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

                                   FORM 10-K

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

                    For the fiscal year ended June 30, 19961997
                                       or

            [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                SECURITIES EXCHANGE ACT OF 1934

                       For the transition period from to

                          Commission file number 1-8038

                              KEY ENERGY GROUP, INC.
                
             (Exact name of registrant as specified in its charter)

                 Maryland                             04-2648081
          (State or other jurisdiction of         (I.R.S. Employer 
           incorporation or organization)         Identification No.)

             Two Tower Center, Tenth Floor, East Brunswick, NJ    08816
                 (Address of principal executive offices)       (Zip Code)

       Registrant's telephone number, including area code: (908)247-4822

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

             Title of Each Class      Name of Each Exchange on Which Registered
        Common Stock, $.10 par value         American Stock Exchange
        7% Convertible Subordinated                     None
           Debentures Due 2003                            

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                                      Common Stock, $.10 par valueNone

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 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. [ X ]

The  aggregate  market value of the Common Shares held by  nonaffiliates  of the
Registrant as of August 1, 1996September 11, 1997 was approximately $86,562,327.$366,091,543.

Indicate by check mark whether the  registrant  has filed all documents  and 
reports  required to be filed by Section 12, 13 or 15(d) of the Securities 
Exchange Act of 1934 subsequent to the  distribution of securities  under a 
plan confirmed by a court. Yes   X    No

Common Shares outstanding at August 1, 1996: 10,413,513September 11, 1997: 16,459,894

DOCUMENTS  INCORPORATED  BY  REFERENCE:  Portions  of the Proxy  Statement  with
respect to the Annual Meeting of Shareholders  are  incorporated by reference in
Part III of this report.



Key Energy Group, Inc. and Subsidiaries

                                      INDEX

 PART I.

    Item 1.  Business.Business                                                      3

    Item 2.  Properties.                                                   8

    Item 3.  Legal Proceedings.                                            119

    Item 4.  Submission of Matters to a Vote of  Security Holders.         119

 PART  II.

    Item 5.  Market for the Registrant's Common Equity and
             Related Stockholder Matters.                                  1110

    Item 6.  Selected Financial Data.                                      1211

    Item 7.  Management's Discussion and Analysis of Financial
             Condition and Results of Operation.                           1312

    Item 8.  Financial Statements and Supplementary Data.                  2019

    Item 9.  Changes in and Disagreements With Accountants 
             on Accounting and Financial Disclosure.                       4652

PART  III.

    Item 10. Directors and Executive Officers of the Registrant.           4652

    Item 11. Executive Compensation.                                       4652
   
    Item 12. Security Ownership of Certain Beneficial Owners 
             and Management.                                               4652

    Item 13. Certain Relationships and Related Transactions.               4652

PART IV.

    Item 14. Exhibits, Financial Statement Schedules and 
             Reports on Form 8-K                                           4753








                                      - 2 -

                     Key Energy Group, Inc. and Subsidiaries

    PART I. ITEM 1.  BUSINESS.

    The Company

    Key Energy  Group,  Inc. (the  "Company" or "Key") operates 332is a leading  provider of
    well services in the United  States and in  Argentina.  As of June 30, 1997,
    the Company operated a fleet of 523 well service rigs, 437 fluid hauling and
    other  trucks,  and nine  drilling rigs  (including  16 workover  rigs,  six
    trucks,  and 3 drilling rigs in Argentina).  As of June 30, 1997, Key's well
    service and workover rigs, which isrig fleet and fluid  hauling and other truck fleet were
    the thirdsecond largest fleet
of well service and workover rigs inlargest fleets, respectively, onshore the continental
    United  States.  The  Company  operates  in  Texas,  New  Mexico,  Oklahoma,
    Michigan,  the  Appalachian  Basin  and  Argentina and is a leader in each of its domestic
markets.Argentina.  The Company provides maintenance and workover rigs to
service producing oil and gas wells.  Although the range and
extent of services provided varies from region to region, as
part of its well service business, the  Company  generally
    provides a full range of  maintenance  and  workover  rig services. 
These services  to major and
    independent  oil and  gas  companies  in all of its  operating  regions.  In
    addition to maintenance and workover  services,  Key also provides  services
    which include the completion of newly drilled  wells,  the  recompletion  of
    existing wells  (including  horizontal  recompletions)  and the plugging and
    abandonment  of wells  at the end of  their  useful  lives.  Other  services
    include hot oiling,
oil field liquidfluid transportation, fishing tools and services,  storage and disposal services, vacuum truck services, frac
    tank rentals,  fishing and rental tools, wireline services, air drilling and
    salt water injection.  Thehot oiling. In addition, the Company also is engaged in the production ofcontract drilling in West
    Texas and Argentina and owns and produces oil and natural gas and contract drilling in the Permian
    Basin of West Texas.Basin.

    The Company  conducts  operations  through four  wholly-owned  subsidiaries:
    Yale E. Key, Inc.  ("Yale E. Key");  WellTech Eastern, Inc. ("WellTech 
    Eastern");  Odessa Exploration Incorporated ("Odessa Exploration");  and 
    Key Energy Drilling, Inc. d/b/a Clint Hurt Drilling ("Clint Hurt"). In 
    addition,  Key operates in Argentina  through its 63% ownership in(wholly-
    owned as of July 1, 1997) of Servicios WellTech,  S.A. ("Servicios"). 
    WellTech Eastern operates through two divisions;divisions:  WellTech Mid-Continent 
    Division and WellTech Eastern  Division.  Yale E. Key,  WellTech  Eastern 
    and Servicios  provide oil and gas well services.services, and Servicios owns 
    contract  drilling  rigs.  Odessa  Exploration is engaged in the production
    of oil and natural gas and Clint Hurt provides contract oil and gas well 
    drilling services. 

In March 1996,services in the Permian Basin of West Texas.

    Subsequent Events

    Subsequent  to June 30,  1997,  the  Company  purchased  the  remaining  37%
    interest in Servicios and completed the  mergeracquisition  of WellTech,
Inc. ("WellTech Eastern").  WellTech Eastern was an established
oilfour well servicesservicing
    companies  which  collectively  operate 83 well  service and  workover  rigs
    (including six in Argentina), three drilling rigs in Argentina, and 75 fluid
    hauling and other trucks. The Company has also announced, subsequent to June
    30, 1997, five acquisitions of well service companies and one acquisition of
    a drilling  company  providingwhich  collectively  operate 153 well service  rigs, 11
    drilling  rigs,  91 fluid  hauling and other trucks and a broad rangefishing and rental
    tool business.  These six announced  acquisitions are currently  pending and
    assuming  their  completion,  the Company will have  expanded its  operating
    presence  into  markets it  previously  did not serve,  including  the Rocky
    Mountains,  the Four Corners area, the Hugoton Basin, Northern Louisiana and
    Arkansas.  Upon completion of these pending  acquisitions,  Key's operations
    will include 764 well service and workover rigs, 603 fluid hauling and other
    trucks, 23 drilling rigs and numerous  ancillary  operations.  Following the
    closing of these  acquisitions,  the Company  believes that,  based upon the
    number of active well service rigs and fluid hauling and other trucks,  that
    it would operate at that time, it will be the largest well service  provider
    onshore the  continental  United States and the second  largest well service
    provider in Argentina.

    Growth Strategy

    The  domestic  well  service  rig  and  production   service   industry  has
    historically  been highly  fragmented,  characterized  by a large  number of
    smaller companies which have competed effectively on a local basis in


                                      - 3 -


         terms of pricing and the quality of services foroffered.  In recent years,
         many major and independent oil and gas wells.companies have placed increasing
         emphasis upon not only pricing,  but also on safety records and quality
         management  systems of, and the breadth of services  offered by,  their
         vendors, including well servicing contractors. This market environment,
         which requires  significant  expenditures by smaller  companies to meet
         these  increasingly  rigorous  standards,  has forced many smaller well
         servicing companies to sell their operations to larger competitors.  As
         a result, the industry has seen high levels of consolidation  among the
         competing contractors.

         Over the past eighteen months, Key has been a the leading  consolidator
         of  this  industry,   completing  twenty-three   acquisitions  of  well
         servicing  operations  (twenty-eight  including pending  transactions).
         This  consolidation has led to reduced  fragmentation in the market and
         has led to more  predictable  demand for well  services for the Company
         and its competitors. Key's management structure is decentralized, which
         allows for rapid  integration  of  acquisitions  and the  retention  of
         strong local identities of many of the acquired businesses. As a result
         of these and other factors, the WellTech merger,Company has developed a growth strategy
         to: (i) identify,  negotiate and consummate additional  acquisitions of
         complementary well servicing  operations,  including rigs, trucking and
         other ancillary services;  (ii)  fully-integrate  acquisitions into the
         Company's fleet of workover rigs more
than doubled in number.  In April 1996, Odessa Exploration
acquired approximately $6.9 million of oildecentralized organizational structure and gas producing
properties from an unrelated third party.

Subsequent Event

In July 1996,thereby attempt to
         maximize  operating  margins;  (iii) expand business lines and services
         offered by the Company completedin existing areas of operations; and (iv) extend
         the  offering of $52,000,000
7% convertible subordinated debentures due 2003 (the
"Offering").  The Offering was a private offering pursuant to
Rule 144A under the Securities Act.  Net proceeds from the
Offering were used to substantially repay existing long-term
debt (approximately $35.2 million).  The remaining proceeds,
together with proceeds of borrowings under existing credit
arrangements, are intended to fund the expansion ofgeographic  scope and  operating  environments  for the  Company's
         services through acquisitions of businesses and assets
and for working capital and general corporate purposes.  See
Note 5 to the Financial Statements for a more detailed
description of the Offering.operations.

         Oil Field Services

         The Company  provides a full range of workoverwell  service rig  services,  oil
         field  liquid  services  and other  production  services  necessary  to
         maintain  and  workover   producing  oil  and  gas  wells  through  its
         wholly-owned  subsidiaries,  Yale E. Key and  WellTech  Eastern.  These
         services  also  include the  completion  of newly  drilled  wells,  the
         recompletion of existing wells (including horizontal recompletions) and
         the plugging and abandonment of wells at the end of their useful lives.
         Other  services  provided include  oil field liquidfluid  transportation,  storage and
         - 3 -


disposal services, vacuum truck  services,  frac  tank  rentals,  fishing  and  rental  tools,
         wireline  services,  air drilling and salt water injection.hot oiling.  The Company has more
         than 750  customers  which are either  major oil and gas  companies  or
         independent  producers  seeking to optimize  performance of oil and gas
         wells.  Although  the mix of oil  and  gas  wells  serviced  varies  by
         particular markets,  approximately  two-thirds of the Company's overall
         business is  attributable  to oil wells.  OfAs of June 30,  1997,  of the
         Company's 332523 well service and workover rigs, 135273 operate in West Texas
         111and New Mexico,  161 in Oklahoma and East Texas, 7679 in Michigan and the
         Appalachian Basin, and ten in Argentina.

         WorkoverWell  Service Rig  Services.  The Company  operates autilizes its fleet to 
         perform  four major  categories  of 332
well service to oil and workover rigs providing maintenance, workover,
completion and plugging and abandonment services.gas
         operators including:

         Maintenance  Services.  Maintenance services are required on producing
         oil and gas wells to ensure efficient and continuous  operation.  These
         services consist of routine  mechanical  repairs  necessary to maintain
         production  from the well,  such as  repairing  parted  sucker  rods or
         defective downholedown-hole pumps in an oil well, or replacing defective tubing
         in an oil or gas well.  The Company  provides  the workoverwell  service  rigs,
         equipment and crews for these maintenance services.  Many of these workoverwell
         service rigs also have pumps and tanks (a workover package) that can be
         used for circulating fluids into and out of the well.  Maintenance jobs
         are often performed on a series of wells in proximity to each other and
         typically take less than 48 hours per well.

         Maintenance  services are generally  required  throughout the life of a
         well. The need for these services does not directly depend on the level
         of  drilling  activity  and  is  generally  independent  of  short-term
         fluctuations



                                      - 4 -



    in oil and gas prices.  Accordingly,  maintenance services are generally the
    most  stable  type of well  service  rig  activity.  The  general  level  of
    maintenance,  however,  is  affected  by  changes  in the  total  number  of
    producing oil and gas wells in the Company's geographic service areas.

    Workover Services.  In addition to periodic  maintenance,  producing oil and
    gas wells  occasionally  require  major  repairs  or  modifications,  called
    "workovers." Workover services include extensions of existing wells to drain
    new formations  either through  deepening well bores or through  drilling orof
    horizontal  laterals.  In less extensive  workovers,  the Company's rigs are
    used to drill out plugs and packersseal off depleted zones in existing well bores toand access previously
    bypassed  productive  zones.  The  Company's  workover rigs are also used to
    convert producing wells to injection wells duringfor enhanced recovery operations.
    Workover services include major subsurface  repairs such as casing repair or
    replacement,  recovery of tubing and removal of foreign  objects in the well
    bore. These extensive  workover  operations are normally performed by a workoverwell
    service  rig with additional
specialized auxiliary equipment,a workover  package , which may  include  rotary  drilling
    equipment,  mud pumps, mud tanks and blowout  preventers  depending upon the
    particular  type of workover  operation.  Most of the Company's workoverwell service
    rigs are  designed  for and can be  equipped  to  perform  complex  workover
    operations. A workover may last from a few days to several weeks.

    The demand for workover services is more sensitive to expectations  relating
    to and  changes  in oil and gas  prices  than  the  demand  for  maintenance
    services,  but not as sensitive as the demand for completion services.  When
    oil and gas prices are low, there is little  incentive to perform  workovers
    on wells  to  increase  production  and well  operators  tend to defer  workover
services.such
    expenditures. As oil and gas prices increase, the level of workover activity
    tends to increase as operators seek to increase  production by enhancing the
    efficiency of their wells.

    Completion  Services.  Completion  services prepare a newly drilled well for
    production.  The completion process may involve selectively  perforating the
    well casing to access producing  zones,  stimulating and testing these zones
    and installing downhole  equipment.  The Company provides a well service and
    workover  package rig to assist in this 







                                 - 4 -  completion  process.  Newly drilled
    wells are frequently completed by a well service rig so that an operator can
    minimize  the use of a higher cost  drilling  rig.  The  completion  process
    typically requires a few days to several weeks,  depending on the nature and
    type  of  the  completion,   and  generally  requires  additional  auxiliary
    equipment which the Company provides for an additional fee.

    The demand for well  completion  services  is  directly  related to drilling
    activity levels, which are highly sensitive to expectations  relating to and
    changes  in oil and gas  prices.  During  periods of weak  drilling  demand,
    drilling  contractors  frequently  price well completion work  competitively
    compared to a workoverwell  service rig so that the  drilling  rig stays on the job.
    Thus, excess drilling capacity will serve to reduce the amount of completion
    work available to the well servicing industry.

    Plugging and Abandonment Services. WorkoverWell service rigs and workover equipment
    are also used in the  plugging  and  abandonment  of oil and gas wells  no 
    longer capable of producing in economic quantities. The demand for oil and 
    gas does not significantly affect the demand for well plugging services.

    Liquid  Services.  The Company  provides  vacuum truck  services,  frac tank
    rentals  and  salt  water  injectiondisposal   services  which  together  provide  an
    integrated mix of liquid services to well site customers.

    Other Production Services.  The Company provides production services,  which
    include hot oiler unit services, pipeline installation and testing services,
    in Oklahoma, Michigan and the
Appalachian Basin, slick-lineslickline wire-line services in Michigan and fishing and rental tool services.



                                      - 5 -


         Shallow Contract Drilling Services

         The Company,  through  Clint Hurt,  owns and operates six drilling rigs
         and provides  contract  drilling services for major and independent oil
         companies,  primarily  in West  Texas.  On August 4, 1997,  the Company
         announced  it had  signed a letter of intent to acquire  BRW  Drilling,
         Inc.  ("BRW") for  approximately  $15.0 million in cash. BRW operates 7
         drilling rigs and related equipment in the Permian Basin of West Texas.
         The closing of the BRW  acquisition  is expected upon  negotiation of a
         definitive   agreement,   completion  of  the  Company's  standard  due
         diligence  and receipt of regulatory  clearances,  if any are required.
         Upon completion, the BRW acquisition will be combined with Clint Hurt's
         drilling  operations  in the  Permian  Basin  of West  Texas  to form a
         thirteen rig shallow drilling  operation.  The Company entered the land
         drilling  business in March 1995 with the  acquisition of four drilling
         rigs from an independent third party and, as the result of the WellTech
         merger,  acquired  two  additional  land  drilling  rigs.  The rigs are
         capable of drilling up to 10,000 feet.

         Production

         The Company is engaged in the  production of oil and natural gas in the
         Permian Basin area of West Texas through its  wholly-owned  subsidiary,
         Odessa Exploration.  Odessa Exploration  acquires and manages interests
         in  producing  oil and gas  properties  for  its  own  account  and for
         drilling   partnerships  it  sponsors.   Odessa  Exploration   acquires
         producing  oil and gas  wells and  related  properties  from  major and
         independent  producers and,  subsequently,  either reworks the acquired
         wells to increase  production or forms drilling ventures for additional
         development  wells.  Odessa  Exploration  operates oil and gas wells on
         behalf  of over  150250  working  interest  owners  as well as for its own
         account.

Contract Drilling Services

The Company, through its wholly-owned subsidiary, Clint Hurt,
provides contract drilling services for major and independent
oil companies, primarily in West Texas.  Clint Hurt owns and
operates six drilling rigs for this purpose.  The Company
entered the land drilling business in March 1995 with the
acquisition of four drilling rigs from an independent third
party and, as the result of the WellTech merger, acquired two
additional land drilling rigs.  The rigs are capable of drilling
up to 10,000 feet.

         Foreign Operations

         The Company  provides oil field  services in Argentina  through its 63%
         ownership  (wholly-owned  as of 63% of the stockJuly 1, 1997) of Servicios.  Currently,As of June
         30, 1997,  Servicios  ownsowned and operatesoperated  ten well  servicing  rigs and
         three  drilling  rigs  in  Argentina  (which  are  currently  idle  and
         undergoing refurbishment). On August 1, 1997, the Company completed the
         acquisition of Kenting Holdings  (Argentina) S.A. ("Kenting") for $10.1
         million in cash. The Kenting assets  included six oilwell service rigs,
         three  drilling rigs and related  equipment in  Argentina.  In addition,The Kenting
         assets are being  operated by  Servicios  operates trucksand are expected to transport
its oil field equipment and, subject to availability, rentsmore than
         double the trucks to other operators to move their oil field equipment.size of Servicios' principal customer is Yacimientos Petroliferos
Fiscales, the Argentine national oil company.



                                    - 5 -operations based on revenues.

         COMPETITION AND OTHER EXTERNAL FACTORS

         The workoverDespite a significant  amount of  consolidation  having  occurred,  the
         domestic  well  service rig and  production  service  industry is still
         highly  fragmented  and includes a large number of small companies that are capable
         of competing effectively on a local basis and two
larger companies which possess greater financial and other
resources than those of the Company.  In addition to those two
larger companies, both of which provide workover rig services
and liquids handling services in all or part of the Company's domestic well servicing
         markets,markets.  Nonetheless,  the Company has numerous
regional competitors for each of the services which it provides.
 The Company  believes that it is competitive in
         terms of  pricing,  performance,  equipment,  safety,  availability  of
         equipment  to meet  customer  needs and  availability  of  experienced,
         skilled personnel in those regions in which it operates.

         Excess capacity in the well servicing industry has resulted in
severe price competition throughout much of the past decade. 
Management expects competitive pricing pressures to continue in
the foreseeable future.  In the well  servicing  market,  an  important  competitive  factor  in
         establishing and maintaining long-term customer relationships is having
         an  experienced,  skilled and well-trainedwell trained work force. In recent years,
         many of the Company's larger customers have placed emphasis not only on
         pricing,  but also on safety records and quality  management systems.systems of
         contractors.  The  Company  believes  that  such  factors  will  be  of
         increased   importance   in  the  future.   The  Company  has  directed
         substantial  resources toward employee safety and training programs, as
         well as its employee  review  process.  While the Company's  efforts in
         these  areas  are not  unique,  many  competitors,  particularly  small
         contractors,  have not undertaken  similar training  programs for their
         employees.  Management  believes that the  Company's  safety record and
         reputation for quality  equipment and service are among the best in the
         industry.

                                      - 6 -


    The Company  acquires oil and gas properties from  independent and major oil
    companies and competes with other  independent  and integrated oil companies
    for the  acquisition  of these  properties.  The Company also  competes with
    other local oil and gas  drilling  contractors,  as well as national oil and
    gas drilling  companies.  As with oil field services,  the need for drilling
    oil and gas wells  fluctuates,  in part,  based on the price of,  and demand
    for, oil and natural gas.

    The Company serves over 750 customers in West Texas, East Texas, New Mexico,
    Oklahoma, Michigan, the Appalachian Basin and Argentina with its two largest
    customers providing 20%13% and 11%7%, of total Company revenue during fiscal 1996.1997.
    The need for  oilfield  services  fluctuates,  in part,  in  relation to the
    demand for oil and natural gas. As demand for those  commodities  increases,
    service  and  maintenance  requirements  increase  as oil  and  natural  gas
    producers  attempt to maximize the producing  efficiency of their wells in a
    higher priced environment.

    EMPLOYEES

    As of June 30,  1996,1997,  the Company  employed  2,0303,175  persons  (1,925(3,047 in well
    service operations,  12 in oil and gas production,  85105 in contract drilling
    operations  and 811 in  corporate).  None  of  the  Company's  employees  are
    represented by a labor union or collective bargaining agent. The Company has
    experienced no work stoppages  associated  with labor disputes or grievances
    and considers its relations with its employees to be satisfactory.









                                     - 6 -

    REGULATIONS

    The oilfield service  operations and the oil and gas production and drilling
    activities  of the Company are subject to various  local,  state and federal
    laws and  regulations  intended to protect the  environment.  The  Company's
    operations routinely involve the handling of waste materials,  some of which
    are  classified  as  hazardous  substances.  Consequently,  the  regulations
    applicable  to the  Company's  operations  include  those  with  respect  to
    containment,  disposal and  controlling  the  discharge of any hazardous oil
    field waste and other  non-hazardous  waste  material into the  environment,
    requiring  removal and cleanup  under  certain  circumstances,  or otherwise
    relating  to  the  protection  of  the  environment.  Laws  and  regulations
    protecting the environment  have become more stringent in recent years,  and
    may in certain  circumstances  impose "strict liability,"  rendering a party
    liable for environmental damage without regard to negligence or fault on the
    part of such  party.  Such laws and  regulations  may expose the  Company to
    liability for the conduct of, or conditions  caused by, others,  or for acts
    of the Company  which were in  compliance  with all  applicable  laws at the
    times such acts were performed.  Management of the Company  believes that it
    is in  substantial  compliance  with all material  federal,  state and local
    regulations  as they  relate to the  environment.  Although  the Company has
    incurred certain costs in complying with environmental laws and regulations,
    such amounts have not been  material to the  Company's  financial  condition
    during the three past fiscal years.

