Union Drilling, Inc. (UDRL) - Description of business
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Our business and operations are substantially dependent upon, and affected by, the level of U.S. onshore natural gas exploration and development activity, which has experienced significant volatility. If the level of that activity decreases, our business and results of operations could be adversely affected.Our business and operations are substantially dependent upon, and affected by, the level of U.S. onshore natural gas exploration and development activity. Exploration and development activity determines the demand for contract land drilling and related services. We have no control over the factors driving the level of U.S. natural gas exploration and development activity. Those factors include, among others, the following: • the market prices of natural gas; • market expectations about future prices of natural gas or oil (which is closely correlated with natural gas prices); • the cost of producing and delivering natural gas; • the capacity of the natural gas pipeline network; • government regulations and trade restrictions; • the presence or absence of tax incentives; • national and international political and economic conditions; • levels of production by, and other activities of, the Organization of Petroleum Exporting Countries and other oil and natural gas producers; • the levels of imports of natural gas, whether by pipelines from Canada or Mexico or by tankers in the form of LNG; and • the development of alternate energy sources and the long-term effects of worldwide energy conservation measures.The onshore contract drilling industry has experienced significant volatility in profitability and asset values. The industry’s most recent significant downturn occurred in 2001 and 2002, and significantly and adversely affected our operating results. Currently, the onshore contract drilling business is experiencing increased demand for drilling services, principally due to improved oil and natural gas drilling and production economics. The increased activity in the exploration and production sector may not continue. In addition, ongoing movement or reactivation of land drilling rigs (including the movement of rigs from outside the U.S. into U.S. markets) or new construction of drilling rigs could increase rig supply and reduce contract drilling dayrates and utilization levels. We cannot predict the future level of demand for our contract drilling services, future conditions in the onshore contract drilling industry or future onshore contract drilling dayrates. Almost 85% of our drilling rigs are more than 20 years old, and may require increasing amounts of capital to upgrade and refurbish. Any failure to continue to invest capital to upgrade and refurbish rigs could result in our having fewer rigs available for service.Most of our drilling rigs were built during the years 1976 to 1982, which until recently was the last period of significant rig building. Our rig upgrade and refurbishment projects on marketed rigs typically require 60 to 90 days to complete at a cost of $175,000 to $250,000. This process includes derrick recertification, engine rebuilding or replacement and upgraded or replaced braking systems. Returning our stacked rigs to service would cost $1.5 to $2.5 million per rig for refurbishment and the purchase of drillpipe, pumps, generators and other required equipment. Depending upon the availability of equipment, this process could take from 90 to 180 days. To the extent we are unable to commence or continue such projects, we will have fewer rigs available for service, which could adversely affect our financial condition and results of operations. In the year ended December 31, 2006, we derived approximately 23% of our total revenues from three customers. The loss of any of those customers or the failure to remarket the rigs employed by those customers could have a material adverse effect on our financial condition and results of operations.In the year ended December 31, 2006, our three largest customers accounted for approximately 12%, 6% and 5%, respectively, of our total revenues. Our principal customers may not continue to employ our services and we may not be able to successfully remarket the rigs that they may choose not to employ. The loss of any of our principal customers or the failure to remarket the rigs employed by those customers could have a material adverse effect on our financial condition and results of operations. Our historical strategy has been predicated on growing through a combination of acquisitions of rigs from third parties and the construction of new rigs. Due to increased competition among drilling contractors for additional rigs, we may not be able to continue to add rigs to our fleet, which could have an adverse effect on our ability to grow revenue and profits.Increased levels of U.S. oil and natural gas exploration and development activity has led to increased demand for drilling services by oil and natural gas producers. This has given drilling contractors an economic incentive to build new rigs and acquire additional rigs from third parties, leading to an increase in the backlog for newly built rigs and enhanced competition for the acquisition of existing rigs. Our business and strategy could be adversely affected if we are unable to acquire newly built rigs or purchase additional drilling rigs on acceptable terms or in a timely manner. Increased demand among drilling contractors for consumable supplies, including fuel, and ancillary rig equipment, such as pumps, valves, drillpipe and engines, may lead to