**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

** **

**FORM 10-Q**

 

| **ý**                                           |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|------------------------------------------------------|--------|------------------------------------------------------------------------------------------------|
|                                                 |   |                                                                                           |
| **For the quarterly period ended December 31, 2003** |
|                                                 |   |                                                                                           |
|                                                 |   | **OR**                                                                                         |
|                                                 |   |                                                                                           |
| **o**                                                |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                                   to**

 

**Commission File Number****001-08182**

 

**PIONEER DRILLING COMPANY**

(Exact name of registrant as specified in itscharter)

 

| **TEXAS**                                                       |   | **74-2088619**                           |
|-----------------------------------------------------------------|--------|------------------------------------------|
| (State or other jurisdiction  of incorporation or organization) |   | (I.R.S. Employer  Identification Number) |
|                                                            |   |                                     |
| **9310 Broadway, Bldg. 1, San Antonio, Texas**                  |   | **78217**                                |
| (Address of principal executive offices)                        |   | (Zip Code)                               |
|                                                            |   |                                     |
| **210-828-7689**                                                |
| (Registrant’s telephone number, including  area code)      |

 

 

(Former name, address and former fiscal year,if changed since last report)

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes ý  No o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act). Yeso  Noý

 

As of February5, 2004, there were 22,211,792 shares of common stock, par value $0.10 pershare, of the registrant issued and outstanding.

 

 

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PART 1. FINANCIAL INFORMATION

ITEM1.     FINANCIAL STATEMENTS

 

PIONEER DRILLING COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 
|                                                                                                                                                               |   | **(Unaudited)  December 31,  2003** |        | **March 31,  2003** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------|-------------|---------------------|--------|
| ASSETS                                                                                                                                                             |   |                                |        |                |   |
| Current assets:                                                                                                                                                    |   |                                |        |                |   |
| Cash and cash equivalents                                                                                                                                          |   | $                                   | 2,829,960   |                | $      | 21,002,913 |   |
| Receivables, net                                                                                                                                                   |   | 11,207,898                          |        | 4,499,378           |   |
| Contract drilling in progress                                                                                                                                      |   | 3,678,962                           |        | 4,429,545           |   |
| Federal income tax receivable                                                                                                                                      |   | —                              |        | 444,900             |   |
| Current deferred income taxes                                                                                                                                      |   | 132,031                             |        | 180,991             |   |
| Prepaid expenses                                                                                                                                                   |   | 1,620,711                           |        | 914,187             |   |
| Total current assets                                                                                                                                               |   | 19,469,562                          |        | 31,471,914          |   |
|                                                                                                                                                               |   |                                |        |                |   |
| Property and equipment, at cost                                                                                                                                    |   | 133,156,735                         |        | 110,223,230         |   |
| Less accumulated depreciation                                                                                                                                      |   | 32,763,264                          |        | 22,367,327          |   |
| Net property and equipment                                                                                                                                         |   | 100,393,471                         |        | 87,855,903          |   |
| Other assets                                                                                                                                                       |   | 345,958                             |        | 366,500             |   |
| Total assets                                                                                                                                                       |   | $                                   | 120,208,991 |                | $      | 119,694,317 |   |
|                                                                                                                                                               |   |                                |        |                |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                          |   |                                |        |                |   |
| Current liabilities:                                                                                                                                               |   |                                |        |                |   |
| Notes payable                                                                                                                                                      |   | $                                   | 889,970     |                | $      | 587,177 |   |
| Current installments of long-term debt and capital  lease obligations                                                                                              |   | 3,609,884                           |        | 2,811,986           |   |
| Accounts payable                                                                                                                                                   |   | 14,071,461                          |        | 14,206,586          |   |
| Accrued payroll                                                                                                                                                    |   | 1,810,723                           |        | 847,163             |   |
| Accrued expenses                                                                                                                                                   |   | 2,507,596                           |        | 1,874,693           |   |
| Total current liabilities                                                                                                                                          |   | 22,889,634                          |        | 20,327,605          |   |
|                                                                                                                                                               |   |                                |        |                |   |
| Long-term debt and capital lease obligations, less  current installments                                                                                           |   | 44,023,163                          |        | 45,854,542          |   |
| Deferred income taxes                                                                                                                                              |   | 5,614,993                           |        | 5,839,908           |   |
| Total liabilities                                                                                                                                                  |   | 72,527,790                          |        | 72,022,055          |   |
|                                                                                                                                                               |   |                                |        |                |   |
| Shareholders’ equity:                                                                                                                                         |   |                                |        |                |   |
| Preferred stock, 10,000,000 shares authorized;  none issued and outstanding                                                                                        |   | —                              |        | —              |   |
| Common stock, $.10 par value,  100,000,000 shares authorized; 22,211,792  and 21,700,792 shares issued at December 31, 2003 and March 31, 2003,  respectively |   | 2,221,179                           |        | 2,170,079           |   |
| Additional paid-in capital                                                                                                                                         |   | 59,887,077                          |        | 57,730,188          |   |
| Accumulated deficit                                                                                                                                                |   | (14,427,055                         | )           | (12,228,005         | )      |
| Total shareholders’ equity                                                                                                                                    |   | 47,681,201                          |        | 47,672,262          |   |
| Total liabilities and shareholders’ equity                                                                                                                    |   | $                                   | 120,208,991 |                | $      | 119,694,317 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

2

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PIONEER DRILLING COMPANY AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

(Unaudited)

 
|                                                     |   | **Three  Months Ended  December 31,** |       | **Nine  Months Ended  December 31,** |   |
|----------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|--------|
|                                                     |   | **2003**                              |       | **2002**                             |   | **2003** |   | **2002** |   |
| Revenues:                                                |   |                                  |       |                                 |   |   |   |   |   |
| Contract drilling                                        |   | $                                     | 26,414,362 |                                 | $      | 19,795,727 |   | $ | 74,508,827 |   | $ | 55,289,179 |   |
| Other                                                    |   | 25,184                                |       | 12,310                               |   | 65,056 |   | 34,743 |   |
| Total operating revenues                                 |   | 26,439,546                            |       | 19,808,037                           |   | 74,573,883 |   | 55,323,922 |   |
|                                                     |   |                                  |       |                                 |   |   |   |   |   |
| Costs and expenses:                                      |   |                                  |       |                                 |   |   |   |   |   |
| Contract drilling                                        |   | 21,599,719                            |       | 18,076,564                           |   | 61,757,266 |   | 47,918,096 |   |
| Depreciation and amortization                            |   | 4,118,811                             |       | 3,006,185                            |   | 11,670,538 |   | 8,521,830 |   |
| General and administrative                               |   | 687,286                               |       | 552,714                              |   | 2,027,132 |   | 1,677,622 |   |
| Bad debt expense                                         |   | —                                |       | —                               |   | — |   | 110,000 |   |
| Total operating costs and expenses                       |   | 26,405,816                            |       | 21,635,463                           |   | 75,454,936 |   | 58,227,548 |   |
|                                                     |   |                                  |       |                                 |   |   |   |   |   |
| Earnings (loss) from operations                          |   | 33,730                                |       | (1,827,426                           | )      | (881,053 | ) | (2,903,626 | ) |
|                                                     |   |                                  |       |                                 |   |   |   |   |   |
| Other income (expense):                                  |   |                                  |       |                                 |   |   |   |   |   |
| Interest expense                                         |   | (683,496                              | )          | (673,194                             | )      | (2,117,226 | ) | (1,900,116 | ) |
| Interest income                                          |   | 10,358                                |       | 19,516                               |   | 86,776 |   | 72,912 |   |
| Gain on sale of marketable securities                    |   | —                                |       | —                               |   | — |   | 203,887 |   |
| Total other income (expense)                             |   | (673,138                              | )          | (653,678                             | )      | (2,030,450 | ) | (1,623,317 | ) |
|                                                     |   |                                  |       |                                 |   |   |   |   |   |
| Loss before income taxes                                 |   | (639,408                              | )          | (2,481,104                           | )      | (2,911,503 | ) | (4,526,943 | ) |
| Income tax benefit                                       |   | 117,862                               |       | 777,009                              |   | 712,453 |   | 1,349,348 |   |
| Net Loss                                                 |   | $                                     | (521,546   | )                                    | $      | (1,704,095 | ) | $ | (2,199,050 | ) | $ | (3,177,595 | ) |
|                                                     |   |                                  |       |                                 |   |   |   |   |   |
| Loss per common share - Basic                            |   | $                                     | (0.02      | )                                    | $      | (0.11 | ) | $ | (0.10 | ) | $ | (0.20 | ) |
|                                                     |   |                                  |       |                                 |   |   |   |   |   |
| Loss per common share - Diluted                          |   | $                                     | (0.02      | )                                    | $      | (0.11 | ) | $ | (0.10 | ) | $ | (0.20 | ) |
|                                                     |   |                                  |       |                                 |   |   |   |   |   |
| Weighted average number of shares outstanding -  Basic   |   | 22,203,194                            |       | 16,142,024                           |   | 21,983,730 |   | 16,078,277 |   |
|                                                     |   |                                  |       |                                 |   |   |   |   |   |
| Weighted average number of shares outstanding -  Diluted |   | 22,203,194                            |       | 16,142,024                           |   | 21,983,730 |   | 16,078,277 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