    Management  believes that the Company is in substantial  compliance with all
    known material local,  state and federal safety  guidelines and regulations.
    In order to comply with such safety  guidelines and regulations and increase
    employee  awareness of on-the-job  safety,  the Company employs eight safety
    officers.  The Company also has a safety training and education center which
    is used by it for continued safety training and awareness.








                                      EXECUTIVE OFFICERS 

Listed below are the names, ages and positions of the Company's
executive officers. Each officer of the Company holds office
until the first meeting of the Board of Directors following the
annual meeting of stockholders and until his successor shall
have been duly elected and qualified, or until he shall have
resigned or been removed as provided by the By-Laws.  No family
relationship exists between any of the listed executive officers
or between any such executive officer and any Director of the
Company.

        Name                      Age	             Positions

   Francis D. John                42     Chairman of the Company since August
                                         1996, President and Chief Executive
                                         Officer since September 1989 and
                                         President	and Chief Financial
                                         Officer of the Company since
                                         June 1988; Director of the Company
                                         since 1988.

   Kenneth V. Huseman             43     Executive Vice President and Chief
                                         Operating Officer of well service
                                         operations since August 1996, Vice
                                         President of WellTech Eastern and
                                         Chief	Executive Officer of its 
                                     		 	Mid-Continent Division since March
                                         1996.  Mid-Continent Regional
                                         President of WellTech from	August
                                         1994 to March	1996.  Vice President
                                         and Mid-Continent Regional Manager
                                         of WellTech from April 1993 to
                                         August 1994.

   Danny R. Evatt                 37     Vice President, Chief Accounting
                                         Officer and Treasurer of the Company
                                         since July 1990; Treasurer,
                                         Secretary and Chief Financial
                                         Officer of Yale E. Key from 1984 to
                                         1996. 


                                   - 7 -

C. Ron Laidley                  50     Vice-President of the Company since
                                         June 1996; President and Chief
                                         Executive Officer of Yale E. Key
                                         since April 1995. Vice President of
                                         Yale E. Key from 1982 until April
                                         1995. 

  Kenneth C. Hill                 52     Vice President of the Company since
                                         March 1996; Vice President of
                                         WellTech Eastern and Chief
                                         Executive Officer of its Welltech
                                         Eastern Division since March 1996. 
                                         Northeast Regional President of
                                         WellTech from August 1994 to March
                                         1996, and Vice President and
                                         Northeast Regional Manager of
                                         WellTech from April 1990 to 	    
 	                                       August 1994. 

  D. Kirk Edwards                 36 		  Executive Vice President of the
                                         Company since March 1996, Vice
                                         President of the Company from July
                                         1993 until March 1996, President and
                                         Chief Executive Officer of Odessa 
                                         Exploration since July 1993. Owner
                                         and President of Odessa Exploration
                                         Inc. from 1987 until 1993.

         ITEM 2.  PROPERTIES.

         The  Company's  corporate  offices are located in East  Brunswick,  New
         Jersey where the Company leases office space from an independent  third
         party.

         Oil Field Services

         The  following  table sets forth the type,  number and  location of the
         major  equipment  owned and operated by the Company's oil field service
         subsidiaries as of June 30, 1996:

                                                    													Slick-line1997:

                                  Well Service/            Hot Oil 		Vacuum	            			Wire-lineFluid Hauling and
   Company                        Workover Rigs               Other Trucks  		Trucks	 Frac Tanks   		 Units

   Domestic:

   Yale E. Key (West Texas)         		135       		21       		6       		65       		   -Texas
    and New Mexico)                    273                         82
   Mid-Continent Division
    of  WellTech Eastern (Texas
    and Oklahoma)                      111        		2        	9        		-	          	-161                        105
   Eastern Division of
    WellTech Eastern (Michigan
    and Appalachian Basin)              76        	11       	12       		16          		479                        244

   International:

   Servicios (Argentina)                10                          -       		-        		-           	-   
                   					___	      	___     		___      		___        		___6
                                     -----                      -----
   TOTAL                               332       		34      		27       		81          		4   
                   					===      		===     		===      		===        		===523                        437       
                                     =====                      =====
   
         Yale E. Key owns ten and  leases six  office  and yard  locations.  The
         Mid-Continent  Division of WellTech  Eastern owns seven and leases five
         office and yard  locations.  The Eastern  Division of WelltechWellTech  Eastern
         owns twofour and leases  sixtwelve office and yard  locations.  In Argentina,
         Servicios owns one and leases onetwo office and yard locations.

         All  operating  facilities  are  metal or brick  one story  office  and/or  shop
         buildings.   All  buildings  are  occupied  and  considered  to  be  in
         satisfactory condition.

                                      - 8 -


All of the Company's owned oil field service operation's
properties are encumbered by security interests in favor of  The
CIT Group/Credit Finance, Inc. the Company's senior lender
("CIT").

         Production

         Odessa  Exploration's  properties  consist  primarily  of oil  and  gas
         leases.  At June 30, 1997,  Odessa  Exploration  operated  and/or owned
         interests in 467 wells.  Odessa  Exploration's  major proved  producing
         properties  are located  primarily  in the  Permian  Basin area of West
         Texas. Odessa Exploration leases office space in Odessa, Texas.

         Producing Wells and Acreage

All wells owned and/or operated by Odessa Exploration are
located in the continental onshore United States, primarily in
West Texas.   The following table sets forth the total gross and
net producing oil and gas wells and its total gross and net
developed and undeveloped acreage asAs of June 30, 1996.  "Gross"1997,  the Company had  interests in 446 gross (127 net)
         oil wells and 21 gross (10 net) gas wells. As of such date, the Company
         owned 71,360 gross  (19,980  net) acres of  developed  acreage  and no 
         undeveloped  acreage.  The Company had working interests in 13 gross 
         (12.5 net) development wells as it applies to wells or acreage refers to the number of wells
or acres in which a working interest is owned by Odessa
Exploration.  "Net" as it applies  to wells or acreage refers to
the sum of the fractional working interests owned by Odessa
Exploration in gross wells or gross acres.

               		Producing Wells        				Developed	
		    	         Oil            Gas     			   Acreage        Undeveloped
State      Gross    Net   Gross     Net   Gross     Net	  	Gross      Net
          --------------  -------------  ----------------  --------------  
Texas       287     206    30       10    55,240   37,277    -         -	

As operator, Odessa Exploration receives fees from other working
interest owners as reimbursement forsame date.  During the general and
administrative expenses attendant to the operation of the wells.

Odessa Exploration's oil and gas properties are subject to
royalty, overriding royalty and other outstanding interests that
are customary in the industry.  The properties are also subject
to burdens such as liens incident to operating agreements,
current taxes, development obligations under oil and gas leases
and other encumbrances, easements and restrictions.  Odessa
Exploration believes that the existence of any such burdens does
not materially detract from the value of its leasehold
interests.  In addition, certain Odessa Exploration properties
are subject to liens securing debt (more fully described in Note
5 of the notes to consolidated financial statements).  

Exploration and Development Activities

The following table shows gross and net wells drilled in which
Odessa Exploration had a working interest during the yearsfiscal 
         year ended June 30, 1996, 1995 and 1994:

                          1996            1995              1994               
        	          		Gross	   Net    Gross    Net	     Gross    Net
                     ------------    ------------      ------------
		Exploratory:	
   Productive          -       -       -       -         -       -		           
   Dry                 -       -       -       -         -       - 		

  Development:
   Productive        10.0    10.0     8.0     6.2       1.0     0.1
   Dry                3.0     1.0 	    -       -         - 		    -

  Total 
   Productive        10.0    10.0     8.0     6.2       1.0     0.1
   Dry                3.0     1.0      -       -         -       - 		


                                     - 9 -


During fiscal 1997, Odessa Exploration expects to participate in
or drill 15 wells on its operated properties.

Oil and Gas Reserve Information

Estimates of Odessa Exploration's proved oil and gas reserves as
of June 30, 1996, 1995 and 1994 were prepared by the Company and
reviewed by independent petroleum reservoir engineering firms. 
All estimates were made in accordance with guidelines
established by the Securities and Exchange Commission.  Provedproduced 178,121 bbls. of oil and gas reserves are the estimated quantities of crude oil
and natural gas which geological and engineering data
demonstrate with reasonable certainty to be recoverable in
future years from known reservoirs under existing economic
conditions, i.e. prices and costs as of the date the estimate is
made.  Prices utilized reflect consideration of changes in
existing prices provided by contractual arrangements if any, but
not of escalations based upon future conditions.

Proved developed oil and gas reserves are reserves that can be
expected to be recovered through existing equipment and
operating methods.

Proved undeveloped oil and gas reserves are proved reserves that
are expected to be recovered from new wells on undrilled acreage
or from existing wells where a relatively major expenditure is
required for recompletion or secondary or tertiary recovery. 
Reserves assigned to undrilled acreage are limited to those
drilling units that offset productive units reasonably certain
of production when drilled.

The following table summarizes oil and gas reserve data with
respect to Odessa Exploration's proved oil and gas reserves:
                                                                
                                                  June 30,
                                    1996            1995           1994   
                                 ----------      ----------    -----------
	Proved developed reserves
				Oil (bbls)		                 2,727,967        750,604    	   114,908
				Gas (mcf)		                 24,517,362     11,203,232      6,785,661

	Proved undeveloped reserves 	
				Oil (bbls)	                  2,457,361        931,613              -
				Gas (mcf)		                 11,224,232      2,794,828              -

Additional information concerning Odessa Exploration's estimated
proved oil and gas reserves is included in Item 8, "Financial
Statements and Supplementary Data".

No major discovery or other favorable or adverse event has
occurred since July 1, 1996 which is believed to have caused a
significant change in the estimated proved oil and gas reserves
of Odessa Exploration.

Odessa Exploration's estimate of reserves has not been filed
with or included in reports to any federal agency other than the
Securities and Exchange Commission.

Production

The following table summarizes the net oil and gas production,at
         an average sales prices,price of $22.19 per bbls., and 1.23 Mcf of gas at an 
         average sales price of $2.74 per Mcf.  Average production (lifting) 
         costs were $7.89 per equivalent barrelbbls. of oil for the years ended June 30, 1996, 1995
and 1994.
	 	     	                                                       
                                 1996          1995           1994  
  -------------------------------------------------------------------
		Oil:
			Production (bbls)		   		    97,130	   	   40,330	       	14,383
			Average sales price
    per bbls		             	   $17.74	   	   $15.02        	$13.54

  Natural Gas:	
			Production (mcf)		       1,026,577 		    770,197 	      552,791
			Average sales price
    per mcf		 	                $ 1.79  		    $ 1.54   	  	 $  2.33

	 Production Costs:
			Production (lifting) costs
   per equivalent
			barrel of oil (boe)			      $ 5.03		      $ 4.48      		$  5.38oil.
     
                               - 108 -

         ITEM 3.  LEGAL PROCEEDINGS AND OTHER ACTIONS.

         See Item 8,7, Note 4 to the Consolidated Financial Statements.

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

         None.


















                                     - 9 -


         PART II

         ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
                                STOCKHOLDER MATTERS.

         The Company's  common stock is traded on the American  Stock  Exchange,
         under the symbol "KEG". As of June 30, 1996,1997,  there were 544498 holders of
         record of 10,413,51312,297,752 shares of common stock.

         The following  table sets forth for the periods  indicated the high and
         low closing prices of the Company's  common stock on the American Stock
         Exchange, as derived from published sources.

                                          High                      Low
         HighFiscal Year Ending 1997:
          First Quarter                $ 8 3/4                    $ 7 1/2
          Second Quarter                12 1/4                      8 3/8
          Third Quarter                 14 7/8                     11 3/8
          Fourth Quarter                17 13/16                   12 7/8

         Fiscal Year Ending 1996:
          First Quarter                $ 4 3/4                    $ 5 1/2
          Second Quarter                 4 15/16                    6 7/16
          Third Quarter                  5 7/8                      7 9/16
          Fourth Quarter                 7 1/16                     8 1/2

    Fiscal Year Ending 1995:
				First Quarter			                    5         		   5 1/2
   	Second Quarter                      4 3/4          5 1/2 	
		  Third Quarter 	                     4 1/4          4 5/8
		  Fourth Quarter                      4 3/4          5 1/2	

			Fiscal Year Ending 1994:
				First Quarter                    			5 	            5 1/2
   	Second Quarter      	               4 3/4          5 1/2 	
		  Third Quarter 	                     4 7/8          5 5/8
		  Fourth Quarter                      4 7/8          5 1/2

There were no dividends paid on the Company's common stock during the fiscal
    years ended June 30, 1997,  1996 1995 or 1994.1995.  The Company does not intend,  for
    the foreseeable future, to pay dividends on its common stock.

    Recent Sales of Unregistered Securities:

    The agreements with CIT and Norwest (see Note 5Company  effected the  following  unregistered  sales of notes to
consolidated financial statements), include certain restrictive
covenants,its  securities
    during the most restrictivethree months ended June 30, 1997. Each of which, prohibitsthe following issuances
    by the Company and Odessa Exploration from declaring or paying dividends onof the securities sold in the transactions  referred to below
    were not registered  under the Securities Act of 1933, as amended,  pursuant
    to the exemption  provided under Section 4 (2) thereof for  transactions not
    involving a public offering:

    Effective  as of June 25, 1997,  the Company  issued  240,000  shares of the
    Company's   and Odessa Exploration's Commoncommon  stock  to  certain   selling   shareholders  as  partial
    consideration for the acquisition of all of the capital stock of Well-Co Oil
    Service, Inc.

    The Company  issued,  pursuant to the Company's  1995 Employee  Stock in any
circumstances.Option
    Plan, various options to purchase shares of the Company's common stock.


                                     - 1110 -

Item 6.
Selected Financial Data.

Five         Seven
             			Fiscal Year   Months (1)  Months
		                 Ended       Ended        Ended          Fiscal Year
		                June 30,   November 30,  June 30,       Ended June 30,
(in thousands)		    1992       1992          1993    	1994   		1995  		1996(3)
- -------------------------------------------------------------------------------
OPERATING DATA:

Revenues		      	 $21,535    	$10,433   	 	$14,256 		$34,621		$44,689		$66,478
Operating costs:
 Direct costs 		   16,299	    		7,947   		  10,863    26,585	  32,793 	 47,118
 Depreciation,
  depletion
  and amortization  1,136     			 505 	        406 	   1,371 	  2,738 	  4,701
 General and 
  administrative	   2,697    		 1,117	  	    1,587	    3,540    4,352 	  6,608
 Interest    	  	   1,320    		   464 		       276	      830		  1,478    2,477

Income before 
 income taxes,
 minority interest,
 reorganization
 items and
 extraordinary
 items 	  	            83      			400		      1,124     2,295	   3,328    5,575
Net income (loss)	   (596)  		  4,986 	        711     1,345    2,178	   3,586

Income (loss) per
common share:
 Primary:
  Income before 
   income taxes,
   minority interest,
   reorganization items
   and extraordinary 
   items		          $0.02 		   $0.02         $0.21  	  $0.44    $0.50  	 $0.70
Net income (loss)   (0.04)	     0.28          0.14 	    0.26  	  0.33   	 0.45
  Fully-diluted:
  Income before
   income taxes,
   minority interest,
   reorganization items
   and extraordinary
   items		         $0.01 	     $0.00         $0.21	 	  $0.43    $0.50  	 $0.69
Net income (loss)  (0.02)		     0.03          0.14	     0.25  	  0.33   	 0.44

Average common shares
 outstanding:	
  Primary    			  14,717	 		  17,942   	     5,124 	   5,274    6,647	   7,941
  Assuming full
   dilution     	 38,339	    176,508         5,138 	   5,288    6,647 	  8,114
Common shares
 outstanding 
  at period end   17,942	     17,942  		     5,124    	5,274		  6,914 	 10,414

Market price per
 common share at
 period end	     	 $0.06		     	n/a		        $3.67	 	  $4.67 	  $5.06	   $8.19

Cash dividends
 paid on 
 common shares  	  $  -	     		$  -	  	      $  -    	   $ -		   $  -    $  -

BALANCE SHEET DATA:

