| GREY WOLF INC Item 1A Risk Factors Below we describe the risks and uncertainties that we believe were material to our business as of February 23, 2006 |
| A material or extended decline in expenditures by oil and natural gas exploration and production companies, due to a decline or volatility in oil and natural gas prices, a decrease in demand for oil and natural gas, an increase in rig supply or other factors, would reduce our revenue and income |
| As a supplier of land drilling services, our business depends on the level of drilling activity by oil and natural gas exploration and production companies operating in the geographic markets where we operate |
| The number of wells they choose to drill is strongly influenced by past trends in oil and natural gas prices, current prices -8- _________________________________________________________________ [59]Table of Contents and their outlook for future prices |
| Natural gas storage is at historically high levels which has affected the price of natural gas |
| Mild weather conditions and increased supply for any other reason could continue to affect these prices |
| Low oil and natural gas prices, or the perception among oil and natural gas companies that prices are likely to decline, can materially and adversely affect us in many ways, including: • our revenues, cash flows and earnings; • the fair market value of our rig fleet, which in turn could trigger a writedown of the carrying value of these assets for accounting purposes; • our ability to maintain or increase our borrowing capacity; • our ability to obtain additional capital to finance our business and make acquisitions, and the cost of that capital; and • our ability to retain skilled rig personnel who we would need in the event of an increase in the demand for our services |
| Depending on the market prices of oil and natural gas, oil and natural gas exploration and production companies may cancel or curtail their drilling programs, thereby reducing demand for our services |
| Even during periods when prices for oil and natural gas are high, companies exploring for oil and natural gas may cancel or curtail their drilling programs for a variety of other reasons beyond our control |
| Any reduction in the demand for drilling services may materially erode dayrates, the prices we receive for our turnkey drilling services and reduce the number of rigs under contract, any of which could adversely affect our financial results |
| Oil and natural gas prices have been volatile historically and, we believe, will continue to be so in the future |
| Many factors beyond our control affect oil and natural gas prices, including: • weather conditions in the United States and elsewhere; • economic conditions in the United States and elsewhere; • actions by OPEC, the Organization of Petroleum Exporting Countries; • political instability in the Middle East, Venezuela, Nigeria and other major producing regions; • governmental regulations, both domestic and foreign; • the pace adopted by foreign governments for exploration of their national reserves; and • the overall supply and demand for oil and natural gas |
| An economic downturn may adversely affect our business |
| An economic downturn may cause reduced demand for oil and natural gas |
| In addition, many oil and natural gas production companies often reduce or delay expenditures to reduce costs, which in turn may cause a reduction in the demand for our services during these periods |
| If the economic environment worsens, our business, financial condition and results of operations may be adversely impacted |
| The intense price competition and cyclical nature of our industry could have an adverse effect on our revenues and profitability |
| The contract drilling business is highly competitive with numerous industry participants |
| The drilling contracts we compete for are usually awarded on the basis of competitive bids |
| We believe pricing and rig availability are the primary factors considered by our potential customers in determining which drilling contractor to select |
| We believe other factors are also important |
| Among those factors are: • the type and condition of drilling rigs; • the quality of service and experience of rig crews; • the safety record of the company and the particular drilling rig; • the offering of ancillary services; and • the ability to provide drilling equipment adaptable to, and personnel familiar with, new technologies and drilling techniques |
| While we must generally be competitive in our pricing, our competitive strategy emphasizes the quality of our equipment, the safety record of our rigs and the experience of our rig crews to differentiate us from our competitors |
| This strategy is less effective during an industry downturn as lower demand for drilling services intensifies price competition and makes it more difficult for us to compete on the basis of factors other than price |
| The contract drilling industry historically has been cyclical and has experienced periods of low demand, excess rig supply, and low dayrates, followed by periods of high demand, short rig supply and increasing dayrates |
| Periods of excess rig supply intensify the competition in our industry and often result in rigs being idle |
| There are numerous competitors in each of the markets in which we compete |
| In all of those markets, an oversupply of rigs -9- _________________________________________________________________ [60]Table of Contents can cause greater price competition |