3

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PIONEER DRILLING COMPANY AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(Unaudited)

 
|                                                                                       |   | **Nine  Months Ended December 31,** |       |
|--------------------------------------------------------------------------------------------|--------|-------------------------------------|------------|
|                                                                                       |   | **2003**                            |       | **2002** |   |
| Cash flows from operating activities:                                                      |   |                                |       |   |   |
| Net loss                                                                                   |   | $                                   | (2,199,050 | ) | $ | (3,177,595 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |   |                                |       |   |   |
| Depreciation and amortization                                                              |   | 11,670,538                          |       | 8,521,830 |   |
| Allowance for doubtful accounts                                                            |   | —                              |       | 110,000 |   |
| Gain on sales of marketable securities                                                     |   | —                              |       | (203,887 | ) |
| Loss on sale of property and equipment                                                     |   | 516,306                             |       | 288,544 |   |
| Change in deferred income taxes                                                            |   | (175,955                            | )          | (456,998 | ) |
| Changes in current assets and liabilities:                                                 |   |                                |       |   |   |
| Receivables                                                                                |   | (6,708,520                          | )          | 182,507 |   |
| Contract drilling in progress                                                              |   | 750,583                             |       | (1,642,000 | ) |
| Prepaid expenses                                                                           |   | (706,524                            | )          | (814,964 | ) |
| Accounts payable                                                                           |   | (135,125                            | )          | 5,259,361 |   |
| Federal income taxes                                                                       |   | 444,900                             |       | 250,850 |   |
| Accrued expenses                                                                           |   | 1,596,464                           |       | 1,067,545 |   |
| Net cash provided by operating activities                                                  |   | 5,053,617                           |       | 9,385,193 |   |
|                                                                                       |   |                                |       |   |   |
| Cash flows from financing activities:                                                      |   |                                |       |   |   |
| Proceeds from notes payable                                                                |   | 2,110,019                           |       | 33,484,147 |   |
| Payments of debt                                                                           |   | (2,840,708                          | )          | (11,396,049 | ) |
| Increase in other assets                                                                   |   | (3,787                              | )          | (234,449 | ) |
| Proceeds from exercise of options                                                          |   | 85,339                              |       | 106,790 |   |
| Net cash provided by (used in) financing  activities                                       |   | (649,137                            | )          | 21,960,439 |   |
|                                                                                       |   |                                |       |   |   |
| Cash flows from investing activities:                                                      |   |                                |       |   |   |
| Purchase of property and equipment                                                         |   | (22,936,033                         | )          | (29,042,533 | ) |
| Marketable securities sold                                                                 |   | —                              |       | 375,414 |   |
| Proceeds from sale of property and equipment                                               |   | 358,600                             |       | 254,130 |   |
| Net cash used in investing activities                                                      |   | (22,577,433                         | )          | (28,412,989 | ) |
|                                                                                       |   |                                |       |   |   |
| Net increase (decrease) in cash                                                            |   | (18,172,953                         | )          | 2,932,643 |   |
|                                                                                       |   |                                |       |   |   |
| Beginning cash and cash equivalents                                                        |   | 21,002,913                          |       | 5,383,045 |   |
| Ending cash and cash equivalents                                                           |   | $                                   | 2,829,960  |   | $ | 8,315,688 |   |
|                                                                                       |   |                                |       |   |   |
| Supplementary disclosure:                                                                  |   |                                |       |   |   |
| Interest paid                                                                              |   | $                                   | 1,655,047  |   | $ | 1,555,093 |   |
| Income taxes refunded                                                                      |   | (990,237                            | )          | (1,143,200 | ) |
| Common stock issued for purchase of rigs                                                   |   | 2,122,650                           |       | — |   |

 

See accompanying notes to condensed consolidated financial statements.

 

4

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 PIONEER DRILLING COMPANY AND SUBSIDARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS

 

**1.  Organization and Basis of Presentation**

 

The condensedconsolidated financial statements include the accounts of Pioneer DrillingCompany and its wholly owned subsidiaries. All significant intercompany balances and transactions have beeneliminated in consolidation.

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and with theinstructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements.  Inthe opinion of our management, all adjustments (consisting of normal recurringaccruals) necessary for a fair presentation have been included.

 

We use theasset and liability method of Statement of Financial Accounting Standards(“SFAS”) No. 109 for accounting for income taxes.  Under this method, we recognize deferred tax assets andliabilities for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases.  We measuredeferred tax assets and liabilities using enacted tax rates we expect to applyto taxable income in the years in which we expect to recover or settle thosetemporary differences.  Under SFAS No.109, the effect on deferred tax assets and liabilities of a change in tax ratesis recognized in income in the period that includes the enactment date.

