10-Q 1 form10q.txt 1 SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 Form 10-Q ____________________ (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-12757 TMBR/SHARP DRILLING, INC. (Exact name of registrant as specified in its charter) TEXAS 75-1835108 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4607 WEST INDUSTRIAL BLVD. MIDLAND, TEXAS 79703 (Address of principal executive offices) (Zip Code) Registrant's telephone number (including area code) (915) 699-5050 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 At August 1, 2002, 5,419,486 shares of the issuer's common stock, $.10 par value, were outstanding. 2 TMBR/SHARP DRILLING, INC. FORM 10-Q REPORT INDEX Page No. Part I. Financial Information (Unaudited) Item 1. Financial Statements Balance Sheets, June 30, 2002 and March 31, 2002 . . . . . . . . . . . . . . . . . . . . 3 Statements of Operations, Three Months Ended June 30, 2002 and 2001 . . . . . . . . . . . . . 5 Statements of Stockholders' Equity . . . . . . . . . . . . . . . . . . . . . . . . 7 Statements of Cash Flows, Three Months Ended June 30, 2002 and 2001 .. . . . . . . . . . . . 8 Notes to Financial Statements. . . . . . . . . . . . . . 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . . . . . . . . 15 Item 3. Quantitative and Qualitative Disclosures About Market Risk. . . . . . . . . . . . . . . . . . . 20 Part II. Other Information Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . . 21 Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . 21 -2- 3 PART ONE - FINANCIAL INFORMATION (UNAUDITED) Item 1. FINANCIAL STATEMENTS TMBR/SHARP DRILLING, INC. BALANCE SHEETS June 30, 2002 (Unaudited) and March 31, 2002 (In thousands, except per share data) June 30, 2002 March 31, ASSETS (Unaudited) 2002 ------ ------------- ----------- Current assets: Cash and cash equivalents $ 3,455 $ 3,258 Marketable securities 90 97 Trade receivables, net of allowance for doubtful accounts of $1,401 on both June 30 and March 31, 2002 11,579 11,011 Inventories 155 162 Deposits 346 346 Other 1,017 1,018 -------- -------- Total current assets 16,642 15,892 -------- -------- Property and equipment, at cost: Drilling equipment 63,021 61,370 Oil and gas properties, based on successful efforts accounting 36,454 34,616 Other property and equipment 3,757 3,531 -------- -------- 103,232 99,517 Less accumulated depreciation, depletion and amortization (74,430) (72,947) -------- -------- Net property and equipment 28,802 26,570 -------- -------- Other assets 173 173 -------- -------- Total assets $ 45,617 $ 42,635 ======== ======== See accompanying notes to financial statements. -3- 4 TMBR/SHARP DRILLING, INC. BALANCE SHEETS June 30, 2002 (Unaudited) and March 31, 2002 (In thousands, except per share data) June 30, 2002 March 31, LIABILITIES AND STOCKHOLDERS' EQUITY (Unaudited) 2002 ------------------------------------ ------------ ----------- Current liabilities: Trade payables $ 6,257 $ 5,193 Other 2,294 1,610 -------- -------- Total current liabilities 8,551 6,803 -------- -------- Contingencies Stockholders' equity: Common stock, $0.10 par value Authorized, 50,000,000 shares; issued 6,687,825 and 6,667,725 shares at June 30, and March 31, 2002, respectively 669 667 Additional paid-in capital 71,660 71,492 Accumulated deficit (35,116) (36,187) Accumulated other comprehensive income 3 10 Treasury stock-common, 1,268,739 shares at June 30, and March 31, 2002, at cost (150) (150) -------- -------- Total stockholders' equity 37,066 35,832 -------- -------- Total liabilities and stockholders' equity $ 45,617 $ 42,635 ======== ======== See accompanying notes to financial statements. -4- 5 TMBR/SHARP DRILLING, INC. STATEMENTS OF OPERATIONS Three months ended June 30, 2002 and 2001 (Unaudited) (In thousands, except per share data) Three months ended June 30, ----------------------------- 2002 2001 ----------- ----------- Revenues: Contract drilling $ 7,743 $ 13,447 Oil and gas 1,685 1,580 ----------- ----------- Total revenues 9,428 15,027 ----------- ----------- Operating costs and expenses: Contract drilling 5,265 6,660 Oil and gas production 474 409 Dry holes and abandonments 28 526 Exploration -- 3 Depreciation, depletion and amortization 1,721 1,609 General and administrative 930 577 ----------- ----------- Total operating costs and expenses 8,418 9,784 ----------- ----------- Operating income 1,010 5,243 ----------- ----------- Other income (expense): Interest, net 11 (21) Gain on sales of assets 46 198 Other, net 4 3 ----------- ----------- Total other income (expense) 61 180 ----------- ----------- Net income before income tax provision 1,071 5,423 Provision for income taxes -- (108) ----------- ----------- Net income $ 1,071 $ 5,315 =========== =========== See accompanying notes to financial statements. -5- 6 TMBR/SHARP DRILLING, INC. STATEMENTS OF OPERATIONS Three months ended June 30, 2002 and 2001 (Unaudited) (In thousands, except per share data) Three months ended June 30, ----------------------------- 2002 2001 ----------- ----------- Net income per common share: Basic $ .20 $ 1.04 Diluted .19 .97 =========== =========== Weighted average number of common shares outstanding: Basic 5,402,873 5,089,168 Diluted 5,643,875 5,493,000 =========== =========== See accompanying notes to financial statements. -6- 7 TMBR/SHARP DRILLING, INC. STATEMENTS OF STOCKHOLDERS EQUITY Three Months Ended June 30, 2002 (Unaudited) and Year Ended March 31, 2002 (Audited) (In thousands)
Accumulated Common Stock Additional Other Treasury Stock Total -------------- Paid-In Accumulated Comprehensive -------------- Stockholders' Shares Amount Capital Deficit Income (Loss) Shares Amount Equity ------ ------ ------- ----------- ------------- ------ ------ ------------ Balance, March 31, 2002 6,668 $ 667 $ 71,492 $(36,187) $ 10 1,270 $(150) $ 35,832 Exercise of Stock Options 15 2 92 -- -- -- -- 94 Issuance of Stock 5 -- 76 -- -- -- -- 76 Net Income -- -- -- 1,071 -- -- -- 1,071 Other comprehensive loss, net of tax Unrealized loss on marketable equity securities -- -- -- -- (7) -- -- (7) --------- Comprehensive Income -- -- -- -- -- -- -- 1,064 --------- Balance, June 30, 2002 6,688 $ 669 $ 71,660 $(35,116) $ 3 1,270 $(150) $ 37,066 ===== ====== ======== ========= ==== ====== ====== ========
