10-Q 1 file1.htm

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, 2006

[_] 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 (I.R.S. Employer
of incorporation or organization) 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)

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

Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.

Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [X]

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 13, 2006, there were 21,393,692 shares of common stock, par value
$0.01 per share, of the registrant issued and outstanding.

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

UNION DRILLING, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

September 30, December 31,
2006 2005
------------- -------------
(unaudited)

ASSETS
Current assets:
Cash and cash equivalents $ 145,994 $ 2,388,276
Accounts receivable (net of allowance for doubtful accounts of $869,919
and $313,436 at September 30, 2006 and December 31, 2005, respectively) 46,293,910 27,579,254
Accounts receivable - related party -- 481,657
Inventories 1,355,991 860,208
Prepaid expenses and deposits 3,041,171 4,930,431
Deferred taxes 6,574,036 10,542,730
------------- -------------
Total current assets 57,411,102 46,782,556
Goodwill 7,843,245 5,424,793
Intangible assets (net of accumulated amortization of $427,222 and
$202,500 at September 30, 2006 and December 31, 2005, respectively) 3,572,778 3,797,500
Property, buildings and equipment (net of accumulated depreciation of
$62,059,576 and $46,250,906 at September 30, 2006 and
December 31, 2005, respectively) 171,318,454 120,783,092
Other assets 466,939 700,409
------------- -------------
Total assets $ 240,612,518 $ 177,488,350
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 11,559,771 $ 9,240,626
Current portion of long-term obligations 2,366,698 2,013,956
Other current obligations 649,647 3,308,678
Current portion of advances from customers 429,000 1,265,067
Accrued expense and other liabilities 8,439,371 5,353,308
------------- -------------
Total current liabilities 23,444,487 21,181,635
Revolving credit facility 30,202,500 --
Long-term obligations 5,295,265 5,812,028
Deferred taxes 23,728,262 17,916,781
Advances from customers 138,605 138,605
------------- -------------
Total liabilities 82,809,119 45,049,049

Stockholders' equity:
Common stock, par value $.01 per share; 75,000,000 shares
authorized; 21,367,192 and 21,166,109 shares issued and outstanding
at September 30, 2006 and December 31, 2005, respectively 213,672 211,661
Additional paid in capital 135,518,813 133,381,395
Retained earnings (deficit) 22,070,914 (1,153,755)
------------- -------------
Total stockholders' equity 157,803,399 132,439,301
------------- -------------
Total liabilities and stockholders' equity $ 240,612,518 $ 177,488,350
============= =============

See accompanying notes to condensed consolidated financial statements.

UNION DRILLING, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

Three Months Ended Nine Months Ended
September 30, September 30,
------------- ------------- ------------- -------------
2006 2005 2006 2005
------------- ------------- ------------- -------------

REVENUES
Nonaffiliates $ 69,482,475 $ 42,041,593 $ 184,876,772 $ 91,026,154
Related party -- 1,188,134 -- 4,138,099
------------- ------------- ------------- -------------
Total revenues 69,482,475 43,229,727 184,876,772 95,164,253
------------- ------------- ------------- -------------
COST AND EXPENSES
Drilling operations 40,836,261 31,638,742 113,298,330 70,448,307
Depreciation and amortization 6,334,364 4,251,326 17,078,825 10,387,396
General and administrative 5,199,813 4,323,583 15,033,998 9,174,805
------------- ------------- ------------- -------------
Total cost and expenses 52,370,438 40,213,651 145,411,153 90,010,508
------------- ------------- ------------- -------------

Operating income 17,112,037 3,016,076 39,465,619 5,153,745

Interest expense (212,303) (900,519) (212,924) (1,905,025)
Gain (loss) on sale of assets (41,023) 82,320 282,312 153,680
Other income 152,070 107,449 278,808 159,853
------------- ------------- ------------- -------------
Income before income taxes 17,010,781 2,305,326 39,813,815 3,562,253
Income tax expense 7,217,099 2,292,371 16,589,146 2,292,371
------------- ------------- ------------- -------------
Net income $ 9,793,682 $ 12,955 $ 23,224,669 $ 1,269,882
============= ============= ============= =============

Earnings per common share:
Basic $ 0.46 $ 0.00 $ 1.09 $ 0.08
============= ============= ============= =============
Diluted $ 0.45 $ 0.00 $ 1.08 $ 0.08
============= ============= ============= =============

Weighted-average common shares outstanding:
Basic 21,337,507 16,226,591 21,239,735 15,205,373
============= ============= ============= =============
Diluted 21,636,504 17,174,310 21,567,444 16,015,059
============= ============= ============= =============

See accompanying notes to condensed consolidated financial statements.

UNION DRILLING, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

Nine Months Ended
September 30,
----------------------------
2006 2005
------------- ------------

OPERATING ACTIVITIES:
Net income $ 23,224,669 $ 1,269,882
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 17,078,825 10,387,396
Non-cash compensation expense 532,172 1,167,398
Provision for doubtful accounts 635,000 107,500
Gain on sale of fixed assets (282,312) (153,680)
Provision for deferred taxes 7,299,000 2,275,000
Excess tax benefits from share-based payment arrangements (879,126) --
Changes in operating assets and liabilities:
Accounts receivable (19,348,074) (12,068,108)
Accounts receivable - related party 481,657 1,317,160
Inventories (495,783) (158,974)
Prepaid and other assets 2,185,453 842,671
Accounts payable (667,835) 6,911,610
Accrued expenses and other liabilities 3,201,761 966,936
------------- ------------
Cash flow provided by operating activities 32,965,407 12,864,791

INVESTING ACTIVITIES:
Purchase of businesses -- (47,517,092)
Purchases of machinery and equipment (68,144,318) (34,354,398)
Proceeds from sale of machinery and equipment 1,037,165 754,697
------------- ------------
Cash flow used in investing activities (67,107,153) (81,116,793)

FINANCING ACTIVITIES:
Borrowings on line of credit 186,638,887 144,886,143
Repayments on line of credit (156,436,387) (94,451,930)
Cash overdrafts 2,989,783 --
Borrowings to finance equipment purchases 1,949,367 2,010,518
Repayments on capital leases and other debt (4,850,431) (3,547,838)
Proceeds from exercise of options 764,115 --
Excess tax benefits from share-based payment arrangements 879,126 --
Repayments on term loan -- (2,053,038)
Issuance of common shares -- 19,920,007
Stock issuance costs (35,984) --
------------- ------------
Cash flow provided by financing activities 31,898,476 66,763,862
Foreign currency translation adjustment 988 83
------------- ------------
Net decrease in cash (2,242,282) (1,488,057)
Cash and cash equivalents at beginning of period 2,388,276 3,871,271
------------- ------------
Cash and cash equivalents at end of period $ 145,994 $ 2,383,214
============= ============

See accompanying notes to condensed consolidated financial statements.

UNION DRILLING, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)

Additional Retained
Paid In Earnings
Common Stock Capital (Deficit) Total
--------------------- ------------ ----------- ------------
Shares $
---------- --------

Balance at December 31, 2005 21,166,109 $211,661 $133,381,395 $(1,153,755) $132,439,301
Non-cash compensation -- -- 532,172 -- 532,172
Stock issuance costs -- -- (35,984) -- (35,984)
Exercise of stock options and
related tax benefits of $879,126 201,083 2,011 1,641,230 -- 1,643,241
Net income -- -- -- 23,224,669 23,224,669
---------- -------- ------------ ----------- ------------
Balance at September 30, 2006 21,367,192 $213,672 $135,518,813 $22,070,914 $157,803,399
========== ======== ============ =========== ============

See accompanying notes to condensed consolidated financial statements.

UNION DRILLING, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business and Principles of Consolidation

Union Drilling, Inc. ("Union" or "the Company") is engaged in the business of
onshore contract drilling and related services. The accompanying unaudited
condensed consolidated financial statements include the accounts of Union
Drilling, Inc. and its wholly owned subsidiaries after the elimination of all
intercompany balances and transactions. The interim period condensed
consolidated 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 accruals) necessary
for a fair presentation have been included. The results for interim periods are
not necessarily indicative of results for a full year.

