SOUTH TEXAS DRILLING & EXPLORATION INC - 10-K Annual Report

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1

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

================================================================================

FORM 10-K

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

For the fiscal year ended March 31, 1996

( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

Commission File Number 2-70145

SOUTH TEXAS DRILLING & EXPLORATION, INC.
(Exact name of registrant as specified in its charter)

TEXAS 74-2088619
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)

9310 Broadway, Bldg. I San Antonio, Texas 78217
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code 210-828-7689

Securities registered pursuant to Section 12(b) of the Act:

Title of each class Name of each exchange on
which registered
None None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock $0.10 par value

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 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]

State the aggregate market value of the voting stock held by non-affiliates
of the registrant (computed by reference to the average of bid and ask closing
sales prices on June 19, 1996): $1,645,496

Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of June 19, 1996.

Class: Common Stock Shares Outstanding: 5,654,333
Par Value: $0.10

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

PART I

ITEM 1. BUSINESS

South Texas Drilling & Exploration, Inc. and its subsidiaries (the
"Company") are engaged in the business of providing land contract drilling
services for the oil and gas industry; oil and gas exploration and development
activity for its own account; and operation of oil and gas wells for its own
account and those of outside investors. The revenues; earnings (loss) from
operations; identifiable assets; depreciation, depletion and amortization; and
capital expenditures are reported for each of its business segments for the
fiscal years ended March 31, 1996, 1995 and 1994 in note 5 ("Business Segments
and Supplementary Earnings Information") of the Notes to Consolidated Financial
Statements, which note is incorporated herein by reference.

CONTRACT DRILLING

The Company currently owns four land drilling rigs with approximate depth
capabilities ranging from 6,000 feet to 11,500 feet. Of these four rigs, three
were operated during all of fiscal 1996, while the fourth was placed in service
in May, 1995. The Company also operated a fifth rig through the end of the
third quarter of fiscal 1996. The rig was owned by a partnership in which one
of the Company's wholly-owned subsidiaries was the general partner. The
operations of the partnership are included in the Company's consolidated
financial statements. In December, 1995, the partnership was terminated and
the Company's subsidiary sold its one-half interest in the drilling rig. The
Company's rigs are presently operating in south Texas and along the Gulf Coast
of Texas. All four of the rigs are currently in operation.

Drilling Equipment

A land drilling rig consists of engines, drawworks, mast, pumps to
circulate the drilling mud, blowout preventors, drillstring and related
equipment. The size and type of rig used depends upon well depth and site
conditions, among other factors. A description of the type and capability of
the land drilling rigs operated by the Company is set forth in the following
table:

Approximate Aggregate
Rig Depth Utilization
Number Type Capability During 1996
------ ---- ---------- -----------

4 Skytop - Brewster
N-46 11,500 59%

6 Skytop - Brewster
DHI-4610 10,000 66%

11 Skytop - Brewster
N-46 11,500 82%

14 Skytop - Brewster
N-46 11,500 62%

Minor repair work on the drilling rigs is performed on-site by the
Company's employees, but major repair work and overhaul of drilling equipment
on a contractual basis are performed by unaffiliated oil field service
companies. In the event of major breakdowns or mechanical problems, the
Company's rigs could be subject to significant idle time and a resulting loss
of revenue if such repair services were not immediately available. The Company
engages in periodic maintenance and improvement of its drilling equipment and
believes that its drilling rigs and other related equipment are in good
operating condition. The Company has experienced no substantial down time as
the result of repair or overhaul of its equipment.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Principal materials, supplies and equipment necessary for drilling
operations are fuels to operate drilling equipment, drilling mud, tubular
steel, cement, drill bits, and other miscellaneous items. Certain of these
items were in short supply from time to time during prior periods of high
drilling demand. At the present time, the Company is not experiencing any
significant shortages of materials, supplies and equipment used in drilling,
and does not foresee any shortages materially affecting its operations.

Contracts

All contracts under which the Company is presently conducting its land
drilling operations provide for rate charges determined on a daywork, footage
or turnkey basis, with rates dependent on the anticipated complexity of
drilling the well, on-site drilling conditions, the type of equipment to be
used, the Company's estimate of the risks involved, the duration of the work to
be performed and competitors' rates among other considerations. Daywork
contracts provide for a fixed charge per day for drilling the well, and the
customer generally bears the major portion of the related costs and risks of
drilling.

With certain limitations, contracts entered into on a footage basis provide
for an agreed price per foot drilled regardless of the time required or the
problems involved in drilling the well. Related costs of drilling (i.e., rig
mobilization, labor, fuel usage and other costs) are included in the footage
charge. As compared to daywork contracts, footage contracts involve a higher
degree of risk to the Company.

Contracts entered into on a turnkey basis usually require the Company to
deliver to the operator a completed hole drilled to a specified depth. In
addition to all costs incurred when drilling on a footage basis, the Company is
usually also responsible for drilling fluids, water and other costs. As this
type of contract places a greater degree of risk on the Company than daywork or
footage contracts, the anticipated gross margin on this type of contract is
usually greater than on daywork or footage contracts.

Drilling contracts are obtained either through competitive bidding or
through direct negotiation. Contracts are usually entered into by the Company
covering the drilling of one well and obligate the Company to advance certain
costs and to assume certain expenses in connection with drilling operations.
During the year ended March 31, 1996 the Company drilled 48 wells with 54% of
contract drilling revenues attributable to daywork contracts, 20% to footage
contracts, and 26% to turnkey contracts.

Uncertainty relating to oil and gas prices and the domestic gas surplus has
led to significant reductions in drilling activity by oil and gas producing
companies. Furthermore, the phased-in reduction of the highest marginal income
tax rates applicable to individual investors has reduced commitments of capital
to oil and gas drilling funds. Additionally, increased costs due to government
regulation have resulted in the movement of much of the drilling activities to
locations overseas. The aggregate impact of these diverse economic factors has
resulted in significant reductions of oil company commitments to domestic oil
and gas exploration and consequent slackening of overall demand for drilling
rigs.

During the year ended March 31, 1996, the largest customer of the Company's
drilling rigs was Columbia Gas Development Corp. This customer accounted for
approximately 17% of contract drilling revenues of the Company during that
period. No other single customer accounted for more than 10% of the Company's
contract drilling revenues for 1996.

The Company actively markets its rigs and completed contracts for 27
customers in 1996, compared to 19 customers in 1995 and 24 customers in 1994.

The loss of any of the Company's land drilling customers could have a
material adverse effect on the Company's business, particularly with respect to
the time required to find other users of the rig concerned. See "Competitive,

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Business and Operational Risks in Contract Drilling" in Part I. During the
last quarter of fiscal 1991, drilling activity in south Texas began to decline,
although, there was marked increase in activity during the third quarter of
fiscal 1993 and the second and third quarters of fiscal 1994. During the first
three quarters of fiscal 1995, drilling activity was stable but it decreased
significantly in the last quarter of the fiscal year primarily due to a fall in
natural gas prices. In fiscal 1996 drilling activity returned to stability.
Since the 1991 decline, the Company has seen an increase in the number of
requests from current and potential customers for bids on footage and turnkey
terms.

Competitive, Business and Operational Risks in Contract Drilling

The Company encounters substantial competition in its contract drilling
operations from other drilling contractors. The usual method of competition in
the contract drilling industry is on the basis of price, customer relations,
rig availability and suitability, service, performance and condition of
equipment used. Competition for contract drilling is primarily on a regional
basis, and many of the Company's competitors in south Texas have financial
resources, and technical staffs and facilities substantially greater than those
of the Company. With the decline in drilling activity which began in the last
quarter of fiscal 1991, competition, especially as to price, has intensified.

Land contract drilling in oil and gas operations is subject to a number of
operational risks and hazards including blowouts, cratering, fires and
explosions. Any one of these happenings could cause serious damage to
equipment, personnel, property and/or the financial condition of the Company.
In addition, there is a risk that damage to the environment could result from
some of the Company's operations, particularly through oil spillage or
extensive, uncontrolled fires. While the Company believes that it is
adequately insured against normal and foreseeable risks in its operations in
accordance with industry standards, such insurance may not be adequate to
protect the Company against liability from all consequences of well disasters,
extensive fire damage, or damage to the environment. In the event that such
insurance was not adequate, the occurrence of a significant event could have a
material adverse effect on the Company's financial position and results of
operations. Under current conditions, the Company anticipates that its present
insurance coverage will be maintained, but no assurance can be given that
insurance coverage will continue to be available at rates considered reasonable
or that certain types of coverage will be available at any cost.

OIL AND GAS OPERATIONS AND PROPERTIES

The Company's oil and gas operations consist of the ownership of certain
oil and gas properties and the exploration, development and production of oil
and gas. In June, 1992, the Company acquired operating interests in 17
producing wells. During fiscal 1994 and fiscal 1995 the Company drilled three
additional wells. No wells were added in fiscal 1996.

Productive Wells and Acreage

At March 31, 1996, the Company had operating interests in 20 producing
wells in Texas. Additionally, at March 31, 1996, the Company had additional
minor investments in working interests and overriding royalty interests in
productive wells and developed acreage in Texas. However, the Company believes
the value and the amount of reserves in these properties are not significant in
relation to the value and the reserves in the operating interests. Therefore,
the working interests and overriding royalty interests have been omitted from
this report. The following table presents information on the wells in which
the Company has an operating interest:

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Productive Wells (1) (2)
--------------------------------- Developed
Oil Gas Acreage(2)(3)
---------------- ------------- ---------------
Location by County Gross Net Gross Net Gross Net
- ------------------ ----- ----- ----- ----- ----- -----

Texas
- -----
Bastrop 14 6.41 1 .62 1,198 522

Lee 5 3.16 - - 369 229
-- ---- - --- ----- ---

19 9.57 1 .62 1,567 751
== ==== = === ===== ===

(1) A "productive well" is a well either producing or capable of producing oil
or gas. The Company owns no interests in wells with multiple completions.

(2) A "gross" well or acre is a well or acre in which a working interest is
owned. "Net" wells or acres reflect the sum of fractional working
interests owned in gross wells or acreage.

(3) "Developed acreage" is acreage spaced or assigned to productive wells.

Oil and gas properties in general are subject to customary royalty
interests contracted for in connection with the acquisition of title, liens
incident to operating agreements, liens for current taxes and other burdens and
minor encumbrances, easements, and restrictions. The Company believes that the
existence of such burdens will not materially detract from the general value of
its working interests.

Exploration and Development

The Company's oil and gas exploration and development activities consist of
the geological evaluation of prospective oil and gas properties, the
acquisition of working interests in oil and gas leases, and the production and
sale of oil and gas from such properties. The Company participates as an
operator and a non-operator with other individuals, partnerships and
corporations in its oil and gas operations, as is customary in the industry.
In June, 1992, the Company acquired operating interests in 17 producing wells.
During fiscal 1994 and fiscal 1995 the Company drilled three additional wells.

Net oil and gas reserves attributable to the interest of the Company,
quantities of oil and gas available to be produced by the Company and the
estimated future net revenue and present worth of future net revenue,
discounted at 10% per annum, have been estimated as set forth in Note 9, "Oil
and Gas Producing Activities", in the "Notes to Consolidated Financial
Statements" of this Report. This note is incorporated herein by reference.

The Company does not believe that there have been any major discoveries or
other favorable or adverse events since the date of the preparation of reserve
estimates which would cause a significant change in the estimated proved
reserves of future net revenue as set forth in "Oil and Gas Producing
Activities" of the "Notes to Consolidated Financial Statements" of this Report.

Estimates of oil and gas reserves are projections based on engineering
information and data. There are uncertainties inherent in the interpretation
of all such data, and there can be no assurance that the reserves will be
ultimately realized.