See accompanying notes to financial statements. -7- 8 TMBR/SHARP DRILLING, INC. STATEMENTS OF CASH FLOWS For the three months ended June 30, 2002 and 2001 (Unaudited) (In thousands) Three months ended June 30, -------------------------- 2002 2001 --------- --------- Cash flows from operating activities: Net income $ 1,071 $ 5,315 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion and amortization 1,721 1,609 Dry holes and abandonments 28 526 Gain on sales of assets (46) (198) Changes in assets and liabilities: Trade receivables (569) (409) Inventories and other assets 9 (28) Trade payables 1,064 (1,321) Accrued interest and other liabilities 684 367 -------- -------- Total adjustments 2,891 546 -------- -------- Net cash provided by operating activities 3,962 5,861 Cash flows from investing activities: Additions to property and equipment (3,978) (5,550) Proceeds from sales of property and equipment 43 235 -------- -------- Net cash required by investing activities (3,935) (5,315) Cash flows from financing activities: Repayments of Bank Borrowings -- (702) Proceeds from exercise of stock options 94 155 Issuance of common stock 76 29 -------- -------- Net cash (required) provided by financing activities 170 (518) -------- -------- Net increase in cash and cash equivalents 197 28 Cash and cash equivalents at beginning of period 3,258 301 -------- -------- Cash and cash equivalents at end of period $ 3,455 $ 329 ======== ======== See accompanying notes to financial statements. -8- 9 TMBR/SHARP DRILLING, INC. NOTES TO FINANCIAL STATEMENTS The amounts presented in the balance sheet as of March 31, 2002 were derived from the Company's audited financial statements included in its Form 10-K Report filed for the year then ended. The notes to such statements are incorporated herein by reference. (1) Management's Representation In the opinion of management, the accompanying unaudited financial statements contain all adjustments (all of which are of a normal recurring nature) necessary to present fairly the Company's financial position as of June 30, 2002 and March 31, 2002, the results of operations for the three months ended June 30, 2002 and 2001, and the cash flows for the three month periods ended June 30, 2002 and 2001. While the Company believes that the disclosures presented are adequate to make the information not misleading, it is suggested that these condensed financial statements be read in conjunction with the financial statements and the related notes in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2002. (2) Summary of Significant Accounting Policies Marketable Securities Under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities", marketable securities, such as those owned by the Company, are classified as available-for-sale securities and are to be reported at market value, with unrealized gains and losses, net of income taxes, excluded from earnings and reported as a separate component of stockholders' equity. The market value of these securities at June 30, 2002 was approximately $90,000. An unrealized loss of approximately $7,000 was deducted from stockholders equity and was included as a component of other comprehensive loss. Inventories Inventories consist primarily of casing and tubing. The Company values its inventories at the lower of cost or estimated net recoverable value using the specific identification method. Property and Equipment Drilling equipment is depreciated on a units-of-production method based on the monthly utilization of the equipment. Drilling equipment which is not utilized during a month is depreciated using a minimum utilization rate of approximately twenty-five percent. Estimated useful lives range from four to eight years. Other property and equipment is depreciated using the straight- -9- 10 line method of depreciation with estimated useful lives of three to seven years. Oil and gas properties are accounted for using the successful efforts method. Accordingly, the costs incurred to acquire property (proved and unproved), all development costs and successful exploratory costs are capitalized, whereas the costs of unsuccessful exploratory wells are expensed. Geological and geophysical costs, including seismic costs, are charged to expense when incurred. In cases where the Company provides contract drilling services related to oil and gas properties in which it has an ownership interest, the Company's proportionate share of costs related to these properties is capitalized as stated above, net of the Company's working interest share of profits from the related drilling contracts. Capitalized costs of undeveloped properties, which are not depleted until proved reserves can be associated with the properties, are periodically reviewed for possible impairment. Depletion, depreciation and amortization of capitalized oil and gas property costs was provided using the units-of-production method based on estimated proved or proved developed oil and gas reserves, as applicable, of the respective property units. Major renewals and betterments are capitalized in the appropriate property accounts while the cost of repairs and maintenance is charged to operating expense in the period incurred. For assets sold or otherwise retired, the cost and related accumulated depreciation amounts are removed from the accounts and any resulting gain or loss is recognized. Net Income Per Common Share On April 1, 1997, the Company adopted Statement of Financial Accounting Standards No. 128 ("SFAS 128") "Earnings Per Share" which superseded Accounting Principles Board Opinion No. 15 ("APB 15") "Earnings Per Share". SFAS 128 simplifies earnings per share ("EPS") calculations by replacing previously reported primary EPS with basic EPS which is calculated by dividing reported earnings available to common shareholders by the weighted average shares outstanding. No dilution for potentially dilutive securities is included in basic EPS. Previously reported fully diluted EPS is called diluted EPS which includes all potentially dilutive securities. -10- 11