The condensed consolidated balance sheet at December 31, 2005, has been derived
from the audited financial statements of Union Drilling, Inc. at that date, but
does not include all of the information and footnotes required by GAAP for
complete financial statements. These interim period condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2005.

During the third quarter of 2006, the Company corrected its income tax
provisions and deferred tax balances for underreporting of meals and incidental
expenses that are only 50% deductible for income tax purposes and to recognize
the deferred tax liability attributable to non-deductible intangibles acquired
from Thornton Drilling Company. As a result, the Company recognized a $1,059,000
additional charge to its income tax provision in the third quarter of 2006, of
which $462,000 was attributable to the year ended December 31, 2005, $282,000
was attributable to the quarter ended March 31, 2006 and $315,000 was
attributable to the quarter ended June 30, 2006. This correction also resulted
in a $1,159,000 increase to deferred tax liabilities, a $2,381,000 reduction in
deferred tax assets and a $2,481,000 increase to recorded goodwill. Management,
after consultation with its independent auditor, concluded that the effect of
the corrections was not material to prior periods, expected 2006 results and
trend of earnings.

Stock-based Compensation

Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123(R), "Share-Based Payment, revised 2004" ("SFAS No.
123R"). The Company adopted the standard by using the modified prospective
method provided for under SFAS No. 123R. SFAS No. 123R, which revised SFAS No.
123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), requires that
the cost resulting from all share-based payment transactions be measured at fair
value and recognized in the financial statements. For the three and nine months
ended September 30, 2006, the Company has recorded total stock-based
compensation expense of $257,973 ($173,230 net of tax) and $786,079 ($546,052,
net of tax), respectively. The condensed consolidated statements of income for
the three and nine months ended September 30, 2005, have not been restated to
reflect stock-based compensation expense in accordance with SFAS No. 123R.

The tax benefit realized from stock options exercised during the nine months
ended September 30, 2006 is included as a cash inflow from financing activities
on the condensed consolidated statement of cash flows.

approximately 4.98%; dividend yield of zero; stock price volatility of
approximately 55.4%; and expected term of approximately 5.5 years.

The risk-free interest rate is the implied yield available for zero-coupon U.S.
government issues with a remaining term equal to the expected life of the
options.

The expected lives of the options are determined based on the Company's
expectations of individual option holders' anticipated behavior and the term of
the option.

The Company has not paid out dividends historically; thus, the dividend yield is
estimated at zero percent.

Volatility is based upon price performance of 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.

Prior to the implementation of SFAS No. 123R, the Company accounted for
stock-based compensation under SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure" ("SFAS No. 148"), and the
disclosure-only provisions of SFAS No. 123. SFAS No. 123 permitted the Company
to continue accounting for stock-based compensation as set forth in APB Opinion
No. 25, "Accounting for Stock Issued to Employees", provided the Company
disclosed the pro forma effect on net income and earnings per share of adopting
the full provisions of SFAS No. 123. Accordingly, the Company continued to
account for stock-based compensation under APB Opinion No. 25 and provided the
required pro forma disclosures.

The following table illustrates the effect on net income and income per share if
the Company had applied the fair value recognition provisions of SFAS No. 123 to
employee stock-based awards prior to January 1, 2006:

Three Months Nine Months
Ended Ended
September 30, 2005 September 30, 2005
------------------ ------------------

Net income, as reported $ 12,955 $1,269,882
Less: Total stock-based compensation expense determined under
fair value method for all awards 51,540 679,049
-------- ----------
Pro forma net (loss) income $(38,585) $ 590,833
======== ==========
Basic and diluted income per share:
Basic, as reported $0.00 $0.08
Diluted, as reported $0.00 $0.08
Basic, pro forma $0.00 $0.04
Diluted, pro forma $0.00 $0.04

The effects of applying SFAS No. 123 in this pro forma disclosure may not be
representative of the effects on reported net income for future periods.

Other Comprehensive Income

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

Recent Accounting Pronouncements

fiscal years beginning after November 15, 2007, and interim periods within those
fiscal years. We do not expect the adoption of SFAS No. 157 to have a material
impact on our financial position or results of operations.

In June 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), "Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109."
FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with SFAS No. 109. This
interpretation prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. This interpretation is effective for fiscal
years beginning after December 31, 2006. We have not yet assessed the impact of
the adoption of FIN 48 on our financial position or results of operations.

In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS No. 154"). This statement changes the requirements for the accounting for
and reporting of a change in accounting principle. SFAS No. 154 requires
retrospective application to prior periods' financial statements of changes in
accounting principle and is limited to direct effects of the change. This
statement became effective for the Company on January 1, 2006, and has not had a
material effect on the Company's financial position or results of operations.

2. ACQUISITIONS

Effective April 1, 2005, the Company acquired substantially all of the drilling
assets (the drilling business) of SPA Drilling L.P. The aggregate cash purchase
price for the drilling assets was $20,320,000. This acquisition provided the
Company with a foothold in the North Texas market. Also, effective April 1,
2005, the Company acquired all the outstanding stock of Thornton Drilling
Company. The aggregate purchase price of approximately $29,197,000 (including
transaction costs of approximately $269,000) consisted of common shares valued
at approximately $2,000,000 and $26,928,000 in cash. The transaction has been
accounted for as a purchase. The purchase price has been allocated to the assets
acquired and liabilities assumed based upon their respective fair market values.
The fair market value of the property and equipment was determined by an
independent appraisal. The fair market values of the identified intangible
assets were determined by an independent valuation and certain assets will be
amortized to expense over their estimated useful lives. The excess of the
purchase price over the fair value of assets acquired and liabilities assumed in
the acquisition of approximately $7,843,000 is classified as goodwill. The
allocation of the assets acquired and liabilities assumed of Thornton Drilling
Company are as follows (in thousands):

Amount
-------
Current assets $ 5,465
Property and equipment 20,765
Identified intangible assets 4,000
Goodwill 7,843
Deferred tax asset 807
Other long-term assets 113
Current liabilities (1,744)
Deferred tax liabilities (8,052)
-------
$29,197
=======

Refer to Note 1 in the financial statements for further information regarding
corrections made to the purchase price allocation in the third quarter of 2006.

The following pro forma information gives effect to the Thornton Drilling
Company acquisition and the purchase of the drilling business of SPA Drilling,
L.P. as though they were effective as of the beginning of 2005. Pro forma
adjustments primarily relate to additional depreciation, amortization and
interest costs. The information reflects our historical data and historical data
from these acquired businesses. The pro forma data may not be indicative of the
results we would have achieved had we completed these acquisitions on January 1,
2005, or that we may achieve in

the future. The pro forma financial information should be read in conjunction
with the accompanying historical financial statements.

Pro Forma
Nine Months Ended
September 30, 2005
-------------------------------------
(in thousands, except per share data)
Total revenues $109,485
Net income $ 1,830
Earnings per common share:
Basic $ 0.09
Diluted $ 0.08

The fair market values of identified intangible assets were determined by an
independent valuation and certain intangible assets will be amortized to expense
over their estimated useful lives. Customer relations are amortized over their
estimated benefit period of 20 years. Intangibles related to the non-compete
agreement are amortized over the period of the non-compete agreement of two
years subsequent to the termination of the named executive prior to fulfilling
the term of his employment agreement. Depreciation and amortization includes
amortization of intangibles of $89,722 and $224,722, respectively, for the three
and nine months ended September 30, 2006.

The total cost and accumulated amortization of intangible assets related to our
2005 acquisition are as follows:

September 30, December 31,
2006 2005
------------- ------------
Customer relations $ 2,200,000 $ 2,200,000
Non-compete agreement 800,000 800,000
Trade name 1,000,000 1,000,000
----------- -----------
Intangible assets 4,000,000 4,000,000
----------- -----------
Customer relations (165,000) (82,500)
Non-compete agreement (262,222) (120,000)
----------- -----------
Accumulated amortization (427,222) (202,500)
----------- -----------
Intangible assets (net) $ 3,572,778 $ 3,797,500
=========== ===========

3. RELATED-PARTY TRANSACTIONS

During 2005, the Company entered into contract arrangements with Triana Energy,
Inc. and Columbia Natural Resources, which was purchased by Triana in August
2003, and sold by Triana Energy, Inc. in December 2005. The Company's former
Vice Chairman of the Board of Directors is the Chief Executive Officer of Triana
Energy, Inc. Effective December 31, 2005, the Chief Executive Officer of Triana
Energy, Inc. resigned as the Vice Chairman of the Board of Directors and as a
Director. During the three and nine months ended September 30, 2005, the Company
had revenues related to transactions with Columbia Natural Resources and Triana
Energy, Inc. of $1,188,134 and $4,138,099, respectively. At December 31, 2005,
the Company had accounts receivable from Columbia Natural Resources and Triana
Energy, Inc. of $481,657.

