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F O R M 1 0 - K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ________ to _________
[Commission File Number 1-9260]
U N I T C O R P O R A T I O N
(Exact Name of Registrant as Specified in its Charter)
Delaware 73-1283193
-------- ----------
(State of Incorporation) (I.R.S. Employer Identification No.)
1000 Kensington Tower
7130 South Lewis
Tulsa, Oklahoma 74136
--------------- -----
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (918) 493-7700
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of each class Name of each exchange
------------------- on which registered
Common Stock, par value -------------------
$.20 per share New York Stock Exchange
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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (Section 229.405 of this chapter) is not
contained herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements incorporated by
reference in PART III of this Form 10-K or any amendment to this Form 10-K.
Aggregate Market Value of the Voting Stock Held By
Non-affiliates on March 6, 2000 - $216,536,460
Number of Shares of Common Stock
Outstanding on March 6, 2000 - 33,820,476
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Registrant's Proxy Statement with respect to the
Annual Meeting of Stockholders to be held May 3, 2000 are incorporated by
reference in Part III.
Exhibit Index - See Page 87
FORM 10-K
UNIT CORPORATION
TABLE OF CONTENTS
PART I
Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . 3
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . 24
Item 4. Submission of Matters to a Vote of Security Holders . . 24
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters . . . . . . . . . . . . . . . . . 25
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . 26
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . 27
Item 7a. Quantitative and Qualitative Disclosure about
Market Risk. . . . . . . . . . . . . . . . . . . . . 34
Item 8. Financial Statements and Supplementary Data . . . . . . 36
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure . . . . . . . . . 77
PART III
Item 10. Directors and Executive Officers of the Registrant. . . 77
Item 11. Executive Compensation. . . . . . . . . . . . . . . . . 79
Item 12. Security Ownership of Certain Beneficial Owners
and Management. . . . . . . . . . . . . . . . . . . . 79
Item 13. Certain Relationships and Related Transactions. . . . . 79
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K . . . . . . . . . . . . . . . . . . . . . 80
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . 86
2
UNIT CORPORATION
Annual Report
For The Year Ended December 31, 1999
PART I
Item 1. Business and Item 2. Properties
- ------- -------- ------- ----------
GENERAL
Through our wholly owned subsidiaries, we contract to drill onshore
oil and natural gas wells for others and explore, develop, acquire and
produce oil and natural gas properties for ourself. We were founded in
1963 as a contract drilling company. Today our contract drilling
operations and our exploration and production operations are carried out
primarily in the natural gas producing provinces of the Oklahoma and Texas
areas of the Anadarko and Arkoma Basins and the Texas Gulf Cost. Our
contract drilling operations are also engaged in the Rocky Mountain region.
Our principal executive offices are located at 1000 Kensington Tower,
7130 South Lewis, Tulsa, Oklahoma 74136; telephone number (918) 493-7700.
We also have regional offices in Oklahoma City, Oklahoma, Woodward,
Oklahoma, Booker, Texas, Houston, Texas and Casper, Wyoming. When used in
this report, the terms Corporation, Unit, our, we and its refer to Unit
Corporation and, at times, Unit Corporation and/or one or more of its
subsidiaries.
LAND CONTRACT DRILLING OPERATIONS
We drill onshore natural gas and oil wells for a wide range of
customers through our wholly owned subsidiary Unit Drilling Company. A land
drilling rig consists, in part, of engines, drawworks or hoists, derrick or
mast, substructure, pumps to circulate the drilling fluid, blowout
preventers and drill pipe. We conduct an active maintenance and
replacement program under which components are upgraded on an individual
basis. Over the life of a typical rig, due to the normal wear and tear of
operating 24 hours a day, several of the major components, such as engines,
mud pumps and drill pipe, are replaced or rebuilt on a periodic basis,
while other components, such as the substructure, mast and drawworks, can
be utilized for extended periods of time with proper maintenance. We also
own additional equipment used in the operation of our rigs, including large
air compressors, trucks and other support equipment.
On November 20, 1997, we acquired Hickman Drilling Company pursuant to
a merger in which all of the holders of the outstanding common stock of
Hickman Drilling received, in total, 1,300,000 shares of our common stock
and promissory notes in the principal amount of $5,000,000 which area
3
payable in five equal annual installments commencing January 2, 1999. The
acquisition included nine land contract drilling rigs with depth capacities
ranging from 9,500 to 17,000 feet, spare drilling equipment and
approximately $2.1 million in working capital. As part of the acquisition
we retained Hickman Drilling's Woodward, Oklahoma, corporate office as a
regional office for our contract drilling operations.
In December 1997, we purchased a Mid-Continent U-36A, 650 horsepower
rig with a 13,000 foot depth capacity and spare components from two
additional rigs for $1 million, of which $200,000 was paid at closing with
the balance to be paid over a period no longer than three years.
On September 30, 1999, we completed the acquisition of 13 land
drilling rigs from Parker Drilling Company and Parker Drilling Company
North America, Inc., for $40 million and one million shares of our common
stock.
At the end of 1999, our drilling rig fleet consisted of 47 rigs with
depth capacities ranging from 9,500 to 40,000 feet. At December 31, 1999,
31 of our rigs were located in the Anadarko and Arkoma Basins of Oklahoma
and Texas while nine of our rigs were located in South Texas and seven in
the Rocky Mountain region.
At present, we do not have a shortage of drilling rig related
equipment. During 1996 and through 1997, we increased our drill pipe
acquisitions since certain grades of drill pipe were in high demand due to
increased rig utilization. However, at any given time our ability to use
all of our rigs will depend on the availability of qualified labor,
drilling supplies and equipment as well as demand. Should industry
conditions improve rapidly, we, as well as the drilling industry as a
whole, might experience a shortage of sufficient supplies of drill pipe,
other drilling equipment and qualified labor.
4
The following table sets forth, for each of the periods indicated,
certain data concerning Unit's contract drilling operations:
Year Ended December 31,
-----------------------------------------
1995 1996 1997 1998 1999
------ ------ ------ ------ ------
Number of Operational
Rigs Owned at End of
Period 22.0 24.0 34.0(1) 34.0 47.0(2)
Average Number of Rigs
Owned During Period 25.0 22.7 25.1 34.0 37.3
Average Number of Rigs
Utilized (3) 10.9 14.7 20.0 22.9 23.1
Utilization Rate (3) 44% 65% 80% 67% 62%
Average Revenue
Per Day (4) $5,081 $5,351 $6,309 $6,394 $6,582
Total Footage Drilled
(Feet in 1000's) 1,196 1,468 1,736 2,203 2,211
Number of Wells
Drilled 111 130 167 198 197
- ----------------------
(1) Includes 10 rigs acquired in the fourth quarter of 1997.
(2) Includes 13 rigs acquired in September 1999.
(3) Utilization rates are based on a 365-day year and are calculated by
dividing the number of rigs utilized by the total number of rigs owned
during the period, including stacked rigs. A rig is considered utilized
when it is operating or being moved, assembled or dismantled under
contract.
(4) Represents total revenues from contract drilling operations divided by
the total number of days rigs were being utilized for the period.
As of February 22, 2000, 33 of our 47 drilling rigs were operating
under contract.
5
The following table sets forth, as of February 22, 2000, the type and
approximate depth capability of each of our drilling rigs:
Approximate
Depth
Capability
Rig# Type (feet)
----- --------------------------- -----------
1 U-15 Unit Rig 11,000
2 BDW 650 13,000
3 BDW 650 13,500
4 U-15 Unit Rig 11,000
5 U-15 Unit Rig 11,000
6 BDW 800 15,000
7 U-15 Unit Rig 11,000
8 Gardner Denver 800 15,000
9 BDW 800 15,000
10 BDW 450T 9,500
11 Gardner Denver 700 15,000
12 BDW 800-M1 15,000
14 Gardner Denver 700 15,000
15 Mid-Continent 914-C 20,000
16 U-15 Unit Rig 11,000
17 Brewster N-75A 15,000
18 BDW 650 12,000
19 Gardner Denver 500 12,000
20 Gardner Denver 700 15,000
21 Gardner Denver 700 15,000
22 BDW 800 15,000
23 Gardner Denver 700M 15,000
24 Gardner Denver 700M 15,000
25 Gardner Denver 700 15,000
29 Brewster N-75A 15,000
30 BDW 1350-M 20,000
31 SU-15 North Texas Machine 12,000
32 Brewster N-75 15,000
34 National 110-UE 20,000
35 Continental Emsco C-1-E 20,000
36 Gardner Denver 1500-E 25,000
37 Mid-Continent 914-EC 20,000
38 Mid-Continent 1220-E 25,000
39 U-36-A 13,000
112 Ideco E-3000 30,000
166 OIME E-3000 30,000
180 OIME E-3000 30,000
182 OIME E-3000 30,000
184 OIME E-3000 30,000
201 OIME E-4000 40,000
203 OIME E-2000 20,000
232 Continental Emsco D-3 E 16,000
233 Continental Emsco C-1 E 20,000
234 Continental Emsco D-3 E 16,000
235 Continental Emsco C-1 E 20,000
237 Continental Emsco C-1 E 20,000
254 OIME E-2000 25,000
6
During the past 15 years, our contract drilling operations have
encountered significant competition due to depressed levels of activity.
In the last 6 months of 1996 and throughout 1997 and the first three
quarters of 1998, our drilling operations showed significant improvement in
rig utilization. However, in late 1998 and through the first six months of
1999 we, and the industry as a whole, experienced a significant reduction
in demand. Although we experienced an increase in demand during the last
half of 1999, we anticipate that competition within the industry will, for
the foreseeable future, continue to adversely affect us.