For the Quarter Ended June 30, 2002 2001 --------------------------- -------------------------- Per Per Share Share Income Shares Amount Income Shares Amount ------ ------ ------- ------ ------ ------ Income before extraordinary item and accounting change $1,071 $5,315 Basic EPS Income available to common stockholders 1,071 5,402,873 $ .20 5,315 5,089,168 $1.04 Effect of Dilutive Securities Stock Options 241,002 403,832 ----- --------- ---- ----- --------- ---- Diluted EPS Income available to common stockholders + assumed conversions $1,071 5,643,875 $ .19 $5,315 5,493,000 $ .97 ===== ========= ==== ===== ========= ====
Reclassifications Certain reclassifications have been made to the June 30, 2001 financial statements to conform to the June 30, 2002 presentation. (3) Debt Line of Credit In May, 1998, the Company entered into a loan agreement with its bank lender which provided for a $5.0 million revolving line of credit secured by substantially all of the Company's drilling rigs and related equipment, accounts receivable and inventory. Borrowings under the line of credit bore interest at the bank's base rate and accrued interest was payable monthly. The loan facility originally matured on May 26, 2000 but was extended to July 15, 2000. On June 26, 2000, the Company renewed and extended the prior loan agreements with its bank lender. The second amended and restated loan agreement provides for a $5.0 million revolving line of credit secured by the Company's drilling rigs and related equipment, accounts receivable and inventory. Borrowings under this line of credit bear interest at the Wells Fargo Bank Texas, N. A. (formerly Norwest Bank, Texas N. A.) Base rate (4.75% at June 30, 2002) and accrued interest is payable monthly. The loan facility originally matured on August 31, 2002. On February 12, 2002, the maturity date of the loan facility was extended to August 31, 2003, at which time all outstanding principal and interest will be due in full. At March 31, 2002 and June 30, 2002, respectively, no amounts were outstanding under the loan facility. -11 12 (4) Stockholders' Equity 1984 Stock Option Plan In August 1984, the Company adopted the 1984 Stock Option Plan (the "Plan") which initially authorized 375,000 shares of the Company's common stock to be issued as either incentive stock options or nonqualified stock options. This Plan was amended in August 1986 to increase the authorized shares to 475,000 shares of the Company's common stock. In January 1988, the Plan was amended to reduce the option price on certain options issued prior to March 31, 1986, to reflect the then current fair market value of the Company's common stock. The Plan provides that options may be granted to key employees or directors for various terms at a price not less than the fair market value of the shares on the date of the grant. Options to purchase 100,000 shares of common stock are outstanding and exercisable under the Plan. No additional shares are available for grant as the Plan expired by its own terms in August 1994. The options that were granted prior to the expiration of the Plan, and which are outstanding, remain subject to the terms of the Plan. 1994 Stock Option Plan In July 1994, the Company adopted its 1994 Stock Option Plan (the "1994 Plan") which authorized the grant of options to purchase up to 750,000 shares of the Company's common stock. These options may be issued as either incentive or nonqualified stock options. The 1994 Plan provides that options may be granted to key employees (including officers and directors who are also key employees) for various terms at a price not less than the fair market value of the shares on the date of grant. The 1994 Plan was ratified and approved by the stockholders at the Company's annual meeting of stockholders held on August 30, 1994. In September 1998, options outstanding under the plan were amended to reduce the option price to $4.125 per share. On September 3, 1996, the Company granted 465,000 shares of nonqualified stock options to key employees under the 1994 Plan. All of the nonqualified stock options granted on September 3, 1996 are earned and exercisable as of May 7, 1997. On September 1, 1998, the Company granted 240,000 shares of incentive stock options at a price of $4.125 to key employees under the 1994 Plan. On March 9, 2002, all of the shares were earned and exercisable. The following sets forth certain information concerning these options. -12- 13 Number of Option Shares Exercise Price Underlying ------------------- Options Per Share Total ---------- ------------------- Outstanding March 31, 2002 250,400 $4.125-4.5375 $ 1,035,375 Exercised (5,000) 4.125 (20,625) ------- ------------ --------- Outstanding June 30, 2002 245,400 $4.125-4.5375 $ 1,014,750 ======= ============ ========= 1998 Stock Option Plan In September 1998, the Company adopted, subject to stockholder approval, its 1998 Stock Option Plan (the "1998 Plan") which authorizes the grant of options to purchase up to 750,000 shares of the Company's common stock. These options may be issued as either incentive or nonqualified stock options. The 1998 Plan provides that options may be granted to key employees or directors at a price not less than the fair market value of the shares on the date of grant. The Company granted options to purchase 50,000 shares of common stock to two outside directors under the 1998 Plan. These nonqualified options were granted on September 1, 1998, subject to stockholder approval, at $4.125 per share and became exercisable on August 31, 1999, the date on which the stockholders of the Company approved and adopted the 1998 Plan. The fair market value of the Company's common stock on August 31, 1999 was $6.063 per share. As a result, the Company recognized approximately $97,000 in compensation expense related to these nonqualified options during the year ended March 31, 2000. On June 13, 2001, the Company granted options to purchase 40,000 shares of common stock of four directors under the 1998 Plan. The nonqualified options were granted at an exercise price of $17.18 per share which represented the fair market value on the date of the grant. On October 10, 2001, the Company granted options to purchase 292,000 shares of common stock to key employees under the 1998 Plan. These incentive options were granted at an exercise