William R. Ziegler, a member of our board of directors through March 31, 2006,
is of counsel to Satterlee Stephens Burke & Burke LLP, legal counsel for the
Company. During the three months ended March 31, 2006, legal fees related to
transactions with Satterlee Stephens Burke & Burke LLP were $49,985. During the
three and nine months ended September 30, 2005, legal fees were $220,603 and
$364,159, respectively. At December 31, 2005, the Company had no outstanding
accounts payable to Satterlee Stephens Burke & Burke LLP.

4. ACCOUNTS RECEIVABLE

Accounts receivable consist of the following:

September 30, December 31,
2006 2005
------------- ------------

Billed receivables $41,422,799 $20,829,400
Unbilled receivables 5,741,030 7,063,290
----------- -----------
Total receivables 47,163,829 27,892,690
Allowance for doubtful accounts (869,919) (313,436)
----------- -----------
Net receivables $46,293,910 $27,579,254
=========== ===========

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.

5. PROPERTY, BUILDINGS AND EQUIPMENT

Major classes of property, buildings and equipment are as follows:

September 30, December 31,
2006 2005
------------- ------------
Land $ 1,010,432 $ 967,432
Buildings 1,357,622 978,489
Drilling equipment 188,193,267 135,617,519
Vehicles 7,240,384 5,949,101
Furniture and fixtures 127,180 37,977
Computer equipment 628,885 595,702
Leasehold improvements 78,175 78,175
Construction in progress 34,742,085 22,809,603
------------ ------------
233,378,030 167,033,998
Less accumulated depreciation (62,059,576) (46,250,906)
------------ ------------
$171,318,454 $120,783,092
============ ============

Property, buildings and equipment include capitalized interest of $1,227,285 and
$307,254 as of September 30, 2006 and December 31, 2005, respectively.

6. ACCRUED EXPENSES AND OTHER LIABILITIES

A detail of accrued expenses and other liabilities is as follows:

September 30, December 31,
2006 2005
------------- ------------

Accrued payroll and bonus $4,596,793 $2,709,219
Accrued workers compensation 3,181,717 1,312,214
Other 660,861 1,331,875

---------- ----------
$8,439,371 $5,353,308
========== ==========

7. REVOLVING CREDIT FACILITY AND LONG-TERM OBLIGATIONS

The Company entered into a Revolving Credit and Security Agreement with PNC
Bank, as agent for a group of lenders, dated March 31, 2005, which matures on
March 30, 2009, that was subsequently amended on April 19, August 15, October 5,
2005 and September 27, 2006, which provides for a borrowing base equal to the
lesser of $60,000,000 or the sum of 85% of eligible receivables and 75% of the
liquidation value of eligible rig fleet equipment. There is a $7,500,000
sublimit for letters of credit. Amounts outstanding under the revolving credit
facility bear interest at either (i) the higher of the Federal Funds Open Rate
plus one half of 1.00% or the base commercial lending rate of the agent for the
lenders (8.25% at September 30, 2006) or (ii) LIBOR plus 2.00% (7.3725% at
September 30, 2006). As of September 30, 2006, approximately $30.2 million was
outstanding under the Revolving Credit and Security Agreement. As of December
31, 2005, the Company had no outstanding loans under this revolving credit
facility. As of September 30, 2006 and December 31, 2005, $3.2 million and $2.7
million, respectively, of the total capacity has been utilized to support the
Company's letter of credit requirement.

The Revolving Credit and Security Agreement is secured by substantially all of
our assets, with certain exceptions, and contains affirmative and negative
covenants and provides for events of default that are typical for an agreement
of this type. Among the affirmative covenants are requirements to maintain a
specified tangible net worth (initially $43 million) and a fixed charge coverage
ratio of 1.10 to 1.00. Among the negative covenants are restrictions on major
corporate transactions, capital expenditures, payment of dividends, incurrence
of indebtedness, and amendments to our organizational documents. Net capital
expenditures (excluding acquisitions) were limited to $45 million in 2005 and
$10 million in subsequent years, but those amounts are increased by permitted
equity issuance proceeds and the unused amounts can be carried over to the next
fiscal year. On September 27, 2006, the Agreement was amended to increase the
2006 net capital expenditure limitation to $125 million. Among the events of
default are a change in control and any change in our operations or condition,
which has a material adverse effect. As of September 30, 2006, the Company was
in compliance with all debt covenants.

In addition, the Company has entered into various equipment-specific financing
agreements with several third-party financing institutions. The terms of these
agreements range from 36 to 60 months. As of September 30, 2006 and December 31,
2005, the total outstanding balance under these arrangements, including
principal and interest, was $8,409,123 and $8,757,891, respectively. The
interest rate on these borrowings ranges from 3.5% to 7.5%.

8. COMMITMENTS AND CONTINGENCIES

Due to the nature of our business, we are, from time to time, involved in
routine litigation or subject to disputes or claims related to our business
activities, including workers' compensation claims and employment-related
disputes. The Company is a defendant in a lawsuit brought in U.S. District Court
to determine insurance coverage for the death of a well worker. The Company
intends to vigorously defend the claim; however, an unfavorable outcome is
reasonably possible. The Company could experience a potential loss of
approximately $500,000 to $700,000. The Company has not reserved any amounts for
this legal matter. In the opinion of our management, no other such pending
litigation, disputes or claims against us will have a material adverse effect on
our financial condition, results of operations or cash flow from operations, and
there is only a remote possibility that any such other matter will require any
additional loss accrual.

NOV $250,000 toward the purchase price of such equipment. In December 2005, the
Company made a further downpayment of $6,936,500 on the first three rigs. Also
in December 2005, the Company paid $1 million to NOV for an option to acquire an
additional three rigs and related equipment for an aggregate purchase price of
$25.2 million. In April 2006, the Company exercised this option and entered into
a purchase and sale agreement with NOV for the additional three rigs, making a
down payment of $6,545,825. The $1 million previously paid by the Company for
the option to purchase the rigs will be applied against the purchase price of
the rigs. All six rigs are capable of horizontal and underbalanced drilling. As
of September 30, 2006, two of the six rigs have been delivered and are currently
in service in the Fort Worth Basin.

The Company leases its corporate office in Fort Worth, Texas. The total
commitment cost through September 30, 2010 is approximately $830,000.

The Company has signed a multi-year contract with a customer that involves
moving the rigs currently employed in the Rockies to eastern Arkansas for
drilling in the Fayetteville Shale. This move will begin in late 2006, after the
rigs fulfill their contractual responsibilities in the Rockies.

In September, 2006, the Company signed a five year lease commencing on October
1, 2006 for an office building and maintenance facility in Searcy, Arkansas. The
total commitment cost is approximately $720,000.

9. STOCKHOLDERS' EQUITY

At September 30, 2006, the number of authorized shares of common and preferred
stock was 75,000,000 and 100,000 shares, respectively, of which 21,367,192 and
zero were outstanding, and 2,492,146 and zero were reserved for future issuance.

On October 6, 2005, the Company effected a stock dividend of 1.6325872 shares
for each outstanding share of common stock. All common stock prices and amounts
impacted by the dividend have been retroactively adjusted. Certain share
calculations resulting in fractional amounts have been truncated.

