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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q þ
    
    Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
 For the quarterly period ended June 30, 2004
 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 1-8226 (GREY WOLF, INC. LOGO) Grey Wolf, Inc.  Texas
    
    74-2144774(State or jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification number)10370 Richmond Avenue, Suite 600Houston, Texas
    
    77042(Address of principal executive offices)
    
    Zip Code)
 Registrants telephone number, including area code: (713) 435-6100 Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X       No Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X       No The number of shares of the Registrants common stock, par value $.10 per
share, outstanding at August 3, 2004, was 186,352,991.    -1-




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GREY WOLF, INC. AND SUBSIDIARIES
Table of Contents PagePart I.
    
    Financial InformationItem 1.
    
    Financial StatementsConsolidated Balance Sheets
    
    
    3Consolidated Statements of Operations
    
    
    4Consolidated
Statements of Shareholders Equityand Comprehensive Loss
    
    
    5Consolidated Statements of Cash Flows
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2.
    
    Management's Discussion and Analysis of FinancialCondition and Results of Operations
    
    
    17Item 3.
    
    Quantitative and Qualitative Disclosure about Market Risk
    
    
    32Item 4.
    
    Controls and Procedures
    
    
    32Part II.
    
    Other InformationItem 1.
    
    Legal Proceedings
    
    
    33Item 2
    
    Changes in Securities and Use of Proceeds
    
    
    33Item 3.
    
    Defaults Upon Senior Securities
    
    
    33Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    33Item 5.
    
    Other Information
    
    
    33Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    35Signatures
    
    
    36Certification of CEO pursuant to Rule 13a-14aCertification of CFO pursuant to Rule 13a-14aCertification pursuant to Section 906
  -2-




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GREY WOLF, INC. AND SUBSIDIARIES 
 Consolidated Balance Sheets
(Amounts in thousands, except share data) June 30,
    
    December 31,2004
    
    2003(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    50,825
    
    
    $
    54,350Restricted cash
    
    
    752
    
    
    
    749Accounts receivable, net of allowance of $2,443
    
    
    84,797
    
    
    
    60,181Prepaids and other current assets
    
    
    5,294
    
    
    
    4,379Total current assets
    
    
    141,668
    
    
    
    119,659Property and equipment:Land, buildings and improvements
    
    
    5,043
    
    
    
    5,043Drilling equipment
    
    
    798,035
    
    
    
    738,097Furniture and fixtures
    
    
    3,515
    
    
    
    3,332Total property and equipment
    
    
    806,593
    
    
    
    746,472Less: accumulated depreciation
    
    
    (368,771
    )
    
    
    (342,194
    )Net property and equipment
    
    
    437,822
    
    
    
    404,278Goodwill
    
    
    9,247
    
    
    
    Other noncurrent assets, net
    
    
    9,841
    
    
    
    5,141$
    598,578
    
    
    $
    529,078LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable-trade
    
    $
    44,753
    
    
    $
    27,893Accrued workers compensation
    
    
    4,494
    
    
    
    5,295Payroll and related employee costs
    
    
    6,750
    
    
    
    6,660Accrued interest payable
    
    
    1,252
    
    
    
    4,664Other accrued liabilities
    
    
    6,260
    
    
    
    6,420Total current liabilities
    
    
    63,509
    
    
    
    50,932Senior notes
    
    
    
    
    
    
    84,898Contingent convertible senior debt
    
    
    275,000
    
    
    
    150,000Other long-term liabilities
    
    
    4,991
    
    
    
    4,115Deferred income taxes
    
    
    45,798
    
    
    
    43,496Commitments and contingent liabilities
    
    
    
    
    
    
    Shareholders equity:Series B Junior Participating Preferred stock,
$1 par value; 250,000 shares authorized;
none outstanding
    
    
    
    
    
    
    Common stock, $.10 par value; 300,000,000 shares
authorized; 186,352,991 and 181,283,431
issued
and outstanding, respectively
    
    
    18,636
    
    
    
    18,129Additional paid-in capital
    
    
    351,315
    
    
    
    330,266Accumulated deficit
    
    
    (160,671
    )
    
    
    (152,758
    )Total shareholders equity
    
    
    209,280
    
    
    
    195,637$
    598,578
    
    
    $
    529,078
 See accompanying notes to consolidated financial statements -3-




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GREY WOLF, INC. AND SUBSIDIARIES 
 Consolidated Statements of Operations
(Amounts in thousands, except per share data)
(Unaudited) Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenues:Contract drilling
    
    $
    103,750
    
    
    $
    66,949
    
    
    $
    178,950
    
    
    $
    129,336Costs and expenses:Drilling operations
    
    
    84,509
    
    
    
    59,569
    
    
    
    147,046
    
    
    
    114,854Depreciation and amortization
    
    
    14,091
    
    
    
    12,509
    
    
    
    27,063
    
    
    
    24,800General and administrative
    
    
    3,167
    
    
    
    2,763
    
    
    
    6,307
    
    
    
    6,009Gain on sale of assets
    
    
    (7
    )
    
    
    (72
    )
    
    
    (18
    )
    
    
    (93
    )Total costs and expenses
    
    
    101,760
    
    
    
    74,769
    
    
    
    180,398
    
    
    
    145,570Operating income (loss)
    
    
    1,990
    
    
    
    (7,820
    )
    
    
    (1,448
    )
    
    
    (16,234
    )Other income (expense):Interest income
    
    
    170
    
    
    
    427
    
    
    
    336
    
    
    
    716Interest expense
    
    
    (3,908
    )
    
    
    (14,528
    )
    
    
    (10,074
    )
    
    
    (20,565
    )Other, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14Other expense, net
    
    
    (3,738
    )
    
    
    (14,101
    )
    
    
    (9,738
    )
    
    
    (19,835
    )Loss before income taxes
    
    
    (1,748
    )
    
    
    (21,921
    )
    
    
    (11,186
    )
    
    
    (36,069
    )Income tax benefit:Current
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Deferred
    
    
    (266
    )
    
    
    (7,736
    )
    
    
    (3,273
    )
    
    
    (12,263
    )Total income tax benefit
    
    
    (266
    )
    
    
    (7,736
    )
    
    
    (3,273
    )
    
    
    (12,263
    )Net loss
    
    $
    (1,482
    )
    
    $
    (14,185
    )
    
    $
    (7,913
    )
    
    $
    (23,806
    )Basic and diluted net loss per common share
    
    $
    (0.01
    )
    
    $
    (0.08
    )
    
    $
    (0.04
    )
    
    $
    (0.13
    )Basic and diluted weighted average
common shares outstanding
    
    
    186,073
    
    
    
    181,217
    
    
    
    183,765
    
    
    
    181,160
 See accompanying notes to consolidated financial statements -4-




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GREY WOLF, INC. AND SUBSIDIARIES 
 Consolidated Statements of Shareholders Equity and Comprehensive Loss
(Amounts in thousands) CommonStock
    
    AdditionalCommon
    
    $.10 Par
    
    Paid-inShares
    
    Value
    
    Capital
    
    Deficit
    
    TotalBalance, December 31, 2002
    
    
    181,038
    
    
    $
    18,104
    
    
    $
    329,712
    
    
    $
    (122,558
    )
    
    $
    225,258Exercise of stock options
    
    
    184
    
    
    
    18
    
    
    
    256
    
    
    
    
    
    
    
    274Tax benefit of stock
option exercises
    
    
    
    
    
    
    
    
    
    
    170
    
    
    
    
    
    
    
    170Comprehensive net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23,806
    )
    
    
    (23,806
    )Balance, June 30, 2003
(Unaudited)
    
    
    181,222
    
    
    $
    18,122
    
    
    $
    330,138
    
    
    $
    (146,364
    )
    
    $
    201,896Balance, December 31, 2003
    
    
    181,283
    
    
    
    18,129
    
    
    
    330,266
    
    
    
    (152,758
    )
    
    
    195,637Issuance of common stock, net
of issuance costs of $256
    
    
    4,610
    
    
    
    461
    
    
    
    19,883
    
    
    
    
    
    
    
    20,344Exercise of stock options
    
    
    460
    
    
    
    46
    
    
    
    687
    
    
    
    
    
    
    
    733Tax benefit of stock
option exercises
    
    
    
    
    
    
    
    
    
    
    402
    
    
    
    
    
    
    
    402Non-cash compensation
expense
    
    
    
    
    
    
    
    
    
    
    77
    
    
    
    
    
    
    
    77Comprehensive net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,913
    )
    
    
    (7,913
    )Balance, June 30, 2004
(Unaudited)
    
    
    186,353
    
    
    $
    18,636
    
    
    $
    351,315
    
    
    $
    (160,671
    )
    
    $
    209,280
 See accompanying notes to consolidated financial statements -5-




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GREY WOLF, INC. AND SUBSIDIARIES 
 Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited) Six Months EndedJune 30,2004
    
    2003Cash flows from operating activities:Net loss
    
    $
    (7,913
    )
    
    $
    (23,806
    )Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:Depreciation and amortization
    
    
    27,063
    
    
    
    24,800Deferred income taxes
    
    
    (3,675
    )
    
    
    (12,433
    )Gain on sale of assets
    
    
    (18
    )
    
    
    (93
    )Foreign exchange gain
    
    
    
    
    
    
    (14
    )Non-cash compensation expense
    
    
    77
    
    
    
    Accretion of debt discount
    
    
    102
    
    
    
    271Tax benefit of stock option exercises
    
    
    402
    
    
    
    170Net effect of changes in assets and liabilities
related to operating accounts
    
    
    (10,647
    )
    
    
    4,978Cash provided by (used in) operating activities
    
    
    5,391
    
    
    
    (6,127
    )Cash flows from investing activities:Cash paid
for acquisition, net of cash acquired
    
    
    (28,488
    )
    
    
    Property and equipment additions
    
    
    (18,229
    )
    
    
    (22,169
    )Proceeds from sale of property and equipment
    
    
    272
    
    
    
    244Cash used in investing activities
    
    
    (46,445
    )
    
    
    (21,925
    )Cash flows from financing activities:Proceeds from long-term debt
    
    
    122,187
    
    
    
    146,625Payment on long-term debt
    
    
    (85,000
    )
    
    
    Irrevocable deposit for redemption
of long-term debt
    
    
    
    
    
    
    (165,000
    )Financing costs
    
    
    (391
    )
    
    
    (575
    )Proceeds from exercise of stock options
    
    
    733
    
    
    
    274Cash provided by (used in) financing activities
    
    
    37,529
    
    
    
    (18,676
    )Net decrease in cash and cash equivalents
    
    
    (3,525
    )
    
    
    (46,728
    )Cash and cash equivalents, beginning of period
    
    
    54,350
    
    
    
    113,899Cash and cash equivalents, end of period
    
    $
    50,825
    
    
    $
    67,171Supplemental cash flow disclosure:Cash paid for interest
    
    $
    11,909
    
    
    $
    11,350Cash paid for taxes
    
    $
    
    
    
    $
    39
 See accompanying notes to consolidated financial statements -6-




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GREY WOLF, INC. AND SUBSIDIARIES 
 Notes to Consolidated Financial Statements
   (1)
    