price of $11.50 per share which represented the fair market value on the date of the grant. These options become exercisable over a two year period ending October 10, 2003. At June 30, 2002, options to purchase 327,000 shares were outstanding under the 1998 Plan. Directors' Fee Stock Plan On June 14, 2001, the Company adopted the Directors' Fee Stock Plan (the "Plan") which authorizes the issuance of up to 25,000 shares of the Company's common stock. The Plan provides that 300 shares of the Company's common stock will be issued to each Non-employee Director for each Board of Directors' meeting attended and 100 shares of common stock to each Non- employee Director for each committee meeting attended. During the quarter ended June 30, 2002, 5,100 shares were issued under the Plan and the Company recognized approximately $78,000 as Directors' compensation expense. -13- 14 In connection with a private placement completed in February 1997, the Company issued a warrant to purchase 36,250 common shares with an exercise price of $13.20 per share. This warrant became exercisable on February 17, 1998 and expired unexercised on February 17, 2002. (5) Contingencies The Company is a defendant in various lawsuits generally incidental to its business. In addition, in August 2001, the Equal Employment Opportunity Commission ("EEOC") filed suit in the El Paso Division of the United States District Court for the Western District of Texas. The suit involved a claim of hostile work environment made on behalf of four former employees. In May, 2002, the Court transferred the cause to the Midland/Odessa Division. The employees on behalf of whom the Equal Employment Opportunity Commission originally brought suit and one additional employee have recently been allowed to intervene in the litigation on an individual basis. It is expected that these employees will file additional state common law causes of action arising out of the allegations of hostile work environment. The EEOC is seeking back pay, front pay, pecuniary losses and punitive damages of an unspecified amount. The intervenors are seeking unspecified damages. The Company disputes the claims made by the Equal Employment Opportunity Commission and the anticipated claims by the intervenors and intends to defend the lawsuits vigorously. The Company does not believe that the ultimate resolution of such litigation, including the lawsuits brought by the EEOC and the five intervenors, will have a significant effect on the Company's financial position or results of operations. On May 8, 2002, the Company experienced an uncontrolled flow ("flow") on the Leiman #1 well in Loving County, Texas. The Company has a 25% working interest in this well. The uncontrolled flow was encountered while running a 7 liner in the well bore. The flow was ultimately controlled with no injury to personnel or damage to the Company's rig or related equipment. The planned total depth of the well was approximately 22,000 feet but the uncontrolled flow was experienced at a depth of 19,115 feet. The well was not salvageable and has been plugged and abandoned. Costs associated with re-gaining control of the well and plugging and abandonment were approximately $1.5 million. The cost to re-drill the well to a depth of 19,115 feet is estimated to be $5.6 million. The Leiman #1R well was spudded on July 8, 2002 and is at depth of 8,787 on August 8, 2002. The Company has submitted claims for reimbursement from its insurance carrier, St. Paul's Surplus Lines, who has acknowledged coverage under both the control of well and re-drill/replacement well provisions under the Company's Operators Extra Expense insurance. The Company's working interest portion of the costs associated with re-gaining control, plugging and abandonment and re-drilling this well have been capitalized. -14- 15 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Some statements contained in this Form 10-Q report are "forward-looking statements". All statements other than statements of historical facts included in this report, including, without limitation, statements regarding planned capital expenditures, the availability of capital resources to fund capital expenditures, estimates of proved reserves, the Company's financial position, business strategy and other plans and objectives for future operations, are forward-looking statements. Forward-looking statements can be identified by the use of forward-looking terminology like "may," "will," "expect," "intend,""anticipate," "estimate," "continue," "present value," "future" or "reserves" or other variations of comparable terminology. The Company believes the assumptions and expectations reflected in these forward- looking statements are reasonable. However, no assurance can be given that the Company's expectations will prove to be correct or that it will be able to take any actions that are presently planned. All of these statements involve assumptions of future events and risks and uncertainties. Risks and uncertainties associated with forward-looking statements include, but are not limited to: fluctuations in prices of oil and gas; future capital requirements and availability of financing; risks associated with the drilling of wells; competition; general economic conditions; governmental regulations; receipt of amounts owed to the Company by purchasers of its production and counterparties to its hedging contracts; and hedging activities. For these and other reasons, actual results may differ materially from those projected or implied. Undue reliance should not be placed on forward-looking statements and projections of any future results should not be based on such statements. Before investing in the Company's common stock, one should be aware that there are various risks associated with an investment. Some of these risk factors are described on page 18 in the Company's Form 10-K dated March 31, 2002. -15- 16 Critical Accounting Policies Contract Drilling Operations Drilling revenues from footage and daywork contracts are recognized as work is performed utilizing the percentage-of-completion method. Costs under footage and daywork contracts are recognized in the period they are incurred. The Company utilizes the completed