10. EARNINGS PER COMMON SHARE

The following table presents a reconciliation of the numerators and denominators
of the basic earnings per share and diluted earnings per share computations as
required by SFAS No. 128:

Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------

Net income $ 9,793,682 $ 12,955 $23,224,669 $ 1,269,882
=========== =========== =========== ===========
Weighted average shares outstanding 21,337,507 16,226,591 21,239,735 15,205,373
Incremental shares from assumed
conversion of stock options 298,997 947,719 327,709 809,686
----------- ----------- ----------- -----------
Weighted average and assumed
incremental shares 21,636,504 17,174,310 21,567,444 16,015,059
=========== =========== =========== ===========
Earnings per share:
Basic $ 0.46 $ 0.00 $ 1.09 $ 0.08
=========== =========== =========== ===========
Diluted $ 0.45 $ 0.00 $ 1.08 $ 0.08
=========== =========== =========== ===========

Basic earnings per share has been computed by dividing net income by weighted
average shares outstanding.

Diluted earnings per share has been computed by dividing net income by weighted
average shares outstanding and assumed incremental shares from assumed
conversion of stock options.

11. MANAGEMENT COMPENSATION

Stock Option Plans

The Company has two stock option plans, the 2005 Stock Option Plan and the
Amended and Restated 2000 Stock Option Plan. Under each plan, 1,579,552 shares
have been authorized for awards of stock options. As of September 30, 2006,
654,275 options have been granted under the 2005 Stock Option Plan and 1,404,401
options have been granted under the Amended and Restated 2000 Stock Option Plan.
In addition, 132,958 options were granted outside the plans in 1999. Options
typically vest in four equal annual installments from the grant date and expire
on the tenth anniversary of the grant date.

A summary of stock option activity for the nine months ended September 30, 2006
is as follows:

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

Outstanding at December 31, 2005 1,541,380 $ 7.21
Granted 122,500 $15.38
Exercised (201,083) $ 3.80
Forfeited (71,079) $14.00

--------- ------
Outstanding at September 30, 2006 1,391,718 $ 8.07 6.77 $4,074,661
========= ====== ==== ==========

Options exercisable at September 30, 2006 604,496 $ 3.52 4.53 $4,523,894
========= ====== ==== ==========

Total unamortized stock-based compensation was $2,874,310 at September 30, 2006,
and will be recognized over the weighted average service period of 2.29 years.

The weighted average fair value of options granted during the period is $6.39.
The total fair value of options vested during the period is $828,326.

Cash received from exercise of options during the nine months ended September
30, 2006 was $764,115. New shares are issued to satisfy options exercised. The
total intrinsic value of options exercised during the period is $2,221,231.

Employee Benefit Plan

The Company has a 401(k) employee benefit plan covering substantially all of its
employees. Company contributions to the plan are discretionary. The Company made
employee matching contributions of $89,638 and $216,731 during the three and
nine months ended September 30, 2006, respectively.

Contingent Management Compensation

Certain members of the Company management and certain other participants have
been awarded rights to participate in the proceeds associated with the
appreciation in value ultimately associated with dispositions of the Company's
shares by Union Drilling Company LLC (UDC). 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 Company management participants in this arrangement are 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 these individuals at fair market
value, which includes consideration of the threshold amount in the determination
of that value, upon termination of their employment by the Company.

At September 30, 2006 and December 31, 2005, the threshold amounts were $28.4
million and $26.5 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, 2006, $264,998 and $253,907,
respectively, of compensation cost reversals was recognized by the Company in
its condensed consolidated statements of income as a result of the decreases in
fair value of the assets owned by UDC exceeding the threshold. This amount is
classified as general and administrative expense.

The defined group of participants in this arrangement would be entitled to up to
22.5% of the value realized in excess of the threshold amount. Members of
Company management are entitled to approximately 4% of the 22.5%.

12. INCOME TAXES

Income tax expense for the three and nine months ended September 30, 2006 was
$7,217,099 and $16,589,146, respectively, which is an effective rate of 42.4%
and 41.7%, respectively, of pre-tax book income. This rate was calculated using
estimated full year pre-tax book income, adjusted for permanent book/tax
differences associated with non-cash compensation expense and meals and
entertainment expense. For both the three and nine months ended September 30,
2005, income tax expense was $2,292,371. The Company had domestic net operating
loss carryforwards of approximately $15.4 million at December 31, 2005. During
the third quarter of 2006, the Company recognized a $1,059,000 additional charge
to its income tax provision, which related to prior periods, and corrected its
deferred tax liability and deferred tax asset balances. Refer to Note 1 in the
financial statements for further information regarding this correction.

13. SUBSEQUENT EVENT

On October 27, 2006, the Company announced the resignation of J. Michael Poole
from his position as Executive Vice President, Operations, effective October 31,
2006. Christopher Strong, President and Chief Executive Officer will fulfill
Poole's duties on an interim basis.

On October 10, 2006, the Company paid its final installment and took delivery of
the third of the six NOV rigs. The rig is currently operating in the Fort Worth
Basin. The remaining three rigs are scheduled for delivery over the next three
months.

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

Statements we make in the following discussion that express a belief,
expectation or intention, as well as those which are not historical fact, are
forward-looking statements that are subject to risks, uncertainties and
assumptions. Our actual results, performance or achievements, or industry
results, could differ materially from those we express in the following
discussion as a result of a variety of factors, 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 the environment. See Item 1A Risk Factors of our Form 10-K for the
year ended December 31, 2005.

COMPANY OVERVIEW

Union Drilling Inc. provides contract land drilling services and equipment,
primarily to natural gas producers in the U.S. In addition to our drilling rigs,
we provide the drilling crews and most of the ancillary equipment needed to
operate our drilling rigs. We commenced operations in 1997 with 12 drilling rigs
and related equipment acquired from a predecessor that was 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 74 land drilling rigs, of which 67 are marketed and seven are stacked. We
have focused our operations in selected natural gas production regions in the
United States. We do not invest in oil and natural gas properties. The drilling
activity of our customers is highly dependent on the current price of oil and
natural gas.

In response to rising demand from our customers for equipment that is capable of
efficiently drilling wells in unconventional natural gas formations, we
completed several transactions in 2005 and the first nine months of 2006 that
enhanced our ability to serve these markets. In April 2005, we acquired Thornton
Drilling Company, which owned a fleet of 12 rigs and leased an additional rig
operating in the Arkoma Basin, and eight rigs from SPA Drilling L.P., five of
which are targeting the Barnett Shale formation in the Fort Worth Basin. In June
2005 and August 2005, we acquired six more rigs, five of which target the
Barnett Shale formation in the Fort Worth Basin. During 2006, we have continued
to add new and newly constructed rigs to our fleet to capitalize on our
customers' rapidly growing unconventional resource exploration and development
activity.

A significant performance measurement in our industry is rig utilization. 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 rig. Revenue days for each rig are days when the
rig is earning revenues under a contract, which is generally a period from the
date the rig begins moving to the drilling location until the rig is released
from the contract.

For the three and nine months ended September 30, 2006 and 2005, our marketed
rig utilization, revenue days and average total number of rigs were as follows:

Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2006 2005 2006 2005
----- ----- ------ -----
Marketed rig utilization rates 79.0% 67.1% 77.4% 58.9%
Revenue days 4,732 3,686 13,430 8,394
Average total number of rigs 72.7 66.3 70.9 57.8

The reasons for the increase in the number of revenue days in 2006 over 2005 are
the increase in size of our rig fleet and the improvement in our overall rig
utilization rate due to improved market conditions. A significant factor
contributing to the growth in the number of rigs and revenue days was the
aforementioned acquisitions in 2005 and 2006.

We devote substantial resources to maintaining and upgrading our rig fleet. On a
regular basis, we remove certain rigs from service to perform upgrades. In the
short term, these actions result in fewer revenue days and slightly lower
utilization; however, in the long term, we believe the upgrades will help the
marketability of the rigs and improve their operating performance. We are
currently performing or have recently performed, between contracts or as
necessary, safety and equipment upgrades to various rigs in our fleet.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

REVENUE AND COST RECOGNITION - We generate revenue principally by drilling wells
for natural gas producers on a contracted basis 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.

At September 30, 2006, our contract drilling work in progress totaled
approximately $5.7 million, and approximately $7.1 million at December 31, 2005,
all of which relates to the revenue recognized but not yet billed on daywork and
footage contracts in progress at September 30, 2006 and December 31, 2005,
respectively. The decrease is due primarily to an increase in progress billings
and more efficient processing of customer invoices.

