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EX-32.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 906 - UNION DRILLING INCdex321.htm
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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number 000-51630

 

 

UNION DRILLING, INC.

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   16-1537048

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

4055 International Plaza

Suite 610

Fort Worth, Texas

  76109
(Address of principal executive offices)   (Zip Code)

817-735-8793

(Registrant’s telephone number, including area code)

www.uniondrilling.com

(Registrant’s website)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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

 

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

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

As of November 2, 2010, there were 25,182,345 shares of common stock, par value $0.01 per share, of the registrant issued and 23,182,345 shares outstanding.

 

 

 


Table of Contents

 

UNION DRILLING, INC.

FORM 10-Q

TABLE OF CONTENTS

 

          Page  

PART I. FINANCIAL INFORMATION

     1   

ITEM 1.

   FINANCIAL STATEMENTS      1   
   CONDENSED BALANCE SHEETS      1   
   CONDENSED STATEMENTS OF OPERATIONS      2   
   CONDENSED STATEMENTS OF CASH FLOWS      3   
   CONDENSED STATEMENT OF STOCKHOLDERS’ EQUITY      4   
   NOTES TO CONDENSED FINANCIAL STATEMENTS      5   

ITEM 2.

   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      12   

ITEM 3.

   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK      21   

ITEM 4.

   CONTROLS AND PROCEDURES      21   

PART II. OTHER INFORMATION

     22   

ITEM 1.

   LEGAL PROCEEDINGS      22   

ITEM 1A.

   RISK FACTORS      22   

ITEM 6.

   EXHIBITS      22   

SIGNATURE

     23   

INDEX TO EXHIBITS

     24   


Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

Union Drilling, Inc.

Condensed Balance Sheets

(in thousands, except share data)

 

     September 30,
2010
    December 31,
2009
 
     (unaudited)        

Assets:

    

Current assets:

    

Cash and cash equivalents

   $ 5      $ 6   

Accounts receivable (net of allowance for doubtful accounts of $193 and $1,379 at September 30, 2010 and December 31, 2009, respectively)

     30,018        22,732   

Inventories

     1,645        1,944   

Income tax recoverable

     1,319        8,913   

Prepaid expenses, deposits and other receivables

     2,480        2,391   

Deferred taxes

     1,169        1,169   
                

Total current assets

     36,636        37,155   

Intangible assets (net of accumulated amortization of $844 and $618 at September 30, 2010 and December 31, 2009, respectively)

     1,356        1,582   

Property, buildings and equipment (net of accumulated depreciation of $228,620 and $194,197 at September 30, 2010 and December 31, 2009, respectively)

     266,389        254,063   

Other assets

     84        210   
                

Total assets

   $ 304,465      $ 293,010   
                

Liabilities and Stockholders’ Equity:

    

Current liabilities:

    

Accounts payable

   $ 12,442      $ 8,180   

Current portion of notes payable for equipment

     277        598   

Financed insurance premiums

     157        855   

Customer advances

     163        —     

Accrued expense and other liabilities

     7,659        4,511   
                

Total current liabilities

     20,698        14,144   

Revolving credit facility

     37,445        8,996   

Long-term notes payable for equipment

     18        173   

Deferred taxes

     44,363        53,157   

Other long-term liabilities

     254        217   
                

Total liabilities

     102,778        76,687   

Stockholders’ equity:

    

Common stock, par value $.01 per share; 75,000,000 shares authorized; 25,182,345 shares and 25,123,103 shares issued at September 30, 2010 and December 31, 2009, respectively

     252        251   

Additional paid in capital

     170,406        169,288   

Retained earnings

     41,492        57,247   

Treasury stock; 2,000,000 shares at both September 30, 2010 and December 31, 2009

     (10,463     (10,463
                

Total stockholders’ equity

     201,687        216,323   
                

Total liabilities and stockholders’ equity

   $ 304,465      $ 293,010   
                

See accompanying notes to condensed financial statements.

 

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Union Drilling, Inc.

Condensed Statements of Operations

(Unaudited, in thousands, except share and per share data)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Revenues

        

Total revenues

   $ 52,028      $ 35,184      $ 134,366      $ 128,353   

Cost and expenses

        

Operating expenses

     39,922        22,334        103,432        82,657   

Depreciation and amortization

     12,523        12,191        37,528        35,643   

Impairment charge

     —          —          —          2,929   

General and administrative

     6,004        5,825        17,694        19,606   
                                

Total cost and expenses

     58,449        40,350        158,654        140,835   
                                

Operating loss

     (6,421     (5,166     (24,288     (12,482

Interest expense, net

     (287     (189     (712     (558

Gain (loss) on disposal of assets

     36        (209     187        (98

Other income

     83        32        130        98   
                                

Loss before income taxes

     (6,589     (5,532     (24,683     (13,040

Income tax benefit

     (2,146     (1,560     (8,928     (3,897
                                

Net loss

   $ (4,443   $ (3,972   $ (15,755   $ (9,143
                                

Loss per common share:

        

Basic

   $ (0.19   $ (0.17   $ (0.68   $ (0.43
                                

Diluted

   $ (0.19   $ (0.17   $ (0.68   $ (0.43
                                

Weighted-average common shares outstanding:

        

Basic

     23,182,345        23,123,103        23,162,003        21,349,931   
                                

Diluted

     23,182,345        23,123,103        23,162,003        21,349,931   
                                

See accompanying notes to condensed financial statements.

 

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Union Drilling, Inc.

Condensed Statements of Cash Flows

(Unaudited, in thousands)

 

     Nine Months Ended
September 30,
 
     2010     2009  

Operating activities:

    

Net loss

   $ (15,755   $ (9,143

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Depreciation and amortization

     37,528        35,643   

Impairment charge

     —          2,929   

Non-cash compensation expense

     894        1,140   

Provision for doubtful accounts

     90        1,074   

(Gain) loss on disposal of assets

     (187     98   

Deferred taxes benefit

     (8,797     (588

Changes in operating assets and liabilities:

    

Accounts receivable

     (7,376     25,533   

Inventories

     299        331   

Income tax recoverable

     7,594        3,373   

Prepaid and other assets

     1,142        2,402   

Accounts payable

     3,610        (6,506

Accrued expenses and other liabilities

     3,351        (3,999
                

Cash flow provided by operating activities

     22,393        52,287   

Investing activities:

    

Purchases of machinery and equipment

     (50,561     (37,913

Proceeds from sale of machinery and equipment

     876        295   
                

Cash flow used in investing activities

     (49,685     (37,618

Financing activities:

    

Borrowings on line of credit

     166,448        153,386   

Repayments on line of credit

     (137,999     (186,064

Cash overdrafts

     (209     133   

Repayments—other debt

     (1,174     (4,384

Exercise of stock options

     225        248   

Purchases of treasury stock

     —          (1,563

Proceeds from stock offering, net of issue costs

     —          23,184   
                

Cash flow provided by (used in) financing activities

     27,291        (15,060
                

Net decrease in cash

     (1     (391

Cash and cash equivalents at beginning of period

     6        406   
                

Cash and cash equivalents at end of period

   $ 5      $ 15   
                

See accompanying notes to condensed financial statements.

