:                                                                               |       |                           |       |   |   |   |   |
| Business acquisitions                                                                                               |       | (35,200,000                    | )          | (14,500,000 | ) | — |   |
| Purchases of property and equipment                                                                                 |       | (45,188,484                    | )          | (28,222,094 | ) | (33,588,972 | ) |
| Purchase of marketable securities, net                                                                              |       | (17,525,000                    | )          | (25,400,000 | ) | (19,925,000 | ) |
| Proceeds from sale of marketable securities                                                                         |       | 21,075,000                     |       | 23,500,000 |   | 21,500,414 |   |
| Proceeds from sale of property and  equipment                                                                       |       | 1,518,549                      |       | 419,658 |   | 314,366 |   |
| Net cash used in investing activities                                                                               |       | (75,319,935                    | )          | (44,202,436 | ) | (31,699,192 | ) |
| Net increase (decrease) in cash and cash  equivalents                                                               |       | 67,857,520                     |       | (16,537,154 | ) | 16,819,868 |   |
| Beginning cash and cash equivalents                                                                                 |       | 1,815,759                      |       | 18,352,913 |   | 1,533,045 |   |
| Ending cash and cash equivalents                                                                                    |       | $                              | 69,673,279 |   | $ | 1,815,759 |   | $ | 18,352,913 |   |
| Supplementary disclosure:                                                                                           |       |                           |       |   |   |   |   |
| Interest paid                                                                                                       |       | $                              | 2,407,193  |   | $ | 2,821,041 |   | $ | 2,785,177 |   |
| Income tax refunded                                                                                                 |       | (30,000                        | )          | (990,237 | ) | (1,143,200 | ) |
| Debenture conversion - common stock issued                                                                          |       | 28,000,000                     |       | — |   | — |   |
| Acquisition - common stock issued                                                                                   |       | —                         |       | 2,122,650 |   | — |   |
| Tax benefit from exercise of nonqualified  options                                                                  |       | 204,964                        |       | 52,423 |   | 2,720 |   |

 

*Seeaccompanying notes to consolidated financial statements.*

 

35

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**PIONEER DRILLING COMPANY ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.****                                      Organizationand Summary of Significant Accounting Policies**

 

***Business and Principles of Consolidation***

 

PioneerDrilling Company provides contract land drilling services to select oil and naturalgas exploration and production regions in the United States.  We conduct our operations through ourprincipal operating subsidiary, Pioneer Drilling Services, Ltd.  The accompanying consolidated financialstatements include our accounts and the accounts of our wholly ownedsubsidiaries.  We have eliminated allintercompany accounts and transactions in consolidation.

 

Wehave prepared the accompanying consolidated financial statements in accordancewith accounting principles generally accepted in the United States ofAmerica.  In preparing the financialstatements, we make various estimates and assumptions that affect the amountsof assets and liabilities we report as of the dates of the balance sheets andincome and expenses we report for the periods shown in the income statementsand statements of cash flows.  Our actualresults could differ significantly from those estimates.  Material estimates that are particularlysusceptible to significant changes in the near term relate to our recognitionof revenues and costs for turnkey contracts, our estimate of the allowance fordoubtful accounts, our estimate of the self-insurance portion of our health andworkers’ compensation insurance, our estimate of asset impairments, ourestimate of deferred taxes and our determination of depreciation andamortization expense.

 

***Income Taxes***

 

Pursuantto Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accountingfor Income Taxes,” we follow the asset and liability method of accounting forincome taxes, under which we recognize deferred tax assets and liabilities forthe future tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax basis.  We measure ourdeferred tax assets and liabilities by using the enacted tax rates we expect toapply to taxable income in the years in which we expect to recover or settlethose temporary differences.  Under SFAS No. 109,we reflect in income the effect of a change in tax rates on deferred tax assetsand liabilities in the period during which the change occurs.

 

***Earnings (Loss) Per Common Share***

 

We compute and present earnings (loss) per common share in accordancewith SFAS No. 128 “Earnings per Share.” This standard requires dual presentation of basic and diluted earnings(loss) per share on the face of our statement of operations.  For fiscal years 2004 and 2003, we did notinclude the effects of convertible subordinated debt and stock options on lossper common share because they were antidilutive.

 

36

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***Stock-based Compensation***

 

Wehave adopted SFAS No. 123, “Accounting for Stock-Based Compensation.”  SFAS No. 123 allows a company to adopt afair value based method of accounting for a stock-based employee compensationplan or to continue to use the intrinsic value based method of accountingprescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees.”  We haveelected to continue accounting for stock-based compensation under the intrinsicvalue method.  Under this method, werecord no compensation expense for stock option grants when the exercise priceof the options granted is equal to the fair market value of our common stock onthe date of grant.  If we had elected torecognize compensation cost based on the fair value of the options we grantedat their respective grant dates as SFAS No. 123 prescribes, our netearnings (loss) and net earnings (loss) per share would have been reduced tothe pro forma amounts the table below indicates:

 

 
| ** **                                                                                                                                  | ** ** | **Years Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                  | ** ** | **2005**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                        |       |                           |       |   |   |   |   |
| Net earnings (loss)-as reported                                                                                                             |       | $                              | 10,811,625 |   | $ | (1,790,057 | ) | $ | (5,085,618 | ) |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards net of  related tax effect |       | (1,175,191                     | )          | (662,933 | ) | (385,671 | ) |
| Net earnings (loss)-pro forma                                                                                                               |       | $                              | 9,636,434  |   | $ | (2,452,990 | ) | $ | (5,471,289 | ) |
| Net earnings (loss) per share-as reported-basic                                                                                             |       | $                              | 0.31       |   | $ | (0.08 | ) | $ | (0.31 | ) |
| Net earnings (loss) per share-as  reported-diluted                                                                                          |       | $                              | 0.30       |   | $ | (0.08 | ) | $ | (0.31 | ) |
| Net earnings (loss) per share-pro  forma-basic                                                                                              |       | $                              | 0.28       |   | $ | (0.11 | ) | $ | (0.34 | ) |
| Net earnings (loss) per share-pro  forma-diluted                                                                                            |       | $                              | 0.27       |   | $ | (0.11 | ) | $ | (0.34 | ) |
| Weighted-average fair value of options  granted during the year                                                                        |       | $                              | 8.85       |   | $ | 4.46 |   | $ | 3.50 |   |

 
| ** **                                | ** ** | **2005** | ** ** | **2004**  | ** ** | **2003** | ** ** |
|-------------------------------------------|------------|----------|------------|-----------|------------|----------|------------|
| Expected volatility                       |       | 86%      |       | 94%       |       | 69%      |       |
| Weighted-average risk-free interest rates |       | 3.7%     |       | 3.3%      |       | 3.2%     |       |
| Expected life in years                    |       | 5        |       | 5         |       | 5        |       |
| Options granted                           |       | 510,000  |       | 1,000,000 |       | 65,000   |       |

 

Aswe have not declared dividends since we became a public company, we did not usea dividend yield.  In each case, theactual value that will be realized, if any, will depend on the future performanceof our common stock and overall stock market conditions.  There is no assurance the value an optioneeactually realizes will be at or near the value we have estimated using theBlack-Scholes model.

 

***Revenue and Cost Recognition***

 

Weearn our contract drilling revenues under daywork, turnkey and footagecontracts.  We recognize revenues ondaywork contracts for the days completed based on the dayrate each contractspecifies.  We recognize revenues fromour turnkey and footage contracts on the percentage-of-completion method basedon our estimate of the number of days to complete each well.  Individual wells are usually completed inless than 60 days.

 

Ourmanagement has determined that it is appropriate to use thepercentage-of-completion method as defined in SOP 81-1to recognizerevenue on our turnkey and footage contracts. Although our turnkey and footage contracts do not have express termsthat provide us with rights to receive payment for the work that we performprior to drilling wells to the agreed on depth, we use this method because, asprovided in applicable accounting literature, we believe we achieve acontinuous sale for our work-in-progress and believe, under applicable statelaw, we ultimately could recover the fair value of our work-in-progress even inthe event we were unable to drill to the agreed on depth in breach of theapplicable contract.  However, ultimaterecovery of that value, in the event we were unable to drill to the agreed ondepth in breach of the contract, would be subject to negotiations with thecustomer and the possibility of litigation.

 

Ifa customer defaults on its payment obligation to us under a turnkey or footagecontract, we would need to rely on applicable law to enforce our lien rights,because our turnkey and footage contracts do not expressly grant to us asecurity interest in the work we have completed under the contract and we haveno ownership rights in the work-in-progress or completed drilling work, exceptany rights arising under the applicable lien statute on foreclosure.  If we were unable to drill to the agreed ondepth in breach of the contract, we also would need to rely on equitableremedies outside of the contract, including *quantum meruit*,available in applicable courts to recover the fair value of our work-in-progressunder a turnkey or footage contract.