delays in obtaining these materials and our inability to operate our rigs in an efficient manner.All of our contracts provide that our customers bear the financial impact of increased fuel prices. However, prolonged shortages in the availability of fuel to run our drilling rigs resulting from action of the elements, warlike actions or other ’Force Majeure’ events could result in the suspension of our contracts and have a material adverse effect on our financial condition and results of operations. In recent months, we have experienced increased lead times in purchasing ancillary equipment for our drilling rigs. To the extent there are continued delays in being able to purchase important components for our rigs, certain of our rigs may not be available for operation or may not be able to operate as efficiently as expected, which could adversely affect our financial condition, results of operations and cash flows. To the extent we acquire additional rigs in the future, we may experience difficulty integrating those acquisitions. Additionally, we may incur leverage to effect those acquisitions, which adds additional financial risk to our business. To the extent we incur too much leverage in undertaking acquisitions, it may adversely affect our financial position.The process of integrating acquired rigs or newly constructed rigs may involve unforeseen difficulties and may require a disproportionate amount of management’s attention and significant financial and other resources. We may not be able to successfully manage and integrate new rigs into our existing operations or successfully maintain the market share attributable to drilling rigs that we purchase. We may also encounter cost overruns related to newly constructed rigs or unexpected costs related to the acquired rigs, including costs associated with major overhauls. To the extent we experience some or all of these difficulties, our financial condition would be adversely affected.Expanding our fleet by building new rigs or acquiring rigs from third parties may cause the company to incur additional financial leverage, increasing our debt service requirements, which could adversely affect our operating results and financial position. We may decide to purchase additional drilling rigs, upgrade some of our marketed drilling rigs and refurbish some of our stacked drilling rigs. Any delay could result in a loss of revenue.We may purchase additional drilling rigs, upgrade some of our marketed drilling rigs and refurbish some of our stacked drilling rigs. All of these projects are subject to risks of delay or cost overruns inherent in large construction projects. Among those risks are: • shortages of equipment, materials or skilled labor; • long lead times or delays in the delivery of ordered materials and equipment; • engineering problems; • work stoppages; • weather interference; • unavailability of specialized services; and • unanticipated cost increases.These factors may contribute to delays in the delivery of the drilling rigs, which could result in a loss of revenue. Additionally, we may incur higher costs than expected, which would adversely affect the economics of the investment in such rigs. We have incurred losses in the past and may incur losses in the future. If we incur losses in the future, the value of our common stock could decline.We reported net losses for the years ended December 31, 2003 and 2002 and for the three years prior to 2001. We earned net income in the years ended December 31, 2006, 2005 and 2004, but we may not be able to continue to realize profits. A lack of profitability could adversely affect the price of our common stock. In addition, if we do not remain profitable, our ability to complete future financings could be impaired, which could have an adverse effect on our business. We may not be able to raise additional funds through public or private financings or additional borrowings, which could have a material adverse effect on our financial condition.The contract drilling industry is capital intensive. Our cash flow from operations and the continued availability of credit are subject to a number of variables, including our rig utilization rates, operating margins and ability to control costs and obtain contracts in a competitive industry. Our cash flow from operations and present borrowing capacity may not be sufficient to fund our anticipated acquisition program, capital expenditures and working capital requirements. We may from time to time seek additional financing, either in the form of bank borrowings, sales of debt or equity securities or otherwise. To the extent our capital resources and cash flow from operations are at any time insufficient to fund our activities or repay our indebtedness as it becomes due, we will need to raise additional funds through public or private financings or additional borrowings. We may not be able to obtain any such capital resources. If we are at any time not able to obtain the necessary capital resources, our financial condition and results of operations could be materially adversely affected. We could be adversely affected if we lost the services of certain of our officers and key employees.The success of our business is highly dependent upon the services, efforts and abilities of Christopher D. Strong, our President and Chief Executive Officer, and certain other officers and key employees, particularly Dan Steigerwald, our Chief Financial Officer, our Division Managers and A.J. Verdecchia, our Corporate Controller. Our business could be materially and adversely affected by the loss of any of these individuals. We do not have employment agreements