Except for filing reserve data with the Securities and Exchange Commission
in various reports which are required to be filed under its rules, the Company
is not required to and does not file any reports of reserves with any federal
or state authority or agency.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

In prior years, the Company participated with small interests as a working
interest owner in various development wells. The Company will participate in
development and exploratory wells in the future on a more focused basis and
with larger working interest participation. Strategically, such investments
will be low to medium risk ventures and/or participation in producing
properties. During the periods covered by this Report, the Company had no
investment in exploratory wells. The following table sets forth certain
information with respect to the Company's investment in development wells
during the years indicated:

Years Ended March 31,
----------------------------------------------------------
1996 1995 1994
-------------- -------------- ----------------
Gross Net Gross Net Gross Net
----- ----- ----- ----- ----- -----

Development Wells:
Oil - - 1 .68 2 1.90
Gas - - - - - -
Dry hole - - 1 .04 1 .05
----- ----- ---- ----- ----- -----
TOTAL - - 2 .72 3 1.95
===== ===== ==== ===== ===== =====

Production Information

The Company is involved in oil and gas exploration, development and
production. Oil and gas production accounted for approximately 5.1% of the
Company's total revenues in the fiscal year ended March 31, 1996 compared with
7.4 % in the fiscal year ended March 31, 1995.

Years Ended March 31,
----------------------------------------
1996 1995 1994
--------- -------- --------

Oil Production (in Bbls) (1) 12,260 15,700 16,458
Gas production (in Mcf) (1) 89,802 73,488 66,805
Revenues from production (1) $ 380,110 405,409 410,674
Production (lifting) costs (2) $ 169,008 166,594 178,501
Net Revenues $ 211,102 238,815 232,173

Average sales price:
Oil (per Bbl) $ 17.70 17.00 16.14
Gas (per Mcf) $ 1.84 1.91 2.19

Average production cost per unit
(in barrel equivalents) (3) $ 6.21 5.96 6.47

(1) Oil and gas production is shown net of royalties attributable to the
interests of others and is based upon production reports furnished to
the Company by the operators.

(2) "Production (lifting) costs" are costs directly related to the
extraction of oil or gas including production taxes, but do not include
depreciation, or amortization of exploration and development costs.

(3) Average production costs per unit were determined on the basis of six
Mcf of gas being equivalent to one barrel of oil.

Marketing and Customers

Oil and gas produced by the Company are marketed under contracts in
accordance with usual industry practice. Oil is sold under short-term
agreements for delivery at or near the well site at posted field prices which
may fluctuate depending on market conditions and the quality and classification
of the oil produced.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

The extent of demand for oil and gas and prices for oil and gas in
general depend on domestic production and consumption, the amount of foreign
oil imported and, in the case of gas, the proximity and capacity of natural gas
pipelines. There can be no assurance that favorable market conditions will
exist in the future, nor can it be determined what effect, if any, future
regulation of the oil and gas industry will have upon the Company's marketing,
operations or production.

GOVERNMENTAL REGULATION

Governmental regulations promulgated by various state and federal
authorities directly influence the Company's operations insofar as they
regulate operations of the Company's rigs, impact prices and therefore supplies
of and demands for oil and gas, and influence various costs associated with
petroleum exploration and production.

Regulation of Production

The production of oil and gas is subject to extensive federal and state
laws, rules, orders and regulations governing a wide variety of matters.
Numerous departments and agencies, both federal and state, are authorized by
statute to issue and have issued rules and regulations binding on the oil and
gas industry and its individual members, some of which carry substantial
penalties for the failure to comply.

State statutes and regulations require permits for drilling operations,
drilling bonds and reports concerning operations. Most states in which the
Company operates or might operate also have statutes and regulations governing
conservation matters, including the unitization or pooling of oil and gas
properties, establishing of maximum rates of production from oil and gas wells
and the spacing of such wells. Many states also restrict production to the
market demand for oil and gas. Such statutes and regulations may limit the
rate at which oil and gas could otherwise be produced from the Company's
properties. As a result of domestic crude oil shortages, there has been no
limit on allowable daily production on the basis of market demand since
mid-1972, although at some locations production continues to be regulated for
conservation purposes. In addition to the direct costs borne in complying with
such regulations, operations and revenues may be impacted to the extent that
certain regulations limit oil and gas production to below economic levels.
Although the particular regulations applicable in each state in which
operations may be conducted vary, such regulations are generally designed to
ensure that oil and gas operations are carried out in a safe and efficient
manner and to ensure that similarly situated operators are provided with
reasonable opportunities to produce their respective fair shares of available
oil and gas reserves. However, since these regulations generally apply to all
oil and gas producers, management of the Company believes that these
regulations should not put the Company at a material disadvantage to other oil
and gas producers.

Regulation of Sales and Transportation of Natural Gas

Certain sales, transportation and resales of natural gas by the Company
are subject to both federal and state laws and regulations, including the
Natural Gas Act ("NGA") and the Natural Gas Policy Act of 1978 (the "NGPA") and
regulations promulgated by the Federal Energy Regulatory Commission (the
"FERC") under the NGA, the NGPA and other statutes. The provisions of the NGA
and the NGPA, as well as the regulations thereunder, are complex and may affect
all who produce, resell, transport, purchase or consume natural gas.

The FERC's transportation regulations primarily affect the operations of
the Company by virtue of the need to deliver the Company's gas production to
markets served by interstate or intrastate pipelines governed by these
regulations. In most instances, interstate pipelines represent the only
available method of accomplishing such transportation.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Federal and state authorities have issued numerous orders during the
last several years governing the sale and transportation of natural gas and, no
doubt, will continue to issue other orders and actions which may significantly
affect the operations of the Company.

Price Controls on Liquid Hydrocarbons

Sales of crude oil, condensate, and natural gas liquids by the Company
can at present be made at uncontrolled market prices. While there are
currently no federal price controls on crude oil, condensate or natural gas
liquids, there can be no assurance that Congress will not reenact controls at a
future time.

Future Legislation

Currently there are many legislative proposals pertaining to regulation
of the oil and gas industry, which may directly or indirectly affect the
Company's activities. No prediction can be made as to what additional energy
legislation may be proposed, if any, or which bills may be enacted or when any
such bills, if enacted, would become effective.

Regulation of the Environment

The exploration, development, production and processing of oil and gas,
including the disposal of produced water, are subject to various federal and
state laws and regulations designed to protect the environment. Compliance
with these regulations is part of the Company's day-to-day operating
procedures. Infrequently, accidental discharge of such materials as oil,
natural gas, drilling fluids or contaminated water can and does occur. Such
accidents can require material expenditures to correct.

Various state and governmental agencies are considering, and some have
adopted, other laws and regulations regarding environmental control which could
adversely affect the business of the Company. Compliance with such measures,
together with any penalties resulting from noncompliance therewith, may
increase the cost of oil and gas development, production and processing
operations or may affect the ability of the Company to complete existing or
future activities in a timely manner.

Compliance with Regulations

The Company believes that it complies with all material legislation and
regulations affecting its operations in the drilling and operation of oil and
gas wells, and in controlling the discharge of wastes. Compliance has not, to
date, materially affected the capital expenditures, earnings or competitive
position of the Company, although these measures add to the costs of operating
drilling equipment in some instances, and in others they may operate to reduce
drilling activity. The Company does not expect to incur material capital
expenditures in the next fiscal year in order to comply with current
environmental control regulations. Further legislation or regulation may
reasonably be anticipated, but the effects thereof on operations cannot be
predicted.

The Company is subject to the requirements of the federal Occupational
Safety and Health Act ("OSHA") and comparable state statutes. The OSHA hazard
communication standard, the Environmental Protection Agency "community
right-to-know" regulations under Title III of the Federal Superfund Amendment
and Reauthorization Act and comparable state statutes require the Company to
organize and report certain information about the hazardous materials used in
its operations to employees, state and local government authorities, and local
citizens.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Taxation

Although the Company's business is subject to many provisions of the
Internal Revenue Code, as amended, the depletion allowance and intangible
drilling costs have particular significance to the exploration, development and
production of oil and gas. Certain state taxes influence operations as well.

Competitive and Operational Risks
in Oil and Gas Exploration and Production

The Company encounters substantial competition in its exploration and
development operations from other oil and gas companies. The usual method of
competition in the exploration, development and production segment is on the
basis of lease acquisition, the cost of such acquisition, geologic information
and its cost, availability of rigs at reasonable cost, successful drilling,
completion and production, availability of pipelines if gas, and successful
negotiation of oil and gas sales contracts. Many of the Company's competitors
have resources, technical staff and facilities substantially greater than those
of the Company.

Exploration and development of oil and gas reserves involves certain
operational risks and hazards. Among these are blowouts, cratering, fires and
explosions, and environmental damage, any one of which could potentially result
in loss of prospect value and liability to the Company.

PRINCIPAL CUSTOMERS

During the fiscal year ended March 31, 1996, Columbia Gas Development
Corp. contributed 17% of the Company's total drilling revenues. This was the
only customer to contribute 10% or more of the Company's total drilling
revenues. See "Contract Drilling - Contracts" in this Item I.

EMPLOYEES

The Company's personnel are leased under an agreement with a personnel
leasing company.

At May 25, 1996, the Company had 94 full-time leased personnel, of whom
78 were paid on an hourly basis and were engaged in operating the Company's
drilling rigs or in other operations. Of the total personnel, nine were
administrative personnel and seven were supervisory. None of the personnel are
represented by any union or collective bargaining group, and there is no
history of strikes, slow downs, or other material labor disputes. Management
believes that the Company's relations with the leased personnel are
satisfactory.

ITEM 2. PROPERTIES

For purposes of property description, see "Contract Drilling - Drilling
Equipment" and "Oil and Gas Operations and Properties" contained in this Part
I. The Company's principal executive office in San Antonio, Texas is
maintained in office space which the Company purchased in September, 1995. The
Company also owns a six-acre tract in Kenedy, Texas utilized as an operating
yard.

ITEM 3. LEGAL PROCEEDINGS

The Company is a defendant in several personal injury lawsuits of a type
which the Company considers routine for the contract drilling industry. These
lawsuits arose out of injuries to personnel under lease from third party
employee leasing companies. These lawsuits are being defended either by the
Company's general liability insurance carrier under what the Company considers
to be adequate coverage, or pursuant to an Indemnity

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Agreement between the Company and the employee leasing company which employed
the Plaintiff. The Company believes that the employee leasing company has
adequate insurance coverage to cover those claims.

Among the lawsuits currently pending against the Company is National
Energy Group, Inc. v. South Texas Drilling Company, cause No. 96-98, 357
Judicial District Court, Willacy County, Texas. This case arose out of a
dispute with a drilling customer over a billing for work performed under a
daywork drilling contract. In the course of drilling the well, some of the
Company's equipment was lost in the hole. Under the terms of the contract, the
customer was billed for the drilling operations and replacement cost of the
lost equipment. The customer has declined to pay the billed amount of $279,000
alleging negligence and seeking damages in excess of $100,000. This lawsuit is
being defended by the Company's general liability insurance carrier with a
rights of reservation letter. Discovery in this case is in the early stages and
depositions have not been completed. However, the Company believes it has
meritorious defenses and is vigorously defending this litigation. The Company
has filed a counter-suit seeking payment in full of the original invoice.

Management believes the ultimate disposition of these matters will have
no material adverse effect on the consolidated financial statements of the
Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the fourth quarter of the fiscal year covered by this report, no
matter was submitted to a vote of the Company's security holders through the
solicitation of proxies or otherwise.

PART II

ITEM 5. MARKET PRICE OF THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS

The initial public offering of the Company's Common Stock occurred on
February 4, 1981, and from that date until August 18, 1981, the Common Stock
was traded in the over-the-counter market. From August 19, 1981 until
February 10, 1986, the Company's Common Stock was listed on the American Stock
Exchange (AMEX) (Symbol: SDR). On February 10, 1986, trading of the Company's
stock was discontinued on the AMEX as the Company no longer met the net worth
requirement for listing on the AMEX. At the present time, the Company's Common
Stock (Symbol: STXD) is not traded on a stock exchange. However, the Company's
Common Stock is traded in the "pink sheets". Shareholders interested in
trading the Company's Common Stock should contact their stockbroker or the
Company for further information. The following table sets forth for the period
indicated quotations from a marketmaker for the Company's common stock.

OVER-THE-COUNTER
-------------------------
Bid Ask
------ ------

1996
----
First Quarter $.1800 .5000
Second Quarter .3100 .5600
Third Quarter .2500 .5000
Fourth Quarter .2500 .5000

1995
----
First Quarter $.4375 .5625
Second Quarter .3750 .7500
Third Quarter .2500 .5000
Fourth Quarter .2500 .5000

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

The above over-the-counter quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.