 

We haveadopted SFAS No. 123, *Accounting for Stock-Based Compensation*.  SFAS No. 123 allows a company to adopta fair 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 net loss andnet loss per share would have been reduced to the pro forma amounts the tablebelow indicates:

 
|                                                                                                                                              |   | **Three  months ended  December 31,** |     | **Nine  months ended  December 31,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|----------|--------------------------------------|--------|
|                                                                                                                                              |   | **2003**                              |     | **2002**                             |   | **2003** |   | **2002** |   |
| Net loss-as reported                                                                                                                              |   | $                                     | (521,546 | )                                    | $      | (1,704,095 | ) | $ | (2,199,050 | ) | $ | (3,177,595 | ) |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all  awards  net of related tax effect |   | (171,870                              | )        | (90,031                              | )      | (380,217 | ) | (319,230 | ) |
| Net loss-pro forma                                                                                                                                |   | $                                     | (693,416 | )                                    | $      | (1,794,126 | ) | $ | (2,579,267 | ) | $ | (3,496,825 | ) |
| Net loss per share-as reported-basic                                                                                                              |   | $                                     | (0.02    | )                                    | $      | (0.11 | ) | $ | (0.10 | ) | $ | (0.20 | ) |
| Net loss per share-as reported-diluted                                                                                                            |   | (0.02                                 | )        | (0.11                                | )      | (0.10 | ) | (0.20 | ) |
| Net loss per share-pro forma-basic                                                                                                                |   | (0.03                                 | )        | (0.11                                | )      | (0.12 | ) | (0.22 | ) |
| Net loss per share-pro forma-diluted                                                                                                              |   | (0.03                                 | )        | (0.11                                | )      | (0.12 | ) | (0.22 | ) |
| Weighted-average fair value of options  granted during the period                                                                                 |   | $                                     | 3.67     |                                 | $      | — |   | $ | 4.23 |   | $ | 4.50 |   |

 

We estimatethe fair value of each option grant on the date of grant using a Black-Scholesoptions-pricing model.  This modelassumed expected volatility of 61% and weighted-average risk-free interest rateof 3.36% for grants in the three-month period ended December 31, 2003 and anexpected life of five years.  There wereno grants in the three-month period ended December 31, 2002.  The model assumed expected volatility of 65%and 69% and

 

5

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weighted-average risk-freeinterest rates of 3.3% and 4.2% for grants in the nine-month periods endedDecember 31, 2003 and 2002, respectively, and an expected life of fiveyears.  As we have not declareddividends since we became a public company, we did not use a dividendyield.  In each case, the actual valuethat will be realized, if any, will depend on the future performance of ourcommon stock and overall stock market conditions.  There is no assurance the value an optionee actually realizeswill be at or near the value we have estimated using the Black-Scholes model.

 

On April 1,2003, we adopted SFAS No. 143, *Accounting forAsset Retirement Obligations*, which addresses financial accountingand reporting for obligations associated with the retirement of tangiblelong-lived assets and the associated asset retirement costs.  The standard applies to legal obligationsassociated with the retirement of long-lived assets that result from theacquisition, construction, development and/or normal use of the asset.  In that connection, we were required toidentify all our legal obligations relating to asset retirements and determinethe fair value of these obligations as of April 1, 2003.  Our adoption of SFAS No. 143 did not have amaterial effect on our financial position or results of operations.

 

On July 1,2003, we adopted SFAS No. 149, *Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities.* This statement amends and clarifiesfinancial accounting and reporting for derivative instruments, includingcertain derivative instruments in other contracts (collectively referred to asderivatives) and for hedging activities under SFAS No. 133, *Accountingfor Derivative Instrument and Hedging Activities*. The provisions ofthis statement are effective for contracts entered into or modified after June30, 2003 and hedging relationships designated after June 30, 2003.  Except for the provisions related to SFASNo. 133, all provisions of this statement will be applied prospectively.  In addition, paragraphs 7(a) and 23(a) ofthis statement, which relate to forward purchases or sales of when-issuedsecurities or other securities that do not yet exist, should be applied to bothexisting contracts and new contracts entered into after June 30, 2003.  Our adoption of SFAS No. 149 did not have amaterial effect on our financial position or results of operations.

 

On July 1,2003, we adopted SFAS No. 150, *Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity.*  This statement requires issuers to classifyas liabilities (or assets in some circumstance) three classes of freestandingfinancial instruments that embody obligations of the issuer. The provisions ofthis statement are effective for financial instruments entered into or modifiedafter May 31, 2003, and otherwise are effective at the beginning of the firstinterim period beginning after June 15, 2003. Our adoption of SFAS No. 150 did not have a material effect on ourfinancial position or results of operations.

 

**2.  Long-term Debt, Subordinated Debt and NotesPayable**

 

On December15, 2003, we obtained a $3,000,000 loan from Frost National Bank and drew$1,000,000 in December.  The loan,secured by a drilling rig, bears interest at prime plus 1% with interest onlyuntil April 15, 2004, when we will begin making monthly payments of $42,401.

 

We have a$2,500,000 line of credit available from Frost National Bank.  Any borrowings under this line of credit aresecured by our trade receivables and bear interest at a rate of prime (4.00% atDecember 31, 2003) plus 1.0%.   The sumof draws under this line and the amount of all outstanding letters of creditissued by the bank for our account are limited to 75% of eligible accountsreceivable.  Therefore, if 75% of oureligible accounts receivable is less than $2,500,000 plus any outstandingletters of credit issued by the bank on our behalf, our ability to draw underthis line would be reduced.  At December31, 2003, we had no outstanding advances under this line of credit, letters ofcredit were $1,684,000 and 75% of our eligible accounts receivable wasapproximately $8,153,000.  The lettersof credit are issued to two workers’ compensation insurance companies to securepossible future claims under the deductibles on these policies.  It is our practice to pay any amounts dueunder these deductibles as they are incurred. Therefore, we do not anticipate the lender will be required to fund anydraws under these letters of credit.

 

On September29, 2003, the monthly installments of our loan from Frost National Bank,maturing in August 2004, were extended through August 2007.

 

At December31, 2003, we were in compliance with all covenants applicable to ouroutstanding debt.  Those covenants include,among others, the maintenance of ratios of debt to net worth, leverage, cashflow and fixed cost coverage.  Thecovenants also restrict the payment of dividends on our common stock.

 

6

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**3.  Commitments and Contingencies**

 

We have signedan asset purchase agreement to acquire a seven-rig drilling fleet and relatedequipment for $12,000,000.  Thetransaction is subject to our obtaining satisfactory financing and is expectedto close in early March 2004.  We alsoplan to acquire 23 used rig hauling trucks for $1,200,000.  In December 2003, we purchased forapproximately $3,750,000 a rig which we had previously leased. We are financingthis rig purchase primarily with a $3,000,000 bank loan.  We drew $1,000,000 of the $3,000,000 bankloan in December to make a down payment on the rig.

 

We are in theprocess of constructing a 1000 hp electric drilling rig from primarily usedcomponents.  As of December 31, 2003, wehave incurred approximately $1,900,000 of construction costs.  We anticipate additional construction costsof $2,100,000 to $2,600,000; however, we do not have a scheduled completiondate at this time.

 

Due to thenature 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 ofsuch pending litigation, disputes or claims against us will have a material adverseeffect on our financial condition or results of operations.

 

**4.   Equity Transactions**

 

On August 1,2003, we issued 477,000 shares of our common stock at $4.45 per share to TexasInterstate Drilling Company, L. P. as part of the purchase price of two landdrilling rigs.

 

Directors andemployees exercised stock options for the purchase of 34,000 and 245,000 sharesof common stock at prices ranging from $.375 to $2.50 per share during the ninemonths ended December 31, 2003 and December 31, 2002, respectively.