with or maintain key man life insurance on the lives of any of our executive officers. If we cannot keep our rigs utilized at profitable rates, our operating results could be adversely affected.Our business has high fixed costs, and if we cannot keep our rigs utilized at profitable rates, our operating results could be adversely affected. Our operations could be adversely affected by abnormally poor weather conditions.Our operations are conducted in areas subject to extreme weather conditions, and often in difficult terrain. Primarily in the winter and spring, our operations are often curtailed because of cold, snow or muddy conditions. Unusually severe weather conditions could further curtail our operations and could have a material adverse effect on our financial condition and results of operations. Increased competition in our drilling markets could adversely affect rates and utilization of our rigs, which could adversely affect our financial condition and results of operations.We face competition from significantly larger drilling contractors with greater resources. Their greater resources may enable them to build new rigs or move existing rigs into any of our regional markets. The addition of rigs into our markets, either by existing competitors or new entrants, including possibly non-U.S. competitors, would increase the supply of available rigs in those markets, which could adversely affect the rates we can charge and utilization levels we can achieve. Our operations are subject to hazards inherent in the land drilling business that are beyond our control. If those risks are not adequately insured or indemnified against, our results of operations could be adversely affected.Our operations are subject to many hazards inherent in the land drilling business, including, but not limited to: • blowouts; • craterings; • fires; • explosions; • equipment failures; • poisonous gas emissions; • loss of well control; • loss of hole; • damaged or lost drill strings; and • damage or loss from inclement weather or natural disasters.These hazards are to some extent beyond our control and could cause, among other things: • personal injury or death; • serious damage to or destruction of property and equipment; • suspension of drilling operations; and • substantial damage to the environment, including damage to producing formations and surrounding areas.Our insurance policies for public liability and property damage to others and injury or death to persons are in some cases subject to large deductibles and may not be sufficient to protect us against liability for all consequences of well disasters, personal injury, extensive fire damage or damage to the environment. We may not be able to maintain adequate insurance in the future at rates we consider reasonable, or particular types of coverage may not be available. The occurrence of events, including any of the above-mentioned risks and hazards, that are not fully insured against or the failure of a customer that has agreed to indemnify us against certain liabilities to meet its indemnification obligations could subject us to significant liability and could have a material adverse effect on our financial condition and results of operations. Our operations are subject to environmental, health and safety laws and regulations that may expose us to liabilities for noncompliance, which could adversely affect us.The U.S. oil and natural gas industry is affected from time to time in varying degrees by political developments and federal, state and local environmental, health and safety laws and regulations applicable to our business. Our operations are vulnerable to certain risks arising from the numerous environmental health and safety laws and regulations. These laws and regulations may restrict the types, quantities and concentration of various substances that can be released into the environment in connection with drilling activities, require reporting of the storage, use or release of certain chemicals and hazardous substances, require removal or cleanup of contamination under certain circumstances, and impose substantial civil liabilities or criminal penalties for violations. Environmental laws and regulations may impose strict liability, rendering a company liable for environmental damage without regard to negligence or fault, and could expose us to liability for the conduct of, or conditions caused by, others, or for our acts that were in compliance with all applicable laws at the time such acts were performed. Moreover, there has been a trend in recent years toward stricter standards in environmental, health and safety legislation and regulation, which may continue.We may incur material liability related to our operations under governmental regulations, including environmental, health and safety requirements. We cannot predict how existing laws and regulations may be interpreted by enforcement agencies or court rulings, whether additional laws and regulations will be adopted, or the effect such changes may have on our business, financial condition or results of operations. Because the requirements imposed by such laws and regulations are subject to change, we are unable to forecast the ultimate cost of compliance with such requirements. The modification of existing laws and regulations or the adoption of new laws or regulations curtailing exploratory or development drilling for oil and natural gas for economic, political, environmental or other reasons could have a material adverse effect on us by limiting drilling opportunities. We may not be able to attract and retain the services of qualified operating personnel, which