 

37

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Weaccrue estimated costs on turnkey and footage contracts for each day of workcompleted based on our estimate of the total cost to complete the contractdivided by our estimate of the number of days to complete the contract.  Contract costs include labor, materials,supplies, repairs, maintenance, operating overhead allocations and allocationsof depreciation and amortization expense. We charge general and administrativeexpenses to expense as we incur them. Changes in job performance, jobconditions and estimated profitability on uncompleted contracts may result inrevisions to costs and income.  When weencounter, during the course of our drilling operations, conditions unforeseenin the preparation of our original cost estimate, we immediately increase ourcost estimate for the additional costs to complete the contract.  If we anticipate a loss on a contract inprogress at the end of a reporting period due to a change in our cost estimate,we immediately accrue the entire amount of the estimated loss including allcosts that are included in our revised estimated cost to complete that contractin our consolidated statement of operations for that reporting period.

 

Theasset “contract drilling in progress” represents revenues we have recognized inexcess of amounts billed on contracts in progress.  The liability “prepaid drilling contracts”represents amounts collected on contracts in excess of revenues recognized.

 

***Prepaid Expenses***

 

Prepaidexpenses include items such as insurance, rent deposits and fees.  We routinely expense these items in thenormal course of business over the periods these expenses benefit.

 

***Property and Equipment***

 

Weprovide for depreciation of our drilling, transportation and other equipmentusing the straight-line method over useful lives that we have estimated andthat range from three to 15 years.  Werecord the same depreciation expense whether a rig is idle or working.

 

Wecharge our expenses for maintenance and repairs to operations.  We charge our expenses for renewals andbetterments to the appropriate property and equipment accounts.  Our gains and losses on the sale of ourproperty and equipment are recorded in drilling costs.  During fiscal 2005 and 2004, we capitalized $86,819and $106,395, respectively, of interest costs incurred during the constructionperiods of certain drilling equipment.  AtMarch 31, 2005 and 2004, costs incurred on rigs under construction were approximately$3,300,000 and $2,800,000, respectively.

 

Wereview our long-lived assets and intangible assets for impairment wheneverevents or circumstances provide evidence that suggests that we may not recoverthe carrying amounts of any of these assets. In performing the review for recoverability, we estimate the future net cashflows we expect to obtain from the use of each asset and its eventualdisposition.  If the sum of theseestimated future undiscounted net cash flows is less than the carrying amountof the asset, we recognize an impairment loss.

 

***Cash and Cash Equivalents***

 

Wemaintain cash accounts at several financial institutions.  These account balances are insured by theFederal Deposit Insurance Corporation up to $100,000.  At March 31, 2005, we had cash accountbalances of approximately $1,200,000 exceeding the $100,000 insurancethreshold.

 

Forpurposes of the statements of cash flows, we consider all highly liquid debtinstruments purchased with a maturity of three months or less to be cashequivalents.  Cash equivalents consist ofinvestments in corporate and government money market accounts.  Cash equivalents at March 31, 2005 and2004 were $65,046,000 and $1,568,000, respectively.

 

***Marketable Securities***

 

Marketable securities consist of auction rate seven-day preferredsecurities whose market value is equal to their cost.  The objective of investing in thesesecurities is to improve our yield on short-term investments of cash.  There were no realized or unrealized gains orlosses relating to marketable securities during the years ended March 31,2005 and 2004.

 

***Trade Accounts Receivable***

 

Werecord trade accounts receivable at the amount we invoice our customers.  These accounts do not bear interest.  The allowance for doubtful accounts is ourbest estimate of the amount of probable credit losses in our accountsreceivable as of the balance sheet date. We determine the allowance based on thecredit worthiness of our customers and general economic conditions.   Consequently, an adverse change in thosefactors could affect our estimate of our allowance for doubtful accounts.  We review our allowance for doubtful accountsmonthly.  Balances more than 90 days pastdue are reviewed individually for collectibility.  We charge off account balances against theallowance after we have exhausted all reasonable means of collection and determinedthat the potential for recovery is remote. We do not have any off-balance sheet credit exposure related to ourcustomers.  At March 31, 2005 and2004 our allowance for doubtful accounts was $352,000 and $110,000.

 

38

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***Intangible and Other Assets***

 

Intangibleand other assets consist of cash deposits related to the deductibles on ourworkers compensation insurance policies, loan fees net of amortization andintangibles related to acquisitions, net of amortization.  Loan fees are amortized over the three-year termof the related debt.  Customer lists areamortized over their estimated benefit periods of up to 18 months.  Intangibles related to non-compete agreementsare amortized over the period of the non-compete agreements of three to fiveyears. Depreciation and amortization expense includes amortization ofintangibles of $142,157, $39,341 and $82,141 during the years ended March 31,2005, 2004 and 2003 respectively. Amortization of intangibles is not expectedto exceed $150,000 per year over the next five years.  Total cost and accumulated amortization ofintangibles at March 31, 2005 was $480,284 and $59,831, respectively, and$162,500 and $43,222, respectively at March 31, 2004.

 

***Derivative Instruments and Hedging Activities***

 

Wedo not have any free standing derivative instruments and we do not engage inhedging activities.

 

***Related Party Transactions***

 

OnAugust 11, 2004 and August 31, 2004, Chesapeake Energy Corporation (“Chesapeake”)purchased 631,133 shares and 94,670 shares of our common stock, respectively,at $6.90 per share pursuant to the preemptive rights we granted to Chesapeakein the stock purchase agreement we entered into in March 2003 when we soldshares of common stock to Chesapeake in a private placement transaction.  On March 29, 2005, we sold Chesapeake anadditional 1,165,769 shares pursuant to the preemptive rights agreement.  At March 31, 2005, Chesapeake owned16.78% of our outstanding common stock, and its preemptive rights have expired.  During the years ended March 31, 2005and 2004, we recognized revenues of approximately $4,885,000 and $924,000,respectively, and recorded contract drilling costs of approximately $3,263,000and $745,000, respectively, excluding depreciation, on contracts withChesapeake.  Our accounts receivable at March 31,2005 and 2004 include $2,939,000 and $532,000, respectively, due fromChesapeake.

 

Wepurchased services from R&B Answering Service and Frontier Service, Inc.during 2005, 2004 and 2003.  Thesecompanies are more than 5% owned by our Chief Operating Officer and animmediate family member of our Vice President, South Texas Division,respectively.  The following summarizesthe transactions with these companies in each period.

 
| ** **                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|----------|------------|
| R&B Answering Service    |       |     |       |     |       |     |       |
| Purchases                    |       | $        | 18,218     |     | $          | 13,526   |       | $ | 10,465 |   |
| Payments                     |       | $        | 17,112     |     | $          | 12,544   |       | $ | 9,678 |   |
| Frontier Services, Inc. |       |     |       |     |       |     |       |
| Purchases                    |       | $        | 81,254     |     | $          | 118,660  |       | $ | 130,513 |   |
| Payments                     |       | $        | 93,709     |     | $          | 136,818  |       | $ | 107,719 |   |
|                              |            |          |            |          |            |          |            |  |  |  |  |  |  |

 

***Recently Issued Accounting Standards***

 

In December 2004, the FASB issued SFAS No. 123(revised 2004), *Share-Based Payment.*  SFAS No. 123R is a revision of FASB SFASNo. 123, *Accounting for Stock-BasedCompensation*and supersedes APB Opinion No. 25, *Accounting for Stock Issued to Employees,*andits related implementation guidance. SFAS No. 123R established standards for the accounting fortransactions in which an entity exchanges its equity instruments for goods orservices.  It also addresses transactionsin which an entity incurs liabilities in exchange for goods or services thatare based on the fair value of the entity’s equity instruments or that may besettled by the issuance of those equity instruments.  SFAS No. 123R focuses primarily onaccounting for transactions in which an entity obtains employee services inshare-based payment transactions.  SFAS No. 123Rrequires a public entity to measure the cost of employee services received inexchange for an award of equity instruments based on the grant-date fair valueof the award (with limited exceptions). That cost will be recognized over the period during which an employee isrequired to provide service in exchange for the award.  The provisions of SFAS No. 123R areeffective for public entities that do not file as small business issuers as ofthe beginning of the first annual reporting period that begins after June 15,2005.  We are currently evaluating thenegative impact SFAS No. 123R will have on our financial position andresults of operations in fiscal year 2007. The negative impact will be created due to the fact that we previouslyissued employee stock options for which no expense has been recognized,  as those options will not be fully vested asof the effective date of SFAS No. 123R.

 

***Reclassifications***

 

Certainamounts in the financial statements for the prior years have been reclassifiedto conform to the current year’s presentation.

 

39

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**2.**                                      **Acquisitions**

 

On November 30, 2004, we acquired all the contract drilling assetsand a 4.7-acre rig storage and maintenance yard of Wolverine Drilling, Inc.,a land drilling contractor based in Kenmare, North Dakota.  The equipment included seven mechanical landdrilling rigs and related assets, including trucks, trailers, vehicles, sparedrill pipe and yard equipment.  We paid$28,000,000 in cash for these assets and non-competition agreements with thetwo owners of Wolverine.  We funded thisacquisition with $28,000,000 of bank debt described in note 3.  This purchase was accounted for as anacquisition of a business, and we have included the results of operation of theacquired business in our statement of operations since the date ofacquisition.  We allocated the purchaseprice to property and equipment and related assets, including thenon-competition agreements and other intangibles, based on their relative fairvalues at the date of acquisition.