ACCOUNTS RECEIVABLE- We evaluate the creditworthiness of our customers based on
their financial information, if available, information obtained from major
industry suppliers and past experiences with customers. In some instances, we
require new customers to establish escrow accounts or make prepayments. We
typically invoice our customers at 15 or 30 day intervals during the performance
of daywork contracts and upon completion of the daywork contract. Footage
contracts are invoiced upon completion of the contract. Our contracts generally
provide for payment of invoices in 30 days. We established an allowance for
doubtful accounts of approximately $870,000 at September 30, 2006 and
approximately $313,000 at December 31, 2005. 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 industry as a whole. We write off specific accounts
receivable when they become uncollectible.

ACCRUED EXPENSES - Our other accrued expenses as of September 30, 2006 and
December 31, 2005 included accruals of approximately $3.2 million and $1.3
million, respectively, for costs under our workers' compensation insurance. We
have a deductible of $100,000 per covered accident under our workers'
compensation insurance. Our insurance policy requires us to maintain a letter of
credit to cover payments by us of that deductible. As of September 30, 2006, we
satisfied this requirement with a $3.2 million letter of credit with our bank
and our borrowing capacity under our revolving credit agreement with our bank
has been reduced by the same amount collateralizing such letter of credit. 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, estimates for claims paid directly by us, our
estimate of the administrative costs associated with these claims and our
historical experience with these types of claims. In addition, we accrue on a
monthly basis the estimated workers compensation premium payable to the two
states (West Virginia and Ohio) that are considered monopolistic.

STOCK-BASED COMPENSATION - Effective January 1, 2006, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 123(R), "Share-Based
Payment, revised 2004" ("SFAS No. 123R"). The Company adopted the standard by
using the modified prospective method provided for under SFAS No. 123R. SFAS No.
123R, which revised SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS No. 123"), requires that the cost resulting from all share-based payment
transactions be measured at fair value and recognized in the financial
statements. For the three and nine months ended September 30, 2006, the Company
has recorded total stock-based compensation expense of $257,973 ($173,230 net of
tax) and $786,079 ($546,052, net of tax), respectively. The remaining estimated
pretax amortization on these outstanding options of approximately $2.9 million
will be recognized through April, 2011. The condensed consolidated statements of
income for the three and nine months ended September 30, 2005, have not been
restated to reflect stock-based compensation expense in

accordance with SFAS No. 123R. During the three months ended September 30, 2006,
100,000 options were granted, no options vested, 71,079 options were forfeited
and 53,000 options were exercised. During the nine months ended September 30,
2006, 122,500 options were granted, 154,664 options vested, 71,079 options were
forfeited and 201,083 options were exercised. During the nine months ended
September 30, 2005, 527,754 options were granted. New shares are issued to
satisfy options exercised.

The fair value of option grants during the three months ended September 30, 2006
was determined using the Black-Scholes option valuation model. The key input
variables used in valuing the options were: risk-free interest rates of
approximately 4.98%; dividend yield of zero; stock price volatility of 55.4%;
and expected term of 5.5 years.

The risk-free interest rate is the implied yield available for zero-coupon U.S.
government issues with a remaining term equal to the expected life of the
options.

The expected lives of the options are determined based on the Company's
expectations of individual option holders anticipated behavior and the term of
the option.

The Company has not paid out dividends historically; thus, the dividend yield is
estimated at zero percent.

Volatility is based upon price performance of 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.

Prior to the implementation of SFAS No. 123R, the Company accounted for
stock-based compensation under SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure" ("SFAS No. 148"), and the
disclosure-only provisions of SFAS No. 123. SFAS No. 123 permitted the Company
to continue accounting for stock-based compensation as set forth in APB Opinion
No. 25, "Accounting for Stock Issued to Employees," provided the Company
disclosed the pro forma effect on net income and earnings per share of adopting
the full provisions of SFAS No. 123. Accordingly, the Company continued to
account for stock-based compensation under APB Opinion No. 25 and provided the
required pro forma disclosures.

RESULTS OF OPERATIONS

Our operations consist of drilling natural gas wells for our customers under
either daywork or 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 and the anticipated duration of the work to be performed. Our
contracts generally provide for the drilling of a single well or series of wells
and typically permit the customer to terminate on short notice.

The current demand for drilling rigs greatly influences the types of contracts
we are able to obtain. As the demand for rigs increases, daywork rates move up
and we are able to switch primarily to daywork contracts.

STATEMENTS OF OPERATIONS ANALYSIS

The following table provides selected information about our operations for the
three and nine months ended September 30, 2006 and 2005 (in thousands, except
day and per day data).

Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2006 2005 2006 2005
------- -------- -------- -------

Drilling revenues $69,482 $43,230 $184,877 $95,164

Drilling operations expenses $40,836 $31,639 $113,298 $70,448

Depreciation and amortization $ 6,334 $ 4,251 $ 17,079 $10,387
General and administrative expense $ 5,200 $ 4,324 $ 15,034 $ 9,175
Interest expense $ (212) $ (901) $ (213) $(1,905)
Other income and gain on sale of fixed assets $ 111 $ 190 $ 561 $ 313

Revenue days during period 4,732 3,686 13,430 8,394

Drilling revenue per revenue day $14,683 $11,728 $ 13,766 $11,337
Drilling cost per revenue day $ 8,630 $ 8,584 $ 8,436 $ 8,393
Rig utilization rates 79.0% 67.1% 77.4% 58.9%
Average number of rigs during the period 72.7 66.3 70.9 57.8

DRILLING REVENUES. Our contract drilling revenues grew by approximately $26.3
million, or 61%, in the three months ended September 30, 2006 compared to the
same period in 2005. Approximately $15.4 million of the increase was due to an
increase in revenue days, where revenue days increased by 1,046 days. In
addition, the average revenue per revenue day increased by $2,955 per day. The
improvement in average revenue per revenue day was a result of increases in our
contract rates due to stronger demand for our drilling services.

For the nine months ended September 30, 2006, contract drilling revenues
increased by approximately $89.7 million, or 94%, compared to the nine months
ended September 30, 2005. This increase was partially a result of the
acquisitions of Thornton Drilling Company and the assets of SPA Drilling, L.P.
on April 1, 2005. The revenues from these acquisitions during the first quarter
of 2006 accounted for $29.2 million of the revenue increase. The balance of the
increase of $60.6 million was due to an increase in revenue days, where revenue
days increased by 2,981 days. In addition, the average revenue per revenue day
increased by $2,352 per day. The improvement in average revenue per revenue day
was a result of increases in our contract rates due to stronger demand for our
drilling services.

DRILLING OPERATIONS EXPENSES. Our contract drilling costs in the three months
ended September 30, 2006 grew by approximately $9.2 million, or 29% compared to
the three months ended September 30, 2005. The increase was related to higher
revenues, however these expenses did not increase at the same rate as revenue
due to improvement in overall drilling margins associated with higher contract
rates.

Contract drilling costs increased $42.9 million during the first nine months of
2006 compared to the first nine months of 2005. This increase, as with the
increase in revenues discussed above, is partly due to the drilling operations
expenses related to Thornton Drilling Company and SPA Drilling, L.P.
acquisitions, which accounted for $17.4 million of the increase during the first
quarter of 2006. The remaining increase is primarily due to the increase in
number of revenue days during which drilling services were being provided,
however these expenses did not increase at the same rate as revenue due to
improvement in overall drilling margins associated with higher contract rates.

DEPRECIATION AND AMORTIZATION. Our depreciation and amortization expense in the
three and nine months ended September 30, 2006 increased by approximately $2.1
million, or 49%, and $6.7 million, or 64%, respectively, as compared to the same
periods in 2005, primarily as a result of the capital spending during the last
three months of 2005 and the first nine months of 2006 for rig purchases and
capital equipment upgrades. In addition, $2.6 million of the increase for the
nine month period is attributable to depreciation expense during the first
quarter of 2006 related to the assets acquired on April 1, 2005.

GENERAL AND ADMINISTRATIVE EXPENSES. Our general and administrative expenses
increased by approximately $876,000, or 20%, during the three months ended
September 30, 2006 compared to the three months ended September 30, 2005. The
third quarter of 2006 includes a $500,000 increase to the provision for doubtful
accounts. The remaining increase in general and administrative expenses is due
primarily to additional professional and consulting costs as a result of
becoming a public company in November 2005, increased insurance costs related to
the 2005 acquisitions and costs related to the corporate office relocation.