    General Grey Wolf, Inc. (the Company or Grey Wolf) is a Texas corporation
formed in 1980. Grey Wolf is a holding company with no independent assets or
operations, but through its subsidiaries is engaged in the business of
providing onshore contract drilling services to the oil and gas industry. The accompanying unaudited consolidated financial statements have been
prepared by the Company in accordance with accounting principles generally
accepted in the United States of America (U.S. GAAP) and include the accounts
of the Company and its majority-owned subsidiaries. In the opinion of
management, the accompanying unaudited consolidated financial statements
contain all adjustments, which are of a normal recurring nature, necessary to
present fairly the Companys financial position as of June 30, 2004 and the
results of operations and cash flows for the periods indicated. All
intercompany transactions have been eliminated. The results of operations for
the three and six month periods ended June 30, 2004 and 2003 are not
necessarily indicative of the results for any other period or for the year as a
whole. Additionally, pursuant to the rules and regulations of the Securities
and Exchange Commission, certain information and footnote disclosures normally
included in annual financial statements in accordance with U.S. GAAP have been
omitted. Therefore, these consolidated financial statements should be read in
conjunction with the Companys audited consolidated financial statements and
notes thereto included in the Companys Annual Report on Form 10-K/A for the
year ended December 31, 2003.  (2)
    
    Significant Accounting Policies Earnings Per Share Basic earnings per share (EPS) is based on the weighted average shares
outstanding, during the applicable period, without any dilutive effects
considered. Diluted earnings per share reflects dilution from all outstanding
options and will reflect the shares issuable upon the conversion of the
Floating Rate Contingent Convertible Senior Notes due 2024 (the Floating Rate
Notes) and the 3.75% Contingent Convertible Senior Notes due 2023 (the 3.75%
Notes) once a contingency has been met. The following is a reconciliation of
basic and diluted weighted average common shares outstanding: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands)(Unaudited)Weighted average common shares
outstanding  basic
    
    
    186,073
    
    
    
    181,217
    
    
    
    183,765
    
    
    
    181,160Effect of dilutive securities:Options  Treasury Stock Method
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Contingent Convertible Senior Notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Weighted average common shares
outstanding  diluted
    
    
    186,073
    
    
    
    181,217
    
    
    
    183,765
    
    
    
    181,160
 -7-




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GREY WOLF, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements
(Unaudited) In 2004, the Company has excluded approximately 23.3 million shares and
19.2 million shares issuable upon conversion of the 3.75% Notes and Floating
Rate Notes, respectively, as none of the contingencies have been met (see Note
4). The Company incurred net losses for the three month periods ended June 30,
2004 and 2003 and has excluded options to purchase 10.9 million shares and 10.7
million shares, respectively, from the computation of diluted EPS as the effect
would be anti-dilutive. If the Company had not incurred a net loss, the number
of shares included in the weighted average common shares outstanding would be
based upon the Treasury stock method. Stock-Based Compensation In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure, which amends SFAS No. 123,
Accounting for Stock-Based Compensation, by providing alternative methods of
transition for a voluntary change to the fair value method of accounting for
stock-based employee compensation. In addition, SFAS No. 148 amends the
provisions of SFAS No. 123 to require more prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results of
operations. The Company has adopted the more prominent disclosures required by
SFAS No. 148 as of March 31, 2003; however, as permitted under SFAS No. 123,
the Company continues to apply Accounting Principles Board (APB) Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations in
accounting for its stock option plans. These plans are more fully described in
Note 7. Accordingly, no compensation expense has been recognized for stock option
grants as all options granted had an exercise price equal to the market value
of the underlying common stock on the date of grant. Had compensation expense
for the stock option grants been determined on the fair value at the grant
dates consistent with the method of SFAS No. 123, the Companys net loss and
net loss per share would have been adjusted to the pro forma amounts indicated
below: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands)(Unaudited)Net loss, as reported
    
    $
    (1,482
    )
    
    $
    (14,185
    )
    
    $
    (7,913
    )
    
    $
    (23,806
    )Add: Stock-based employee
compensation expense included in
reporting net loss, net of
related tax effects
    
    
    
    
    
    
    
    
    
    
    52
    
    
    
    Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects
    
    
    (803
    )
    
    
    (567
    )
    
    
    (1,274
    )
    
    
    (1,476
    )Pro forma net loss
    
    $
    (2,285
    )
    
    $
    (14,752
    )
    
    $
    (9,135
    )
    
    $
    (25,282
    )Loss per share  basic and dilutedAs reported
    
    $
    (0.01
    )
    
    $
    (0.08
    )
    
    $
    (0.04
    )
    
    $
    (0.13
    )Pro Forma
    
    $
    (0.01
    )
    
    $
    (0.08
    )
    
    $
    (0.05
    )
    
    $
    (0.14
    )
 -8-




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GREY WOLF, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements
(Unaudited) For purposes of determining compensation expense using the provisions of
SFAS No. 123, the fair value of option grants was determined using the
Black-Scholes option-valuation model. The key input variables used in valuing
the options granted in 2004 and 2003 were: risk-free interest rate based on
five-year Treasury strips of 3.67% in 2004 and 2.89% in 2003; dividend yield of
zero in each year; stock price volatility of 56% in 2004 and 71% in 2003; and
expected option lives of five years for each year presented. Recent Accounting Pronouncement In January 2003, the FASB issued FIN 46, Consolidation of Variable
Interest Entities. In December 2003, the FASB issued a revised version of FIN
46. FIN 46 clarifies existing accounting literature regarding the consolidation
of entities in which a company holds a controlling financial interest. A
majority voting interest in an entity has generally been considered indicative
of a controlling financial interest. FIN 46 specifies other factors (variable
interests) which must be considered when determining whether a company holds a
controlling financial interest in, and therefore must consolidate, an entity
(variable interest entities). The provisions of FIN 46, as revised, are
effective for the first reporting period ending after March 15, 2004. The
provisions of FIN 46 did not have an effect on the Companys consolidated
financial statements for the quarter ended June 30, 2004.  (3)
    
    Accounting for Income Taxes The Company records deferred taxes utilizing an asset and liability
approach. This method gives consideration to the future tax consequences
associated with differences between the financial accounting and tax basis of
assets and liabilities. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. The Company and its domestic subsidiaries file a consolidated
federal income tax return.  (4)
    
    Long-Term Debt Long-term debt consists of the following (amounts in thousands): June 30,
    
    December 31,2004
    
    2003(Unaudited)8 7/8% Senior Notes due July 2007
    
    $
    
    
    
    $
    84,8983.75% Contingent Convertible
Senior Notes due May 2023
    
    
    150,000
    
    
    
    150,000Floating Rate Contingent Convertible
Senior Notes due April 2024
    
    
    125,000
    
    
    
    275,000
    
    
    
    234,898Less current maturities
    
    
    
    
    
    
    Long-term debt
    
    $
    275,000
    
    
    $
    234,898
 -9-




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GREY WOLF, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements
(Unaudited) Floating Rate Notes On March 31, 2004, the Company issued $100.0 million aggregate principal
amount of Floating Rate Notes in a private offering that yielded net proceeds
of approximately $97.8 million. On April 27, 2004, one of the initial
purchasers in the Companys private offering of the Floating Rate Notes
exercised its full option to purchase an additional $25.0 million aggregate
principal amount of the Floating Rate Notes with the same terms. This yielded
net proceeds of $24.4 million. The Floating Rate Notes bear interest at a per
annum rate equal to 3-month LIBOR, adjusted quarterly, minus a spread of 0.05%.
The per annum interest rate will never be less than zero or more than 6.00%.
These Notes mature on April 1, 2024. The Floating Rate Notes are convertible
into shares of the Companys common stock, upon the occurrence of certain
events, at a conversion price of $6.51 per share, which is equal to a
conversion rate of approximately 153.6098 shares per $1,000 principal amount of
the Floating Rate Notes, subject to adjustment. The Floating Rate Notes are
general unsecured senior obligations of the Company and are fully and
unconditionally guaranteed, on a joint and several basis, by all domestic
wholly-owned subsidiaries of the Company. Non-guarantor subsidiaries are
immaterial. The Floating Rate Notes and the guarantees rank equally with all
of the Companys other senior unsecured debt, including the Companys 3.75%
Notes. Fees and expenses of approximately $3.2 million incurred at the time of
issuance are being amortized through April 1, 2014, the first date the holders
may require the Company to repurchase the Floating Rate Notes. The Company may redeem some or all of the Floating Rate Notes at any time
on or after April 1, 2014, at a redemption price equal to 100% of the principal
amount of the Floating Rate Notes, plus accrued but unpaid interest and
liquidated damages, if any, to the date of repurchase, payable in cash.
Holders may require the Company to repurchase all or a portion of the Floating
Rate Notes on April 1, 2014 or April 1, 2019, and upon a change of control, as
defined in the indenture governing the Floating Rate Notes, at 100% of the
principal amount of the Floating Rate Notes, plus accrued but unpaid interest
and liquidated damages, if any, to the date of repurchase, payable in cash. The Floating Rate Notes are convertible, at the holders option, prior to
the maturity date into shares of the Companys common stock under the following
circumstances:  
    
    during any calendar quarter, if the closing sale price per
share of the Companys common stock for at least 20 trading days in
the period of 30 consecutive trading days ending on the last trading
day of the calendar quarter preceding the quarter in which the
conversion occurs, is more than 120% of the conversion price per
share ($7.81 per share) on that 30th trading day;
    
    if the Company has called the Floating Rate Notes for
redemption;
    
    during any period that the credit ratings assigned to the
Companys senior unsecured debt by both Moodys Investors Service
(Moodys) and Standard & Poors Ratings Group (S&P) are reduced
below B1 and B+, respectively, or if neither rating agency is rating
the Companys senior unsecured debt;
    
    during the five trading day period immediately following any
nine consecutive trading day period in which the average trading
price per $1,000 principal amount of the Floating Rate Notes for
each day of such period was less than 95% of the product of the
closing sale price per share of the Companys common stock on that
day multiplied by the number of shares of common stock issuable upon
conversion of $1,000 principal amount of the Floating Rate Notes; or
    
    upon the occurrence of specified corporate transactions,
including a change of control. -10-




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GREY WOLF, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements
(Unaudited) As of June 30, 2004, none of the conditions enabling the holders of the
Floating Rate Notes to convert them into shares of the Companys common stock
have occurred. The indenture governing the Floating Rate Notes does not
contain any restriction on the payment of dividends, the incurrence of
indebtedness or the repurchase of the Companys securities, and does not
contain any financial covenants. 3.75% Notes On May 7, 2003, the Company issued $150.0 million aggregate principal
amount of 3.75% Notes in a private offering that yielded net proceeds of
$146.6 million. The 3.75% Notes bear interest at 3.75% per annum and mature on
May 7, 2023. The 3.75% Notes are convertible into shares of the Companys
common stock, upon the occurrence of certain events, at a conversion price of
$6.45 per share, which is equal to a conversion rate of approximately 155.0388
shares per $1,000 principal amount of the 3.75% Notes, subject to adjustment.
The Company will pay contingent interest at a rate equal to 0.50% per annum
during any six-month period, with the initial six-month period commencing May
7, 2008, if the average trading price of the 3.75% Notes per $1,000 principal
amount for the five day trading period ending on the third day immediately
preceding the first day of the applicable six-month period equals $1,200 or
more. The 3.75% Notes are general unsecured senior obligations of the Company
and are fully and unconditionally guaranteed, on a joint and several basis, by
all domestic wholly-owned subsidiaries of the Company. Non-guarantor
subsidiaries are immaterial. The 3.75% Notes and the guarantees rank equally
with the Floating Rate Notes. Fees and expenses of $3.9 million incurred at
the time of issuance are being amortized through May 2013, the first date the
holders may require the Company to repurchase the 3.75% Notes. The Company may redeem some or all of the 3.75% Notes at any time on or
after May 14, 2008, at a redemption price shown below, payable in cash, plus
accrued but unpaid interest, including contingent interest, if any, to the date
of redemption: RedemptionPeriod
    