 

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Union Drilling, Inc.

Condensed Statement of Stockholders’ Equity

(Unaudited, in thousands, except share data)

 

     Common Stock      Additional
Paid In
Capital
     Retained
Earnings
    Treasury
Stock
    Total  
     Shares      $                            

Balance at January 1, 2010

     23,123,103       $ 251       $ 169,288       $ 57,247      $ (10,463   $ 216,323   

Non-cash compensation

     —           —           894         —          —          894   

Exercise of stock options

     59,242         1         224         —          —          225   

Net loss

     —           —           —           (15,755     —          (15,755
                                                   

Balance at September 30, 2010

     23,182,345       $ 252       $ 170,406       $ 41,492      $ (10,463   $ 201,687   
                                                   

See accompanying notes to condensed financial statements.

 

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UNION DRILLING, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

September 30, 2010

(Unaudited)

 

1. Business and Basis of Presentation

Union Drilling, Inc. (“Union Drilling,” “Company” or “we”) provides contract land drilling services and equipment to oil and natural gas producers. The accompanying unaudited condensed financial statements relate solely to the accounts of Union Drilling, Inc. The interim period condensed financial statements, including the notes thereto, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation have been included. The results for interim periods are not necessarily indicative of results for a full year.

These interim period condensed financial statements should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

For all periods reported, other comprehensive loss equals net loss.

 

2. Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-13, amending Subtopic 605-25 Revenue Recognition – Multiple-Element Arrangements, which establishes the accounting and reporting guidance for arrangements under which a vendor will perform multiple revenue-generating activities. This ASU amends the criteria for separating consideration in multiple-deliverable arrangements and expands the related disclosures. This ASU will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of ASU No. 2009-13 to have a material effect on the financial condition or results of operations of the Company.

In January 2010, the FASB issued ASU No. 2010-06, amending Topic 820 Fair Value Measurements and Disclosures. This ASU updates Subtopic 820-10 and requires the following new disclosures: 1) disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and 2) present separately in the reconciliation for fair value measurements using significant unobservable inputs (Level 3), information about purchases, sales, issuances and settlements (on a gross basis rather than one net number). In addition, this ASU clarifies existing disclosures as follows: 1) provide fair value measurement disclosures for each class of assets and liabilities (often a subset within a line item in the statement of financial position); and 2) provide disclosures about the valuation techniques and inputs used to measure both recurring and nonrecurring Level 2 or Level 3 fair value measurements. These new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the Level 3 reconciliation of fair value measurements, which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of ASU No. 2010-06 did not have a material impact on our financial condition or results of operations.

 

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3. Fair Value Measurement

The Fair Value Measurements and Disclosures Topic of the FASB Codification utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

Level 1:

   Observable inputs such as quoted prices for identical assets or liabilities in active markets

Level 2:

   Other inputs that are observable directly or indirectly, such as quoted prices for similar assets or liabilities or market-corroborated inputs

Level 3:

   Unobservable inputs for which there is little or no market data and which require us to develop our own assumptions about how market participants would price the assets or liabilities

We use the following methods and assumptions in estimating our fair value disclosures for financial instruments. The carrying amount of cash and cash equivalents approximates fair value due to the short-term maturity of these instruments (Level 1). For accounts and other receivables, accounts payable, accrued liabilities, debt and notes payable, we believe that recorded amounts approximate fair value due to the relatively short maturity period (Level 2). Further, the pricing mechanisms in the Company’s debt agreements combined with the short-term nature of the equipment financing arrangements result in the carrying values of these obligations approximating their respective fair values.

We do not have any financial instruments for which estimates of fair value disclosures utilize Level 3 inputs.

 

4. Accounts Receivable

Accounts receivable consist of the following (in thousands):

 

     September 30,
2010
    December 31,
2009
 

Billed receivables

   $ 28,844      $ 22,691   

Unbilled receivables

     1,491        1,613   

Reserve for sales credits

     (124     (193
                

Total receivables

     30,211        24,111   

Allowance for doubtful accounts

     (193     (1,379
                

Net receivables

   $ 30,018      $ 22,732   
                

Unbilled receivables represent recorded revenue for contract drilling services performed that is billable by the Company at future dates based on contractual payment terms, and is anticipated to be billed and collected in the quarter following the balance sheet date.

 

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5. Property, Buildings and Equipment

Major classes of property, buildings and equipment are as follows (in thousands):

 

     September 30,
2010
    December 31,
2009
 

Land

   $ 988      $ 988   

Buildings

     1,641        1,643   

Drilling and related equipment

     462,743        423,588   

Vehicles

     12,346        12,053   

Furniture and fixtures

     168        168   

Information systems

     688        663   

Leasehold improvements

     126        126   

Construction in progress

     16,309        9,031   
                
     495,009        448,260   

Accumulated depreciation

     (228,620     (194,197
                
   $ 266,389      $ 254,063   
                

During the nine months ended September 30, 2010, we acquired three 1,000 hp rigs. After adding additional capital improvements, two of these rigs were deployed in the Permian Basin. As of September 30, 2010, the third rig was classified as construction in progress, pending capital improvements prior to its deployment in the Marcellus Shale in the fourth quarter of 2010. Other capital additions for the nine months ended September 30, 2010 included rig enhancements, such as seven top drives and four pad drilling packages, as well as drillpipe and other capital maintenance.

During the nine months ended September 30, 2010 and 2009, we capitalized $384,000 and $579,000, respectively, of interest costs incurred during the construction periods of certain drilling equipment.

 

6. Accrued Expenses and Other Liabilities

A detail of accrued expenses and other liabilities is as follows (in thousands):

 

     September 30,
2010
     December 31,
2009
 

Payroll and bonus

   $ 2,179       $ 1,755   

Workers’ compensation

     2,554         888   

Medical claims

     1,028         871   

Other taxes

     811         269   

Other

     1,087         728   
                 
   $ 7,659       $ 4,511   
                 

Other taxes include sales and use, franchise and property taxes.