 

On December 15, 2004, we acquired all the contract drilling assetsand a 17-acre rig storage and maintenance yard of Allen Drilling Company,a land drilling contractor based in Woodward, Oklahoma.  The equipment included five mechanicaldrilling rigs and related assets, including trucks, trailers, vehicles, sparedrill pipe and yard equipment.  We paid$7, 200,000 in cash for these assets.  Wealso entered into a non-competition agreement with the President of AllenDrilling which provides for the payment of $500,000 due in annual installmentsof $100,000 each beginning December 15, 2005.  We funded this acquisition with $7,200,000 ofbank debt described in note 3.  Thispurchase was accounted for as an acquisition of a business, and we haveincluded the results of operations of the acquired business in our statement ofoperations since the date of acquisition. We allocated the purchase price to property and equipment and relatedassets, including the non-competition agreements and other intangibles, basedon their relative fair values at the date of acquisition.

 

Thefollowing table summarizes the allocation of purchase price to property andequipment and other assets acquired in the Wolverine and Allen Drillingacquisitions:

 
| ** **                                     | ** ** | **Wolverine** | ** ** | **Allen** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|---------------|------------|-----------|------------|-----------|------------|
| Assets acquired:                               |       |          |       |      |       |      |       |
| Drilling equipment                             |       | $             | 27,620,214 |      | $          | 7,057,500 |       | $ | 34,677,714 |   |
| Vehicles                                       |       | 214,786       |       | 230,000   |       | 444,786   |       |
| Buildings                                      |       | 30,000        |       | 260,000   |       | 290,000   |       |
| Land                                           |       | 20,000        |       | 40,000    |       | 60,000    |       |
| Intangibles, primarily non-compete  agreements |       | 115,000       |       | 112,500   |       | 227,500   |       |
|                                           |       | $             | 28,000,000 |      | $          | 7,700,000 |       | $ | 35,700,000 |   |
| Less non-compete obilgation                    |       | —        |       | (500,000  | )          | (500,000  | )          |
|                                           |       | $             | 28,000,000 |      | $          | 7,200,000 |       | $ | 35,200,000 |   |

 

Thefollowing pro forma information gives effect to the Wolverine and AllenDrilling acquisitions as though they were effective as of the beginning of thefiscal year for each period presented. Pro forma adjustments primarily relate to additional depreciation,amortization and interest costs.  Theinformation reflects our historical data and historical data from theseacquired businesses for the periods indicated. The pro forma data may not be indicative of the results we would haveachieved had we completed these acquisitions on April 1, 2003 or 2004, orthat we may achieve in the future.  Thepro forma financial information should be read in conjunction with theaccompanying historical financial statements.

 
| ** **                        | ** ** | **Pro Forma  Years Ended March 31,** | ** **  |
|-----------------------------------|------------|-------------------------------------------|-------------|
| ** **                        | ** ** | **2005**                                  | ** **  | **2004** | ** ** |
| Total revenues                    |       | $                                         | 208,394,551 |   | $ | 132,287,140 |   |
| Net earnings (loss)               |       | $                                         | 11,943,137  |   | $ | (2,100,116 | ) |
| Earnings (loss) per common share: |       |                                      |        |   |   |
| Basic                             |       | $                                         | 0.35        |   | $ | (0.09 | ) |
| Diluted                           |       | $                                         | 0.33        |   | $ | (0.09 | ) |

 

On May 28, 2002, weacquired all the land contract drilling assets of United Drilling Company andU-D Holdings, L.P.  The assets includedtwo land drilling rigs, associated spare parts and equipment and vehicles.  We paid $7,000,000 in cash for theseassets.  The purchase was accounted foras an acquisition of assets, and the purchase price was allocated to drilling equipmentand related assets based on their relative fair values at the date ofacquisition.

 

On August 1, 2003, wepurchased two land drilling rigs, associated spare parts and equipment andvehicles from Texas Interstate Drilling Company, L. P. for $2,500,000 in cashand the issuance of 477,000 shares of our common stock at $4.45 per share.  The purchase was accounted for as anacquisition of a business, and we have included the results of operations ofthese assets in our statement of operations since the date of acquisition. Weallocated the purchase price to drilling equipment and related assets,including intangibles, based on their relative fair values at the date ofacquisition.

 

40

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OnDecember 15, 2003, we acquired for approximately $3,770,000 a rig we hadpreviously been leasing from International Drilling Services, Inc.  This purchase was accounted for as anacquisition of assets.

 

OnMarch 2, 2004, we acquired 23 used rig hauling trucks and associatedtrailers and equipment from A & R Trejo Trucking for $1,200,000.  This purchase was accounted for as anacquisition of assets, and the purchase price was allocated to the trucks andrelated assets based on their relative fair values at the date of acquisition.

 

OnMarch 4, 2004, we acquired a seven-rig drilling fleet from Sawyer Drilling &Services, Inc. for $12,000,000. This purchase was accounted for as anacquisition of a business, and we have included the results of operations ofthese assets in our statement of operations since the date of acquisition.  We allocated the purchase price to drillingequipment and related assets, including intangibles, based on their relativefair values at the date of acquisition.

 

On March 12, 2004, we acquired one drilling rig from SEDCODrilling Co., Ltd. for $2,015,000. This purchase was accounted for as anacquisition of assets, and we have included the results of operations of theseassets in our statement of operations since the date of acquisition.  We allocated the purchase price to drillingequipment and related assets, including intangibles, based on their relativefair values at the date of acquisition.

 

**3.****                                     ****Long-term Debt, SubordinatedDebt and Note Payable**

 

Ourlong-term debt is described below:

 
| ** **                                                                                                                                                                                                                                        | ** ** | **March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                                        | ** ** | **2005**           | ** ** | **2004** | ** ** |
| Indebtedness under $47,000,000 credit  facility, secured by drilling equipment, due in monthly payments of $388,889  plus interest at prime (5.75% at March 31, 2005), with final maturity on  December 1, 2007                         |       | $                  | 18,077,778 |   | $ | — |   |
|                                                                                                                                                                                                                                              |       |               |       |   |   |
| Convertible subordinated debentures due July 2007  at 6.75% (1)                                                                                                                                                                              |       | —             |       | 28,000,000 |   |
|                                                                                                                                                                                                                                              |       |               |       |   |   |
| Note payable to Merrill Lynch Capital,  secured by drilling equipment, due in monthly payments of $172,619 plus  interest at a floating rate equal to the 3-month LIBOR rate plus 385  basis points, remaining balance due December 2007 (2) |       | —             |       | 13,119,048 |   |
|                                                                                                                                                                                                                                              |       |               |       |   |   |
| Note payable to Frost National Bank,  secured by drilling equipment, due in monthly payments of $107,143 plus  interest at prime plus 1.0%, due August 2007 (2)                                                                              |       | —             |       | 4,392,174 |   |
|                                                                                                                                                                                                                                              |       |               |       |   |   |
| Note payable to Frost National Bank,  secured by drilling equipment, due in monthly payments of $42,401, including  interest at prime plus 1.0%, beginning April 15, 2004, due March 15,  2007 (2)                                      |       | —             |       | 3,000,000 |   |
|                                                                                                                                                                                                                                              |       | 18,077,778         |       | 48,511,222 |   |
|                                                                                                                                                                                                                                              |       |               |       |   |   |
| Less current installments                                                                                                                                                                                                                         |       | (4,666,667         | )          | (3,724,302 | ) |
|                                                                                                                                                                                                                                              |       | $                  | 13,411,111 |   | $ | 44,786,920 |   |

 

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(1)          WEDGE Energy Services, LLC (“WEDGE”) held $27,000,000 of the convertiblesubordinated debentures and William H. White, a former director of our company,held $1,000,000 of the convertible subordinated debentures.  The convertible subordinate debentures wereconverted into 6,496,519 shares of our common stock on August 11, 2004.

 

(2)          These notes were repaid in August and September 2004 withproceeds from our August 2004 common stock offering.