    PriceMay 14, 2008 through May 6, 2009
    
    
    101.88
    %May 7, 2009 through May 6, 2010
    
    
    101.50
    %May 7, 2010 through May 6, 2011
    
    
    101.13
    %May 7, 2011 through May 6, 2012
    
    
    100.75
    %May 7, 2012 through May 6, 2013
    
    
    100.38
    %May 7, 2013 and thereafter
    
    
    100.00
    %
 Holders may require the Company to repurchase all or a portion of the
3.75% Notes on May 7, 2013 or May 7, 2018, and upon a change of control, as
defined in the indenture governing the 3.75% Notes, at 100% of the principal
amount of the 3.75% Notes, plus accrued but unpaid interest, including
contingent interest, if any, to the date of repurchase, payable in cash. -11-




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GREY WOLF, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements
(Unaudited) The 3.75% Notes are convertible, at the holders option, prior to the
maturity date into shares of the Companys common stock under the following
circumstances:  
    
    during any calendar quarter, if the closing sale price per
share of the Companys common stock for at least 20 trading days in
the period of 30 consecutive trading days ending on the last trading
day of the calendar quarter preceding the quarter in which the
conversion occurs, is more than 110% of the conversion price per
share ($7.10 per share) on that 30th trading day;
    
    if the Company has called the 3.75% Notes for redemption;
    
    during any period that the credit ratings assigned to the
3.75% Notes by both Moodys and S&P are reduced below B1 and B+,
respectively, or if neither rating agency is rating the 3.75% Notes;
    
    during the five trading day period immediately following any
nine consecutive trading day period in which the average trading
price per $1,000 principal amount of the 3.75% Notes for each day of
such period was less than 95% of the product of the closing sale
price per share of the Companys common stock on that day multiplied
by the number of shares of common stock issuable upon conversion of
$1,000 principal amount of the 3.75% Notes; or
    
    upon the occurrence of specified corporate transactions,
including a change of control. As of June 30, 2004, none of the conditions enabling the holders of the
3.75% Notes to convert them into shares of the Companys common stock have
occurred. At June 30, 2004, the credit ratings assigned to the 3.75% Notes by
Moodys and S&P were B1 and BB-, respectively. The indenture governing the
3.75% Notes does not contain any restriction on the payment of dividends, the
incurrence of indebtedness or the repurchase of the Companys securities, and
does not contain any financial covenants. 87⁄8% Senior Notes On July 1, 2003, the $146.6 million of net proceeds from the issuance of
the 3.75% Notes plus $30.6 million of available cash were used to redeem $165.0
million aggregate principal amount of 87⁄8% Notes previously outstanding at
102.9580%, plus accrued interest. The redemption premium of $4.9 million was
included in interest expense in the second quarter of 2003. Amortization of
the previously deferred financing costs associated with the partial redemption
of the 87⁄8% Notes on July 1, 2003 was accelerated and approximately $2.5 million
was recognized in interest expense in the quarter ended June 30, 2003. On March 31, 2004, $90.0 million of the $97.8 million of net proceeds
received from the issuance of the Floating Rate Notes was irrevocably deposited
with the trustee for the 87⁄8% Senior Notes (the 87⁄8% Notes) to redeem the
remaining $85.0 million aggregate principal amount of those notes at 102.9580%,
plus accrued interest to the redemption date. On April 30, 2004, the cash
deposited with the trustee was used to redeem the $85.0 million aggregate
principal amount of the 87⁄8% Notes. The redemption premium of $2.5 million is
included in interest expense during the quarter ended March 31, 2004 and the
remaining $1.1 million of deferred financing costs associated with the 87⁄8%
Notes was accelerated and amortized through the redemption date of April 30,
2004. -12-




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GREY WOLF, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements
(Unaudited) CIT Facility The Companys subsidiary Grey Wolf Drilling Company L.P. has a $75.0
million credit facility with the CIT Group/Business Credit, Inc. (the CIT
Facility) which expires during January 2006. The CIT Facility provides the
Company with the ability to borrow up to the lesser of $75.0 million or 50% of
the orderly liquidation value (as defined in the agreement) of certain drilling
rig equipment located in the 48 contiguous states of the United States of
America. The CIT Facility is a revolving facility with automatic renewals
after expiration unless terminated by the lender on any subsequent anniversary
date and then only upon 60 days prior notice. Periodic interest payments are
due at a floating rate based upon the Companys debt service coverage ratio
within a range of either LIBOR plus 1.75% to 3.50% or prime plus 0.25% to
1.50%. The CIT Facility provides up to $20.0 million available for letters of
credit. The Company is required to pay a commitment fee of 0.375% per annum on
the unused portion of the CIT Facility and letters of credit accrue a fee of
1.25% per annum. The CIT Facility contains affirmative and negative covenants and the
Company is in compliance with these covenants. Substantially all of the
Companys assets, including its drilling equipment, are pledged as collateral
under the CIT Facility which is also secured by a guarantee of Grey Wolf and
certain of the Companys wholly-owned subsidiaries guarantees. The Company,
however, retains the option, subject to a minimum appraisal value, under the
CIT Facility to extract $75.0 million of the equipment out of the collateral
pool in connection with the sale or exchange of such collateral or relocation
of equipment outside the contiguous 48 states of the United States of America. Among the various covenants that must be satisfied under the CIT Facility
are the following two covenants, as defined in the CIT Facility, which apply
whenever the Companys liquidity, defined as the sum of cash, cash equivalents
and availability under the CIT Facility, falls below $25.0 million. At June
30, 2004 our liquidity, as defined above, was $109.4 million.  
    
    1 to 1 EBITDA coverage of debt service, tested monthly on a
trailing 12 month basis; and
    
    minimum tangible net worth at the end of each quarter will be
at least the prior year tangible net worth less $30.0 million
adjusted for quarterly tests. Additionally, if the total amount outstanding under the CIT Facility
(including outstanding letters of credit) exceeds 50% of the orderly
liquidation value of our domestic rigs, we are required to make a prepayment in
the amount of the excess. Also, if the average rig utilization rate falls
below 45% for two consecutive months, the lender will have the option to
request one additional appraisal per year to aid in determining the current
orderly liquidation value of the drilling equipment. Average rig utilization
is defined as the total number of rigs owned which are operating under drilling
contracts in the 48 contiguous states of the United States of America divided
by the total number of rigs owned, excluding rigs not capable of working
without substantial capital investment. Events of default under the CIT
Facility include, in addition to non-payment of amounts due, misrepresentations
and breach of loan covenants and certain other events including:  
    
    default with respect to other indebtedness in excess of $350,000;
    
    judgments in excess of $350,000; or
    
    a change in control which means that we cease to own 100% of
our two principal subsidiaries, some person or group has either
acquired beneficial ownership of 30% or more of the Company or
obtained the power to elect a majority of our board of directors, or
our board of directors ceases to consist of a majority of
continuing directors (as defined by the CIT Facility). -13-




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GREY WOLF, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements
(Unaudited) The Company currently has no outstanding balance under the CIT Facility
and had $16.4 million of undrawn standby letters of credit at June 30, 2004.
These standby letters of credit are for the benefit of various insurance
companies as collateral for premiums and retained losses which may become
payable under the terms of the underlying insurance contracts and for other
purposes. Outstanding letters of credit reduce the amount available for
borrowing under the CIT facility.  (5)
    
    Segment Information The Company manages its business as one reportable segment. Although the
Company provides contract drilling services in several markets domestically,
these operations have been aggregated into one reportable segment based on the
similarity of economic characteristics among all markets, including the nature
of the services provided and the type of customers of such services.  (6)
    
    Contingencies The Company is involved in litigation incidental to the conduct of its
business, none of which management believes is, individually or in the
aggregate, material to the Companys consolidated financial condition or
results of operations.  (7)
    
    Stock Option Plans and Severance The 2003 Incentive Plan (the 2003 Plan) was approved by shareholders in
May 2003. The 2003 Plan authorizes the grant of the following equity-based
awards:  
    
    incentive stock options;
    
    non-statutory stock options;
    
    restricted shares; and
    
    other stock-based and cash awards. The 2003 Plan replaced the Companys 1996 Employee Stock Option Plan (the
1996 Plan); provided, however that outstanding options previously granted
under the 1996 Plan shall continue to be exercisable subject to the terms and
conditions of such grants. The 1996 Plan allowed for grants of non-statutory
options to purchase common stock, but no further grants of common stock will be
made under the 1996 Plan. The 2003 Plan reserves a maximum of 17.0 million
shares of the Companys common stock underlying all equity-based awards, but is
reduced by the number of shares of common stock subject to previous grants
under the 1996 Plan. At June 30, 2004, there were 5.4 million shares of common
stock available for grant under the 2003 Plan. Grants will not be made after
March 2013, the date the 2003 Plan expires. Prior to 2003, the Company also
granted options under stock option agreements with its chief executive officer
and directors that are outside of the 2003 Plan and the 1996 Plan. At June 30,
2004, these individuals had options outstanding to purchase an aggregate of 2.0
million shares of the Companys common stock. The exercise price of stock options approximates the fair market value of
the stock at the time the option is granted. A portion of the outstanding
options became exercisable upon issuance and the remaining become exercisable
in varying increments over three to five-year periods. The options expire on
the tenth anniversary of the date of grant. On November 13, 2001, the Company amended all outstanding stock option
agreements issued under the 1996 Plan and certain stock option agreements
issued to executive officers and directors. Based upon the occurrence of
certain events (triggering events), the amendments provide for accelerated -14-




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GREY WOLF, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements
(Unaudited) vesting of options and extension of the period in which a current employee
option holder has to exercise his options. The provisions of the amendments
provide for accelerated vesting of options after termination of employment of a
current option holder within one year of a change of control of the Company (as
defined in the amendments). Triggering events that cause an extension of the
exercise period, but not longer than the remaining original exercise period,
include termination of employment as a result of any reason not defined as
termination for cause, voluntary resignation, or retirement in the amendments. In accordance with APB No. 25, the amendments to the stock option
agreements created a new measurement date of November 13, 2001. APB No. 25
requires the Company to determine the intrinsic value of the options at the
measurement date and recognize non-cash compensation expense upon the
occurrence of a triggering event. The amount of compensation expense that
would be recognized upon the occurrence of a triggering event is the difference
between the fair market value of the Companys common stock on the measurement
date and the original exercise price of the options. During the three months ended March 31, 2004, the Company recognized
non-cash compensation expense of approximately $77,000 as a result of employee
terminations. These amounts have been included in general and administrative
expenses on the consolidated statement of operations.  (8)
    
    Concentrations Substantially all of the Companys contract drilling activities are
conducted with independent and major oil and gas companies in the United
States. Historically, the Company has not required collateral or other
security to support the related receivables from such customers. However, the
Company has required certain customers to deposit funds in escrow prior to the
commencement of drilling. Actions typically taken by the Company in the event
of nonpayment include filing a lien on the customers producing property and
filing suit against the customer. For the three and six month periods ended June 30, 2004, there were no
customers which provided greater than 10% of revenue. The Company had one
customer which represented 14% of revenue in the second quarter of 2003;
however, there were no customers with revenue greater than 10% for the six
month period ended June 30, 2003.  (9)
    
    Acquisition and Intangible Assets On April 6, 2004, the Company acquired all of the outstanding capital
stock and stock equivalents of New Patriot Drilling Corp. by merger. The
Company recorded all revenue and expenses since that date. Patriot had a fleet
of ten drilling rigs and provided onshore contract land drilling services to
the oil and gas industry in the Rocky Mountain region. This acquisition
allowed the Company to expand its presence in this region with large natural
gas reserves. The aggregate purchase price for Patriot was $49.3 million, including
$13.8 million in cash, $14.7 million in cash to retire the outstanding debt of
Patriot and 4,610,480 shares of the Companys common stock valued at $20.6
million. The value of the common stock issued was determined based upon the
average market price of the Companys common stock over the two day period
before and after the signing of the agreement and plan of merger. The cash
consideration is subject to final adjustment for changes in Patriots working
capital. -15-