Drilling Contracts. Most of our drilling contracts are obtained
through competitive bidding. Generally, our contracts are for a single
well with the terms and rates varying depending upon the nature and
duration of the work, the equipment and services supplied and other
matters. The contracts obligate us to pay certain operating expenses,
including wages of drilling personnel, maintenance expenses and incidental
rig supplies and equipment. Usually, the contracts are subject to
termination by the customer on short notice upon payment of a fee. We
generally indemnify our customers against certain types of claims by our
employees and claims arising from surface pollution caused by spills of
fuel, lubricants and other solvents within our control. Customers
generally indemnify us against claims arising from other surface and
subsurface pollution other than claims resulting from our gross negligence.
Our contracts generally compensate us on a daywork, footage or turnkey
basis with additional compensation for special risks and unusual
conditions. Under daywork contracts, we provide the drilling rig with the
required personnel to the operator who supervises the drilling of the
contracted well. Our compensation is based on a negotiated rate for each
day the rig is utilized. Footage contracts usually require us to bear some
of the drilling costs in addition to providing the rig. We are compensated
on a negotiated rate, per foot drilled, upon completion of the well. Under
turnkey contracts, we contract to drill a well for a lump sum amount to a
specified depth and provide most of the equipment and services required.
We bear the risk of drilling the well to the contract depth and are
compensated when the contract provisions have been satisfied.
Turnkey drilling operations, in particular, might result in losses if
we underestimate the costs of drilling a well or if unforeseen events
occur. To date, we have not experienced significant losses in performing
turnkey contracts. For 1999, turnkey revenue represented approximately 21
percent of our contract drilling revenues as compared to 15 percent for
1998. Because the proportion of turnkey drilling is currently dictated by
market conditions and the desires of customers using our services, we can't
predict whether the portion of drilling conducted on a turnkey basis will
increase or decrease in the future.
Customers. During 1999, 10 contract drilling customers accounted for
approximately 23 percent of our total contract drilling revenues.
Approximately 3 percent of our total contract drilling revenues were
7
generated from drilling on oil and natural gas properties of which we were
the operator (including properties owned by limited partnerships for which
we acted as general partner).
Further information relating to contract drilling operations is
presented in Notes 1, 2 and 10 of Notes to Consolidated Financial
Statements set forth in Item 8 hereof.
OIL AND NATURAL GAS OPERATIONS
In 1979, we began to develop our exploration and production operations
to diversify our contract drilling revenues. Our wholly owned subsidiary,
Unit Petroleum Company, conducts our exploration and production activities.
As of December 31, 1999, we had estimated net proved reserves of 3,934
Mbbls and 170,084 MMcf. Our producing oil and natural gas interests,
undeveloped leaseholds and related assets are located primarily in
Oklahoma, Texas, Louisiana and New Mexico and, to a lesser extent, in
Arkansas, North Dakota, Colorado, Wyoming, Montana, Alabama, Mississippi,
Illinois, Michigan, Nebraska and Canada. As of December 31, 1999, we had
an interest in a total of 2,419 wells in the United States and served as
the operator of 519 wells. We also had an interest in 64 wells located in
Canada. Our technical staff generates the majority of our development and
exploration prospects. When we are the operator of a property, we
generally employ our own drilling rigs and our own engineering staff
supervises the drilling operation.
We intend to continue the growth in our oil and natural gas operations
utilizing funds generated from operations and our bank loan agreement.
8
Well and Leasehold Data. The tables below set forth certain
information regarding our oil and natural gas exploration and development
drilling activities for the periods indicated:
Year Ended December 31,
---------------------------------------------------------
1997 1998 1999
------------------ ----------------- ------------------
Gross Net Gross Net Gross Net
-------- -------- -------- -------- -------- --------
Wells Drilled:
- --------------
Exploratory:
Oil - - - - - -
Natural gas - - - - - -
Dry - - 1 .26 - -
-------- -------- -------- -------- -------- --------
Total - - 1 .26 - -
======== ======== ======== ======== ======== ========
Development:
Oil 10 4.84 4 .44 1 .48
Natural gas 57 23.85 52 19.26 43 16.23
Dry 15 9.27 21 10.62 7 4.72
-------- -------- -------- -------- -------- --------
Total 82 37.96 77 30.32 51 21.43
======== ======== ======== ======== ======== ========
Oil and Natural
Gas Wells
Producing or
Capable of
Producing:
- ---------------
Oil - USA 684 197.67 726 196.64 668 206.08
Oil -
Canada - - - - - -
Gas - USA 1,545 260.40 1,773 286.73 1,751 314.28
Gas -
Canada 64 1.60 64 1.60 64 1.60
-------- -------- -------- -------- -------- --------
Total 2,293 459.67 2,563 484.97 2,483 521.96
======== ======== ======== ======== ======== ========
9
The following table summarizes our oil and natural gas leasehold
acreage as of the end of each of the years indicated:
Developed Acreage Undeveloped Acreage
--------------------- ---------------------
Gross Net Gross Net
--------- --------- --------- ---------
1997:
- -----
USA 432,824 118,926 37,844 26,116
Canada 39,040 976 18,970 18,970
--------- --------- --------- ---------
471,864 119,902 56,814 45,086
========= ========= ========= =========
1998:
- -----
USA 569,076 130,440 52,958 35,371
Canada 39,040 976 22,763 22,763
--------- --------- --------- ---------
Total 608,116 131,416 75,721 58,134
========= ========= ========= =========
1999:
- -----
USA 488,811 130,362 55,989 35,245
Canada 39,040 976 25,293 25,293
--------- --------- --------- ---------
Total 527,851 131,338 81,282 60,538
========= ========= ========= =========
10
Price and Production Data. The following table sets forth our average
sales price, oil and natural gas production volumes and average production
cost per equivalent Mcf [1 barrel (Bbl) of oil = 6 thousand cubic feet
(Mcf) of natural gas] of production for the periods indicated:
Year Ended December 31,
----------------------------------
1997 1998 1999
---------- ---------- ----------
Average Sales Price per Barrel of Oil
Produced:
USA $ 19.19 $ 12.81 $ 17.51
Canada - - -
Average Sales Price per Mcf of Natural
Gas Produced:
USA $ 2.43 $ 1.90 $ 2.02
Canada $ .93 $ 1.46 $ 1.81
Oil Production (Mbbls):
USA 493 443 373
Canada - - -
---------- ---------- ----------
Total 493 443 373
========== ========== ==========
Natural Gas Production (MMcf):
USA 13,742 16,427 15,919
Canada 74 38 35
---------- ---------- ----------
Total 13,816 16,465 15,954
========== ========== ==========
Average Production Expense per
Equivalent Mcf:
USA $ .64 $ .61 $ .58
Canada $ .33 $ .54 $ .56
11
Reserves. The following table sets forth our estimated proved
developed and undeveloped oil and natural gas reserves at the end of each
of the years indicated:
Year Ended December 31,
----------------------------------
1997 1998 1999
---------- ---------- ----------
Oil (Mbbls):
USA 4,131 3,245 3,934
Canada - - -
---------- ---------- ----------
Total 4,131 3,245 3,934
========== ========== ==========
Natural gas (MMcf):
USA 144,661 160,795 169,515
Canada 723 523 569
---------- ---------- ----------
Total 145,384 161,318 170,084
========== ========== ==========
Further information relating to oil and natural gas operations is
presented in Notes 1, 10 and 12 of Notes to Consolidated Financial
Statements set forth in Item 8 hereof.
VOLATILE NATURE OF OUR OIL AND NATURAL GAS MARKETS;
FLUCTUATIONS IN PRICES
Our revenues, operating results, cash flows and future rate of growth
are significantly affected by the prevailing prices for natural gas and
oil. Historically, oil and natural gas prices and markets have been
volatile, and they are likely to continue to be volatile in the future.
Oil and natural gas prices declined substantially in 1998 and, despite
recent improvements, could decline again. These declines had a significant
negative impact on our financial results for 1998 and the first six months
of 1999. We incurred a net loss for the two quarterly periods ending March
31 and June 30, 1999 before incurring net income for the two quarterly
periods ending September 30 and December 31, 1999. Although we had net
income for the twelve months ended December 31, 1999, depressed prices in
the future would have a negative impact on our future financial results.
Because our oil and natural gas reserves are predominantly natural gas,
changes in natural gas prices may have a particularly large impact on our
financial results.
12
Prices for oil and natural gas are subject to wide fluctuations in
response to relatively minor changes in the supply of and demand for oil
and natural gas, market uncertainty and a variety of additional factors
that are beyond our control. These factors include:
. political conditions in oil producing regions, including the
Middle East;
. the ability of the members of the Organization of Petroleum
Exporting Countries to agree to and maintain oil price and
production controls;
. the price of foreign imports;
. actions of governmental authorities;
. the domestic and foreign supply of oil and natural gas;
. the level of consumer demand;
. weather conditions;
. domestic and foreign government regulations;
. the price, availability and acceptance of alternative fuels; and
. overall economic conditions.
These factors and the volatile nature of the energy markets make it
impossible to predict with any certainty the future prices of oil and
natural gas.
Our oil and condensate production is sold at or near our wells under
purchase contracts at prevailing prices in accordance with arrangements
customary in the oil industry. Our natural gas production is sold to
intrastate and interstate pipelines as well as to independent marketing
firms under contracts with original terms ranging from one month to several
years. Most of these contracts contain provisions for readjustment of
price, termination and other terms customary in the industry.
Our contract drilling operations depend on levels of activity in the
oil and natural gas exploration and production in our operating markets.
Both short-term and long-term trends in oil and natural gas prices affect
the level of that activity. Because oil and natural gas prices are
volatile, the level of exploration and production activity can also be
volatile. Decreased oil and natural gas prices during 1998 and early 1999
adversely affected our contract drilling activity by lowering the demand
for our rigs and reducing the rates we charged for our rigs.
13
Although oil and natural gas prices have recently improved, we expect
that in the near term our customers will continue a cautious approach to
exploration and development spending until price gains prove to be
sustainable. Any decrease from current oil and natural gas prices would
depress the level of exploration and production activity. This in turn
would likely result in a decline in our contract drilling revenues, cash
flows and profitability. As a result, the future demand for our drilling
services is uncertain.