 

41

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Long-termdebt maturing each year subsequent to March 31, 2005 is as follows:

 
| **Year Ended  March 31,** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|
| 2006                           |       | $          | 4,666,667  |   |
| 2007                           |       | 4,666,667  |       |
| 2008                           |       | 8,744,444  |       |
| 2009                           |       | —     |       |
| 2010                           |       | —     |       |
| 2010 and thereafter            |       | —     |       |
|                                |            |            |            |  |

 

On October 9, 2001, we issued a 6.75% five-year $18,000,000convertible subordinated debenture, Series A, to WEDGE Energy Services,L.L.C. (“WEDGE”). The debenture was convertible into 4,500,000 shares of commonstock at $4.00 per share.  We used approximately$9,000,000 of the proceeds to complete the construction of two drillingrigs.  Approximately $6,000,000 was usedto reduce a $12,000,000 credit facility. The balance of the proceeds was used for drilling equipment and workingcapital. On July 3, 2002, we issued an additional $10,000,000 of 6.75%convertible subordinated debt to WEDGE with an effective conversion rate of$5.00 per share.  The transaction waseffected by an agreement between Pioneer and WEDGE under which WEDGE agreed toprovide the additional $10,000,000 in financing and to cancel the previouslyissued debenture in the principal amount of $18,000,000 in exchange for$28,000,000 in new 6.75% convertible subordinated debentures.  The new debentures was convertible into 6,496,519shares of common stock at $4.31 per share, which resulted from a pro ratablending of the $5.00 conversion rate of the new $10,000,000 financing and the$4.00 conversion rate of the $18,000,000 debenture being cancelled.  WEDGE funded $7,000,000 of the $10,000,000 onJuly 3, 2002 and $2,000,000 on July 29, 2002.   William H. White, a former Director of our Companyand the former President of WEDGE, purchased the remaining $1,000,000 on July 29,2002.  Unlike the cancelled debenture,which was not redeemable by Pioneer, the new debentures were redeemable at ascheduled premium.  We used $7,000,000 ofthe proceeds to pay down bank debt and $3,000,000 for the purchase of drillingequipment.  On August 11, 2004,these debentures were converted in accordance with their terms into 6,496,519shares of our common stock.

 

On October 29, 2004, we entered into a $47,000,000 credit facilitywith a group of lenders consisting of a $7,000,000 revolving line and letter ofcredit facility and a $40,000,000 acquisition facility for the acquisition ofdrilling rigs, drilling rig transportation equipment and associated equipment.Frost National Bank is the administrative agent and lead arranger under the newcredit facility, and the lenders include Frost National Bank, the Bank ofScotland and Zions First National Bank. Borrowings under the new creditfacility bear interest at a rate equal to Frost National Bank’s prime rate(5.75% at March 31, 2005) and are secured by most of our assets, includingall our drilling rigs and associated equipment and receivables. We borrowed theentire $40,000,000 available under the acquisition facility and we have usedapproximately $2,825,000 of availability under the revolving line and letter ofcredit facility through the issuance of letters of credit in the ordinarycourse of business. On March 29, 2005, we repaid $20,000,000 of theborrowings under the acquisition facility. On May 11, 2005, the lenders amended the acquisition facility toprovide us with the ability to again draw the $20,000,000 for futureacquisitions.  The remaining approximately$20,0000,000 and $4,175,000 of availability under the acquisition facility andthe revolving line and letter of credit facility, respectively, should remainavailable to us until those facilities mature in October 2006 and October 2005,respectively.

 

The sum of (1) the draws under and (2) the amount of alloutstanding letters of credit issued for our account under the revolving lineand letter of credit facility portion of our new credit facility are limited to75% of our eligible accounts receivable, not to exceed $7,000,000. Therefore,if 75% of our eligible accounts receivable was less than $7,000,000, ourability to draw under this line would be reduced. At March 31, 2005, wehad no outstanding advances under this line of credit, outstanding letters ofcredit were $2,825,000 and 75% of our eligible accounts receivable wasapproximately $19,084,000. The letters of credit are issued to three workers’compensation insurance companies to secure possible future claims under thedeductibles on these policies. It is our practice to pay any amounts due underthese deductibles as they are incurred. Therefore, we do not anticipate thatthe lenders will be required to fund any draws under these letters of credit.The termination date of the revolving line and letter of credit facilityportion of our new credit facility is October 28, 2005.

 

AtMarch 31, 2005, we were in compliance with all covenants applicable to ouroutstanding debt.  Those covenantsinclude, among others, a debt to total capitalization ratio of not greater than..3 to 1, a fixed charged coverage ratio of not less than 1.5 to 1, an operatingleverage ratio of less than 3 to 1, restrict us from paying dividends, restrictus from the sale of assets not permitted by the credit facility and restrict usfrom the incurrence of additional indebtedness in excess of $3,000,000 notalready allowed by the credit facility.

 

Notespayable at March 31, 2005 consists of a $681,975 insurance premium notedue in monthly installments of $137,400, including interest, through August 26,2005, which bears interest at the rate of 3.15% per year.

 

42

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**4.****                                     ****Leases**

 

Weare obligated under capital leases covering several trucks that expire atvarious dates through January 2007. At March 31, 2005 and 2004, the gross amount of transportationequipment and related amortization recorded under capital leases were asfollows:

 
| ** **                    | ** ** | **March 31,** | ** ** |
|-------------------------------|------------|--------------------|------------|
| ** **                    | ** ** | **2005**           | ** ** | **2004** | ** ** |
| Transportation equipment      |       | $                  | 405,320    |   | $ | 665,195 |   |
| Less accumulated amortization |       | 299,861            |       | 413,797 |   |
|                          |       | $                  | 105,459    |   | $ | 251,398 |   |

 

Amortization of assets held under capital leases is included withdepreciation expense.

 

We lease various office equipment under non-cancelable operating leasesexpiring through 2008 and real estate as follows:

 

•                  a 43-acredivision office and storage yard in Decatur, Texas, at a cost of $800 permonth, pursuant to a lease extending through September 2006;

 

•                  a truckingdepartment office, storage and maintenance yard in Alice, Texas, at a cost of$4,500 per month, pursuant to a lease extending through July 2006;

 

•                  a divisionoffice in Denver, Colorado, at a cost of $1,210 per month, pursuant to a leaseextending through June 2005;

 

•                  a yard office inKenmare, North Dakota, at a cost of $700 per month, pursuant to a leaseextending through March 31, 2006; and

 

•                  part of a 2.2-acredivision office and storage yard in Vernal, Utah at a cost of $2,000 per monthpursuant to a lease extending through October 2005.

 

In August 2004, we purchased the real estate we had previouslybeen leasing in Henderson, Texas.

 

Rent expense under these operating leases for the years ended March 31,2005, 2004 and 2003 was $102,077, $278,746 and $344,752, respectively.

 

In four to six months we will take over the entire division office andstorage yard in Vernal, Utah and will enter into a two year lease at a cost of$6,000 per month.

 

In June 2005, we are moving our corporate headquarters to newoffice space in San Antonio, Texas.  Wehave entered into a 102 month lease, beginning upon occupancy, with monthlypayments of approximately $12,300 for the first two years increasing to anaverage of approximately $20,000 per month thereafter. The lease grants twooptions to renew the lease for a renewal term of five years each.  We plan to sell our current corporateheadquarters building in San Antonio, Texas.

 

43

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Futurelease obligations, including our new corporate headquarters, and minimum capitallease payments as of March 31, 2005 were as follows:

 

 
| **Year Ended**                                                           | ** ** | **Operating** | ** ** | **Capital** | ** ** |
|--------------------------------------------------------------------------|------------|---------------|------------|-------------|------------|
| **March 31,**                                                       | ** ** | **Leases**    | ** ** | **Leases**  | ** ** |
|                                                                     | 2006       |          | $          | 224,873     |       | $ | 70,446 |   |
|                                                                     | 2007       |          | 173,935    |        | 34,106     |   |
|                                                                     | 2008       |          | 217,492    |        | —     |   |
|                                                                     | 2009       |          | 234,291    |        | —     |   |
|                                                                     | 2010       |          | 237,905    |        | —     |   |
|                                                                     | Thereafter |          | 903,438    |        | —     |   |
| Total minimum lease payments                                             |       | $             | 1,991,934  |        | $          | 104,552 |   |
|                                                                     |       |          |       |        |       |
| Less amounts representing interest (at  rates ranging from 5.7% to 8.4%) |       |          |       | (4,287      | )          |
| Present value of net minimum capital lease  payments                     |       |          |       | 100,265     |       |
| Less current installments of capital lease  obligations                  |       |          |       | (66,359     | )          |
| Capital lease obligations, excluding  current installments               |       |          |       | $           | 33,906     |   |

 

**5.****                                     ****Income Taxes**

 

Our provision for income taxes consists of the following:

 
| ** **                   | ** ** | **Years Ended March 31,** | ** ** |
|------------------------------|------------|--------------------------------|------------|
| ** **                   | ** ** | **2005**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                         |       |                           |       |   |   |   |   |
| Current tax - state          |       | $                              | 56,400     |   | $ | — |   | $ | — |   |
| Current tax - federal        |       | 335,109                        |       | — |   | (708,032 | ) |
| Deferred tax - state         |       | 55,164                         |       | — |   | — |   |
| Deferred tax - federal       |       | 5,902,828                      |       | (426,299 | ) | (1,511,744 | ) |
| Income tax expense (benefit) |       | $                              | 6,349,501  |   | $ | (426,299 | ) | $ | (2,219,776 | ) |

 