Cash and restricted 
 cash			            $208
Five Fiscal Year Fiscal Year(1) Fiscal Year Fiscal Year Seven Months Months (2) Ended Ended Ended Ended Ended Ended June 30, June 30, June 30, June 30, June 30, November 30, (in thousands) 1997 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------------------- OPERATING DATA: - ------------------------------------------- Revenues $163,630 $66,478 $44,689 $34,621 $14,256 $10,433 Operating costs: Direct costs 111,551 47,117 32,793 26,585 10,863 7,947 Depreciation, depletion and amortization 11,420 4,701 2,738 1,371 406 505 General and administrative 18,522 6,608 4,352 3,540 1,587 1,117 Interest 7,535 2,477 1,478 830 276 464 Income before income taxes, minority interest, reorganization items and extraordinary items 14,602 5,575 3,328 2,295 1,124 400 Net income 9,098 3,586 2,178 1,345 711 4,986 Income per common share: Primary: Net income $0.75 $0.45 $0.33 $0.26 $0.14 $0.28 Fully-diluted: Net income $0.65 $0.44 $0.33 $0.25 $0.14 $0.03 Average common shares outstanding: Primary 12,205 7,941 6,647 5,274 5,124 17,942 Assuming full dilution 17,963 8,114 6,647 5,288 5,138 176,508 Common shares outstanding at period end 12,298 10,414 6,914 5,274 5,124 17,942 Market price per common share at period end $17.81 $8.19 $5.06 $4.67 $3.67 n/a Cash dividends paid on common shares $ - $ - $ - $ - $ - $ - BALANCE SHEET DATA: - ------------------------------------------- Cash $41,704 $4,211 $1,275 $1,173 $623 * Current assets 93,333 27,481 11,290 9,167 4,922 * Property and equipment 227,255 96,127 36,336 18,935 10,093 * Property and equipment, net 208,186 87,207 31,942 17,159 9,688 * Total assets 320,095 121,722 45,243 28,095 15,906 * Current liabilities 33,142 24,339 9,228 8,383 4,113 * Long-term debt, including current portion 174,167 46,825 15,949 11,501 5,374 * Stockholders' equity 73,179 41,624 20,111 9,263 7,280 * OTHER DATA: - ------------------------------------------- EBITDA (3) 33,557 12,752 7,544 4,496 1,806 * Net cash (used) provided by: Operating activities 1,306 7,121 3,258 1,842 (123) * Investing activities (82,062) (13,551) (7,154) (5,608) (1,284) * Financing activities 118,249 9,366 3,998 4,316 (73) * Working capital 60,191 3,142 2,062 784 809 * Book value per common share (4) $5.95 $4.00 $2.91 $1.76 $1.42 * Ratio of earnings to fixed charges (5) $2.61 $2.77 $2.54 $2.65 $2.91 * $623 $1,173 $1,275 $4,211 Current assets 3,194 * 4,922 9,167 11,290 27,481 Property and equipment 20,921 * 10,093 18,935 36,336 95,127 Property and equipment, net 7,417 * 9,688 17,159 31,942 87,207 Total assets 12,239 * 15,906 28,095 45,243 121,722 Current liabilities 5,296 * 4,113 8,38 9,228 24,339 Long-term debt, incl. current portion 13,287 * 5,374 11,501 15,949 46,825 Stockholders' equity (deficit) (4,938) * 7,280 9,263 20,111 41,624 OTHER DATA: EBITDA (2) 2,539 * 1,806 4,496 7,544 12,752 Net cash (used) provided by: Operating activities 1,109 * (123) 1,842 3,258 7,121 Investing activities (1,689) * (1,284) (5,608) (7,154) (13,551) Financing actvities 501 * (73) 4,316 3,998 9,366 Working capital (2,102) * 809 784 2,062 3,142 Book value per common share ($0.26) * $1.42 $1.76 $2.91 $4.00 Ratio of earnings to fixed charges (4) 1.05 * 2.91 2.65 2.54 2.77
* - Not applicable due to the Company's 1992 Reorganization plan.Plan. (1) Financial data for the year ended June 30, 1996 includes the allocated purchase price of WellTech Eastern and the results of their operations, beginning March 26, 1996. (2) Financial Data for the five months ended November 30, 1992 and prior periods reflect the previous capital structure of Key Energy Group, Inc. (previously "National Environmental Group, Inc.") prior tobefore the Company's 1992 Reorganization Plan and are not always comparable to subsequent periods. (2)(3) Net income before interest exp., income taxes, depreciation, depletion and amortization. EBITDA is presented because of its wide acceptance as a financial indicators of a company's ability to service or incur debt. EBITDA should not be considered as an alternative to operating or net net income, (as determined in accordance with GAAP)as defined by generally accepted accounting principals, as indicators of the Company's financial performance or to cash flow as a measure of liquidity. (3) Financial data for(4) Book value per common share are stockholders' equity at end of period divided by the year ended June 30, 1996 includesnumber of outstanding shares at period end. (5) For purposes of computing the allocated purchase priceratios of WellTech Eastern, Inc.earnings to fixed charges, earnings consist of income from continuing operations before income taxes and fixed charges. Fixed charges consist of interest expenses, amortization of debt issuance expenses and the resultsportions of their operations, beginning March 26, 1996. (4) Fixed Charges arerentals and lease obligations representative of the sum of (i) interest costs, (ii) interest component of rent expenses, and (iii) amortization of deferred financing costs (if any).factor. - 1211 - ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION. Recent Developments In March 1996,The following discussion provides information to assist in the understanding of the Company's financial condition and results of operations. It should be read in conjunction with the financial statements and related notes appearing elsewhere in this report. Overview The Company completed the mergerexperienced its most successful year during fiscal 1997. All regions have increased equipment use because of WellTech, Inc. ("WellTech"). WellTech was an established oil well services company providing a broad range of workover and production services forhigher oil and gas wells. As a result of the WellTech merger, the Company's fleet of workover rigs more than doubled in number. In April 1996, Odessa Exploration (a wholly-owned subsidiary of the company) acquired approximately $6.9 million ofprices, increased emphasis on horizontal drilling, lower production costs for major and independent oil and gas producing properties from an unrelated third party. Subsequent Event In July 1996,producers, renewed focus on domestic production and the effects of several new alliances the Company completed the offering of $52,000,000 7% convertible subordinated debentures due 2003 (the "Offering"). The Offering was a private offering pursuant to Rule 144A under the Securities Act. Net proceeds from the Offering were used substantially to repay existing long-term debt (approximately $35.2 million). The remaining proceeds, togetherentered into with proceeds of borrowings under existing credit arrangements, are intended to fund the expansion of the Company's services through acquisitions of businesses and assets and for working capital and general corporate purposes. See Note 5 to the Financial Statements for a more detailed description, (including an interest rate increase), of the Offering. Overviewits customers. Fluctuations in well servicing activity historically have had a strong correlation with fluctuations in oil and gas prices. If oil and gas prices were to drop significantly from current levels, the Company would expect a decrease in demand for drilling and services which would negatively affect the Company's operating performance. The Company seeks to minimize the effects of such fluctuations on its operations and financial condition through diversification of services, entry into new markets and customer alliances. Since 1993, the Company has made a number of acquisitions, which have significantly expanded the Company's operations: * In April 1996, Odessa Exploration consummated the purchase of $6.9 million of oil and gas properties, and as a result, acquired additional oil and gas producing properties with daily average net production of 240 barrels of oil and 1.5 million cubic feet of natural gas. * In March 1996, WellTech, a well services provider, merged into the Company, doubling the Company's fleet of well service and workover rigs and adding two oil and gas drilling rigs to the Company's contract drilling operations. WellTech now operates as WellTech Eastern and has two operating divisions, WellTech Mid-Con and WellTech Eastern. * In March 1995, the Company acquired four oil and gas drilling rigs from Clint Hurt. * In August 1994, the Company acquired 58 well service and workover rigs and other well service equipment in West Texas from WellTech. * In July 1993, the Company acquired Odessa Exploration, an oil and gas production company. In addition to the above acquisitions, the Company has acquired several smaller oilwell service related entities and expanded its ancillary equipment services. - 13 - RESULTS OF OPERATIONSFISCAL YEAR ENDED JUNE 30, 1997 VERSUS FISCAL YEAR ENDED JUNE 30, 1996 VERSUS FISCAL YEAR ENDED JUNE 30, 1995 The following discussion provides information to assist in the understandingResults of Key Energy Group, Inc.'s ("Key" or "the Company") financial condition and results of operations. It should be read in conjunction with the financial statements and related notes appearing elsewhere in this report. Operating results for the fiscal year ended June 30, 1996 include the Company's oilfield well service operations conducted by its wholly-owned subsidiaries, Yale E. Key, Inc. ("Yale E. Key"), its oil and natural gas exploration and production operations conducted by its wholly-owned subsidiary, Odessa Exploration, Inc. ("Odessa Exploration") and Key Energy Drilling, Inc. d/b/a Clint Hurt Drilling ("Clint Hurt Drilling") which is engaged in oil and natural gas well contract drilling and was acquired in March 1995. Also included are the operating results of WellTech Eastern for the period of March 26, 1996 (the date of the merger, See Note 2 ) to June 30, 1996. Historically, fluctuations in oilfield well service operations and oil and gas well contract drilling activity have been closely linked to fluctuations in crude oil and natural gas prices. However, the Company, through acquisitions, customer alliances and agreements, and diversification of services, seeks to minimize the effects of such fluctuations on the Company's results of operations and financial condition.Operations Operating Income The Company Revenues of the Company for the year ended June 30, 1997 increased $97,152,000, or 146%, from $66,478,000 in fiscal 1996 increased $21,789,000 or 49% to $66,478,000 from $44,689,000 for the year ended June 30, 1995,$163,630,000 in fiscal 1997, while net income of $3,585,000for fiscal 1997 increased $1,407,000$5,512,000, or 65%154% , from the 1995$3,586,000 in fiscal year total of $2,178,000.1996 to $9,098,000 in fiscal 1997. The increase in revenues was primarily due to oilwell service acquisitions throughout the addition of Clint Hurt Drilling on April 1, 1995, whose operations were only included for one quarter in fiscal year, 1995 results, increased oil and gas revenues from Odessa Exploration, and increased oilwell service equipment utilizationoil and the acquisition of WellTech operations from the date of acquisition of March 26, 1996 (see Note 2 ). The increase in fiscal year 1996 net income over fiscal year 1995 net income is partially attributable to the inclusion of Clint Hurt Drilling and the acquisition of WellTech, but is also a result of an increase in oilwell service equipment utilization and a decrease in total consolidated Company costs and expenses as a percent of totalgas drilling revenues. Oilfield Services Oilfield services are performed by Yale E. Key and WellTech Eastern. Yale E. Key conducts oilfield services primarily in West Texas, while WellTech Eastern conducts oilfield services in the Mid-Continent region of the United States (primarily in Oklahoma) through its operating division, WellTech Mid-Con, and in the Northeastern United States (primarily in Michigan, Pennsylvania and West Virginia) through its operating division; WellTech Eastern. In addition, the Company conducts oilfield services in Argentina through its 63% ownership in Servicios WellTech, S.A. ("Servicios"), an Argentinean corporation. Oilfield service revenues increased $15,828,000 or 39% from $40,105,000 for the 1995 fiscal year toended June 30, 1997 increased $88,452,000, or 158%, from $55,933,000 for the year ended June 30, 1996 fiscal year.to $144,385,000 for the year ended June 30, 1997. The increase in revenues is primarily attributable to acquisitions throughout the year and higher equipment utilization as the result ofuse resulting from an increase in demand for oilfield services and the acquisition of WellTech Eastern whose operating results are included for the period of March 26, 1996 (the date of the merger, see Note 2 ) to June 30, 1996. In addition, Yale E. Key diversified oilfield services into higher margin business segments such as oilfield frac tanks, oilfield fishing tools and trucking operations. - 14 -services. Oil and Natural Gas Exploration and Production Oil and natural gas exploration and production operations are performed by Odessa Exploration. Revenues from oil and gas activities increased $1,841,000$4,005,000, or 79%96%, from $2,334,000$4,175,000 during the year ended June 30, 19951996 to $4,175,000$8,180,000 for the current year. The increase in revenues was primarily the result of increased production of oil and natural gas asfrom several oil and natural gas wells whichthat were drilled and began production during 1996,fiscal 1997, higher oil and natural gas prices for the current year,fiscal 1997, and the April 1996 purchase of $6.9 million of oil and gas properties from an unrelated third party,party. Of the total $8,180,000 of revenues for the year ended June 30, 1997, approximately $6,975,000 was from the sale of oil and gas and $1,205,000 represented primarily administrative fee income. - 12 - Oil and Natural Gas Well Drilling Revenues from oil and gas well drilling activities increased $3,768,000, or 61%, from $6,188,000 during the year ended June 30, 1996 to $9,956,000 for the year ended June 30, 1997. The increase was primarily the result of increased oilwell drilling activity and an increase in the Company's pricing structure. Operating Expenses Oilfield Services Oilfield service expenses for the year ended June 30, 1997 increased $59,629,000, or 146%, from $40,737,000 for the year ended June 30, 1996 to $100,366,000 for the year ended June 30, 1997. The increase was due primarily to acquisitions made throughout the fiscal year and the increased demand for oilfield services. In addition, the Company has continued to expand its services, offering fishing tools, blow-out preventers and oilwell frac tanks. Oil and Natural Gas Exploration and Production Expenses related to oil and gas activities increased $1,680,000, or 124%, from $1,350,000 for the year ended June 30, 1996 to $3,030,000 for the year ended June 30, 1997. The increase was primarily the result costs associated with several oil and natural gas wells that were drilled and began producting during fiscal 1997 and the April 1996 purchase of $6.9 million in oil and gas properties. Oil and Natural Gas Well Drilling Expenses related to oil and gas well drilling activities increased $3,125,000, or 62%, from $5,030,000 for the year ended June 30, 1996 to $8,155,000 for the year ended June 30, 1997. The increase was primarily the result of increased revenues. Depreciation and Depletion Expense Depreciation, depletion and amortization expense increased $6,719,000, or 143%, from $4,701,000 for fiscal 1996 to $11,420,000 for fiscal 1997. The increase is primarily due to oilfield service depreciation expense, which almost doubledis the sizeresult of increased oilfield service capital expenditures for the current period versus the prior period and the acquisitions completed throughout fiscal 1997. In addition, depletion expense increased for the period due to the increase in the production of oil and natural gas. General and Administrative Expenses General and administrative expenses increased $11,914,000, or 180%, from $6,608,000 for the year ended June 30, 1996 to $18,522,000 for the year ended June 30, 1997. The increase was primarily attributable to oilfield service acquisitions throughout the fiscal year. Interest Expense Interest expense increased $5,058,000, or 204%, from $2,477,000 for fiscal 1996 to $7,535,000 in fiscal 1997. The increase was primarily the result of debt incurred in connection with acquisitions completed throughout fiscal 1997. - 13 - Income Taxes Income tax expense increased $3,612,000, or 191%, from $1,888,000 in income tax expense for fiscal 1996 to $5,500,000 for fiscal 1997. The increase in income taxes is primarily due to the increase in operating income. However, the Company does not expect to be required to remit a significant amount of the $5,500,000 in total federal income taxes for fiscal year 1997 because of the availability of net operating loss carryforwards, accelerated depreciation and drilling tax credits. Cash Flow Net cash provided by operating activities decreased $4,965,000, or 70%, from $7,121,000 during fiscal 1996 to $2,156,000 for fiscal 1997. The decrease is attributable primarily to increases in accounts receivable, decreases in accounts payable and accrued expenses, but was partially offset by increases in depreciation and net income. Net cash used in investing activities increased $68,511,000, or 506%, from $13,551,000 for fiscal 1996 to $82,062,000 for fiscal 1997. The increase is primarily the result of increased capital expenditures for oilwell service operations and oilwell service acquisitions. Net cash provided by financing activities was $117,399,000 for fiscal 1997 as compared to $9,366,000 for fiscal 1996, which represents an increase of $108,033,000, or 1,153%. The increase, which is partially offset by repayments of long-term debt, is primarily the result of proceeds from the existing Debentures and commercial paper during the current fiscal year. - 14 - FISCAL YEAR ENDED JUNE 30, 1996 VERSUS FISCAL YEAR ENDED JUNE 30, 1995 Operating Income The Company Revenues for the year ended June 30, 1996 increased $21,789,000, or 49%, from $44,689,000 for the year ended June 30, 1995 to $66,478,000 for the year ended June 30, 1996, while net income increased $1,408,000, or 65%, from $2,178,000 in fiscal 1995 to $3,586,000 in fiscal 1996. The increase in revenues was primarily due to the acquisition of Clint Hurt Drilling in March 1995, whose operations were only included for one quarter in the 1995 year-end results, increased oil and gas revenues from Odessa Exploration.Exploration and increased oilwell service equipment use and the acquisition of WellTech. The increase in fiscal year 1996 net income over fiscal year 1995 net income was partially attributable to the inclusion of Clint Hurt Drilling and the acquisition of WellTech Eastern, but also was a result of an increase in oilwell service equipment use and a decrease in total consolidated Company costs and expenses as a percentage of total revenues. Oilfield Services Oilfield service revenues for the year ended June 30, 1996 increased $15,828,000, or 40%, from $40,105,000 for the year ended June 30, 1995 to $55,933,000 for the year ended June 30, 1996. The increase in revenues was primarily attributable to higher equipment use resulting from an increase in demand for oilfield services and the acquisition of WellTech Eastern, whose operating results were included for the period of March 26, 1996 to June 30, 1996. Oil and Natural Gas Exploration and Production Revenues from oil and gas activities increased $1,841,000, or 79%, from $2,334,000 during the year ended June 30, 1995 to $4,175,000 for the year ended June 30, 1996. The increase in revenues was primarily the result of increased production of oil and natural gas from several wells that were drilled during 1996, higher oil and natural gas prices during 1995 and the April 1996 purchase of $6.9 million of oil and gas properties from an unrelated third party. Of the total $4,175,000 of revenues for fiscalthe year ended June 30, 1996, approximately $3,554,000 was from the sale of oil and gas - 97,130 barrels of oil at an average price of $17.74 per barrel and 1,026,577 MCF of natural gas at an average price of $1.79 per MCF. Thethe remaining $621,000 of revenues representedwas attributable primarily to administrative fee income and other miscellaneous income. Oil and Natural Gas Well Drilling Oil and natural gas well drilling operations are performed by Clint Hurt Drilling which was acquired in March 1995. Comparable numbers for the full prior fiscal year are, therefore, not available. In addition, two drilling rigs were acquired in the March 1996 merger with WellTech. Revenues for fiscalthe year ended June 30, 1996 were $6,188,000. Operating Expenses Oilfield Services Oilfield service expenses for the year ended June 30, 1996 increased $10,145,000, or 33%, from $30,592,000 for the fiscalyear ended June 30, 1995 to $40,737,000 for fiscalthe year ended June 30, 1996. The increase was due primarily to the acquisition of WellTech Eastern on March 26, 1996, and thean increased demand for oilfield services. In addition, the Company has continued to expand its services, offering ancillary services and equipment such as oilwell fishing tools, blow-out preventers and oilwell frac tanks.- 15 - Oil and Natural Gas Exploration and Production Expenses related to oil and gas activities increased $593,000, or 78%, from $757,000 for fiscalthe year ended June 30, 1995 to $1,350,000 for fiscalthe year ended June 30, 1996. The increase in expenses was primarily the result of increased production of oil and natural gas asfrom several oil and natural gas wells whichthat were drilled began production during fiscal 1996 and the April 1996 purchase of $6.9 million in oil and gas properties which almost doubled the size of Odessa Exploration.properties. Oil and Natural Gas Well Drilling Clint Hurt Drilling was acquired in March 1995. Comparable numbers for the full prior fiscal year are, therefore, not available. Expenses for fiscalthe year ended June 30, 1996 were $5,031,000. Interest Expense Interest expense increased $999,000 or 68% to $2,477,000 for the fiscal year 1996 from $1,478,000 for fiscal 1995. The increase was primarily the result of acquisitions$5,030,000. Depreciation and the addition of certain oil and gas properties. - 15 - General and Administrative Expenses General and administrative expenses increased $2,256,000, or 52%, to $6,608,000 for the fiscal year 1996 from $4,352,000 for the fiscal year 1995. The increase was primarily attributable to the Company's recent acquisitions and expanded services. Depreciation, Depletion and Amortization Expense Depreciation, depletion and amortization expense increased $1,963,000, or 72%, from $2,738,000 for fiscal 1995 to $4,701,000 for the fiscal year 1996 from $2,738,000 for the fiscal year 1995.1996. The increase iswas primarily due to oilfield service depreciation expense, which is the result of increasedresulted from an increase in oilfield service capital expenditures for the current1996 period versus the prior period and the acquisition of WellTech and Clint Hurt. In addition, depletion expense increased for the period due to the increase in the production of oil and natural gas. General and Administrative Expenses General and administrative expenses increased $2,256,000, or 52%, from $4,352,000 for the year ended June 30, 1995 to $6,608,000 for the year ended June 30, 1996. The increase was primarily attributable to the acquisition of contract drilling assets, the subsequent inclusion of general and administrative expenses related to contract drilling operations and the acquisition of WellTech Eastern. Interest Expense Interest expense increased $999,000, or 68%, from $1,478,000 for fiscal 1995 to $2,477,000 for fiscal 1996. The increase was primarily the result of acquisitions and the addition of certain oil and gas properties that were financed with proceeds from borrowings. Income Taxes Income tax expense of $1,888,000 for fiscal year 1996 increased $738,000, or 64%, from $1,150,000 in income tax expense for fiscal year 1995.1995 to $1,888,000 in fiscal 1996. The increase in income taxes iswas primarily due to the increasesan increase in operating income. However, the Company doeswas not expect to be required to remit a significant amount of the $1,888,000 in total federal income taxes for fiscal year 1996 because of the availability of net operating loss carryforwards, accelerated depreciation and drilling tax credits. Cash Flow Net cash provided by operating activities increased $3,863,000, or 119%, from $3,258,000 during the fiscal year 1995 to $7,121,000 for fiscal year 1996. The increase iswas attributable primarily to increases in net income. Net cash used in investing activities increased $6,397,000, or 89%, from $7,154,000 for fiscal year 1995 to $13,551,000 for fiscal 1996. The increase iswas primarily the result of increased capital expenditures for oil and gas properties and costs associated with the acquisition of Welltech.WellTech. This increase iswas partially offset by a decrease in oilfield service capital expenditures. - 16 - Net cash provided by financing activities was $9,366,000 for the fiscal year 1996 as compared toincreased $5,368,000, or 134%, from $3,998,000 in net cash provided by financing activities for fiscal year 1995.1995 to $9,366,000 in fiscal 1996. The increase is primarily the result of increased principal payments during fiscal 1996. This increase in principal payments was somewhat offset by an increase in proceeds from long-term debt and borrowings under the line-of-credit during fiscal 1996 primarily as the result of the purchase of oil and gas properties by Odessa Exploration and the acquisition of WellTech. FISCAL YEAR ENDED JUNE 30, 1995 VERSUS FISCAL YEAR ENDED JUNE 30, 1994 Operating Income Fiscal 1995 revenues of $44,689,000LIQUIDITY AND CAPITAL RESOURCES The Company's cash and cash equivalents increased $10,068,000 or 29% over fiscal 1994 revenues of $34,621,000. Fiscal 1995 revenues increased due to the acquisition of oil and gas producing properties by Odessa Exploration, the operation of the assets of WellTech West Texas (which included twelve months of fiscal 1995 and seven months of fiscal 1994), and the additional revenues from Clint Hurt Drilling (which was acquired in March 1995). In addition, the Company has continued to expand its services offering oilwell fishing tools, blow-out preventers and oilwell frac tanks. - 16 - Income before income taxes was $3,328,000 for fiscal 1995, which was an increase from $2,295,000 in fiscal 1994. The increase in income before income taxes was due to the increase in gross revenues$37.5 million for the current fiscal year the acquisition by Odessa Explorationended June 30, 1997 from $4.2 million as of producing oil and gas properties, the operationsJune 30, 1996 to $41.7 million as of WellTech West Texas and the acquisition of Clint Hurt Drilling. Operating Expenses Fiscal 1995 costs and expenses of $41,361,000 increased $9,035,000 or 28% over fiscal 1994 costs and expenses of $32,326,000. Fiscal 1995 costs and expenses increased primarily due to the operations of WellTech West Texas and the acquisition of Clint Hurt Drilling, as well as increased lease operating costs due to acquisitions of oil and gas producing properties by Odessa Exploration. Interest Expense Interest expense increased from $830,000 during fiscal 1994 to $1,478,000 during fiscal 1995, primarily as a result of borrowings for the acquisition and drilling of oil and gas producing properties by Odessa Exploration and the acquisition of Clint Hurt Drilling. General and Administrative Expenses General and administrative expenses include those of the Company, Yale E. Key, Odessa Exploration and Clint Hurt Drilling. These expenses increased $812,000 to $4,352,000 during fiscal 1995 from $3,540,000 during fiscal 1994, primarily due to increased expenses of Odessa Exploration and the acquisition of Clint Hurt Drilling and WellTech West Texas. However, as a percent of gross revenues, general and administrative expenses decreased from 10.2% of gross revenues during fiscal 1994 to 9.7% of gross revenues during fiscal 1995. Depreciation and Depletion Expense Depreciation and depletion expense increased to $2,738,000 in fiscal 1995 from $1,371,000 in fiscal 1994 due mainly to the additional depreciation expense associated with the acquisition of the WellTech West Texas oilfield service equipment and subsequent capital expenditures on such equipment. Income Taxes Income tax expense of $1,150,000 for fiscal 1995 increased from $950,000 in income tax expense for fiscal 1994. TheJune 30, 1997. This increase in income taxes is primarily