For the nine month period ended September 30, 2006 compared to the nine month
period ended September 30, 2005, general and administrative expenses increased
by approximately $5.9 million, or 64%, primarily due to the increase in
employment costs (including non-cash compensation costs), insurance costs,
additional professional and consulting costs and relocation costs. In addition,
approximately $917,000 of the increase is a result of first quarter 2006 general
and administrative costs associated with operations established to support the
purchase of SPA Drilling assets and the Thornton Drilling Company acquisition.

INTEREST EXPENSE. Interest expense decreased by approximately $689,000 and $1.7
million, respectively, for the three and nine months ended September 30, 2006
compared to the same periods in 2005. These decreases were due primarily to the
higher interest in 2005 related to the financing of the April 1, 2005
acquisitions, and interest capitalized in 2006 related to capital associated
with construction in progress. Much of these financing costs were repaid in the
fourth quarter of 2005 with the proceeds from the Company's initial public
offering.

OTHER INCOME AND GAIN ON SALE OF FIXED ASSETS. Other income and gain on sale of
fixed assets decreased by approximately $79,000 for the three ended September
30, 2006 compared to the three months ended September 30, 2005. For the nine
months ended September 30, 2006, other income and gain on sale of fixed assets
increased approximately $248,000. During the second quarter of 2006, the Company
received insurance settlement proceeds of approximately $456,000 related to a
2004 rig accident, resulting in a gain of approximately $274,000.

TAXES. Our effective income tax rate of approximately 42.4% and 41.7% for the
three and nine months ended September 30, 2006, respectively, differs from the
federal statutory rate of 34% due to related state income taxes and permanent
differences associated with meals and entertainment (primarily for our direct
service personnel) and non-cash compensation. Permanent differences are costs
included in results of operations in the accompanying financial statements,
which are not fully deductible for federal income tax purposes. During the third
quarter of 2006, the Company recognized a $1,059,000 additional charge to its
income tax provision, which related to prior periods. Refer to Note 1 in the
financial statements for further information regarding this correction. For both
the three and nine months ended September 30, 2005, income tax expense was
$2,292,371.

At December 31, 2005, we had domestic net operating loss carryforwards for
income tax purposes of approximately $15.4 million. These losses may be carried
forward for 20 years and will begin to expire in 2019. The state losses vary as
to carryforward period and will begin to expire in 2008, depending upon the
jurisdiction where applied. Based upon 2006 results and forecasted future
operations, we feel it is more likely than not that the amounts will be
realized.

LIQUIDITY AND CAPITAL RESOURCES

Sources of Capital Resources

Our rig fleet has grown from 12 rigs in 1997 to 73 rigs as of September 30,
2006. We have financed this growth with a combination of debt and equity
financing. We plan to continue to grow our rig fleet. At September 30, 2006, our
total debt to total capital was approximately 19.7%. Due to the volatility in
our industry, we are reluctant to take on substantial additional debt in excess
of the approximately $26.6 million of remaining availability under our

revolving credit facility. However, our ability to continue funding our growth
through the issuance of shares of our common stock is uncertain, as our common
stock is not heavily traded and the market price for our common stock has been
volatile in recent periods.

On April 1, 2005, we raised approximately $20 million, after expenses, through a
sale of shares of our common stock. These proceeds plus additional borrowing
under our revolving credit facility were used to fund the acquisitions of
Thornton Drilling Company, an Oklahoma-based drilling company which owned 12
drilling rigs and substantially all of the drilling assets (eight rigs) of SPA
Drilling L.P., a Texas-based drilling company.

On November 22, 2005, we also sold 4,411,765 shares of our common stock at
approximately $13.05 per share, net of underwriters' commissions, pursuant to a
public offering we registered with the Securities and Exchange Commission. The
net proceeds to Union, after expenses, of this sale were $55,379,482, and were
used primarily to repay indebtedness under our revolving credit facility.

We entered into a Revolving Credit and Security Agreement with PNC Bank, as
agent for a group of lenders, dated March 31, 2005, which matures on March 30,
2009, and subsequently amended on April 19, August 15, October 5, 2005 and
September 27, 2006, which provides for a borrowing base equal to the lesser of
$60,000,000 or the sum of 85% of eligible receivables and 75% of the liquidation
value of eligible rig fleet equipment. The agent may, in the exercise of its
reasonable business judgment, increase or decrease those percentage advance
rates against eligible receivables and liquidation value. The liquidation value
of eligible rig fleet equipment is determined annually (or semi-annually in
certain circumstances) by an independent appraisal, with adjustments for
acquisitions and dispositions between appraisals. There is a $7,500,000 sublimit
for letters of credit. Amounts outstanding under the revolving credit facility
bear interest at either (i) the higher of the Federal Funds Open Rate plus 1/2
of 1% or PNC Bank's base commercial lending rate (8.25% at September 30, 2006)
or (ii) LIBOR plus 2.00% (7.3725% at September 30, 2006). Those rates may
increase by up to 0.50% for LIBOR loans or up to 0.25% for domestic rate loans
if our fixed charge coverage ratio falls below certain targets.

Interest on outstanding loans is due monthly for domestic rate loans and at the
end of the relevant interest period for LIBOR loans. All outstanding principal
and interest is due at maturity on March 30, 2009. As of September 30, 2006, we
had a loan balance of approximately $30.2 million under the Revolving Credit and
Security Agreement, and an additional $3.2 million of the total capacity has
been utilized to support our letter of credit requirement. To date, the
revolving credit facility has been used to pay for rig acquisitions and for
working capital requirements. If we repay and terminate the obligations under
the Revolving Credit and Security Agreement, we would be liable for a prepayment
penalty.

Uses of Capital Resources

Effective April 1, 2005, the Company acquired all of the capital stock of
Thornton Drilling Company, an Oklahoma-based drilling company, which owned 12
drilling rigs. Also, effective the same date, the Company acquired substantially
all of the drilling assets (eight rigs) of SPA Drilling L.P., a Texas-based
drilling company. The total purchase price for these businesses was $49,517,419.
These acquisitions were financed by a new $50,000,000 revolving line of credit
with PNC Bank, as agent for a group of lenders, (subsequently amended - see
above), and collateralized by substantially all of the assets of the Company.
The previous debt facilities were both retired at that time. In addition, the
Company also received an equity infusion of approximately $20,000,000 from
private

investors. Also, the seller of Thornton Drilling Company received approximately
$2,000,000 in stock of Union Drilling Inc. as part of the transaction. The
funding of these transactions occurred on April 1, 2005.

In June 2005 and August 2005, the Company entered into agreements to purchase
six additional rigs for a total of $16,650,000.

In the fourth quarter of 2005, the Company acquired two new top head drive rigs
for approximately $1,700,000.

In December 2005, the Company entered into a contract with National Oilwell
Varco L.P. ("NOV") to acquire three rigs and related equipment for an aggregate
purchase price of $24 million. In November 2005, Union had paid NOV $250,000
toward the purchase price of such equipment. In December 2005, the Company made
a further downpayment of $6,936,500 on the first three rigs. Also in December
2005, the Company paid $1 million to NOV for an option to acquire an additional
three rigs and related equipment for an aggregate purchase price of $25.2
million. In April 2006, the Company exercised this option and entered into a
purchase and sale agreement with NOV for the additional three rigs, making a
down payment of $6,545,825. The $1 million previously paid by the Company for
the option to purchase the rigs will be applied against the purchase price of
the rigs. All six rigs, are capable of horizontal and underbalanced drilling. As
of September 30, 2006, two of the six rigs have been delivered and are currently
in service in the Fort Worth Basin.

In the first nine months of 2006, the Company acquired two rigs for deployment
in the Fayetteville Shale play in eastern Arkansas for a total purchase price of
$8.8 million. In addition, capital expenditures were made to maintain our
current fleet and refurbish existing equipment.