In fiscal years 2005, 2004and 2003, our expected tax, which we compute by applying the federal statutoryrate of  34% to income (loss) beforeincome taxes, differs from our income tax expense as follows:

 
| ** **                                    | ** ** | **Years Ended March 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **2005**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                          |       |                           |       |   |   |   |   |
| Expected tax expense (benefit)                |       | $                              | 5,834,783  |   | $ | (753,561 | ) | $ | (2,483,834 | ) |
| Non taxable interest income                   |       | —                         |       | — |   | (10,400 | ) |
| Club dues, meals and entertainment            |       | 24,050                         |       | 13,941 |   | 10,443 |   |
| State income taxes                            |       | 92,388                         |       | — |   | — |   |
| Reimbursement of food costs for rig employees |       | 396,968                        |       | 314,622 |   | 275,338 |   |
| Other                                         |       | 1,312                          |       | (1,301 | ) | (11,323 | ) |
|                                          |       | $                              | 6,349,501  |   | $ | (426,299 | ) | $ | (2,219,776 | ) |

 

44

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Deferred income taxes arisefrom temporary differences between the tax basis of assets and liabilities andtheir reported amounts in the consolidated financial statements.  The components of our deferred income taxliabilities were as follows:

 
| ** **                                                              | ** ** | **March 31,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                              | ** ** | **2005**           | ** ** | **2004** | ** ** |
|                                                                    |       |               |       |   |   |
| Deferred tax assets:                                                    |       |               |       |   |   |
| Vacation expense accruals                                               |       | $                  | 71,446     |   | $ | 37,233 |   |
| Workers compensation and health insurance  accruals                     |       | 378,423            |       | 187,752 |   |
| Bad debt expense                                                        |       | 119,680            |       | 37,400 |   |
| Net operating loss carryforwards                                        |       | 4,329,933          |       | 7,825,126 |   |
| Alternative minimum tax credit                                          |       | 311,915            |       | 181,770 |   |
| Loss accrual on turnkey contracts                                       |       | —             |       | 23,000 |   |
| Total deferred tax assets                                               |       | 5,211,397          |       | 8,292,281 |   |
| Deferred tax liabilities:                                               |       |               |       |   |   |
| Property and equipment, principally due to  differences in depreciation |       | 16,924,919         |       | 14,017,813 |   |
| Total deferred tax liabilities                                          |       | 16,924,919         |       | 14,017,813 |   |
| Net deferred tax liabilities                                            |       | $                  | 11,713,522 |   | $ | 5,725,532 |   |

 

In assessing our ability to realize deferred tax assets, we considerwhether it is more likely than not that some portion or all of the deferred taxassets will not be realized.  Ourultimate realization of deferred tax assets depends on the generation of futuretaxable income during the periods in which those temporary differences becomedeductible.  We consider the scheduledreversal of deferred tax liabilities, projected future taxable income, and taxplanning strategies in making this assessment. Based on the level of historical taxable income and projections forfuture taxable income over the periods during which the deferred tax assets aredeductible, we believe it is more likely than not that we will realize thebenefits of these deductible differences

 

AtMarch 31, 2005, we had net operating loss carryforwards for federal incometax purposes of approximately $16,500,000, which will expire if not utilized asof the end of our fiscal years ending as follows:

 
| **Year** | ** ** | **Amount** | ** ** |
|----------|------------|------------|------------|
| 2023     |       | $          | 6,600,000  |   |
| 2024     |       | 9,900,000  |       |
|          |            |            |            |  |

 

**6.****                                     ****Fair Value of FinancialInstruments**

 

***Cash and cash equivalents, trade receivablesand payables and short-term debt:***

 

The carrying amounts of our cash and cashequivalents, trade receivables, payables and short-term debt approximate theirfair values.

 

***Long-term debt:***

 

The carrying amount of our long-term debtapproximates its fair value, as supported by the recent issuance of the debtand because the rates and terms currently available to us approximate the ratesand terms on the existing debt.

 

45

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**7.****                                     ****Earnings (Loss) Per CommonShare**

 

Thefollowing table presents a reconciliation of the numerators and denominators ofthe basic EPS and diluted EPS comparisons as required by SFAS No. 128:

 
| ** **                                                               | ** ** | **Years Ended March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **2005**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                     |       |                           |       |   |   |   |   |
| Basic                                                                    |       |                           |       |   |   |   |   |
| Net earnings (loss)                                                      |       | $                              | 10,811,625 |   | $ | (1,790,057 | ) | $ | (5,085,618 | ) |
|                                                                     |       |                           |       |   |   |   |   |
| Weighted average shares                                                  |       | 34,543,695                     |       | 22,585,612 |   | 16,163,098 |   |
|                                                                     |       |                           |       |   |   |   |   |
| Earning (loss) per share                                                 |       | $                              | 0.31       |   | $ | (0.08 | ) | $ | (0.31 | ) |
|                                                                     |       |                           |       |   |   |   |   |
| Diluted                                                                  |       |                           |       |   |   |   |   |
| Earnings (loss) applicable to common  shareholders                       |       | $                              | 10,811,625 |   | $ | (1,790,057 | ) | $ | (5,085,618 | ) |
| Effect of dilutive securities - Convertible  subordinated debenture      |       | 459,483                        |       | — |   | — |   |
| Earnings (loss) available to common  shareholders and assumed conversion |       | $                              | 11,271,108 |   | $ | (1,790,057 | ) | $ | (5,085,618 | ) |
| Weighted average shares:                                                 |       |                           |       |   |   |   |   |
| Outstanding                                                              |       | 34,543,695                     |       | 22,585,612 |   | 16,163,098 |   |
| Options                                                                  |       | 684,806                        |       | — |   | — |   |
| Convertible subordinated debenture                                       |       | 2,349,426                      |       | — |   | — |   |
|                                                                     |       | 37,577,927                     |       | 22,585,612 |   | 16,163,098 |   |
| Earnings (loss) per share                                                |       | $                              | 0.30       |   | $ | (0.08 | ) | $ | (0.31 | ) |

 

Theweighted average number of diluted shares in 2004 and 2003 excludes 7,612,924and 7,185,995, respectively, of shares for options and convertible debt due totheir antidilutive effects.

 

**8.****                                     ****Equity Transactions**

 

OnMarch 31, 2003, we sold 5,333,333 shares of our common stock to ChesapeakeEnergy Corporation for $20,000,000 ($3.75 per share), before related offeringexpenses.  In connection with that sale,we granted Chesapeake Energy a preemptive right to acquire equity securities wemay issue in the future, under specified circumstances, in order to permitChesapeake Energy to maintain its proportionate ownership of our outstandingshares of common stock.  We also grantedChesapeake Energy a right, under certain circumstances, to request registrationof the acquired shares under the Securities Act of 1933.  At March 31, 2005, Chesapeake Energyowned 16.78% of our outstanding common stock and its preemptive rights haveexpired.

 

OnFebruary 20, 2004, we sold 4,400,000 shares of our common stock at $5.40per share in a private placement for $23,760,000 in proceeds, before related offeringexpenses.  We issued those shares withoutregistration under the Securities Act of 1933 in reliance on the exemption thatSection 4(2) of that Act provides for transactions not involving anypublic offering.  We subsequently filed aregistration statement on Form S-3 to register the resales of thoseshares.  The registration statementbecame effective on June 22, 2004.

 

OnAugust 11, 2004, the entire $28,000,000 in aggregate principal amount ofour 6.75% convertible subordinated debentures held by WEDGE Energy Services,L.L.C. and William H. White was converted in accordance with the terms of thosedebentures into 6,496,519 shares of our common stock.

 

OnAugust 11, 2004, we sold 4,000,000 shares of our common stock atapproximately $6.61 per share, net of underwriters’ commissions, pursuant to apublic offering we registered with the SEC under a registration statement filedon Form S-1. On August 31, 2004, we sold 600,000 additionalshares of our common stock at approximately $6.61 per share, net ofunderwriters’ commissions, pursuant to the underwriters’ exercise of anover-allotment option granted in connection with that public offering.

 

46

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OnMarch 22, 2005, we sold 6,945,000 shares of our common stock, includingshares we sold pursuant to the underwriters’ exercise of an over-allotmentoption, at approximately $11.78 per share, net of underwriters’ commissions,pursuant to a public offering we registered with the SEC.

 

Directorsand employees exercised stock options for the purchase of 551,666 shares ofcommon stock at prices ranging from $.375 to $6.44 per share during the fiscal yearended March 31, 2005, 722,334 shares of common stock at prices rangingfrom $.625 to $3.20 per share during the fiscal year ended March 31, 2004and 445,000 shares of common stock at prices ranging from $0.375 to $2.50 pershare during the fiscal year ended March 31, 2003.

 

**9.**                                      **Stock Options, Warrants and StockOption Plan**

 

Underour stock option plans, employee stock options generally become exercisableover three- to five-year periods, and all options generally expire 10 yearsafter the date of grant.  Our plansprovide that all options must have an exercise price not less than the fairmarket value of our common stock on the date of grant.  Accordingly, as we discussed in Note 1,we do not recognize any compensation expense relating to these options in ourresults of operations.