due to the increase in operating income. However, the Company does not expect to be required to remit a significant amount of the $1,150,000 in total federal income taxes in cash during fiscal 1996. Cash Flow Net cash provided by operating activities increased $1,416,000 from $1,842,000 during the 1994 fiscal year to $3,258,000 for the 1995 fiscal period. The increases are attributable primarily to increases in net income. Net cash used in investing activities increased from $5,608,000 for fiscal 1994 to $7,154,000 for fiscal 1995. The increase iswas primarily the result of increased capital expenditures for oil and gas properties and costs associated with the acquisition of Clint Hurt Drilling. This increase is partially offset by a decrease in oilfield service capital expenditures. The capital expenditures for the oilfield service operations during fiscal 1994 were primarily the result of the improvements necessary for the WellTech West Texas equipment. - 17 - Net cash provided by financing activities was $3,998,000 for the 1995 fiscal year as compared to $4,316,000 in net cash provided by financing activities for fiscal 1994. The decrease is primarily the result of increased principal payments during fiscal 1995. This increase in principal payments is somewhat off-set by an increase in proceeds from long-term debt during fiscal 1995 as the result of the financing of the improvement costs to the equipment of the West Texas operations of WellTech, the purchase of oil and gas properties by Odessa Exploration and the acquisition of Clint Hurt Drilling. LIQUIDITY AND CAPITAL RESOURCES At June 30, 1996, the Company had $3,240,000 in cash as compared to $865,000 in cash at June 30, 1995. At June 30, 1995, the Company had $865,000 in cash (the Company also had $267,000 in restricted marketable securities) as compared to $717,000 in cash at June 30, 1994.Bank Credit Agreement. The Company has projected $6.2$20 million for oilfield service capital expenditures for fiscal 19971998 as compared to $15.1 million and $5.2 million for fiscal 1996. Capital expenditures are expected to be primarily capitalized improvement costs to existing equipment and machinery. The Company expects to finance these capital expenditures utilizing the operating cash flows of the Company. Capital expenditures were $2,839,000 in fiscal 1995.1997 and 1996, respectively. Odessa Exploration is forecastinghas projected outlays of approximately $6.0$10 million in development costs for fiscal 1997,1998, as compared to $8.2 million and $9.8 million duringin fiscal 1996. Financing is expected to come from borrowings.1997 and 1996, respectively. Clint Hurt Drilling has forecast approximately $250,000$2 million for oil and gas drilling capital expenditures for fiscal 19971998, primarily for improvements to existing equipment and machinery, as compared to $598,000$1.5 million for fiscal 1997 and $598,000 in fiscal 1996. Such outlays are treated asThe Company expects to finance these capital costs. Financing is expectedexpenditures and development costs using cash flows from operations and available credit. The Company believes that its cash flows and, to come from existing cash flow.the extent required, borrowings under the Bank Credit Agreement, will be sufficient to fund such expenditures. Debt In July 1996,June 1997, the Company completedentered into the offering of $52,000,000 7% convertible subordinated debentures due 2003Credit Agreement (the "Debentures""Bank Credit Agreement") with PNC Bank, N.A. ("PNC"), as administrative agent, Norwest Bank Texas, N.A., as collateral agent, Lehman Commercial Paper, Inc., as advisor, arranger and syndication agent and the "Offering")lenders named therein pursuant to which the lenders agreed to make available to the Compaany a five-year revolving credit facilty in the amount of $135 million and a seven-year term loan facility in the amount of $120 million. Up to $10 million of letters of credit may be issued pursuant to the Bank Credit Agreement. The amount of letters of credit outstanding from time to time reduces the amount of revolving credit loans which may be outstanding. Revolving credit loans incurred pursuant to the Bank Credit Agreement will bear interest, at the Company's option, at PNC's base rate plus 1.00% or LIBOR plus 2.25% and term loans will bear interest, at the Company's option, at PNC's base rate plus 1.75% or LIBOR plus 2.75%. In August 1996,After September 30, 1997, the interestmargin applicable to revolving credit loans will fluctuate from time to time between 0.25% and 1.25% with respect to base rate loans and between 1.50% and 2.50% for LIBOR based loans. Such fluctuations will be based on the Debentures was increasedCompany's ratio of consolidated total debt (net of cash in excess of $5 million) to 7 1/2%.a pro forma calculation of consolidated earnings before interest expense, taxes and depreciation, depletion and amortization. The Offering was a private offering pursuant to Rule 144A underCompany used the Securities Act. Net proceeds from the Offering were used to substantiallyBank Credit Agreement to: (i) repay existing long-term debt (approximately $35.2 million). The remaining proceeds are intended to fund the expansion of the Company's services throughdebt; (ii) make additional acquisitions of businesses and assetscapital expenditures; and for(iii) provide working capital and general corporate purposes.capital. Long-term debt whichthat was repaid with proceeds from the OfferingBank Credit Agreement in July 1996June 1997 included the term noteall debt with CIT Group/Credit Finance, Inc. ("CIT") of approximately $21.1$54.3 million and all bank debt associated with Odessa Exploration, previously with Norwest Bank Texas, N.A. ("Norwest"), of approximately $14.1$2.1 million. The Debentures mature on July 1, 2003 and are convertible at any time after November 1, 1996 and before maturity, unless previously redeemed, into shares of the Company's common stock at a conversion price of $9 3/4 per share, subject to adjustment in certain events. In addition, holders of the Debentures who convert prior to July 1, 1999 will receive, in addition to the Company's common stock, a payment generally equal to 50% of the interest otherwise payable on the converted Debentures from the date of conversion through July 1, 1999, payable in cash or common stock, at the Company's option. Interest on the Debentures is payable semi-annually on January 1 and July 1 of each year, commencing January 1, 1997. In August 1996, the interest rate was increased from 7% to 7 1/2% due to certain modifications in the Debenture indenture involving a certain subsidiary's inability to guarantee the obligations under the indenture, relating to the Debentures (the "Prospectus"). The 7 1/2% effective interest rate is expected to remain for the foreseeable future. - 1817 - The Debentures will not be redeemable before July 15, 1999. Thereafter, the Debentures will be redeemable at the option of the Company in whole or part, at the declining redemption prices set forth in the original prospectus, together with accrued and unpaid interest thereon. The Debentures also may be redeemed at the option of the holder if there is a change in control (as defined in the original prospectus) at 100% of their principal amount, together with accrued interest thereon. In January 1996, prior to the merger with Welltech described in Note 2, and prior to the consummation of the Offering described above, the Company, Yale E. Key, Clint Hurt Drilling and WellTech entered into separate credit facilities with CIT totaling approximately $35 million (the combined maximum credit limit). The credit facilities were combined into one facility after the consummation of the Welltech merger. As a result of the separate credit facilities, the interest rate for Yale E. Key was lowered from two and one-half to one and one-quarter percent over the stated prime rate of 8.25% at June 30, 1996. Each of the CIT term notes required principal and interest payments, due the first day of each month beginning February 1, 1996, plus a final payment of the unpaid balance of the note due December 31, 1998. The expiration of each of the lines of credit is December 31, 1998. As a result of the convertible subordinated debenture Offering described above and subsequent repayment of all long-term debt with CIT, except the lines of credit, the Company is currently renegotiating its overall credit facilities with CIT, including, but not limited to, maximum credit availability, interest rate and maturity dates. Impact of SFAS 121 In March 1995,As of July 1, 1996, the Financial Accounting Standards Board issuedCompany adopted the provisions of Statement of Financial Accounting Standards No. 121 - Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of ("SFAS 121") regarding. Consequently, the impairment ofCompany reviews its long-lived assets identifiable intangiblesto be held and goodwill relatedused, including oil and gas properties accounted for under the successful efforts method of accounting, whenever events or circumstances indicate that the carrying value of those assets may not be recoverable. Long-lived assets to thosebe disposed of are to be accounted for at the lower of carrying amount or fair value less cost to sell when management has committed to a plan to dispose of the assets. All companies, including successful efforts oil and gas companies, are required to adopt SFAS 121 is effective for financial statements for fiscal years beginning after December 15, 1995, although earlier adoption is encouraged. The application of SFAS 121 will require periodic determination of1995. In order to determine whether an impairment had occurred, the book value of long-lived assets exceedsCompany estimated the expected future cash flows expectedof its income producing equipment and oil and gas properties and compared such future cash flows to result from the use of such assets and, if so, will require reduction of the carrying amount of the "impaired" assetsasset to their estimated fair values.determine if the carrying amount was recoverable. Based on this process, no writedown in the carrying amount of the Company's property was necessary at June 30, 1997. Impact of Recently Issued Accounting Standards The Financial Accounting Standards Board has recently issued the following accounting standards which will be adopted by the Company in the future. Statement of Financial Accounting Standards No. 128 ("SFAS 128") - Earnings per Share, is effective for periods ending on or after December 15, 1997. FAS 128 replaces the presentation of primary earnings per share ("EPS") with the presentation of basic EPS, which excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. SFAS 128 also requires dual presentation of basic EPS and diluted EPS on the face of the income statement and requires a reconciliation of the numerators and denominators of basic EPS and diluted EPS.The Company will adopt SFAS 128 for the quarter ended December 31, 1997. Statement of Financial Accounting Standards No. 130 ("SFAS 130") - Reporting Comprehensive Income, is effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The Company currently, estimates thatwill adopt SFAS 130 for the implementationfiscal year ended June 30, 1999. Statement of Financial Accounting Standards No. 131 ("SFAS 131") - Disclosures about Segments of an Enterprise and Related Information, is effective for financial statements for periods beginning after December 15, 1997. SFAS 131 need not be applied to interim financial statements in the initial year of its application. However, comparative information for interim periods in the initial year of application is to be reported in the financial statements for interim periods in the second year of application. The Company will adopt SFAS 131 for the fiscal year ended June 30, 1999. Management believes the adoption of SFAS 121128, SFAS 130 and SFAS 131 will not have a material effect on its financial position or results of operations of the Company's financial position. The Company will implement SFAS 121 beginning July 1, 1996.Company. Impact of Inflation on Operations Although in our complex environment it is extremely difficult to make an accurate assessment of the impact of inflation on the Company's operations, managementManagement is of the opinion that inflation has not had a significant impact on itsthe Company's business. - 1918 - ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Presented herein are the consolidated financial statements of Key Energy Group, Inc. and Subsidiaries as of June 30, 1997 and 1996 and 1995 and for the years ended June 30, 1997, 1996 1995 and 1994.1995. Also, included is the report of KPMG Peat Marwick LLP, independent certified public accountants, on such consolidated financial statements as of June 30, 1997 and 1996 and 1995 and for each of the three years ended June 30, 1996.1997, 1996 and 1995. INDEX toTO FINANCIAL STATEMENTS Page Consolidated Balance Sheets............................Sheets................................ 20 Consolidated Statements of Operations ..................... 21 Consolidated Statements of Operations..................Cash Flows ..................... 22 Consolidated Statements of Cash Flows..................Stockholders' Equity ........... 23 Consolidated Statements of Stockholders' Equity........ 24 Notes to Consolidated Financial Statements............. 25Statements ................ 24 Independent Auditors' Report........................... 45Report ................................ 51 - 2019 - Key Energy Group, Inc. and Subsidiaries Consolidated Balance Sheets
June 30, June 30, (Thousands, except share and per share data) 1997 1996 ------------------------------------------------------------------------------ ASSETS Current Assets: Cash $41,704 $ 4,211 Accounts receivable, net of allowance for doubtful accounts ($1,552 - 1997, $992 - 1996) 45,230 20,570 Inventories 5,171 1,957 Prepaid expenses and other current assets 1,228 743 ------------------------------------------------------------------------------ Total Current Assets 93,333 27,481 ------------------------------------------------------------------------------ Property and Equipment: Oilfield service equipment 176,326 66,432 Oil and gas well drilling equipment 6,319 4,862 Motor vehicles 10,569 1,159 Oil and gas properties and other related equipment, successful efforts method 23,622 17,663 Furniture and equipment 1,661 716 Buildings and land 8,758 5,295 ------------------------------------------------------------------------------ 227,255 96,127 Accumulated depreciation & depletion (19,069) (8,920) ------------------------------------------------------------------------------ Net Property and Equipment 208,186 87,207 ------------------------------------------------------------------------------ Other Assets 18,576 7,034 ------------------------------------------------------------------------------ Total Assets $320,095 $121,722 ============================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $15,339 $11,086 Other accrued liabilities 12,507 11,002 Accrued interest 2,102 417 Accrued income taxes 1,664 53 Deferred tax liability 126 310 Current portion of long-term debt 1,404 1,471 - ------------------------------------------------------------------------------- Total Current Liabilities 33,142 24,339 - ------------------------------------------------------------------------------- Long-term debt, less current portion 172,763 45,354 Non-current accrued expenses 4,017 4,909 Deferred tax liability 35,738 4,244 Minority interest 1,256 1,252 Commitments and contingencies Stockholders' equity: Common stock, $.10 par value; 25,000,000 shares authorized, 12,297,752 and 10,413,513 sharesissued and outstanding at June 30, 1997 and 1996, respectively 1,230 1,041 Additional paid-in capital 55,031 32,763 Retained earnings 16,918 7,820 - ------------------------------------------------------------------------------- Total Stockholders' Equity 73,179 41,624 - ------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $320,095 $121,722 ===============================================================================
See the accompanying notes which are an integral part of these consolidated financial statements. - 20 - Key Energy Group, Inc. and per share data) 1996 1995 --------------------------------------------------------------------------- ASSETS Current Assets: Cash $3,240 $865 Restricted cash 971 410 Restricted marketable securities - 267 Accounts receivable, netSubsidiaries Consolidated Statements of allowance for doubtful accounts of $1,942 and $133, respectively) 20,570 8,133 Inventories 1,957 1,257 Prepaid expenses and other current assets 743 358 -------------------------------------------------------------------------- Total Current Assets 27,481 11,290 -------------------------------------------------------------------------- Property and Equipment: Oilfield service equipment 66,432 23,726 Oil and gas well drilling equipment 4,862 2,014 Motor vehicles 1,159 526 Oil and gas properties and other related equipment,successful efforts method 17,663 7,652 Furniture and equipment 716 332 Buildings and land 5,295 2,086 -------------------------------------------------------------------------- 95,127 36,336 Accumulated depreciation & depletion (8,920) (4,394) -------------------------------------------------------------------------- Net Property and Equipment 87,207 31,942 -------------------------------------------------------------------------- Other Assets 7,034 2,011 -------------------------------------------------------------------------- Total Assets $121,722 $45,243 ========================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $11,086 $3,930 Other accrued liabilities 11,002 2,612 Accrued interest 417 145 Accrued income taxes 53 174 Deferred tax liability 310 118 Current portion of long-term debt 1,471 2,249 -------------------------------------------------------------------------- Total Current Liabilities 24,339 9,228 -------------------------------------------------------------------------- Long-term debt,less current portion 45,354 13,700 Non-current accrued expenses 4,909 - Deferred income taxes 4,244 2,204 Minority interest 1,252 - Commitments and contingencies Stockholders' equity: Common stock, $.10 par value; 25,000,000 shares authorized, 10,413,513 and 6,913,513 issued and outstanding at June 30, 1996 and 1995, respectively 1,041 691 Additional paid-in capital 32,763 15,186 Retained earnings 7,820 4,234 -------------------------------------------------------------------------- Total Stockholders' Equity 41,624 20,111 -------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $121,722 $45,243 ==========================================================================Operations
Year Ended Year Ended Year Ended (Thousands, except per share data) June 30, 1997 June 30, 1996 June 30, 1995 - --------------------------------------------------------------------------------------------------------------------------------- REVENUES: Oilfield services $144,385 $55,933 $40,105 Oil and gas 8,180 4,175 2,334 Oil and gas well drilling 9,956 6,188 1,932 Other, net 1,109 182 318 - --------------------------------------------------------------------------------------------------------------------------------- 163,630 66,478 44,689 - --------------------------------------------------------------------------------------------------------------------------------- COSTS AND EXPENSES: Oilfield services 100,366 40,737 30,592 Oil and gas 3,030 1,350 757 Oil and gas well drilling 8,155 5,030 1,444 Depreciation, depletion and amortization 11,420 4,701 2,738 General and administrative 18,522 6,608 4,352 Interest 7,535 2,477 1,478 - --------------------------------------------------------------------------------------------------------------------------------- 149,028 60,903 41,361 - --------------------------------------------------------------------------------------------------------------------------------- Income before income taxes and minority interest 14,602 5,575 3,328 Income tax expense 5,500 1,888 1,150 Minority interest in net income 4 101 - - --------------------------------------------------------------------------------------------------------------------------------- NET INCOME $9,098 $3,586 $2,178 ================================================================================================================================= EARNINGS PER SHARE : Primary: Net income $0.75 $0.45 $0.33 Assuming full dilution: Net income $0.65 $0.44 $0.33 ================================================================================================================================= WEIGHTED AVERAGE OUTSTANDING: Primary 12,205 7,941 6,647 Assuming full dilution 17,963 8,114 6,647 =================================================================================================================================
See the accompanying notes which are an integral part of these consolidated financial statements. - 21 - Key Energy Group, Inc. and Subsidiaries Consolidated Statements of Operations Fiscal Year Ended June 30, (Thousands, except per share data) 1996 1995 1994 --------------------------------------------------------------------------- REVENUES: Oilfield services $55,933 $40,105 $32,616 Oil and gas 4,175 2,334 1,936 Oil and gas well drilling 6,188 1,932 - Other, net 182 318 69 --------------------------------------------------------------------------- 66,478 44,689 34,621 --------------------------------------------------------------------------- COSTS AND EXPENSES: Oilfield services 40,737 30,592 25,992 Oil and gas 1,350 757 593 Oil and gas well drilling 5,030 1,444 - Depreciation, depletion and amortization 4,701 2,738 1,371 General and administrative 6,608 4,352 3,540 Interest 2,477 1,478 830 --------------------------------------------------------------------------- 60,903 41,361 32,326 --------------------------------------------------------------------------- Income before income taxes and minority interest 5,575 3,328 2,295 Income tax expense 1,888 1,150 950 Minority interest in net income 101 - - --------------------------------------------------------------------------- NET INCOME $3,586 $2,178 $1,345 =========================================================================== EARNINGS PER SHARE : Primary: Income before income taxes and minority interest $0.70 $0.50 $0.44 Net income $0.45 $0.33 $0.26 Assuming full dilution: Income before income taxes and minority interest $0.69 $0.50 $0.43 Net income $0.44 $0.33 $0.25 WEIGHTED AVERAGE OUTSTANDING: Primary 7,941 6,647 5,274 Assuming full dilution 8,114 6,647 5,288Cash Flows
Year Ended June 30, --------------------------------------- (Thousands) 1997 1996 1995 - ------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $9,098 $3,586 $2,178 Adjustments to reconcile income from operations to net cash provided by operations: Depreciation, depletion and amortization 11,420 4,701 2,738 Deferred income taxes 3,836 1,618 1,370 Minority interest in net income 4 101 - Gain on sale of assets (235) (186) - Other non-cash items - 6 (312) Change in assets and liabilities net of effects from the acquisitions: Increase in accounts receivable (14,904) (2,180) (1,327) Increase (decrease) in other current assets (2,811) 765 (940) Decrease in accounts payable and accrued expenses (5,565) (1,293) (154) Other assets and liabilities 1,313 3 (295) - -------------------------------------------------------------------------------------------------- Net cash provided by operating activities 2,156 7,121 3,258 - -------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures - Oilwell service operations (15,084) (5,188) (2,839) Capital expenditures - Oil and gas operations (8,188) (1,879) (2,823) Capital expenditures - Oil and gas well drilling operations (1,483) (598) (143) Proceeds from sale of fixed assets 3,159 574 - Cash received in acquisitions 2,342 1,168 - Acquisitions - oil and gas operations - (7,895) (1,348) Acquisitions - oilwell service operations, net of cash acquired (62,808) - - Redemption (purchase) of restricted marketable securities - 267 (1) - -------------------------------------------------------------------------------------------------- Net cash used in investing activities (82,062) (13,551) (7,154) - -------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on debt (1,772) (2,601) (2,148) Repayment of long-term debt (47,815) - - Borrowings (payments) under line-of-credit - 1,100 (605) Proceeds from stock options exercised 141 - - Proceeds from warrants exercised 1,362 - - Proceeds from convertible subordinated debentures - net of debt issuance costs 49,590 - - Proceeds from long-term commercial paper debt - net of debt issuance costs 115,021 - - Proceeds from other long-term debt 872 10,867 6,751 - -------------------------------------------------------------------------------------------------- Net cash provided by financing activities 117,399 9,366 3,998 - -------------------------------------------------------------------------------------------------- Net increase in cash 37,493 2,936 102 Cash at beginning of period 4,211 1,275 1,173 - -------------------------------------------------------------------------------------------------- Cash at end of period $41,704 $4,211 $1,275 ==================================================================================================
See the accompanying notes which are an integral part of these consolidated financial statements. - 22 - Key Energy Group, Inc. and Subsidiaries Consolidated Statements of Cash Flows Fiscal Year Ended June 30, (Thousands) 1996 1995 1994 --------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $3,586 $2,178 $1,345 Adjustments to reconcile income from operations to net cash provided by operations: Depreciation, depletion and amortization 4,701 2,738 1,371 Deferred income taxes 1,618 1,370 493 Minority interest in net income 101 - - Gain on sale of assets (186) - - Other non-cash items 6 (312) - Change in assets and liabilities net of effects from the acquisitions: Increase in accounts receivable (2,180) (1,327) (389) Increase (decrease) in other current assets 765 (940) (613) Decrease in accounts payable and accrued expenses (1,293) (154) (392) Other assets and liabilities 3 (295) 27 --------------------------------------------------------------------------- Net cash provided by operating activities 7,121 3,258 1,842 --------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures - Oilwell service operations (5,188) (2,839) (4,395) Capital expenditures - Oil and gas operations (1,879) (2,823) (1,253) Capital expenditures - Oil and gas well drilling operations (598) (143) - Proceeds from sale of fixed assets 574 - - Cash received in WellTech merger 1,168 - - Acquisitions - oil and gas operations (7,895) (1,348) - Redemption (purchase) of restricted marketable securities 267 (1) 40 --------------------------------------------------------------------------- Net cash used in investing activities (13,551) (7,154) (5,608) --------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on debt (2,601) (2,148) (1,771) Borrowings (payments) under line-of-credit 1,100 (605) 1,551 Borrowings from long-term debt 10,867 6,751 4,536 --------------------------------------------------------------------------- Net cash provided by financing activities 9,366 3,998 4,316 --------------------------------------------------------------------------- Net increase in cash and restricted cash 2,936 102 550 Cash and restricted cash at beginning of period 1,275 1,173 623 --------------------------------------------------------------------------- Cash and restricted cash at end of period $4,211 $1,275 $1,173 ===========================================================================Stockholders' Equity