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GREY WOLF, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements
(Unaudited) The purchase price was allocated among assets acquired and liabilities
assumed based on their fair market value at the date of acquisition.
The purchase price allocation, which is subject to refinement and the
final working capital adjustment, is as follows (in thousands): Current assets
    
    $
    3,698Property and equipment
    
    
    42,384Intangible assets
    
    
    3,200Goodwill
    
    
    9,247Total assets acquired
    
    
    58,529Current liabilities
    
    
    (3,278
    )Deferred tax liabilities
    
    
    (5,977
    )Total liabilities assumed
    
    
    (9,255
    )Net assets acquired
    
    $
    49,274
 Goodwill represents the excess of costs over the fair value of assets of
businesses acquired. None of the goodwill resulting from this acquisition is
deductible for tax purposes. The Company follows the provisions of SFAS No.
142, Goodwill and Other Intangible Assets. Pursuant to SFAS No. 142, goodwill
and intangible assets acquired in a purchase business combination and
determined to have an indefinite useful life are not amortized, but instead are
tested for impairment at least annually in accordance with the provisions of
SFAS No. 142. SFAS No. 142 also requires that intangible assets with estimable
useful lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 144, Accounting for Impairment or Disposal of Long-Lived Assets. The
Company did not record an impairment charge for goodwill and its intangible
assets during the second quarter of 2004. The intangible assets represent customer contracts and related
relationships acquired and are being amortized the useful life of three years.
Amortization expense related to these intangible assets was $248,000 during
the second quarter of 2004 and accumulated amortization was the same as of June
30, 2004. Amortization expense related to these intangible assets over the
next five fiscal years will be: 2004  $781,000; 2005 
$1.1 million; 2006  $1.1 million; 2007  $219,000; and 2008  0. The net balance of these
intangible assets were included in net other noncurrent assets on the
consolidated balance sheet. -16-




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GREY WOLF INC. AND SUBSIDIARIES 
 Managements Discussion and Analysis of Financial
Condition and Results of Operations
 The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto of Grey Wolf, Inc. included
elsewhere herein and with our audited consolidated financial statements and
accompanying notes included in our Annual Report on Form 10-K/A for the year
ended December 31, 2003. Overview We are a leading provider of contract oil and gas land drilling services
in the United States with a fleet of 127 rigs, of which 98 rigs are currently
marketed. Our customers include independent producers and major oil and gas
companies. We conduct our operations through our subsidiaries in what we
believe to be the best natural gas producing regions in the United States. Our business is cyclical and our financial results depend upon several
factors. These factors include the overall demand for land drilling services,
the level of demand for turnkey and footage services, the demand for deep
versus shallow drilling services, the dayrates we receive for our services and
our success drilling turnkey and footage wells. We make available free of charge through our website our annual reports on
Form 10-K and 10-K/A, quarterly reports on Form 10-Q and 10-Q/A, current
reports on Form 8-K, and all amendments to those reports as soon as reasonably
practicable after such material is electronically filed with the Securities and
Exchange Commission. Information on our website is not a part of this report.
Our website address is www.gwdrilling.com. Rig Activity Beginning in the first quarter of 2004 and continuing into the third
quarter of 2004, we have seen an increase in our average rigs working.
Excluding the 10 rigs that we added to our fleet in connection with our
acquisition of the New Patriot Drilling Corp. (Patriot), our average working
rig count rose approximately 20% from the first quarter of 2004 to the second
quarter of 2004, and has continued to climb for the third quarter to date. For
the week ending July 29, 2004, we had an average of 92 rigs working, including
the Patriot rigs. The table below shows the average number of land rigs working in the
United States according to the Baker Hughes rotary rig count and the average
number of our rigs working. 2002
    
    2003
    
    2004DomesticLand Rig
    
    Full
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Full
    
    
    
    
    
    
    
    
    
    July 1-Count
    
    Year
    
    Q-1
    
    Q-2
    
    Q-3
    
    Q-4
    
    Year
    
    Q-1
    
    Q-2
    
    July 30Baker
Hughes
    
    
    695
    
    
    
    773
    
    
    
    903
    
    
    
    964
    
    
    
    988
    
    
    
    880
    
    
    
    1,002
    
    
    
    1,049
    
    
    
    1,096Grey Wolf
    
    
    55
    
    
    
    59
    
    
    
    60
    
    
    
    62
    
    
    
    62
    
    
    
    61
    
    
    
    65
    
    
    
    86
    
    
    
    91
 -17-




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Drilling Contract Bid Rates Dayrates are generally driven by the number of rigs working, or
utilization. Our daywork bid rates ranged between $7,000 and $8,500 per rig
day during the first quarter of 2003 and increased to $8,000 to $9,500 per rig
day for the remainder of 2003 and the beginning of the first quarter of 2004.
As of August 3, 2004, bid rates have risen to between $9,000 to $13,500 per rig
day, without fuel or top drives. This increase is driven by the improvement in
the land rig count. In addition to our fleet of drilling rigs, we own 16 top drives for which
our bid rates range from $1,500 to $1,750 per day. Bid rates for our top
drives are in addition to the above stated bid rates for our rigs. Turnkey and Footage Contract Activity Turnkey and footage work continues to be an important part of our business
and operating strategy. Our engineering and operating expertise allow us to
provide this service to our customers and has historically provided higher
revenues and earnings before interest expense, taxes, depreciation and
amortization (EBITDA) per rig day worked than under daywork contracts. A rig
day is defined as a twenty-four hour period in which a rig is under contract
and should be earning revenue. However, under turnkey and footage contracts we
are typically required to bear additional operating costs (such as drill bits)
and risk (such as loss of hole) that would otherwise be assumed by the customer
under daywork contracts. For the quarter ended June 30, 2004, our turnkey and
footage EBITDA was $4,594 per rig day compared to daywork EBITDA of $1,687 per
rig day. Our turnkey and footage revenue was $32,945 per rig day compared to
$10,203 per rig day for daywork. For the quarter ended June 30, 2004, turnkey
and footage work represented 14% of total days worked compared to 15% of total
days worked during the first quarter of 2004 and 15% in the second quarter of
2003. EBITDA generated on turnkey and footage contracts can vary widely based
upon a number of factors, including the location of the contracted work as well
as the depth and level of complexity of the wells drilled. The demand for
drilling services under turnkey and footage contracts has historically been
greater during periods of overall lower demand. While overall demand has been
higher as evidenced by the increase in rig count, the demand for turnkey
services has not declined. We believe this is due in large part to daywork
rates increasing more slowly in comparison to the increase in rig count than
has historically been the case. Financial Outlook We believe the outlook for the future of natural gas exploration and
production remains positive. Natural gas and oil prices remain at attractive
levels, in our opinion, with the twelve-month strips for natural gas and oil at
$6.37 per mmbtu and $41.63 per barrel, respectively, at August 3, 2004. The
twelve-month strip represents the average price of monthly futures contracts
expiring over the next twelve months on the  New York Mercantile
Exchange (NYMEX). The market for U.S. land rigs is improving, and we believe our customers
are revising their spending objectives upward to take advantage of the
favorable commodity price environment. We also believe that the U.S. land rig
count has reached the point which provides solid support for improved economics
for our industry. Specifically, we are experiencing increasing dayrates and
improved mobilization recoveries. We recently moved two rigs into central
Oklahoma and one rig into Mexico. We will continue to evaluate other
opportunities in Mexico as they arise. We believe we are ready to respond to continued increases in demand. We
currently have 14 cold-stacked rigs, which can be reactivated quickly, as
demand dictates, with relatively little capital outlay (see Critical Accounting
Policies). This would increase our marketed rig count to 112 rigs. In the
third quarter we will reactivate two cold-stacked rigs in our Rocky Mountain
division, one under a term -18-




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contract. In addition, we have 15 inventory rigs that are available for
refurbishment and reactivation should the demand arise. The acquisition of Patriot has allowed us to expand our presence in the
Rocky Mountain market. We have also reduced our ongoing interest expense with
the refinancing of the remainder of our 87⁄8% Senior Notes due
2007 (the 87⁄8%
Notes). In the last year, we reduced our annual interest expense by
approximately $15.0 million from approximately $24.0 million to approximately
$9.0 million going forward at current interest rates. The following estimate of results for the third quarter of 2004 is based
upon currently anticipated levels of activity and dayrates. We expect the
third quarter of 2004 to reflect an average of 91 rigs working. Operating
income is projected at $4.8 million which includes depreciation expense of
approximately $14.1 million and general and administrative expenses of $3.1
million. We expect interest expense of approximately $2.3 million in the third
quarter of 2004. Net income per share is expected to be approximately $0.01 on
a diluted basis, using a tax rate of approximately 55% based upon the expected
level of net income. The tax rate includes the amortization of permanent
differences that arose because of the differences between the financial
accounting and tax basis of assets that were purchased in capital stock
acquisitions. The effective tax rate can vary widely depending upon the
current level of income or loss. These projections are forward-looking statements and while we believe our
estimates are reasonable, we can give no assurance that such expectations or
the assumptions that underlie such assumptions will prove to be correct. We
expect to average between nine and 11 rigs working under turnkey and footage
contracts during the third quarter of 2004; however, there can be no assurance
that we will be able to maintain the current level of activity or EBITDA
derived from turnkey and footage contracts. Critical Accounting Policies Our consolidated financial statements and accompanying notes have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements require
our management to make subjective estimates, judgments and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses.
However, these estimates, judgments and assumptions concern matters that are
inherently uncertain. Accordingly, actual amounts and results could differ from
these estimates made by management, sometimes materially. Critical accounting
policies and estimates are defined as those that are both most important to the
portrayal of our financial condition and operating results and require
managements most subjective judgments. The accounting policies that we
believe are critical are property and equipment, impairment of long-lived
assets, revenue recognition, insurance accruals, and income taxes. Property and Equipment Property and equipment, including betterments and improvements, are stated
at cost with depreciation calculated using the straight-line method over the
estimated useful lives of the assets. We make estimates with respect to the
useful lives that we believe are reasonable. However, the cyclical nature of
our business or the introduction of new technology in the industry could cause
us to change our estimates, thus impacting the future calculation of
depreciation. When any asset is tested for recoverability, we also review the
remaining useful life of the asset. Any changes to the estimated useful life
resulting from that review are made prospectively. We expense our maintenance
and repair costs as incurred. We estimate the useful lives of our assets are
between three and fifteen years. -19-