As of June 19, 1996, there were approximately 1,000 registered
stockholders of Common Stock of the Company.

The Board of Directors has followed a policy of reinvesting the earnings
of the Company in its business and of not distributing any part thereof as
dividends to shareholders. The Board of Directors has no present intention to
initiate the payment of cash dividends, and future dividends of the Company
will depend upon the earnings, capital requirements and financial condition of
the Company and other relevant factors.

ITEM 6. SELECTED FINANCIAL DATA
(In thousands, except per share amounts)

Years Ended
March 31,
-------------------------------------------------------------
1996 1995 1994 1993 1992
-------- ----- ------ ----- ------

Revenues $ 7,500 5,494 7,050 6,109 3,983

Earnings (loss) before income taxes and
extraordinary item 3 (244) 723 486 (841)

Net earnings (loss) 3 (244) 723 486 (841)

Earnings (loss) per share before extraordinary
item - (0.05) .14 .07 (.18)

Net earnings (loss) per share - (0.05) .14 .10 (.18)

Long-term debt, excluding current installments 554 88 91 96 97

Shareholders' equity 1,477 1,541 1,744 1,013 498

Total assets 4,286 3,473 4,093 2,781 1,794

Capital expenditures 1,162 835 961 953 584

See Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations" of this Report.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

Liquidity

The reduced level of drilling activity in the oil and gas industry
during the period of 1982-1989 had a detrimental effect on the Company's
operations. Beginning in March, 1987, the Company experienced increased rig
utilization which continued until December, 1990. Beginning with the last
quarter of fiscal 1991, drilling activity in the Company's market area began to
decline and this lower level of activity continued through fiscal 1993 with a
brief surge of activity in November and December, 1992 and also during the
second and third quarters of fiscal 1994. During the first three quarters of
fiscal 1995, drilling activity was stable but it decreased significantly in the
last quarter of the fiscal year primarily due to a fall in natural gas prices.
In fiscal 1996, drilling activity returned to a more stable level. During
fiscal 1995, the utilization rate for the Company's rigs was 64 percent.
During that year, the Company operated four rigs. In fiscal 1996, the
utilization rate remained at 64 percent. However, in

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

fiscal 1996, the Company operated or had available to operate five rigs. The
actual number of drilling days increased to 1,076 in fiscal 1996 from 842 in
fiscal 1995. Drilling rates charged to customers on drilling contracts in
fiscal 1996 showed some increase over those charged in fiscal 1995. This
increase in drilling rates reflects the increased demand for drilling rigs
during the period. At March 31, 1996, the Company's current ratio was .51
compared to .59 at March 31, 1995. Working capital at March 31, 1996 was
($1,104,828) compared to ($658,399) at March 31, 1995. This decrease was due,
in part, to the effects of an uncollected trade receivable; increased current
portion of long-term debt incurred to acquire drilling equipment, transportation
equipment and land and building; and increased trade payables incurred to
acquire, improve and maintain drilling equipment.

During fiscal 1996, the Company utilized its line of credit with its
bank on several occasions. At March 31, 1996, the Company owed $200,000 on its
$200,000 line of credit. This was necessary to offset the effect on the
Company's cash position of increased accounts receivables from drilling
operations. Additional borrowings during the year included $300,000 for the
purchase of a drilling rig; $120,000 for additional drilling equipment;
$106,641 for the drilling of a well in which the Company has a 67.5% working
interest; $245,250 for the purchase of the Company's headquarters building in
San Antonio; and $31,575 for the purchase of transportation equipment.

In May, 1996, the Company closed on a debt restructuring which included
a term loan of $1,250,000 and a revolving line of credit of $500,000, which has
allowed the Company to pay off all its bank debt with the exception of the loan
secured by the headquarters building in San Antonio and a minimal balance on
the loan secured by the oil and gas properties. The new debt also allowed the
Company to pay off the seller financing on the rig purchased in May, 1995.
Proceeds from the new debt were also used to reduce trade accounts payable and
to provide funds for future drilling equipment purchases. The term loan is
secured by drilling equipment, transportation equipment and the yard facility
in Kenedy, Texas. The loan carries an interest rate of prime (8.25% at March
31, 1996) plus 3% and is payable in monthly payments of $14,881 plus interest.
Payments are based on a seven-year amortization and the loan is due in June,
1998. The revolving loan is secured by the Company's trade accounts receivable
and carries an interest rate of prime plus 2.75%.

During fiscal 1996, the Company negotiated with its Bank to have the
Bank's demand clause removed from all of the Company's debt with the Bank.
Because of the change the Company is able to classify as long-term the
long-term portion of the bank debt. This results in a higher current ratio and
a lower working capital deficit than would have been reported had the demand
clause not been removed.

The ratio of trade accounts receivable to total revenue increased to
7.1% at the end of fiscal 1996 from 3.6% at the end of fiscal 1995. This
increase was the result of the increased drilling activity in the fourth
quarter of the fiscal year. Due to the Company's incurring of additional debt
to purchase equipment and the minimal earnings incurred by the Company during
fiscal 1996, the ratio of the Company's shareholders' equity in relation to
outstanding debt (vendor and bank notes payable) decreased. At March 31, 1995,
the ratio of shareholders' equity to notes payable was 1 to .46. At March 31,
1996, the ratio had declined to 1 to .83. Shareholders' equity was also
affected by a pending lawsuit in which the Company is the plaintiff in a cross
action filed in a Declaratory Judgment case filed by one of its Company's
insurers contesting payment of a personal injury judgment entered against the
Company. Due to the uncertainty of the outcome of the case, the Company has
established a provision of $200,000 relating to the Company's obligation under
a judgment in a personal injury lawsuit in which the Company was the defendant
and represented by the insurer of its former employee leasing company. If the
insurer should prevail in its Declaratory Judgment action the Company is
required to pay $200,000 over a three year period to the personal injury
plaintiff. Since the insurer has refused to pay on the $200,000 judgment, the
Company has made payments of $45,000 to the personal injury plaintiff. The
Company has also recorded a liability for the remaining $155,000 of which
$60,000 is classified as current portion of long-term debt and $95,000 as
long-term debt.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

The Company's liquidity was also affected by an uncollected account
receivable of $279,000 from drilling operations. In this case, the Company
drilled a well under a daywork contract. In the course of drilling the well,
some of the Company's equipment was lost in the hole. Under the terms of the
contract, the customer was billed for the drilling operations and the
replacement cost of the lost equipment. The customer filed a lawsuit alleging
negligence, denying responsibility for the $279,000 billed by the Company, and
seeking additional damages in excess of $100,000. Management, which believes
the customer's claim to be without merit, has filed a counter-suit seeking
payment in full of the original invoice in the amount of $279,000.

Changes in Financial Condition

During fiscal 1996, the Company had a net increase in property and
equipment of $844,000 before accumulated depreciation, depletion and
amortization. Of this increase, $530,000 was attributable to the purchase of
drilling equipment, $7,000 to purchase or acquisition of oil and gas
properties, and $307,000 to the purchase of transportation and office
equipment, land and buildings and improvements. The net increase in drilling
equipment included the addition of Rig 11 which was placed in service in May,
1995 and the disposal of Rig 10 in December, 1995. Rig 11 was purchased for
$345,000 of which $45,000 was paid in cash and $300,000 was financed through
owner financing. In December, 1995, a partnership in which a wholly-owned
subsidiary of the Company was the general partner distributed Rig 10 back to
the partners of the partnership. The Company's subsidiary then sold its
one-half interest in the rig to the other partner for 319,767 shares of the
Company's stock. The main component in the increase in transportation and
office equipment, land and buildings and improvements was the purchase of the
building which the Company occupies as its headquarters in San Antonio, Texas.
The building was purchased for $273,000 of which $137,000 was financed by a
bank and $114,000 was financed by the Small Business Administration.

At March 31, 1996, current debt and notes payable were $667,000. Of
this amount, $277,000 was owed on oil and gas properties, $200,000 on the line
of credit, $98,000 on drilling equipment, $7,000 on the yard facility, $13,000
on land and buildings and improvements, $12,000 on transportation equipment and
$60,000 as the current amount of the loss related to the personal injury claim
discussed above in the "Liquidity" section of this ITEM 7. Trade accounts
payable at March 31, 1996 were $1,256,000 compared to $764,000 at March 31,
1995. At March 31, 1996, long-term debt was $554,000. Of this amount,
$232,000 was owed on land and buildings and equipment; $126,000 on drilling
equipment; $95,000 long-term portion of the $200,000 contingent obligation on
the possible lawsuit judgment related to the personal injury claim; $73,000 to
an employee for unpaid salary and $28,000 on transportation equipment.

Results of Operations

Rig utilization rates for the years ended March 31, 1996, 1995 and 1994
were 64%, 64% and 57%, respectively. In fiscal 1996, the Company completed
1,076 drilling days while in fiscal 1995, the Company completed 842 drilling
days. This was a 28% increase compared to fiscal 1995 in the number of
drilling days. This increase reflects the increased demand during the period
for drilling rigs and the increased efforts of the Company's staff to obtain
contracts for the rigs.

During fiscal 1996, the Company's drilling margin increased when
compared to fiscal 1995 and it decreased when compared to fiscal 1994. In
fiscal 1996, the drilling margin was $912,230, while in fiscal 1995 and fiscal
1994 it was $539,801 and $1,149,247, respectively. The increase in fiscal 1996
over fiscal 1995 was principally the result of the 28% increase in the number
of drilling days during fiscal 1996. The drilling margin in 1996 was less than
1994 because of increased repairs, maintenance and operating costs.

The Company markets its rigs to a number of customers. In fiscal 1996,
the Company drilled for 27 different customers. In fiscal 1995, the Company
drilled for 19 different customers. Of the 27 customers in fiscal

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

1996, 22 were customers the Company had not drilled for in fiscal 1995. These
22 customers accounted for over 68% of the Company's drilling revenue in fiscal
1996. In fiscal 1994, two customers accounted for 23% of total drilling
revenue. In fiscal 1995, two customers accounted for 36% of total drilling
revenue. In fiscal 1996, three customers accounted for 34% of total drilling
revenue. Of these three customers, only one was included in the top two
customers of fiscal 1995. The loss of any of these customers could have a
material adverse effect on the Company's business for the time required to find
other users of the rig concerned.

Oil and gas revenue for fiscal 1996 decreased by $25,299 from fiscal
1995. The decrease was primarily due to a 22% decrease in oil production and a
4% decrease in the average price per MCF of gas. These decreases were offset
to an extent by a 22% increase in gas production and a 4% increase in the
average price per barrel of oil. In fiscal 1996, the Company's average
production cost per unit in barrel equivalents increased 4% from fiscal 1995.
This compares with a 8% decrease in the average production cost for 1995
compared to 1994.

Depreciation, depletion and amortization expense in fiscal 1996
increased to $576,894 from $475,708 in fiscal 1995. Depreciation expense
increased to $384,400 in fiscal 1996 from $277,986 in fiscal 1995. This
increase was the result of equipment purchased in late fiscal 1995 and fiscal
1996. Depletion expense decreased to $192,494 in fiscal 1996 compared to
$197,722 in fiscal 1995. Production decreased to 27,227 barrel equivalents in
fiscal 1996 from 27,948 barrel equivalents in fiscal 1995. In fiscal 1996, the
Company was not subject to the ceiling test limitation as it applies to oil and
gas properties. Under such a test, the depleted carrying value of the
Company's oil and gas properties is compared to the net present worth of
estimated future oil and gas revenues, discounted at 10%. If the depleted
carrying value exceeds the discounted net present worth of estimated future oil
and gas revenues, the carrying value must be written down. Conversely, if the
discounted net present value exceeds the carrying value of the properties, no
adjustment is made to the carrying value, even if there had been a write-off in
prior years.

General and administrative expenses increased from $450,609 in fiscal
1995 to $520,402 in fiscal 1996. The primary reasons for the increase were an
increase in payroll costs associated with additional personnel and costs
incurred related to the annual meeting in August, 1995.