COMPETITION
All of our lines of business are highly competitive. Competition in
onshore contract drilling traditionally involves such factors as price,
efficiency, condition of equipment, availability of labor and equipment,
reputation and customer relations. Some of our competitors in the onshore
contract drilling business are substantially larger than we are and have
appreciably greater financial and other resources. As a result of the
decrease in demand for onshore contract drilling services over the past
decade, a surplus of certain types of drilling rigs currently exists within
the industry while inventories of certain components such as specific
grades of drill pipe have been depleted from continued use. Accordingly,
the competitive environment within which we operate is uncertain and
extremely price oriented.
Our oil and natural gas operations likewise encounter strong
competition from major oil companies, independent operators and others.
Many of these competitors have appreciably greater financial, technical and
other resources and are more experienced in the exploration for and
production of oil and natural gas than we are.
OIL AND NATURAL GAS PROGRAMS
Our subsidiary, Unit Petroleum Company, serves as the general partner
of four oil and gas limited partnerships and 11 employee oil and gas
limited partnerships. Each year we form an employee partnership which
acquires an interest, ranging from 5% to 15% of our interest, in most oil
and natural gas drilling activities and purchases of producing oil and
natural gas properties that we do that year. The limited partners in the
employee partnerships are either employees or directors of Unit or its
subsidiaries.
Under the terms of the partnership agreements, the general partner has
broad discretionary authority to manage the business and operations of the
partnership, including the authority to make decisions on such matters as
the partnership's participation in a drilling location or a property
acquisition, the partnership's expenditure of funds and the distribution of
funds to partners. Because the business activities of the limited partners
14
on the one hand, and the general partner on the other hand, are not the
same, conflicts of interest will exist and it is not possible to eliminate
entirely such conflicts. Additionally, conflicts of interest may arise
when we are the operator of an oil and natural gas well and also provide
contract drilling services. In such cases, these drilling operations are
done pursuant to contracts containing terms and conditions comparable to
those contained in our drilling contracts with non-affiliated operators.
Although we have no formal procedures for resolving such conflicts, we
believe we fulfill our responsibility to each contracting party and comply
fully with the terms of the agreements which regulate such conflicts.
EMPLOYEES
As of February 22, 2000, we had approximately 735 employees in our
land contract drilling operations, 48 employees in our oil and natural gas
operations and 41 in our general corporate area. None of our employees are
represented by a union or labor organization nor have our operations ever
been interrupted by a strike or work stoppage. We consider relations with
our employees to be satisfactory.
OPERATING AND OTHER RISKS
Our drilling operations are subject to many hazards inherent in the
drilling industry, including blowouts, cratering, explosions, fires, loss
of well control, loss of hole, damaged or lost drilling equipment and
damage or loss from inclement weather. Our exploration and production
operations are subject to these and similar risks Any of these events
could result in personal injury or death, damage to or destruction of
equipment and facilities, suspension of operations, environmental damage
and damage to the property of others. Generally, drilling contracts
provide for the division of responsibilities between a drilling company and
its customer, and we seek to obtain indemnification from our drilling
customers by contract for some of these risks. To the extent that we are
unable to transfer these risks to drilling customers by contract or
indemnification agreements, we seek protection through insurance. However,
we cannot assure you that our insurance or our indemnification agreements,
if any, will adequately protect us against liability from all of the
consequences of the hazards described above. The occurrence of an event
not fully insured or indemnified against, or the failure of a customer to
meet its indemnification obligations, could result in substantial losses to
us. In addition, we cannot assure you that insurance will be available to
cover any or all of these risks. Even if available, the insurance might
not be adequate to cover all of our losses, or we might decide against
obtaining that insurance because of high premiums or other costs.
Exploration and development operations involve numerous risks that may
result in dry holes, the failure to produce oil and natural gas in
commercial quantities and the inability to fully produce discovered
15
reserves. The cost of drilling, completing and operating wells is
substantial and uncertain. Our operations may be curtailed, delayed or
cancelled as a result of many things beyond our control, including:
. unexpected drilling conditions;
. pressure or irregularities in formations;
. equipment failures or accidents;
. adverse weather conditions;
. compliance with governmental requirements; and
. shortages or delays in the availability of drilling rigs or delivery
crews and the delivery of equipment.
The majority of the wells in which we own an interest are operated by
other parties. As a result, we have little control over the operations of
such wells which can act to increase our risk. Operators of these wells
may act in ways that are not in our best interests.
Our future performance depends upon our ability to find or acquire
additional oil and natural gas reserves that are economically recoverable.
In general, production from oil and natural gas properties declines as
reserves are depleted, with the rate of decline depending on reservoir
characteristics. Unless we successfully replace the reserves that we
produce, our reserves will decline, resulting eventually in a decrease in
oil and natural gas production and lower revenues and cash flow from
operations. Historically, we have succeeded in increasing reserves after
taking production into account through exploitation, development and
exploration. We have conducted such activities on our existing oil and
natural gas properties as well as on newly acquired properties. We may not
be able to continue to replace reserves from such activities at acceptable
costs. Low prices of oil and natural gas may further limit the kinds of
reserves that can economically be developed. Lower prices also decrease
our cash flow and may cause us to decrease capital expenditures.
GOVERNMENTAL REGULATIONS
The production and sale of oil and natural gas is highly affected by
various state and federal regulations. All states in which we conduct
activities impose restrictions on the drilling, production, transportation
and sale of oil and natural gas.
Under the Natural Gas Act of 1938, the Federal Energy Regulatory
Commission (the "FERC") regulates the interstate transportation and the
sale in interstate commerce for resale of natural gas. The FERC's
jurisdiction over interstate natural gas sales was substantially modified
by the Natural Gas Policy Act under which the FERC continued to regulate
the maximum selling prices of certain categories of gas sold in "first
sales" in interstate and intrastate commerce. Effective January 1, 1993,
16
however, the Natural Gas Wellhead Decontrol Act (the "Decontrol Act")
deregulated natural gas prices for all "first sales" of natural gas.
Because "first sales" include typical wellhead sales by producers, all
natural gas produced from our natural gas properties is being sold at
market prices, subject to the terms of any private contracts which may be
in effect. The FERC's jurisdiction over natural gas transportation was not
affected by the Decontrol Act.
Our sales of natural gas are affected by intrastate and interstate gas
transportation regulation. Beginning in 1985, the FERC adopted regulatory
changes that have significantly altered the transportation and marketing of
natural gas. These changes were intended by the FERC to foster competition
by, among other things, transforming the role of interstate pipeline
companies from wholesale marketers of natural gas to the primary role of
gas transporters. All natural gas marketing by the pipelines was required
to be divested to a marketing affiliate, which operates separately from the
transporter and in direct competition with all other merchants. As a
result of the various omnibus rulemaking proceedings in the late 1980s and
the individual pipeline restructuring proceedings of the early to mid-
1990s, the interstate pipelines are now required to provide open and
nondiscriminatory transportation and transportation-related services to all
producers, natural gas marketing companies, local distribution companies,
industrial end users and other customers seeking service. Through similar
orders affecting intrastate pipelines that provide similar interstate
services, the FERC expanded the impact of open access regulations to
intrastate commerce.
More recently, the FERC has pursued other policy initiatives that have
affected natural gas marketing. Most notable are (1) the large-scale
divestiture of interstate pipeline-owned gas gathering facilities to
affiliated or non-affiliated companies; (2) further development of rules
governing the relationship of the pipelines with their marketing
affiliates; (3) the publication of standards relating to the use of
electronic bulletin boards and electronic data exchange by the pipelines to
make available transportation information on a timely basis and to enable
transactions to occur on a purely electronic basis; (4) further review of
the role of the secondary market for released pipeline capacity and its
relationship to open access service in the primary market; and (5)
development of policy and promulgation of orders pertaining to its
authorization of market-based rates (rather than traditional cost-of-
service based rates) for transportation or transportation-related services
upon the pipeline's demonstration of lack of market control in the relevant
service market. It remains to be seen what effect the FERC's other
activities will have on the access to markets, the fostering of competition
and the cost of doing business.
As a result of these changes, sellers and buyers of natural gas have
gained direct access to the particular pipeline services they need and are
better able to conduct business with a larger number of counter parties.
We believe these changes generally have improved the access to markets for
17
natural gas while, at the same time, substantially increasing competition
in the natural gas marketplace. We cannot predict what new or different
regulations the FERC and other regulatory agencies may adopt or what effect
subsequent regulations may have on production and marketing of natural gas
from our properties.
In the past, Congress has been very active in the area of natural gas
regulation. However, as discussed above, the more recent trend has been in
favor of deregulation and the promotion of competition in the natural gas
industry. Thus, in addition to "first sales" deregulation, Congress also
repealed incremental pricing requirements and natural gas use restraints
previously applicable. There are other legislative proposals pending in the
Federal and State legislatures which, if enacted, would significantly
affect the petroleum industry. At the present time, it is impossible to
predict what proposals, if any, might actually be enacted by Congress or
the various state legislatures and what effect, if any, these proposals
might have on the production and marketing of natural gas by us. Similarly,
and despite the trend toward federal deregulation of the natural gas
industry, whether or to what extent that trend will continue or what the
ultimate effect will be on the production and marketing of natural gas by
us cannot be predicted.
Our sales of oil and natural gas liquids are not regulated and are at
market prices. The price received from the sale of these products is
affected by the cost of transporting the products to market. Much of that
transportation is through interstate common carrier pipelines. Effective
as of January 1, 1995, the FERC implemented regulations generally
grandfathering all previously approved interstate transportation rates and
establishing an indexing system for those rates by which adjustments are
made annually based on the rate of inflation, subject to certain conditions
and limitations. These regulations may tend to increase the cost of
transporting oil and natural gas liquids by interstate pipeline, although
the annual adjustments may result in decreased rates in a given year. These
regulations have generally been approved on judicial review. Every five
years, the FERC will examine the relationship between the annual change in
the applicable index and the actual cost changes experienced by the oil
pipeline industry. The first such review is scheduled for the year 2000. We
are not able to predict with certainty what effect, if any, these
relatively new federal regulations or the periodic review of the index by
the FERC will have on us.