| Contract drilling companies compete primarily on a regional basis, and the intensity of competition may vary significantly from region to region at any particular time |
| If demand for drilling services improves in a region where we operate, our competitors might respond by moving in suitable rigs from other regions, by reactivating previously stacked rigs or purchasing new rigs |
| An influx of rigs into a market area from any source could rapidly intensify competition and make any improvement in demand for drilling rigs short-lived |
| Some of our competitors have greater financial and human resources than do we |
| Their greater capabilities in these areas may enable them to: • build new rigs or acquire and refurbish existing rigs to be able to place rigs into service more quickly than us in periods of high drilling demand; • compete more effectively on the basis of price and technology; • better withstand industry downturns; and • retain skilled rig personnel |
| Our drilling operations involve operating hazards which if not adequately insured or indemnified against could adversely affect our results of operations and financial condition |
| Our operations are subject to the usual hazards inherent in the land drilling business including the risks of: • blowouts; • reservoir damage; • cratering; • fires, pollution and explosions; • collapse of the borehole; • lost or stuck drill strings; and • damage or loss from natural disasters |
| If these events occur they can produce substantial liabilities to us which include: • suspension of drilling operations; • damage to the environment; • damage to, or destruction of, our property and equipment and that of others; • personal injury and loss of life; and • damage to producing or potentially productive oil and natural gas formations through which we drill |
| We attempt to obtain indemnification from our customers by contract for certain of these risks under daywork contracts but are not always able to do so |
| We also seek to protect ourselves from some but not all operating risks through insurance coverage |
| The indemnification we receive from our customers and our own insurance coverage may not, however, be sufficient to protect us against liability for all consequences of disasters, personal injury and property damage |
| Additionally, our insurance coverage generally provides that we bear a portion of the claim through substantial insurance coverage deductibles |
| Our insurance or indemnification arrangements may not adequately protect us against liability from all of the risks of our business |
| If we were to incur a significant liability for which we were not fully insured or indemnified, it could adversely affect our financial position and results of operations |
| We may be unable to obtain or renew insurance coverage of the type and amount we desire at reasonable rates |
| Business acquisitions entail numerous risks and may disrupt our business or distract management attention |
| As part of our business strategy, we plan to consider acquisitions of, or significant investments in, businesses and assets that are complementary to ours |
| Any acquisition that we complete could have a material adverse affect on our operating results and/or the price of our securities |
| Acquisitions involve numerous risks, including: • unanticipated costs and liabilities; • difficulty of integrating the operations and assets of the acquired business; -10- _________________________________________________________________ [61]Table of Contents • our ability to properly access and maintain an effective internal control environment over an acquired company, in order to comply with public reporting requirements; • potential loss of key employees and customers of the acquired companies; and • an increase in our expenses and working capital requirements |
| We may incur substantial indebtedness to finance future acquisitions and also may issue equity securities or convertible securities in connection with any such acquisitions |
| Debt service requirements could represent a significant burden on our results of operations and financial condition and the issuance of additional equity could be dilutive to our existing shareholders |
| Acquisitions could also divert the attention of our management and other employees from our day-to-day operations and the development of new business opportunities |
| Our operations are subject to environmental laws that may expose us to liabilities for noncompliance, which may adversely affect us |
| Many aspects of our operations are subject to domestic laws and regulations |
| For example, our drilling operations are typically subject to extensive and evolving laws and regulations governing: • environmental quality; • pollution control; and • remediation of environmental contamination |
| Our operations are often conducted in or near ecologically sensitive areas, such as wetlands, which are subject to special protective measures and which may expose us to additional operating costs and liabilities for noncompliance with applicable laws |
| The handling of waste materials, some of which are classified as hazardous substances, is a necessary part of our operations |
| Consequently, our operations are subject to stringent regulations relating to protection of the environment and waste handling which may impose liability on us for our own noncompliance and, in addition, that of other parties without regard to whether we were negligent or otherwise at fault |