 

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7. Debt Obligations

In March 2005, the Company entered into a Revolving Credit and Security Agreement with PNC Bank, for itself and as agent for a group of lenders. This credit facility has been amended numerous times, most recently in September 2008. In addition to PNC Bank, the current group of lenders consists of Capital One Leverage Finance Corp., M&I Business Credit, LLC, M&T Bank and TD Bank, N.A.. This credit facility matures on March 30, 2012 and provides for a $97.5 million borrowing base. Amounts outstanding under the credit facility bear interest, depending upon facility usage, at either (i) the higher of the Federal Funds Open Rate plus 75 to 125 basis points or PNC Bank’s base commercial lending rate (4.25% at September 30, 2010) or (ii) LIBOR plus 250 to 300 basis points (3.01% at September 30, 2010). Interest on outstanding loans is due monthly for domestic rate loans and at the end of the relevant interest period for LIBOR loans. Depending upon our facility usage, we are assessed an unused line fee of 37.5 to 62.5 basis points on the available borrowing capacity. The available borrowing capacity was $55.8 million as of September 30, 2010. There is a $7.5 million sublimit for letters of credit issued under this facility. If we repay and terminate the obligations under this facility, we will incur a substantial prepayment penalty. As of September 30, 2010, we had a loan balance of $37.4 million under the credit facility, and an additional $4.3 million of the total capacity was utilized to support our letter of credit requirement. As of December 31, 2009, $9.0 million was outstanding under our credit facility and $4.8 million of the total capacity had been utilized to support our letter of credit requirement.

In general, the credit facility is secured by substantially all of our assets. The forced liquidation value of our assets serving as collateral is determined at least annually by an independent appraisal, with adjustments for acquisitions and dispositions between appraisals. The credit facility contains affirmative and negative covenants and also provides for events of default typical for such an agreement. Among the affirmative covenants are requirements to maintain a specified tangible net worth and fixed charge coverage ratio. As of September 30, 2010, our actual tangible net worth was $200.3 million compared to the required minimum tangible net worth of $67.0 million and our actual fixed charge coverage ratio of 12.6 exceeded the required 1.1 fixed charge coverage ratio. Among the negative covenants are restrictions on major corporate transactions, incurrence of indebtedness and amendments to our organizational documents. Events of default would include a change in control and any change in our operations or condition which has a material adverse effect. As of September 30, 2010, we were in compliance with all of our financial covenants.

To date, the credit facility primarily has been used to pay for rig acquisitions and for our working capital requirements. The credit facility may also be used by the Company, subject to certain conditions, to repurchase its common stock and/or pay a cash dividend.

In addition, the Company has entered into various equipment-specific financing agreements with a third-party financing institution. The original terms of these agreements range from 24 to 48 months. As of September 30, 2010 and December 31, 2009, the total outstanding balance under these arrangements was $295,000 and $771,000, respectively, and is classified, according to payment date, in current portion of notes payable for equipment and long-term notes payable for equipment in the accompanying condensed balance sheets. At September 30, 2010, the stated interest rates on these borrowings range from zero percent to 4.2%.

 

8. Commitments and Contingencies

From time to time, we are a party to claims, litigation or other legal or administrative proceedings that we consider to arise in the ordinary course of our business. While no assurances can be given regarding the outcome of these or any other pending proceedings, or the ultimate effect such outcomes may have, other than the item discussed below, we do not believe we are a party to any legal or administrative proceedings which, if determined adversely to us, individually or in the aggregate, would have a material effect on our financial position, results of operations or cash flows. Management believes that the Company maintains adequate levels of insurance necessary to cover its business risks.

The Company’s 2006 through 2009 U.S. federal income and employment tax returns are currently under examination by the I.R.S. We believe the primary focus of the I.R.S. relates to our treatment of certain per diem payments to field employees and worker classification for certain independent contractors. To date, we have not received any notice of proposed assessment. Given the stage of the examination and because the I.R.S. has not proposed any assessments, the Company cannot, at this time, reasonably estimate the amount, if any, of employment taxes, interest, penalties or additions to tax that may be assessed by the I.R.S. The Company may be able to estimate a reasonable amount or range of exposure, if any, in the future as more information is obtained during the course of the examination. Should an assessment be proposed, the Company believes that it has valid arguments in support of its employment tax positions and intends to vigorously assert them. Although the final resolution of this matter could have a material effect on our results of operations for the particular reporting period in which the estimated liability is recorded, we believe that any resulting liability would not materially affect our financial position.

 

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9. Stockholders’ Equity

At September 30, 2010, the number of authorized shares of common stock was 75,000,000 shares, of which 23,182,345 were outstanding, and 1,650,744 were reserved for future issuance through the Company’s equity based plans. The number of authorized shares of preferred stock was 100,000 shares at September 30, 2010. No shares of preferred stock were outstanding or reserved for future issuance.

 

10. Loss Per Common Share

Because we incurred a net loss in the three and nine months ended September 30, 2010 and 2009, basic and diluted loss per share for each period were calculated as our net loss divided by the weighted average shares outstanding. Approximately 282,000 and 302,000 weighted average options and restricted stock units to purchase shares of our common stock were excluded from the computation of diluted loss per share for the three and nine months ended September 30, 2010, respectively, because the effect of including them would have been antidilutive. Similarly, during the three and nine months ended September 30, 2009, respectively, 262,000 and 283,000 options and restricted stock units were excluded from the computation of diluted loss per share because the effect of including them would have been antidilutive.

 

11. Management Compensation

Equity based plans

The Company has two equity based plans, the Amended and Restated 2000 Stock Option Plan and the Amended and Restated 2005 Stock Incentive Plan. Given that more than 10 years have elapsed since the approval of the 2000 Stock Option Plan, no future stock option awards can be made under this plan. In addition to grants of incentive and non-qualified stock options to directors and employees, restricted stock and restricted stock units may also be granted under the Amended and Restated 2005 Stock Incentive Plan.

For the three and nine months ended September 30, 2010, the Company recorded stock-based compensation expense of $333,000 ($220,000, net of tax) and $922,000 ($600,000, net of tax), respectively, which is included in general and administrative expense. For the three and nine months ended September 30, 2009, the Company recorded stock-based compensation expense of $173,000 ($33,000 net of tax) and $1.1 million ($700,000 net of tax), respectively. Total unamortized stock-based compensation was $4.0 million at September 30, 2010, and will be recognized over a weighted average service period of 3.5 years.

Stock options. Options typically vest over a three or four year period and, unless earlier exercised or forfeited, expire on the tenth anniversary of the grant date. A summary of stock option activity for the nine months ended September 30, 2010 is as follows:

 

     Number
of Shares
    Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Term in
Years
     Aggregate
Intrinsic
Value
 

Outstanding at January 1, 2010

     894,333      $ 9.64         

Granted

     75,000      $ 6.36         

Exercised

     (59,242   $ 3.80         
                      

Outstanding at September 30, 2010

     910,091      $ 9.75         7.2       $ 33,565   
                                  

Options exercisable at September 30, 2010

     484,126      $ 11.73         5.8       $ 33,565   
                                  

The weighted average fair value of options granted during the three and nine months ended September 30, 2010 was $4.00. The fair value of option grants is determined using the Black-Scholes option valuation model. The key input variables used in valuing these options were: risk free interest rate of 1.6%; stock price volatility of 77.1%; dividend yield of zero; and expected term of five years.