 

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

 

The followingtable presents a reconciliation of the numerators and denominators of the basicEPS and diluted EPS computations as required by SFAS No. 128:

 
|                    |   | **Three  Months Ended  December 31,** |     | **Nine  Months Ended  December 31,** |   |
|-------------------------|--------|---------------------------------------|----------|--------------------------------------|--------|
|                    |   | **2003**                              |     | **2002**                             |   | **2003** |   | **2002** |   |
| Basic                   |   |                                  |     |                                 |   |   |   |   |   |
| Net loss                |   | $                                     | (521,546 | )                                    | $      | (1,704,095 | ) | $ | (2,199,050 | ) | $ | (3,177,595 | ) |
| Weighted average shares |   | 22,203,194                            |     | 16,142,024                           |   | 21,983,730 |   | 16,078,277 |   |
| Loss per share          |   | $                                     | (0.02    | )                                    | $      | (0.11 | ) | $ | (0.10 | ) | $ | (0.20 | ) |

 
|                             |   | **Three Months Ended  December 31,** |     | **Nine Months Ended  December 31,** |   |
|----------------------------------|--------|--------------------------------------|----------|-------------------------------------|--------|
|                             |   | **2003**                             |     | **2002**                            |   | **2003** |   | **2002** |   |
| Diluted                          |   |                                 |     |                                |   |   |   |   |   |
| Net loss                         |   | $                                    | (521,546 | )                                   | $      | (1,704,095 | ) | $ | (2,199,050 | ) | $ | (3,177,595 | ) |
| Effect of dilutive  securities:  |   |                                 |     |                                |   |   |   |   |   |
| Convertible debentures           | (1)    |                                 | —   |                                | — |   | — |   | — |   |
|                             |   |                                 |     |                                |   |   |   |   |   |   |
| Net loss and assumed  conversion |   | $                                    | (521,546 | )                                   | $      | (1,704,095 | ) | $ | (2,199,050 | ) | $ | (3,177,595 | ) |
| Weighted average shares:         |   |                                 |     |                                |   |   |   |   |   |
| Outstanding                      |   | 22,203,194                           |     | 16,142,024                          |   | 21,983,730 |   | 16,078,277 |   |
| Options                          | (1)    |                                 | —   |                                | — |   | — |   | — |   |
| Convertible debentures           | (1)    |                                 | —   |                                | — |   | — |   | — |   |
|                             |   | 22,203,194                           |     | 16,142,024                          |   | 21,983,730 |   | 16,078,277 |   |
| Loss per share                   |   | $                                    | (0.02    | )                                   | $      | (0.11 | ) | $ | (0.10 | ) | $ | (0.20 | ) |

 

7

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----

(1)          Employee stock options to purchase 2,310,000shares and 6,500,000 shares from convertible debentures were not included inthe computation of diluted loss per share for the three and nine months endedDecember 31, 2003, because we reported a loss. Options to purchase 1,975,000 shares and 6,500,000 shares fromconvertible debentures were not included in the computation of diluted earningsper share for the three and nine months ended December 31, 2002, because wereported a loss.

 

8

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS

 

*Statements we make in the followingdiscussion which express a belief, expectation or intention, as well as thosethat are not historical fact, are forward-looking statements that are subjectto risks, uncertainties and assumptions. Our actual results, performance or achievements, or industry results,could differ materially from those we express in the following discussion as aresult of a variety of factors, including general economic and businessconditions and industry trends, the continued strength or weakness of thecontract land drilling industry in the geographic areas in which we operate,decisions about onshore exploration and development projects to be made by oiland gas companies, the highly competitive nature of our business, our futurefinancial performance, including availability, terms and deployment of capital,the continued availability of qualified personnel, and changes in, or ourfailure or inability to comply with, government regulations, including thoserelating to the environment.*

 

*Company Overview*

 

We provideland contract drilling services to independent and major oil and gas operatorsdrilling wells primarily in South, East and North Texas.  We are an oil and gas services company.  We do not invest in oil and natural gasproperties.  The drilling activity ofour customers is highly dependent on the current price of oil and natural gas.

 

Over the pastfour fiscal years, we have significantly expanded our fleet of drilling rigsthrough acquisitions and the construction of new and refurbished rigs.  As of December 31, 2003, our rig fleetconsisted of 28 land drilling rigs that drill in depth ranges between 8,000 and18,000 feet.  We actively market 27 ofthese rigs, while one is idled or “cold stacked.”

 

We arecontinuing to pursue opportunities to expand our rig fleet.  We have agreed to acquire a seven-rigdrilling fleet in a transaction which we expect to close in early March 2004,subject to obtaining satisfactory financing. Closing this transaction would increase our fleet to 35 rigs, of which34 would be actively marketed.

 

We earn ourrevenues by drilling oil and gas wells and use the percentage-of-completionmethod to record revenues and costs.  Weobtain our contracts for drilling oil and gas wells either through competitivebidding or through direct negotiations with customers.  Our drilling contracts generally provide forcompensation on either a daywork, turnkey or footage basis.  Contract terms we offer generally depend onthe complexity and risk of operations, the on-site drilling conditions, thetype of equipment used and the anticipated duration of the work to beperformed.  Generally, our contractsprovide for the drilling of a single well and typically permit the customer toterminate on short notice.

 

A significantperformance 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 of calendar days during theperiod that we have owned the rig. Revenue days for each rig are days when the rig is earning revenuesunder a contract, which is usually a period from the date the rig begins movingto the drilling location until the rig is released from the contract.  On daywork contracts, during themobilization period we earn a fixed amount of revenue based on the mobilizationrate stated in the contract.  We attemptto set the mobilization rate at an amount equal to our external costs for themove plus our internal costs during the mobilization period.  We begin earning our contracted daywork ratewhen we begin drilling the well.

 

For thethree-month and nine-month periods ended December 31, 2003 and 2002, our rigutilization and revenue days were as follows:

 
|              |   | **Three  Months Ended  December 31,** |   | **Nine  Months Ended  December 31,** |   |
|-------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|              |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
|              |   |                                  |   |                                 |   |   |   |   |   |
| Utilization Rates |   | 88                                    | %      | 76                                   | %      | 87 | % | 78 | % |
| Revenue Days      |   | 2,246                                 |   | 1,579                                |   | 6,268 |   | 4,609 |   |

 

9

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The reasonsfor the increase in the number of revenue days in 2003 over 2002 are theincrease in size of our rig fleet from 24 at December 31, 2002 to 28 atDecember 31, 2003 and the improvement in our overall rig utilization rate.

 

In recentperiods, we have maintained rig utilization rates above many of ourcompetitors.  We attribute ourrelatively high utilization rates to a strong sales effort, quality equipment,good field and operations personnel, a disciplined safety approach, and ourgenerally successful performance of turnkey operations.  Turnkey contracts account for approximatelyone-fourth of our contracts; therefore, a higher percentage of our revenues arederived from turnkey contracts than many of our competitors.  Turnkey contracts provide us with theopportunity to improve our drilling margin, but at an increased risk.  Over the long term, turnkey margins perrevenue day are greater than daywork margins; however, occasionally, a turnkeywill not be profitable if the contract cannot be completed successfully withoutunanticipated complications.  InDecember 2003, we encountered problems with a turnkey well on which we lostapproximately $250,000 rather than realizing a projected profit ofapproximately $118,000, which affected our daily margin for the quarter andyear to date.

 

We devotesubstantial resources to maintaining and upgrading our rig fleet.  In December 2003, we removed two rigs fromservice for approximately three weeks each, in order 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.

 

*Market Conditions in Our Industry*

 

The UnitedStates 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 dayrates we can chargefor our rigs.  The availability offinancing sources, past trends in oil and gas prices and the outlook for futureoil and gas prices strongly influence the number of wells oil and gasexploration and production companies decide to drill.