contract method to recognize drilling revenues and expenses relating to turnkey contracts. Expected losses on all in-process contracts are recognized in the period the loss can reasonably be determined. Drilling equipment is depreciated on a units-of-production method based on the monthly utilization of the equipment. Drilling equipment which is not utilized during a month is depreciated using a minimum utilization rate of approximately 25%. Estimated useful lives range from four to eight years. Other property and equipment is depreciated using the straight-line method of depreciation with estimated useful lives of three to seven years. The contract drilling industry is currently experiencing a decrease in demand and downward pressure on prices for contract drilling services due to the uncertainty surrounding oil and gas prices. The Company has been and will continue to be affected by oil and gas industry conditions but cannot predict either the future level of demand for its contract drilling services or future conditions in the contract drilling industry. The contract drilling industry remains highly competitive. The Company believes it owns a sufficient number of drilling rigs to remain competitive within its areas of operation. In addition, the Company believes it competes favorably with respect to the depth capabilities of its rigs, the experience level of its personnel, its reputation and its relationship with existing customers. However, the Company's operating results will continue to be directly affected by the level of drilling activity in the Company's service areas. Oil and Gas Operations The Company's oil and gas producing activities are accounted for using the successful efforts method of accounting. Accordingly, the Company capitalizes all costs incurred to acquire oil and gas properties (proved and unproved), all development costs, and the costs of successful exploratory wells. The costs of unsuccessful exploratory wells are expensed. Geological and geophysical costs, including seismic costs, are charged to expense when incurred. In cases where the Company provides contract drilling for oil and gas properties in which it has an ownership interest, the Company's proportionate share of costs is capitalized as stated above, net of its working-interest share of profits from the related drilling contracts. Capitalized costs of undeveloped properties, which are not depleted until proved reserves can be associated with the properties, are periodically reviewed for possible impairment. For properties with proved or proved developed oil and gas reserves, depletion, depreciation and amortization of capitalized costs is calculated -16- 17 by applying the units-of-production method to the estimated amount of such reserves. Recent Accounting Pronouncements The FASB has issued SFAS No. 143, "Accounting for Asset Retirement Obligations" which establishes requirements for the accounting of removal- type costs associated with asset retirements. The standard is effective for fiscal years beginning after June 15, 2002, with earlier application encouraged. The Company is currently assessing the impact on its financial statements. On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This pronouncement supercedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to Be Disposed" and eliminates the requirement for SFAS 121 to allocate goodwill to long-lived assets to be tested for impairment. The provisions of this statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The Company adopted this statement on April 1, 2002. The adoption of this statement had no immediate impact on the Company but will change how the Company assesses impairment of long-lived assets and may result in discontinued operations presentation for future sales of certain assets. Results of Operations Total revenues were $9,428,000 for the three months ended June 30, 2002 which represents a 37% decrease from the same period in 2001. Operating expenses as a percent of revenues were 89% for the three months ended June 30, 2002 versus 65% for the same period of the prior year. The operating results were negatively affected by a decrease in demand for the Company's contract drilling services which resulted in a decrease in rig utilization rates. The Company has also experienced a decrease in the average price received for its contract drilling services. Rig utilization rates were 51% for the three months ended June 30, 2002 compared to 76% in the same period in 2001. -17- 18 Oil and gas revenues increased by approximately 7% for the three months ended June 30, 2002. The following table sets forth certain information relating to crude oil and natural gas produced: Three months ended June 30, ---------------------- 2002 2001 ------- ------- Quantities Produced ------------------- Oil (bbls) 46,388 27,583 Gas (mcf) 261,572 154,698 Average Price ------------- Oil (bbls) $ 22.82 $ 26.27 Gas (mcf) $ 2.40 $ 5.53 Average Daily Production ------------------------ Oil (bbls) 510 303 Gas (mcf) 2,874 1,700 Oil and gas production expenses increased approximately 16% for the three months ended June 30, 2002. The increase in production expenses for the three months ended June 30, 2002 can be attributed to the increase in quantities of crude oil and natural gas produced. In addition, the Company has experienced a general rise in the cost of services and supplies which are included in production expenses. Depreciation, depletion and amortization expense increased by approximately 7% compared to the three months ended June 30, 2001. The company has been purchasing drill pipe and has updated and refurbished drilling rigs and ancillary equipment. In addition, depletion expense increased as a result of an increase in the number of oil and gas producing properties in which the Company has an ownership interest coupled with an increase in the quantities of crude oil and natural gas produced as oil and gas properties are depleted using the units-of-production method. The depreciable base of the Company's assets increased by approximately $4.0 million during the quarter ended June 30, 2002 compared to $ 5.6 million during the same quarter in the prior year. General and administrative expenses