 

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New shares of common stock are issued to satisfy options exercised. During the three and nine months ended September 30, 2010, zero and 59,242 options, respectively, were exercised. Cash received from the exercise of options for the nine months ended September 30, 2010 was $225,000. The total intrinsic value of options exercised during the nine months ended September 30, 2010 was $168,000.

A summary of options outstanding as of September 30, 2010, is as follows:

 

     Options Outstanding      Options Exercisable  

Range of Exercise Prices

   Number
Outstanding
     Weighted
Average Years
of Remaining
Contractual
Life
     Weighted
Average
Exercise
Price
     Number
Outstanding
     Weighted
Average
Exercise
Price
 

$3.80 to $9.89

     452,436         8.4       $ 5.95         104,039       $ 4.81   

$12.75 to $14.62

     457,655         6.0       $ 13.50         380,087       $ 13.62   
                          
     910,091               484,126      
                          

Restricted stock awards. A summary of restricted stock unit activity for the nine months ended September 30, 2010 is as follows:

 

     Shares      Weighted Average
Grant Date Fair
Value
 

Outstanding at January 1, 2010

     299,036       $ 14.69   

Granted

     50,000       $ 7.41   
           

Outstanding at September 30, 2010

     349,036       $ 13.65   
           

Employee retirement plan

The Company has a 401(k) plan available to substantially all of its employees. Company contributions to the plan are discretionary. The Company made matching cash contributions of $74,000 and $234,000 for the three and nine months ended September 30, 2010, respectively, and $62,000 and $277,000 during the three and nine months ended September 30, 2009.

Contingent management compensation

The Company’s Chief Executive Officer (“CEO”) has been awarded rights to participate in the proceeds associated with the appreciation in value ultimately associated with dispositions of the Company’s shares owned by Union Drilling Company LLC (“UDC”), our largest stockholder. In order to receive benefits from this arrangement, the fair market value of the Company’s shares held by UDC must exceed certain threshold amounts.

The CEO is to receive benefits as a result of UDC’s sale, distribution or disposition of Company shares and the related recognition of a gain in excess of the threshold amount. These rights may be repurchased from the CEO at fair market value, which includes consideration of the threshold amount in the determination of that value, upon his termination of employment by the Company. Further, these rights may be repurchased from the CEO for no consideration upon his voluntary termination or upon his termination of employment by the Company for cause.

At September 30, 2010 and December 31, 2009, the threshold amounts were $41.6 million and $38.7 million, respectively. These amounts are determined based upon cash invested in UDC (and invested by UDC in the Company’s stock) plus a compounded annual return of 10% less cash returned to investors. During the three and nine months ended September 30, 2010, $8,000 and $28,000, respectively, of compensation cost reversals were recognized as a result of the decrease in the market value of the Company’s stock price. During the three and nine months ended September 30, 2009, $18,000 and $42,000, respectively, of compensation costs were recognized as a result of the fair value of the assets owned by UDC exceeding the threshold. These amounts were classified as general and administrative expense.

 

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The defined participants in this arrangement would be entitled to up to 22.5% of the value realized in excess of the threshold amount. Our CEO is entitled to approximately 1% of the 22.5%, or 0.225%.

 

12. Income Taxes

Income tax benefit for the three and nine months ended September 30, 2010 was $2.1 million and $8.9 million, respectively, which is an effective rate of 32.6% and 36.2%, respectively, of pre-tax book loss. These rates differ from the statutory rate of 35% primarily due to state income taxes, permanent book/tax differences such as those associated with the 50% deduction limitation on per diem payments for meals, and non-cash compensation. Income tax benefit for the three and nine months ended September 30, 2009 was $1.6 million and $3.9 million, respectively, which is an effective rate of 28% and 30%, respectively, of pre-tax book loss.

At September 30, 2010 and December 31, 2009, we had $239,000 and $208,000, respectively, of unrecognized tax benefits, of which $156,000 and $135,000, respectively, would affect our effective tax rate if recognized. Such amounts are carried as other long-term liabilities.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

 

Balance at January 1, 2010

   $ 208   

Increases for tax positions taken in prior years

     8   

Reductions for tax positions taken in prior years

     (17

Increases for tax positions taken in current year

     40   
        

Balance at September 30, 2010

   $ 239   
        

Interest and penalties related to uncertain tax positions are classified as interest expense and general and administrative costs, respectively. During the three and nine months ended September 30, 2010, the Company recognized $2,000 and $6,000, respectively, in interest expense related to unrecognized tax benefits. During the three and nine months ended September 30, 2009, the Company recognized cost reversals of zero and $104,000 in interest and penalty expense related to unrecognized tax benefits. As of September 30, 2010 and December 31, 2009, the Company had $15,000 and $8,000, respectively, of interest and penalties accrued in relation to uncertain tax positions. It is reasonably possible that within the next 12 months, we may resolve some or all of the uncertain tax positions as a result of negotiations with taxing authorities which would result in a decrease in unrecognized tax.

The Company files U.S. federal income tax returns and income tax returns in various state jurisdictions. The tax years 2006 through 2009 remain open to examination by the major taxing jurisdictions to which we are subject. In addition, tax years 1999, 2000, 2002 and 2003 remain open due to utilized losses in certain jurisdictions. The Company’s 2006 through 2009 U.S. federal returns are currently under examination by the I.R.S. Although the Company believes it has adequately provided for all tax positions, amounts asserted by taxing authorities could be greater than the Company’s accrued positions.

 

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

This management’s discussion and analysis of financial condition and results of operations (“MD&A”) section of our Quarterly Report on Form 10-Q discusses our results of operations, liquidity and capital resources, and certain factors that may affect our future results, including economic and industry-wide factors. You should read this MD&A in conjunction with our condensed financial statements and accompanying notes included under Part I, Item 1, of this Quarterly Report, as well as with our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

Statements we make in the following MD&A discussion and in other parts of this report that express a belief, expectation or intention, as well as those which are not historical fact, are forward-looking statements within the meaning of the federal securities laws and are subject to risks, uncertainties and assumptions. These forward-looking statements may be identified by the use of words such as “expect,” “anticipate,” “believe,” “estimate,” “potential” or similar words. These matters include statements concerning management’s plans and objectives relating to our operations or economic performance and related assumptions, including general economic and business conditions and industry trends, the continued strength or weakness of the contract land drilling industry in the geographic areas in which we operate, decisions about onshore exploration and development projects to be made by oil and gas companies, the highly competitive nature of our business, our future financial performance, including availability, terms and deployment of capital, the continued availability of qualified personnel, and changes in, or our failure or inability to comply with, government regulations, including those relating to workplace safety and the environment. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Further, we specifically disclaim any duty to update any of the information set forth in this report, including any forward-looking statements. Forward-looking statements are made based on management’s current expectations and beliefs concerning future events and, therefore, involve a number of assumptions, risks and uncertainties, including the risk factors described in Part II. Item 1A, “Risk Factors,” below. Management cautions that forward-looking statements are not guarantees, and our actual results could differ materially from those expressed or implied in the forward-looking statements.