 

Oil prices arecurrently in the $32.00 to $35.00 per barrel range, and natural gas prices arecurrently in the $5.00 to $7.00 per mmbtu range.  The average weekly spot prices of crude oil and natural gas andthe average weekly domestic land rig count for each of the previous six yearsended December 31, 2003 were: 

 
|                           |   | **2003** |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|--------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
| Oil (West  Texas Intermediate) |   | $        | 31.22  |     | $      | 26.20    |   | $        | 26.08  |     | $      | 29.83    |   | $ | 19.71 |   | $ | 14.43 |   |
|                           |   |     |   |     |   |     |   |     |   |     |   |     |   |   |   |   |   |   |   |
| Gas (Henry  Hub)               |   | $        | 5.43   |     | $      | 3.33     |   | $        | 3.90   |     | $      | 4.28     |   | $ | 2.29 |   | $ | 2.06 |   |
|                           |   |     |   |     |   |     |   |     |   |     |   |     |   |   |   |   |   |   |   |
| U.S. Land  Rig Count           |   | 906      |   | 700      |   | 981      |   | 747      |   | 512      |   | 685      |   |

 

The decline inoil and natural gas prices from mid-2001 to mid-2002 resulted in a reduction inthe demand for contract land drilling services, which resulted in a substantialreduction in the rates land drilling companies have been able to obtain fortheir services.  While oil and naturalgas prices have recovered in recent months, drilling activity has not yet recoveredto a level at which we are able to significantly improve our revenue rates anddrilling margins. The Baker Hughes domestic land rig count of rigs undercontract was 1,003 on January 16, 2004, a 41% increase from 713 on January 17,2003.

 

During fiscal2003 and the first nine months of fiscal 2004, substantially all the wells wedrilled for our customers were drilled in search of natural gas because of thedepth capacity of our rigs and the gas rich areas in which we operate.  Natural gas reserves are typically found indeeper geological formations and generally require premium equipment andquality crews to drill the wells.

 

*Critical Accounting Policies and Estimates*

 

*Revenue and cost recognition –*We earn our revenues by drilling oil and gas wells for our customers underdaywork, turnkey or footage contracts, which usually provide for the drillingof a single well.  We recognize

 

10

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revenues on daywork contractsfor 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 ourestimate of 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 areusually completed in less than 60 days. The risks to us under a turnkey contract, and to a lesser extent underfootage contracts, are substantially greater than on a contract drilled on adaywork basis, because we assume most of the risks associated with drillingoperations generally assumed by the operator in a daywork contract, includingthe risks of blowout, loss of hole, stuck drill pipe, machinery breakdowns andabnormal drilling conditions, as well as risks associated with subcontractors’services, supplies, cost escalations and personnel operations.

 

We accrueestimated contract costs on turnkey and footage contracts for each day of workcompleted based on our estimate of the total costs to complete the contractdivided by our estimate of the number of days to complete the contract.Contract costs include labor, materials, supplies, repairs and maintenance andoperating overhead allocations.   Werecord provisions for estimated losses on uncompleted contracts in the periodin which such losses are determined. Changes in job performance, job conditions and estimated profitabilitymay result in revisions to costs and income and are recognized in the period inwhich we determine the revisions.  Inaddition, the occurrence of uninsured or under-insured losses or operating costoverruns on our turnkey and footage contracts could have a material adverseeffect on our financial position and results of operations.* *Therefore, our actual results could differ significantly ifour cost estimates are later revised from our original estimates.

 

*Asset impairments*  –  Weassess the impairment of property and equipment whenever events orcircumstances indicate that the carrying value may not be recoverable.  Factors that we consider important and  that could trigger an impairment reviewwould be our customers’ financial condition and any significant negativeindustry or economic trends.  If areview of our drilling rigs indicates that our carrying value exceeds theestimated undiscounted future cash flows, we are required under applicableaccounting standards to write down the drilling equipment to its fair marketvalue.

 

*Deferred taxes*  –  Weprovide deferred taxes for net operating loss carryforwards and for the basisdifference in our property and equipment between financial reporting and taxreporting purposes.  For property andequipment, basis differences arise from differences in depreciation periods andmethods and the value of assets acquired in a business acquisition where weacquire an entity rather than just its assets. For financial reporting purposes we depreciate the various components ofour drilling rigs over 8 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*  –  Weconsider the recognition of revenues and costs on turnkey and footage contractscritical accounting estimates.  On thesetypes of contracts, we are required to estimate the number of days it willrequire for us to complete the contract and our total cost to complete thecontract.    Our actual costs couldsubstantially exceed our estimated costs if we encounter problems such as lostcirculation, stuck drill pipe or an underground blowout subsequent to therelease of the financial statements. Revenues and costs during a reporting period could be affected forcontracts in progress at the end of that reporting period which have not beencompleted before our financial statements for that period are released.  Turnkey contract revenues we had accrued in “ContractDrilling in Progress” at December 31, 2003 were approximately $2,293,000.  We had six turnkey contracts in progress atDecember 31, 2003 and all were completed prior to the release of thesefinancial statements.

 

We estimate anallowance for doubtful accounts based on the creditworthiness of our customersas well as general economic conditions. Consequently, an adverse change in those factors could affect ourestimate of our allowance for doubtful accounts.

 

Anothercritical estimate is our determination of the useful lives of our depreciableassets, which directly affects our determination of depreciation expense anddeferred taxes.  A decrease in theuseful life of our drilling equipment would increase depreciation expense andreduce deferred taxes.

 

Our financialstatements include accruals for costs incurred under the $100,000self-insurance portion of our health insurance, the $250,000 deductible underour workers’ compensation insurance and the $100,000 deductible under ourgeneral liability insurance.  Theseaccruals of approximately $713,000 at December 31, 2003

 

11

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are based on informationprovided by the insurance companies and our historical experience with thesetypes of insurance costs.

 

*Liquidity and Capital Resources*

 

Our rig fleethas grown from 8 rigs in August 2000 to 28 as of December 31, 2003.  We have financed this growth with acombination of debt and equity financing. We have raised additional equity or used equity for growth five timessince January 2000 and have increased our long-term debt from approximately$3,909,000 at June 30, 2000 to approximately $47,600,000 at December 31,2003.  We plan to continue to grow ourrig fleet.  We believe that near-termgrowth will require the use of equity financing rather than additionaldebt.  At December 31, 2003, our debt tocapital ratio was approximately 1:1. Due to the volatility in our industry, we are reluctant to take onsubstantial additional debt at this time. However, our ability to continue funding our growth through the issuanceof shares of our common stock is uncertain, as our common stock is not heavilytraded and the market price for our common stock has been volatile in recentperiods.

 

We have agreedto acquire a seven-rig drilling fleet for $12,000,000 in a transaction which weexpect to close in early March 2004, subject to our obtaining satisfactoryfinancing.  We also plan to acquire 23used rig hauling trucks and associated trailers and equipment for $1,200,000.  In December 2003, we purchased for approximately$3,750,000 a rig we had previously leased. We paid $1,000,000 of the purchase price in December, and the balance ofthe purchase price is included in accounts payable at December 31, 2003.  We are financing this rig purchase primarilywith a $3,000,000 bank loan.  Weborrowed the first $1,000,000 of the $3,000,000 bank loan in December to makethe down payment on this rig.