Federal, state, and local agencies have promulgated extensive rules
and regulations applicable to our oil and natural gas exploration,
production and related operations. Oklahoma, Texas and other states
require permits for drilling operations, drilling bonds and the filing of
reports concerning operations and impose other requirements relating to the
exploration of oil and natural gas. Many states also have statutes or
regulations addressing conservation matters including provisions for the
unitization or pooling of oil and natural gas properties, the establishment
of maximum rates of production from oil and natural gas wells and the
18
regulation of spacing, plugging and abandonment of such wells. The statutes
and regulations of some states limit the rate at which oil and natural gas
can be produced from our properties. The federal and state regulatory
burden on the oil and natural gas industry increases our cost of doing
business and affects its profitability. Because these rules and regulations
are frequently amended or reinterpreted, we are unable to predict the
future cost or impact of complying with those laws.
SAFE HARBOR STATEMENT OF FURTHER ACTIVITY
Statements in this document as well as information contained in
written material, press releases and oral statements issued by or on behalf
of us contain, or may contain, certain "forward-looking statements" within
the meaning of federal securities laws. All statements, other than
statements of historical facts, included in this document which address
activities, events or developments which we expect or anticipate will or
may occur in the future are forward-looking statements. The words
"believes," "intends," "expects," "anticipates," "projects," "estimates,"
"predicts" and similar expressions are also intended to identify forward-
looking statements. These forward-looking statements include, among
others, such things as:
. Year 2000 plans;
. the amount and nature of future capital expenditures;
. wells to be drilled or reworked;
. oil and natural gas prices and demand;
. exploitation and exploration prospects;
. estimates of proved oil and natural gas reserves;
. reserve potential;
. development and infill drilling potential;
. drilling prospects;
. expansion and other development trends of the oil and natural gas
industry;
. business strategy;
. production of oil and natural gas reserves;
. expansion and growth of our business and operations; and
. drilling rig utilization, revenues and costs.
These statements are based on certain assumptions and analyses made by
us in light of our experience and our perception of historical trends,
current conditions and expected future developments as well as other
factors we believe are appropriate in the circumstances. However, whether
actual results and developments will conform to our expectations and
predictions is subject to a number of risks and uncertainties which could
cause actual results to differ materially from our expectations, including:
. the risk factors discussed in this document;
. general economic, market or business conditions;
. the nature or lack of business opportunities that may be presented to
19
and pursued by us;
. demand for land drilling services;
. changes in laws or regulations; and
. other factors, most of which are beyond our control.
In order to provide a more thorough understanding of the possible
effects of some of these influences on any forward-looking statements made
by us, the following discussion outlines certain factors that in the future
could cause our consolidated results for 2000 and beyond to differ
materially from those that may be set forth in any such forward-looking
statement made by or on behalf of us.
Commodity Prices
The prices we receive for our oil and natural gas production have a
direct impact on our revenues, profitability and cash flow as well as our
ability to meet our projected financial and operational goals. The prices
for natural gas and crude oil are heavily dependent on a number of factors
beyond our control, including the demand for oil and/or natural gas;
current weather conditions in the continental United States which can
greatly influence the demand for natural gas at any given time as well as
the price to be received for such natural gas; and the ability of current
distribution systems in the United States to effectively meet the demand
for oil and or natural gas at any given time, particularly in times of peak
demand which may result due to adverse weather conditions. Oil prices are
extremely sensitive to foreign influences that may be based on political,
social or economic underpinnings, any one of which could have an immediate
and significant effect on the price and supply of oil. In addition, prices
of both natural gas and oil are becoming more and more influenced by
trading on the commodities markets which, at times, has tended to increase
the volatility associated with these prices resulting, at times, in large
differences in such prices even on a month-to-month basis. All of these
factors, especially when coupled with the fact that much of our product
prices are determined on a month-to-month basis, can, and at times do,
lead to wide fluctuations in the prices we receive.
Based upon the results of our operations for 1999 we estimate that a
change of $0.10/Mcf in the average price of natural gas and a change of
$1.00/Bbl in the price of crude oil throughout such period would have
resulted in approximate changes in net income before income taxes of
$1,488,000 and $348,000, respectively. During 1999, substantially all of
our natural gas and crude oil volumes were sold at market responsive
prices.
In order to reduce our exposure to short-term fluctuations in the
price of oil and natural gas, we sometimes enter into hedging or swap
arrangements. Our hedging or swap arrangements apply to only a portion of
our production and provide only partial price protection against declines
in oil and natural gas prices. These hedging or swap arrangements may
20
expose us to risk of financial loss and limit the benefit to us of
increases in prices.
Customer Demand
Demand for our drilling services is dependent almost entirely on the
needs of third parties. Based on past history, such parties' requirements
are subject to a number of factors, independent of any subjective factors,
that directly impact the demand for our drilling rigs. These include the
availability of funds to such third parties to carry out their drilling
operations during any given time period which, in turn, are often subject
to downward revision based on decreases in the then current prices of oil
and natural gas. Many of our customers are small to mid-size oil and
natural gas companies whose drilling budgets tend to be susceptible to the
influences of current price fluctuations. Other factors that affect our
ability to work our drilling rigs are: the weather which, under adverse
circumstances, can delay or even cause a project to be abandoned by an
operator; the competition faced by us in securing the award of a drilling
contract in a given area; our experience and recognition in a new market
area; and the availability of labor to run our drilling rigs.
Uncertainty Of Oil and Natural Gas Reserves and Well Performance
There are numerous uncertainties inherent in estimating quantities of
proved reserves and their values, including many factors beyond our
control. The reserve data included in this document represent only
estimates. Reservoir engineering is a subjective and inexact process of
estimating underground accumulations of oil and natural gas that cannot be
measured in an exact manner. Estimates of economically recoverable oil and
natural gas reserves depend on a number of variable factors, including
historical production from the area compared with production from other
producing areas, and assumptions concerning:
. the effects of regulations by governmental agencies;
. future oil and natural gas prices;
. future operating costs;
. severance and excise taxes;
. development costs; and
. workover and remedial costs.
Some or all of these assumptions may vary considerably from actual
results. For these reasons, estimates of the economically recoverable
quantities of oil and natural gas attributable to any particular group of
properties, classifications of those reserves based on risk of recovery,
and estimates of the future net cash flows from reserves prepared by
different engineers or by the same engineers but at different times may
vary substantially. Accordingly, reserve estimates may be subject to
downward or upward adjustment. Actual production, revenues and expenditures
with respect to our reserves will likely vary from estimates, and those
variances may be material.
21
The information regarding discounted future net cash flows included in
this document should not be considered as the current market value of the
estimated oil and natural gas reserves attributable to our properties. As
required by the SEC, the estimated discounted future net cash flows from
proved reserves are based on prices and costs as of the date of the
estimate, while actual future prices and costs may be materially higher or
lower. Actual future net cash flows also will be affected by the following
factors:
. the amount and timing of actual production;
. supply and demand for oil and natural gas;
. increases or decreases in consumption; and
. changes in governmental regulations or taxation.
In addition, the 10% discount factor, which is required by the SEC to
be used in calculating discounted future net cash flows for reporting
purposes, is not necessarily the most appropriate discount factor based on
interest rates in effect from time to time and risks associated with our
operations or the oil and natural gas industry in general.
We periodically review the carrying value of our oil and natural gas
properties under the full cost accounting rules of the SEC. Under these
rules, capitalized costs of proved oil and natural gas properties may not
exceed the present value of estimated future net revenues from proved
reserves, discounted at 10%. Application of the ceiling test generally
requires pricing future revenue at the unescalated prices in effect as of
the end of each fiscal quarter and requires a write-down for accounting
purposes if the ceiling is exceeded, even if prices were depressed for only
a short period of time. We may be required to write down the carrying value
of our oil and natural gas properties when oil and natural gas prices are
depressed or unusually volatile. If a write-down is required, it would
result in a charge to earnings but would not impact cash flow from
operating activities. Once incurred, a write-down of oil and natural gas
properties is not reversible at a later date.
We are continually identifying and evaluating opportunities to acquire
oil and natural gas properties, including acquisitions that would be
significantly larger than those consummated to date by us. We cannot
assure you that we will successfully consummate any acquisition, that we
will be able to acquire producing oil and natural gas properties that
contain economically recoverable reserves or that any acquisition will be
profitably integrated into our operations.
Debt and Bank Borrowing
We have experienced and expect to continue to experience substantial
working capital needs due to our growth in drilling operations and our
active exploration, development and exploitation programs. Historically,
we have funded our working capital needs through a combination of
22
internally generated cash flow, equity financing and borrowings under our
bank loan agreement. As a result of our significant working capital
requirements, we currently have, and will continue to have, a large amount
of indebtedness. At December 31, 1999, our long-term debt outstanding was
$65.4 million. As of December 31, 1999, the amount available for borrowing
under our bank loan agreement was $85 million, of which $62.4 million was
outstanding.
Our level of indebtedness, the cash flow needed to satisfy our
indebtedness and the covenants governing our indebtedness could:
. limit funds available for financing capital expenditures, our drilling
program or other activities or cause us to curtail these activities;
. limit our flexibility in planning for or reacting to changes in our
business;
. place us at a competitive disadvantage to some of our competitors that
are less leveraged than us;
. make us more vulnerable during periods of low oil and natural gas
prices or in the event of a downturn in our business; and
. prevent us from obtaining additional financing on acceptable terms or
limit amounts available under our existing or any future credit
facilities.
Our ability to meet our debt service obligations will depend on our
future performance. We cannot assure you that we will be able to meet our
debt service requirements. In addition, lower oil and natural gas prices
could result in future reductions in the amount available for borrowing
under our bank loan agreement, reducing our liquidity and even triggering
mandatory loan repayments.