Earnings (loss) from operations increased to $15,608 in fiscal 1996 from
($222,900) in fiscal 1995. Of the $15,608, ($65,506) was contributed by
drilling operations and $81,114 by oil and gas operations. When compared with
oil and gas operations, drilling operations generate significantly more
revenue, but they are far more costly, requiring large expenditures for
equipment, personnel and maintenance and repairs. Oil and gas operations, on
the other hand, normally do not require significant expenditures once the
original purchase or investment is accomplished. Oil and gas operations
require limited personnel involvement to produce the oil and gas, whereas
drilling operations require continuous involvement of significant numbers of
personnel to complete a contract.

The exploration, development, production and processing of oil and gas,
including the disposal of produced water, are subject to various federal and
state laws and regulations designed to protect the environment. Compliance
with these regulations is part of the Company's day-to-day operating
procedures. The Company is not aware of any potential clean-up obligations
which would have a material effect on its financial condition or results of
operations.

In March, 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of".
This Statement requires that long-lived assets and certain identifiable
intangibles to be held and used by an entity be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable. This Statement requires that long-lived
assets and certain identifiable intangibles to be disposed of be reported at
the lower of carrying amount or fair value less cost to sell. This Statement
is not expected to impact the Company's oil and gas properties as they are
accounted for under the full

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

cost accounting method. The Company has not yet performed an analysis of the
impact of implementation of this Statement on its drilling rigs and equipment.
The Company is required to adopt this Statement in fiscal year 1997.

In October, 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," which requires adoption of the disclosure provisions
no later than fiscal years beginning after December 15, 1995. This Statement
establishes financial accounting and reporting for stock-based employee
compensation plans, including stock purchase plans, stock option plans,
restricted stock and stock appreciation rights. The Statement requires a fair
value based method of accounting for employee stock options or similar
instruments and encourages a similar method for all employee stock compensation
plans. This method measures compensation cost at the grant date based on the
value of an award and recognizes it over the service period, usually the
vesting period. However, the Statement also allows an entity to continue
measuring compensation cost for such plans using the intrinsic value method of
accounting prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees", provided pro forma disclosures are
made. The Company has not yet determined the effect the new standard will have
on net income and earnings per share should it elect to make such a change.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Independent Auditors' Report

The Board of Directors
South Texas Drilling & Exploration, Inc.:

We have audited the consolidated balance sheets of South Texas Drilling
& Exploration, Inc. and subsidiaries as of March 31, 1996 and 1995 and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the years in the three-year period ended March 31, 1996. In
connection with our audits of the consolidated financial statements, we also
have audited the financial statement schedule (Schedule II) for each of the
years in the three-year period ended March 31, 1996. These consolidated
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatements. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of South Texas
Drilling & Exploration, Inc. and subsidiaries as of March 31, 1996 and 1995,
and the results of their operations and their cash flows for each of the years
in the three-year period ended March 31, 1996, in conformity with generally
accepted accounting principles. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.

KPMG Peat Marwick LLP

San Antonio, Texas
June 19, 1996

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

Assets
------

March 31,
----------------------------
1996 1995
---------- ----------

Current assets:
Cash and cash equivalents $ 325,568 221,816
Receivables:
Trade, net of allowance for
doubtful accounts of $140,000
in 1996 and $0 in 1995 530,393 195,131
Contract drilling in progress 234,527 437,563
Employees and officers 10,926 13,857
Prepaid expenses 48,016 60,006
----------- ----------
Total current assets 1,149,430 928,373
----------- ----------

Property and equipment, at cost (note 2):
Drilling rigs and equipment 8,287,756 7,757,780
Oil and gas properties,
based on full cost accounting
method (note 9) 1,749,467 1,741,982
Transportation, office, land and other 1,072,847 766,278
----------- -----------
11,110,070 10,266,040

Less accumulated depreciation,
depletion and amortization 8,001,254 7,751,704
----------- -----------
Net property and equipment 3,108,816 2,514,336

Notes receivable-employees,
at 5% and 7%, due in 1995
and 1998, respectively 27,404 30,549
----------- -----------
$ 4,285,650 3,473,258
=========== ===========

See accompanying notes to consolidated financial statements.
(Continued)

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Continued)

Liabilities and Shareholders' Equity
- ------------------------------------

March 31,
-----------------------------
1996 1995
----------- -----------

Current liabilities:
Current installments of long-term
debt (note 2) $ 467,416 291,311
Line of credit with bank (note 2) 200,000 200,000
Notes payable, interest at 10% to 11-1/2% - 133,530
Accounts payable 1,255,505 763,591
Accrued expenses:
Payroll and payroll taxes 166,580 127,156
Other 164,757 71,184
---------- ----------
Total current liabilities 2,254,258 1,586,772

Note payable to employee, interest at 7%
(note 2) 73,416 73,416

Long-term debt, less current installments
and note payable to employee (note 2) 480,500 14,207

Minority interest in partnership (note 10) - 258,024
---------- ----------
Total liabilities 2,808,174 1,932,419
---------- ----------

Shareholders' equity (note 4):
Preferred stock, Series A,
noncumulative dividend at 8%
of liquidation preference value,
$1.00 par value. Authorized
1,000,000 shares; issued and
outstanding 235,000 shares.
Liquidation preference value
of $4.26 per share ($1,000,000);
redeemable at the Company's option
at $1.00 per share 235,000 235,000

Common stock, $.10 par value.
Authorized 15,000,000 shares;
issued and outstanding 5,601,000
shares at March 31, 1996 and
5,408,000 shares at March 31, 1995 560,100 540,800
Additional paid-in capital 15,899,227 15,854,757
Accumulated deficit (15,086,946) (15,089,718)
----------- -----------
1,607,381 1,540,839
Less treasury stock, 319,767 shares, at cost (129,905) -
----------- -----------
Total shareholders' equity 1,477,476 1,540,839
----------- ----------
$ 4,285,650 3,473,258
=========== ==========

See accompanying notes to consolidated financial statements.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended March 31,
---------------------------------------
1996 1995 1994
----------- --------- ---------

Revenues:
Contract drilling $ 6,989,972 4,935,510 6,476,450
Oil and gas 380,110 405,409 410,674
Administrative overhead and other 129,572 153,175 163,046
----------- --------- ---------
Total operating revenues 7,499,654 5,494,094 7,050,170
----------- --------- ---------

Costs and expenses:
Contract drilling 6,077,742 4,395,709 5,327,203
Oil and gas 169,008 166,594 178,501
Depreciation, depletion and
amortization 576,894 475,708 344,488
General and administrative 520,402 450,609 412,854
Doubtful accounts 140,000 228,374 62,949
----------- --------- ---------
Total operating costs and expense 7,484,046 5,716,994 6,325,995
----------- --------- ---------
Earnings (loss) from operations 15,608 (222,900) 724,175
----------- --------- ---------

Other income (expense):
Interest expense (108,121) (65,465) (55,190)
Interest income 5,443 6,409 10,697
Gain on sale of assets 273,251 48,774 43,206
Provision for litigation settlement (200,000) - -
Minority interest in operation
of partnership 16,591 (11,224) -
----------- --------- ---------

Total other income (expense) (12,836) (21,506) (1,287)
----------- --------- ---------
Earnings (loss) before income
taxes 2,772 (244,406) 722,888

Income taxes - - -
----------- --------- ----------
Net earnings (loss) $ 2,772 (244,406) 722,888
=========== ========= ==========

Net earnings (loss) per common
and common equivalent share $ - ( 0.05) 0.14
=========== ========= ==========

Weighted average common and
common equivalent shares
outstanding 5,401,578 5,336,167 5,078,000
=========== ========= ==========

See accompanying notes to consolidated financial statements.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

Shares Amount
-------------------------- -------------------------
Common Preferred Common Preferred
---------- --------- ---------- ---------

Balance at March 31, 1993 5,058,000 235,000 $ 505,800 235,000
Issuance of common stock for fees
to directors 30,000 - 3,000 -
Net earnings - - - -
---------- --------- ---------- ---------
Balance at March 31, 1994 5,088,000 235,000 508,800 235,000
Issuance of common stock for bonus
to employees 50,000 - 5,000 -
Issuance of common stock for fees
to directors 25,000 - 2,500 -
Issuance of common stock for
exercise of warrants 245,000 - 24,500 -
Net loss - - - -
---------- --------- ---------- ---------
Balance at March 31, 1995 5,408,000 235,000 540,800 235,000

Issuance of common stock for bonus
to employee 50,000 - 5,000 -
Issuance of common stock
for fees to directors 8,000 - 800 -
Issuance of common stock
for exercise of warrant 35,000 - 3,500 -
Issuance of common stock for
exercise of option 100,000 - 10,000 -
Acquisition of 319,767 shares
of common stock in
exchange for equipment - - - -
Net earnings - - - -
---------- --------- ---------- ---------
Balance at March 31, 1996 5,601,000 235,000 $ 560,100 235,000
========== ========= ========== =========

Additional Total
Paid-in Accumulated Treasury Shareholders'
Capital Deficit Stock Equity
------------ --------------- --------- ------------

Balance at March 31, 1993 15,840,287 (15,568,200) - 1,012,887
Issuance of common stock for fees
to directors 5,700 - - 8,700
Net earnings - 722,888 - 722,888
------------ --------------- --------- ------------
Balance at March 31, 1994 15,845,987 (14,845,312) - 1,744,475
Issuance of common stock for bonus
to employees 6,500 - 11,500
Issuance of common stock for fees
to directors 2,270 - 4,770
Issuance of common stock for
exercise of warrants - - 24,500
Net loss - (244,406) - (244,406)
------------ --------------- --------- ------------
Balance at March 31, 1995 15,854,757 (15,089,718) - 1,540,839

Issuance of common stock for bonus
to employee 6,500 - 11,500
Issuance of common stock
for fees to directors 1,040 - 1,840
Issuance of common stock
for exercise of warrant 6,300 - 9,800
Issuance of common stock for
exercise of option 30,630 - 40,630
Acquisition of 319,767 shares
of common stock in
exchange for equipment - - (129,905) (129,905)
Net earnings - 2,772 - 2,772
------------ --------------- --------- ------------
Balance at March 31, 1996 15,899,227 (15,086,946) (129,905) 1,477,476
============ =============== ========= ============

See accompanying notes to consolidated financial statements.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended March 31,
------------------------------------------
1996 1995 1994
---------- ---------- ----------

Cash flows from operating activities:
Net earnings (loss) $ 2,772 (244,406) 722,888
Adjustments to reconcile net earnings (loss) to net
cash provided by operating activities:
Depreciation, depletion and amortization 576,894 475,708 344,488
Provision for doubtful accounts 140,000 228,374 62,949
Stock issued to directors and employees 13,340 16,270 8,700
Gain on sale of assets (273,251) (48,774) (43,206)
Minority interest in operations of partnership (16,591) 11,224 -
Changes in current assets and liabilities:
Receivables (266,150) 225,620 (772,752)
Prepaid expenses 11,990 (25,950) 11,409
Accounts payable 491,914 (425,644) 489,482
Accrued expenses 132,997 28,767 24,400
---------- ---------- ----------
Net cash provided by operating activities $ 813,915 241,189 848,358
---------- ---------- ----------

See accompanying notes to consolidated financial statements.

(Continued)

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

Years Ended March 31,
------------------------------------------
1996 1995 1994
----------- ---------- ----------

Cash flows from financing activities:
Proceeds from notes payable $ 1,580,707 630,165 442,037
Proceeds from exercise of warrants 9,800 24,500 -
Proceeds from exercise of options 37,500 - -
Payments of debt (2,078,094) (987,597) (657,379)
----------- ---------- ----------
Net cash used in financing activities (450,087) (332,932) (215,342)

Cash flows from investing activities:
Purchase of property and equipment (410,757) (754,963) (678,758)
Contribution from limited partner - 275,000 -
Proceeds from sale of property and equipment 150,681 5,350 75,462
----------- ---------- ----------
Net cash used in investing activities (260,076) (474,613) (603,296)
----------- ---------- ----------

Net increase (decrease) in cash and cash equivalents 103,752 (566,356) 29,720
Beginning cash and cash equivalents 221,816 788,172 758,452
----------- ---------- ----------
Ending cash and cash equivalents $ 325,568 221,816 788,172
=========== ========== ==========
Supplementary disclosure:
Interest paid $ 101,289 71,078 49,268
Debt incurred for litigation settlement 200,000 - -
Notes payable issued for equipment and
oil and gas properties 809,266 79,730 282,687
Treasury stock received for drilling equipment 129,905 - -

See accompanying notes to consolidated financial statements.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1) Organization and Summary of Significant Accounting Policies

Business and Principles of Consolidation

The Company provides land contract drilling services for the oil
and gas industry, primarily in southern Texas, and engages in oil and
gas exploration and development activity for its own account. The
consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiaries and its limited partnership interest
through December, 1995. All significant intercompany accounts and
transactions have been eliminated in consolidation.