 

We are also inthe process of accumulating primarily used components for the construction of a1000-hp electric drilling rig.  As ofDecember 31, 2003, we have incurred approximately $1,900,000 of constructioncosts.  We anticipate additionalconstruction costs of $2,100,000 to $2,600,000; however, we do not have ascheduled completion date at this time. When funds are available, we plan to reactivate and upgrade our coldstacked rig at a cost of approximately $2,500,000.

 

Since March31, 2003, the additions to our property and equipment were $25,058,683.  Additions consisted of the following:

 
| Drilling rigs (1)        |   | $         | 19,170,016 |   |
|--------------------------|--------|-----------|------------|--------|
| Other drilling equipment |   | 5,283,469 |       |
| Transportation equipment |   | 542,596   |       |
| Other                    |   | 62,602    |       |
|                     |   | $         | 25,058,683 |   |

 

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(1) Includes capitalizedinterest costs of $78,163.

 

In May 2003,we added one refurbished 18,000-foot SCR land drilling rig at a cost of approximately$7,000,000.  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.  On August 26, 2003, we purchased a14,000-foot mechanical rig for $2,925,661 in cash.  Since accepting delivery of the rig, we have spent approximately$2,400,000 preparing the rig for utilization.

 

Our workingcapital decreased to ($3,420,072) at December 31, 2003 from $11,144,309 atMarch 31, 2003.  Our current ratio,which we calculate by dividing our current assets by our current liabilities,was 0.85 at December 31, 2003 compared to 1.55 at March 31, 2003.  The principal reason for the decrease in ourworking capital at December 31, 2003 was our use of approximately $19,200,000of working capital toward the purchase of five drilling rigs, the partialconstruction of a sixth rig, and approximately $1,700,000 for the purchase ofspare equipment and  upgrades to otherrigs.  We used substantially all the$20,000,000 proceeds from the shares of common stock we sold Chesapeake EnergyCorporation on March 31, 2003 to expand our rig fleet or reduce debt weincurred to expand our rig fleet.  Our operationsgenerated cash flows in excess of our requirements for debt service and normalcapital expenditures.  If necessary, wecan defer rig upgrades to improve our cash position.  Therefore, we believe our cash generated by operations and ourability to borrow on our currently unused line of credit of $2,500,000 shouldallow us to meet our routine financial obligations.

 

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The changes inthe components of our working capital were as follows:

 
|                      |   | **December  31,  2003** |       | **March 31,  2003** |   | **Change**  |   |
|---------------------------|--------|-------------------------|------------|---------------------|--------|-------------|--------|
|                      |   |                    |       |                |   |        |   |
| Cash and cash equivalents |   | $                       | 2,829,960  |                | $      | 21,002,913  |   | $ | (18,172,953 | ) |
| Receivables               |   | 14,886,860              |       | 8,928,923           |   | 5,957,937   |   |
| Income tax receivable     |   | —                  |       | 444,900             |   | (444,900    | )      |
| Deferred tax receivable   |   | 132,031                 |       | 180,991             |   | (48,960     | )      |
| Prepaid expenses          |   | 1,620,711               |       | 914,187             |   | 706,524     |   |
| Current assets            |   | 19,469,562              |       | 31,471,914          |   | (12,002,352 | )      |
|                      |   |                    |       |                |   |        |   |
| Current debt              |   | 4,499,854               |       | 3,399,163           |   | 1,100,691   |   |
| Accounts payable          |   | 14,071,461              |       | 14,206,586          |   | (135,125    | )      |
| Accrued expenses          |   | 4,318,319               |       | 2,721,856           |   | 1,596,463   |   |
| Current liabilities       |   | 22,889,634              |       | 20,327,605          |   | 2,562,029   |   |
|                      |   |                    |       |                |   |        |   |
| Working capital (deficit) |   | $                       | (3,420,072 | )                   | $      | 11,144,309  |   | $ | (14,564,381 | ) |

 

The increasein our receivables at December 31, 2003 from March 31, 2003 was due to ouroperating four additional rigs in the quarter ended December 31, 2003 and theholiday period at the end of the period and not a  result of any significant change in our collection of receivables.  By the end of January 2004, we had collectedover 85% of the approximately $11,200,000 of receivables outstanding atDecember 31, 2003.

 

Substantiallyall our prepaid expenses at December 31, 2003 consisted of prepaidinsurance.  We renew and pay ourinsurance premium in late October of each year.  At December 31, 2003, we had only amortized two months of thepremiums, compared to five months of amortization as of March 31, 2003.

 

Of the totalincrease in accrued expenses at December 31, 2003 from March 31, 2003, accruedpayroll cost accounted for approximately $963,000 (16 days compared to 7 daysof accrual), accrued interest on our subordinated debt accounted forapproximately $472,000 (6 months compared to 3 months of accrual), and accruedproperty taxes accounted for the balance (12 months compared to 3 months ofaccrual).

 

Our long-termdebt at December 31, 2003 consisted of the following:

 
| 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, due  December 2007 |   | 13,636,905 |       |
|                                                                                                                                                                                                                   |   |       |       |
| Note payable to Frost National Bank, secured by  drilling equipment, due in monthly payments of $107,143 plus interest at  prime (4.0% at December 31, 2003) plus 1.00%, due August 2007                               |   | 4,713,603  |       |
|                                                                                                                                                                                                                   |   |       |       |
| Note payable to Frost National Bank, secured by  drilling equipment, due in monthly payments of $42,401, including interest at  prime plus 1%, beginning April 15, 2004, due March 15, 2007 (2)                        |   | 1,000,000  |       |
|                                                                                                                                                                                                                   |   |       |       |
| Capital lease obligations                                                                                                                                                                                              |   | 282,539    |       |
|                                                                                                                                                                                                                   |   | $          | 47,633,047 |   |

 

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(1)          Wedge Energy Services, LLC (WEDGE) holds$27,000,000 of the convertible subordinated debentures and Bill White, adirector of our company, holds $1,000,000. WEDGE owns 32.6% of our common stock

 

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(47.4% if the debentures were converted).  Beginning July 3, 2004, we have the option to redeem all or partof the debentures by paying a premium of 5% through July 2, 2005, 4% throughJuly 2, 2006, 3% through July 2, 2007 and 0% thereafter.

 

(2)          This loan is being used to finance thepurchase of the rig we were previously leasing.  The loan is for $3,000,000. We anticipate drawing the remaining $2,000,000 by early March.

 

Our currentlong-term debt, capital lease and operating lease obligations in the yearssubsequent to December 31, 2003 are as follows:

 
|   |   | **Long-term  Debt** |       | **Capital  Leases** |   | **Operating  Leases** |   |
|--------|--------|---------------------|------------|---------------------|--------|-----------------------|--------|
|   |   |                |       |                |   |                  |   |
| 2004   |   | $                   | 3,464,286  |                | $      | 145,598               |   | $ | 112,008 |   |
| 2005   |   | 3,500,000           |       | 90,516              |   | 111,009               |   |
| 2006   |   | 3,500,000           |       | 45,437              |   | 51,537                |   |
| 2007   |   | 36,886,222          |       | 988                 |   | 678                   |   |
|   |   | $                   | 47,350,508 |                | $      | 282,539               |   | $ | 275,232 |   |

 

Borrowingsfrom Frost National Bank and Merrill Lynch Capital, a division of Merrill LynchBusiness Financial Services, Inc. (“MLC”), contain various covenants pertainingto leverage, cash flow coverage, fixed charge coverage and net worth ratios andrestrict us from paying dividends.  Underthese credit arrangements, we determine compliance with the ratios on aquarterly basis based on the previous four quarters.  As of December 31, 2003, we were in compliance with all covenantsapplicable to our outstanding debt.