Company Overview

Union Drilling, Inc. (“Union Drilling,” “Company” or “we”) provides contract land drilling services and equipment, to oil and natural gas producers. We presently focus our operations in selected U.S. oil and shale formations, with high growth potential, low finding and development costs and adequate take away capacity. Our principal operations are in the Appalachian and Arkoma Basins, as well as the Fort Worth Basin’s Barnett Shale formation and the Permian Basin of West Texas. As our rigs are mobile, we are capable of moving them from one region to another in response to market conditions. In addition to our drilling rigs, we provide the drilling crews and most of the ancillary equipment needed to operate our drilling rigs. We do not invest in oil and natural gas properties.

We commenced operations in 1997 with 12 drilling rigs and related equipment acquired from an entity providing contract drilling services under the name “Union Drilling.” Through a combination of acquisitions and new rig construction, we have increased the size of our fleet to 71 marketed land drilling rigs. We continue to enhance our fleet of drilling rigs with technological capabilities through upgrades, acquisitions or new rig construction in order to improve drilling productivity and reduce total well costs for our customers. At various times, we remove rigs from our marketed fleet, and the components are sold or made available for use on our other rigs.

Key Indicators of Financial Performance for Management

Key performance measurements in our industry are rig utilization, revenue per revenue day and operating expenses per revenue day. Revenue days for each rig are days when the rig is earning revenues under a contract, which is usually a period from the date the rig begins moving to the drilling location until the rig is released from the contract. We compute rig utilization rates by dividing revenue days by total available days during a period. Total available days are the number of calendar days during the period that we have owned the marketed rig.

 

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The following table summarizes management’s key indicators of financial performance for the three and nine months ended September 30, 2010 and 2009.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Revenue days

     3,470        2,000        8,911        7,282   

Average number of marketed rigs

     71.0        71.0        71.0        71.0   

Marketed rig utilization rates

     53.1     30.6     46.0     37.6

Revenue per revenue day

   $ 14,994      $ 17,592      $ 15,079      $ 17,626   

Operating expenses per revenue day

   $ 11,505      $ 11,167      $ 11,607      $ 11,351   

Drilling margin per revenue day

   $ 3,489      $ 6,425      $ 3,472      $ 6,275   

EBITDA (in thousands)

   $ 6,221      $ 6,848      $ 13,557      $ 26,090   

Our business is substantially dependent on and affected by the level of U.S. land-based oil and natural gas exploration and development activity. As a result of the decline in natural gas prices commencing in the second half of 2008, overall demand for drilling services correspondingly decreased and we reached a trough in the third quarter of 2009. Since that time, particularly during the first nine months of 2010, we experienced improvement in our marketed rig utilization rates due to a shift to oil drilling and relatively stable demand for natural gas drilling in shale plays. However, as term contracts with higher rates expired and re-priced in the current market, our revenue per revenue day declined in 2010 compared to the same periods in 2009. In conjunction with the improvement of our marketed rig utilization, we incurred additional start up costs to return idled rigs to operations, which also decreased our drilling margin per revenue day.

EBITDA is earnings before net interest, income taxes, depreciation and amortization and non-cash impairment. We believe EBITDA is a useful measure in evaluating financial performance because it is used by external users, such as investors, commercial banks, research analysts and others, to assess: (1) the financial performance of Union Drilling’s assets without regard to financing methods, capital structure or historical cost basis, (2) the ability of Union Drilling’s assets to generate cash sufficient to pay interest costs and support its indebtedness, and (3) Union Drilling’s operating performance and return on capital as compared to those of other entities in our industry, without regard to financing or capital structure. EBITDA is not a measure of financial performance under generally accepted accounting principles. However, EBITDA is a common alternative measure of operating performance used by investors, financial analysts and rating agencies. A reconciliation of EBITDA to net earnings is included below. EBITDA as presented may not be comparable to other similarly titled measures reported by other companies (in thousands).

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Calculation of EBITDA:

        

Net loss

   $ (4,443   $ (3,972   $ (15,755   $ (9,143

Impairment charge

     —          —          —          2,929   
                                

Net loss excluding impairment charge

     (4,443     (3,972     (15,755     (6,214

Interest expense, net

     287        189        712        558   

Income tax benefit

     (2,146     (1,560     (8,928     (3,897

Depreciation and amortization

     12,523        12,191        37,528        35,643   
                                

EBITDA

   $ 6,221      $ 6,848      $ 13,557      $ 26,090   
                                

 

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Drilling margin represents contract drilling revenues less contract drilling costs. We believe that drilling margin is a useful measure for evaluating financial performance, although it is not a measure of financial performance under generally accepted accounting principles. However, drilling margin is a common measure of operating performance used by management, investors, financial analysts and rating agencies. A reconciliation of drilling margin to operating income is included below. Drilling margin as presented may not be comparable to other similarly titled measures reported by other companies (in thousands, except day and per day data).

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Calculation of drilling margin:

        

Operating loss

   $ (6,421   $ (5,166   $ (24,288   $ (12,482

Depreciation and amortization

     12,523        12,191        37,528        35,643   

Impairment charge

     —          —          —          2,929   

General and administrative

     6,004        5,825        17,694        19,606   
                                

Drilling margin

   $ 12,106      $ 12,850      $ 30,934      $ 45,696   

Revenue days

     3,470        2,000        8,911        7,282   

Drilling margin per revenue day

   $ 3,489      $ 6,425      $ 3,472      $ 6,275   

Critical Accounting Policies and Estimates

Revenue and cost recognition. We generate revenue principally by drilling wells for oil or natural gas producers under daywork or footage contracts, which provide for the drilling of single or multiple well projects. Revenues on daywork contracts are recognized based on the days worked at the dayrate each contract specifies. Mobilization fees are recognized as the related drilling services are provided. We recognize revenues on footage contracts based on the footage drilled for the applicable accounting period. Expenses are recognized based on the costs incurred during that same accounting period. Reimbursements received for out-of-pocket expenses are recorded as revenues and direct expenses.