If the requirements of our indebtedness are not satisfied, a default
would be deemed to occur and our lenders would be entitled to accelerate
the payment of the outstanding indebtedness. If this occurs, we cannot
assure you that we would have sufficient funds available or could obtain
the financing required to meet our obligations.
The amount of our existing debt as well as its future debt is, to a
large extent, a function of the costs associated with the projects
undertaken by us at any given time and the cash flow received by us.
Generally, the costs incurred by us in our normal operations are those
associated with the drilling of oil and natural gas wells, the acquisition
of producing properties, and the costs associated with the maintenance of
our drilling rig fleet. To some extent, these costs, particularly the first
two items, are discretionary and we maintain a degree of control regarding
the timing and/or the need to incur the same. However, in some cases,
unforeseen circumstances may arise, such as in the case of an unanticipated
opportunity to acquire a large producing property package or the need to
replace a costly rig component due to an unexpected loss, which could force
us to incur increased debt above that which we had expected or forecasted.
23
Likewise, for many of the reasons mentioned above, our cash flow may not be
sufficient to cover our current cash requirements which would then require
us to increase our debt either through bank borrowings or otherwise.
Item 3. Legal Proceedings
- ------- -----------------
We are a party to various legal proceedings arising in the ordinary
course of our business, none of which, in our opinion, will result in
judgments which would have a material adverse effect on our financial
position, operating results or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
- ------- ---------------------------------------------------
No matters were submitted to our security holders during the fourth
quarter of 1999.
24
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
- ------- ------------------------------------------------------------------
Matters
-------
Our common stock is traded on the New York Stock Exchange under the
symbol "UNT." The following table sets forth the high and low sale prices
per share of our common stock as reported in the New York Stock Exchange
composite transactions for the periods indicated:
1998 1999
------------------------- ------------------------
QUARTER High Low High Low
------- ----------- ----------- ----------- -----------
First $ 9 13/16 $ 6 7/16 $ 7 $ 3 1/2
Second $ 9 7/8 $ 5 1/2 $ 8 1/4 $ 4 7/8
Third $ 6 5/16 $ 3 3/4 $ 9 $ 6 3/4
Fourth $ 6 15/16 $ 3 5/8 $ 7 3/4 $ 4 7/8
As of February 22, 2000 our common stock was held by 2,370 holders of
record.
We have not declared nor paid any cash dividends on shares of our
common stock since organization and currently intend to continue our policy
of retaining earnings from our operations. We are prohibited by certain
loan agreement provisions from declaring and paying dividends (other than
stock dividends) during any fiscal year in excess of 25 percent of our
consolidated net income of the preceding fiscal year, and only if working
capital provided from operations during the prior year is equal to or
greater than 175 percent of current maturities of long-term debt at the end
of the prior year.
25
Item 6. Selected Financial Data
- ------- -----------------------
Year Ended December 31,
------------------------------------------------------------
1995 1996 1997 1998 1999
---------- ---------- ---------- ---------- ----------
(In thousands except per share amounts)
Revenues $ 53,074 $ 72,070 $ 91,864 $ 93,337 $ 97,453
========== ========== ========== ========== ==========
Income From
Continuing
Operations $ 3,751(1) $ 8,333 $ 11,124 $ 2,246 $ 1,486
========== ========== ========== ========== ==========
Net Income $ 3,999(1) 8,333 11,124 2,246 1,486
========== ========== ========== ========== ==========
Basic Earnings Per
Common Share:
Continuing
operations $ .18(1) .37 .46 .09 .05
Discontinued
operations $ .01 - - - -
---------- ---------- ---------- ---------- ----------
Net Income $ .19(1) $ .37 $ .46 $ .09 $ .05
========== ========== ========== ========== ==========
Diluted Earnings
Per Common Share:
Continuing
operations $ .18(1) $ .37 $ .45 $ .09 $ .05
Discontinued
operations $ .01 - - - -
---------- ---------- ---------- ---------- ----------
Net Income $ .19(1) $ .37 $ .45 $ .09 $ .05
========== ========== ========== ========== ==========
Total Assets $ 110,922 $ 137,993 $ 202,497 $ 223,064 $ 283,573
========== ========== ========== ========== ==========
Long-Term Debt $ 41,100 $ 40,600 $ 54,100 $ 72,900 $ 65,400
========== ========== ========== ========== ==========
Other Long-Term
Liabilities $ 2,109 $ 2,276 $ 2,279 $ 2,301 $ 2,265
========== ========== ========== ========== ==========
Cash Dividends
Per Common Share $ - $ - $ - $ - $ -
========== ========== ========== ========== ==========
- ------------------
(1) Includes a $635,000 gain on compressor sale, a $850,000 gain from
settlement of litigation and a net $530,000 deferred tax benefit.
See Management's Discussion of Financial Condition and Results of
Operations for a review of 1997, 1998 and 1999 activity.
26
Item 7. Management's Discussion and Analysis of Financial Condition and
- ------------------------------------------------------------------------
Results of Operations
---------------------
Financial Condition and Liquidity
- ---------------------------------
Our bank loan agreement provides for a total loan facility of $100
million with a current available borrowing value of $85 million. Each year
on April 1 and October 1 our banks redetermine our available borrowing
value which is an amount equal to a percentage of the discounted future
value of our oil and natural gas reserves plus an amount which is the
greater of (i) 50 percent of the appraised value of our contract drilling
rigs or (ii) two times the previous 12 months cash flow from our contract
drilling rigs, limited, in either case, to $20 million. Our loan agreement
provides for a revolving credit facility which terminates on May 1, 2002
followed by a three year term loan. Borrowings under our loan agreement
totaled $62.4 million at December 31, 1999 and $61.0 million at February
27, 2000. We are charged a facility fee of .375 of 1 percent on any unused
portion of the available borrowing value. The loan agreement also contains
covenants which require us to maintain
. consolidated tangible net worth of at least $75 million,
. a current ratio of not less than 1 to 1,
. a ratio of long-term debt, as defined in the loan agreement, to
consolidated tangible net worth not greater than 1.2 to 1,
. a ratio of total liabilities, as defined in the loan agreement, to
consolidated tangible net worth not greater than 1.65 to 1, and
. working capital provided by operations, as defined in the loan
agreement, cannot be less than $18 million in any year.
The interest rate on our bank debt was 7.47 percent at December 31,
1999 and 7.44 percent at February 22, 2000. At our election, any portion
of our outstanding bank debt may be fixed at the London Interbank Offered
Rate ("Libor Rate"), as adjusted depending on the level of our debt as a
percentage of the available borrowing value. The Libor Rate may be fixed
for periods of up to 30, 60, 90 or 180 days with the remainder of our bank
debt being subject to the Chase Manhattan Bank, N. A. prime rate. During
any Libor Rate funding period, we may not pay any part of the outstanding
principal balance which is subject to the Libor Rate. Borrowings subject
to the Libor Rate were $61.0 million at both December 31, 1999 and February
22, 2000.
Our shareholders' equity at December 31, 1999 was $171.9 million
giving us a ratio of long-term debt-to-total capitalization of 28 percent.
27
Our primary source of funds consists of the cash flow from our operating
activities and borrowings under our bank loan agreement. Net cash provided
by our operating activities in 1999 was $21.3 million compared to $33.5
million in 1998. We had working capital of $3.4 million at December 31,
1999. Our total 1999 capital expenditures were $76.7 million of which
$20.3 million was spent on our oil and natural gas operations, $14.9
million for exploration and development drilling and $3.6 million for
producing property acquisitions, and $55.7 million on our contract drilling
operations. Capital expenditures for our contract drilling operations
consisted primarily of $48.1 million to acquire the 13 Parker land drilling
rigs with the rest for major components on our rig fleet. We anticipate
that we will spend approximately $15 million in 2000 for drilling rig
equipment capital expenditures.
As natural gas and oil prices increased during the last six months of
1999, we increased our development drilling activity with the result that
we drilled 20 wells during the fourth quarter as compared to a total of 31
wells during the first three quarters of 1999. If oil and natural gas
prices remain favorable, we anticipate that we may spend approximately $30
million drilling or buying oil and natural gas properties in 2000.
Most of our capital expenditures are discretionary and directed toward
increasing oil and natural gas reserves and future growth. Current
operations do not depend on our ability to obtain funds outside of our loan
agreement. Future decisions to acquire or drill on oil and natural gas
properties will depend on prevailing or anticipated market conditions,
potential return on investment, future drilling potential and the
availability of opportunities to obtain financing under the circumstances
involved, thus providing us with a large degree of flexibility in
determining when and if to incur such costs.
On December 8, 1999, we signed an agreement and plan of merger with
Questa Oil and Gas Co.("Questa") under which one of our wholly owned
subsidiaries will be merged (the "merger") with Questa. Questa will
continue as the surviving corporation and as a wholly owned subsidiary of
ours. In the merger each of Questa's outstanding shares of common stock
(excluding treasury shares) will be converted into the right to receive .95
shares of our common stock. Questa has 1.9 million shares outstanding. We
anticipate that this merger, which is subject to a number of conditions,
will close late in the first quarter of 2000 and will be accounted for as a
pooling of interests.
On September 30, 1999, we completed the acquisition of 13 land
drilling rigs from Parker Drilling Company and Parker Drilling Company
North America, Inc., for 1,000,000 shares of our common stock and
$40,000,000 in cash. The cash part of this acquisition was funded through
a public offering of 7,000,000 shares of our common stock which closed on
September 29, 1999. We received proceeds of $50.1 million from the
offering net of commission fees and other costs.
28
On November 20, 1997, we acquired Hickman Drilling Company pursuant to
an agreement and plan of merger entered into by and between us, Hickman
Drilling Company and all of the holders of the outstanding capital stock of
Hickman Drilling Company. As part of this acquisition, the former
shareholders of Hickman held, as of December 31, 1999, promissory notes in
the aggregate outstanding principal amount of $4.0 million. These notes are
payable in equal annual installments on January 2, 2000 through January 2,
2003. The notes bear interest at the Chase Prime Rate which at December 31,
1999 was 8.5 percent and February 22, 2000 was 8.75 percent. At February
22, 2000, the promissory notes outstanding totaled $3.0 million.