 

Events ofdefault in our loan agreements, which could trigger an early repaymentrequirement, include among others:

 

•                  our failure tomake required payments;

 

•                  our failure tocomply with financial covenants;

 

•                  our incurrenceof additional indebtedness in excess of $2,000,000 not already allowed by theloan agreements; and

 

•                  any payment ofcash dividends on our common stock.

 

We have a$2,500,000 line of credit available from Frost National Bank.  Any borrowings under this line of credit aresecured by our trade receivables and bear interest at a rate of prime (4.00% atDecember 31, 2003) plus 1.0%.   The sumof draws under this line and the amount of all outstanding letters of creditissued by the bank for our account are limited to 75% of eligible accountsreceivable.  Therefore, if 75% of oureligible accounts receivable is less than $2,500,000 plus any outstandingletters of credit issued by the bank on our behalf, our ability to draw underthis line would be reduced.  At December31, 2003, we had no outstanding advances under this line of credit, letters ofcredit were $1,684,000 and 75% of eligible accounts receivable wasapproximately $8,153,000.  The lettersof credit are issued to two workers’ compensation insurance companies to securepossible future claims that do not exceed the deductibles on these policies.  It is our practice to pay any amounts duethat do not exceed these deductibles as they are incurred.  Therefore, we do not anticipate the lenderwill be required to fund any draws under these letters of credit.

 

*Results of Operations*

 

Our operationsconsist of drilling oil and gas wells for our customers under daywork, turnkey,or footage contracts usually on a well-to-well basis.  Daywork contracts are the easiest for us to perform and involvethe least risk.  Turnkey contracts arethe most difficult to perform and involve much greater risk but provide theopportunity for higher operating margins.

 

14

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*Daywork Contracts*.  Under daywork drilling contracts, we providea drilling rig with required personnel to our customer, who supervises thedrilling of the well.  We are paid basedon a negotiated fixed rate per day while the rig is used.

 

*Turnkey Contracts. *Under a turnkey contract, we agree todrill a well for our customer to a specified depth and under specifiedconditions for a fixed price, regardless of the time required or the problemsencountered in drilling the well.  Weprovide technical expertise and engineering services, as well as most of theequipment and drilling supplies required to drill the well.  We often subcontract for related services,such as the provision of casing crews, cementing and well logging.  Under typical turnkey drilling arrangements,we do not receive progress payments and are entitled to be paid by our customeronly after we have performed the terms of the drilling contract in full.  The risks under a turnkey contract aregreater than those under a daywork contract, because we assume most of therisks associated with drilling operations that the operator generally assumesunder a daywork contract.

 

*Footage Contracts*.  Under footage contracts, we are paid a fixedamount for each foot drilled, regardless of the time required or the problemsencountered in drilling the well.  Wetypically pay more of the out-of-pocket costs associated with footage contractscompared with daywork contracts. Similar to turnkey contracts, under a footage contract we assume most ofthe risks associated with drilling operations that the operator generallyassumes under a daywork contract.

 

We have a historyof losses.  We incurred net losses ofapproximately $5,100,000, $400,000 and $1,600,000 in the fiscal years endedMarch 31, 2003, 2000 and 1999, respectively, and incurred a net loss ofapproximately $2,200,000 for the nine months ended December 31, 2003.  Our profitability in the future will dependon many factors, but largely on utilization rates and dayrates for our drillingrigs.

 

The currentdemand for drilling rigs greatly influences the types of contracts we are ableto obtain.  As the demand for rigsincreases, daywork rates move up and we are able to switch to primarily dayworkcontracts.

 

For thethree-month and nine-month periods ended December 31, 2003 and 2002, thepercentages of our drilling revenues by type of contract were as follows:

 
|              |   | **Three  Months Ended  December 31,** |   | **Nine  Months Ended  December 31,** |   |
|-------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|              |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
| Daywork Contracts |   | 55                                    | %      | 38                                   | %      | 49 | % | 48 | % |
| Turnkey Contracts |   | 40                                    | %      | 60                                   | %      | 47 | % | 50 | % |
| Footage Contracts |   | 5                                     | %      | 2                                    | %      | 4 | % | 2 | % |

 

While currentdemand for drilling rigs has increased, we continue to bid on turnkey contractsin an effort to improve margins and maintain rig utilization.  In spite of improvements in oil and naturalgas prices, we anticipate only a moderate change in the mix of our types ofcontracts in the near future.

 

Our drilling margins, which we compute by subtracting contract drillingcosts from contract drilling revenues, margin percentages, which we compute bydividing the drilling margin by contract drilling revenues, and drilling marginper revenue day, which we compute by dividing the drilling margin by revenuedays, for the three- month and nine-month periods ended December 31, 2003 and2002 were:

 
|                            |   | **Three  Months Ended  December 31,** |       | **Nine  Months Ended  December 31,** |   |
|---------------------------------|--------|---------------------------------------|------------|--------------------------------------|--------|
|                            |   | **2003**                              |       | **2002**                             |   | **2003** |   | **2002** |   |
|                            |   |                                  |       |                                 |   |   |   |   |   |
| Contract drilling revenues      |   | $                                     | 26,414,362 |                                 | $      | 19,795,727 |   | $ | 74,508,827 |   | $ | 55,289,179 |   |
| Contract drilling costs         |   | 21,599,719                            |       | 18,076,564                           |   | 61,757,266 |   | 47,918,096 |   |
| Drilling margin                 |   | $                                     | 4,814,643  |                                 | $      | 1,719,163 |   | $ | 12,751,561 |   | $ | 7,371,083 |   |
| Drilling margin percent         |   | 18                                    | %          | 8                                    | %      | 17 | % | 13 | % |
| Drilling margin per revenue day |   | $                                     | 2,144      |                                 | $      | 1,089 |   | $ | 2,034 |   | $ | 1,599 |   |

 

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The drillingmargin percentage increase in the three-month period ended December 31, 2003compared with the same period in 2002 primarily resulted from increases in rigrevenue rates we charged under our drilling contracts.  The additional costs associated with turnkeycontracts account for the substantial increase in our drilling costs in thethree-month and the nine-month periods ended December 31, 2003 and 2002.  These additional costs negatively affect ourmargin percentage in periods in which turnkey contracts make up a higherpercentage of our revenues.

 

Drillingmargin per revenue day is a measure of profitability from drilling operations,before taxes, depreciation, general and administrative expenses and otherincome (expense), for each day a rig is earning revenue.  Rigs earn revenue while moving, drilling,waiting on standby or cleaning up at the end of a contract.  We believe drilling margin per revenue dayis a good measure to compare our drilling operations from year to year as wellas against competitors in our peer group. Drilling margin per revenue day rose in the quarter and the nine-monthperiod ended December 31, 2003 compared to the same periods in 2002 due to theincreased dayrate environment we experienced in the quarter and the nine-monthperiod ended December 31, 2003.

 

Ourdepreciation and amortization expense in the quarter ended December 31, 2003increased to approximately $4,119,000 from approximately $3,006,000 in thequarter ended December 31, 2002.  Ourdepreciation and amortization expense in the nine months ended December 31, 2003increased to approximately $11,671,000 from approximately $8,522,000 in thecorresponding period of 2002.  Theseincreases resulted from our purchase of five drilling rigs and relatedequipment since December 31, 2002.