The financial statements have been prepared in accordance with
generally accepted accounting principles. In preparing the financial
statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the
dates of the balance sheets and income and expenses for the periods.
Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant
changes in the near term relate to the determination of depreciation,
depletion and amortization expense.

Reclassifications

Certain reclassifications of prior period amounts have been made
to conform with the current period presentation.

Income Taxes

The Company files a consolidated Federal income tax return with
its subsidiaries using a December 31 year- end.

Pursuant to Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes", the Company follows the asset and
liability method of accounting for income taxes under which deferred
tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income
in the years in which those temporary differences are expected to be
recovered or settled. Under Statement 109, the effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.

Earnings (Loss) Per Common Share

Earnings (loss) per common and common equivalent share are based
upon the weighted average number of outstanding shares during each
period. Dilutive common equivalent shares consist of stock warrants
and the weighted average is computed using the treasury stock method.
Earnings (loss) per share computed on a fully diluted basis is not
presented as it is not significantly different from earnings (loss)
per share computed on a primary basis.

(Continued)

-23-
24
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Contract Drilling in Progress

Contract drilling revenues are earned on footage, daywork and
turnkey contracts and such revenues and related costs are included in
the determination of earnings as work progresses. Contract drilling
in progress consists of revenues earned on contracts which have not
yet been billed.

Property and Equipment

Oil and gas producing activities are accounted for using the full
cost method. Under the full cost method, all costs incurred in the
acquisition, exploration and development of all oil and gas
properties, including surrendered and abandoned leaseholds, delay
lease rentals and dry hole costs, are capitalized. All costs related
to production, general corporate overhead and other similar activities
are expensed in the period incurred.

Depletion of oil and gas properties is provided by the unit of
production method based on the Company's interest in the aggregated,
estimated recoverable reserves of all properties. Depletion includes
a ceiling limitation adjustment required under the full cost method of
accounting. The ceiling limitation adjustment is applicable when the
carrying value of oil and gas properties exceeds the discounted net
present worth of estimated future cash flows on those properties.

Depreciation of drilling, transportation and other equipment is
provided using the straight-line method over estimated useful lives
ranging from three to ten years.

Maintenance and repairs are charged to operations; renewals and
betterments are charged to appropriate property and equipment
accounts.

Cash Equivalents

For purposes of the statements of cash flows, the Company
considers all highly liquid debt instruments purchased with a maturity
of three months or less to be cash equivalents.

(2) Notes Payable and Long-term Debt

As of March 31, 1996 and 1995, the Company had established a line
of credit with a bank enabling the Company to borrow up to $200,000 at
the bank's prime rate (9.25% at March 31, 1996 and 10.0% at March 31,
1995) all of which was outstanding as of March 31, 1996 and 1995. The
line of credit would have been due October 21, 1996, however, it was
paid in full through a debt restructuring accomplished in May, 1996
and more fully described in footnote No. 8, "Subsequent Events." The
Company had no other credit facilities at March 31, 1996 except for
the long-term debt described below:

March 31,
----------------------
1996 1995
---------- ------

Note payable to employee for unpaid compensation,
at 7.0%, due in 1998. $ 73,416 73,416

(Continued)

-24-
25
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

March 31,
-------------------------
1996 1995
---------- ----------

Note payable, secured by a vehicle, due in monthly payments of
$380 including interest at 10.9%, due in January, 2000. 14,191 17,023

Note payable, secured by a vehicle, due
in monthly payments of $426 including
interest at 12.35%, due in June, 1999. 13,855 -

Note payable, secured by a vehicle, due
in monthly payments of $498 including
interest at 9.7%, due in June, 1998. 11,635 -

Note payable, secured by a vehicle, due in
monthly payments of $413 including interest
at 8.5%, due in October, 1995. - 2,811

Note payable to seller, secured by a
drilling rig, due in monthly payments of
$9,540 including interest at 9.0%, due
in May, 1998. (note b) 224,591 -

Note payable to bank, secured by land and
improvements, due in monthly payments of
$1,900 including interest at the bank's prime rate
(9.25% at March 31, 1996) plus 0.5%, due in
September, 2005. (note c) 131,756 -

Note payable to Small Business Administration,
secured by second lien on land and improvements,
due in monthly payments of $921 including interest
at 6.713% due in November, 2015. (note c) 112,765 -

Note payable to bank, secured by land and improvements due in
monthly payments of $1,800 including interest at the bank's
prime rate (9.25% at March 31, 1996), due September, 1996.
(note a) 8,392 28,020

Note payable to bank, secured by oil and gas properties, due in
monthly installments of $17,510 including interest at the bank's
prime rate (9.25% at March 31, 1996) plus 1%, due January, 1997.
(note a)
275,731 257,664

(Continued)

-25-
26
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

March 31,
-------------------------
1996 1995
---------- ----------

Litigation settlement due in
quarterly payments of $15,000 without
interest, due in August, 1998. 155,000 -
---------- ----------
1,021,332 378,934
Less current portion 467,416 291,311
---------- ----------
$ 553,916 87,623
========= =========

Long-term debt maturing each year subsequent to March 31, 1996 is
as follows: 1997 - $467,416; 1998 - $268,001; 1999 - $78,296; 2000 -
$21,627; 2001 and thereafter- $185,992.

At March 31, 1996, the Company was in compliance with various
negative and affirmative covenants on its note payable to bank,
secured by oil and gas properties. Such covenants included the
maintenance of at least $25,000 in depository accounts at the bank and
a net worth of at least $400,000 at all times.

Note a: On April 14, 1995, the Company executed a Master Real
Estate Lien Note in the amount of $800,000 with a bank. This note
provides the Company with a $400,000 "Guidance Line of Credit
Facility" to be used for drilling, completion and equipping expenses
of wells to be drilled. This note has an interest rate of one percent
over the Bank's prime rate, 9.25% at March 31, 1996, and is due
January 1, 1997. In addition to the Guidance Line of Credit Facility,
the Master Note covers the other notes executed by the Company in
favor of the Bank, the line of credit, the loan secured by the yard
facility in Kenedy and the loan secured by oil and gas properties
purchased in 1992 and drilled in 1993. Subsequent to the execution of
the Master Real Estate Lien Note, the bank has funded $107,000 to the
Company.

Note b: In May, 1995, the Company purchased an additional land
drilling rig for $345,000. $300,000 of the purchase price was financed
by the seller through a note payable in monthly payments of $9,540
including interest at 9.0%. This note has a three year term.

Note c: In September, 1995, the Company executed a note payable,
in the amount of $245,250, to a bank for the purchase of the office
building which the Company occupies as its headquarters in San
Antonio, Texas. The note has a term of ten years and is payable in
monthly payments of $1,900 including interest at 0.5% over the Bank's
prime rate, 9.25% at March 31, 1996. In November, 1995 the Company
closed on financing with the Small Business Administration which
became a second lien on the headquarters building. The loan is in the
amount of $114,000 and was used to pay down the amount borrowed from
the bank for the purchase. This debt has a 20 year term and is
payable in monthly payments of $921 including interest at 6.713%.

Subsequent to the end of fiscal 1996, the Company restructured a
majority of its bank and long-term debt. See footnote 8, "Subsequent
Events".

(3) Income Taxes

Due to the utilization of net operating loss carryforwards, the
Company had no Federal income tax liability at March 31, 1996 or 1995.

(Continued)

-26-
27
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

At March 31, 1996, for Federal income tax purposes the Company
had a net operating loss carryforward of approximately $15,820,000 and
investment tax credit carryforwards of approximately $671,000
available to offset future taxable income and taxes.

Unless utilized, net operating loss and investment tax credit
carryforwards will expire as follows:

Net Investment
Operating Tax
Year Loss Credits
---- ------------ ----------

1996 - 546,000
1997 - 110,000
1998 11,717,000 9,000
1999 1,025,000 5,000
2000 2,225,000 1,000
2001 452,000 -
2006 401,000 -
------------ ----------
$ 15,820,000 671,000
============ ==========

The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and deferred tax
liabilities at March 31, 1996 and 1995 are presented below:

March 31,
-------------------------
1996 1995
---------- ----------

Deferred tax assets:
Property and equipment, principally due to differences in
depreciation $ - 82,000
Allowance for bad debts 48,000 -
Investment tax credit carryforwards 671,000 789,000
Net operating loss carryforwards 5,381,000 5,494,000
---------- ----------
Total gross deferred tax assets 6,100,000 6,365,000

Less valuation allowance (5,871,000) (6,158,000)
---------- ----------
Total deferred tax assets 229,000 207,000
---------- ----------

Deferred tax liabilities:
Property and equipment, principally due to
differences in depreciation 45,000 -
Oil and gas properties, principally due to intangible
drilling costs and differences in depletion
184,000 207,000
---------- ----------
Total gross deferred tax liabilities 229,000 207,000
---------- ----------
Net deferred tax asset $ - -
========== ==========

A valuation allowance has been established to decrease total
gross deferred tax assets to the amount of the total gross tax
liabilities due to the uncertainties involved in the ultimate
realization of the deferred

(Continued)

-27-
28
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

tax assets. The valuation allowance for deferred tax assets at March
31, 1995 was $6,158,000. The net change in total valuation allowance
for the year ended March 31, 1996 was a decrease of $287,000 due to the
change in the corresponding gross deferred tax assets and liabilities.

(4) Stock Options and Warrants

In December, 1988, the Board of Directors issued certain
directors, officers and employees warrants to purchase 435,000 shares
of the Company's common stock at $.15 per share, of which three
warrants for a total of 55,000 shares have been exercised as of March
31, 1996 and two warrants for 245,000 shares have been canceled.
These warrants are exercisable upon issuance and expire December 8,
1998. As of March 31, 1996, 135,000 shares of Common stock were
reserved for future issuance in connection with warrants issued to
employees, directors, officers and former employees.

In August, 1992, the Board of Directors issued certain directors,
officers and employees warrants to purchase 235,000 shares of the
Company's stock at $.10 per share, all of which have been exercised as
of March 31, 1996.

On May 1, 1995, the Board of Directors issued an option to Mr.
Locke, President and Chief Executive Officer, to purchase 1,200,000
shares of the Company's common stock at $.375 per share. This option
expires on May 1, 2005. At March 31, 1996, 100,000 shares have been
purchased under this option.

On June 15, 1995, the Board of Directors issued certain
directors, officers and employees options to purchase 128,500 shares
of the Company's common stock at $.375 per share, none of which has
been exercised as of March 31, 1996.

In October, 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," which requires adoption of the disclosure
provisions no later than fiscal years beginning after December 15,
1995. This Statement establishes financial accounting and reporting
for stock-based employee compensation plans, including stock purchase
plans, stock option plans, restricted stock and stock appreciation
rights. The Statement requires a fair value based method of
accounting for employee stock options or similar instruments and
encourages a similar method for all employee stock compensation plans.
This method measures compensation cost at the grant date based on the
value of an award and recognizes it over the service period, usually
the vesting period. However, the Statement also allows an entity to
continue measuring compensation cost for such plans using the
intrinsic value method of accounting prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees", provided pro forma disclosures are made. The Company has
not yet determined the effect the new standard will have on net income
and earnings per share should it elect to make such a change.