Due to a settlement agreement which terminated at December 31, 1997,
we have a liability of $1.3 million at December 31, 1999, representing
proceeds received from a natural gas purchaser as prepayment for natural
gas. The $1.3 million is payable in equal annual payments from June 1, 2000
to June 1, 2002.
The prices we received for our oil in 1999 increased throughout the
year ending 135 percent higher than the prices we received during February
1999, when oil prices were at their lowest for the year. While oil prices
steadily increased during the year, natural gas prices were volatile. Our
average natural gas price in December 1999 as compared to January 1999 was
31 percent higher but dropped 28 percent in one month from November 1999 to
December 1999. For the year, the average natural gas price we received was
$2.02 per Mcf and the average oil price we received was $17.51 per barrel.
Natural gas prices are influenced by weather conditions and supply
imbalances, particularly in the domestic market, and by world wide oil
price levels. Domestic oil price levels continue to be primarily influenced
by world market developments. Since natural gas comprises approximately 88
percent of our total oil and natural gas reserves, large drops in spot
market natural gas prices have a significant adverse effect on the value of
our oil and natural gas reserves and price declines could cause us to
reduce the carrying value of our oil and natural gas properties. Any price
decreases, if sustained, would also adversely affect our future cash flow
by reducing our oil and natural gas revenues and, if continued over an
extended period, could lessen not only the demand for our contract drilling
rigs but also the rate we would receive. Any declines in natural gas and
oil prices could also adversely affect the semi-annual determination of the
loan value under our bank loan agreement since this determination is based
on the value of our oil and natural gas reserves and our drilling rigs.
Such a reduction would reduce the amount available to us under our loan
agreement which, in turn, would affect our ability to carry out our capital
projects.
Generally, during the past 15 years, our contract drilling operations
have encountered significant competition although in the last six months of
1996, all of 1997 and the first nine months of 1998 we experienced
significant improvement in rig utilization. However, in late 1998 and
through the first six months of 1999 we, along with the drilling industry
as a whole, experienced a significant reduction in demand for our drilling
29
rigs. While we experienced an increase in demand during the last six
months of 1999, we anticipate that competition within our industry will,
for the foreseeable future, continue to influence the use of our drilling
rigs. In addition to competition, our ability to use our drilling rigs at
any given time depends on a number of other factors, including the price of
both oil and natural gas, the availability of labor and our ability to
supply the type of equipment required. We expect these factors will also
continue to influence the use of our rigs in 2000.
At December 31, 1999, we had tax net operating loss carryforwards
("NOL's") of approximately $61.8 million, the benefit of which has been
recognized in our financial statements as we believe it to be more likely
than not that these NOL's will be utilized by us. Approximately $1.4
million of the NOL's expire in 2000 and approximately $12.3 million expire
in 2001. Should we be unable to generate sufficient income in these years
to allow the utilization of the NOL's, a charge to expense will be required
to give recognition to any loss of the NOL's.
In the third quarter of 1994, our board of directors authorized us to
purchase up to 1,000,000 shares of our outstanding common stock on the open
market. Since that time, 160,100 shares have been repurchased at prices
ranging from $2.50 to $9.69 per share. In the first quarter of 1997, 1998
and 1999, we used 23,892, 19,863 and 25,000 of the purchased shares,
respectively, as our matching contribution to our 401(k) Employee Thrift
Plan. At December 31, 1999 we held no treasury shares.
Year 2000 Statement
- -------------------
We spent approximately $130,000 to make our software and hardware
compliant for the transition into the year 2000. We have not experienced
any material problems during the transition into the new year and have not
received reports of any material problems from any of our suppliers or
customers.
Effects of Inflation
- --------------------
In previous years the effects of inflation on our operations have been
minimal due to low inflation rates. However, during the last six months of
1996, throughout 1997 and in the last half of 1999, as drilling rig day
rates and drilling rig utilization increased, the impact of inflation
increased as the availability of equipment, third party services and
qualified labor decreased. How inflation will effect us in the future will
depend on the increase, if any, we realize in our drilling rig rates and
the prices we receive for our oil and natural gas. If industry activity
suddenly and substantially increases, shortages in support equipment such
as drill pipe, third party services and qualified labor could occur
30
resulting in additional corresponding increases in our material and labor
costs. These conditions may limit our ability to realize improvements in
operating profits.
New Accounting Pronouncement
- ----------------------------------
On June 15, 1998, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (FAS 133). In June 1999,
FAS 133 was amended by FAS 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB No. 133 - an
amendment of FASB Statement No. 133" (FAS 137). FAS 133 is now effective
for all fiscal quarters of fiscal years beginning after June 15, 2000
(January 1, 2001 for Unit). FAS 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes
in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative
is designated as part of a hedge transaction and, if it is, the type of
hedge transaction. We anticipate that, based on the nature of our use of
derivative instruments, the adoption of FAS 133 will not have a significant
effect on our results of operations or financial position.
Results of Operations
- ---------------------
1999 versus 1998
- ----------------
Net income for 1999 was $1,486,000, compared with $2,246,000 in 1998.
Lower natural gas and oil prices in the first half of 1999 reduced both the
demand for our drilling rigs and the rates we received for the drilling
rigs that were operating.
Our oil and natural gas revenues increased 5 percent in 1999 due to a
6 percent and 37 percent increase in the average prices we received for
natural gas and oil, respectively. For the year, natural gas production
decreased by 3 percent and oil production decreased by 16 percent when
compared to 1998. Our oil production is declining because we have
emphasized in recent years the drilling of development wells aimed at
replacing and increasing our natural gas reserves. Our natural gas
production decreased because we curtailed our development drilling program
during the first half of 1999 while oil and natural gas prices were
depressed. As prices began to improve during the last six months of 1999,
our natural gas production increased as we increased our drilling program.
Natural gas production for the fourth quarter of 1999 exceeded 1998's
fourth quarter production by 3 percent.
In 1999, revenues from our contract drilling operations increased by 4
percent as the average number of drilling rigs being used increased from
31
22.9 in 1998 to 23.1 in 1999. Revenues per rig per day increased 3 percent
between the comparative years. During the first nine months of 1999 as
compared to the same period of 1998, our average drilling rig utilization
was down 22 percent and our average revenues per rig day was down 4
percent. The acquisition of the Parker drilling rigs added 6.5 rigs to our
utilization rate in the fourth quarter of 1999 at dayrates substantially
higher than those achieved in our other marketing area. As a result, that
acquisition had a strong impact on our contract drilling fourth quarter and
year-end operating results, adding $5.6 million in revenues. Daywork
revenues represented 61 percent of our total drilling revenues in 1999 and
64 percent in 1998.
Operating margins (revenues less operating costs) for our oil and
natural gas operations were 67 percent in 1999 and 64 percent in 1998.
This increase resulted primarily from the increase in the average oil and
natural gas prices we received and a 3 percent decrease in operating costs
between the comparative years.
Our contract drilling operating margins decreased from 18 percent in
1998 to 14 percent in 1999. This reduction was generally due to decreases
during the first nine months of 1999 in both daily drilling rig revenue
rates and utilization and increases in operating costs. Total contract
drilling operating costs were up 9 percent in 1999 versus 1998 due to
increased labor costs and related benefit costs, including workers'
compensation.
Contract drilling depreciation increased 19 percent due to the impact
of higher depreciation per operating day associated with the newly acquired
Parker rigs. Depreciation, depletion and amortization ("DD&A") of our oil
and natural gas properties increased 1 percent as the average DD&A rate per
Mcfe increased 5 percent to $0.88 in 1999. The DD&A rate increase was
partially offset by the previously discussed decrease in production.
General and administrative expenses increased 4 percent as certain
employee benefit costs and outside services increased. Interest expense
increased 6 percent as our average outstanding debt increased 10 percent
during 1999. The average interest rate decreased from 7.11 percent in 1998
to 7.00 percent in 1999.
On May 3, 1999, our contract drilling offices in Moore, Oklahoma were
struck by a tornado destroying two buildings and damaging various vehicles
and drilling equipment. In May 1999, we received $500,000 of insurance
proceeds for the destroyed buildings, and as a result, in the second
quarter of 1999, we recognized a gain of $315,000 recorded as part of other
revenues. Other claims for the contents of the two buildings and damaged
equipment and damage removal covered under other insurance policies have
been filed. We do not expect any financial loss to be incurred from these
claims.
32
1998 versus 1997
- ----------------
Net income for 1998 was $2,246,000, compared with $11,124,000 in 1997.
Increases in the number of rigs utilized and increased natural gas
production were more than offset by substantial decreases in the average
price received for both oil and natural gas and to a lesser extent from
reduced oil production and contract drilling rates.
Oil and natural gas revenues decreased 13 percent in 1998 due to a 21
percent and 33 percent decrease in average natural gas and oil prices
received, respectively along with a 10 percent reduction in oil production.
These decreases were partially offset by a 19 percent increase in natural
gas production. Oil production declined from 1997 levels due to our
emphasis over the past three years in drilling development wells which
focused on replacing and increasing natural gas reserves. Average natural
gas spot market prices received by us decreased 20 percent. The natural
gas previously subject to the settlement agreement, which ended at December
31, 1997 and contained provisions for prices higher than current spot
market prices, is now being sold at spot market prices consistent with the
rest of the natural gas sold by us. The impact of higher prices received
under the settlement agreement increased pre-tax income by approximately
$540,000 in 1997.
In 1998, revenues from contract drilling operations increased by 16
percent as average rig utilization increased from 19.2 rigs operating in
1997 to 22.9 rigs operating in 1998. Daywork revenues per rig per day
decreased 3 percent between the comparative years. During the first three
quarters of 1998, our monthly rig utilization consistently remained at or
above 23 rigs with daywork revenue per rig per day declining by 8 percent
from the January 1998 rate. In the fourth quarter utilization dropped 27
percent from the previous quarter and dayrates decreased another 6 percent.