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Impairment of Long-Lived Assets We assess the impairment of our long-lived assets under Statement of
Financial Accounting Standards Board (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Such
indicators include changes in our business plans, a change in the physical
condition of a long-lived asset or the extent or manner in which it is being
used, or a severe or sustained downturn in the oil and gas industry. If we
determine that a triggering event, such as those described previously, has
occurred we perform a review of our rig and rig equipment. Our review is
performed by comparing the carrying value of each rig plus the estimated cost
to refurbish or reactivate to the estimated undiscounted future net cash flows
for that rig. If the carrying value plus estimated refurbishment and
reactivation cost of any rig is more than the estimated undiscounted future net
cash flows expected to result from the use of the rig, a write-down of the rig
to estimated fair market value must be made. The estimated fair market value is
the amount at which an asset could be bought or sold in a current transaction
between willing parties. Quoted market prices in active markets are the best
estimate of fair market value, however, quoted market prices are generally not
available. As a result, fair value must be determined based upon other
valuation techniques. This could include appraisals or present value
calculations. The calculation of undiscounted future net cash flows and fair
market value is based on our estimates and projections. The demand for land drilling services is cyclical and has historically
resulted in fluctuations in rig utilization. The severity and duration of the
downturn during 1998 triggered a pre-tax asset impairment charge of $93.2
million. We believe the contract drilling industry will continue to be
cyclical and rig utilization will fluctuate. The likelihood of an asset
impairment increases during extended periods of rig inactivity. Each year we
evaluate our cold stacked and inventory rigs and determine our intentions for
their future use. This evaluation takes into consideration, among other
things, the physical condition and marketability of the rig, and projected
reactivation or refurbishment cost. To the extent that our estimates of
refurbishment and reactivation cost, undiscounted future net cash flows or fair
market value change or there is a deterioration in the physical condition of
the inventory or cold stacked rigs, we could be required under SFAS No. 144 to
record an impairment charge. During the fourth quarter of 2002, we recorded a
pre-tax, non-cash asset impairment charge of $3.5 million after performing such
a review. Due to the deterioration of the physical condition of five of the
inventory rigs and changes in market conditions, it was determined that the
rigs, based upon the economics, could no longer be returned to service at a
reasonable cost that would have provided an acceptable return and that the
usable component parts would be included in spare equipment and depreciated
over five years. In the first half of 2004, no impairment of our long-lived
assets was recorded as no change in circumstances indicated that the carrying
value of the assets was not recoverable. Below is a summary of our rig fleet
and the estimated cost to refurbish and reactive by category as of August 3,
2004: EstimatedPer RigRefurbishmentNumber
    
    and ReactivationRig Category
    
    Of Rigs
    
    CostMarketed
    
    
    98
    
    
    
    N/ACold Stacked
    
    
    14
    
    
    $0.2-0.6 MillionInventory
    
    
    15
    
    
    $4.5-5.5 Million
 The net book value of the inventory rigs at June 30, 2004 was $18.9 million. Goodwill and Other Intangible
Assets During
the period, we completed the acquisition of New Patriot Drilling
Corp., which was accounted for as a business combination in
accordance with SFAS No. 141. In conjunction with the
purchase price allocation of the New Patriot Drilling Company
acquisition we recorded Goodwill of $9.2 million and intangible
assets of $3.2 million. The intangible assets represent customer
contracts and related relationships acquired and are being amortized
the useful life of three years. Goodwill represents the
excess of costs over the fair value of assets of businesses acquired.
None of the goodwill resulting from this acquisition is deductible
for tax purposes. The Company follows the provisions of SFAS
No. 142, Goodwill and Other Intangible Assets.
Pursuant to SFAS No. 142, goodwill and intangible assets
acquired in a purchase business combination and determined to have an
indefinite useful life are not amortized, but instead are tested for
impairment at least annually in accordance with the provisions of
SFAS No. 142. SFAS No. 142 also requires that intangible
assets with estimable useful lives be amortized over their respective
estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144,
Accounting for Impairment or Disposal of Long-Lived
Assets. The Company did not record an impairment charge for
goodwill and its intangible assets during the second quarter of 2004. -20-




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Revenue Recognition Revenues are earned under daywork, turnkey and footage contracts. Revenue
from daywork and footage contracts is recognized when it is realized or
realizable and earned. On daywork contracts revenue is recognized based on the
number of days completed at fixed rates stipulated by the contract. On footage
contracts revenue is recognized based on the number of feet that have been
drilled at fixed rates stipulated by the contract. Revenue from turnkey
drilling contracts is recognized using the percentage-of-completion method
based upon costs incurred to date compared to our estimate of the total
contract costs. Under percentage-of-completion, we make estimates of the total
contract costs to be incurred, and to the extent these estimates change, the
amount of revenue recognized could be affected. The significance of the
accrued turnkey revenue varies from period to period depending on the overall
level of demand for our services and the portion of that demand that is for
turnkey services. At June 30, 2004, there were nine turnkey wells in progress
versus eight wells at December 31, 2003, with accrued revenue of $14.9 million
and $5.0 million, respectively at such dates. Anticipated losses, if any, on
uncompleted contracts are recorded at the time our estimated costs exceed the
contract revenue. Insurance Accruals We maintain insurance coverage related to workers compensation and
general liability claims up to $1.0 million per occurrence with an aggregate of
$2.0 million for general liability claims. These policies include deductibles
of $350,000 per occurrence for workers compensation coverage and $250,000 per
occurrence for general liability coverage. If losses should exceed the
workers compensation and general liability policy amounts, we have excess
liability coverage up to a maximum of $75.0 million. At June 30, 2004 and
December 31, 2003, we had $9.5 million and $9.4 million, respectively, accrued
for losses incurred within the deductible amounts for workers compensation and
general liability claims. The amount accrued for the provision for losses incurred varies depending
on the number and nature of the claims outstanding at the balance sheet dates.
In addition, the accrual includes managements estimate of the future cost to
settle each claim such as future changes in the severity of the claim and
increases in medical costs. We use third parties to assist us in developing
our estimate of the ultimate costs to settle each claim, which is based upon
historical experience associated with the type of each claim and specific
information related to each claim. The specific circumstances of each claim
may change over time prior to settlement and as a result, our estimates made as
of the balance sheet dates may change. Income Taxes Our deferred tax assets consist primarily of net operating loss
carryforwards (NOLs). The estimated amount of our NOLs included in our
deferred tax assets at June 30, 2004 are $148.8 million, which expires from
2010 to 2024. Approximately $7.2 million of these NOLs expire in 2010 and
2011, while the remaining $141.6 million expire between 2019 and 2024.
Deferred tax assets must be assessed based upon the likelihood of
recoverability from future taxable income and to the extent that recovery is
not likely, a valuation allowance is established. At June 30, 2004, we do not
have a valuation allowance as we believe that it is more likely than not that
our future taxable income and reversal of deferred tax liabilities will be
sufficient to recover our deferred tax assets. Our business, however, is
extremely cyclical and is highly sensitive to changes in oil and natural gas
prices and demand for our services and there can be no assurances that future
economic or financial developments will not impact our ability to recover our
deferred tax assets. In addition, we have $22.3 million in permanent differences which relate
to differences between the financial accounting and tax basis of assets that
were purchased in capital stock acquisitions. The permanent difference will be
reduced as the assets are depreciated for financial accounting purposes on a -21-




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straight-line basis over the next nine years. As the amortization of
these permanent differences is a fixed amount, our effective tax rate can vary
widely based upon the current level of income or loss. Financial Condition and Liquidity The following table summarizes our financial position as of June 30, 2004
and December 31, 2003. June 30, 2004
    
    December 31, 2003(Unaudited)(Dollars in thousands)Amount
    
    %
    
    Amount
    
    %Working capital
    
    $
    78,159
    
    
    
    15
    
    
    $
    68,727
    
    
    
    14Property and equipment, net
    
    
    437,822
    
    
    
    82
    
    
    
    404,278
    
    
    
    85Other noncurrent assets
    
    
    19,088
    
    
    
    3
    
    
    
    5,141
    
    
    
    1Total
    
    $
    535,069
    
    
    
    100
    
    
    $
    478,146
    
    
    
    100Long-term debt
    
    $
    275,000
    
    
    
    51
    
    
    $
    234,898
    
    
    
    49Other long-term liabilities
    
    
    50,789
    
    
    
    10
    
    
    
    47,611
    
    
    
    10Shareholders equity
    
    
    209,280
    
    
    
    39
    
    
    
    195,637
    
    
    
    41Total
    
    $
    535,069
    
    
    
    100
    
    
    $
    478,146
    
    
    
    100
 Significant Changes in Financial Condition The
acquisition of Patriot and the refinancing of our remaining 87⁄8% Notes
brought significant changes to our balance sheet, including increases in net
property and equipment, other noncurrent assets and shareholders equity. On
April 6, 2004, we acquired all the outstanding capital stock and stock
equivalents of Patriot by merger in exchange for $15.8 million in cash and
4,610,480 shares of our common stock. In addition, we made payments of $14.7
million to retire the outstanding debt of Patriot. The cash consideration is
subject to final adjustment for changes in Patriots working capital. Patriot
had a fleet of ten drilling rigs and provided onshore contract land drilling
services to the oil and gas industry in the Rocky Mountain region. The fair
value of the property and equipment acquired was $42.4 million while intangible
assets acquired were valued at $3.2 million. The intangible assets represent
customer contracts and related customer relationships acquired and are included
in net other noncurrent assets on the consolidated balance sheet. The
intangible assets along with $9.2 million of goodwill related to this
acquisition are included in other noncurrent assets in the table above. Net
property and equipment was also affected by capital expenditures other than for
Patriot of $18.2 million and depreciation for the first six months of 2004 of
$26.8 million. On March 31, 2004, we issued $100.0 million aggregate principal amount of
Floating Rate Notes in a private offering which yielded net proceeds of $97.8
million. Of the net proceeds, $90.0 million was irrevocably deposited with the
trustee of the 87⁄8% Notes to redeem the $85.0 million aggregate principal amount
of those notes at 102.9580%, plus accrued interest on April 30, 2004. The
redemption premium of $2.5 million on the 87⁄8% Notes is
included in interest expense for the quarter ended March 31, 2004. In addition, on April 27, 2004, one of the initial purchasers in our
private offering of the Floating Rate Notes exercised its full option to
purchase an additional $25.0 million aggregate principal amount of the Floating
Rate Notes. As a result, we have $125.0 million aggregate principal amount of
the Floating Rate Notes outstanding. The additional Floating Rate Notes have
the same terms as those issued on March 31, 2004 and we will use the net
proceeds of approximately $24.4 million for general corporate purposes. The
issuance of the Floating Rate Notes and redemption of the 87⁄8% Notes results in
an increase in long-term debt of $40.1 million. -22-




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Working capital increased $9.4 million from December 31, 2003 to June 30,
2004 due primarily to an increase in accounts receivable balances partially
offset by an increase in accounts payable balances. These balances have
changed because of the increase in rig activity. Floating Rate Notes The Floating Rate Notes bear interest at a per annum rate equal to 3-month
LIBOR, adjusted quarterly, minus a spread of 0.05% but will never be less than
zero or more than 6.00%. These notes mature on April 1, 2024. The Floating
Rate Notes are convertible into shares of our common stock, upon the occurrence
of certain events, at a conversion price of $6.51 per share, which is equal to
a conversion rate of approximately 153.6098 shares per $1,000 principal amount
of the Floating Rate Notes, subject to adjustment. The Floating Rate Notes are
our general unsecured senior obligations and are fully and unconditionally
guaranteed, on a joint and several basis, by all our domestic wholly-owned
subsidiaries. Non-guarantor subsidiaries are immaterial. The Floating Rate
Notes and the guarantees rank equally with all of our other senior unsecured
debt, including our 3.75% Notes. Fees and expenses of $3.2 million incurred at
the time of issuance are being amortized through April 1, 2014, the first date
the holders may require us to repurchase the Floating Rate Notes. We may redeem some or all of the Floating Rate Notes at any time on or
after April 1, 2014, at a redemption price equal to 100% of the principal
amount of the Floating Rate Notes, plus accrued but unpaid interest and
liquidated damages, if any, to the date of repurchase, payable in cash.
Holders may require us to repurchase all or a portion of the Floating Rate
Notes on April 1, 2014 or April 1, 2019, and upon a change of control, as
defined in the indenture governing the Floating Rate Notes, at 100% of the
principal amount of the Floating Rate Notes, plus accrued but unpaid interest
and liquidated damages, if any, to the date of repurchase, payable in cash. The Floating Rate Notes are convertible, at the holders option, prior to
the maturity date into shares of our common stock under the following
circumstance  
    
    during any calendar quarter, if the closing sale price per
share of our common stock for at least 20 trading days in the period
of 30 consecutive trading days ending on the last trading day of the
calendar quarter preceding the quarter in which the conversion
occurs, is more than 120% of the conversion price per share ($7.81
per share) on that 30th trading day;
    
    if we have called the Floating Rate Notes for redemption;
    
    during any period that the credit ratings assigned to our
senior unsecured debt by both Moodys Investors Service (Moodys)
and Standard & Poors Ratings Group (S&P) are reduced below B1 and
B+, respectively, or if neither rating agency is rating our senior
unsecured debt;
    
    during the five trading day period immediately following any
nine consecutive trading day period in which the average trading
price per $1,000 principal amount of the Floating Rate Notes for
each day of such period was less than 95% of the product of the
closing sale price per share of our common stock on that day
multiplied by the number of shares of common stock issuable upon
conversion of $1,000 principal amount of the Floating Rate Notes; or
    
    upon the occurrence of specified corporate transactions,
including a change of control. As of the date of this report, none of the conditions enabling the holders
of the Floating Rate Notes to convert them into shares of our common stock have
occurred. The indenture governing the Floating Rate Notes does not contain any
restriction on the payment of dividends, the incurrence of indebtedness or the
repurchase of our securities, and does not contain any financial covenants. -23-