| Compliance with applicable laws and regulations may require us to incur significant expenses and capital expenditures which could have a material and adverse effect on our operations by increasing our expenses and limiting our future contract drilling opportunities |
| Our ability to achieve profitability in the future will depend on many factors, but primarily on the number of days our rigs work during any period and the rates we charge our customers for them during that period |
| In the years in which we incurred losses, those losses were primarily due to the fact that the number of days our rigs worked and the rates we were able to charge customers for the days worked generated insufficient revenue to cover our expenses |
| In some years, we have also incurred charges for impairment of our drilling equipment assets that contributed to our losses in a year |
| Unexpected cost overruns on our turnkey and footage drilling jobs could adversely affect us |
| We have historically derived a significant portion of our revenues from turnkey and footage drilling contracts and we expect that they will continue to represent a significant component of our revenues |
| The occurrence of operating cost overruns on our turnkey and footage jobs could have a material adverse effect on our financial position and results of operations |
| Under a typical turnkey or footage drilling contract, we agree to drill a well for our customer to a specified depth and under specified conditions for a fixed price |
| We typically provide technical expertise and engineering services, as well as most of the equipment required for the drilling of turnkey and footage wells |
| We often subcontract for related services |
| Under typical turnkey drilling arrangements, we do not receive progress payments and are entitled to be paid by our customer only after we have performed the terms of the drilling contract in full |
| For these reasons, our risk under turnkey and footage drilling contracts is substantially greater than for wells drilled on a daywork basis because we must assume most of the risks associated with drilling operations that are generally assumed by our customer under a daywork contract |
| -11- _________________________________________________________________ [62]Table of Contents We could be adversely affected if delivery times for rigs and rig equipment lengthen |
| The land drilling industry is experiencing price increases and extended delivery times for newly-built rigs |
| Prices and delivery times for important rig components, including engines, mud pumps, top drives and drill pipe that may be needed to refurbish or repair rigs have also increased |
| If these price increases continue or extended delivery times lengthen, it could adversely affect our business and results of operations by increasing our costs for, and delaying: • deployment of newly-built rigs; • redeployment of the rigs we are refurbishing or plan to refurbish; • upgrades to our marketed fleet of rigs; and • repair and maintenance of our rigs |
| We could be adversely affected if the demand for qualified rig personnel increases |
| Although we have not encountered material difficulty in hiring and retaining qualified rig crews, shortages of qualified personnel have occurred in the past in our industry during periods of high demand |
| The demand for qualified rig personnel has increased as a result of overall stronger demand for land drilling services in 2005 and 2006 |
| We believe the demand for qualified rig personnel may increase further as new and refurbished rigs are brought into service by us and our competitors |
| If the demand for qualified rig personnel persists or increases, we may experience shortages of qualified personnel to operate our rigs despite these and any other employee retention and hiring measures we may implement |
| Any such personnel shortages could have a material adverse effect on our financial condition and results of operations |
| Our credit agreement may prohibit us from participation in certain transactions that we may consider advantageous |
| Our subsidiary, Grey Wolf Drilling Company LP, has entered into a credit facility that contains covenants restricting our ability to undertake many types of transactions and contains financial ratio covenants when certain conditions are met |
| These restrictions may limit our ability to respond to changes in market conditions |
| Our ability to meet the financial ratio covenants of our credit agreement can be affected by events and conditions beyond our control and we may be unable to meet those tests (see Note 4 to the consolidated financial statements) |
| We may in the future incur additional indebtedness that may contain additional covenants that may be more restrictive than our current covenants |
| Our credit facility contains default terms that effectively cross default with any of our other debt agreements, including the indentures for our Contingent Convertible Floating Rate Notes due April 2024 (the “Floating Rate Notes”) and our 3dtta75prca Contingent Convertible Notes due May 2023 (the “3dtta75prca Notes”) |
| Thus, if we breach the covenants in the indentures for our 3dtta75prca Notes and Floating Rate Notes, it could cause our default under our 3dtta75prca Notes, our Floating Rate Notes, our credit facility and, possibly, other then outstanding debt obligations owed by us |