 

Thefollowing table provides information relating to our outstanding stock optionsat March 31, 2005, 2004 and 2003:

 
| ** **                            | ** ** | **2005**                                      | ** ** | **2004**                     | ** ** | **2003**                                      | ** ** |
|---------------------------------------|------------|-----------------------------------------------|------------|------------------------------|------------|-----------------------------------------------|------------|
| ** **                            | ** ** | **Shares  Issuable on  Exercise of  Options** | ** ** | **Weighted  Average  Price** | ** ** | **Shares  Issuable on  Exercise of  Options** | ** ** | **Weighted  Average  Price** | ** ** | **Shares  Issuable on  Exercise of  Options** | ** ** | **Weighted  Average  Price** | ** ** |
| Balance Outstanding Beginning of year |       | 2,056,666                                     |       | $                            | 3.24       |                                          | 1,825,000  |   | $ | 1.63 |   | 2,320,000 |   | $ | 1.47 |   |
| Granted                               |       | 510,000                                       |       | $                            | 8.85       |                                          | 1,000,000  |   | $ | 4.46 |   | 65,000 |   | $ | 1.72 |   |
| Exercised                             |       | (551,666                                      | )          | $                            | 1.37       |                                          | (722,334   | ) | $ | 0.93 |   | (445,000 | ) | $ | 0.40 |   |
| Canceled                              |       | (10,000                                       | )          | $                            | 4.52       |                                          | (46,000    | ) | $ | 2.25 |   | (115,000 | ) | $ | 4.29 |   |
| Balance Outstanding End of year       |       | 2,005,000                                     |       | $                            | 5.30       |                                          | 2,056,666  |   | $ | 3.24 |   | 1,825,000 |   | $ | 1.63 |   |
| Options Exercisable End of year       |       | 798,002                                       |       | $                            | 3.58       |                                          | 884,001    |   | $ | 1.95 |   | 1,437,334 |   | $ | 1.28 |   |

 

As of March 31, 2005, there were no outstandingwarrants.

 

Thefollowing table summarizes information about our employee stock optionsoutstanding and exercisable at March 31, 2005:

 
| ** **                    | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                             | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                          |       |                    |       |                                                |       |   |   |   |   |   |   |
| $2.25 - $4.65                 |       | 1,065,000               |       | 7.45                                                |       | $ | 3.60 |   | 681,002 |   | $ | 3.32 |   |
|                          |       |                    |       |                                                |       |   |   |   |   |   |   |
| $4.77 - $10.31                |       | 940,000                 |       | 9.11                                                |       | $ | 7.22 |   | 117,000 |   | $ | 5.05 |   |
|                          |       |                    |       |                                                |       |   |   |   |   |   |   |
|                          |       | 2,005,000               |       | 8.23                                                |       | $ | 5.30 |   | 798,002 |   | $ | 3.58 |   |

 

**10.**                               **Employee Benefit****Plans and Insurance**

 

Wemaintain a 401(k) retirement plan for our eligible employees.  Under this plan, we may contribute, on adiscretionary basis, a percentage of an eligible employee’s annualcontribution, which we determine annually. Our contributions for fiscal 2005, 2004 and 2003 were approximately $399,000,$76,000 and $92,000, respectively.

 

47

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Wemaintain a self-insurance program, for major medical, hospitalization anddental coverage for employees and their dependents, which is partially fundedby payroll deductions.  We have providedfor both reported and incurred but not reported medical costs in theaccompanying consolidated balance sheets. We have a maximum liability of $100,000 per employee/dependent peryear.  Amounts in excess of the statedmaximum are covered under a separate policy provided by an insurancecompany.  Accrued expenses at March 31,2005 include approximately $489,000 for our estimate of incurred but unpaidcosts related to the self-insurance portion of our health insurance.

 

Weare self-insured for up to $250,000 for all workers’ compensation claimssubmitted by employees for on-the-job injuries, except in North Dakota wherethe deductible is $100,000.  We haveprovided for both reported and incurred but not reported costs of workers’compensation coverage in the accompanying consolidated balance sheets.  Accrued expenses at March 31, 2005include approximately $845,000 for our estimate of incurred but unpaid costsrelated to workers’ compensation claims. Based upon our past experience, management believes that we haveadequately provided for potential losses. However, future multiple occurrences of serious injuries to employeescould have a material adverse effect on our financial position and results ofoperations.

 

**11.****                              ****Business Segments and Concentrations**

 

Substantiallyall our operations relate to contract drilling of oil and gas wells.  Accordingly, we classify all our operationsin a single segment.

 

Duringthe fiscal year ended March 31, 2005, our three largest customersaccounted for 6.5%, 5.0% and 4.6%, respectively, of our total contract drillingrevenue.   All three of these customerswere customers of ours in 2004.  Infiscal 2004, our three largest customers accounted for 10.5%, 6.4% and 4.9%, ofour total contract drilling revenue.  Twoof these customers were customers of ours in fiscal 2003.   In  fiscal  2003,  our three  largest  customers  accounted  for 10.8%, 6.5% and 5.4% of our total contractdrilling revenue.

 

**12.**                               **Commitments and Contingencies**

 

Weare in the process of constructing, primarily from new and used components, two1000 horsepower electric rigs at an estimated cost of $6,500,000 each.  We expect to place one of these rigs inservice in June 2005 and the second in August 2005.  As of March 31, 2005, we have incurredapproximately $3,300,000 of construction cost on these rigs.

 

Inaddition, due to the nature of our business, we are, from time to time,involved in routine litigation or subject to disputes or claims related to ourbusiness activities, including workers’ compensation claims andemployment-related disputes.  In theopinion of our management, none of the pending litigation, disputes or claimsagainst us will have a material adverse effect on our financial condition,results of operations or cash flow from operations and there is only a remotepossibility that any such matter will require any additional loss accrual.

 

48

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**13.****                              ****Quarterly Results of Operations(unaudited)**

 

Thefollowing table summarizes quarterly financial data for our fiscal years ended March 31,2005 and 2004 (in thousands, except per share data):

 
| ** **                    | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Total** | ** ** |
|-------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|-----------|------------|
| 2005                          |       |               |       |                |       |               |       |                |       |      |       |
| Revenues                      |       | $                  | 40,719     |                | $          | 42,783             |       | $                   | 46,387     |      | $          | 55,357 |   | $ | 185,246 |   |
| Income from operations        |       | 1,046              |       | 1,960               |       | 6,704              |       | 9,064               |       | 18,774    |       |
| Income tax expense            |       | (139               | )          | (590                | )          | (2,428             | )          | (3,192              | )          | (6,349    | )          |
| Net earnings                  |       | 216                |       | 923                 |       | 4,179              |       | 5,494               |       | 10,812    |       |
| Earnings per share:           |       |               |       |                |       |               |       |                |       |      |       |
| Basic                         |       | .01                |       | .03                 |       | .11                |       | .14                 |       | .31       |       |
| Diluted                       |       | .01                |       | .03                 |       | .11                |       | .14                 |       | .30       |       |
| 2004                          |       |               |       |                |       |               |       |                |       |      |       |
| Revenues                      |       | $                  | 23,850     |                | $          | 24,244             |       | $                   | 26,414     |      | $          | 33,368 |   | $ | 107,876 |   |
| Income (loss) from operations |       | (789               | )          | (166                | )          | 9                  |       | 1,384               |       | 438       |       |
| Income tax expense (benefit)  |       | 409                |       | 185                 |       | 118                |       | (286                | )          | 426       |       |
| Net earnings (loss)           |       | (1,056             | )          | (621                | )          | (522               | )          | 409                 |       | (1,790    | )          |
| Earnings (loss) per share:    |       |               |       |                |       |               |       |                |       |      |       |
| Basic                         |       | (.05               | )          | (.03                | )          | (.02               | )          | .02                 |       | (.08      | )          |
| Diluted                       |       | (.05               | )          | (.03                | )          | (.02               | )          | .02                 |       | (.08      | )          |

 

## ***The sum of the quarterly earnings per share amounts do notnecessarily agree with the year end amounts due to the dilutive effects ofconvertible instruments.***

 

49

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## ***Item 9.***                    Changesin and Disagreements With Accountants on Accounting and Financial Disclosure

##  

Notapplicable.

 

***Item 9A.*****          ****Controls and Procedures**

 

Inaccordance with Exchange Act Rules 13a-15 and 15d-15, wecarried out an evaluation, under the supervision and with the participation ofmanagement, including our Chief Executive Officer and Chief Financial Officer,of the effectiveness of our disclosure controls and procedures as of the end ofthe period covered by this report.  Basedupon that evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective as of March 31,2005 to provide reasonable assurance that information required to be disclosedin our reports filed or submitted under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms.

 

There has been no change in our internal controls overfinancial reporting that occurred during the three months ended March 31,2005 that has materially affected, or is likely to materially affect, our internalcontrols over financial reporting.