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3.75% Notes The 3.75% Notes bear interest at 3.75% per annum and mature on May 7,
2023. The 3.75% Notes are convertible into shares of our common stock, upon
the occurrence of certain events, at a conversion price of $6.45 per share,
which is equal to a conversion rate of approximately 155.0388 shares per $1,000
principal amount of 3.75% Notes, subject to adjustment. We will pay contingent
interest at a rate equal to 0.5% per annum during any six-month period, with
the initial six-month period commencing May 7, 2008, if the average trading
price of the 3.75% Notes per $1,000 principal amount for the five day trading
period ending on the third day immediately preceding the first day of the
applicable six-month period equals $1,200 or more. The 3.75% Notes are our
general unsecured senior obligations and are fully and unconditionally
guaranteed, on a joint and several basis, by all of our domestic wholly-owned
subsidiaries. Non-guarantor subsidiaries are immaterial. The 3.75% Notes and
the guarantees rank equally with our Floating Rate Notes. Fees and expenses of
approximately $3.9 million incurred at the time of issuance are being amortized
through May 2013, the first date the holders may require us to repurchase the
3.75% Notes. We may redeem some or all of the 3.75% Notes at any time on or
after May 14, 2008, payable in cash, plus accrued but unpaid interest,
including contingent interest, if any, to the date of redemption at various
redemption prices shown in Note 4 to our consolidated financial statements. Holders may require us to repurchase all or a portion of their 3.75% Notes
on May 7, 2013 or May 7, 2018, and upon a change of control, as defined in the
indenture governing the 3.75% Notes, at 100% of the principal amount of the
3.75% Notes, plus accrued but unpaid interest, including contingent interest,
if any, to the date of repurchase, payable in cash. The 3.75% Notes are convertible, at the holders option, prior to the
maturity date into shares of our common stock in the following circumstances:  
    
    during any calendar quarter, if the closing sale price per
share of our common stock for at least 20 trading days in the period
of 30 consecutive trading days ending on the last trading day of the
calendar quarter preceding the quarter in which the conversion
occurs, is more than 110% of the conversion price per share ($7.10
per share) on that 30th trading day;
    
    if we have called the 3.75% Notes for redemption;
    
    during any period that the credit ratings assigned to the
3.75% Notes by both Moodys and S&P are reduced below B1 and B+,
respectively, or if neither rating agency is rating the 3.75% Notes;
    
    during the five trading day period immediately following any
nine consecutive trading day period in which the average trading
price per $1,000 principal amount of the 3.75% Notes for each day of
such period was less than 95% of the product of the closing sale
price per share of our common stock on that day multiplied by the
number of shares of common stock issuable upon conversion of $1,000
principal amount of the 3.75% Notes; or
    
    upon the occurrence of specified corporate transactions,
including a change of control. The 3.75% Notes did not meet the criteria for conversion into common stock
at any time during the quarter ended June 30, 2004 or to the date of this
report. At August 3, 2004, the credit ratings assigned to the 3.75% Notes by
Moodys and S&P were B1 and BB-, respectively. The indenture governing the
3.75% Notes does not contain any restriction on the payment of dividends, the
incurrence of indebtedness or the repurchase of our securities, and does not
contain any financial covenants. -24-




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CIT Facility Our subsidiary, Grey Wolf Drilling Company L.P., has entered into a $75.0
million credit facility with the CIT Group/Business Credit, Inc. (the CIT
Facility) which expires during January 2006. The CIT Facility provides us
with the ability to borrow up to the lesser of $75.0 million or 50% of the
orderly liquidation value (as defined in the agreement) of certain drilling rig
equipment located in the 48 contiguous states of the United States of America.
The CIT Facility is a revolving facility with automatic renewals after
expiration unless terminated by the lender on any subsequent anniversary date
and then only upon 60 days prior notice. Periodic interest payments are due at
a floating rate based upon our debt service coverage ratio within a range of
either LIBOR plus 1.75% to 3.50% or prime plus 0.25% to 1.50%. The CIT
Facility provides up to $20.0 million available for letters of credit. We are
required to pay a commitment fee of 0.375% per annum on the unused portion of
the CIT Facility and letters of credit accrue a fee of 1.25% per annum. The CIT Facility contains affirmative and negative covenants and we are in
compliance with these covenants. Substantially all of our assets, including
our drilling equipment, are pledged as collateral under the CIT Facility which
is also secured by a guarantee of Grey Wolf, Inc. and certain of our
wholly-owned subsidiaries guarantees. However, we retain the option, subject
to a minimum appraisal value, under the CIT Facility to extract $75.0 million
of the equipment out of the collateral pool in connection with the sale or
exchange of such collateral or relocation of equipment outside the contiguous
48 states of the United States of America. Among the various covenants that we must satisfy under the CIT Facility
are the following two covenants, as defined in the CIT Facility, which apply
whenever our liquidity, defined as the sum of cash, cash equivalents and
availability under the CIT Facility, falls below $25.0 million. At June 30,
2004, our liquidity as defined above was $109.4 million.  
    
    1 to 1 EBITDA coverage of debt service, tested monthly on a
trailing 12 month basis; and
    
    minimum tangible net worth ) at the end of each quarter will
be at least the prior year tangible net worth less $30.0 million
adjusted for quarterly tests. Additionally, if the total amount outstanding under the CIT Facility
(including outstanding letters of credit) exceeds 50% of the orderly
liquidation value of our domestic rigs, we are required to make a prepayment in
the amount of the excess. Also, if the average rig utilization rate falls
below 45% for two consecutive months, the lender will have the option to
request one additional appraisal per year to aid in determining the current
orderly liquidation value of the drilling equipment. Average rig utilization
is defined as the total number of rigs owned which are operating under drilling
contracts in the 48 contiguous states of the United States of America divided
by the total number of rigs owned, excluding rigs not capable of working
without substantial capital investment. Events of default under the CIT Facility include, in addition to
non-payment of amounts due, misrepresentations and breach of loan covenants and
certain other events including:  
    
    default with respect to other indebtedness in excess of $350,000;
    
    judgments in excess of $350,000; or
    
    a change in control which means that we cease to own 100% of
our two principal subsidiaries, some person or group has either
acquired beneficial ownership of 30% or more of the outstanding
common stock of Grey Wolf, Inc. or obtained the power to elect a
majority of our board of directors, or our board of directors ceases
to consist of a majority of continuing directors (as defined by
the CIT Facility). We currently have no outstanding balance under the CIT Facility but had
$16.4 million of undrawn letters of credit at August 3, 2004. These standby
letters of credit are for the benefit of various insurance companies as
collateral for premiums and retained losses which may become payable under the -25-




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terms of the underlying insurance contracts and for other purposes.
Outstanding letters of credit reduce the amount available for borrowing under
the CIT facility. Certain Contractual Commitments The following table summarizes certain of our contractual cash obligations
and related payments due by period at June 30, 2004 (unaudited) (amounts in
thousands): Payments Due by Period(1)Less than
    
    1-3
    
    4-5
    
    After 5Contractual Obligation
    
    Total
    
    1 year
    
    years
    
    years
    
    yearsFloating Rate
Notes(2)Principal
    
    $
    125,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    125,000Interest(3)
    
    
    26,500
    
    
    
    1,325
    
    
    
    2,650
    
    
    
    2,650
    
    
    
    19,8753.75% Notes(2)Principal
    
    
    150,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150,000Interest
    
    
    106,875
    
    
    
    5,625
    
    
    
    11,250
    
    
    
    11,250
    
    
    
    78,750Operating leases
    
    
    3,663
    
    
    
    686
    
    
    
    1,152
    
    
    
    1,036
    
    
    
    789Total contractual
cash obligations
    
    $
    412,038
    
    
    $
    7,636
    
    
    $
    15,052
    
    
    $
    14,936
    
    
    $
    374,414
   (1)
    
    This assumes no conversion, acceleration of maturity dates due to
redemption, breach of, or default under, the terms of the applicable
contractual obligation.(2)
    
    See 3.75% Notes and Floating Rate Notes above, for information
relating to covenants, the breach of which could cause a default under,
and acceleration of the maturity date. Also see 3.75% Notes and
Floating Rate Notes for information related to the holders
conversion rights.(3)
    
    Assumes the 3-month LIBOR at June 30, 2004 of 1.11% minus a spread
of 0.05% (1.06%). Our CIT Facility provides up to $20.0 million for the issuance of letters
of credit. If letters of credit which we cause to be issued are drawn upon by
the holders of those letters of credit, then we will become obligated to repay
those amounts along with any accrued interest and fees. Letters of credit
issued reduce the amount available for borrowing under the CIT Facility and, as
a result, we had borrowing capacity of $58.6 million at June 30, 2004. The
following table illustrates the undrawn outstanding standby letters of credit
at June 30, 2004 and the potential maturities if drawn upon by the holders
(unaudited) (amounts in thousands): Payments Due by Period(1)Potential
    
    Total
    
    Less than
    
    1-3
    
    4-5
    
    Over 5Contractual Obligation
    
    Committed
    
    1 year
    
    years
    
    years
    
    yearsStandby letters of credit
    
    $
    16,445
    
    
    $
    
    
    
    $
    16,445
    
    
    $
    
    
    
    $
    Total
    
    $
    16,445
    
    
    $
    
    
    
    $
    16,445
    
    
    $
    
    
    
    $
    
   (1)
    
    Assumes no acceleration of maturity date due to breach of, or default
under, the potential contractual obligation. -26-




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Cash Flow The net cash provided by or used in our operating, investing and financing
activities is summarized below: Six Months EndedJune 30,2004
    
    2003(In thousands)(Unaudited)Net cash provided by (used in):Operating activities
    
    $
    5,391
    
    
    $
    (6,127
    )Investing activities
    
    
    (46,445
    )
    
    
    (21,925
    )Financing activities
    
    
    37,529
    
    
    
    (18,676
    )Net decrease in cash
    
    $
    (3,525
    )
    