Total daywork revenues represented 64 percent of total drilling revenues in
1998 and 72 percent in 1997. Turnkey and footage contracts typically
provide for higher revenues since a greater portion of the expense of
drilling the well is borne by the drilling contractor.
Operating margins (revenues less operating costs) for our natural gas
and oil operations were 64 percent in 1998 compared to 71 percent in 1997.
Decreased operating margins resulted primarily from the decrease in average
natural gas and oil prices received by us between the two years. Total
operating costs were 9 percent higher in 1998 compared to 1997 as we
continue to add producing properties.
Operating margins for contract drilling decreased from 21 percent in
1997 to 18 percent in 1998. Margins in 1998 were lower primarily due to
decreases in both daily rig rates and utilization in the fourth quarter of
1998. Total operating costs for contract drilling were up 20 percent in
1998 versus 1997 due to increased drilling rig utilization and costs
associated with the November 1997 Hickman Acquisition.
33
Contract drilling depreciation increased 37 percent in response to
increased rig utilization and additional drilling capital expenditures
throughout 1997 and 1998. Depreciation, depletion and amortization
("DD&A") of oil and natural gas properties increased 27 percent as we
increased our equivalent barrels of production by 14 percent and our
average DD&A rate per Mcfe increased 11 percent to $0.83 in 1998.
General and administrative expenses increased 6 percent as certain
employee costs increased. Interest expense increased 65 percent as our
average outstanding debt increased 65 percent during 1998. The average
interest rate decreased from 7.28 percent in 1997 to 7.11 percent in 1998.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
- -------- ----------------------------------------------------------
Our operations are exposed to market risks primarily as a result of
changes in commodity prices and interest rates.
Commodity Price Risk - Our major market risk exposure is in the
pricing of our oil and natural gas production. The price we receive is
primarily driven by the prevailing worldwide price for crude oil and market
prices applicable to our natural gas production. Historically, prices we
have received for our oil and natural gas production have been volatile and
such volatility is expected to continue.
To reduce the impact of price fluctuations, we periodically use
hedging strategies to hedge the price we will receive for a portion of our
future oil and natural gas production. During six different months of 1999
we had swap transactions applying to approximately 22 to 44 percent of our
daily gas production. These transactions yielded a reduction in our
natural gas revenues of $487,000. At December 31, 1999, we did not have
any forward of future contracts relating to the production of our oil and
natural gas. In the first quarter of 2000, we entered into swap
transactions in an effort to lock in a portion of our production at the
higher oil prices which currently exist. These transactions apply to
approximately 60 percent of our daily natural gas production covering the
period from April 1, 2000 to July 31, 2000 and 30 percent of our oil
production for August and September of 2000, at prices ranging from $24.42
to $27.01.
Interest Rate Risk - Our interest rate exposure relates to our long-
term debt, all of which bears interest at variable rates based on the prime
rate or the London Interbank Offered Rate ("Libor rate"). At our election,
borrowings under our revolving credit and term loan may be fixed at the
Libor rate for periods up to 180 days. Historically, we have not utilized
any financial instruments, such as interest rate swaps, to attempt to
manage the exposure to increases in interest rates. However, we may
consider the use of such financial instruments in the future based on our
34
assessment of future interest rates. The impact on annual cash flow before
taxes of a one percent change in the floating rate bases on our average
outstanding long-term debt in 1999 would have been approximately $711,000.
35
Item 8. Financial Statements and Supplementary Data
- -----------------------------------------------------
UNIT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 31,
----------------------
1998 1999
---------- ----------
(In thousands)
ASSETS
- ------
Current Assets:
Cash and cash equivalents $ 446 $ 478
Accounts receivable (less allowance for
doubtful accounts of $274 and $573) 13,149 21,528
Materials and supplies 3,298 3,259
Prepaid expenses and other 2,650 2,475
---------- ----------
Total current assets 19,543 27,740
---------- ----------
Property and Equipment:
Drilling equipment 123,258 177,238
Oil and natural gas properties, on
the full cost method 271,960 291,760
Transportation equipment 2,955 3,448
Other 6,870 7,593
---------- ----------
405,043 480,039
Less accumulated depreciation, depletion,
amortization and impairment 207,883 230,233
---------- ----------
Net property and equipment 197,160 249,806
---------- ----------
Other Assets 6,361 6,027
---------- ----------
Total Assets $ 223,064 $ 283,573
========== ==========
The accompanying notes are an integral part of the
consolidated financial statements
36
UNIT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
As of December 31,
----------------------
1998 1999
---------- ----------
(In thousands)
LIABILITIES AND SHAREHOLDERS' EQUITY
- -----------------------------------
Current Liabilities:
Current portion of long-term
liabilities and debt $ 1,801 $ 1,719
Accounts payable 8,517 14,285
Accrued liabilities 7,362 7,977
Contract advances 310 358
---------- ----------
Total current liabilities 17,990 24,339
---------- ----------
Long-Term Debt 72,900 65,400
---------- ----------
Other Long-Term Liabilities (Note 4) 2,301 2,265
---------- ----------
Deferred Income Taxes 18,583 19,712
---------- ----------
Commitments and Contingencies (Note 9)
Shareholders' Equity:
Preferred stock, $1.00 par value,
5,000,000 shares authorized, none issued - -
Common stock, $.20 par value,
40,000,000 shares authorized,
25,563,165 and 33,815,676 shares
issued, respectively 5,113 6,763
Capital in excess of par value 82,187 139,487
Retained earnings 24,121 25,607
Treasury stock, at cost (25,000 and 0
shares, respectively) (131) -
---------- ----------
Total shareholders' equity 111,290 171,857
---------- ----------
Total Liabilities and Shareholders' Equity $ 223,064 $ 283,573
========== ==========
The accompanying notes are an integral part of the
consolidated financial statements
37
UNIT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
--------------------------------------
1997 1998 1999
---------- ---------- ----------
(In thousands except per share amounts)
Revenues:
Contract drilling $ 46,199 $ 53,528 $ 55,479
Oil and natural gas 45,581 39,703 41,540
Other 84 106 434
---------- ---------- ----------
Total revenues 91,864 93,337 97,453
---------- ---------- ----------
Expenses:
Contract drilling:
Operating costs 36,419 43,729 47,721
Depreciation 4,216 5,766 6,851
Oil and natural gas:
Operating costs 13,201 14,328 13,898
Depreciation, depletion
and amortization 12,625 16,069 16,197
General and administrative 4,621 4,891 5,071
Interest 2,921 4,815 5,081
---------- ---------- ----------
Total expenses 74,003 89,598 94,819
---------- ---------- ----------
Income Before Income Taxes 17,861 3,739 2,634
---------- ---------- ----------
Income Tax Expense:
Current 118 139 19
Deferred 6,619 1,354 1,129
---------- ---------- ----------
Total income taxes 6,737 1,493 1,148
---------- ---------- ----------
Net Income $ 11,124 $ 2,246 $ 1,486
========== ========== ==========
Net Income Per Common Share:
Basic $ .46 $ .09 $ .05
========== ========== ==========
Diluted $ .45 $ .09 $ .05
========== ========== ==========
The accompanying notes are an integral part of the
consolidated financial statements
38
UNIT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Year Ended December 31, 1997, 1998 and 1999
Capital
In
Excess
Common Of Par Retained Treasury
Stock Value Earnings Stock Total
-------- ---------- --------- -------- ----------
(In thousands)
Balances,
January 1, 1997 $ 4,831 $ 62,735 $ 10,751 $ (107) $ 78,210
Net income - - 11,124 - 11,124
Activity in employee
compensation plans
(57,524 shares) 12 718 - 89 819
Issuance of stock for
acquisition
(1,300,000 shares) 260 18,590 - - 18,850
Purchase of treasury
stock
(15,000 shares) - - - (138) (138)
-------- ---------- --------- -------- ----------
Balances,
December 31, 1997 5,103 82,043 21,875 (156) 108,865
Net income - - 2,246 - 2,246
Activity in employee
compensation plans
(48,329 shares) 10 144 - 156 310
Purchase of treasury
stock (25,000
shares) - - - (131) (131)
-------- ---------- --------- -------- ----------
Balances,
December 31, 1998 5,113 82,187 24,121 (131) 111,290
Net income - - 1,486 - 1,486
Activity in employee
compensation plans
(252,511 shares) 50 680 - 131 861
Sale of Common Stock
(7,000,000 shares) 1,400 48,682 - - 50,082
Issuance of stock for
acquisition
(1,000,000 shares) 200 7,938 - - 8,138
-------- ---------- --------- -------- ----------
Balances,
December 31, 1999 $ 6,763 $ 139,487 $ 25,607 $ - $ 171,857
======== ========== ========= ======== ==========
The accompanying notes are an integral part of the
consolidated financial statements
39
UNIT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
----------------------------------
1997 1998 1999
---------- ---------- ----------
(In thousands)
Cash Flows From Operating
Activities:
Net Income $ 11,124 $ 2,246 $ 1,486
Adjustments to reconcile
net income to net cash
provided (used) by
operating activities:
Depreciation, depletion,
and amortization 17,199 22,186 23,367
Loss (gain) on disposition
of assets (94) 17 (400)
Employee stock compensation
plans 244 561 436
Bad debt expense 250 - 255
Deferred tax expense 6,619 1,354 1,129
Changes in operating assets and
liabilities increasing
(decreasing) cash:
Accounts receivable (1,762) 6,664 (8,634)
Materials and supplies (1,233) 237 39
Prepaid expenses and other (211) (444) 175
Accounts payable 2,062 948 2,503
Accrued liabilities 1,430 (27) 1,383
Contract advances (1,208) 218 48
Other liabilities (70) (447) (442)
---------- ---------- ----------
Net cash provided by
operating activities 34,350 33,513 21,345
---------- ---------- ----------
The accompanying notes are an integral part of the
consolidated financial statements
40
UNIT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Year Ended December 31,
----------------------------------
1997 1998 1999
---------- ---------- ----------
(In thousands)
Cash Flows From Investing Activities:
Capital expenditures (including
producing property acquisitions) $ (45,115) $ (53,654) (68,313)
Cash received on acquisition
of drilling company (Note 2) 1,611 - -
Proceeds from disposition of
property and equipment 792 964 1,372
(Acquisition) disposition
of other assets (314) (93) 91
---------- ---------- ----------
Net cash used in
investing activities (43,026) (52,783) (66,850)
---------- ---------- ----------
Cash Flows From Financing Activities:
Borrowings under line of credit 34,400 52,700 61,600
Payments under line of credit (25,900) (32,900) (68,100)
Net payments on notes payable
and other long-term debt - (470) (1,081)
Proceeds from sale of common stock 225 59 50,144
Book overdrafts (Note 1) - - 2,974
Acquisition of treasury stock (138) (131) -
---------- ---------- ----------
Net cash provided by
financing activities 8,587 19,258 45,537
---------- ---------- ----------
Net Increase (Decrease) in Cash
and Cash Equivalents (89) (12) 32
Cash and Cash Equivalents,
Beginning of Year 547 458 446
---------- ---------- ----------
Cash and Cash Equivalents, End of Year $ 458 $ 446 $ 478
========== ========== ==========
Supplemental Disclosure of Cash Flow
Information:
Cash paid during the year for:
Interest $ 2,910 $ 4,064 $ 5,660
Income taxes $ 102 $ 507 -
The accompanying notes are an integral part of the
consolidated financial statements
41
UNIT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
Principles of Consolidation
The consolidated financial statements include the accounts of Unit
Corporation and its directly and indirectly wholly owned subsidiaries. The
investment in limited partnerships is accounted for on the proportionate
consolidation method, whereby Unit's share of the partnerships' assets,
liabilities, revenues and expenses is included in the appropriate
classification in the accompanying consolidated financial statements.