increased primarily as a result of an increase in insurance expenses and directors' fees. Net working capital was $8.1 million at June 30, 2002 compared to $9.1 million at March 31, 2002. -18- 19 Income Taxes At March 31, 2002, the Company had approximately $47.2 million of unused net operating loss ("NOL") carryforwards for tax purposes. Use of these carryforwards is dependent upon the Company's ability to generate taxable earnings in future periods. These carryforwards began to expire in fiscal 2000 and approximately $5.7 million will expire in 2002. The Company's ability to utilize its NOL carryforwards may be substantially limited in the future under the Internal Revenue Code of 1986, as amended (the "Code"). If the Company experiences an ownership change under applicable provisions of the Code, the carryforward would be limited to an annual amount determined by specified interest rates and other variables. The Company does not believe an ownership change has occurred to date. The effective tax rates differ from the statutory tax rate of 34% primarily due to the utilization of NOLs. Tax expense is generally limited to alternative minimum tax. The Company utilizes an asset and liability approach for financial accounting and reporting for income taxes. The Company has a deferred tax asset primarily due to its NOL carryforwards. The Company has provided a valuation allowance for the entire balance of deferred tax assets as it is more likely than not that the deferred tax asset will not be realized. Liquidity and Capital Resources In June, 2000, the Company entered into a second amended and restated loan agreement with Wells Fargo Bank Texas, N.A. The loan agreement provides for a $5.0 million revolving line of credit facility, of which $5.0 million was available at June 30, 2002. The facility is secured by the Company's drilling rigs and related equipment, accounts receivable and inventory. Borrowings under the revolving facility bear interest at annual rate equal to the bank's base rate, or 4.75% at June 30, 2002. Accrued and unpaid interest on outstanding principal is payable monthly. The loan facility matures on August 31, 2003, at which time all outstanding principal and accrued and unpaid interest will be due in full. At June 30, 2002, no amounts were outstanding under the loan facility. The principal amount outstanding at any one time may not exceed the lesser of $5.0 million or one-third of the borrowing base amount. The borrowing base amount is the sum of the Company's accounts receivable and the value of its inventory, drilling rigs, drill pipe and related equipment. The borrowing base amount is redetermined quarterly by the Company, except that the bank may, in its discretion, make its own determination of the borrowing base which will be the controlling borrowing base amount. At June 30, 2002, the borrowing base amount was $38,328,742. The Company anticipates that funds for its capital expenditures in fiscal 2003 will be available from a combination of sources, including (i) borrowings under the line of credit, (ii) funds raised through issuances of equity or debt securities in public or private transactions, and (iii) internally generated funds. -19- 20 Trends and Prices The contract drilling industry is currently experiencing decreased demand and decreasing prices for contract drilling services due to the instability of oil and gas prices. The Company will be affected by price fluctuations in the industry, but cannot predict either the future level of demand for its contract drilling services or future conditions in the contract drilling industry. In recent years, oil and gas prices have been extremely volatile. Prices are affected by market supply and demand factors as well as by actions of state and local agencies, the U.S. and foreign governments and international cartels. The Company has no way of accurately predicting the supply of and demand for oil and gas, domestic or international political events or the effects of any such factors on the prices received by the Company for its oil and gas. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The primary sources of market risk for the Company include fluctuations in commodity prices and interest rate fluctuations. At March 31, 2002, the Company had not entered into any hedge arrangements, commodity swap agreements, commodity futures, options or other similar agreements relating to crude oil and natural gas. Commodity Price Risk - The Company produces and sells crude oil, natural gas and natural gas liquids. As a result, its operating results are significantly affected by fluctuations in commodity prices caused by changing market forces. Historically, the Company has not entered into hedging arrangements for its oil and gas production and it does not have any delivery commitments. The Company may, in the future, attempt to reduce its exposure to the volatility of oil and gas prices by hedging a portion of its production. In a typical hedge transaction, the Company would have the right to receive from the counterparty to the hedge, the excess of the fixed price specified in the hedge over a floating price based on a market index, multiplied by the quantity hedge. If the floating price exceeds the fixed price, the Company would be required to pay the counterparty this difference multiplied by the quantity hedged. In the case, the Company would be required to pay the difference regardless of whether it had sufficient production to cover the quantities specified in the hedge. Significant reductions in production at times when the floating price exceeds the fixed price could require the Company to make payments under the hedge agreements even though such payments are not offset by sales of production. Hedging could also prevent the hedging party from receiving the full advantage of increases in oil and gas prices above the fixed amount specified in the hedge. Interest Rate Risk - At June 30, 2002 the Company had no borrowings outstanding under its loan agreement. However, when it does have outstanding borrowings, the Company's exposure to changes in interest rates primarily results from short term changes in its bank's prime rate. -20- 21 PART TWO - OTHER INFORMATION