    $
    (46,728
    )
 Our cash flows from operating activities are affected by a number of
factors including the number of rigs under contract, whether the contracts are
daywork, footage, or turnkey, and the rate received for these services. Our
cash flow from operating activities provided $5.4 million and used $6.1 million
during the first six months of 2004 and 2003, respectively. The increase in
cash flow from operating activities from the second quarter of 2003 to the
second quarter of 2004 is due primarily to an increase in EBITDA as a result of
higher dayrates and rig activity. Cash flow used in investing activities for the six months ended June 30,
2004 primarily consisted of $28.5 million of cash paid in the Patriot
acquisition, and $18.2 million of capital expenditures. For the six months
ended June 30, 2003, cash flow used consisted of $22.2 million of capital
expenditures, including the purchase of two diesel electric SCR rigs for $9.0
million. Capital expenditures in 2004 and 2003 included betterments and
improvements to our rigs, the acquisition of drill pipe and collars, and other
capital items. Cash flow provided by financing activities for the six months ended June
30, 2004 primarily consisted of the net proceeds of $122.2 million from the
issuance of $125.0 million of Floating Rate Notes on March 31, 2004 and April
27, 2004, offset by $85.0 million for the redemption of the 87⁄8% Notes on April
30, 2004. Cash flow used in financing activities for the six months ended June
30, 2003 consisted of $165.0 million of funds irrevocably deposited with the
trustee of the 87⁄8% Notes for partial redemption on July 1, 2003 offset by net
proceeds of $146.6 million from the issuance of $150.0 million of 3.75% Notes
on May 7, 2003. Projected Cash Sources We expect to use cash generated from operations to cover cash
requirements, including debt service on the Floating Rate Notes and 3.75% Notes
and capital expenditures in 2004. Capital expenditures for 2004 are projected
to be between $30.0 million and $34.0 million, subject to the actual level of
rig activity and exclusive of the cost for the acquisition of Patriot. We will
make quarterly interest payments on the Floating Rate Notes on January 1, April
1, July 1, and October 1 of each year and semi-annual interest payments of $2.8
million on the 3.75% Notes on May 7 and November 7 of each year through the
dates of maturity. To the extent that we are unable to generate sufficient
cash from operations, we would be required to use cash on hand or draw on our
CIT Facility. From time to time we also review possible acquisition opportunities.
While we currently have no agreements to acquire additional businesses or
equipment, we may enter into such agreements in the future. Our ability to
consummate any such transaction will be dependent in large part on our ability
to fund such a transaction. Depending on the size of a transaction, we may
need to obtain funding through -27-




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the capital markets. We cannot give assurance that adequate funding will
be available on satisfactory terms. Inflation and Changing Prices Contract drilling revenues do not necessarily track the changes in general
inflation as they tend to respond to the level of activity on the part of the
oil and gas industry in combination with the supply of equipment and the number
of competing companies. Capital and operating costs are influenced to a larger
extent by specific price changes in the oil and gas industry and to a lesser
extent by changes in general inflation. Other We have not paid any cash dividends on our common stock and do not
anticipate paying dividends on the common stock at any time in the foreseeable
future. Furthermore, the CIT Facility prohibits the payment of cash dividends
without the consent of the participating lenders. Results of Operations Our drilling contracts generally provide compensation on either a daywork,
turnkey or footage basis. Successfully completed turnkey and footage contracts
generally result in higher revenues per rig day worked than under daywork
contracts. EBITDA per rig day worked on successful turnkey and footage jobs
are also generally greater than under daywork contracts, although we are
typically required to bear additional operating costs (such as drill bits) that
would typically be paid by the customer under daywork contracts. Contract
drilling revenues and EBITDA on turnkey and footage contacts are affected by a
number of variables, which include the depth of the well, geological
complexities and the actual difficulties encountered in drilling the well. In the following discussion of the results of our operations and elsewhere
in our filings, we use EBITDA and EBITDA per rig day. EBITDA is a non-GAAP
financial measure under the rules and regulations of the Securities and
Exchange Commission. In accordance with these rules, we have included below a
reconciliation of EBITDA to net income (loss), which is the nearest comparable
GAAP financial measure. We believe that our disclosure of EBITDA per rig day as a measure of rig
operating performance allows investors to make a direct comparison between us
and our competitors, without regard to differences in capital structure or to
differences in the cost basis of our rigs and those of our competitors.
Investors should be aware, however, that there are limitations inherent in
using this performance measure as a measure of overall company profitability
because it excludes significant expense items such as depreciation expense and
interest expense. An improving trend in EBITDA per rig day may not be
indicative of an improvement in our overall profitability. To compensate for
the limitations in utilizing EBITDA per rig day as an operating measure, our
management also uses GAAP measures of performance including operating income
(loss) and net income (loss) to evaluate performance but only with respect to
the company as a whole and not on a per rig basis. -28-




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##### Table of Contents



Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(Dollars in thousand)(Unaudited)Earnings before interest, taxes,
depreciation and amortization
    
    $
    16,251
    
    
    $
    5,116
    
    
    $
    25,951
    
    
    $
    9,296Depreciation
    
    
    14,091
    
    
    
    12,509
    
    
    
    27,063
    
    
    
    24,800Interest expense
    
    
    3,908
    
    
    
    14,528
    
    
    
    10,074
    
    
    
    20,565Total income tax expense (benefit)
    
    
    (266
    )
    
    
    (7,736
    )
    
    
    (3,273
    )
    
    
    (12,263
    )Net income (loss) applicable to
Common shares
    
    $
    (1,482
    )
    
    $
    (14,185
    )
    
    $
    (7,913
    )
    
    $
    (23,806
    )
 Comparison of the Three Months Ended June 30, 2004 and 2003 The following table highlights rig days worked, contract drilling revenue,
and EBITDA for our daywork and turnkey operations for the three months ended
June 30, 2004 and 2003. Three Months Ended
    
    Three Months EndedJune 30, 2004
    
    June 30, 2003Daywork
    
    Turnkey
    
    
    
    
    
    Daywork
    
    TurnkeyOperations
    
    Operations(1)
    
    Total
    
    Operations
    
    Operations(1)
    
    Total(Dollars in thousands except averages per rig day worked)(Unaudited)Rig days worked
    
    
    6,752
    
    
    
    1,058
    
    
    
    7,810
    
    
    
    4,643
    
    
    
    825
    
    
    
    5,468Contract drilling revenue
    
    $
    68,894
    
    
    $
    34,856
    
    
    $
    103,750
    
    
    $
    43,821
    
    
    $
    23,128
    
    
    $
    66,949Drilling operating
expenses
    
    
    54,879
    
    
    
    29,630
    
    
    
    84,509
    
    
    
    39,799
    
    
    
    19,770
    
    
    
    59,569General and
administrative expenses
    
    
    2,777
    
    
    
    390
    
    
    
    3,167
    
    
    
    2,421
    
    
    
    342
    
    
    
    2,763Interest income
    
    
    (147
    )
    
    
    (23
    )
    
    
    (170
    )
    
    
    (363
    )
    
    
    (64
    )
    
    
    (427
    )Gain on sale of assets
    
    
    (6
    )
    
    
    (1
    )
    
    
    (7
    )
    
    
    (61
    )
    
    
    (11
    )
    
    
    (72
    )EBITDA
    
    $
    11,391
    
    
    $
    4,860
    
    
    $
    16,251
    
    
    $
    2,025
    
    
    $
    3,091
    
    
    $
    5,116Average per rig day
worked:Contract drilling
revenue
    
    $
    10,203
    
    
    $
    32,945
    
    
    $
    13,284
    
    
    $
    9,438
    
    
    $
    28,034
    
    
    $
    12,244EBITDA
    
    $
    1,687
    
    
    $
    4,594
    
    
    $
    2,081
    
    
    $
    436
    
    
    $
    3,747
    
    
    $
    936
   (1)
    
    Turnkey operations include the results from turnkey and footage
contracts. Our EBITDA increased by $11.2 million, or 218%, to $16.3 million for the
quarter ended June 30, 2004 from $5.1 million for the quarter ended June 30,
2003. The increase resulted from a $9.4 million increase in EBITDA from
daywork operations and a $1.8 million increase in EBITDA from turnkey
operations. On a per rig day basis, our EBITDA increased by $1,145 per rig
day, or 122% to $2,081 in the second quarter of 2004 from $936 for the same
period in 2003. This increase included a $1,251 per rig day increase from
daywork operations and a $847 per rig day increase from turnkey operations.
Total general and administrative expenses increased by $404,000 due to higher
payroll costs, professional fees, and public company fees. Total interest
income decreased by $257,000 due primarily to lower cash balances during the
two periods. -29-




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##### Table of Contents



Daywork Operations The increase in EBITDA discussed above was due in part to an increase of
45%, or 2,109 rig days worked on daywork contracts in the second quarter of
2004 when compared with the second quarter of 2003. This increase in days was
due to the acquisition of Patriot and overall higher demand for our services.
Higher dayrates in the second quarter of 2004 versus the same period in 2003
also contributed to the increase. Contract drilling revenue per rig increased
$765, or 8%, the bulk of the increase falling straight through to EBITDA per
day which increased by 287%, or $1,251 per rig day. Overall, expenses
increased as a result of the increase in activity but were less on a per rig
day basis as fixed costs were spread over more days worked. Turnkey Operations The increase in turnkey EBITDA was partially due to an increase of 233 rig
days worked, or 28% in the second quarter of 2004 compared to the second
quarter of 2003. The increase in the number of rig days worked under turnkey
contracts resulted in an increase in contract drilling revenue and drilling
operating expenses. EBITDA and contract drilling revenue on a per rig day
basis increased from 2003 due to the differences in the complexity and success
of the wells drilled. Other Depreciation and amortization expense increased by $1.6 million, or 13%,
to $14.1 million for the three months ended June 30, 2004, compared to $12.5
million for the three months ended June 30, 2003. Depreciation and
amortization expense is higher due to the acquisition of Patriot and capital
expenditures during 2003 and 2004. Interest expense decreased by $10.6 million, or 73% to $3.9 million in the
second quarter of 2004 from $14.5 million in the second quarter of 2003. This
decrease is due to the issuance of the 3.75% Notes and Floating Rate Notes and
subsequent redemption of our 87⁄8% Notes. This refinancing resulted in
substantial interest savings given the lower interest rate debt
outstanding. Our income tax benefit decreased by $7.5 million to $266,000 for the three
months ended June 30, 2004 from $7.7 million for the same period in 2003. The
decrease is due to the level of losses and is also affected by the annual
amortization of $2.8 million in permanent differences related to differences
between the financial accounting and tax basis of assets that were purchased in
capital stock acquisitions. The permanent difference will be reduced as these
assets are depreciated for financial accounting purposes on a straight-line
basis over their remaining useful lives of approximately nine years. As the
amortization of these permanent differences is a fixed amount, our book
effective tax rate can vary widely based upon the current and projected levels
of income or loss. -30-




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##### Table of Contents



Comparison of the Six Months Ended June 30, 2004 and 2003 The following tables highlight rig days worked, contract drilling revenue
and EBITDA for our daywork and turnkey operations for the six months ended June
30, 2004 and 2003. Six Months Ended
    
    Six Months EndedJune 30, 2004
    
    June 30, 2003Daywork
    
    Turnkey
    
    
    
    
    
    Daywork
    
    TurnkeyOperations
    
    Operations(1)
    
    Total
    
    Operations
    
    Operations(1)
    
    Total(Dollars in thousands except averages per rig day worked)(Unaudited)Rig days worked
    
    
    11,792
    
    
    
    1,964
    
    
    
    13,756
    
    
    
    9,251
    
    
    
    1,489
    
    
    
    10,740Contract drilling revenue
    
    $
    119,528
    
    
    $
    59,422
    
    
    $
    178,950
    
    
    $
    86,468
    
    
    $
    42,868
    
    
    $
    129,336Drilling operating
expenses
    
    
    96,951
    
    
    
    50,095
    
    
    
    147,046
    
    
    
    78,047
    
    
    
    36,807
    
    
    
    114,854General and
administrative expenses
    
    
    5,535
    
    
    
    772
    
    
    
    6,307
    
    
    
    5,322
    
    
    
    687
    
    
    
    6,009Interest income
    
    
    (288
    )
    
    
    (48
    )
    
    
    (336
    )
    
    
    (616
    )
    
    
    (100
    )
    
    
    (716
    )Gain on sale of assets
    
    
    (15
    )
    