Nature of Business
Unit is engaged in the land contract drilling of natural gas and oil
wells and the exploration, development, acquisition and production of oil
and natural gas properties. Our current contract drilling operations are
focused primarily in the natural gas producing provinces of the Oklahoma
and Texas areas of the Anadarko and Arkoma Basins, the Texas Gulf Cost and
the Rocky Mountain regions. Unit's primary exploration and production
operations are also conducted in the Anadarko and Arkoma Basins and in the
Texas Gulf Coast area. The majority of its contact drilling and
exploration and production activities are oriented toward drilling for and
producing natural gas. At December 31, 1999, Unit had an interest in a
total of 2,483 wells and served as operator of 519 of those wells. Unit
provides land contract drilling services for a wide range of customers
using the drilling rigs which it owns and operates. In 1999, 40 of the
Company's 47 rigs were in operation.
Drilling Contracts
Unit recognizes revenues generated from "daywork" drilling contracts
as the services are performed, which is similar to the percentage of
completion method. Under "footage" and "turnkey" contracts, Unit bears the
risk of completion of the well therefore, revenues and expenses are
recognized using the completed contract method. The duration of all three
types of contracts range typically from 20 to 90 days. The entire amount
of a loss, if any, is recorded when the loss is determinable. The costs of
uncompleted drilling contracts include expenses incurred to date on
"footage" or "turnkey" contracts, which are still in process at the end of
the period, and are included in other current assets.
42
Cash Equivalents and Book Overdrafts
Unit includes as cash equivalents, certificates of deposits and all
investments with maturities at date of purchase of three months or less
which are readily convertible into known amounts of cash. Book overdrafts
are checks that have been issued prior to the end of the period, but not
presented to Unit's bank for payment prior to the end of the period. At
December 31, 1999, book overdrafts of $2.9 million have been included in
accounts payable.
Property and Equipment
Drilling equipment, transportation equipment and other property and
equipment are carried at cost. Renewals and betterments are capitalized
while repairs and maintenance are expensed. Depreciation of drilling
equipment is recorded using the units-of-production method based on
estimated useful lives, including a minimum provision of 20 percent of the
active rate when the equipment is idle. Unit uses the composite method of
depreciation for drill pipe and collars and calculates the depreciation by
footage actually drilled compared to total estimated remaining footage.
Depreciation of other property and equipment is computed using the straight-
line method over the estimated useful lives of the assets ranging from 3 to
15 years.
Realization of the carrying value of our property and equipment is
reviewed for possible impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable.
Assets are determined to be impaired if a forecast of undiscounted
estimated future net operating cash flows directly related to the asset
including disposal value if any, is less than the carrying amount of the
asset. If any asset is determined to be impaired, the loss is measured as
the amount by which the carrying amount of the asset exceeds its fair
value. An estimate of fair value is based on the best information
available, including prices for similar assets. Changes in such estimates
could cause Unit to reduce the carrying value of our property and
equipment.
When property and equipment components are disposed of, the cost and
the related accumulated depreciation are removed from the accounts and any
resulting gain or loss is generally reflected in operations. For
dispositions of drill pipe and drill collars, an average cost for the
appropriate feet of drill pipe and drill collars is removed from the asset
account and charged to accumulated depreciation and proceeds, if any, are
credited to accumulated depreciation.
43
Goodwill
Goodwill represents the excess of the cost of the acquisition of
Hickman Drilling Company over the fair value of the net assets acquired and
is being amortized on the straight-line method over 25 years. Goodwill is
evaluated periodically for impairment, when it appears an impairment may
have occurred. If an impairment is determined, the amount of such
impairment is calculated based on the estimated fair market value of the
related assets. Net goodwill reported in other assets at December 31, 1998
and 1999 was $5,818,000 and $5,575,000, respectively with accumulated
amortization at December 31, 1998 and 1999 of $264,000 and $507,000,
respectively.
Oil and Natural Gas Operations
Unit accounts for its oil and natural gas exploration and development
activities on the full cost method of accounting prescribed by the
Securities and Exchange Commission ("SEC"). Accordingly, all productive
and non-productive costs incurred in connection with the acquisition,
exploration and development of oil and natural gas reserves are capitalized
and amortized on a composite units-of-production method based on proved oil
and natural gas reserves. Independent petroleum engineers annually review
Unit's determination of its oil and natural gas reserves. The average
composite rates used for depreciation, depletion and amortization ("DD&A")
were $0.75, $0.83 and $0.88 per Mcfe in 1997, 1998 and 1999, respectively.
The calculation of DD&A includes estimated future expenditures to be
incurred in developing proved reserves and estimated dismantlement and
abandonment costs, net of estimated salvage values. In the event the
unamortized cost of oil and natural gas properties being amortized exceeds
the full cost ceiling, as defined by the SEC, the excess is charged to
expense in the period during which such excess occurs. The full cost
ceiling is based principally on the estimated future discounted net cash
flows from Unit's oil and natural gas properties. As discussed in Note 12,
such estimates are imprecise. Changes in these estimates or declines in
oil and natural gas prices could cause Unit in the near-term to reduce the
carrying value of our oil and natural gas properties.
No gains or losses are recognized upon the sale, conveyance or other
disposition of oil and natural gas properties unless a significant reserve
amount is involved.
The SEC's full cost accounting rules prohibit recognition of income in
current operations for services performed on oil and natural gas properties
in which Unit has an interest or on properties in which a partnership, of
which Unit is a general partner, has an interest. Accordingly, in 1997 and
1998, Unit recorded $314,000 and $437,000 of contract drilling profits,
respectively, as a reduction of the carrying value of its oil and natural
gas properties rather than including these profits in current operations.
No contract drilling profits were realized on such interests in 1999.
44
Limited Partnerships
Unit's wholly owned subsidiary, Unit Petroleum Company, is a general
partner in fifteen oil and natural gas limited partnerships sold privately
and publicly. Some of Unit's officers, directors and employees own
interests in most of these partnerships. Unit shares partnership revenues
and costs in accordance with formulas prescribed in each limited
partnership agreement. The partnerships also reimburse Unit for certain
administrative costs incurred on behalf of the partnerships.
Income Taxes
Measurement of current and deferred income tax liabilities and assets
is based on provisions of enacted tax law; the effects of future changes in
tax laws or rates are not included in the measurement. Valuation
allowances are established where necessary to reduce deferred tax assets to
the amount expected to be realized. Income tax expense is the tax payable
for the year and the change during that year in deferred tax assets and
liabilities.
Natural Gas Balancing
We use the sales method for recording natural gas sales. This method
allows for recognition of revenue, which may be more or less than our share
of pro-rata production from certain wells. Based upon our 1999 average
natural gas price of $2.05 per Mcf received (exclusive of hedging
activities), Unit estimates its balancing position to be approximately $4.6
million on under-produced properties and approximately $3.0 million on over-
produced properties. Unit's policy is to expense the pro-rata share of
lease operating costs from all wells as incurred. Such expenses relating
to the balancing position on wells in which Unit has imbalances are not
material.
Employee and Director Stock Based Compensation
Unit applies APB Opinion 25 in accounting for its stock option plans
for its employees and directors. Under this standard, no compensation
expense is recognized for grants of options, which include an exercise
price equal to or greater than the market price of the stock on the date of
grant. Accordingly, based on Unit's grants in 1997, 1998 and 1999 no
compensation expense has been recognized. As provided by Financial
Accounting Standard No. 123 "Accounting for Stock-Based Compensation," Unit
has disclosed the pro forma effects of recording compensation for such
option grants based on fair value in Note 6 to the financial statements.
45
Self Insurance
Unit utilizes self insurance programs for employee group health and
worker's compensation. Self insurance costs are accrued based upon the
aggregate of estimated liabilities for reported claims and claims incurred
but not yet reported.
Financial Instruments and Concentrations of Credit Risk
Financial instruments, which potentially subject Unit to
concentrations of credit risk, consist primarily of trade receivables with
a variety of