could restrict our ability to market and operate our drilling rigs or result in accidents and other operational difficulties.Increases in both onshore and offshore U.S. oil and natural gas exploration and production and resultant increases in contract drilling activity have created a shortage of qualified drilling rig personnel in the industry. If we are unable to attract and retain sufficient qualified operating personnel, our ability to market and operate our drilling rigs will be restricted. In addition, labor shortages could result in wage increases, which could reduce our operating margins and have an adverse effect on our financial condition and results of operations. To the extent that we are required to hire less experienced personnel, we may experience accidents or other operational difficulties and incur related costs. Our debt agreements contain restrictions that limit our flexibility in operating our business.Our revolving credit facility contains various covenants that limit our ability to engage in specified types of transactions. These covenants limit our ability to, among other things: • incur additional indebtedness or issue certain preferred shares; • pay dividends on or make distributions in respect of our capital stock or make other restricted payments; • make certain investments, including capital expenditures; • sell certain assets; • create liens; and • consolidate, merge, sell or otherwise dispose of all or substantially all of our assets.Risks Related to Our Common Stock Our principal stockholder has significant ownership.Union Drilling Company LLC, our principal stockholder, owns approximately 37% of our outstanding common stock. Union Drilling Company LLC is controlled by Metalmark Capital LLC. As a result, Union Drilling Company LLC and its affiliates may substantially influence the outcome of stockholder votes, including votes concerning the election of directors, the adoption or amendment of provisions in our certificate of incorporation or bylaws and the approval of mergers and other significant corporate transactions. The existence of this level of ownership concentration makes it less likely that any small holder of our common stock will be able to affect the management or direction of Union. These factors may also have the effect of delaying or preventing a change in the management or voting control of Union. We have renounced any interest in specified business opportunities, and our directors and their affiliates generally have no obligation to offer us those opportunities.Several of our directors and affiliates of Union Drilling Company LLC, our principal stockholder, have investments in other oilfield service companies that may compete with us, and they may invest in other similar companies in the future. Our certificate of incorporation provides that we have renounced any interest in related business opportunities and that neither our directors nor their affiliates have any obligation to offer us those opportunities. These provisions of our certificate of incorporation may be amended only by an affirmative vote of holders of at least two-thirds of our outstanding common stock. As a result of these charter provisions, our future competitive position and growth potential could be adversely affected. Our existing dividend policy and contractual restrictions limit our ability to pay dividends.We have never declared a cash dividend on our common stock and do not expect to pay cash dividends for the foreseeable future. We expect that all cash flow generated from our operations in the foreseeable future will be retained and used to develop or expand our business. In addition, our loan agreement prohibits the payment of dividends without the prior consent of the lenders. Provisions in our certificate of incorporation and bylaws and of Delaware corporate law may make a takeover difficult.Provisions in our certificate of incorporation and bylaws and of Delaware corporate law may make it difficult and expensive for a third party to pursue a tender offer, change in control or takeover attempt that is opposed by our management and board of directors. These anti-takeover provisions could substantially impede the ability of public stockholders to benefit from a change of control or change our management and board of directors. Limited trading volume of our common stock may contribute to its price volatility.Our common stock is traded on the NASDAQ Global Market. During the period from January 1, 2006 through March 8, 2007, the average daily trading volume of our common stock as reported by the NASDAQ Global Market was 150,436 shares. There can be no assurance that a more active trading market in our common stock will develop. As a result, relatively small trades may have a significant impact on the price of our common stock and, therefore, may contribute to the price volatility of our common stock. As a result, our common stock may be subject to greater price volatility than the stock market as a whole and comparable securities of other contract drilling service providers.The market price of our common stock has been, and may continue to be, volatile. For example, during the period from January 1, 2006 through March 8, 2007, the trading price of our common stock ranged from $10.29 to $18.63 per share.Because of the limited trading market of our common stock and the price volatility of our common stock, you may be unable to sell shares of common stock when you desire or at a price you desire. The inability to sell your shares in a declining market because of such illiquidity or at a price you desire may substantially increase your risk of loss.