(Continued)

-28-
29
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(5) Business Segments and Supplementary Earnings Information

The Company is engaged in contract drilling of oil and gas wells
and in oil and gas exploration, development and production.
Information concerning business segments and supplementary earnings
information is as follows:

Years Ended March 31,
-------------------------------------------
1996 1995 1994
----------- ---------- ----------

Revenues:
Contract drilling $ 7,024,144 4,998,555 6,558,667
Oil and gas 475,510 495,539 492,024
Elimination of intersegment revenue - - (521)
----------- ---------- ----------
$ 7,499,654 5,494,094 7,050,170
=========== ========== ==========

Earnings (loss) from operations:
Contract drilling $ (65,506) (313,847) 553,696
Oil and gas 81,114 90,947 171,000
Elimination of intersegment revenue - - (521)
----------- ---------- ----------
$ 15,608 (222,900) 724,175
=========== ========== ==========
Identifiable assets at end of period:
Contract drilling $ 3,501,058 2,419,778 3,065,005
Oil and gas 784,592 1,053,480 1,028,443
----------- ---------- ----------
$ 4,285,650 3,473,258 4,093,448
=========== ========== ==========
Depreciation, depletion and amortization:
Contract drilling $ 384,400 277,986 209,300
Oil and gas 192,494 197,722 135,188
----------- ---------- ----------
$ 576,894 475,708 344,488
=========== ========== ==========
Capital expenditures:
Contract drilling $ 1,154,698 609,842 516,738
Oil and gas 7,485 224,851 444,707
----------- ---------- ----------
$ 1,162,183 834,693 961,445
=========== ========== ==========

Maintenance and repairs $ 502,844 414,812 640,622
=========== ========== ==========

Total revenues for the year ended March 31, 1996 included revenues
of $1,809,804 from two customers as follows: $1,204,983; $604,821.

Total revenues for the year ended March 31, 1995 included revenues
of $1,784,218 from two customers as follows: $1,121,651; $662,567.

Total revenues for the year ended March 31, 1994 included revenues
of $1,459,951 from two customers as follows: $765,159; $694,792.

(Continued)

-29-
30
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

The intersegment revenue that is eliminated in the above tables
represents the reduction in drilling revenue due to full cost accounting
for oil and gas properties. Under such method, drilling revenue from
wells where the Company owns a working interest can only be recognized
to the extent it exceeds the total cost of the well, including the cost
to acquire the interest. There were no such participations in fiscal
1996 or fiscal 1995. Therefore, there were no eliminations in those
years.

(6) Related Party Transactions

A director owns an interest in several oil and gas properties in
which the Company owns an interest. Two directors own interests in the
well which the Company drilled in February, 1995 and continues to
operate.

(7) Commitments and Contingencies

Rental expense for the years ended March 31, 1996, 1995, and 1994
was $2,421, $15,825, and $13,275, respectively.

The Company is a defendant in several personal injury lawsuits of a
type which the Company considers routine for the contract drilling
industry. These lawsuits arose out of injuries to personnel under lease
from third party employee leasing companies. These lawsuits are being
defended either by the Company's general liability insurance carrier
under what the Company considers to be adequate coverage, or pursuant to
an Indemnity Agreement between the Company and the employee leasing
company which employed the Plaintiff. The Company believes that the
employee leasing company has adequate insurance coverage to cover those
claims.

Among the lawsuits currently pending against the Company is
National Energy Group, Inc. v. South Texas Drilling Company, cause No.
96-98, 357 Judicial District Court, Willacy County, Texas. This case
arose out of a dispute with a drilling customer over a billing for work
performed under a daywork drilling contract. In the course of drilling
the well, some of the Company's equipment was lost in the hole. Under
the terms of the contract, the customer was billed for the drilling
operations and replacement cost of the lost equipment. The customer has
declined to pay the billed amount of $279,000 alleging negligence and
seeking damages in excess of $100,000. This lawsuit is being defended
by the Company's general liability insurance carrier with a rights of
reservation letter. Discovery in this case is in the early stages and
depositions have not been completed. Therefore, it is impractical to
render an opinion about whether the likelihood of an unfavorable outcome
is either "probable" or "remote". However, the Company believes it has
meritorious defenses and is vigorously defending this litigation. The
Company has filed a counter-suit seeking payment in full of the original
invoice.

Management believes the ultimate disposition of these matters will
have no material adverse effect on the consolidated financial statements
of the Company.

(8) Subsequent Events

In May, 1996, the Company closed on a debt restructuring which
included a term loan of $1,250,000 and a revolving line of credit of
$500,000, which has allowed the Company to pay off all its bank debt
with the exception of the loan secured by the headquarters building in
San Antonio and a minimal balance on the loan secured by the oil and gas
properties. The new debt also allowed the Company to pay off the seller

(Continued)

-30-
31
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

financing on the rig purchased in May, 1995. Proceeds from the new debt
were also used to reduce trade accounts payable and to provide funds for
future drilling equipment purchases. The term loan is secured by
drilling equipment, transportation equipment and the yard facility in
Kenedy, Texas. The loan carries an interest rate of prime (8.25% at
March 31, 1996) plus 3% and is payable in monthly payments of $14,881
plus interest. Payments are based on a seven-year amortization and the
loan is due in June, 1998. The revolving loan is secured by the
Company's trade accounts receivable and carries an interest rate of prime
plus 2.75%.

(9) Oil and Gas Producing Activities (Unaudited)

The Company's oil and gas properties and operations are presented
in the consolidated financial statements on the full cost method of
accounting. All of the Company' exploration and production is conducted
in the United States.

The aggregate amount of capitalized costs relating to oil and gas
producing activities at the dates indicated are as follows:

Years Ended March 31,
-------------------------------------------
1996 1995 1994
------------ ---------- ----------

Proved properties $ 1,749,467 1,741,982 1,580,142
Unproved properties - - -
------------ ---------- ----------
1,749,467 1,741,982 1,580,142
Accumulated depletion (1,012,830) (820,337) (622,615)
------------ ---------- ----------
$ 736,637 921,645 957,527
============ ========== ==========
Depletion rate per unit of production (net
equivalent barrel, exclusive of ceiling
limitation adjustment) $ 7.07 7.07 4.90
============ ========== ==========

During the periods indicated in the preceding table, no internal
costs were capitalized. Internal costs incurred during these periods
were in the nature of general corporate overhead. All costs related to
production, general corporate overhead and other similar activities are
expensed in the period incurred. Costs of site restoration and
dismantlement and abandonment have historically been equal to or less
than revenue earned from salvage of the well equipment. Such costs, net
of the salvage revenue, are added to or subtracted from the full cost of
oil and gas properties. These costs have been minimal in the years
being reported.

(Continued)

-31-
32
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

The following table sets forth information with respect to
quantities of net proved oil and gas reserves, as estimated by an
in-house petroleum engineer, and changes in proved reserves. Estimates
of reserves and production performance are subjective and may change
materially as actual production information becomes available.

Oil and
Condensate Gas
(Bbls) (Mcf)
---------- ----------

Estimated quantity, March 31, 1993 310,250 1,267,800
Revisions in previous estimates (458) (48,564)
Extensions, discoveries and other additions 67,626 143,499
Production (16,458) (66,805)
---------- ----------

Estimated quantity, March 31, 1994 377,418 1,362,735
Revisions in previous estimates 2,200 94,938
Extensions, discoveries and other additions 21,520 209,750
Production (15,700) (73,488)
---------- ----------

Estimated quantity, March 31, 1995 368,980 1,527,130
Revisions in previous estimates (13,490) (180,078)
Production (12,260) (89,802)
---------- ----------
Estimated quantity, March 31, 1996 343,230 1,257,250
========== ==========

Years Ended March 31,
-----------------------------------------------------------------------------
1996 1995 1994
-------------------- --------------------- --------------------
(Bbl) (Mcf) (Bbl) (Mcf) (Bbl) (Mcf)
------ ------- ------ ------- ------ -------

Proved developed
reserves:

Balance at
beginning of year 69,890 362,300 90,599 383,651 97,080 469,120
====== ======= ====== ======= ====== =======
Balance at end of year 60,420 302,960 69,890 362,300 90,599 383,651
====== ======= ====== ======= ====== =======

(Continued)

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33
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Costs incurred for property acquisition, exploration and
development activities are summarized below:

Years Ended March 31,
-------------------------------------------
1996 1995 1994
------------ ---------- ----------

Property acquisition costs $ - 23,863 80,962
Exploration costs - - -
Development costs 7,485 200,988 363,745
------------ ---------- ----------
$ 7,485 224,851 444,707
============ ========== ==========

Results of operations for producing activities for the periods
indicated were as follows:

Years Ended March 31,
-------------------------------------------
1996 1995 1994
------------ ---------- ----------

Revenues $ 380,110 405,409 410,674
Production costs (169,008) (166,594) (178,501)
Depletion (192,494) (197,722) (135,188)
------------ ---------- ----------
Results of operations from producing activities
(excluding corporate overhead and interest costs) $ 18,608 41,093 96,985
============ ========== ==========

The following is a standardized measure of the discounted net
future cash flows and changes applicable to proved oil and gas
reserves required by FASB 69. The future cash flows are based on
estimated oil and gas reserves utilizing prices and costs in effect as
of year end discounted at 10% per year and assuming continuation of
existing economic conditions.

The standardized measure of discounted future net cash flows, in
management's opinion, should be examined with caution. The basis for
this table is a reserve study, as prepared by an in-house petroleum
engineer, which contains estimates of quantities and rates of
production of reserves. Revisions of previous year estimates can have
a significant impact on these results. Also, exploration costs in one
year may lead to significant discoveries in later years and may
significantly change previous estimates of proved reserves and their
valuation. Therefore, the standardized measure of discounted future
net cash flow is not necessarily a "best estimate" of the fair value
of the Company's proved oil and gas properties.

(Continued)

-33-
34
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Years Ended March 31,
-------------------------------------------
1996 1995 1994
------------ ---------- ----------

Estimated future cash flows $ 10,314,000 9,475,000 8,028,000
Estimated future production costs (3,013,000) (2,956,000) (2,866,000)
Estimated future development costs (1,547,000) (1,827,000) (1,567,000)
------------ ---------- ----------
Estimated future net cash flows
before income taxes 5,754,000 4,692,000 3,595,000
Estimated future income taxes (1,684,000) (1,324,000) (960,000)
Ten percent discount for estimated timing of
future cash flows (1,372,000) (1,105,000) (855,000)
------------ ---------- ----------
Standardized measure of discounted estimated
future net cash flows $ 2,698,000 2,263,000 1,780,000
============ ========== ==========

Changes in standardized measure of discounted
estimated future net cash flows:
Sales of oil and gas produced, net of
production costs (223,000) (239,000) (232,000)
Extensions, discoveries and other
additions, less related costs - 257,000 320,000
Changes in estimated future
development costs 179,000 (103,000) 130,000
Revisions of previous quantity estimates (369,000) 124,000 (48,000)
Net changes in prices 1,010,000 567,000 (1,075,000)
Accretion of discount 302,000 230,000 294,000
Income taxes (223,000) (235,000) 480,000
Other (241,000) (118,000) (30,000)
------------ ---------- ----------
Net increase (decrease) $ 435,000 483,000 (161,000)
============ ========== ==========

(10) Minority Interest in Partnership

In August, 1994, the Company, through one of its wholly-owned
subsidiaries, became the managing and general partner of a partnership
whose purpose was to operate a drilling rig contributed to the
partnership by the two partners. The partnership operated the rig
through December 20, 1995 at which

-34-
35
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

time the rig was distributed back to the partners and the partnership
was terminated. The Company's subsidiary then sold its remaining
one-half interest in the rig to the other partner. Since the Company
is no longer involved in the operations of the rig, the Company was
able, in fiscal 1996, to recognize the gain on the sale of the rig
which was deferred in fiscal 1995 when the first one-half interest in
the rig was sold. In exchange for the rig, the Company received
$250,000 in cash and 319,767 shares of the Company's common stock. The
gain attributable to the disposition of the rig was $183,000.

(11) Liquidity

In order to improve its financial position, management plans to
increase utilization of its drilling rigs, reduce indebtedness and
increase its base of oil and gas producing properties. Management
anticipates an improved working capital position in 1997 and believes
that by emphasizing the above plans, in conjunction with its
continuing commitment to closely monitor operational costs, the
Company will improve both its results of operations and its financial
position. The debt restructuring discussed in Note 8, "Subsequent
Events." will allow the Company to improve its current position. The
new debt allowed the Company to reduce its current debt obligations
and to reduce accounts payable. This will improve the Company's
current ratio and reduce its working capital deficit. The removal of
its demand clause by the Bank from its debt will also improve the
Company's current ratio and reduce its working capital deficit.