 

**Management’s Report on InternalControl over Financial Reporting**

 

The management of PioneerDrilling Company is responsible for establishing and maintaining adequateinternal control over financial reporting. Pioneer Drilling Company’s internal control over financial reporting isa process designed to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles.  Pioneer Drilling Company’s internal controlover financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generallyaccepted accounting principles.  Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reportingmay not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periodsare subject to the risk that controls may become inadequate because of changesin conditions, or that the degree of compliance with the policies or proceduresmay deteriorate.

 

Pioneer Drilling Company’smanagement assessed the effectiveness of the Company’s internal control overfinancial reporting as of March 31, 2005. In making this assessment, it used the criteria set forth by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO) inInternal Control-Integrated Framework. Based on our assessment we have concluded that, as of March 31,2005, Pioneer Drilling Company’s internal control over financial reporting waseffective based on those criteria.

 

Pioneer Drilling Company’s independentregistered public accounting firm has audited management’s assessment of theeffectiveness of Pioneer Drilling Company’s internal control over financialreporting as of March 31, 2005, as stated in their report which appearsherein.  That report appears on page 31.

 

# **PART III**

#  

InItems 10, 11, 12, 13 and 14 below, we are incorporating by reference theinformation we refer to in those Items from the definitive proxy statement forour 2005 Annual Meeting of Shareholders. We intend to file that definitive proxy statement with the SEC by July 15,2005.

 

## ***Item 10.***             Directors and Executive Officers of the Registrant

##  

Pleasesee the information appearing under the headings “Proposal No. 1—Electionof Directors” and “Executives and Executive Compensation” in the definitiveproxy statement for our 2005 Annual Meeting of Shareholders for the informationthis Item 10 requires.

 

## ***Item 11.***             Executive Compensation

##  

Pleasesee the information appearing under the heading “Executives and ExecutiveCompensation” in the definitive proxy statement for our 2005 Annual Meeting ofShareholders for the information this Item 11 requires.

 

50

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## ***Item 12.***             Security Ownership of Certain Beneficial Owners andManagement and Related Stockholder Matters

##  

Pleasesee the information appearing (1) under the heading “Equity CompensationPlan Information” in Item 5 of this report and (2) under the heading “SecurityOwnership of Certain Beneficial Owners and Management” in the definitive proxystatement for our 2005 Annual Meeting of Shareholders for the information thisItem 12 requires.

 

## ***Item 13.***             Certain Relationships and Related Transactions

##  

Pleasesee the information appearing under the heading “Certain Transactions” in thedefinitive proxy statement for our 2005 Annual Meeting of Shareholders for theinformation this Item 13 requires.

 

## ***Item 14.***             Principal Accountant Fees and Services

##  

Please see the information appearing under the heading “Ratification ofAppointment of Independent Auditors” in the definitive proxy statement for our2005 Annual Meeting of Shareholders for the information this Item 14 requires.

 

# **PART IV**

#  

## ***Item15***.             Exhibits, Financial Statement Schedules and Reports on Form 8-K

##  

(1)                                  *Financial Statements.*

 

SeeIndex to Consolidated Financial Statements on page 29.

 

(2)*                                 **Financial Statement Schedules:*

 

Schedule II

 
| ** **                                                         | ** ** | **Valuation  and Qualifying Accounts** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                         | ** ** | **Balance  at  Beginning  of Year**    | ** ** | **Charged  to Costs  and  Expenses** | ** ** | **Deductions  from  Accounts** | ** ** | **Balance  at  Year End** | ** ** |
|                                                               |       |                                   |       |   |   |   |   |   |   |
| Year ended March 31, 2003  Allowance for doubtful receivables |       | $                                      | —     |   | $ | 110,000 |   | $ | — |   | $ | 110,000 |   |
|                                                               |       |                                   |       |   |   |   |   |   |   |
| Year ended March 31, 2004  Allowance for doubtful receivables |       | $                                      | 110,000    |   | $ | — |   | $ | — |   | $ | 110,000 |   |
|                                                               |       |                                   |       |   |   |   |   |   |   |
| Year ended March 31, 2005  Allowance for doubtful receivables |       | $                                      | 110,000    |   | $ | 242,000 |   | $ | — |   | $ | 342,000 |   |

 

51

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(3)                            *Exhibits.*  Thefollowing exhibits are filed as part of this report:

 
| **Exhibit  Number** | ** ** | ** ** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                   |
|---------------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 2.1                 |       | -          |       | Asset Purchase Agreement dated November 11, 2004  between Wolverine Drilling, Inc. and Robert Mau, Robert S. Blackford and  Pioneer Drilling Services, Ltd. (Form 8-K dated November 11,  2004 (File No. 1-8182, Exhibit 2.1)).                                                                                                                                                                     |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 2.2                 |       | -          |       | Asset Purchase Agreement dated November 29,2004,  by and among Allen Drilling Company, the Earl Allen Family Trust dated April 1,  1079, the sole shareholder of Allen Drilling Company, Dixon Allen, Paula K.  Hoisington and Lisa D. Johonnesson, all of the beneficiaries of the Trust,  and Pioneer Drilling Services, Ltd. (Form 8-K dated November 30,  2004 (File No. 1-8182m Exhibit 2.1)). |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 3.1*                |       | -          |       | Articles of Incorporation of Pioneer Drilling Company,  as amended (Form 10-K for the year ended March 31, 2001 (File  No. 1-8182, Exhibit 3.1)).                                                                                                                                                                                                                                                             |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 3.2*                |       | -          |       | Articles of Amendment to the Articles of Incorporation  of Pioneer Drilling Company (Form 10-Q for the quarter ended September 30,  2001 (File No. 1-8182, Exhibit 3.1)).                                                                                                                                                                                                                                     |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 3.3*                |       | -          |       | Amended and Restated Bylaws of Pioneer Drilling  Company (Form 10-Q for the quarter ended December, 2003 (File No. 1-8182,  Exhibit 3.3)).                                                                                                                                                                                                                                                                         |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.1*                |       | -          |       | Form of Certificate representing Common Stock of  Pioneer Drilling Company (Form s-8 filed November 18, 2003  (Reg. No. 333-110569, Exhibit 4.3)).                                                                                                                                                                                                                                                       |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.2*                |       | -          |       | Form of Purchase Agreement dated February 13,  2004 between Pioneer Drilling Company and the several purchasers (Form s-3  filed February 24, 3004 (Reg. No. 333-113036, Exhibit 4.1)).                                                                                                                                                                                                             |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.3*                |       | -          |       | Credit Agreement between Pioneer Drilling Services,  Ltd. and Frost National Bank, as Administrative Agent, Agent, Lead Arranger  and Lender dated October 29, 2004 (Form 8-K dated October 29,  2004 (File No. 1-8182, Exhibit 4.1)).                                                                                                                                                                   |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.1+*              |       | -          |       | Executive Employment Agreement dated May 1, 1995  between Pioneer Drilling Company and Wm. Stacy Locke (Form 10-K  for the year ended March 31, 2001 (File No. 1-8182, Exhibit 10.1+)).                                                                                                                                                                                                                  |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.2+*              |       | -          |       | Second Amendment to Executive Employment Agreement  dated August 21, 2000 between Pioneer Drilling Company and Wm. Stacy  Locke (Form 10-K for the year ended March 31, 2001 (File No. 1-8182, Exhibit 10.4+)).                                                                                                                                                                                          |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.3+*              |       | -          |       | Pioneer Drilling Company’s 1995 Stock Plan and form of  Stock Option Agreement (Form 10-K for the year ended March 31,  2001 (File No. 1-8182, Exhibit 10.5+)).                                                                                                                                                                                                                                          |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.4+*              |       | -          |       | Pioneer Drilling Company’s 1999 Stock Plan and form of  Stock Option Agreement (Form 10-K for the year ended March 31,  2001 (File No. 1-8182, Exhibit 10.7+)).                                                                                                                                                                                                                                          |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.5*               |       | -          |       | Pioneer Drilling Company 2003 Stock Plan (Form S-8  filed November 18, 2003 (File No. 333-110569, Exhibit 4.4)).                                                                                                                                                                                                                                                                                              |
|                |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.6                |       | -          |       | Termination Agreement dated May 26, 2005 between  Michael E. Little, Wm. Stacy Locke, Pioneer Drilling Company and WEDGE Energy  Services, L.L.C.                                                                                                                                                                                                                                                                            |

 

52

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| 21.1   |   | -      |   | Subsidiaries of Pioneer Drilling Company.                                                                                                                                                                                                                        |
|--------|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                             |
| 23.1   |   | -      |   | Consent of KPMG LLP.                                                                                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                             |
| 31.1   |   | -      |   | Certification by Wm. Stacy Locke, President and Chief  Executive Officer, pursuant to Rule 13a-14(a) or Rule 15d-14(a) under  the Securities Exchange Act of 1934.                                                                           |
|   |   |   |   |                                                                                                                                                                                                                                                             |
| 31.2   |   | -      |   | Certification by William D. Hibbetts, Senior Vice  President and Chief Financial Officer, pursuant to Rule 13a-14(a) or  Rule 15d-14(a) under the Securities Exchange Act of 1934.                                                           |
|   |   |   |   |                                                                                                                                                                                                                                                             |
| 32.1   |   | -      |   | Certification by Wm. Stacy Locke, President and Chief  Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of  Title 18, United States Code).                 |
|   |   |   |   |                                                                                                                                                                                                                                                             |
| 32.2   |   | -      |   | Certification by William D. Hibbetts, Senior Vice President  and Chief Financial Officer, pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350,  Chapter 63 of Title 18, United States Code). |

 

----

*                                         Incorporated byreference to the filing indicated.