Accounts receivable. We evaluate the creditworthiness of our customers based on their financial information, if available, information obtained from major industry suppliers, and our past experiences, if any, with the customer. In some instances, we require new customers to make prepayments. We typically invoice our customers semimonthly during the performance of daywork contracts and upon completion of the contract, with payment due within 30 days. We established an allowance for doubtful accounts of $193,000 and $1.4 million at September 30, 2010 and December 31, 2009, respectively. Any allowance established is subject to judgment and estimates made by management. We determine our allowance by considering a number of factors, including the length of time trade accounts receivable are past due, our previous loss history, our assessment of our customers’ current abilities to pay obligations to us and the condition of the general economy and the oil and gas industry as a whole. Our bad debt expense was $77,000 and $90,000 for the three and nine months ended September 30, 2010, respectively. During the nine months ended September 30, 2009, our bad debt expense was $1.1 million, including $154,000 of expense reversal during the three months ended September 30, 2009. This expense reversal was the result of the collection of a fully reserved account and a decrease to our general reserve. We write off specific accounts receivable when we determine they are uncollectible. No accounts receivable were determined to be uncollectible during the three months ended September 30, 2010. During the nine months ended September 30, 2010, we wrote off $1.3 million of previously reserved accounts receivable for one customer. During the three and nine months ended September 30, 2009, $1.2 million of accounts receivable for two customers were determined to be uncollectible and therefore written off.

At September 30, 2010 and December 31, 2009, our unbilled receivables totaled $1.5 million and $1.6 million, respectively, all of which relates to the revenue recognized, but not yet billed, on contracts in progress at September 30, 2010 and December 31, 2009, respectively.

 

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Impairment of long-lived assets. We assess the impairment of long-lived assets whenever events or circumstances indicate that the asset’s carrying value may not be recoverable. Factors that could trigger an impairment review would be any significant negative trends in the industry or the general economy, our contract revenue rates, our rig utilization rates, cash flows generated from operating our drilling rigs, existence of term drilling contracts, current and future oil and natural gas prices, industry analysts’ outlook for the oil and gas industry and their view of our customers’ access to capital and the trends in the price of used drilling equipment observed by our management. If a review of our long-lived assets indicates that our carrying value exceeds the estimated undiscounted future cash flows, an impairment charge is made to adjust the carrying value to the estimated fair value. Cash flows are estimated by management considering factors such as expectations of future industry trends and the impact on dayrates, utilization and operating expenses; historical performance of the asset; the remaining expected life of the asset; any cash investment required to make the asset more marketable; suitability, specification and size of the rig; terminal value; as well as overall competitive dynamics. Use of different assumptions could result in an impairment charge different from that reported.

Accrued workers’ compensation. The Company accrues for costs under its workers’ compensation insurance program in accrued expenses and other liabilities. We have a deductible of $100,000 per covered accident under our workers’ compensation insurance. Our insurance policies require us to maintain letters of credit to collateralize incurred and future deductible payments. As of September 30, 2010 and December 31, 2009, we satisfied this requirement with letters of credit totaling $4.3 million and $4.8 million, respectively. We accrue for these costs as claims are incurred based on cost estimates established for each claim by the insurance companies providing the administrative services for processing the claims, including an estimate for incurred but not reported claims, claims paid directly by us, administrative costs associated with these claims and our historical experience with these types of claims. In addition, if needed, we accrue the estimated workers’ compensation premium payable to Ohio, a monopolistic state, when our rigs work in that state.

Stock-based compensation. Compensation cost resulting from share-based payment awards are measured at fair value and recognized in general and administrative expense on a straight line basis over the requisite service period for the entire award. The amount of compensation cost recognized at any date is at least equal to the portion of the grant-date value of the award that is vested at that date. For the three and nine months ended September 30, 2010, the Company recorded stock-based compensation expense of $333,000 ($220,000, net of tax) and $922,000 ($600,000, net of tax), respectively, which is included in general and administrative expense. For the three and nine months ended September 30, 2009, the Company recorded stock-based compensation expense of $173,000 ($33,000 net of tax) and $1.1 million ($700,000 net of tax), respectively. Total unamortized stock-based compensation was $4.0 million at September 30, 2010, and will be recognized over a weighted average service period of 3.5 years.

The fair value of stock options granted is estimated using the Black-Scholes option valuation model based on assumptions for the risk-free interest rate, expected life of the option, dividend yield and volatility of our stock price. Volatility is based upon price performance of the Company and a peer company, as the Company does not have a sufficient historical price base to determine potential volatility over the term of the issued options. During the three and nine months ended September 30, 2010, 75,000 stock options were granted. During the three and nine months ended September 30, 2009, zero and 25,000 stock options were granted. The weighted average fair value of options granted during the three and nine months ended September 30, 2010 was $4.00. The fair value of option grants is determined using the Black-Scholes option valuation model. The key input variables used in valuing the options were: risk free interest rate of 1.6%; stock price volatility of 77.1%; dividend yield of zero; and expected term of five years.

The fair value of restricted stock or restricted stock units is the closing market price of the Company’s stock on the award grant date. No restricted stock or restricted stock units were granted during the three months ended September 30, 2010. During the nine months ended September 30, 2010, 50,000 restricted stock units were granted. No restricted stock or restricted stock units were granted during the three and nine months ended September 30, 2009.

New shares of common stock are issued to satisfy options exercised. Cash received from the exercise of options during the three and nine months ended September 30, 2010 was zero and $225,000, respectively. No options were exercised during the three months ended September 30, 2009. During the nine months ended September 30, 2009, $248,000 was received from the exercise of options. Tax benefits for option exercises are not recognized until the related net operating loss carryforward is realized. Any tax benefit realized from stock option exercises is included as a cash inflow from financing activities on the condensed statements of cash flows.

 

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Income taxes. We record deferred taxes for the basis difference in our property and equipment between financial reporting and tax reporting purposes and other costs such as compensation, employee benefits and other accrued liabilities which are deductible in different periods for financial reporting and tax reporting purposes. For property and equipment, basis differences arise from differences in depreciation periods and methods and the value of assets acquired in a business acquisition where we acquire the stock of an entity rather than its assets. For financial reporting purposes, we depreciate the various components of our drilling rigs and refurbishments over two to 12 years, while federal income tax rules require that we depreciate drilling rigs and refurbishments over five years. In 2009, tax depreciation also included bonus depreciation allowed as a result of the American Recovery and Reinvestment Act of 2009. Therefore, in the earlier years of our ownership of a drilling rig, our tax depreciation exceeds our financial reporting depreciation, resulting in our recording deferred tax liabilities on this depreciation difference. In later years, financial reporting depreciation exceeds tax depreciation, and the deferred tax liability begins to reverse.

Results of Operations

Our operations primarily consist of drilling oil or natural gas wells for our customers under either daywork contracts and, to a lesser extent, footage contracts. Contract terms we offer generally depend on the complexity and risk of operations, the on-site drilling conditions, the type of equipment used, the anticipated duration of the work to be performed and the overall demand for rigs in our markets. Our contracts generally provide for the drilling of a specified number of wells or a specific period of time for which the rig will be under contract.

Statements of Operations Analysis

The following table provides selected information about our operations for the three and nine months ended September 30, 2010 and 2009 (in thousands).