For the three and nine months ended September 30, 2006, the additions to our
property and equipment consisted of the following:

Three Months Nine Months
Ended Ended
September 30, 2006 September 30, 2006
------------------ ------------------
Land $ -- $ 43,000
Buildings -- 83,950
Drilling and well service equipment 24,471,860 65,665,271
Vehicles 656,485 2,225,443
Furniture and fixtures -- 89,204
Computer equipment -- 37,450
----------- -----------
$25,128,345 $68,144,318
=========== ===========

Working Capital

Our working capital increased $8.4 million to $34.0 million at September 30,
2006 from $25.6 million at December 31, 2005. Our current ratio, which we
calculate by dividing our current assets by our current liabilities, was 2.45 at
September 30, 2006 compared to 2.21 at December 31, 2005.

Our operations have historically generated sufficient cash flow to meet our
requirements for debt service and equipment expenditures (excluding major
business and asset acquisitions). The significant improvement in cash flow from
operating activities for the nine months ended September 30, 2006 over the nine
months ended September 30, 2005 is primarily due to the $22.0 million
improvement in net earnings, plus the approximate $6.7 million increase in
depreciation and amortization expense and the utilization of our deferred tax
asset of $7.3 million. We believe our cash generated by operations and our
ability to borrow the currently unused portion of our line of credit and letter
of credit facility of approximately $26.6 million, which takes into account
reductions for approximately $3.2 million of outstanding letters of credit as of
September 30, 2006, should allow us to meet our routine financial obligations
for the foreseeable future.

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

September 30, December 30,
2006 2005 Change
------------- ------------ -----------
Cash and cash equivalents $ 145,994 $ 2,388,276 $(2,242,282)
Receivables 46,293,910 28,060,911 18,232,999
Inventories 1,355,991 860,208 495,783
Prepaid expenses 3,041,171 4,930,431 (1,889,260)
Deferred taxes 6,574,036 10,542,730 (3,968,694)
----------- ----------- -----------
Current assets 57,411,102 46,782,556 10,628,546
----------- ----------- -----------
Accounts payable 11,559,771 9,240,626 2,319,145
Current debt 3,016,345 5,322,634 (2,306,289)
Current portion of advances
from customers 429,000 1,265,067 (836,067)
Accrued expenses 8,439,371 5,353,308 3,086,063
----------- ----------- -----------
Current liabilities 23,444,487 21,181,635 2,262,852
----------- ----------- -----------
Working capital $33,966,615 $25,600,921 $ 8,365,694
=========== =========== ===========

The increase in our receivables at September 30, 2006 from December 31, 2005 was
due primarily to the increase in revenue days during the third quarter of 2006,
compared to the fourth quarter of 2005, as well as an improvement in utilization
and revenue rates.

Prepaid expenses at September 30, 2006, include $1.5 million of accrued tax
receivables. Substantially all of the remaining prepaid expenses at September
30, 2006 and December 31, 2005 consisted of prepaid insurance. The decrease in
prepaid expenses from December 31, 2005 was due to $3.7 million amortization of
prepaid insurance during the nine months ended September 30, 2006 and
approximately $900,000 of collections on non-trade receivables in the first
quarter of 2006, partially offset by $1.4 million of insurance premiums paid in
2006 and the $1.5 million accrued tax receivables.

The decrease in the deferred tax asset is due to the use of some of the net
operating loss carryforward and during the third quarter of 2006, the Company
corrected its deferred tax asset by recording a $2,381,000 reduction to the
balance. Refer to Note 1 in the financial statements for further information
regarding this correction.

The increase in payables at September 30, 2006 from December 31, 2005 was
primarily due to higher supplies, repairs and capital expenditures resulting
from the increase in the size of our drilling rig fleet.

The increase in accrued expenses at September 30, 2006 from December 31, 2005
was due to the growth in payroll, workers compensation and other costs which can
be attributed to additional employee headcount. In addition, we have incurred
other expenses associated with being a public company, such as consulting fees
related to Sarbanes-Oxley and additional legal and audit fees.

Historically, we have not been required to make income tax payments due to net
operating loss ("NOL") carryforwards, however, due to the expected utilization
of those NOL's in 2006 and the limitation of NOL's associated with the change of
control provisions of Code Section 382, we made estimated tax payments of $9.8
million during the nine months ended September 30, 2006.

Long-term Debt

Our long-term debt at September 30, 2006 and December 31, 2005 consisted of the
following:

September 30, December 31,
2006 2005
------------- ------------
Revolving credit facility $30,202,500 $ --
Notes payable for equipment financed 7,661,963 7,825,984
Less current installments (2,366,698) (2,013,956)
----------- -----------
$35,497,765 $ 5,812,028
=========== ===========

CONTRACTUAL OBLIGATIONS

In December 2005, the Company entered into a contract with National Oilwell
Varco, L.P. ("NOV"), to acquire three rigs and related equipment for an
aggregate purchase price of $24 million. In November 2005, Union had paid NOV
$250,000 toward the purchase price of such equipment. In December 2005, the
Company made a further downpayment of $6,936,500 on the first three rigs. Also
in December 2005, the Company paid $1 million to NOV for an option to acquire an
additional three rigs and related equipment for an aggregate purchase price of
$25.2 million. In April 2006, the Company exercised this option and entered into
a purchase and sale agreement with NOV for the additional three rigs, making a
down payment of $6,545,825. The $1 million previously paid by the Company for
the option to purchase the rigs will be applied against the purchase price of
the rigs. All six rigs are capable of horizontal and underbalanced drilling. As
of September 30, 2006, two of the six rigs have been delivered and are currently
in service in the Fort Worth Basin.

The Company leases its corporate office in Fort Worth, Texas. The total
commitment cost through September 30, 2010 is approximately $830,000.

INFLATION

As a result of the relatively low levels of inflation during the past two years,
inflation did not significantly affect our results of operations in any of the
periods reported.

OFF BALANCE SHEET ARRANGEMENTS

We do not currently have any off balance sheet arrangements.

RECENTLY ISSUED ACCOUNTING STANDARDS

In September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 157 "Fair Value Measurements". This Statement defines fair value,
establishes a framework for measuring fair value in GAAP, and expands
disclosures about fair value measurements. SFAS No. 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. We do not expect the adoption of
SFAS No. 157 to have a material impact on our financial position or results of
operations.

taxes recognized in an enterprise's financial statements in accordance with SFAS
No. 109. This interpretation prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. This interpretation is effective for
fiscal years beginning after December 31, 2006. We do not expect the adoption of
FIN 48 to have a material impact on our financial position or results of
operations.

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 under
the facility at a floating rate. At September 30, 2006, we had approximately
$30.2 million outstanding debt on our revolving credit facility. An increase or
decrease of 1% in the interest rate would have a corresponding decrease or
increase in our net income of approximately $302,000 annually.

ITEM 4. CONTROLS AND PROCEDURES

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 that are 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 the Chief Executive
Officer and the Chief Financial Officer, 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 our company have
been detected.

As of September 30, 2006, an evaluation was carried out under the supervision
and with the participation of our management, including the Chief Executive
Officer and the Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls. Based upon that evaluation, the Chief
Executive Officer and the Chief Financial Officer 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.

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, 2006 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Due to the nature of our business, we are, from time to time, involved in
routine litigation or subject to disputes or claims related to our business
activities, including workers' compensation claims and employment-related
disputes. The Company is a defendant in a lawsuit brought in U.S. District Court
to determine insurance coverage for the death of a well worker. The Company
intends to vigorously defend the claim; however, an unfavorable outcome is
reasonably possible. The Company could experience a potential loss of
approximately $500,000 to $700,000. The Company has not reserved any amounts for
this legal matter. In the opinion of our management, no other such pending
litigation, disputes or claims against us will have a material adverse effect on
our financial condition, results of operations or cash flow from operations, and
there is only a remote possibliity that any such other matter will require any
additional loss accrual.

ITEM 6. EXHIBITS

The following exhibits are filed as part of this report or incorporated by
reference herein:

EXHIBIT
NUMBER DESCRIPTION
------- -------------------------------------------------------------------
3.1 -- Amended and Restated Certificate of Incorporation of Union
(incorporated by reference to Exhibit 3.1 to our Quarterly Report
on Form 10-Q (File No. 000-51630) filed on May 12, 2006).

3.2 -- Amended and Restated Bylaws of Union (incorporated by reference to
Exhibit 3.2 to our Quarterly Report on Form 10-Q (File No.
000-51630) filed on May 12, 2006).