 

Our generaland administrative expenses increased to approximately $687,000 in the quarterended December 31, 2003 from approximately $553,000 in the quarter endedDecember 31, 2002.  Our general andadministrative expenses increased to approximately $2,027,000 in the ninemonths ended December 31, 2003 from approximately $1,678,000 in thecorresponding period of 2002.  Theincreases resulted from increased payroll costs, employment fees, loan fees andinsurance costs.  In the nine-monthperiod, payroll cost increased by approximately $223,000 due to pay raises andthe increase from 12 to 15 employees in our corporate office.  Employment and loan fees increased by$55,000 in the nine-month period due to the employee additions and feesassociated with the Merrill Lynch Capital loan.  In addition, our directors and officers liability insuranceincreased by approximately $45,000 in the nine-month period.

 

Our contractland drilling operations are subject to various federal and state laws andregulations designed to protect the environment.  Maintaining compliance with these regulations is part of ourday-to-day operating procedures.  We arenot aware of any potential clean-up obligations that would have a materialadverse effect on our financial condition or results of operations.

 

Our effectiveincome tax benefit rates of 18% and 31% for the three-month periods endedDecember 31, 2003 and 2002 and 24% and 30% for the nine-month periods endedDecember 31, 2003 and 2002, respectively, differ from the federal statutoryrate of 34% due to permanent differences. Permanent differences are costs included in results of operations in theaccompanying financial statements which are not fully deductible for federalincome tax purposes.

 

*Inflation*

 

As a result ofthe relatively low levels of inflation during the past two years, inflation didnot significantly affect our results of operations in any of the periodsreported.

 

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ITEM 3.                             QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are subjectto market risk exposure related to changes in interest rates on some of ouroutstanding debt.  At December 31, 2003,we had outstanding debt of approximately $19,351,000 that was subject tovariable interest rates, in each case based on an agreed percentage-pointspread from the lender’s prime interest rate. An increase or decrease of 1% in the interest rate would have acorresponding decrease or increase in our net income of approximately $128,000annually.  We did not enter into thesedebt arrangements for trading purposes.

 

ITEM 4.                             CONTROLS AND PROCEDURES

 

In accordancewith Exchange Act Rules 13a-15 and 15d-15, we carried out an evaluation, underthe supervision and with the participation of management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of ourdisclosure controls and procedures as of the end of the period covered by thisreport.  Based on that evaluation, ourChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective as of December 31, 2003 toprovide reasonable assurance that information required to be disclosed in ourreports filed or submitted under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms.

 

There has beenno change in our internal controls over financial reporting that occurredduring the three months ended December 31, 2003 that has materially affected,or is reasonably likely to materially affect, our internal controls overfinancial reporting.

 

PART II. OTHER INFORMATION

 

ITEM 6.                             EXHIBITS AND REPORTS ONFORM 8-K

 

(a) Exhibits.                                  Thefollowing exhibits are filed as part of this report or incorporated byreference herein:

 
| 3.1  * |   | -      |   | Articles of Incorporation of Pioneer  Drilling Company, as amended (Form 10-K for the year ended March 31, 2001  (File No. 001-08182, 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. 001-08182, Exhibit 3.1)).   |
|        |   |   |   |                                                                                                                                                                           |
| 3.3         |   | -      |   | Amended and Restated Bylaws of Pioneer  Drilling Company.                                                                                                                      |
|        |   |   |   |                                                                                                                                                                           |
| 4.1         |   | -      |   | Amended and Restated Loan Agreement dated  December 15, 2003, between Pioneer Drilling Services, Ltd., Pioneer Drilling  Company and The Frost National Bank.                  |
|        |   |   |   |                                                                                                                                                                           |
| 4.2         |   | -      |   | First Amendment to Amended and Restated  Loan Agreement dated January 29, 2004 between Pioneer Drilling Services,  Ltd., Pioneer Drilling Company and The Frost National Bank. |
|        |   |   |   |                                                                                                                                                                           |
| 31.1        |   | -      |   | Rule 13a-14(a)/15d-14(a) Certification by  Pioneer Drilling Company’s Chief Executive Officer.                                                                            |
|        |   |   |   |                                                                                                                                                                           |
| 31.2        |   | -      |   | Rule 13a-14(a)/15d-14(a) Certification by  Pioneer Drilling Company’s Chief Financial Officer.                                                                            |
|        |   |   |   |                                                                                                                                                                           |
| 32.1        |   | -      |   | Section 1350 Certification by Pioneer  Drilling Company’s Chief Executive Officer.                                                                                        |

 

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| 32.2 |   | - |   | Section 1350 Certification by Pioneer  Drilling Company’s Chief Financial Officer. |
|------|--------|---|--------|-----------------------------------------------------------------------------------------|

 

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*                                         Incorporatedherein by reference as indicated.

 

(b)                                 Reportson Form 8-K.                              OnNovember 6, 2003, we furnished a current report on Form 8-K relating to thepress release we issued on November 6, 2003 with respect to our results ofoperations for the second quarter (ended September 30, 2003) of our fiscal yearending March 31, 2004.

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                                     | PIONEER DRILLING COMPANY                                         |
|------------------------------------------|------------------------------------------------------------------|
|                                     |                                                             |
|                                     |                                                             |
|                                     |   /s/  William D. Hibbetts                             |   |
|                                     | William D. Hibbetts                                              |
|                                     | Senior Vice President and Chief Financial Officer                |
|                                     | (Principal Financial Officer and Duly Authorized Representative) |
|                                     |                                                             |
| Dated:   February 5, 2004 |                                                             |

 

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Index to Exhibits

 
| 3.1   * |   | -      |   | Articles of Incorporation of Pioneer  Drilling Company, as amended (Form 10-K for the year ended March 31, 2001  (File No. 001-08182, 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. 001-08182, Exhibit 3.1)).   |
|         |   |   |   |                                                                                                                                                                           |
| 3.3          |   | -      |   | Amended and Restated Bylaws of Pioneer  Drilling Company.                                                                                                                      |
|         |   |   |   |                                                                                                                                                                           |
| 4.1          |   | -      |   | Amended and Restated Loan Agreement dated  December 15, 2003, between Pioneer Drilling Services, Ltd., Pioneer Drilling  Company and The Frost National Bank.                  |
|         |   |   |   |                                                                                                                                                                           |
| 4.2          |   | -      |   | First Amendment to Amended and Restated  Loan Agreement dated January 29, 2004 between Pioneer Drilling Services,  Ltd., Pioneer Drilling Company and The Frost National Bank. |
|         |   |   |   |                                                                                                                                                                           |
| 31.1         |   | -      |   | Rule 13a-14(a)/15d-14(a) Certification by  Pioneer Drilling Company’s Chief Executive Officer.                                                                            |
|         |   |   |   |                                                                                                                                                                           |
| 31.2         |   | -      |   | Rule 13a-14(a)/15d-14(a) Certification by  Pioneer Drilling Company’s Chief Financial Officer.                                                                            |
|         |   |   |   |                                                                                                                                                                           |
| 32.1         |   | -      |   | Section 1350 Certification by Pioneer  Drilling Company’s Chief Executive Officer.                                                                                        |
|         |   |   |   |                                                                                                                                                                           |
| 32.2         |   | -      |   | Section 1350 Certification by Pioneer  Drilling Company’s Chief Financial Officer.                                                                                        |

 

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*                                         Incorporatedherein reference as indicated.

 

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