| If the indebtedness under our credit facility or other indebtedness owed by us is more than dlra10dtta0 million and is not paid when due, or is accelerated by the holders of the debt, then an event of default under the indentures covering our 3dtta75prca Notes and our Floating Rate Notes would occur |
| If circumstances arise in which we are in default under our various credit agreements, our cash and other assets may be insufficient to repay our indebtedness |
| We have a significant amount of indebtedness and could incur additional indebtedness, which could materially and adversely affect our financial condition and results of operations and prevent us from fulfilling our obligations under the notes and our other outstanding indebtedness |
| We have now and will continue to have a significant amount of indebtedness |
| On December 31, 2005, our total long-term indebtedness was approximately dlra275dtta0 million in principal amount, (primarily consisting of dlra150dtta0 million in principal amount of our 3dtta75prca Notes and dlra125dtta0 million in principal amount of our Floating Rate Notes) |
| -12- _________________________________________________________________ [63]Table of Contents Our substantial indebtedness could: • make it more difficult for us to satisfy our obligations with respect to the 3dtta75prca Notes and the Floating Rate Notes; • increase our vulnerability to general adverse economic and industry conditions; • require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes; • limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; • place us at a competitive disadvantage compared to our competitors that have less debt; and • limit our ability to borrow additional funds |
| Neither the indentures governing our 3dtta75prca Notes and our Floating Rate Notes nor the terms of our 3dtta75prca Notes or our Floating Rate Notes limit our ability to incur additional indebtedness, including senior indebtedness, or to grant liens on our assets |
| We, and our subsidiaries, may incur substantial additional indebtedness and liens on our assets in the future |
| The Floating Rate Notes bear interest annually at a rate equal to 3-month LIBOR, adjusted quarterly, minus a spread of 0dtta05prca |
| Although the interest rate on the Floating Rate Notes will never be more 6dtta00prca, we are subject to market risk exposure related to changes in interest rates on the Floating Rate Notes up to 6dtta00prca |
| A significant increase in 3-month LIBOR would increase the interest rate on the Floating Rate Notes and the amount of interest we pay on the Floating Rate Notes, which may have an adverse affect on our financial condition and liquidity |
| Our existing senior indebtedness is, and any senior indebtedness we incur will be, effectively subordinated to any present or future obligations to secured creditors and liabilities of our subsidiaries |
| Substantially all of our assets and the assets of our subsidiaries, including our drilling equipment and the equity interest in our subsidiaries, are pledged as collateral under our credit facility |
| Our credit facility is also secured by our guarantee and the guarantees of our subsidiaries |
| The 3dtta75prca Notes and the Floating Rate Notes are, and any senior indebtedness we incur will be, effectively subordinated to all of our and our subsidiaries’ existing and future secured indebtedness, including any future indebtedness incurred under our credit facility |
| As of February 23, 2006, we had the ability to borrow approximately dlra76dtta1 million under our credit facility (after reductions for undrawn outstanding standby letters of credit of dlra23dtta9 million) |
| In addition, the 3dtta75prca Notes and the Floating Rate Notes are effectively subordinated to the claims of all of the creditors, including trade creditors and tort claimants, of our subsidiaries |
| To service our indebtedness, we will require a significant amount of cash |
| Our ability to generate cash depends on many factors beyond our control |
| Although our operating activities did provide net cash sufficient to pay our debt service obligations for the years ended December 31, 2005 and 2004, respectively, there can be no assurances that we will be able to generate sufficient cash flow in the future |
| Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future |
| Credit ratings affect our ability to obtain financing and the cost of such financing |
| Our credit ratings affect our ability to obtain financing and the cost of such financing |
| At December 31, 2005, our corporate and unsecured debt ratings were rated B1 by Moody’s Investors Service and BB- by Standard & Poor’s Ratings group |
| In determining our credit ratings, the rating agencies consider a number of both quantitative and qualitative factors |
| These factors include earnings, fixed charges such as interest, cash flows, total debt outstanding, off balance sheet obligations and other commitments, total capitalization and various ratios calculated from these factors |
| The rating agencies also consider predictability of cash flows, business strategy, industry conditions and contingencies |
| Lower ratings on our senior unsecured debt could impair our ability to obtain additional financing and will increase the cost of the financing that we do obtain |
| -13- _________________________________________________________________ [64]Table of Contents Investors in our common stock should not expect to receive dividend income, and will be dependent on the appreciation of our common stock to earn a return on their investment |