 

+                                         Management contract orcompensatory plan or arrangement.

 

53

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SIGNATURES

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 

 
|               | PIONEER  DRILLING COMPANY |
|--------------------|---------------------------|
|               |                      |
| June 1,  2005 | By:                       | /s/  Wm. Stacy Locke |   |
|               |                      |    Wm.  Stacy Locke |
|               |                      |    Chief  Executive Officer and President |

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
| **Signature**            | ** ** | **Title** | ** **                                                                                                   | **Date** | ** **         |
|--------------------------|------------|-----------|--------------------------------------------------------------------------------------------------------------|----------|--------------------|
|                     |       |      |                                                                                                         |     |               |
| /s/  Michael E. Little   |       |      |                                                                                                         |     |               |   |
| Michael  E. Little       |       |      | Chairman                                                                                                     |     | June 1,  2005 |   |
|                     |       |      |                                                                                                         |     |               |   |
| /s/  Wm. Stacy Locke     |       |      |                                                                                                         |     |               |   |
| Wm.  Stacy Locke         |       |      | President,  Chief Executive Officer and  Director (Principal Executive Officer)                              |     | June 1,  2005 |   |
|                     |       |      |                                                                                                         |     |               |   |
| /s/  William D. Hibbetts |       |      |                                                                                                         |     |               |   |
| William  D. Hibbetts     |       |      | Senior  Vice President, Chief Financial  Officer and Secretary (Principal Financial  and Accounting Officer) |     | June 1,  2005 |   |
|                     |       |      |                                                                                                         |     |               |   |
|                     |       |      |                                                                                                         |     |               |   |
| C.  John Thompson        |       |      | Director                                                                                                     |     | June 1,  2005 |   |
|                     |       |      |                                                                                                         |     |               |   |
|                     |       |      |                                                                                                         |     |               |   |
| /s/  James M. Tidwell    |       |      |                                                                                                         |     |               |   |
| James  M. Tidwell        |       |      | Director                                                                                                     |     | June 1,  2005 |   |
|                     |       |      |                                                                                                         |     |               |   |
|                     |       |      |                                                                                                         |     |               |   |
| /s/  C. Robert Bunch     |       |      |                                                                                                         |     |               |   |
| C.  Robert Bunch         |       |      | Director                                                                                                     |     | June 1,  2005 |   |
|                     |       |      |                                                                                                         |     |               |   |
|                     |       |      |                                                                                                         |     |               |   |
| /s/  Dean A. Burkhardt   |       |      |                                                                                                         |     |               |   |
| Dean  A. Burkhardt       |       |      | Director                                                                                                     |     | June 1,  2005 |   |
|                     |       |      |                                                                                                         |     |               |   |
|                     |       |      |                                                                                                         |     |               |   |
| /s/  Michael F. Harness  |       |      |                                                                                                         |     |               |   |
| Michael  F. Harness      |       |      | Director                                                                                                     |     | June 1,  2005 |   |

 

54

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Index To Exhibits

 
| 2.1    |   | -      |   | Asset Purchase Agreement dated November 11, 2004  between Wolverine Drilling, Inc. and Robert Mau, Robert S. Blackford and  Pioneer Drilling Services, Ltd. (Form 8-K dated November 11,  2004 (File No. 1-8182, Exhibit 2.1)).                                                                                                                                                                     |
|--------|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 2.2    |   | -      |   | Asset Purchase Agreement dated November 29,2004,  by and among Allen Drilling Company, the Earl Allen Family Trust dated April 1,  1079, the sole shareholder of Allen Drilling Company, Dixon Allen, Paula K.  Hoisington and Lisa D. Johonnesson, all of the beneficiaries of the Trust,  and Pioneer Drilling Services, Ltd. (Form 8-K dated November 30,  2004 (File No. 1-8182m Exhibit 2.1)). |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 3.1*   |   | -      |   | Articles of Incorporation of Pioneer Drilling Company,  as amended (Form 10-K for the year ended March 31, 2001 (File  No. 1-8182, Exhibit 3.1)).                                                                                                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 3.2*   |   | -      |   | Articles of Amendment to the Articles of Incorporation  of Pioneer Drilling Company (Form 10-Q for the quarter ended September 30,  2001 (File No. 1-8182, Exhibit 3.1)).                                                                                                                                                                                                                                     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 3.3*   |   | -      |   | Amended and Restated Bylaws of Pioneer Drilling  Company (Form 10-Q for the quarter ended December, 2003 (File No. 1-8182,  Exhibit 3.3)).                                                                                                                                                                                                                                                                         |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.1*   |   |   |   | Form of Certificate representing Common Stock of  Pioneer Drilling Company (Form S-8 filed November 18, 2003  (Reg. No. 333-110569, Exhibit 4.3)).                                                                                                                                                                                                                                                       |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.2*   |   |   |   | Form of Purchase Agreement dated February 13,  2004 between Pioneer Drilling Company and the several purchasers (Form S-3  filed February 24, 2004 (Reg. No. 333-113036, Exhibit 4.1)).                                                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.3    |   | -      |   | Credit Agreement between Pioneer Drilling Services,  Ltd. and Frost National Bank, as Administrative Agent, Agent, Lead Arranger  and Lender dated October 29, 2004 (Form 8-K dated October 29,  2004 (File No. 1-8182, Exhibit 4.1)).                                                                                                                                                                   |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.1+* |   | -      |   | Executive Employment Agreement dated May 1, 1995  between Pioneer Drilling Company and Wm. Stacy Locke (Form 10-K  for the year ended March 31, 2001 (File No. 1-8182, Exhibit 10.1+)).                                                                                                                                                                                                                  |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.2+* |   | -      |   | Second Amendment to Executive Employment Agreement  dated August 21, 2000 between Pioneer Drilling Company and Wm. Stacy  Locke (Form 10-K for the year ended March 31, 2001 (File No. 1-8182, Exhibit 10.4+)).                                                                                                                                                                                          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.3+* |   | -      |   | Pioneer Drilling Company’s 1995 Stock Plan and form of  Stock Option Agreement (Form 10-K for the year ended March 31,  2001 (File No. 1-8182, Exhibit 10.5+)).                                                                                                                                                                                                                                          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.4+* |   | -      |   | Pioneer Drilling Company’s 1999 Stock Plan and form of  Stock Option Agreement (Form 10-K for the year ended March 31,  2001 (File No. 1-8182, Exhibit 10.7+)).                                                                                                                                                                                                                                          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.5*  |   | -      |   | Pioneer Drilling Company 2003 Stock Plan (Form S-8  filed November 18, 2003 (File No. 333-110569, Exhibit 4.4)).                                                                                                                                                                                                                                                                                              |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.6   |   | -      |   | Termination Agreement date May 26, 2005 between  Michael E. Little, Wm. Stacy Locke, Pioneer Drilling Company and WEDGE Energy  Services, L.L.C.                                                                                                                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 21.1   |   | -      |   | Subsidiaries of Pioneer Drilling Company.                                                                                                                                                                                                                                                                                                                                                                                         |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 23.1   |   | -      |   | Consent of KPMG LLP.                                                                                                                                                                                                                                                                                                                                                                                                              |

 

55

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| 31.1   |   | -      |   | Certification by Wm. Stacy Locke, President and Chief  Executive Officer, pursuant to Rule 13a-14(a) or Rule 15d-14(a) under  the Securities Exchange Act of 1934.                                                                           |
|--------|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                             |
| 31.2   |   | -      |   | Certification by William D. Hibbetts, Senior Vice  President and Chief Financial Officer, pursuant to Rule 13a-14(a) or  Rule 15d-14(a) under the Securities Exchange Act of 1934.                                                           |
|   |   |   |   |                                                                                                                                                                                                                                                             |
| 32.1   |   | -      |   | Certification by Wm. Stacy Locke, President and Chief  Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of  Title 18, United States Code).                 |
|   |   |   |   |                                                                                                                                                                                                                                                             |
| 32.2   |   | -      |   | Certification by William D. Hibbetts, Senior Vice  President and Chief Financial Officer, pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350,  Chapter 63 of Title 18, United States Code). |

 

----

*                                         Incorporated byreference to the filing indicated.

 

+                                         Management contract or compensatory plan orarrangement.

 

56

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