Common Stock -------------------------------- Number of Additional Shares Amount Paid-in Retained (Thousands) Outstanding at par Capital Earnings Total - ------------------------------------------------------------------------------- --------------- ------------------ ------------ Balance at June 30, 1994 5,274 $527 $6,680 $2,056 $9,263 - -------------------------------------------------------------------------------- --------------- ------------------ ------------ Issuance of common stock for WellTech West Texas assets 1,635 164 8,420 - 8,584 Issuance of warrants for WellTech West Texas assets - - 63 - 63 Issuance of common stock for Clint Hurt Drilling assets 5 - 23 - 23 Net income - - - 2,178 2,178 - -------------------------------------------------------------------------------- --------------- ------------------ ------------ Balance at June 30, 1995 6,914 $691 $15,186 $4,234 $20,111 - -------------------------------------------------------------------------------- --------------- ------------------ ------------ Issuance of common stock for WellTech Merger 3,500 350 17,577 - 17,927 Net income - - - 3,586 3,586 - -------------------------------------------------------------------------------- --------------- ------------------ ------------ Balance at June 30, 1996 10,414 $1,041 $32,763 $7,820 $41,624 - -------------------------------------------------------------------------------- --------------- ------------------ ------------ Issuance of common stock for Brownlee Well Service stock 61 6 665 - 671 Issuance of common stock for Woodward Well Service stock 75 8 555 - 563 Issuance of common stock for Brooks Well Service stock 918 92 11,033 - 11,125 Issuance of common stock for Enerair Oilwell Service assets 4 - 48 - 48 Issuance of common stock for Cobra Well Service stock 175 18 2,368 - 2,386 Issuance of common stock for Tri-State Well Service assets 84 8 992 - 1,000 Issuance of common stock for Kal-Con Well Service assets and stock 78 8 1,103 - 1,111 Issuance of common stock for Well-Co Well Service stock 240 24 4,026 - 4,050 Exercise of warrants 221 22 1,340 - 1,362 Exercise of options 28 3 138 - 141 Net income - - - 9,098 9,098 - -------------------------------------------------------------------------------- --------------- ------------------ ------------ Balance at June 30, 1997 12,298 $1,230 $55,031 $16,918 $73,179 ================================================================================ =============== ================== ============
See the accompanying notes which are an integral part of these consolidated financial statements. - 23 - Key Energy Group, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity Common Stock ------------------- Number of Additional Shares Amount Paid-in Retained (Thousands) Outstanding at par Capital Earnings Total -------------------------------------------------------------------------- Balance at June 30, 1993 5,124 $512 $6,057 $711 $7,280 Issuance of common stock for Odessa Exploration, Inc. 150 15 623 - 638 Net income - - - 1,345 1,345 -------------------------------------------------------------------------- Balance at June 30, 1994 5,274 $527 $6,680 $2,056 $9,263 -------------------------------------------------------------------------- Issuance of common stock for WellTech West Texas assets 1,635 164 8,420 - 8,584 Issuance of warrants for WellTech West Texas assets - - 63 - 63 Issuance of common stock for Clint Hurt Drilling assets 5 - 23 - 23 Net income - - - 2,178 2,178 -------------------------------------------------------------------------- Balance at June 30, 1995 6,914 $691 $15,186 $4,234 $20,111 -------------------------------------------------------------------------- Issuance of common stock for WellTech merger 3,500 350 17,577 - 17,927 Net income - - - 3,586 3,586 -------------------------------------------------------------------------- Balance at June 30, 1996 10,414 $1,041 $32,763 $7,820 $41,624 ========================================================================== See the accompanying notes which are an integral part of these consolidated financial statements. - 24 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 1997, 1996 1995 and 19941995 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company Key Energy Group, Inc. herein after referred to as the "Company" or "Key", was organized in April 1977, and commenced operations in July 1978. Results of operations for the twelve months ended June 30, 1997, 1996 1995 and 19941995 include the Company's oilfield service operations conducted by its wholly-owned subsidiary, Yale E. Key, Inc., ("Yale E. Key"), the Company's oil and gas exploration and production wholly-owned subsidiary, Odessa Exploration Incorporated ("Odessa Exploration"), and the Company's oil and gas well drilling operations conducted by the Company's wholly-owned subsidiary, Key Energy Drilling, Inc. d/b/a Clint Hurt Drilling ("Clint Hurt Drilling"). Clint Hurt Drilling was acquired in March of 1995 (see Note 2).1995. Also included in the results of operations for the fiscal year ended June 30, 1996 are1997 and approximately three months offor the fiscal year ended June 30, 1996 are those operating results from the Company's wholly-owned subsidiary; WellTech Eastern, Inc. ("WellTech Eastern") which currently holds the assets acquired in the merger with WellTech, Inc. ("WellTech"), on March 26, 1996 (see Note 2). WellTech Eastern operates through two divisions; the WellTech Mid-Continent Division and the WellTech Eastern Division. In addition, as a result of the Welltech acquisition, the Company acquired a 63% ownership in ServiciousServicios WellTech, S.A. ("Servicious"Servicios"), an Argentinean corporation. ServiciousServicios conducts oilfield services operations in Argentina and is accounted for using the consolidation with a minority interest method. Basis of Presentation The Company's consolidated financial statements include the accounts of the Company and its majority-ownedwholly-owned subsidiaries. All significant inter-company transactions and balances have been eliminated. The accounting policies presented below have been followed in preparing the accompanying consolidated financial statements. The Company's ownership of less than 50% owned entities are accounted for by the cost or equity methods, depending on the Company's ownership percentage. The preparationEstimates and Uncertainties Preparation of thesethe accompanying consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the use of management estimates. Cash, Restricted Cash and Marketable Securities The Company holds significant cash in certain financial institutions. Restricted cash, $971,000 and $410,000 at June 30, 1996 and 1995, respectively, consists of monies held in Key's cash lock-box and certifcates of deposit. The cash lock-box is a requirement under the line of credit with CIT (see Note 5). Restricted marketable securities of $267,000 at June 30, 1995 consist primarily of an investment in a mutual fund which invests, primarily, in short-term intermediate government securities which are recorded at market value at June 30, 1995. The investment was held in escrow for a letter-of-credit (issued in thereported amount of approximately $244,000) for workers' compensation insurance. During fiscal 1996,assets and liabilities and disclosures of contingent assets and liabilities at the investment was converted into a Certificatedate of Deposit which is recorded at cost.the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Inventories Inventories, which consist primarily of oilwell service parts and supplies, are held for use in the operations of Key and are valued at the lower of average cost (first-in first-out method) or market. - 25 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Property and Equipment The Company provides for depreciation and amortization of non-oil and gas properties using the straight-line method over the following estimated useful lives of the assets: (table follows on next page) - 24 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Description Years --------------------------------------------------------------------------------------------------------------------- Oilfield service equipment 3 - 20 Oil and gas well drilling equipment 3 - 15 Motor vehicles 3 - 7 Furniture and equipment 3 - 10 Buildings and improvements 10 - 40 Gas processing facilities 10 --------------------------------------------------------------------------------------------------------------------- Upon disposition or retirement of property and equipment, the cost and related accumulated depreciation are removed from the accounts and the gain or loss thereon, if any, is included in the results of operations. Odessa Exploration's aggregate oil and gas properties are stated at cost, not in excess of total estimated future net revenues net of related income tax effects. Odessa Exploration utilizes the successful efforts method of accounting for its oil and gas properties. Under this method, all costs associated with productive wells and nonproductive development wells are capitalized, while nonproductive exploration costs and geological and geophysical costs (if any), are expensed. Capitalized costs relating to proved properties are depleted using the unit-of-production method. Upon disposition, the carrying amounts of properties sold or otherwise disposed of and the related allowance for depletion are eliminated from the accounts and any gain/loss is included in results of operations. Gas Balancing Deferred income associated with gas balancing is accounted for on the entitlements method and represents amounts received for gas sold under gas balancing arrangements in excess of Odessa Exploration's interest in properties covered by such agreements. Odessa Exploration had deferred income associated with gas balancing of approximately $155,000, $198,000 and $253,000 as of June 30, 1997, 1996 and 1995, respectively. Environmental The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and/or remediation is probable, and the costs can be reasonably estimated. Other Assets and Goodwill At June 30, 1997, 1996 and 1995, other assets consisted primarily of goodwill, capitalized debt issuance costs and security and escrow deposits from Key's workers' compensation retrospective insurance program, in addition to an interest, (approximately 13%), in an insurance company (the insurance company is affiliated with Key's workers' compensation carrier). - 2625 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) At June 30, 1997, 1996 and 1995, the Company classified as goodwill the cost in excess of fair value of the net tangible assets acquired in purchase transactions. Goodwill is being amortized on a straight-line basis over ten to twenty-five years. Management continually evaluates whether events or circumstances have occurred that indicate the remaining useful life of goodwill may warrant revision or the remaining balance of goodwill may not be recoverable. Goodwill amortization expense totaled $622,000 for fiscal 1997 and $100,000 for fiscal 1996 and $100,000 for fiscal 1995. Debt issuance cost amortization expense totaled $344,000 for the year ended June 30, 1996.1997 and is amortized over the term of the applicable debt. Earnings per Share Primary earnings per common share are determined by dividing net earnings applicable to common stock by the weighted average number of common shares actually outstanding during the year and common equivalent shares resulting from the assumed exercise of stock options and warrants (if any) using the treasury stock method, except in periods with reported losses as the inclusion of common stock equivalents would be antidilutive. Fully diluted earnings per common share are based on the increased number of shares that would be outstanding assuming conversion of dilutive outstanding convertible securities using the "as if converted" method. Income Taxes The Company accounts for income taxes based upon Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under SFAS 109, 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. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date. A valuation allowance for deferred tax assets is recognized when it is "more likely than not" that the benefit of deferred tax assets will not be realized. The Company and its wholly-ownedeligible subsidiaries file a consolidated U. S. federal income tax return. Certain subsidiaries that are consolidated for financial reporting purposes are not eligible to be included in the consolidated U. S. federal income tax return and separate provisions for income taxes have been determined for these entities or groups of entities. Concentration of Credit Risk Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of temporary cash investments and trade receivables. The Company restricts investment of temporary cash investments to financial institutions with high credit standing and by policy limits the amount of credit exposure to any one financial institution. The Company's customer base consists primarily of multi-national, foreign national and independent oil and natural gas producers. See Note 1112 for additional information regarding customers which accounted for more than 10% of consolidated revenues. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on its trade receivables. Such credit risk is considered by management to be limited due to the large number of customers comprising the Company's customer base. The Company maintains reserves for potential credit losses, and such losses have been within management's expectations. - 26 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Impact of SFAS 121 In March 1995,On July 1, 1996, the Financial Accounting Standards Board issuedCompany adopted the provisions of Statement of Financial Accounting Standards No. 121 - Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of ("SFAS 121") regarding the impairment of long-lived assets, identifiable intangibles and goodwill related to those assets. SFAS 121 is effective for financial statements for fiscal years beginning after December 15, 1995, although earlier adoption is encouraged. Under SFAS 121 an entity shall review. This Statement requires that long-lived assets and certain identifiable intangibles to be held and usedreviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. - 27 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) If the book valueAdoption of long-lived assets exceeds the future cash flows expected to result from the use of such assets and a reduction of the carrying amount of the "impaired" assets to their estimated fair values is required. The Company, currently, estimates that the implementation of SFAS 121 willthis Statement did not have a material effectan impact on the Company's financial position.position, results of operations, or liquidity. Stock-based Compensation The Company will implement accounts for employee stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"). Accordingly, the company has only adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 121 beginning July 1, 1996.123"). See Note 8 for the pro forma disclosures of compensation expense determined under the fair-value provisions of SFAS 123. Cash Flows For cash flow purposes, the Company considers all unrestricted highly liquid investments with less than a three month maturity when purchased as cash equivalents. Reclassifications Certain reclassifications have been made to the fiscal 1996 and 1995 consolidated financial statements to conform to the fiscal 1997 presentation. Impact of Recently Issued Accounting Standards The Financial Accounting Standards Board has recently issued the following accounting standards which will be adopted by the Company in the future. Statement of Financial Accounting Standards No. 128 ("SFAS 128") - Earnings per Share, is effective for periods ending on or after December 15, 1997. FAS 128 replaces the presentation of primary earnings per share ("EPS") with the presentation of basic EPS, which excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. SFAS 128 also requires dual presentation of basic EPS and diluted EPS on the face of the income statement and requires a reconciliation of the numerators and denominators of basic EPS and diluted EPS.The Company will adopt SFAS 128 for the quarter ended December 31, 1997. Statement of Financial Accounting Standards No. 130 ("SFAS 130") - Reporting Comprehensive Income, is effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The Company will adopt SFAS 130 for the fiscal year ended June 30, 1999. Statement of Financial Accounting Standards No. 131 ("SFAS 131") - Disclosures about Segments of an Enterprise and Related Information, is effective for financial statements for periods beginning after December 15, 1997. SFAS 131 need not be applied to interim financial statements in the initial year of its application. However, comparative information for interim periods in the initial year of application is to be reported in the financial statements for interim periods in the second year of application. The Company will adopt SFAS 131 for the fiscal year ended June 30, 1999. - 27 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Management believes the adoption of SFAS 128, SFAS 130 and SFAS 131 will not have a material effect on its financial position or results of operations of the Company. Impact of Inflation on Operations Although in our complex environment it is extremely difficult to make an accurate assessment of the impact of inflation on the Company's operations, management is of the opinion that inflation has not had a significant impact on its business. 2. BUSINESS AND PROPERTY ACQUISITIONS The following described acquisitions have been completed during the current year and are included in the Company's results of operations for the twelve months ended June 30, 1997. Well-Co Oil Service. Inc. On June 26, 1997, the Company completed its acquisition of Well-Co Oil Service, Inc. ("Well-Co") which operates 79 oilwell service rigs and related equipment in west Texas. Well-Co was acquired for $17.5 million in cash and 240,000 shares of the Company's common stock. Well-Co will be operated by the Company's west Texas subsidiary of Yale E. Key. The results of operations of Well-Co are included in the Company's results of operations effective June 26, 1997. The acquisition was accounted for using the purchase method. Phoenix Well Service, Inc. On June 10, 1997, the Company completed its acquisition of Phoenix Well Service, Inc. ("Phoenix") which operates 11 oilwell service rigs and related equipment in west Texas. Phoenix was acquired for $2.3 million in cash. Phoenix will be operated by the Company's west Texas subsidiary of Yale E. Key. The results of operations of Phoenix are included in the Company's results of operations effective June 26, 1997. The acquisition was accounted for using the purchase method. Southwest Oilfield Services, Inc. On June 10, 1997, the Company completed its acquisition of Southwest Oilfield Services, Inc. ("Southwest") which operates 3 oilwell service rigs and related equipment in western Oklahoma. Southwest was acquired for $455,000 in cash. Southwest will be operated by the WellTech Mid-Con Division of WellTech Eastern, Inc. The results of operations of Southwest are included in the Company's results of operations effective June 10, 1997. The acquisition was accounted for using the purchase method. Wireline and Excavation Assets On May 1, 1997, the Company completed an acquisition of ten wireline units and related equipment for approximately $600,000 in cash. These assets will be operated in West Virginia by the WellTech Eastern Division of WellTech Eastern. On May 5, 1997, the Company completed its acquisition of several dump trucks and related excavation equipment for $410,000 in cash. These assets will be operated in Michigan by the WellTech Eastern Division of WellTech Eastern. The results of operations of these assets are included in the Company's results of operations effective May 1, 1997. The acquisition was accounted for using the purchase method. Shreve's Well Service On April 18, 1997, the Company completed its acquisition of the assets of Shreve's Well Service, Inc. ("Shreve's") which operated in West Virginia. Shreve's assets were acquired for $550,000 in cash and included five well service rigs and related equipment. The Shreve's assets will be operated by the WellTech Eastern Division of WellTech - 28 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Eastern. The results of operations of Shreve's are included in the Company's results of operations effective May 1, 1997. The acquisition was accounted for using the purchase method. Argentine Drilling Rigs On April 16, 1997, the Company acquired three drilling rigs and related equipment in Argentina from Drillers, Inc. for $1.5 million in cash. The drilling rigs will be operated by WellTech Servicios, the Company's Argentine subsidiary. Diamond Well Service On April 3, 1997, the Company completed the acquisition of the assets of Diamond Well Service, Inc. ("Diamond") for $675,000 in cash. The Diamond assets included four oilwell service rigs and related equipment in Oklahoma. The Diamond assets will be operated by the WellTech Mid-Continent Division of WellTech Eastern. The results of operations of Diamond are included in the Company's results of operations effective April 1, 1997. The acquisition was accounted for using the purchase method. Kalkaska Construction Service, Inc. ,Kalkaska Oilfield Service, Inc. and Elder Well Service, Inc. On March 31, 1997, the Company completed the acquisition of the assets of Kalkaska Construction Service, Inc., Kalkaska Oilfield Service, Inc. ("KalCon") and Elder Well Service, Inc. ("Elder"), both based in Michigan. The KalCon assets included 40 vacuum (fluid transport) trucks, 40 trucks used in oilfield equipment hauling, seven saltwater disposal wells and other oilfield related equipment, and were acquired for approximately $8.5 million in cash and 77,998 shares of the Company's common stock. The Elder assets included six oilwell service rigs and related equipment and were acquired for $609,000 in cash. Both the KalCon and Elder assets will be operated by the WellTech Eastern Division of WellTech Eastern. The operating results of KalCon and Elder are included in the Company's results of operations effective April 1, 1997. The acquisition was accounted for using the purchase method. T.S.T. Paraffin Service Co., Inc. On March 27, 1997, the Company completed the acquisition of T.S.T. Paraffin Service Co., Inc. ("TST") for $8.7 million in cash. TST operates approximately 61 trucks, 22 hot oil units and other related equipment in west Texas. TST will be operated by the Company's west Texas subsidiary: Yale E. Key, Inc. The operating results of TST are included in the Company's results of operations effective April 1, 1997. The acquisition was accounted for using the purchase method. Tri-State Wellhead & Valve, Inc. The Company completed its acquisition of the assets of Tri-State Wellhead & Valve, Inc. ("Tri-State") on March 17, 1997 for $550,000 in cash and 83,770 shares of the Company's common stock. The Tri-State assets consisted of a wellhead equipment rental business and five oilwell service rigs. These assets will be operated by the WellTech Mid-Continent Division of WellTech Eastern. The operating results from these assets are included in the Company's results of operations effective April 1, 1997. The acquisition was accounted for using the purchase method. Cobra Industries, Inc. Effective as of January 13, 1997, the Company completed the purchase of Cobra Industries, Inc. ("Cobra") for $5 million in cash and 175,000 shares of the Company's common stock. Cobra operates 26 oilwell service rigs in southeastern New Mexico. The operating results from Cobra are included in the Company's results of operations effective February 1, 1997. The acquisition was accounted for using the purchase method. - 29 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Talon Trucking Co. Effective as of January 7, 1997, the Company completed the acquisition of the assets of Talon Trucking Co. ("Talon") for $2.7 million in cash. Talon operated three oilwell service rigs, 21 trucks and related fluid transportation and disposal assets in Oklahoma, which assets are currently operated by the WellTech Mid-Continent Division of WellTech Eastern. The operating results from these assets are included in the Company's results of operations effective January 7, 1997. The acquisition was accounted for using the purchase method. B&L Hotshot, Inc. Effective as of December 13, 1996, the Company completed the acquisition of B&L Hotshot, Inc. and affiliated entities ("B&L) for $4.9 million in cash. B&L provides trucking and related services for oil and natural gas wells in Michigan, which operations are currently conducted by the WellTech Eastern Division of WellTech Eastern. The operating results from B&L are included in the Company's results of operations effective January 1, 1997. The acquisition was accounted for using the purchase method. Brooks Well Servicing, Inc. Effective as of December 1, 1996, the Company completed the acquisition of Brooks Well Servicing, Inc. ("Brooks") for 917,500 shares of the Company's common stock. Brooks was a wholly-owned subsidiary of Hunt Oil Company and operated 32 oilwell service rigs and ancillary equipment in east Texas, which operations are currently conducted by the WellTech Mid-Continent Division of WellTech Eastern. The operating results from Brooks are included in the Company's results of operations effective December 1, 1996. The acquisition was accounted for using the purchase method. Hitwell Surveys, Inc. Effective as of December 2, 1996, the Company completed the purchase of Hitwell Surveys, Inc. ("Hitwell") for approximately $1.3 million in cash. Hitwell operates eight oilwell logging and perforating trucks in the Appalachian Basin and Michigan. The operating results from Hitwell are included in the Company's results of operations effective December 1, 1996. The acquisition was accounted for using the purchase method. Energy Air Drilling Services Co. Effective as of November 1, 1996, the Company completed the acquisition of certain assets of Energy Air Drilling Services Co. ("Energy Air") for $500,000 in cash and 4,386 shares of the Company's common stock. Energy Air operated four air drilling packages in west Texas, which operations are currently conducted by Yale E. Key. The acquisition was accounted for using the purchase method. Brownlee Well Service Inc. Effective as of October 24, 1996, the Company completed the purchase of Brownlee Well Service, Inc. ("Brownlee") and Integrity Fishing and Rental Tools Inc., ("Integrity"). Consideration for the acquisition was $6.5 million in cash and 61,069 shares of the Company's common stock. Brownlee and Integrity operate 16 oilwell service rigs with ancillary equipment and a variety of oilfield fishing tools in west Texas. The operating results from Brownlee are included in the Company's results of operations effective November 1, 1996. The acquisition was accounted for using the purchase method. - 30 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Woodward Well Service, Inc Effective as of October 1, 1996, the Company completed the acquisition of Woodward Well Service, Inc. ("Woodward") for 75,000 shares of the Company's common stock and approximately $100,000 in cash, most of which is payable over a four-year period. Woodward operated five oilwell service units in Oklahoma, which operations are currently conducted by the WellTech Mid-Continent Division of Welltech Eastern. The operating results from Woodward are included in the Company's results of operations effective October 1, 1996. The acquisition was accounted for using the purchase method. Acquisitions Completed Prior to June 30, 1996 Odessa Exploration Properties In April of 1996, Odessa Exploration purchased approximately $6.9 million in cash of oil and gas producing properties from an unrelated company using proceeds from bank borrowings, which indebtedness was subsequently repaid (see Note 5). The acquisition was accounted for using the purchase method. WellTech, Inc. On March 26, 1996, the Company acquired, through acompleted the merger WellTech. Key wasof WellTech, Inc. ("WellTech") into the surviving entity in the merger. NetCompany. The net consideration for the merger was 3,500,000 shares of the Company's common stock and warrants to purchase 500,000 additional shares. In the merger, WellTech stockholders received an aggregate of 4,929,962 shares of the Company's common stock and warrants to purchase 750,000 sharesCommon Stock at an exercise price of the Company's common stock at $6.75 per share. As part of the merger, 1,429,962 of the 1,635,000 shares of the Company's common stock owned by WellTech and previously issued warrants to purchase 250,000 shares of the Company's common stock at $5.00 per share were cancelled. WellTech's principal line of business isconducted oil and gas well servicing and it operatesoperations in the Mid-Continent and Northeast areas of the United States and in Argentina. The acquisition was accounted for using the purchase method and the results from operations from the acquisition have been included in thosemethod. Pro Forma Results of the Company's since March 26, 1996. Odessa Exploration Properties In April of 1996, Odessa Exploration purchased approximately $6.9 million of oil and gas producing properties from an unrelated company. Financing