(12) Fair Value of Financial Instruments

Cash, trade receivables and payables and short-term debt:

The Company holds cash, trade receivables and payables and
short-term debt. The carrying amount of these instruments
approximates fair value due to the short maturity of the instruments.

Long-term debt:

The carrying amount of the Company's long-term debt approximates
fair value due to the recentness of the issuance of the debt.

-35-
36
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

ROBERT R. MARMOR, 70, Chairman of the Board since April, 1980. Mr. Marmor
was Chief Executive Officer of the Company from April, 1980 until February,
1992 and President from June, 1984 until November, 1991, at which time he
voluntarily resigned from these positions and recommended his replacement.
From December, 1979 until April, 1980, Mr. Marmor was President of the
Company. From September, 1979 until December, 1979, Mr. Marmor was engaged in
founding the Company. From October, 1978 until September, 1979 he was
associated as a petroleum engineering consultant with Max K. Watson &
Associates, Inc. of Austin, Texas, petroleum and natural gas consultants. From
1977 to October, 1978 he was engaged in various personal investment ventures.
Mr. Marmor was employed from 1971 to 1977 in Adelaide, Australia by Delhi
International Oil Corporation, Dallas, Texas, and served as project development
manager and later as operations manager responsible for the exploration,
drilling and production divisions.

WILLIAM D. HIBBETTS, 47, CPA, a Director since June, 1984. Mr. Hibbetts
is Chief Accounting Officer of Southwest Venture Management Company. He was
Treasurer/Controller of Gary Pools, Inc. from May, 1986 to July, 1988. He
served as an officer of the Company from January 1, 1982 until May 1, 1986.
Mr. Hibbetts served in various positions as an accountant with KPMG Peat
Marwick from June, 1971 to December, 1981. Mr. Hibbetts served as manager in
that accounting firm's audit group from July, 1978 to December, 1981.

CHARLES B. TICHENOR, 69, a Director since May, 1988. Mr. Tichenor is
Corporation Chief Executive-in- Residence/Professor at The Indiana University
of Pennsylvania since January 1, 1995. Mr. Tichenor was Vice- Chancellor at
Elizabeth City State University from May, 1992 to December 31, 1994. He was a
professor at the College of Business of Mississippi State University where he
occupied the position of Distinguished Corporation Chief Executive Officer-in-
Residence from 1987 to 1992. Mr. Tichenor is the retired Chairman of Champale,
Inc., a Fortune 1000 Company, where he served as president and chairman of the
board from 1975 to 1983. He is a member of the Board of Trustees of Rider
College, Lawrenceville, NJ and he currently or formerly served on the Boards of
Doughty Foods, Inc., NYP Container Corp., MCM Investments Co. and Johnston
Printing Co.

ALVIS L. DOWELL, 60, a Director since February, 1991. Mr. Dowell was
President and Chief Executive Officer from November 7, 1992 to May 1, 1995. He
was Chief Operating Officer from February, 1991 and Vice President from May 2,
1991. From 1988 until 1991, Mr. Dowell was employed by Maersk Oil and Gas,
Copenhagen, Denmark as Assistant Manager, Drilling Department. From 1972 to
1988, Mr. Dowell was with Aramco, Saudi Arabian Operations as Drilling Safety
Engineer and later as Superintendent Offshore Drilling and then Drilling
Manager. He served as Director/Safety and Loss Prevention, Safety Engineering
and Regional Engineering Manager with Holiday Inns, Inc., Texas Employers
Insurance and Northwestern National Insurance Company.

WM. STACY LOCKE, 40, a Director since May 1, 1995. Mr. Locke is President
and Chief Executive Officer since May 1, 1995. He was Vice President-
Investment Banking with Arneson, Kercheville, Ehrenberg & Associates, Inc. from
January 1, 1993 to April 30, 1995. From 1988-1992, Mr. Locke was Vice
President-Investment Banking with Chemical Banking Corporation, Texas Commerce
Bank. He was Senior Geologist with

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Huffco Petroleum Corporation from 1982-1986. From 1979 to 1982 Mr. Locke worked
for Tesoro Petroleum Corporation and Valero Energy as a Geologist.

MARY L. KILGORE, 57, Vice President of Administration since December, 1993
and Corporate Secretary of the Company since May, 1986, has been employed in
various positions by the Company and its predecessor from August, 1978.

CHRIS F. PARMA, 46, CPA, Vice President and Chief Financial Officer since
December, 1995. He has been employed as Controller of the Company since
October, 1990. He served in various accounting positions from Staff Accountant
to Controller from 1972 to 1990 with J. H. Uptmore & Associates, Inc., Real
Estate Developer. He served as Vice President of Uptmore from 1985 to 1990.

MARTIN KALER, 34, Vice President of Engineering since December, 1995. He
has been employed as an Engineer of the Company since June, 1993. From 1987
until 1991, Mr. Kaler was with Dowell Schlumberger as Engineer and later as
District Engineer.

ITEM 11. EXECUTIVE COMPENSATION

The following table sets forth the compensation paid or accrued by the
Company and its subsidiaries for services performed during the fiscal year
ended March 31, 1996, to the chief executive officer of the Company. No other
officer was paid total compensation of $100,000 or more. See Item 13 for a
summary of compensation due to Mr. Locke, the chief executive officer of the
Company, under his employment agreement with the Company.

Summary Compensation Table

Other All
Name and Annual Restricted Warrants/ LTIP Other
Principal Compen- Stock Options/ Payouts Compen-
Position Year Salary $ Bonus $ sation $ Award $ SARS # $ $
--------- ---- -------- ------- -------- ---------- ---------- ------ ----------

Wm. Stacy Locke CEO 1996 33,000 - 479(1) 18,333(2) - - 3,130(3)

Al L. Dowell CEO 1996 56,250 - 2,244(4) 11,960(5) - - -
1995 76,716(6) - 1,075(1) 5,770(7) - - -
1994 67,500 - 1,475(8) - - - -

(1) Includes value of personal use of company-provided vehicle.

(2) Includes 48,889 shares accrued per employment agreement.

(3) Includes value realized on exercise of 100,000 shares of Stock Option Plan
granted May, 1995. See "Option/SAR Grants in Last Fiscal Year".

(4) Includes value of personal use of company-provided vehicle and Directors'
fee paid by the Company.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

(5) Includes 50,000 shares issued as a bonus. Value is calculated based on
the average of the bid and ask prices at issue date discounted due to
2-year restriction on sale or transfer of stock.

(6) Includes $2,885 voluntarily deferred at election of Executive.

(7) Includes 20,000 shares issued as bonus and 6,000 shares issued as a
directors' fee. Value is calculated based on bid price at issue date
discounted due to 2-year restriction on sale or transfer of stock.

(8) Includes value of personal use of company-provided vehicle and legal fees
paid by the Company.

From December, 1988, through June, 1995, Directors received 1,000 shares
of the Company's common stock for each directors' meeting attended. Since
June, 1995, Directors who are not officers or employees of the Company receive
$1,000 each quarter for their service on the Board and $250 for each meeting
attended. Directors who are not officers or employees of the Company and
reside outside of the surrounding area in which a board meeting is held are
entitled to reimbursement for travel expenses incurred by them in attending
directors' meetings.

The following table summarizes as to the chief executive officer of the
Company, the number and terms of stock options granted during the year ended
March 31, 1996:

Option/SAR Grants in Last Fiscal Year

Number of % of Total Potential
Securities Options/ Realized Value at Assumed
Underlying SARs Granted Annual Rates of Stock Price
Options/ to Employees Excercise or Appreciation for Option Term
SARs Granted in Fiscal Base Price Expiration ----------------------------
Name (#) Year ($/sh) Date 5% ($) 10%($)
---- ------------ ------------- ------------ ----------- ---------- -----------

Wm. Stacy Locke 1,200,000 90 0.375 06/15/2005 273,228 701,616

The following table shows as to the chief executive officer of the Company
the net value realized (market value less exercise price) with respect to stock
options exercisable/unexercisable during the last year:

Aggregated Option/SAR Exercises in Last Fiscal Year
and FY-End Option/SAR Values

Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs at Options/SARs at
FY-End (#) FY-End ($)
Shares Acquired Value Excercisable/ Exercisable/
Name on Exercise (#) Realized ($) Unexercisable Unexercisable
---- ------------- ------------ ------------- -------------

Wm. Stacy Locke 100,000 3,130 0/1,100,000 0/0

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

The following table summarizes as to each of the executive officers of the
Company, the number and terms of stock warrants granted during the year ended
March 31, 1996:

Stock Warrants Granted in Last Fiscal Year
Individual Grants

% of Total
Warrants
Stock Granted to
Warrant Employees in Exercise Expiration
Name Grants Fiscal Year Price Date
---- ------- ------------ --------- ----------

No stock warrants were granted in the current fiscal year.

The following table shows as to each of the executive officers of the
Company the net value of securities or cash realized (market value less
exercise price) with respect to stock warrants exercisable/unexercisable during
the last year:

Aggregated Stock Warrant Exercises in Last Fiscal Year
and Fiscal Year End Stock Warrant Values

Value of
Number of Unexercised
Unexercised In-the-Money
Stock Warrants Stock Warrants
Shares at FY-End at FY-End
Acquired on Value Exercisable/ Exercisable/
Name Exercise Realized Unexercisable Unexercisable
---- ----------- -------- -------------- -------------

In the current fiscal year, there were no stock warrant exercises by
executive officers nor were there any stock warrant values at year end.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information, as of June 19, 1996,
with respect to each person who is known by the Company to be the beneficial
owner of more than 5% of the outstanding shares of Common Stock and the Series
A Preferred Stock, each director of the Company, and all officers and directors
of the Company as a group. Except as otherwise indicated, each person has sole
investment and voting power with respect to the shares shown.

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40
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Nature of Percentage
Title of Name and Address of Beneficial Ownership
Class Beneficial Owner Ownership of Class(7)
------- --------------------- --------- -----------

Preferred Series A Alfred G. Holcomb 117,500 50.0%
300 Convent, Suite 1775
San Antonio, Texas 78205

Preferred Series A Rodney Lewis 117,500 50.0%
P.O. Box 118
Encinal, TX 78019

Common Rowan Companies, Inc. 750,000(1) 10.9%
1900 Post Oak Tower
5051 Westheimer
Houston, TX 77056

Common Robert R. Marmor 572,393(1)(2) 8.4%
9310 Broadway, Bldg. I
San Antonio, TX 78217

Common William D. Hibbetts 146,612(3) 2.1%
13007 Blanche Coker
San Antonio, TX 78216

Common Charles B. Tichenor 57,500(4) 0.8%
1402 N. Negley Ave.
Pittsburgh, PA 15206

Common Alvis L. Dowell 208,000 3.0%
9310 Broadway, Bldg. I
San Antonio, Texas 78217

Common Wm. Stacy Locke 1,278,333(5) 18.6%
9310 Broadway, Bldg. I
San Antonio, Texas 78217

All officers and directors as a group 2,401,679(6) 34.9%
(8 persons)

(1) The Rowan Companies, Inc. have granted an option, which initially expired
on August 15, 1993, but has been extended to August 15, 1996, to Mr.
Marmor to purchase its holdings of Common Stock in the Company.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

(2) Does not include 30,420 shares owned by Mr. Marmor's children. Mr. Marmor
disclaims beneficial ownership and has no voting rights or dispositive
power in these 30,420 shares. Includes options issued to Mr. Marmor by
the Board of Directors to purchase 50,000 shares.

(3) Includes options issued to Mr. Hibbetts by the Board of Directors to
purchase 10,000 shares .

(4) Includes options issued to Mr. Tichenor by the Board of Directors to
purchase 10,000 shares.

(5) Includes options issued to Mr. Locke to purchase an additional 1,100,000
shares. (See Item 13.)

(6) Includes options to purchase 82,500 shares issued to the officers and
directors by the Board of Directors. Also includes an option to purchase
an additional 1,100,000 shares by Mr. Locke (see item 13).