    
    (3
    )
    
    
    (18
    )
    
    
    (79
    )
    
    
    (14
    )
    
    
    (93
    )Other, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12
    )
    
    
    (2
    )
    
    
    (14
    )EBITDA
    
    $
    17,345
    
    
    $
    8,606
    
    
    $
    25,951
    
    
    $
    3,806
    
    
    $
    5,490
    
    
    $
    9,296Average per rig day
worked:Contract drilling revenue
    
    $
    10,136
    
    
    $
    30,256
    
    
    $
    13,009
    
    
    $
    9,347
    
    
    $
    28,790
    
    
    $
    12,042EBITDA
    
    $
    1,471
    
    
    $
    4,382
    
    
    $
    1,887
    
    
    $
    411
    
    
    $
    3,687
    
    
    $
    866
   (1)
    
    Turnkey operations include the results from turnkey and footage
contracts. Our EBITDA increased by $16.7 million, or 179%, to $26.0 million for the
six months ended June 30, 2004 from $9.3 million for the six months ended June
30, 2003. The increase resulted from a $13.5 million increase in EBITDA from
daywork operations and a $3.1 million increase in EBITDA from turnkey
operations. On a per rig day basis, our total EBITDA increased by $1,021 per
rig day, or 118% to $1,887 for the first six months of 2004 from $866 for the
same period in 2003. This increase included a $1,060 per rig day increase from
daywork operations and a $695 per rig day increase from turnkey operations.
Total general and administrative expenses increased by $298,000 due to higher
payroll costs, professional fees, and public company costs. Total interest
income decreased by $380,000 due primarily to lower cash balances during the
two periods. Daywork Operations The increase in EBITDA discussed above was due in part to an increase of
27%, or 2,541 rig days worked on daywork contracts in the first six months of
2004 when compared with the same period of 2003. This increase in days was due
to the acquisition of Patriot and overall higher demand for our services.
Higher dayrates in 2004 versus 2003 also contributed to the increase. Contract
drilling revenue per rig day increased $789, or 8%, the bulk of the increase
falling straight through to EBITDA per day, which also increased by 258%, or
$1,060 per rig day. Overall, expenses increased as a result of the increase in
activity but were less on a per rig day basis as fixed costs were spread over
more days worked. Turnkey Operations The increase in turnkey EBITDA was partially due to an increase of 475 rig
days worked, or 32% in the first six months of 2004 compared to the same period
of 2003. The increase in the number of rig days worked under turnkey contracts
resulted in an increase in contract drilling revenue and drilling -31-




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##### Table of Contents



operating expenses. Contract drilling revenue and EBITDA on a per rig day
basis increased from 2003 due to the differences in the complexity and success
of the wells drilled. Other Depreciation and amortization expense increased by $2.3 million, or 9%, to
$27.1 million for the six months ended June 30, 2004 compared to $24.8 million
for the six months ended June 30, 2003. Depreciation and amortization expense
is higher due to the acquisition of Patriot and capital expenditures during the
first six months of 2004. Interest expense decreased by $10.5 million, or 51%, to $10.1 million for
the six months ended June 30, 2004 from $20.6 million for the same period in
2003. The decrease is due to the issuance of the 3.75% Notes and Floating Rate
Notes and subsequent redemption of our 87⁄8% Notes. This refinancing resulted in
substantial interest savings given the lower interest rate debt outstanding. Our income tax benefit decreased by $9.0 million to $3.3 million for the
six months ended June 30, 2004 from $12.3 million for the same period in 2003.
The decrease is due to the level of losses and is also affected by the annual
amortization of $2.8 million in permanent differences related to differences
between the financial accounting and tax basis of assets that were purchased in
capital stock acquisitions. The permanent difference will be reduced as these
assets are depreciated for financial accounting purposes on a straight-line
basis over their remaining useful lives of approximately nine years. As the
amortization of these permanent differences is a fixed amount, our book
effective tax rate varies widely based upon the current and projected levels of
income or loss. 
 Item 3. Quantitative and qualitative disclosure about market risk Interest Rate Risk.We are subject to market risk exposure related to
changes in interest rates on the Floating Rate Notes and the CIT Facility. The
Floating Rate Notes bear interest at a per annum rate which is equal to 3-month
LIBOR, adjusted quarterly, minus a spread of 0.05%. We had $125.0 million of
the Floating Rate Notes outstanding at June 30, 2004. A 1% change in the
interest rate on the Floating Rate Notes would change our interest expense by
$1.3 million on an annual basis. However, the annual interest on the Floating
Rate Notes will never be below zero or more than 6.00%, which could yield
interest expense ranging from zero to $7.5 million on an annual basis.
Interest on borrowings under the CIT Facility accrues at a variable rate, using
either the prime rate plus 0.25% to 1.50% or LIBOR plus 1.75% to 3.50%,
depending upon our debt service coverage ratio for the trailing 12 month
period. We currently have no outstanding balance under the CIT Facility and as
such have no exposure under this facility at this time to a change in interest
rates. 
 Item 4. Controls and Procedures As of June 30, 2004, we carried out an evaluation, under the supervision
and with the participation of management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation
of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15.
Based upon that evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures are effective.
Disclosure controls and procedures are controls and procedures that are
designed to ensure that information required to be disclosed in our reports
filed or submitted under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commissions rules and forms. There have been no significant changes in our internal control over
financial reporting that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting. -32-




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##### Table of Contents



PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings We are involved in litigation incidental to the conduct of our business,
none of which management believes is, individually or in the aggregate,
material to our consolidated financial condition or results of operations. See
Note 6  Contingencies in Notes to Consolidated Financial Statements. 
 Item 2. Changes in Securities and Use of Proceeds Recent Sales of
Unregistered Securities See
Note (9) to our Consolidated Financial Statements for information
regarding the sale of our common stock which was made in reliance on
the exemption from registration contained in Section 4(2) of the
Securities Act of 1933 in connection with the negotiated acquisition
of New Patriot Drilling Corp. by merger from the nine shareholders of the company
who were sophisticated purchasers. See
Note (4) to our Consolidated Financial Statements for information regarding the sale of our Floating Rate
Notes which was made in reliance on the exemption from registration
contained in Section 4(2) of the Securities Act of 1933 and Rule
144A thereunder in a negotiated sale of Deutsche Bank Securities Inc. and Credit Suisse First Boston, LLC
the initial purchasers of the Floating Rate Notes. 
 Item 3. Defaults Upon Senior Securities None 
 Item 4. Submission of Matters to a Vote of Security Holders On May 11, 2004, the Annual Meeting of our shareholders was held and the
holders of our common stock elected James K.B. Nelson and Robert E. Rose as
Class II Directors. The Class II Directors will hold office until the Annual
Meeting in 2007 or until their successors have been duly elected and qualified.
The following details the number of votes for the election of these directors
and the number of votes withheld. Director
    
    For
    
    WithheldJames K.B. Nelson
    
    
    138,539,176
    
    
    
    37,974,406Robert E. Rose
    
    
    174,575,996
    
    
    
    1,937,586
 
 Item 5. Other Information This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. All
statements other than statements of historical facts included in this report
are forward-looking statements, including statements regarding the following:  
    
    business strategy;
    
    demand for our services;
    
    2004 rig activity and financial results;
    
    rigs expected to be engaged in turnkey and footage operations;
    
    reactivation and cost of reactivation of non-marketed rigs;
    
    projected dayrates;
    
    projected interest expense;
    
    projected tax rate;
    
    wage rates and retention of employees;
    
    sufficiency of our capital resources and liquidity; and
    
    depreciation and capital expenditures in 2004. -33-




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##### Table of Contents



Although we believe the forward-looking statements are reasonable, we
cannot assure you that these statements will prove to be correct. We have
based these statements on assumptions and analyses in light of our experience
and perception of historical trends, current conditions, expected future
developments and other factors we believe are appropriate when the statements
are made. Important factors that could cause actual results to differ
materially from our expectations include:  
    
    fluctuations in prices and demand for oil and natural gas;
    
    fluctuations in levels of oil and natural gas exploration and development activities;
    
    fluctuations in demand for contract land drilling services;
    
    fluctuations in interest rates;
    
    the existence and competitive responses of our competitors;
    
    uninsured or underinsured casualty losses;
    
    technological changes and developments in the industry;
    
    the existence of operating risks inherent in the contract land drilling industry;
    
    U.S. and global economic conditions;
    
    the availability and terms of insurance coverage;
    
    the ability to attract and retain qualified personnel;
    
    unforeseen operating costs such as cost for environmental
remediation and turnkey cost overruns; and
    
    weather conditions. Our forward-looking statements speak only as of the date specified in such
statements or, if no date is stated, as of the date of this report. Grey Wolf,
Inc. expressly disclaims any obligation or undertaking to release publicly any
updates or revisions to any forward-looking statement contained in this report
to reflect any change in our expectations or with regard to any change in
events, conditions or circumstances on which our forward-looking statements are
based. Please refer to our Form 10-K/A filed with the Securities and Exchange
Commission on August 9, 2004 for additional information concerning risk factors
that could cause actual results to differ from the forward-looking statements. -34-




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##### Table of Contents



Item 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits  31.1
    
    Certification of Chief Executive Officer pursuant
to Rule 13a-14(a)31.2
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a)32.1
    
    Certification pursuant to 18 U.S.C. Section 1350
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 of Thomas P. Richards, Chairman, President and Chief
Executive Officer and David W. Wehlmann, Executive Vice
President and Chief Financial Officer.  (b)
    
    Reports on Form 8-K  1.
    
    We filed a Report on Form 8-K under Item 5 with
the Securities and Exchange Commission on April 1, 2004 with
regard to our press release, pursuant to Rule 135c under the
Securities Act of 1933, announcing the closing of our
previously announced private offering of $100.0 million
aggregate principal amount of floating rate contingent
convertible senior notes due 2024.2.
    
    We filed a Report on Form 8-K under Item 5 with
the Securities and Exchange Commission on April 7, 2004 with
regard to our press release announcing the closing of the
previously announced acquisition of New Patriot Drilling Corp.3.
    
    We filed a Report on Form 8-K under Item 5 with
the Securities and Exchange Commission on April 22, 2004 with
regard to our press release, pursuant to Rule 135c under the
Securities Act of 1933, announcing that one of the initial
purchasers in our previously announced private offering of
$100.0 million aggregate principal amount of floating rate
contingent convertible senior notes due 2024 has exercised its
full option to purchase an additional $25.0 million aggregate
principal amount of the notes.4.
    
    We furnished a Report on Form 8-K under Item 12
with the Securities and Exchange Commission on April 27, 2004
with regard to our press release announcing operating results
for the quarter ended March 31, 2004.5.
    
    We furnished a Report on Form 8-K under Item 12
with the Securities and Exchange Commission on July 29, 2004
with regard to our press release announcing operating results
for the quarter ended June 30, 2004. -35-




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. GREY WOLF, INC.Date: August 9, 2004
    By:
    /s/ David W. WehlmannDavid W. WehlmannExecutive Vice President and
Chief Financial OfficerDate: August 9, 2004
    By:
    /s/ Merrie S. CostleyMerrie S. CostleyVice President and Controller -36-




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##### Table of Contents



Index to Exhibits



| | 31.1 |  | Certification of Chief Executive Officer pursuant
to Rule 13a-14(a)                                                                                                                                                                                                      
| | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 31.2 |  | Certification of Chief Financial Officer pursuant to Rule
13a-14(a)                                                                                                                                                                                                      
|
| | 32.1 |  | Certification pursuant to 18 U.S.C. Section 1350
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 of Thomas P. Richards, Chairman, President and Chief
Executive Officer and David W. Wehlmann, Executive Vice
President and Chief Financial Officer.