for the acquisition came from bank financing. The acquisition was accounted for using the purchase method. The results of operations of the acquired properties are included in the consolidated statements of operations beginning April 26, 1996. Clint Hurt Drilling On March 30, 1995, the Company and Clint Hurt Associates, Inc. ("CHA") entered into an asset purchase agreement pursuant to which CHA sold to the Company all of its assets in West Texas. Such assets mainly consisted of four oil and gas drilling rigs and related equipment. As consideration for the acquisition, the Company paid CHA $1,750,000, of which $1,000,000 was paid in cash and the balance in the form of a $725,000 note payable to CHA (the note was paid in full in July 1995). Mr. Clint Hurt entered into consulting and noncompetition agreements with the Company in consideration for which the Company issued 5,000 shares of common stock. The acquisition was accounted for using the purchase method and the results of operations of Clint Hurt Drilling have been included in those of the Company since April 1, 1995. WellTech West Texas In December 1993, the Company and WellTech entered into a purchase agreement pursuant to which the Company purchased substantially all assets used by Welltech in its West Texas operations. The acquisition was dependent on shareholder approval which occurred in August of 1994. As consideration for the acquisition, the - 28 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Company issued to WellTech 1,635,000 shares of common stock of the Company and warrants to acquire 250,000 additional shares of common stock, (at $5.00 per share which expire on February 5, 1997). The issued warrants have been subsequently modified as the result of the WellTech merger described above. The closing of the transaction occurred on August 11, 1994. Prior to the closing, the Company (through its wholly-owned subsidiary; Yale E. Key, Inc.) operated and managed the operations of the WellTech West Texas region in connection with an interim operating agreement. The Company's consolidated statements of operations from December 10, 1993 through August 11, 1994, include the direct revenues and expenses from the West Texas operations of WellTech. For the period after August 11, 1994, the results of operations include the effects of ownership of WellTech West Texas.Operations--(unaudited) The following unaudited pro forma results of operations have been prepared as though WellTech Eastern, Clint Hurt DrillingWell-Co, Cobra and WellTech West TexasT.S.T. had been acquired on July 1, 1993: (unaudited)1995. Pro-forma amounts are not necessarily indicative of the results that may be reported in the future. Year Ended June 30, (Thousands, except per share data) June 30, 1997 June 30, 1996 1995 1994 ------------------------------------------------------------------ ------------------------------------------------------------------------------- Revenues $ 113,022 $ 119,645 $ 97,111198,088 $162,988 Net income 5,247 4,875 4,26611,591 8,964 Earnings per share: Primary $0.50 $0.48 $0.42 Fully-diluted $0.47 $0.45 $0.40 Weighted average shares outstanding: Primary 10,414 10,106 10,106 Fully-diluted 11,106 10,798 10,798share $ 0.92 $ 0.76 3. OTHER ASSETS Other assets consist of the following: June 30, (Thousands) 1997 1996 1995 ------------------------------------------------------------------------------------------------------------------------------------------------ Investment in insurance company - common stock * $ 368 $ 368 Workers compensation security premiums 1,817 1,117 326 Deferred acquisitionDebt issuance costs (net of amortization; 1997 - 200$344) 7,045 - Goodwill (net of amortizationamortization: 1997 - $822, 1996 - $200) 9,256 5,400 963 Other 90 149 154 ------------------------------------------------------------------------------------------------------------------------------------------------ $18,576 $ 7,034 $2,011 ================================================================================================================================================ * - Represents approximately 13% ownership. - 31 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 4. COMMITMENTS AND CONTINGENCIES Various suits and claims arising in the ordinary course of business are pending against the Company. Management does not believe that the disposition of any of these items will result in a material adverse impact to the consolidated financial position of the Company. As of June 30, 1996,1997, the Company had reserved $425,000$133,000 for potential suits and claims. During 1995, the Company entered into employment agreements with certain of its officers. These employment agreements generally run to June 30, 1997, but will automatically be extended on a yearly basis - 29 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) unless terminated by the Company or the applicable officer. In addition to providing a base salary for each officer, the employment agreements provide for severance payments for each officer varying from 12 to 24 months of the officers base salary. The current annual base salaries for the officers covered under such employment agreements total approximately $800,000. 5. LONG-TERM DEBT In July 1996,On June 6, 1997, the Company completedentered into an agreement (the "Bank Credit Agreement") with PNC Bank, N.A., as administrative agent, Norwest Bank Texas, N.A., as collateral agent. Lehman Commercial Paper, Inc., as advisor, arranger and syndication agent and the offering of $52,000,000 7% convertible subordinated debentures due 2003 (the "Debentures" or the "Offering"). The Offering was a private offeringlenders named thereas pursuant to Rule 144A underwhich the Securities Act. Proceeds fromlenders provided a $255 million credit facility, consisting of a $120 million seven-year term loan and a $135 million five-year revolver. The interest rate, on the Offering were approximately $52,000,000term loan, is LIBOR plus 2.75 percent and were used to substantially repay existing long-term debt (approximately $35.2 million). The remaining proceeds are intended to fund the expansioninterest rate on the revolver varies based on the LIBOR and the level of the Company's services throughindebtedness and is currently LIBOR plus 2.25 percent. The Company used the proceeds from the facility to: (i) repay existing bank debt; (ii) make additional acquisitions and capital expenditures; and (iii) provide working capital. In addition, the credit facility provides, under certain conditions, for the repurchase of businessesa portion of the Company's outstanding common stock in the open market from time to time. In connection with the credit facility, the company incurred and assetscapitalized $4,979,000 of debt issuance costs. These costs are being amortized over the life of the credit facility. The credit facility contains certain restrictive covenants and for working capital and general corporate purposes.requires certain financial ratios. Long-term debt which was repaid with proceeds from the OfferingAgreement in July 1996 were the term noteJune 1997 included all debt with CIT Group/Credit Finance, Inc. ("CIT") of approximately $21.1$54.3 million and all bank debt associated with Odessa Exploration, previously with Norwest Bank Texas, N.A. ("Norwest") of approximately $14.1$2.1 million. In July 1996, the Company completed the offering of $52,000,000 7% convertible subordinated debentures due 2003 (the "Debentures"). In August 1996, the interest rate on the Debentures was increased to 7 1/2%. As the result of the Company's purchase of the remaining 37% ownership in Servicios, the interest rate was reduced to 7% in July of 1997. The offering was a private offering pursuant to Rule 144A under the Securities Act of 1933. Proceeds from the offering were used to substantially repay existing long-term debt (approximately $35.2 million). In connection with the offering of the Debentures, the Company capitalized and incurred $2,410,000 of debt issuance costs. These costs are being amortized over the life of the Debentures. The Debenture contains certain restrictive covenants and requires certain financial ratios. The Debentures mature on July 1, 2003 and are convertible at any time after November 1, 1996 and before maturity, unless previously redeemed, into shares of the Company's common stock at a conversion price of $9 3/4 per share, subject to adjustment in certain events. In addition, holders of the Debentures who convert prior to July 1, 1999 will receive, in addition to the Company's common stock, a payment generally equal to 50% of the interest otherwise payable on the converted Debentures from the date of conversion through July 1, 1999, payable in cash or common stock, at the Company's option. Interest on the Debentures is payable semi-annually on January 1 and July 1 of each year, commencing January 1, 1997. In August, 1996, the interest rate was increased from 7% to 7 1/2% due to certain modifications in the Debenture indenture involving a certain subsidiary's - 32 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) inability to guarantee the obligations under the indenture, relating to the Debentures (the "Prospectus"), (specifically, Servicios). As the result of the Company's purchase of the remaining 37% ownership in Servicios, the interest rate was reduced to 7% in July of 1997. The Debentures will not be redeemable by the Company before July 15, 1999. Thereafter, the Debentures will be redeemable at the option of the Company in whole or part, at the declining redemption prices set forth in the original Prospectus, together with accrued and unpaid interest thereon.(see Note 17, for further discussion.) In January 1996, prior to the consummation of the Bank Credit Agreement and offering described above, the Company, Yale E. Key, Clint Hurt and WellTech entered into separate credit facilities with CIT totaling approximately $35 million (the combined maximum credit limit). The credit facilities were combined into one facility after the consummation of the Welltech merger. As a result of the separate credit facilities, the interest rate for Yale E. Key was lowered from two and one-half to one and one-quarter percent over the stated prime rate (8.25% at June 30, 1996). Each of the CIT term notes required principal and interest payments, due the first day of each month beginning February 1, 1996, plus a final payment of the unpaid balance of the note due December 31, 1998. The expiration of each of the lines of credit was December 31, 1998. The components of long-term debt are as follows: June 30, (Thousands) 1997 1996 Term Note (i) $120,000 $ - Subordinated Debentures (ii) 52,000 - Term Note(s) - CIT, interest and principal payable monthly (iii) - 21,062 Revolving Line(s) of Credit - CIT, interest payable monthly (iii) - 9,910 Revolver Note - Norwest, interest payable monthly (iv) - 6,300 Term Note(s) - Norwest, interest and principal payable monthly (v) - 7,000 Other notes payable 2,167 2,553 174,167 46,825 Less current portion 1,404 1,471 ----------------------------------------------------------------------- Long-term debt $172,763 $ 45,354 ======================================================================= (i). Under the Bank Credit Agreement, the term loan of $120 million requires interest payments at the termination of the LIBOR interest period. The term loan is seven years and the interest rate is LIBOR plus 2.75 percent. Principal payments are $500,000 at June 30, 1998, $125,000 at the end of each quarter beginning September 30, 1998 through June 30, 2002, $8,750,000 at the end of each quarter beginning September 30, 2002 through June 30, 2003 and $20,625,000 beginning September 30, 2003 with a final payment of $20,625,000 on June 30, 2004. The Company used the proceeds from the facility to: (i) repay existing bank debt; (ii) make additional acquisitions and capital expenditures; and (iii) provide working capital. In addition, the credit facility, of $135 million, provides, under certain conditions, for the repurchase of a portion of the Company's outstanding common stock in the open market from time to time. At June 30, 1997, there was $135 million available on the credit facility. Under the credit facility the Company may be obligated to pay certain fees including a commitment fee which ranges from .25% to .375% based on the unused portion of the credit facility. - 33 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) (ii). The Debentures mature on July 1, 2003 and are convertible at any time after November 1, 1996 and before maturity, unless previously redeemed, into shares of the Company's common stock at a conversion price of $9 3/4 per share, subject to adjustment in certain events. In addition, holders of the Debentures who convert prior to July 1, 1999 will receive, in addition to the Company's common stock, a payment generally equal to 50% of the interest otherwise payable on the converted Debentures from the date of conversion through July 1, 1999, payable in cash or common stock, at the Company's option. Interest on the Debentures is payable semi-annually on January 1 and July 1 of each year, commencing January 1, 1997. In August, 1996, the interest rate was increased from 7% to 7 1/2% due to certain modifications in the Debenture indenture involving a certain subsidiary's inability to guarantee the obligations under the indenture, (specifically, Servicious). The 7 1/2% effective interest rate is expectedrelating to remain for the foreseeable future. The Debentures are not redeemable before July 15, 1999. Thereafter, the Debentures will be redeemable at(the "Prospectus"), (specifically, Servicios). As the option of the Company in whole or part, at the declining redemption prices set forth in the original Debenture prospectus, together with accrued and unpaid interest thereon. The Debentures also may be redeemed at the option of the holder if there is a change in control (as defined in the original Debenture prospectus) at 100% of their principal amount, together with accrued interest thereon. In January 1996, prior to the completed merger described in Note 2, and prior to the consummation of the Offering described above, the Company, Yale E. Key, Clint Hurt and WellTech entered into separate credit facilities with CIT totaling approximately $35 million (the combined maximum credit limit). The credit facilities were combined into one facility after the consummation of the Welltech merger. As a result of the separate credit facilities,Company's purchase of the remaining 37% ownership in Servicios, the interest rate for Yale E. Key was lowered from two and one-halfreduced to one and one-quarter percent over the stated prime rate7% in July of 8.25% at June 30, 1996. Each of the CIT term notes required principal and interest payments, due the first day of each month beginning February 1, 1996, plus a final payment of the unpaid balance of the note due December 31, 1998.1997. (iii). The expiration of each of the lines of credit was December 31, 1998. - 30 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) As a result of the Offering described above and subsequent repayment of all long-term debt with CIT, except the lines of credit, the Company is currently renegotiating its overall credit facilities with CIT including, but not limited to, maximum credit availability, interest rate and maturity dates. The components of long-term debt, prior to the Offering described above, were as follows: June 30, (Thousands) 1996 1995 --------------------------------------------------------------------------- Term Note(s) - CIT, interest and principal payable monthly (i) $ 21,062 $ 6,032 Revolving Line(s) of Credit - CIT, interest payable monthly (i) 9,910 3,846 Revolver Note - Norwest, interest payable monthly (ii) 6,300 4,237 Term Note(s) - Norwest, interest and principal payable monthly (iii) 7,000 944 Other notes payable 2,554 890 --------------------------------------------------------------------------- 46,826 15,949 Less current portion 1,472 2,249 --------------------------------------------------------------------------- Long-term debt $ 45,354 $ 13,700 =========================================================================== (i).Prior to the Offering described above, the CIT term note, as amended, required principal payments of approximately $275,000, plus interest, due the first day of each month plus a final payment of the unpaid balance of the note due December 31, 1998. The interest rate was one and one-quarter percent above the stated prime rate of 8.25% at June 30, 1996. The note was collateralized by all of the assets (including equipment and inventory) of Yale E. Key, Clint Hurt and WellTech Eastern. The CIT line of credit, as amended, currently requiresrequired monthly payments of interest at one and one-quarter percent above the stated prime rate of 8.25% at June 30, 1996. The line of credit iswas collateralized by the accounts receivable of Yale E. Key, Clint Hurt and WellTech Eastern. At June 30, 1996, there was no credit line availability. The agreement with CIT included certain restrictive covenants, the most restrictive of which prohibitsprohibited the Company from making distributions and declaring dividends on its common stock. (ii)(iv). Prior to the Agreement and Offering described above, Odessa Exploration had a loan agreement, as amended, with Norwest. The loan agreement provided for a $7.5 million revolving line of credit note subject to a borrowing base limitation (approximately $6.3 million at June 30, 1996). The borrowing base was redetermined on at least a semi-annual basis. The borrowing base was reduced by approximately $100,000 per month through October 1997; the maturity of the note. The note's interest rate was one-half of one percent over Norwest's prime rate of 8.25% at June 30, 1996).1996. The note was secured by substantially all of the oil and gas properties of Odessa Exploration. - 31 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) The loan agreement had contained various restrictive covenants and compliance requirements, which included (a) prohibits Odessa Exploration from declaring or paying dividends on Odessa Exploration's common stock, (b) limiting the incurrence of additional indebtedness by Odessa Exploration, (c) the limitation on the disposition of assets and (d) various financial covenants. (iii)(v). In April, 1996, as the result of the acquisition of certain properties by Odessa Exploration, but prior to the Offering described above, Odessa Exploration entered into a loan agreement with Norwest. The loan agreement provided for a term loan of $9.3 million to be reduced by $2.4 million in principal amount after the consummation of the acquisition of certain properties by Odessa Exploration. The note's interest rate was one-half of one percent over Norwest's prime rate of 8.25% at June 30, 1996. The note required interest payments beginning June 1, 1996. The note was secured by substantially all of the oil and gas properties of Odessa Exploration. As a result of the Offering described above, the note was repaid in full in July 1996. In March 1995, Clint Hurt entered into a loan agreement with Norwest. The loan agreement provided for a $1 million term note and a $200,000 line of credit note. The $1 million term note required principal payments of approximately $28,000 per month plus interest with the first payment due May 5th, 1995 and monthly thereafter for 36 months with a maturity date of April 1998. The $200,000 line of credit note required principal payments of $20,000 per month beginning July 5, 1995, plus interest, through its maturity in April 1996. Both notes had an interest rate of Norwest prime rate (8.25% at June 30, 1996), plus 3/4 of one percent. The notes were secured by all of the equipment of Clint Hurt Drilling and were guaranteed by the Company. In January 1996, as the result of the new credit facilities with CIT as described above, but prior to the Offering, also described above, the Clint Hurt loan and line of credit with Norwest was repaid in full. Presented below is a schedule of the repayment requirements of long-term debt which reflects the revised payment terms of the Offering, for each of the next five years and thereafter as of June 30, 1996: (in thousands) Fiscal year Principal Ended Amount -------------------------------- 1997 $ 1,472 1998 111 1999 9,956 2000 39 2001 38 Thereafter 35,210 -------------------------------- $ 46,826 ================================1997: - 3234 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) (in thousands) Fiscal year Principal Ended Amount --------------------------------------------------------- 1998 $ 1,404 1999 1,392 2000 701 2001 637 2002 533 Thereafter 169,500 ------- $ 174,167 ========================================================= 6. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, other current assets and other current liabilities approximates fair value because of the short maturity of these instruments. Based on the borrowing rates currently estimated to be available to the Company for loans with similar terms, the fair value of long-term debt approximates the carrying amount as of June 30, 1997 and 1996, except for the subordinated convertible debentures which have a carrying value of $52 million and a fair value of approximately $98.9 million at June 30, 1997. 7. OTHER ACCRUED LIABILITIES Other accrued liabilities consist of the following: June 30, (Thousands) 1997 1996 1995 ----------------------------------------------------------------------------------------------------------------------------------------------- Accrued payroll and taxes $ 2,614 $ 6246,674 $2,614 Group medical insurance 891 1,536 - Workers compensation 1,683 1,067 704 State sales and use and property taxes 247 414 208 Gas imbalance - deferred income 155 198 253 Revenue distribution 145 437 215 Acquisition and reorganization accrual 838 3,720 - Other 1,874 1,016 608 ------------------------------------------------------------------------------------------- Total $ 11,002 $2,612 ==================================================================== 7.12,507 $11,002 =========================================================================== 8. STOCKHOLDERS' EQUITY The 1995 Stock Option Plan On October 5, 1995,March 26, 1996, a Stock Option Plan (the "1995 Plan") was approved by the Company's Board of Director's.stockholders. The Plan became effective July 1, 1995, and , unless terminated earlier, will terminate July 1, 2005. The 1995 Plan is administered by a committee (the "Committee") consisting of at least three directors of Key, each of whom is a "disinterested person" within the meaning of rule 16b-3 under the Exchange Act and an "outside director" within the meaning of Section 162(m) of the Code. - 35 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued The total number of shares of the Company's common stock that may be subject to options under the 1995 Plan may not exceed 1,150,0001,800,000 in the aggregate. The total amount of common stock with respect to which options may be granted over the life of the 1995 Plan to any single employee shall not exceed 500,000 shares in the aggregate. Options which are canceled, forfeited or have expired or expire by their terms without being exercised shall be available for future grants under the 1995 Plan. The Committee may determine may determine which key employees of the Company or any subsidiary or other persons shall be granted options under the 1995 Plan, the terms of the options and the number of shares which may be purchased under the option. The individuals eligible to receive options under the 1995 Plan consist of key employees (including officers who may be members of the Board), directors who are neither employees nor members of the Committee and other individuals who render services of special importance to the management, operation or development of Key or any subsidiary, and who have contributed or may be expected to contribute materially to the success of Key or a subsidiary, provided, however, that only key employees are eligible to receive options. The price at which shares of common stock may be purchased upon exercise of an option will be specified by the Committee at the time the option is granted, but in the case of an individual stock option, except under certain conditions, may not be less than the fair market value of the common stock on the date of grant. The duration of any option is determined by the Committee in its discretion and shall be specified in the option agreement. No individual stock option may be exercisable after the expiration of ten years. - 33 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) The 1995 Outside Directors Stock Option Plan On October 5, 1995,March 26, 1996, an Outside Directors Stock Option Plan was approved by the Company's Board of Director'sShareholder's (the "Directors Plan"). Individuals who are "Outside Directors" are eligible to participate in the Directors Plan. An "Outside Director" is defined as a member of the Board of Directors who is not an employee of the Company or any of its subsidiaries. Under the Directors Plan, Outside Directors are divided into three groups dependent upon certain dates and length of service on the Board. Only nonqualified stock options ("NSO's") may be granted under the Directors Plan. An NSO granted under the Directors Plan shall expire ten years after the date of the grant. An NSO may not be granted under the Directors Plan after July 1, 1998. The Directors Plan provides for the issuance of an aggregate of 300,000400,000 shares of common stock, which may be authorized but unissued shares, treasury shares, or shares purchased on the open market. The exercise price of the NSO shall be the fair market value on the date of the grant. The following table summarizes the stock option activity related to the Company's plans: Price Shares Per Share -------------------------------------------------------------------------------------------------------------------------------- Outstanding, July 1, 1995 - $ - Granted 1,075,000 $ 5.00 - $ 7.50 Cancelled - $ - Exercised - $ - ------------------------------------------------------------------- Outstanding, June 30, 1996 1,075,000 $ 5.00 ---------- Granted 175,000 $ 7.50 ==========================================================175,000 $8.313 50,000 $8.375 25,000 $8.50 25,000 $11.125 535,000 $13.25 25,000 $14.50 - 36 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Price Shares Per Share 50,000 $16.875 Canceled 26,668 $5.00 Exercised 28,332 $5.00 ---------- Outstanding, June 30, 1997 2,080,000 ========== Exercisable, June 30, 1997 810,417 The Company applies APB 25 and related Interpretations in accounting for its stock option awards. Accordingly, no compensation expense has been recognized for its stock option awards. If compensation expense for the stock option awards had been determined consistent with SFAS 123, the Company's net income and net income per share, for the years ended June 30, 1997 and 1996 281,250would have been adjusted to the following pro forma amounts: (unaudited) Year Ended June 30, 1997 1996 ---- ---- Net income (in thousands) $8,680 $2,945 Primary net income per share $ 5.000.71 $ 0.37 Fully-diluted net income per share $ 0.61 $ 0.35 The pro forma net income and pro forma net income per share amounts noted above are not likely to be representative of the pro forma amounts to be reported in future years. Pro forma adjustments in future years will include compensation expense associated with the options granted in fiscal year 1996 and 1997 plus compensation expense associated with any options awarded in future years. As a result, such pro forma compensation expense is likely to be higher than the levels reflected for 1996 and 1997 if any options are awarded in future years. Under SFAS 123, the fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grant in 1997 and 1996: 1997 1996 ---- ---- Risk-free interest rate 6.59% 6.54% Expected life 5 years 5 years Expected volatility 28% 29% Expected dividend yield 0% 0% The total fair value of options granted at June 30, 1997 is $6,541,000. - $ 7.50 ========================================================== 8.37 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 9. INCOME TAXES Components of income tax expense (benefit) are as follows: Fiscal Year Ended June 30, (Thousands) 1997 1996 1995 1994 ------------------------------------------------------------------------------------------------------------------------------------- Federal and State: Current $ 1,664 $ 270 $ (220) $ 457 Deferred 3,836 1,618 1,370 493 -------------------------------------------------------------- $1,888--------------------------------------- $ 1,1505,500 $ 950 ============================================================== - 34 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)1,888 $1,150 ====================================================================== Income tax expense (benefit) differs from amounts computed by applying the statutory federal rate as follows: Fiscal Year Ended June 30, (Thousands) 1997 1996 1995 1994 -------------------------------------------------------------------------------------------------------------------------------------------- Income tax computed at Statutory rate 35.0% 34.0% 34.0% 34.0% State taxes netAmortization of federal benefitgoodwill disallowance 1.5 - - 2.4 Expiration of capital loss carryover - - 4.4 Meals and entertainment disallowance 0.8 1.7 2.2 - Accrual to return adjustments 0.3 (1.5) (1.0) - Other 0.1 (0.3) (0.7) .5 ---------------------------------------------------------------------_______________________________________________________________________ 37.7% 33.9% 34.5% 41.3% ============================================================================================================================================ Deferred tax assets (liabilities) are comprised of the following:following : Fiscal Year Ended June 30, (Thousands) 1997 1996 1995 1994 ----------------------------------------------------------------------------------------------------------------------------------------------- Net operating loss carry-forwards net of allowance and Sec. 382 limitations$ 4,628 $ 6,293 $ 1,140 $ 1,143 Property and equipment (40,410) (10,942) (3,437) (2,095) Other (82) 95 (25) - ----------------------------------------------------------------------------------------------------------------------------------------------- Net deferred tax liability $(4,554) $(2,322) $ (952) ========================================================================(35,864) $ (4,554) $ (2,322) ======================================================================= A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Based on expectations for the future, management has determined that taxable income of the Company will more likely than not be sufficient to fully utilize available carryforwards prior to their ultimate expiration. The Company estimates that as of June 30, 1996,1997, the Company will have available approximately $186,837,042$148,414,060 of net operating loss carryforwards (which begin to expire in 2001). The net operating loss carryforwards are subject to an annual limitation of approximately $940,000, under Sections 382 and 383 of the Internal Revenue Code. 9.