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Revenues

   $ 52,028      $ 35,184      $ 134,366      $ 128,353   

Operating expenses

     39,922        22,334        103,432        82,657   

Depreciation and amortization

     12,523        12,191        37,528        35,643   

Impairment charge

     —          —          —          2,929   

General and administrative expense

     6,004        5,825        17,694        19,606   

Interest expense, net

     287        189        712        558   

Other income and (loss) gain on disposal of assets

     119        (177     317        —     

Income tax benefit

     (2,146     (1,560     (8,928     (3,897

Revenues. Our revenues increased by $16.8 million, or 48%, in the three months ended September 30, 2010 compared to the same period in 2009. This increase in revenues was primarily attributable to the increase in our marketed rig utilization and partially offset by lower dayrates.

The $6.0 million, or 5%, increase in revenues for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 was also primarily due to the increase in our marketed rig utilization and partially offset by lower dayrates.

Operating expenses. Our operating expenses during the three and nine months ended September 30, 2010 compared to the same periods in 2009 increased $17.6 million, or 79%, and $20.8 million, or 25%, respectively. The increase in operating expenses was primarily due to the increase in marketed rig utilization, additional costs incurred to prepare certain idled rigs to return to operation during 2010 and increased safety training and supplies costs. In addition, employment costs increased beginning the second quarter of 2010 as the Company restored wage reductions implemented in 2009 in response to the deteriorating market conditions.

Depreciation and amortization. The increase in depreciation and amortization expense during the three and nine months ended September 30, 2010 compared to the same period in 2009 was due to the increase in depreciable assets, resulting from capital equipment upgrades that enhanced our fleet capabilities.

 

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Impairment charge. During the nine months ended September 30, 2009, $2.9 million of impairment charges were recognized related to certain of our long-lived assets to write down the carrying value of these assets to fair value. No such charge was recognized in the three and nine months ended September 30, 2010.

General and administrative expenses. Our general and administrative expenses increased slightly during the third quarter of 2010 compared to the third quarter of 2009. During the nine months ended September 30, 2010, general and administrative expenses decreased $1.9 million, or 10%, compared to the same period in 2009. This decrease was primarily due to a $1.0 million decrease in the provision for doubtful accounts. In addition, corporate insurance rates for 2010 were lower as were property tax expenses.

Interest expense, net. The $98,000 increase in interest expense for the three months ended September 30, 2010 compared to the same period in 2009 was primarily attributable to the increase in the average balance of our revolving credit facility during the third quarter of 2010 compared to the third quarter of 2009. For the nine months ended September 30, 2010, the increase in interest expense compared to the nine months ended September 30, 2009 was due to the decrease in capitalized interest costs incurred during the construction periods of certain drilling equipment.

Other income and gain (loss) on disposal of assets. Other income and gain (loss) on disposal of assets increased for the three and nine months ended September 30, 2010 compared to the same periods in 2009 primarily due to the net loss on disposition of drillpipe during the third quarter of 2009.

Income tax benefit. The increase in income tax benefit for the three and nine months ended September 30, 2010, as compared to the same periods in 2009, was primarily due to the increase in pre-tax loss in 2010, and partially offset by the increase in the effective income tax rates in 2010. Our effective income tax rate of 33% and 36% for the three and nine months ended September 30, 2010, respectively, differs from the federal statutory rate of 35% due to state income taxes and permanent book/tax differences such as those associated with the 50% deduction limitation on per diem meals expense and stock-based compensation. Further, the effective tax rate for 2010 differs from 2009 due to state apportionment, effect of the 50% deduction limitation on per diems and the domestic production manufacturers deduction.

The Company’s 2006 through 2009 U.S. federal income and employment tax returns are currently under examination by the I.R.S. Although we believe our tax estimates are reasonable, the final determination of tax audits could be materially different than that which is reflected in our tax provisions and accruals.

Liquidity and Capital Resources

Our operations have historically generated sufficient cash flow to meet our requirements for debt service and equipment expenditures (excluding major business and asset acquisitions). Cash flow provided by operating activities during the first nine months of 2010 was $22.4 million compared to $52.3 million during the first nine months of 2009. The decrease in 2010 is primarily the result of higher accounts receivable collections during the first quarter of 2009 and an increase in operating expenses to return idled rigs to operations in 2010.

Our cash flow from operations was primarily used to invest in new drilling and related equipment. During the first nine months of 2010 and 2009, cash used in investing activities totaled $49.7 million and $37.6 million, respectively.

Cash flow provided by financing activities was $27.3 million in the first nine months of 2010, compared to $15.1 million of cash flow used in financing activities for the first nine months of 2009. The $28.4 million increase in net borrowings on our revolving credit facility in 2010 was primarily for capital expenditures. In addition, during the first nine months of 2010, we paid $1.2 million on our notes payable for equipment and financed insurance premiums, and received $225,000 cash proceeds from the exercise of stock options. In June 2009, the Company completed a secondary public offering consisting of 3.0 million shares of newly issued common stock at a price of $8.25 per share. Proceeds to the Company, net of underwriting discounts and other fees and expenses, were $23.2 million and were used to repay indebtedness outstanding under the Company’s revolving credit facility. Net repayments on our revolving credit facility during the nine months ended September 30, 2009 were $32.7 million. Also in June 2009, we used $2.5 million in borrowings on our credit facility to pay off certain notes payable for equipment which carried a higher interest rate. Net repayments on notes payable for equipment were $4.4 million for the nine months ended September 30, 2009. In addition, during the nine months ended September 30, 2009, treasury stock was repurchased for $1.6 million.

 

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We believe cash generated by our operations and our ability to borrow the currently unused portion of our revolving credit facility of $55.8 million, after reductions for approximately $4.3 million outstanding letters of credit as of September 30, 2010, should allow us to meet our routine financial obligations for the foreseeable future.

Sources of Capital Resources

Our rig fleet has grown from 12 rigs in 1997 to 71 marketed rigs at September 30, 2010. We have financed this growth with a combination of debt and equity financing, as well as operating cash flows. At September 30, 2010, our total debt to total capital was 15.8%. Total debt includes our revolving credit facility and current and long-term portions of notes payable for equipment.

See Note 7 “Debt Obligations” of the financial statements for information on the Company’s debt agreements as sources of capital resources, such information being incorporated herein by reference.