(7) Percentage of class outstanding is calculated assuming all officers and
directors exercise all outstanding options and warrants.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The Company's president and chief executive officer, Mr. Wm.
Stacy Locke, commenced employment by the Company on May 1, 1995, under
a two year employment agreement calling for a base salary of $100,000
for the first year of the two year term and $150,000 for year two.
$20,000 of Mr. Locke's first year's salary will be payable in Common
Stock valued at the average market value of such shares during March,
1996. Likewise, $55,000 of the $150,000 salary payable to Mr. Locke
during the second year of his employment with the Company is payable
in Common Stock valued at its average market value during March, 1997.
Furthermore, if the Company should experience a loss for the last two
consecutive quarters of the term of Mr. Locke's employment agreement
the $55,000 payable in Common Stock for the second year of Mr. Locke's
employment shall be reduced to $30,000. The Company may terminate Mr.
Locke's employment agreement without cause at any time after May 1,
1996 and prior to the end of its two year term, upon payment to him of
$75,000 in cash and the issuance to him of a five-year warrant to
purchase 120,000 shares of Common Stock at $0.375 per share.

The terms of Mr. Locke's agreement require the Company to issue
ISO's to Mr. Locke for 1,200,000 shares of Common Stock with an
exercise price of $.375 per share. While Mr. Locke remains employed
by the Company and after the earlier to occur of (i) May 1, 1998 or
(ii) the acquisition by Mr. Locke of at least 10% of the Company's
outstanding Common Stock, on a fully diluted basis, and assuming the
exercise of all exercisable stock options held by Mr. Locke, on each
May 1 Mr. Locke may accelerate his ability to exercise all or any part
of the options to purchase 240,000 shares of Common Stock which would
otherwise become exercisable on the next following May 1 under his ISO
up to the amount necessary for him to achieve or maintain the 10%
ownership of Common Stock determined as described above. After all of
Mr. Locke's ISO's become exercisable, the Company has agreed to issue
additional ISO's (or non- qualified options if ISO's cannot be made
available) covering up to 240,000 shares on each May 1 at an exercise
price equal to the then market value of Common Stock in order to
provide Mr. Locke with an opportunity to acquire and maintain
ownership of 10% of the Company's Common Stock on the basis described
above. In the event the Company shall receive gross cash proceeds of
$10 million or more in connection with an underwritten public offering
of Common Stock, Mr. Locke's rights to additional options shall cease.

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) Index to Financial Statements and Schedules and Exhibits

1. The following consolidated financial statements of South Texas
Drilling & Exploration, Inc. and its subsidiaries are included in
Part II, Item 8 of this Report:

Independent Auditors' Report

Consolidated Balance Sheets at March 31, 1996 and 1995

Consolidated Statements of Operations for the years ended
March 31, 1996, 1995 and 1994.

Consolidated Statements of Shareholders' Equity for the years
ended March 31, 1996, 1995 and 1994.

Consolidated Statements of Cash Flows for the years ended
March 31, 1996, 1995 and 1994.

Notes to Consolidated Financial Statements.

2. Financial Statement Schedules:

Supplementary Income Statement Information is included in
Part IV, Item 14, "Financial Statements and Supplementary
data" of this Report.

Schedule II - Valuation and Qualifying Accounts

(All other schedules are omitted as inapplicable, not
required, or already covered in the financial statements and
notes thereto).

3. The following exhibits are filed as part of this Report:

Page
----

- (3) Articles of Incorporation and Bylaws of the Company (previously filed as an Exhibit to the
company's 1981 Annual Report on Form 10-K, File No. 2-70145).

- (10)(a) Stock Purchase and Options Agreement dated December 28, 1981 between the Company and Rowan
Companies, Inc. ("Rowan") (previously filed as an Exhibit to the Company's 1981 Annual
Report on Form 10-K, File No. 2-70145).

- (10)(b) Amended and Restated Agreement of Sale dated December 28, 1981 between the Company and Rowan
relating to acquisition of the Tender Rigs (previously filed as an Exhibit to the Company's
1981 Annual Report on Form 10-K, File No. 2-70145).

- (10)(c) Note Purchase and Warrant Agreement between the Company and Connecticut General Life
Insurance Company and Teachers Insurance and Annuity Association

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43
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

relating to acquisition of the Tender Rigs (previously filed as an Exhibit to the Company's
1981 Annual Report on Form 10-K, File No. 2-70145).

- (10)(d) Amendment No. 2 to Warrant Agreement dated April 12, 1984 between the Company and
Connecticut General Life Insurance Company and Teachers Insurance and Annuity Association
(previously filed as an Exhibit to the Company's 1983 Annual Report on Form 10-K, File No.
2-70145).

- (10)(e) Letter of Basic Terms dated April 12, 1984 between the Company and Connecticut General Life
Insurance Company and Teachers Insurance and Annuity Association regarding the
recapitalization or reorganization of South Texas Offshore Drilling Company (previously
filed as an Exhibit to the Company's 1983 Annual Report on Form 10-K, File No. 2-70145).

- (10)(f) Agreement dated April 12, 1984 among the Company and Connecticut General Life Insurance
Company and Teachers Insurance and Annuity Association of America releasing certain
obligations of the Company (previously filed as an Exhibit to the Company's 1983 Annual
Report on Form 10-K, File No. 2-70145).

- (10)(g) Loan Agreement dated December 28, 1981 between the Company and Frost National Bank of San
Antonio (previously filed as an Exhibit to the Company's 1983 Annual Report on Form 10-K,
File No. 2-70145).

- (10)(h) Second Amendment dated April 13, 1984 to the Loan Agreement dated December 28, 1981 between
the Company and Frost National Bank of San Antonio (previously filed as an Exhibit to the
Company's 1983 Annual Report on Form 10-K, File No. 2- 70145).

- (10)(i) Modification of General Guaranty dated April 13, 1984 between the Company and Frost National
Bank of San Antonio modifying the Company's guarantee of the Promissory Note of South
Texas/1200, Ltd. (previously filed as an Exhibit to the Company's 1983 Annual Report on Form
10-K, File No. 2-70145).

- (10)(j) The Company's 1983 Non-qualified Stock Option Plan (previ-ously filed as an Exhibit to the
Company's 1983 Annual Report on Form 10-K, File No. 2-70145).

- (10)(k) Letter from Hoy M. Booker deferring enforcement of legal remedies (previously filed as an
Exhibit to the Company's 1983 Annual Report on Form 10-K, File No. 2- 70145).

- (10)(l) Letter from R. L. Kirkwood deferring enforcement of legal remedies (previously filed as an
Exhibit to the Company's 1983 Annual Report on Form 10-K, File No. 2- 70145).

- (10)(m) Modification of Representation and Warranty of Second Amendment dated April 13, 1984 to the
Loan Agreement dated December 28, 1981 between the company and Frost National Bank of San
Antonio (previously filed as an Exhibit to the Company's 1984 Annual Report on Form 10-K,
File No. 2-70145).

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44
SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

- (10)(n) Agreement and Release dated January 3, 1986, between the Company and Hoy M. Booker and
Robert L. Kirkwood regarding the assignment of certain oil and gas properties in
satisfaction of certain promissory notes (previously filed as an Exhibit to the Company's
1985 Annual Report on Form 10-K, File No. 2-70145).

- (10)(o) Debt Cancellation Agreement dated March 24, 1986 between the company and Frost National Bank
of San Antonio (previously filed as an Exhibit to the Company's 1985 Annual Report on Form
10-K, File No. 2-70145).

- (10)(p) Amendment #1 To Debt Cancellation Agreement dated March 24, 1986 between the Company and
Frost National Bank of San Antonio (previously filed as an Exhibit to the Company's 1986
Annual Report on Form 10-K, File No. 2-70145).

- (10)(q) Amendment #2 To Debt Cancellation Agreement dated March 24, 1986 between the Company and
Frost National Bank of San Antonio (previously filed as an Exhibit to the Company's 1986
Annual Report on Form 10-K, File No. 2-70145).

- (10)(r) Modification and Extension of Term Note dated April 16, 1986 between the Company and Frost
National Bank of San Antonio (previously filed as an Exhibit to the Company's 1986 Annual
Report on Form 10-K, File No. 2-70145).

- (10)(s) Bill of Sale of Oil and Gas Drilling Rigs dated April 16, 1986 between the Company and Frost
National Bank of San Antonio (previously filed as an Exhibit to the Company's 1986 Annual
Report on Form 10-K, File No. 2-70145).

- (10)(t) Convertible subordinated note dated January 1, 1989 between the Company and Frost Bank
(previously filed as an Exhibit to the Company's 1989 Annual Report on Form 10-K, File No.
2-70145).

- (10)(u) Convertible subordinated note dated November 1, 1988 between the Company and Larry Temple
(previously filed as an Exhibit to the Company's 1989 Annual Report on Form 10-K, File No.
2-70145).

- (10)(v) Rig Lease and Refurbishing Agreement (Rig 11) dated September 21, 1990 between the Company
and LB Sales and Leasing, Inc. (previously filed as an Exhibit to the Company's 1991 Annual
Report on Form 10-K, File No. 2-70145).

- (10)(w) Rig Lease and Refurbishing Agreement (Rig 12) dated September 21, 1990 between the Company
and LB Sales and Leasing, Inc. (previously filed as an Exhibit to the Company's 1991 Annual
Report on Form 10-K, File No. 2-70145).

- (10)(x) Revised and restated rig Lease and Refurbishing Agreement regarding Rig 11 and Rig 12 dated
September 27, 1991 between the Company and LB Sales and Leasing, Inc. (previously filed as
an Exhibit to the Company's 1992 Annual Report on Form 10-K, File No. 2-70145).

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SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

- (10)(y) Settlement Agreement dated November 13, 1991 between the Company and Frio Drilling Company
(previously filed as an Exhibit to the Company's 1992 Annual Report on Form 10-K, File No.
2-70145).

- (10)(z) Settlement Agreement dated December 29, 1994 between the Company and L. B. Sales and
Leasing, Inc. ( previously filed as an Exhibit to the Company's 1995 Annual Report on Form
10-K, File No. 2-70145).

- (10)(aa) Executive Employment Agreement dated May 1, 1995 between the Company and Wm. Stacy Locke (
previously filed as an Exhibit to the Company's 1995 Annual Report on Form 10-K, File No. 2-
70145).

48 (10)(bb) Form of Loan and Security Agreement dated May 8, 1996 between the Company and Finova Capital
Corporation

70 (10)(cc) Form of Schedule to Loan and Security Agreement dated May 8, 1996 between the Company and
Finova Capital Corporation

- (22) Subsidiaries of the registrant (previously filed as an Exhibit to the Company's 1992 Annual
Report on Form 10-K, File No. 2-70145).

(b) Reports of Form 8-K: No reports on Form 8-K were filed with the
Securities and Exchange Commission during the last quarter of the
period covered by this report.

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46
SCHEDULE II

SOUTH TEXAS DRILLING & EXPLORATION, INC. AND SUBSIDIARIES

Valuation and Qualifying Accounts

Balance at Charged Deductions
beginning to costs and from Balance at
of year expenses accounts year end
---------- ------------ ---------- ----------

Year ended March 31, 1994:
Allowance for doubtful receivables $ 170,945 62,949 - 233,894
========== ======== =========== =========

Year ended March 31, 1995:
Allowance for doubtful receivables $ 233,894 228,374 462,268 -
========== ======== =========== =========

Year ended March 31, 1996:
Allowance for doubtful receivables $ - 140,000 - 140,000
========== ======== =========== =========

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47
SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, South Teas Drilling & Exploration, Inc. has duly caused
this report to be signed on its behalf by the undersigned, this 28th day of
June, 1996 thereunto duly authorized.

By /s/ Robert R. Marmor
--------------------------------------------------
Robert R. Marmor, Chairman

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.

Signature Title Date
--------- ----- ----

/s/ Robert R. Marmor
----------------------------
Robert R. Marmor Chairman and Director June 28, 1996

/s/ Wm. Stacy Locke
----------------------------
Wm. Stacy Locke President and Chief June 28, 1996
Executive Officer and
Director

/s/ Al Dowell
----------------------------
Al Dowell Director June 28, 1996

/s/ William D. Hibbets
----------------------------
William D. Hibbetts Director June 28, 1996

/s/ Chris F. Parma
----------------------------
Chris F. Parma Vice President and June 28, 1996
Chief Financial Officer

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