- 38 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 10. LEASING ARRANGEMENTS Among other leases, the Company (primarily its subsidiaries), lease certain automotive equipment under non-cancellablenon-cancelable operating leases which expire at various dates through 1999.2002. The term of the operating leases generally run from 36 to 60 months with varying payment dates throughout each month. In addition, in the case of Yale E. Key, each lease includes an option to purchase the equipment and an excess mileage charge as defined in the leases. - 35 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) As of June 30, 1996,1997, the future minimum lease payments under non-cancellablenon-cancelable operating leases, in thousands, are as follows: Fiscal Year Lease Ending June 30, Payments ------------------------------------- 19971998 $ 2,819 1998 2,2174,348 1999 1,3713,433 2000 5872,044 2001 286 ------------------------------------- $ 7,280 =====================================1,122 2002 391 --------- $11,338 ========= Operating lease expense was approximately $5,299,000, $2,897,000, $1,930,000 and $1,640,000$1,930,000, for the fiscal years ended June 30, 1997, 1996 and 1995, and 1994, respectively. 10.11. EMPLOYEE BENEFIT PLANS At June 30, 1996,1997, as the result of the WellTech merger (Note 2), the Company maintains two 401-(k) plan'splans (the "Plans") for its employees. Employee'sEmployees of WellTech Eastern are eligible for participation in one Plan (the "WellTech 401-(k) Plan"), while all other employee'semployees are eligible for participation in the other Plan (the "Key 401-(k) Plan"). The Company intends to merge the two Plans during fiscal 1997.at January 1, 1998. The 401-(k) plan'splans cover substantially all employees of the Company. The Company did not make a contribution to the Key 401-(k) Plan during the fiscal year ended June 30, 1994, however, beginning July 1, 1994, the Company agreed to match employeesmatches employees' contributions up to 10% of the employeesemployees' contribution to the Key 401-(k) Plan. These contributions totaled approximately $35,000, $19,000 and $20,000 for the years ended June 30, 1997, 1996 and 1995, respectively. Additionally, the Company contributed $300,000 and $37,000 into the WelltechWellTech 401-(k) Plan for the year ended June 30, 1997 and the period of March 26, 1996 (the date of the WellTech merger) to June 30, 1996.1996, respectively . The Company agreed to match employee contributions up to 50% (to a maximum of $1,000 per employee) of the employeesemployees' contributions to the WelltechWellTech 401-(k) Plan. 11.12. MAJOR CUSTOMERS Sales to customers representing 10% or more of consolidated revenues for the years ended June 30, 1997, 1996 1995 and 19941995 were as follows: Fiscal Year Ended June 30, 1997 1996 1995 1994 ---------------------------------------------------------- Customer A 13% 20% 18% 15% Customer B 7% 11% 10% 14% The accounts receivable balance for customers A and B at June 30, 1996 were $1,603,000 and $835,000, respectively. - 3639 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 12.13. TRANSACTIONS WITH RELATED PARTIES WellTech Eastern paid $78,000 and $18,000 for the year ended June 30, 1997 and for the period March 26, 1996 (the date of the Welltech merger) to June 30, 1996, respectively, for office/yard rental expense in which an officer of the Company and WellTech Eastern has an interest. In the opinion of the Board of Directors of the Company, based on the Board's review of competitive bids, this transaction was on terms at least as favorable to the Company as could have been obtained from a third party. In connection with the Odessa Exploration acquisition, (see Note 2) the Company granted D. Kirk Edwards (President of Odessa Exploration) a percentage reversionary working interest in five deep gas wells located in West Texas upon repayment of $1,622,000 of the bank debt assumed by the Company in the acquisition from the Company's earnings from the five wells. The percentage reversionary working interest decreases based on the date of repayment of the assumed bank debt and ranges from 20% of the earnings from the five wells if repayment occurs on or prior to July 7, 1995, to 5% of the earnings from the five wells if repayment occurs after July 7, 1996. The value of the reversionary interest assigned was insignificant at July 1, 1993. Key leases automotive equipment from an independent third party (see Note 9)10). The independent third party purchases the automotive equipment from an automobile dealership in which a former officer owns a majority interest. Net proceeds to the automobile dealership totaled $399,000 and $1,058,000 for yearsthe year ended June 30, 1995 and 1994, respectively.1995. The leases are considered operating leases. In the opinion of the Board of Directors of the Company, the net proceeds from automotive equipment were on terms at least as favorable to the Company as could have been obtained from a third party. This opinion is based on information provided by a third party leasing company, that is not affiliated with the former officer or the Company, to the Board of Directors regarding purchase prices and equipment lease rentals offered by third parties. Space left blank intentionally - 40 - Key paid $55,000 for the year ended June 30, 1994 for oilfield related servicesEnergy Group, Inc. and equipment to two oilfield related companies in which two officers of Key had an interest. In the opinion of the Board of Directors of the Company, based on the Board's review of competitive bids, these transactions were on terms at least as favorable to the Company as could have been obtained from a third party. 13.Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 14. CONCENTRATIONS OF CREDIT RISK The Company has a concentration of customers in the oil and gas industry. Substantially all of the Company's customers are major integrated oil companies, major independent producers of oil and gas and smaller independent producers. This may affect the Company's overall exposure to credit risk either positively or negatively, in as much as its customers are effected by economic conditions in the oil and gas industry, which has historically been cyclical. However, accounts receivable are well diversified among many customers and a significant portion of the receivables are from major oil companies, which management believes minimizes potential credit risk. Historically, credit losses have been insignificant. Receivables are generally not collateralized, although the Company may generally secure a receivable at any time by filing a mechanic's and material-mans' lien on the well serviced. - 37 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 14.15. BUSINESS SEGMENT INFORMATION Information about the Company's operations by business segment is as follows: Year Ended June 30, (Thousands) 1997 1996 1995 1994 ------------------------------------------------------------------------------------------------------------------------------------------------ Revenues: Oil and gas $ 8,180 $ 4,175 $ 2,334 $ 1,936 Oilfield services 144,385 55,933 40,105 32,616 Oil and gas well drilling services 9,956 6,188 1,932 - Other 1,109 182 318 69 -------------------------------------------------------------------- $66,478---------------------------------------------------------------------------- $163,630 $ 44,689 $34,621 ====================================================================66,478 $44,689 ============================================================================ Income before minority interest and and income taxes: Oil and gas $ 3,719 $ 1,596 $ 941 $ 814 Oilfield services 20,639 6,482 4,105 2,823 Oil and gas well drilling services 1,036 639 367 - Interest expense (7,535) (2,477) (1,478) (830) General corporate (3,257) (665) (607) (512) ------------------------------------------------------------------------------------------------------------------------------------------------- $ 14,602 $ 5,575 $ 3,328 $ 2,295 ================================================================================================================================================= Identifiable assets: Oil and gas $ 18,17023,544 $18,170 $ 8,289 $ 5,258 Oilfield services 242,001 94,962 33,516 22,022 Oil and gas well drilling services 8,365 5,583 3,160 - General corporate 46,185 3,007 278 815 ------------------------------------------------------------------------------------------------------------------------------------------------- $320,095 $121,722 $ 45,243 $ 28,095 =====================================================================$45,243 ============================================================================ - 41 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Year Ended June 30, -------------------------- (Thousands) 1997 1996 1995 ---------------------------------------------------------------------------- Capital Expenditures:expenditures (excluding acquisitions): Oil and gas $ 9,7748,188 $ 3,7361,879 $ 4,4492,823 Oilfield services 15,084 5,188 11,422 4,3952,839 Oil and gas well drilling services 1,483 598 2,141 - ---------------------------------------------------------------------143 --------------------------------------------------------------------------- $ 15,56024,755 $ 17,2997,665 $ 8,844 =====================================================================5,805 =========================================================================== Depreciation, depletion and amortization: Oil and gas $ 870 $ 618 $ 426 $ 412 OilfieldOifield services 9,198 3,862 2,279 959 Oil and gas well drilling services 436 221 33 General corporate 916 - ---------------------------------------------------------------------- --------------------------------------------------------------------------- $ 11,420 $ 4,701 $ 2,738 $ 1,371 ================================================================================================================================================ Key operates a variety of oilfield service equipment including workover rigs, hot oil units, transports and various other oilfield servicing equipment. In addition, Key performs a variety of other oilfield services including fishing tools, frac tanks and blow-out preventers. - 38 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Oil and gas production is conducted by Odessa Exploration. Odessa Exploration acquires and manages interests in producing oil and gas properties for its own account and for its sponsored investors. The CompanyOdessa Exploration is engaged in the drilling and production of oil and natural gas in the United States. Odessa Exploration acquires producing oil and gas properties from major and independent producers. After acquisition, Odessa Exploration may either rework the acquired wellwells to increase production and/or form drilling partnerships for additional development wells. Oil and gas well drilling services are conducted by Clint Hurt Drilling. Clint Hurt Drilling operates six drilling rigs which drill for oil and gas in the West Texas area. 15.16. DERIVATIVE FINANCIAL INSTRUMENTS The Company utilizes derivative financial instruments to manage well-defined commodity price risks. The Company is exposed to credit losses in the event of nonperformance by the counterparties to its commodity hedges. The Company anticipates, however, that such counterparties will be able to fully satisfy their obligations under the contracts. The Company does not obtain collateral or other security to support financial instruments subject to credit risk but monitors the credit standing of the counterparties. The Company utilizes option contracts to hedge the effect of price changes on future oil and gas production. If market prices of oil and gas exceed the strike price of put options, the options will expire unexercised, therefore reducing the effective price received for oil and gas sales by the cost of the related option. As of June 30, 1996, Odessa Exploration had 6,000 Bbls of oil per month hedged with a strike price of $19.50 per Bbl., from the period of July 1, 1996 through December 31, 1996. Premiums paid for commodity options contracts are amortized to oil and gas sales over the terms of the agreements. Unamortized premiums of $91,789 and $0 are included in other current assets in the consolidated balance sheet at June 30, 1996 and 1997, respectively. Amounts receivable, if any, under commodity option contracts are accrued as an increase in oil and gas sales for the applicable periods. - 42 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 17. SUBSEQUENT EVENTS. Acquisitions Announced but not yet Completed after June 30, 1997 The following described acquisitions that have been announced but not yet completed after June 30, 1997 and are not included in the Company's results of operations for the twelve months ended June 30, 1997. BRW Drilling, Inc. On August 4, 1997, the Company announced it had signed a letter of intent to acquire BRW Drilling, Inc. ("BRW") for approximately $15.0 million in cash. BRW operates 7 drilling rigs and related equipment in the Permian Basin of West Texas. The closing of the BRW acquisition is expected upon negotiation of a definitive agreement, completion of the Company's standard due diligence and receipt of regulatory clearances, if any are required. Upon completion, the BRW acquisition will be combined with Clint Hurt's drilling operations in the Permian Basin of West Texas to form a thirteen rig shallow drilling operation. Frontier Well Service, Inc. On August 21, 1997, the Company announced a definitive agreement for the acquisition of Frontier Well Service, Inc. ("Frontier") for approximately $3.5 million in cash. Frontier operates 12 oilwell service rigs and related equipment in Wyoming. The closing of the Frontier acquisition is expected upon negotiation of a definitive agreement, completion of the Company's standard due diligence and receipt of regulatory clearances, if any are required. Dunbar Well Service, Inc. On August 4, 1997, the Company announced it had signed a letter of intent to acquire Dunbar Well Service, Inc. ("Dunbar") for approximately $11.8 million in cash. Dunbar operates 38 oilwell service rigs and related equipment in Wyoming. The closing of the Dunbar acquisition is expected upon negotiation of a definitive agreement, completion of the Company's standard due diligence and receipt of regulatory clearances, if any are required. J.W. Gibson Well Service Company On August 4, 1997, the Company announced a definitive agreement for the acquisition of J.W. Gibson Well Service Company ("Gibson") for cash, stock and warrants with an estimated value of approximately $25.0 million. Gibson operates 74 oilwell service rigs and related equipment in eight western states. The closing of the Gibson acquisition is expected in October 1997. The Company will manage the operations of Gibson during the interim period. The acquired Rocky Mountain operations of Gibson, together with the acquired Dunbar and Frontier operations, will operate as a separate subsidiary of Key Energy. Big A Well Service Co., Sunco Trucking Co. and Justis Supply Co. On July 21, 1997, the Company announced it had signed a letter of intent to acquire Big A Well Service Co., Sunco Trucking Co. and Justis Supply Co. (collectively, "Big A/Sunco") for cash and stock with an estimated value of approximately $31.0 million. Big A/Sunco operates 29 oilwell service rigs, four drilling rigs, 75 fluid hauling and other trucks, a machine shop/supply store and related equipment in the Four Corners region of the Southwestern United States. The closing of the Big A/Sunco acquisition is expected upon negotiation of a definitive agreement, completion of the Company's standard due diligence and receipt of regulatory clearances, if any are required. The acquired Big A/Sunco operations will operate as a separate subsidiary of Key Energy. - 43 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Acquisitions Completed after June 30, 1997 The following described acquisitions were completed after June 30, 1997 and are not included in the Company's results of operations for the twelve months ended June 30, 1997. Landmark Fishing & Rental, Inc. On September 16, 1997, the Company closed the acquisition of Landmark Fishing & Rental, Inc. ("Landmark") for approximately $3.3 million in cash. Landmark operates a rental tool business in Western Oklahoma and the Texas Panhandle. Landmark will be operated by WellTech Mid-Continent Division of WellTech Eastern. The operating results of Landmark will be included in the Company's results of operations effective September 16, 1997. Ram Oil Well Service, Inc. and Rowland Trucking Co., Inc. On September 1, 1997, the Company completed the acquisition of Ram Oil Well Service, Inc. and Rowland Trucking Co., Inc. ("Ram/Rowland") for $21.5 million in cash. Ram/Rowland operates approximately 17 oilwell service rigs, 93 fluid hauling and other trucks, 290 frac tanks, three disposal and brine wells, and dirt construction equipment in West Texas and Southeast New Mexico. Ram/Rowland will be operated by the Company's west Texas subsidiary: Yale E. Key, Inc. The operating results of Ram/Rowland will be included in the Company's results of operations effective September 1, 1997. Mosley Well Service, Inc. On August 22, 1997, the Company completed the acquisition of Mosley Well Service, Inc., ("Mosley") which operates in East Texas, Northern Louisiana and Arkansas. Mosley was acquired for approximately $16.2 million in cash and included thirty-six well service rigs and related equipment. Moseley will be integrated with the Brooks Division of WellTech Eastern. The operating results of Mosley will be included in the Company's results of operations effective September 1, 1997. Kenting Holdings (Argentina) S.A. On July 30, 1997, the Company completed the acquisition of the assets of Kenting Holdings (Argentina) S.A. ("Kenting") for $10.1 million in cash. The Kenting assets included six oilwell service rigs, three drilling rigs and related equipment in Argentina. The Kenting assets will be operated by Servicios. Patrick Well Service, Inc. On July 17, 1997, the Company completed the acquisition of the assets of Patrick Well Service, Inc. ("Patrick") for $7.0 million in cash. The Patrick assets included 29 oilwell service rigs and related equipment located in Southwest Kansas, Oklahoma and Southeast Colorado. The Patrick assets will be operated by the WellTech Mid-Continent Division of WellTech Eastern. - 44 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Servicios WellTech, S.A. Minority Interest Effective July 1, 1997, the Company purchased the remaining 37% interest in Servicios from two unrelated parties for $3.4 million in cash. As a result of the purchase, the Company will now own 100% of Servicios. Conversion of Convertible Subordinated Debentures As of September 11, 1997, $33,245,000 in principal amount of the Company's Debentures had converted into the Company's common stock. The conversion was at the option of the holders. The Debentures converted into 3,552,539 shares of the Company's common stock. The conversion included 188,488 shares, in addition to the conversion of shares at $9.75 per share. Such additional consideration will be accounted for as an increase to the Company's Equity. However, the proportional amount of debt issuance costs associated with the converted Debentures will be expensed as an extraordinary item in the period in which it occurs. 18. QUARTERLY RESULTS OF OPERATIONS (Unaudited) Summarized quarterly financial data for 1997 and 1996 are as follows:
First Second Third Fourth (in thousands, except per share amounts) Quarter Quarter Quarter Quarter - ----------------------------------------------------------------------------------------------------------------------------- 1997 Revenues . . . . . . . . . . . . . . . . . . . . . $31,462 $36,197 $43,050 $52,921 Earnings from operations . . . . . . . . . . . . . 2,396 3,022 3,563 5,621 Net earnings . . . . . . . . . . . . . . . . . . . 1,554 2,043 2,365 3,136 Earnings per share . . . . . . . . . . . . . . . . .14 .18 .19 .24 Weighted average common shares and equivalents outstanding. . . . . . . . . . . 10,894 11,634 12,572 13,294 1996 Revenues . . . . . . . . . . . . . . . . . . . . . $12,398 $12,394 $14,302 $27,384 Earnings from operations . . . . . . . . . . . . . 3,522 3,763 4,180 7,895 Net earnings . . . . . . . . . . . . . . . . . . . 726 768 827 1,265 Earnings per share . . . . . . . . . . . . . . . . .11 .11 .12 .16 Weighted average common shares and equivalents outstanding. . . . . . . . . . . 6,914 6,914 6,981 7,941
The fourth quarter of fiscal 1997 includes an adjustment of $2 million for previously unrecorded inventory. - 45 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 19. SUPPLEMENTAL INFORMATION ON OIL AND GAS ACTIVITIES (unaudited) CAPITALIZED COSTS: June 30, (in thousands) 1997 1996 1995 --------------------------------------------------------------- Oil and Gas Properties: Proved properties $ 23,402 $ 17,290 $ 7,652 UnprovenUnproved properties - - Less accumulated depletion (1,868) (1,364) (766) ---------------------------------------------------------------------------------------------------------------------------------------- Net capitalized costs $ 21,534 $ 15,926 $ 6,886 ======================================================================================================================================== COSTS INCURRED: June 30, (in thousands) 1997 1996 1995 1994 ------------------------------------------------------------------------------------------------------------------------------------------------- Proved property acquisition costs $ - $ 7,786 $ 1,054 $ 4,390 Development costs 8,188 1,848 2,581 40 ------------------------------------------------------------------------------------------------------------------------------------------------- Total Costs Incurredcosts incurred $ 8,188 $ 9,634 $ 3,635 $ 4,430 ================================================================================================================================================= RESULTS OF OPERATIONS: June 30, (in thousands) 1997 1996 1995 ------------------------------------------------------------------------- Oil and gas sales $ 6,975 $ 3,555 $ 1,793 $ 1,483 Production costs, including production taxes (3,030) (1,350) (756) (573) Depletion (835) (598) (398) (386) Income taxes * (1,057) (546) (217) (178) ------------------------------------------------------------------------- Results of operations for oil and gas producing activities ** $ 2,053 $ 1,061 $ 422 $ 346 ========================================================================= * - computed at the statutory rate of 34%35%. ** - excludes corporate overhead and financing costs. - 39 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Oil and Gas Reserve Information Estimates of Odessa Exploration's proved oil and gas reserves as of June 30, 1997, 1996 1995 and 19941995 were prepared by the Company and reviewed by an independent petroleum reservoir engineering firms. All estimatesfirm. Estimates were made in accordance with guidelines established by the Securities and Exchange Commission. Proved oil and gas reserves are the estimated quantities of crude oil and natural gas which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic conditions, i.e. prices and costs as of the date the estimate is made. Prices utilized reflect consideration of changes in existing prices provided by contractual arrangements, if any, but not of escalations based upon future conditions. The reserve estimates are presented utilizing an average oil price of $19.17$21.00 Bbl and an average natural gas price of $1.95$2.20 Mcf as of June 30, 1996.1997. - 47 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Proved developed oil and gas reserves are reserves that can be expected to be recovered through existing equipment and operating methods. Proved undeveloped oil and gas reserves are proved reserves that are expected to be recovered from new wells on undrilled acreage or from existing wells where a relatively major expenditure is required for recompletion or secondary or tertiary recovery. Reserves assigned to undrilled acreage are limited to those drilling units that offset productive units reasonably certain of production when drilled. No major discovery or other favorable or adverse event has occurred since July 1, 19961997 which is believed to have caused a significant change in the estimated proved oil and gas reserves of Odessa Exploration. Odessa Exploration's estimate of reserves has not been filed with or included in reports to any federal agency other than the Securities and Exchange Commission. Oil and gas reserve quantity estimates are subject to numerous uncertainties inherent in the estimation of quantities of proved reserves and in the projection of future rates of production and the timing of development expenditures. The accuracy of such estimates is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of subsequent drilling, testing and production may cause either upward or downward revision of previous estimates. Further, the volumes considered to be commercially recoverable fluctuate with changes in prices and operating costs. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries are more imprecise than those of currently producing oil and gas properties. Accordingly, these estimates are expected to change as additional information becomes available in the future. (continuedOil and Gas Producing Activities: Oil and Natural Condensate Gas (Bbls) (Mcf) Total Proved Reserves: Balance, June 30, 1994 114,908 6,785,661 ------------------------------------------------------------------------ Revisions of previous estimates 92,080 1,945,659 Purchases of minerals-in-place 1,515,559 6,036,937 Production (40,330) (770,197) Balance, June 30, 1995 1,682,217 13,998,060 ------------------------------------------------------------------------ Revisions of previous estimates 438,142 6,313,118 Purchases of minerals-in-place 3,162,099 16,456,993 Production (97,130) (1,026,577) Balance, June 30, 1996 5,185,328 35,741,594 ======================================================================== (table continued next page) - 4047 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Oil and Gas Producing Activities: Oil and Natural Condensate Gas (Bbls) (Mcf) ---------------------------------------------------------------- Total Proved Reserves: Balance, July 1, 1993: - - Purchases of minerals-in-place 129,291 7,338,452 Production (14,383) (552,791) ---------------------------------------------------------------- Balance, June 30, 1994 114,908 6,785,661 Revisions of previous estimates 92,080 1,945,659 Purchases of minerals-in-place 1,515,559 6,036,937 Production (40,330) (770,197) ---------------------------------------------------------------- Balance, June 30, 1995 1,682,217 13,998,060 Revisions of previous estimates 275,499 4,520,007 Discoveries and extensions 162,643 1,793,111 Purchases of minerals-in-place 3,162,099 16,456,993 Production (97,130) (1,026,577) ---------------------------------------------------------------- Balance, June 30, 1996 5,185,328 35,741,594 ================================================================ Proved Developed Reserves: June 30, 1994 114,908 6,785,661 ================================================================ June 30, 1995 750,604 11,203,232 ======================================================================================================================================== June 30, 1996 2,727,967 24,517,362 ======================================================================================================================================== Standardized Measure of Discounted Future Cash Flows The following schedules present estimates of the standardized measure of discounted future net cash flows from the Company's proved reserves as of June 30, 1996, and an analysis of the changes in these amounts for the years ended June 30, 1996 1995 and 1994.1995. June 30, 1997 information is not included, as during the current year oil and gas producing activities are no longer considered significant in accordance with reporting requirements under FAS 14 - Financial Reporting for Segments of a Business Enterprise. Estimated future cash flows are determined using year-end prices adjusted only for fixed and determinable increases for natural gas provided by contractual agreement (if any). Estimated future production and development costs are based on economic conditions at year-end. Future federal income taxes are computed by applying the statutory federal income tax rate of 34% to the difference between the future pretax net cash flows and the tax basis of proved oil and gas properties, after considering investment tax credits and net operating loss carry-forwards (if any), associated with these properties. Discounted future cash flow estimates like those shown below are not intended to represent estimates of the fair value of oil and gas properties. Estimates of fair value should also consider probable reserves, anticipated future oil and gas prices, interest rates, changes in development and production costs and risks associated with future production. Because of these and other considerations, any estimate of fair value is necessarily subjective and imprecise. - 41 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)(in thousands) June 30, (in thousands) 1996 June 30, 1995 ----------------------------------------------------------------------- Standardized Measure: Future cash inflows $171,000$ 171,000 $ 51,830 Future production costs (61,521) (11,852) Future development costs (15,495) (6,160) Future income taxes (12,092) (10,477) -----------------------------------------------------------------------_______________________________________________________________________ Future after-tax net cash flows 81,892 23,341 10% annual discount (42,188) (8,183) ----------------------------------------------------------------------------------------------------------------------------------------------- Standardized Measure $ 39,704 $ 15,158 =============================================================================================================================================== (table continued next page) - 48 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Changes in Standardized Measure: Standardized Measure, July 1, 1993 $ - Oil and gas sales, net of production costs (910) Purchases of minerals in place 6,030 Net change in income taxes (381) Accretion of discount - ------------------------------------------------------------- Standardized Measure, June 30, 1994 $ 4,739 Oil and gas sales, net of production costs (1,037) Purchases of minerals in place 13,033 Net change in income taxes (5,881) Accretion of discount 512 Revision of quantity estimates 1,745 Change in future development costs 1,227 Net change in sales prices 79 Changes in production rates (timing) and other 741 ------------------------------------------------------------------------------------------------------------------------------- Standardized Measure, June 30, 1995 $ 15,158 Oil and gas sales, net of production costs (2,205) Purchases of minerals in place 24,216 Net change in income taxes 75 Accretion of discount 2,142 Revision of quantity estimates 6,189 Change in future development costs (982) Extensions and discoveries 2,952 Net change in sales prices 1,397 Changes in production rates (timing) and other (9,238) ------------------------------------------------------------------------------------------------------------------------------- Standardized Measure, June 30, 1996 $ 39,704 ============================================================= - 42 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 16.================================================================== 20. CASH FLOW DISCLOSURES Supplemental cash flow disclosures for the years ended June 30, 1997, 1996 1995 and 19941995 are presented below: Year Ended June 30, (Thousands) 1997 1996 1995 1994 --------------------------------------------------------------------------- -------------------------------------------------------------------------------- Interest paid $ 5,850 $ 2,205 $ 1,422 $ 759$1,422 Taxes paid - 391 53 10 Supplemental schedule of non-cash investing and financing transactions for the years ended June 30, 1996 1995 and 19941995 are presented below: Year Ended June 30, (Thousands) 1996 1995 1994 ------------------------------------------------------------------------- Fair value of Common Stock issued for Odessa Exploration, Inc. $ - $ - $ 638 Assumption of Odessa Exploration, Inc. liabilities - - 2,752 Acquisition of Odessa Exploration, Inc. property and equipment - - 3,196-------------------------------------------------------------------------------- Fair value of Common Stock issued for Clint Hurt Drilling - 23 - Fair value of Common Stock and Warrants issued for WellTech West Texas - 8,647 - Capital lease obligation reduced for purchase of asset - 275 (table continued next page) - 49 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Proceeds on sale of assets not received - 132 - Property and equipment additions and acquisition costs not paid as of June 30th - 1,015 - Issuance of note payable in Clint Hurt Drilling acquisition - 725 - Fair value of Common Stock issued for WellTech, Inc. 17,729 -17,929 - Assumption of Welltech, Inc. workingWorking capital deficit 1,734 - - Assumption of Welltech, Inc. non-current liabilities and debt 27,570 - - Acquisition of WellTech, Inc. property and equipment and other assets 47,455 - Supplemental schedule of non-cash investing and financing transactions for the year ended June 30, 1997 is presented below:
Fair Value Acquisition of Issued Assumption of Assumption of of Property Acquisition Common Stock (1) Debt Liabilities and Equipment - -------------------------------------------------------------------------------------------------------------------------- Brownlee Well Service Inc. $ 672 $ 1,948 $ 3,558 $ 11,234 Woodward Well Service, Inc. 562 80 771 1,351 Brooks Well Servicing, Inc. 11,125 - 6,291 16,935 Hitwell Surveys, Inc. - 176 1,425 2,655 B&L Hotshot, Inc. - - 175 4,575 Energy Air Drilling Services Co. 50 150 - 700 Talon Trucking Co. - - - 2,700 Cobra Industries, Inc. 2,384 625 3,867 10,171 T.S.T Paraffin Service Co., Inc. - 70 3,599 10,035 Tri-State Wellhead & Valve, Inc. 1,000 - - 1,339 Kalkaska Construction Service, Inc. 1,112 - 1,187 10,711 Well-Co Oilwell Co. 4,048 599 11,337 28,463 Shreve's Well Service - - 50 600 Youngs Wireline - - 225 744 Phoenix Well Service - 410 1,761 3,897 Elder Well Service, Inc. - - 40 649 Diamond Well Service, Inc. - - - 675 Southwest Oilfield Services, Inc. - - - 455 Edco Well Service - - 50 460
(1) - - 43 - Key Energy Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 17. QUARTERLY RESULTS OF OPERATIONS (Unaudited) Summarized quarterly financial data for 1996 and 1995 are as follows: First Second Third Fourth Quarter Quarter Quarter Quarter (in thousands, except per share amounts) ---------------------------------------------------------------------------- 1996 Revenues . . . . . . . . . . $12,398 $12,394 $14,302 $27,384 Earnings from operations . . 3,522 3,763 4,180 7,895 Net earnings . . . . . . . . 726 768 827 1,265 Earnings per share . . . . . .11 .11 .12 .16 Weighted averageFair value of issued common stock represents number of common shares and equivalents outstanding 6,914 6,914 6,981 7,941 1995 Revenues . . . . . . . . . . $11,181 $10,781 $11,049 $11,678 Earnings from operations . . 2,645 2,683 3,083 3,485 Net earnings . . . . . . . . 519 492 631 536 Earnings per share . . . . . .09 .08 .10 .08 Weighted averageissued at the market value of Company's common shares and equivalents outstanding 6,091 6,500 6,637 6,647 18. DERIVATIVE FINANCIAL INSTRUMENTS The Company utilizes derivative financial instruments to manage well-defined commodity price risks. The Company is exposed to credit losses in the event of nonperformance by the counterparties to its commodity hedges. The Company anticipates, however, that such counterparties will be able to fully satisfy their obligations under the contracts. The Company does not obtain collateral or other security to support financial instruments subject to credit risk but monitors the credit standing of the counterparties. The Company utilizes option contracts to hedge the effect of price changes on future oil and gas production. If market prices of oil and gas exceed the strike price of put options, the options will expire unexercised, therefore reducing the effective price received for oil and gas sales by the cost of the related option. As of June 30, 1996, Odessa Exploration had 6,000 Bbls of oil per month hedged with a strike price of $19.50 per Bbl., for the period of July 1, 1996 through December 31, 1996. Premiums paid for commodity options contracts are amortized to oil and gas sales, over the terms of the agreements. Unamortized premiums of $91,789 are included in other current assets in the consolidated balance sheetstock at June 30, 1996. Amounts receivable, if any, under commodity option contracts are accrued as an increase in oil and gas sales for the applicable periods.acquisition date. - 4450 - Independent Auditors' Report To The Board of Directors and Stockholders Key Energy Group, Inc. We have audited the accompanying consolidated balance sheets of Key Energy Group, Inc. and Subsidiaries as of June 30, 19961997 and 1995,1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the three-year period ended June 30, 1996.1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements 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 misstatement. 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 consolidated financial position of Key Energy Group, Inc. and Subsidiaries as of June 30, 19961997 and 1995,1996, and the results of their operations and their cash flows for each of the three years in the three-year period ended June 30, 1996,1997, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Midland, Texas September 13, 1996 - 45 -August 28, 1997 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III. ITEMS 10 - 13. Pursuant to Instruction G(3) to Form 10-K, the information required in Items 10-13 is incorporated by reference from the Company's definitive proxy statement, which will be filed with the Commission pursuant to Regulation 14A within 120 days of June 30, 1996.1997. - 4652 - PART IV. TEMITEM 14. EXHIBITS FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K.10-K. (a) Reports on Form 8-K The Company filed a report on Form 8-K during the quarter ended June 30, 1996 which was dated June 28, 1996 relating to the private placement offering of the Company's convertible subordinated debentures. (b) Index to Exhibits The following exhibits have beendocuments are filed with the Securities and Exchange Commission:as part of this report: (1) See Index to Financial Statements set forth in Item 8. (2) Financial Statements Schedules: [None] (3) Exhibits: Exhibit 2.1 Agreement and Plan ofo f Merger dated as of November 18, 1995, between Key and WellTech, as amended. (Incorporated by reference to the Company's Registration Statement Form S-4, Registration No. 333-369)No.333-369). Exhibit 2.2 Joint Plan of Reorganization, dated as of October 20, 1992, of the Company, ESKEY Inc. andInc.and YFC International Finance N.V. and Order, dated December 4, 1992, of the United States Bankruptcy Court for the District of New Jersey, approving the Joint Plan of Reorganization (Incorporated by reference to Exhibits 2 (a) and 28 (a) of the Company's Report on Form 8-K dated December 14, 1992,File No.1-8038)No. 1-8038). Exhibit 2.3 Agreement and Plan of Merger dated as of July 20, 1993, by and among the Company, OEI Acquisition Corp. and Odessa Exploration Incorporated. (Incorporated by reference to Exhibit 2(a) of the Company's Report on Form 8-K dated September 2, 1993, File No. 1-8038). Exhibit 2.4 Asset Purchase Agreement dated as of December 10, 199310,1993 between the Company and WellTech, Inc. (Incorporated(Incorporated by reference to exhibit 2(a) of the Company's report on Formform 8-K dated August 17, 1974, 1984,File No. 1-8038). Exhibit 3.1 Amended and Restated Articles of Incorporation of the Company (Incorporated by reference to the Company's Registration Statement on Form S-4,Registration No. 333-369). Exhibit 3.2 Amended and Restated By-Laws of the Company (Incorporated by reference to the Company's Registration Statement on Form S-4 dated March 8, 1996,8,1996, Registration No. 333-369). Exhibit 4.1*4.1 7% Convertible Subordinated Debenture of the Company due July 1, 2003. (Incorporated by reference to exhibit 4.1 of the Company's Report on Form 10-K dated June 30, 1996, File No. 1-8038). Exhibit 4.2*4.2 Indenture for the 7% Convertible Subordinated Debenture of the Company due July 1, 2003.(Incorporated by reference to exhibit 4.2 of the Company's Report on Form 10-K dated June 30, 1996, File No. 1-8038). Exhibit 4.3*4.3 Registration Rights Agreement among the Company, McMahan Securities Co., L.P. and Rausher Pierce Refsnes, Inc., dated as of July 3, 1996. - 47 -(Incorporated by reference to exhibit 4.3 of the Company's Report on Form 10-K dated June 30, 1996, File No. 1-8038). Exhibit 4.4 Registration Rights Agreement between the Company and D. Kirk Edwards, dated as of July 20, 1993. (Incorporated(Incorporated by reference to Exhibit 10 (c)( c ) to the Company's Report on Form 8-K/A). - 53 - Exhibit 4.5 Registration Rights Agreement dated as of March 2, 1996 among the Company and certain of its stockholdersstockholders. (Incorporated by reference to the Company's Registration Statement on Form S-4,Registration No. 353-369). Exhibit 4.6 Registration Rights Agreement dated as of March 30, 1995 between the Company, Clint Hurt and Associates, Inc. and Clint HurtHurt. (Incorporated by reference to Exhibit 10(d)10 (d) of the Company's Report on Form 10-KSB dated June 30, 1995, File No. 1-8038). Exhibit 4.7 Form of Common Stock Purchase Warrant to Purchase Key Common Stock issued in connection with the WellTech Merger. (Incorporated by reference to the Company's Registration Statement on Form S-4, Registration No. 353-369). Exhibit 4.8 Common Stock Purchase Warrant to Purchase 75,000 shares of Key Common Stock issued to CIT Group/Credit Finance, Inc. (Incorporated(Incorporated by reference to the Company's Registration Statement on Form S-4, Registration No. 353-369). Exhibit 10.1 * Employment Agreement between the Company and D. Kirk Edwards, dated as of July 20, 1993. (Incorporated by reference to Exhibit 10 (b) to the Company's Report on Form 8-K/A).1, 1996. Exhibit 10.2 Asset Purchase Agreement dated as of March 30, 1995 between the Company and Clint Hurt and Associates, Inc. (Incorporated by reference to the Company's Report on Form 10-KSB dated June 30, 1995, File No. 1-8038)No.1-8038). Exhibit 10.3 Non-Competition Agreement dated as of March 30,3, 1995 between the Company, Clint Hurt and Associates,Inc. and Clint Hurt.(Incorporated by reference to Exhibit 10(f) of the Company's Report on Form 10-KSB dated June 30, 1995, File No. 1-8038). Exhibit 10.4*10.4 Employment Agreement between Welltech,WellTech Eastern, Inc. and Kenneth Hill, dated as of March 29, 1996.(Incorporated by reference to Exhibit 10.5*10.4 to the Company's Report on Form 10-K dated June 30, 1996, File No. 1-8038). Exhibit 10.5 * Employment Agreement between Welltech, Inc.the Company and Kenneth Huseman, dated as of March 29,August 3, 1996. Exhibit 10.6*10.6 Letter Agreement between Van Greenfield and the Company dated May 15, 1996. (Incorporated by reference to Exhibit 10.7*10.6 to the Company's Report on Form 10-K dated June 30, 1996, File No. 1-8038). Exhibit 10.7 Amendment No. 2 to the Company's Employment with Agreement between Francis D. John and the Company, dated as of May 15, 1996. ( Incorporated by reference to Exhibit 10.8*10.7 to the Company's Report on Form 10-K dated June 30, 1996, File No. 1-8038). Exhibit 10.8 Letter Agreement between Morton Wolkowitz and the Company dated June 3, 1996. - 48 -(Incorporated by reference to Exhibit 10.9* Third Amended and restated Loan and Security Agreement between The CIT Group/Credit Finance, Inc., Yale E. Key, Inc., Key Energy Drilling, Inc. d/b/a Clint Hurt Drilling, and Welltech Eastern, Inc.10.8 to the Company's Report on Form 10-K dated June 30, 1996, File No. 1-8038). Exhibit 10.10* Cross-Collaterization and Cross-Guaranty Agreement among The CIT Group/Credit Finance, Inc., Yale E. Key, Inc., Key Energy Drilling, Inc. d/b/a Clint Hurt Drilling, and Welltech Eastern, Inc. Exhibit 10.11* Guaranty Agreement among The CIT Group/Credit Finance, Inc., Yale E. Key, Inc., Key Energy Drilling, Inc. d/b/a Clint Hurt Drilling, and Welltech Eastern, Inc. Exhibit 10.12*10.9 Asset Purchase Agreement between Hardy Oil & Gas USA, Inc. and Arch Petroleum, Inc. dated as of April.April 1996. (Incorporated by reference to Exhibit 10.13*10.12 to the Company's Annual Report on Form 10-K dated June 30, 1996, File No. 1-8038). Exhibit 10.10 Asset Purchase Agreement between Arch Petroleum, Inc. toand Odessa Exploration, Inc. dated as of April 18, 1996. (Incorporated by reference to Exhibit 10.14*10.13 to the Company's Annual Report on Form 10-K dated June 30, 1996, File No. 1-8038). Exhibit 10.11 General Conveyance by Arch Petroleum, Inc. to Odessa Exploration, Inc. dated as of January 1, 1996.(Incorporated by reference to Exhibit 10.1510.14 to the Company's Annual Report on Form 10-K dated June 30,1996, File No. 1-8038). - 54 - Exhibit 10.12 The Company's 1995 Stock Option PlanPlan. ( Incorporated by reference to the Company's Registration Statement on Form S-4, Registration No. 353-369). Exhibit 10.13 The Company's Outside Directors Stock Option Plan. (Incorporated by reference to the Company's Registration Statement on Form S-4, Registration No. 353-369). Exhibit 10.14 Plan and Agreement of Merger among Key Energy Group, Inc., WellTech Eastern, Inc. and Woodward Well Service, Inc. dated as of September 30, 1996. (Incorporated by reference to Exhibit 10 (a) to the Company's Quarterly Report on Form 10-Q dated December 31, 1996, File No. 1-8038). Exhibit 10.15 Stock Purchase Agreement among Key Energy Group, Inc., Reo Brownlee, Elvin Brownlee, Jr. And Elvin Brownlee III dated as of October 24, 1996.(Incorporated by reference to Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q dated December 31, 1996, File No. 1-8038). Exhibit 10.16 TheAsset Purchase Agreement among Yale E. Key, Inc., Key Energy Group, Inc., Energy Air Drilling Service Co.and Dale Rennels dated as of November 1, 1996. (Incorporated by reference to Exhibit 10( c ) to the Company's Outside DirectorsQuarterly Report on Form 10-Q dated December 31, 1996, File No. 1-8038). Exhibit 10.17 Stock OptionPurchase Agreement among Key Energy Group, Inc., Ed Hitt, Helen Hitt, Michael E. Thompson and Edward Monroe, Jr. Dated as of December 2, 1996. (Incorporated by reference to Exhibit 10(d) to the Company's Quarterly Report on Form 10-Q dated December 31 1996, File No. 1-8038). Exhibit 10.18 Plan and Agreement of Merger among Key Energy Group, Inc., WellTech Eastern, Inc., Hunt Oil Company and Brooks Well Servicing, Inc. dated as of November 22, 1996. (Incorporated by reference to Exhibit 10(e) to the Company's Quarterly Report on Form 10-Q dated December 31, 1996, File No. 1-8038). Exhibit 10.19 Asset Purchase Agreement among WellTech Eastern, Inc., B&L Hotshot, Inc., McDowell & Sons, Inc., 4 Star Trucking, Inc., R.B.R. Inc., Royce D. Thomas, John F. McDowell and John R. McDowell dated as of December 13, 1996. (Incorporated by reference to Exhibit 10(f) to the Company's Quarterly Report on Form 10-Q dated December 31, 1996, File No. 1-8038). Exhibit 10.20 Asset Purchase Agreement among WellTech Eastern, Inc., Talon Trucking company and Lomak Petroleum, Inc.dated as of December 31, 1996. (Incorporated by reference to Exhibit 10(g) to the Company's Quarterly Report on Form 10-Q dated December 31, 1996, File No. 1-8038). Exhibit 10.21 First Supplemental Indenture dated as of November 20, 1996 by and between Key Energy Group, Inc. and American Stock Transfer & Trust Company, as Trustee. (Incorporated by reference to Exhibit 10(i) to the Company's Quarterly Report on Form 10-Q dated December 31, 1996, File No. 1-8038). Exhibit 10.22 Stock Purchase Agreement among Key Energy Group, Inc., Michael and Georgia McDermett dated as of January 10, 1997. (Incorporated by reference to Exhibit 10(a) to the Company's Quarterly Report onForm 10-Q dated March 31, 1997, File No. 1-8038). Exhibit 10.23 Asset Purchase Agreement among WellTech Eastern, Inc., Key Energy Group, Inc. Tri State Wellhead & Valve,Inc. and John C. Bozeman dated as of March 14, 1997. (Incorporated by reference to Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q dated March 31, 1997, File No. 1-8038). - 55 - Exhibit 10.24 Stock Purchase Agreement among Yale E. Key, Inc., Keith and Leslie Neill as of March 24, 1997.(Incorporated by reference to Exhibit 10( c ) to the Company's Quarterly Report on Form 10-Q dated March 31, 1997, File No. 1-8038). Exhibit 10.25 Asset Purchase Agreement among Key Energy Group, Inc., WellTech Eastern, Inc., Elder Well Service, Inc., Martha Elder, Kenneth L. Ward, Nona Faye Mugraur, Lela Gaye Biehl and Johnny Ray Johnson dated as of March 28, 1997.(Incorporated by reference to Exhibit 10(d) to the Company's Quarterly Report on Form 10-Q dated March 31, 1997, File No. 1-8038). Exhibit 10.26 Asset Purchase Agreement #1 among WellTech Eastern, Inc., Key Energy Group, Inc., Kalkaska Construction Service, Inc., Dennis Hogerheide, LaWenda Hogerheide, David Hogerheide and Derek Hogerheide dated March 31, 1997. (Incorporated by reference to Exhibit 10(e) to the Company's Quarterly Report on Form 10-Q dated March 31,1997, File No. 1-8038). Exhibit 10.27 Asset Purchase Agreement #2 among WellTech Eastern, Inc., Key Energy Group, Inc., Kalkaska Construction Service, Inc., Dennis Hogerheide,LaWenda Hogerheide, David Hogerheide and Derek Hogerheide dated March 31, 1997. (Incorporated by reference to Exhibit 10(f) to the Company's Quarterly Report on Form 10-Q dated March 31, 1997, File No. 1-8038). Exhibit 10.28 Stock Purchase Agreement among WellTech Eastern, Inc., Dennis Hogerheide and LaWenda Hogerheide dated as of March 31, 1997.(Incorporated by reference to Exhibit 10(g) to the Company's Quarterly Report on Form 10-Q dated March 31, 1997, File No. 1-8038). Exhibit 10.29 Asset Purchase Agreement among WellTech Eastern, Inc., Diamond Well Service, Inc., John Scott and Dwayne Wardwell dated as of April 3,1997. (Incorporated by reference to Exhibit 10(h) to the Company's Quarterly Report on Form 10-Q dated March 31, 1997, File No. 1-8038). Exhibit 10.30 Asset Sale Agreement among WellTech Eastern, Inc. and Drillers, Inc. dated as of April 14, 1997.(Incorporated by reference to Exhibit 10(i) to the Company's Quarterly Report on Form 10-Q dated March 31, 1997, File No. 1-8038). Exhibit 10.31 Asset Purchase Agreement among WellTech Eastern, Inc., Shreve's Well Service, Inc. and William A. Shreve dated April 18, 1997. (Incorporated by reference to Exhibit 10(j) to the Company's Quarterly Report on Form 10-Q dated March 31, 1997, File No. 1-8038). Exhibit 10.32 Asset Purchase Agreement among WellTech Eastern, Inc. and Petro Equipment, Inc. and Donald E. Clark dated as of May 1, 1997. (Incorporated by reference to Exhibit 10(k) to the Company's Quarterly Report on Form 10-Q dated March 31, 1997, File No. 1-8038). Exhibit10.33 * Asset Purchase Agreement among WellTech Eastern, Inc., Southwest Oilfield Services,Inc., David Wright and Roy Wofford dated May 29,1997. Exhibit 10.34 *Stock Purchase Agreement among Yale E. Key, Inc. and Raleigh K. Turn and David Butts dated June 9, 1997. Exhibit 10.35 Stock Purchase Agreement among Key Energy Group, Inc. and Mark Duane Massingill and Claudia Lynn Massingill dated as of June 25, 1997. (Incorporated by reference to the Company's Registration StatementReport on Form S-4, Registration8-K dated July 9, 1997, File No. 353-369)1-8038). - 56 - Exhibit 10.36 *Stock Purchase Agreement among WellTech Eastern, Inc. between Monty D. Elmore dated as of July 17, 1997.(Incorporated by reference to the Company's Report on Form 8-K dated July 9, 1997, File No. 1-8038). Exhibit 22*10.37 *Stock Purchase Agreement between WellTech Eastern, Inc. and Kenting Energy Services, Inc. dated as of July 30, 1997. Exhibit 10.38 *Stock Purchase Agreement between WellTech Eastern, Inc. and Robert E. Mosley, Jr. et al dated as of August 22, 1997. Exhibit 10.39 *Credit Agreement dated as of June 6, 1997 among Key Energy Group, Inc., several banks and other financial institutions or entities from time to time parties to the Agreement, PNC Bank, N.A,Norwest Bank of Texas, N.A., and Lehman Commercial Paper Inc. Exhibit 10.40 *Master Guarantee and Collateral Agreement made by Key Energy Group, Inc. and certain of its Subsidiaries in favor of Norwest Bank of Texas, N.A. dated as of June 6, 1997. Exhibit 11(a) *Statement - Computation of per share earnings. (Filed herewith as part of the Condensed Consolidated Financial Statements). Exhibit 22 *Subsidiaries of the Registrant. Exhibit 27*27(a) *Statement - Financial Data Schedule. ______________________________________ * Filed(Filed herewith as part of the Condensed Consolidated Financial Statements). (b) Reports on Form 8-K The Company did not file a report on Form 8-K during the quarter ended June 30, 1997. ------------------------------------ *Filed herewith. - 4957 - SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. KEY ENERGY GROUP, INC. (Registrant) By /s/ Francis D. John Francis D. John President, Chief Executive and ChiefOfficer Dated: September 25, 199618, 1997 and Director By /s/ Stephen E. McGregor Stephen E. McGregor Dated: September 18, 1997 Chief Financial Officer and Director Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. By /s/ Francis D. John Francis D. John President, Chief Executive and Chief Dated: September 25, 199618, 1997 Financial Officer and Director By /s/ Morton Wolkowitz Morton Wolkowitz Dated: September 25, 199618, 1997 Chairman of the Board and Director By /s/ Van Greenfield Van Greenfield Dated: September 25, 199618, 1997 Director By /s/ William Manly William Manly Dated: September 25, 199618, 1997 Director By /s/ Kevin P. Collins Kevin P. Collins Dated: September 25, 199618, 1997 Director By /s/ W. Phillip Marcum W. Phillip Marcum Dated: September 25, 199618, 1997 Director By /s/ Danny R. Evatt Danny R. Evatt Dated: September 25, 199618, 1997 Chief Accounting Officer - 5058 -