Item 1. Legal Proceedings The Company is a defendant in various lawsuits generally incidental to its business. In addition, in August 2001, the Equal Employment Opportunity Commission ("EEOC") filed suit in the El Paso Division of the United States District Court for the Western District of Texas. The suit involved a claim of hostile work environment made on behalf of four former employees. In May, 2002, the Court transferred the cause to the Midland/Odessa Division. The employees on behalf of whom the Equal Employment Opportunity Commission originally brought suit and one additional employee have recently been allowed to intervene in the litigation on an individual basis. It is expected that these employees will file additional state common law causes of action arising out of the allegations of hostile work environment. The EEOC is seeking back pay, front pay, pecuniary losses and punitive damages of an unspecified amount. The intervenors are seeking unspecified damages. The Company disputes the claims made by the Equal Employment Opportunity Commission and the anticipated claims by the intervenors and intends to defend the lawsuits vigorously. The Company does not believe that the ultimate resolution of such litigation, including the lawsuits brought by the EEOC and the five intervenors, will have a significant effect on the Company's financial position or results of operations. Item 6. Exhibits and reports on Form 8-K. (a) Exhibits: 3.1 - Articles of Incorporation of the Company, as amended. (Incorporated by reference to exhibit 3.1 in Registrant's Annual Report on Form 10-K dated June 28, 1991) 3.2 - Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.2 in Registrant's Annual Report on Form 10-K dated June 27, 1994) Executive Compensation Plans and Arrangements --------------------------------------------- (Exhibits 10.1 through and including Exhibit 10.20 constitute executive compensation plans and arrangements of the Registrant) Exhibit 10.1 - Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10.3 in Registrant's Registration Statement on Form 10 as amended, effective October 9, 1984) Exhibit 10.2 - Nonqualified Stock Option Agreement dated August 29, 1990, between Thomas C. Brown and the Registrant. (Incorporated by reference to Exhibit 10.15 in Registrant's Annual Report on form 10-K dated June 25, 1993) Exhibit 10.3 - Nonqualified Stock Option Agreement dated August 30, 1988, between Joe G. Roper and the Registrant. (Incorporated by reference to Exhibit 10.17 in Registrant's Annual Report on Form 10-K dated June 25, 1993) -21- 22 Exhibit 10.4 - Incentive Stock Option Agreement dated November 16, 1993 between Joe G. Roper and the Registrant. (Incorporated by reference to Exhibit 10.5 in Registrant's Annual Report on Form 10- K dated June 27, 1994) Exhibit 10.5 - Incentive Stock Option Agreement dated December 4, 1992 between Patricia R. Elledge and the Registrant. (Incorporated by reference to Exhibit 10.20 in Registrant's Annual Report on Form 10-K dated June 25, 1993) Exhibit 10.6 - Incentive Stock Option Agreement dated December 4, 1992 between Don H. Lawson and the Registrant. (Incorporated by reference to Exhibit 10.21 in Registrant's Annual Report on Form 10-K dated June 25, 1993) Exhibit 10.7 - Incentive Stock Option Agreement dated November 16, 1993 between Don H. Lawson and the Registrant. (Incorporated by reference to Exhibit 10.10 in Registrant's Annual Report on Form 10-K dated June 27, 1994) Exhibit 10.8 - 1994 Stock Option Plan. (Incorporated by reference to Exhibit 10.10 in Registrant's Annual Report on Form 10-K dated June 28, 1995) Exhibit 10.9 - TMBR/Sharp Drilling, Inc. Employee Retirement Plan. (Incorporated by reference to Exhibit 10.11 in Registrant's Annual Report on Form 10-K dated June 28, 1995) Exhibit 10.10 - 1998 Stock Option Plan (Incorporated by reference to Exhibit 10.1 in Registrant's Quarterly Report on Form 10-Q dated November 12, 1998) Exhibit 10.11 - Incentive Stock Option Agreement dated September 1, 1998, between Don H. Lawson and the Registrant. (Incorporated by reference to Exhibit 10.18 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.12 - Incentive Stock Option Agreement dated September 1, 1998, between Jeffrey D. Phillips and the Registrant. (Incorporated by reference to Exhibit 10.19 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.13 - Incentive Stock Option Agreement dated September 1, 1998, between Patricia R. Elledge and the Registrant. (Incorporated by reference to Exhibit 10.20 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.14 - Incentive Stock Option Agreement dated September 1, 1998, between Joe G. Roper and the Registrant. (Incorporated by reference to Exhibit 10.21 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.15 - Incentive Stock Option Agreement dated September 1, 1998, between Thomas C. Brown and the Registrant. (Incorporated by reference to Exhibit 10.22 in Registrant's Annual Report on Form 10-K dated June 29, 1999) -22- 23 Exhibit 10.16 - First Amended and Restated Nonstatutory Stock Option Agreement dated September 1, 1998, between Patricia R. Elledge and the Registrant. (Incorporated by reference to Exhibit 10.23 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.17 - First Amended and Restated Nonstatutory Stock Option Agreement dated September 1, 1998, between Jeffrey D. Phillips and the Registrant. (Incorporated by reference to Exhibit 10.24 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.18 - First Amended and Restated Nonstatutory Stock Option Agreement dated September 1, 1998, between Joe G. Roper and the Registrant. (Incorporated by reference to Exhibit 10.25 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.19 - First Amended and Restated Nonstatutory Stock Option Agreement dated September 1, 1998, between Thomas C. Brown and the Registrant. (Incorporated by reference to Exhibit 10.26 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.20 - Directors' Fee Stock Plan (Incorporated by reference to Exhibit 10.20 of Registrant's Annual Report on Form 10-K dated June 15, 2001) Exhibit 10.21 - Form of Stock Purchase Agreement, dated as of February 13, 1997, between the Registrant and the stockholders named therein (Incorporated by reference to Exhibit 10.1 in the Registrant's Registration Statement on Form S-3, No. 333-23391) Exhibit 10.22 - Second Amended and Restated Loan Agreement dated June 26, 2000 between Wells Fargo Bank, Texas N. A. and the Registrant. (Incorporated by reference to Exhibit 10.1 in Registrant's Quarterly Report on Form 10-Q dated August 9, 2000) --------------------------------- (b) Reports on Form 8-K: The following reports on Form 8-K were filed during the first quarter ended June 30, 2002: (1) Report dated May 22, 2002, announcing the dismissal Registrant's Certifying Accountant. (2) Report dated June 3, 2002, announcing the engagement of Registrant's new Certifying Accountant. -23- 24 SIGNATURES 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. TMBR/SHARP DRILLING, INC. August 12, 2002 By: /s/ Patricia R. Elledge --------------- ------------------------- Date Patricia R. Elledge Controller/Treasurer (Ms. Elledge is the Chief Financial Officer and has been duly authorized to sign on behalf of the Registrant) -24- 25 INDEX TO EXHIBITS Description ----------- Exhibit 3.1 Articles of Incorporation of the Company, as amended. (Incorporated by reference to Exhibit 3.1 in Registrant's Annual Report on Form 10-K dated June 28, 1991) Exhibit 3.2 Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.2 in Registrant's Annual Report on Form 10-K dated June 27, 1994) Executive Compensation Plans and Arrangements --------------------------------------------- (Exhibits 10.1 through and including Exhibit 10.20 constitute executive compensation plans and arrangements of the Registrant) Exhibit 10.1 Incentive Stock Option Plan (Incorporated by reference to Exhibit 10.3 in Registrant's Registration Statement on Form 10, as amended, effective October 9, 1984) Exhibit 10.2 Nonqualified Stock Option Agreement dated August 29, 1990, between Thomas C. Brown and the Registrant. (Incorporated by reference to Exhibit 10.15 in Registrant's Annual Report on Form 10-K dated June 25, 1993) Exhibit 10.3 Nonqualified Stock Option Agreement dated August 30, 1988, between Joe G. Roper and the Registrant. (Incorporated by reference to Exhibit 10.17 in Registrant's Annual Report on Form 10-K dated June 25, 1993) Exhibit 10.4 Incentive Stock Option Agreement dated November 16, 1993 between Joe G. Roper and the Registrant. (Incorporated by reference to Exhibit 10.5 in Registrant's Annual Report on Form 10-K dated June 27, 1994) Exhibit 10.5 Incentive Stock Option Agreement dated December 4, 1992 between Patricia R. Elledge and the Registrant. (Incorporated by reference to Exhibit 10.20 in Registrant's Annual Report on Form 10-K dated June 25, 1993) Exhibit 10.6 Incentive Stock Option Agreement dated December 4, 1992 between Don H. Lawson and the Registrant. (Incorporated by reference to Exhibit 10.21 in Registrant's Annual Report on Form 10-K dated June 25, 1993) -25- 26 Exhibit 10.7 Incentive Stock Option Agreement dated November 16, 1993 between Don H. Lawson and the Registrant. (Incorporated by reference to Exhibit 10.10 in Registrant's Annual Report on Form 10-K dated June 27, 1994) Exhibit 10.8 1994 Stock Option Plan. (Incorporated by reference to Exhibit 10.10 in Registrant's Annual Report on Form 10-K dated June 28, 1995) Exhibit 10.9 TMBR/Sharp Drilling, Inc. Employee Retirement Plan. (Incorporated by reference to Exhibit 10.11 in Registrant's Annual Report on Form 10-K dated June 28, 1995) Exhibit 10.10 1998 Stock Option Plan (Incorporated by reference to Exhibit 10.1 in Registrant's Quarterly Report on Form 10-Q dated November 12, 1998) Exhibit 10.11 Incentive Stock Option Agreement dated September 1, 1998, between Don H. Lawson and the Registrant. (Incorporated by reference to Exhibit 10.18 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.12 Incentive Stock Option Agreement dated September 1, 1998, between Jeffrey D. Phillips and the Registrant. (Incorporated by reference to Exhibit 10.19 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.13 Incentive Stock Option Agreement dated September 1, 1998, between Patricia R. Elledge and the Registrant. (Incorporated by reference to Exhibit 10.20 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.14 Incentive Stock Option Agreement dated September 1, 1998, between Joe G. Roper and the Registrant. (Incorporated by reference to Exhibit 10.21 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.15 Incentive Stock Option Agreement dated September 1, 1998, between Thomas C. Brown and the Registrant. (Incorporated by reference to Exhibit 10.22 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.16 First Amended and Restated Nonstatutory Stock Option Agreement dated September 1, 1998, between Patricia R. Elledge and the Registrant. (Incorporated by reference to Exhibit 10.23 in Registrant's Annual Report on Form 10-K dated June 29, 1999) -26- 27 Exhibit 10.17 First Amended and Restated Nonstatutory Stock Option Agreement dated September 1, 1998, between Jeffrey D. Phillips and the Registrant. (Incorporated by reference to Exhibit 10.24 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.18 First Amended and Restated Nonstatutory Stock Option Agreement dated September 1, 1998, between Joe G. Roper and the Registrant. (Incorporated by reference to Exhibit 10.25 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.19 First Amended and Restated Nonstatutory Stock Option Agreement dated September 1, 1998, between Thomas C. Brown and the Registrant. (Incorporated by reference to Exhibit 10.26 in Registrant's Annual Report on Form 10-K dated June 29, 1999) Exhibit 10.20 Directors' Fee Stock Plan (Incorporated by reference to Exhibit 10.20 in Registrant's Annual Report on Form 10-K dated June 15, 2001) Exhibit 10.21 Form of Stock Purchase Agreement, dated as of February 13, 1997, between the Registrant and the stockholders named therein (Incorporated by reference to Exhibit 10.1 in the Registrant's Registration Statement on Form S-3, No. 333-23391) Exhibit 10.22 Second Amended and Restated Loan Agreement dated June 26, 2000 between Wells Fargo Bank, Texas N. A. and the Registrant. (Incorporated by reference to Exhibit 10.1 in Registrant's Quarterly Report on Form 10-Q dated August 9,2000) -27-