4.1 -- Specimen Stock Certificate for the common stock, par value $0.01
per share, of Union (incorporated by reference to Exhibit 4.1 to
our Registration Statement on Form S-1 (File No. 333-127525) filed
on August 15, 2005).

10.1* -- Amended and Restated 2000 Stock Option Plan of Union (incorporated
by reference to Exhibit 10.1 to our Registration Statement on Form
S-1 (File No. 333-127525) filed on August 15, 2005).

10.2* -- Form of stock option agreements under the Amended and Restated 2000
Stock Option Plan (incorporated by reference to Exhibit 10.2 to our
Registration Statement on Form S-1 (File No. 333-127525) filed on
August 15, 2005).

10.3* -- Stock Option Plan and Agreement, dated May 13, 1999, by and between
Union and Christopher Strong (incorporated by reference to Exhibit
10.3 to our Registration Statement on Form S-1 (File No.
333-127525) filed on August 15, 2005).

10.4* -- 2005 Stock Option Plan of Union (incorporated by reference to
Exhibit 10.4 to our Registration Statement on Form S-1 (File No.
333-127525) filed on August 15, 2005).

10.5* -- Form of stock option agreements under the 2005 Stock Option Plan
(incorporated by reference to Exhibit 10.5 to our Registration
Statement on Form S-1 (File No. 333-127525) filed on August 15,
2005).

10.6 -- Form of Stockholders Agreement by and among Union and certain of
its direct and indirect stockholders (incorporated by reference to
Exhibit 10.6 to Amendment No. 2 to our Registration Statement on
Form S-1 (File No. 333-127525) filed on October 18, 2005).

10.7 -- Revolving Credit and Security Agreement, dated March 31, 2005,
between Union the lenders signatory thereto and PNC Bank, as agent
for the lenders, together with the First Amendment dated April 19,
2005 (incorporated by reference to Exhibit 10.7 to our Registration
Statement on Form S-1 (File No. 333-127525) filed on August 15,
2005).

10.8 -- Stock Purchase Agreement, dated as of March 31, 2005, by and
between Union and Richard Thornton, the sole stockholder of
Thornton Drilling Company (incorporated by reference to Exhibit
10.8 to our Registration Statement on Form S-1 (File No.
333-127525) filed on August 15, 2005).

10.9 -- Registration Rights Agreement, dated as of March 31, 2005, between
Union and Richard Thornton (incorporated by reference to Exhibit
10.9 to our Registration Statement on Form S-1 (File No.
333-127525) filed on August 15, 2005).

10.10* -- Employment Agreement, dated as of March 31, 2005, between Union and
Richard Thornton (incorporated by reference to Exhibit 10.10 to our
Registration Statement on Form S-1 (File No. 333-127525) filed on
August 15, 2005).

10.11 -- Stock Purchase Agreement, dated as of March 31, 2005, by and
between Union, Steven A. Webster, Wolf Marine S.A. and William R.
Ziegler (incorporated by reference to Exhibit 10.11 to our
Registration Statement on Form S-1 (File No. 333-127525) filed on
August 15, 2005).

10.12 -- Option and Asset Purchase and Sale Agreement dated as of February
28, 2005 between Thornton Drilling Company and SPA Drilling, LP;
Amendment No. 1 to Purchase and Sale Agreement between Thornton
Drilling Company and SPA Drilling, LP; and Assignment and

Assumption Agreement between Thornton Drilling Company and Union
Drilling Texas, LP. (incorporated by reference to Exhibit 10.12 to
Amendment No. 4 to our Registration Statement on Form S-1 (File No.
333-127525) filed on November 7, 2005).

10.13 -- Asset Purchase Agreement, dated May 31, 2005, between C and L
Services, LP and Union Drilling Texas, LP. (incorporated by
reference to Exhibit 10.13 to our Registration Statement on Form
S-1 (File No. 333-127525) filed on August 15, 2005).

10.14 -- Forms of Indemnification Agreement with Union directors and certain
of its officers (incorporated by reference to Exhibit 10.14 to
Amendment No. 2 to our Registration Statement on Form S-1 (File No.
333-127525) filed on October 18, 2005).

10.15 -- Second Amendment, dated August 15, 2005, to the Revolving Credit
and Security Agreement between Union, the lenders signatory thereto
and PNC Bank, as agent for the lenders (incorporated by reference
to Exhibit 10.15 to Amendment No. 1 to our Registration Statement
on Form S-1 (File No. 333-127525) filed on September 28, 2005).

10.16 -- Asset Purchase Agreement, dated August 12, 2005, between C and L
Services, LP and Union Drilling Texas, LP. (incorporated by
reference to Exhibit 10.16 to Amendment No. 1 to our Registration
Statement on Form S-1 (File No. 333-127525) filed on September 28,
2005).

10.17 -- Third Amendment, dated October 5, 2005, to the Revolving Credit and
Security Agreement between Union, the lenders signatory thereto and
PNC Bank, as agent for the lenders (incorporated by reference to
Exhibit 10.17 to Amendment No. 2 to our Registration Statement on
Form S-1 (File No. 333-127525) filed on October 18, 2005).

10.18 -- Option to purchase drilling rigs from National Oilwell Varco
(incorporated by reference to Exhibit 10.18 to Amendment No. 4 to
our Registration Statement on Form S-1 (File No. 333-127525) filed
on November 7, 2005).

10.19 -- Purchase and Sale Agreement, dated December 8, 2005, between Union
and National-Oilwell, L.P., relating to the purchase of three
drilling rigs (incorporated by reference to Exhibit 10.1 to our
Form 8-K (File No. 000-51630) filed on December 13, 2005).

10.20 -- Option Agreement, dated December 8, 2005, between Union and
National-Oilwell, L.P., relating to the purchase of three drilling
rigs (incorporated by reference to Exhibit 10.2 to our Form 8-K
(File No. 000-51630) filed on December 13, 2005).

10.21 -- Assets Purchase Agreement, dated December 19, 2005, between Permian
Drilling Corporation and Maverick Oil and Gas, Inc., (incorporated
by reference to Exhibit 10.1 to our Form 8-K (File No. 000-51630)
filed on February 3, 2006).

10.22 -- Agreement Regarding Assignment and Assumption of Rights and
Obligations under Assets Purchase Agreement, dated January 30,
2006, between Maverick Oil and Gas, Inc. and Thornton Drilling
Company; (incorporated by reference to Exhibit 10.1 to our Form 8-K
(File No. 000-51630) filed on February 3, 2006).

10.23 -- Addendum to Assets Purchase Agreement and Letter Agreement, dated
January 30, 2006, between Permian Drilling Corporation, Maverick
Oil and Gas, Inc. and Thornton Drilling Company, (incorporated by
reference to Exhibit 10.1 to our Form 8-K (File No. 000-51630)
filed on February 3, 2006).

10.24 -- Purchase and Sale Agreement dated April 21, 2006 between Union and
National-Oilwell, L.P., relating to the purchase price of three
drilling rigs (incorporated by reference to Exhibit 10.2 to our
Form 8-K (File No. 000-51630) filed on May 2, 2006).

10.25 -- Fourth Amendment to Revolving Credit and Security Agreement, dated
September 27, 2006, between Union Drilling, Inc., Thorton Drilling
Company, Union Drilling Texas L.P., and PNC Bank, National
Association, for itself and for other lenders (incorporated by
reference to Exhibit 10.1 to our Form 8-K (File No. 000-51630)
filed on September 28, 2006).

21.1 -- List of Subsidiaries (incorporated by reference to Exhibit 21.1 to
our Form 10-K (File No. 000-51630) filed on March 28, 2006).

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.**

----------
* Management contract or compensatory plan or arrangement.

** This certification is being furnished solely to accompany this Quarterly
Report pursuant to 18 U.S.C. Section 1350, and is not being filed for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended,
and is not to be incorporated by reference to any filing of the Company,
whether made before or after the date hereof, regardless of any general
incorporation language in such filing.

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.

/s/ Dan E. Steigerwald
----------------------------------------
Dan E. Steigerwald
Vice President, Chief Financial Officer,
Treasurer and Secretary
(Principal Financial and Accounting
Officer)

Dated: November 13, 2006