| The decision to pay a dividend on our common stock rests with our board of directors and will depend on our earnings, available cash, capital requirements and financial condition |
| We have never declared a cash dividend on our common stock and do not expect to pay cash dividends on our common stock 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, pay debt service and reduce outstanding indebtedness |
| Investors will likely have to depend on sales of our common stock at appreciated prices, which we cannot assure, in order to achieve a positive return on their investment in our common stock |
| Certain provisions of our organizational documents, securities and credit agreement have anti-takeover effects which may prevent our shareholders from receiving the maximum value for their shares |
| Our articles of incorporation, bylaws, securities and credit agreement contain certain provisions that may delay or prevent entirely a change of control transaction not supported by our board of directors, or any transaction which may have that general effect |
| These provisions include: • classification of our board of directors into three classes, with each class serving a staggered three year term; • giving our board of directors the exclusive authority to adopt, amend or repeal our bylaws and thus prohibiting shareholders from doing so; • requiring our shareholders to give advance notice of their intent to submit a proposal at the annual meeting; and • limiting the ability of our shareholders to call a special meeting and act by written consent |
| Additionally, the indentures under which our 3dtta75prca Notes and Floating Rate Notes are issued require us to offer to repurchase the 3dtta75prca Notes and Floating Rate Notes then outstanding at a purchase price equal to 100prca and 100prca, respectively, of the principal amount plus accrued and unpaid interest to the date of purchase in the event that we become subject to a change of control, as defined in the indentures |
| This feature of the indentures could also have the effect of discouraging potentially attractive change of control offers |
| Furthermore, we have adopted a shareholder rights plan which may have the effect of impeding a hostile attempt to acquire control of us |
| Large amounts of our common stock may be resold into the market in the future which could cause the market price of our common stock to drop significantly, even if our business is doing well |
| As of February 23, 2006, 192cmam715cmam080 million shares of our common stock were issued and outstanding |
| An additional 4dtta5 million shares of our common stock were issuable upon exercise of outstanding stock options (of which 2dtta3 million shares are currently exercisable) and 23dtta3 million shares were issuable upon conversion of the 3dtta75prca Notes and 19dtta2 million shares are issuable upon conversion of the Floating Rate Notes, in each case once a conversion contingency is met |
| Our 3dtta75prca Notes are presently convertible through the end of the first quarter of 2006 |
| See Note 4 to the consolidated financial statements for information on the conditions under which our 3dtta75prca Notes and our Floating Rate Notes become convertible into our common stock |
| The market price of our common stock could drop significantly if future sales of substantial amounts of our common stock occur, if the perception exists that substantial sales may occur or if our convertible notes become convertible |
| Forward-Looking Statements This annual report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended |
| All statements other than statements of historical facts included in this report are forward-looking statements, including statements regarding the following: • business strategy; • demand for our services; • spending by our customers; • 2006 rig activity and financial results; • projected depreciation expense and interest expense; -14- _________________________________________________________________ [65]Table of Contents • reactivation, timing and cost of reactivation of rigs available for refurbishment; • cost of building new rigs; • projected dayrates; • the ability to recover our refurbishment costs or the purchase price of rigs from term contracts; • the availability and financial terms of term contracts; • rigs expected to be engaged in turnkey and footage operations; • projected tax rate; • wage rates and retention of employees; • sufficiency of our capital resources and liquidity; and • depreciation and capital expenditures in 2006 |
| Although we believe the forward-looking statements are reasonable, we cannot assure you that these statements will prove to be correct |
| We have based these statements on assumptions and analyses in light of our experience and perception of historical trends, current conditions, expected future developments and other factors we believe were appropriate when the statements were made |
| The risks and uncertainties generally described above in this Item 1A Risk Factors could cause actual results to differ materially from those expressed in our forward-looking statements |
| Accordingly, we urge you not to place undue reliance on forward-looking statements |
| Our forward-looking statements speak only as of the date specified in such statements or, if no date is stated, as of the date of this report |
| Grey Wolf expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement contained in this report to reflect any change in our expectations or with regard to any change in events, conditions or circumstances on which our forward-looking statements are based |