Uses of Capital Resources

For the three and nine months ended September 30, 2010 and 2009, the additions to our property and equipment consisted of the following (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Buildings

   $ —        $ 20      $ —        $ 37   

Drilling and related equipment

     13,187        1,107        49,170        24,245   

Vehicles

     190        143        201        257   

Furniture and fixtures

     —          —          —          2   

Information systems

     1,085        28        2,050        31   
                                

Property and equipment additions

     14,462        1,298        51,421        24,572   

Plus adjustments for non-cash transactions:

        

Cash paid in current period for prior period accruals

     7,107        889        1,086        13,824   

Current period accruals

     (1,946     (475     (1,946     (475

Asset exchange

     —          (8     —          (8
                                

Cash used for purchases of machinery and equipment

   $ 19,623      $ 1,704      $ 50,561      $ 37,913   
                                

For the three months ended September 30, 2010, additions to drilling equipment included $7.7 million for the purchase and upgrade of a 1,000 hp electrical rig and an additional $1.0 million of upgrades for two 1,000 hp mechanical rigs purchased in the first half of 2010. For the nine months ended September 30, 2010, three rigs and related upgrades were added for a total cost of $18.7 million. Other capital additions for the nine months ended September 30, 2010 included rig enhancements, such as seven top drives and four pad drilling packages, as well as drillpipe and other capital maintenance. Additions to drilling equipment during the nine months ended September 30, 2009 included $18.3 million for progress payments related to four rigs that became available for service during the second quarter of 2009.

Working Capital

Our working capital was $15.9 million and $23.0 million at September 30, 2010 and December 31, 2009, respectively. Our current ratio, which we calculate by dividing our current assets by our current liabilities, was 1.8 at September 30, 2010 compared to 2.6 at December 31, 2009.

 

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The changes in the components of our working capital were as follows (in thousands):

 

     September 30,
2010
     December 31,
2009
     Change  

Cash and cash equivalents

   $ 5       $ 6       $ (1

Accounts receivable

     30,018         22,732         7,286   

Inventories

     1,645         1,944         (299

Income tax recoverable

     1,319         8,913         (7,594

Prepaid expenses, deposits and other receivables

     2,480         2,391         89   

Deferred taxes

     1,169         1,169         —     
                          

Current assets

     36,636         37,155         (519
                          

Accounts payable

     12,442         8,180         4,262   

Current portion of notes payable for equipment

     277         598         (321

Financed insurance premiums

     157         855         (698

Customer advances

     163         —           163   

Accrued expenses and other liabilities

     7,659         4,511         3,148   
                          

Current liabilities

     20,698         14,144         6,554   
                          

Working capital

   $ 15,938       $ 23,011       $ (7,073
                          

The $7.3 million increase in accounts receivable at September 30, 2010 compared to December 31, 2010 was primarily due to the increase in revenue during the third quarter of 2010 compared to the fourth quarter of 2009.

The $7.6 million decrease in income tax recoverable at September 30, 2010 compared to December 31, 2009 was primarily due to an $8.7 million tax refund received in September 2010, and partially offset by a $1.1 million tax payment in February 2010 related to an amended 2008 federal tax return. We expect to recover this payment later in 2010.

The $4.3 million increase in accounts payable at September 30, 2010 from December 31, 2009 was primarily due to increased operating and general and administrative expenses in the third quarter of 2010 compared to the fourth quarter of 2009, as well as an increase in capital expenditures.

Accrued expenses and other liabilities increased $3.1 million at September 30, 2010 from December 31, 2009 primarily due to accruals for annual payments, such as property tax and bonus expense. In addition, our workers’ compensation claims accrual increased $1.7 million, of which $500,000 related to five of our employees injured in a fire at a drill site in West Virginia in June 2010 and $700,000 related to the prior policy year premium refund received in September 2010.

Long-term Debt

Our long-term debt at September 30, 2010 and December 31, 2009 consisted of the following (in thousands):

 

     September 30,
2010
     December 31,
2009
 

Revolving credit facility

   $ 37,445       $ 8,996   

Long-term notes payable for equipment

     18         173   
                 
   $ 37,463       $ 9,169   
                 

 

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Contractual Obligations

The Company did not enter into any significant contractual obligations during the nine months ended September 30, 2010.

Inflation

Other than the restoration of prior wage reductions during the second quarter of 2010, inflation did not have a significant effect on our results of operations in any of the periods reported. Management believes it is possible for some inflationary pressure to arise if the U.S. economic recovery becomes more certain.

Off Balance Sheet Arrangements

We do not currently have any off balance sheet arrangements.

Recently Issued Accounting Standards

See Note 2 “Recent Accounting Pronouncements” of the financial statements for recently issued accounting standards, such information being incorporated herein by reference.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are subject to market risk exposure related to changes in interest rates on our revolving credit facility, which provides for interest on borrowings at a floating rate. At September 30, 2010, we had $37.4 million outstanding debt on our revolving credit facility. Assuming no change in the net principal balance, a hypothetical increase or decrease of 100 basis points in the interest rate would have a corresponding decrease or increase in our annual pre-tax income of approximately $374,000.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a) Evaluation of Disclosure Controls and Procedures

Our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)), which we refer to as disclosure controls, are controls and procedures designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this quarterly report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any control system. A control system, no matter how well conceived and operated, can provide only reasonable assurance that its objectives are met. No evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

As of September 30, 2010, an evaluation was carried out under the supervision and with the participation of our management, including the CEO and the CFO, of the effectiveness of the design and operation of our disclosure controls. Based upon that evaluation, the CEO and the CFO concluded that, as of such date, the design and operation of these disclosure controls were effective to accomplish their objectives at the reasonable assurance level.

 

(b) Changes in Internal Control over Financial Reporting

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

Refer to Note 8 “Commitments and Contingencies” of the financial statements for information on legal proceedings, such information being incorporated herein by reference.

 

ITEM 1A. RISK FACTORS

There have been no material changes during the quarter ended September 30, 2010 in our “Risk Factors” as discussed in detail in our 2009 Annual Report on Form 10-K. The risks described in our Form 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may, especially in a volatile economic environment, materially adversely affect our business, financial condition and/or operating results.

Items 2, 3, 4 and 5 are not applicable and have been omitted.

 

ITEM 6. EXHIBITS

A list of the exhibits required by Item 601 of Regulation S-K to be filed as a part of this report is set forth in the Index to Exhibits on page 24, which immediately precedes such exhibits.

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

   UNION DRILLING, INC.

Dated: November 3, 2010

  

/s/ Tina L. Castillo

   Tina L. Castillo
   Vice President, Chief Financial Officer and Treasurer
   (Principal Financial and Accounting Officer)

 

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UNION DRILLING, INC.

INDEX TO EXHIBITS

 

Exhibit
Number

      

Description

  3.1      Form of Amended and Restated Certificate of Incorporation of Union Drilling (incorporated by reference to Exhibit 3.1 to our Registration Statement on Form S-1 (File No. 333-127525) filed on August 15, 2005).
  3.2      Form of Amended and Restated Bylaws of Union Drilling (incorporated by reference to Exhibit 3.1 to our Form 8-K (File No. 000-51630) filed on August 9, 2007).
31.1*      Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 filed herewith.**
31.2*      Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 filed herewith.**
32.1*      Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 filed herewith.**
32.2*      Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 filed herewith.**

 

* Filed with this Report.
** This Certification shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. This Certification shall not be deemed to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, each as amended, whether made before or after the date hereof, except to the extent that the Company specifically incorporates it by reference.

 

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