Key Energy Services (KEGX) 10-Q 2003 Q1 Quarterly report

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Key Energy Services, Inc. INDEX

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

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
o	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 SERVICES, INC.
(Exact name of registrant as specified in its charter)

Maryland	04-2648081
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
6 Desta Drive, Midland, Texas (Address of principal executive offices)	79705 (ZIP Code)
Registrant's telephone number including area code: (915) 620-0300

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

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act. Yes ý    No o

        Common Shares outstanding at May 14, 2003: 129,477,901

Key Energy Services, Inc.

INDEX

PART I. Financial Information
Item 1.	Financial Statements
		Consolidated Balance Sheets as of March 31, 2003 (unaudited) and December 31, 2002
		Unaudited Consolidated Statements of Operations for the Three Months Ended March 31, 2003 and 2002
		Unaudited Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2003 and 2002
		Unaudited Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2003 and 2002
		Notes to Consolidated Financial Statements
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Disclosure Controls and Procedures
PART II. Other Information
Item 1.	Legal Proceedings
Item 2.	Changes in Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
Signatures

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Key Energy Services, Inc.

Consolidated Balance Sheets

		March 31, 2003			December 31, 2002
		(Unaudited)
		(thousands, except share data)
ASSETS
Current assets:
	Cash and cash equivalents	$	3,562		$	9,044
	Accounts receivable, net of allowance for doubtful accounts of $4,768 and $4,439, at March 31, 2003 and December 31, 2002, respectively		151,534			141,958
	Inventories		11,684			10,243
	Prepaid expenses and other current assets		13,713			14,329
Total current assets			180,493			175,574
Property and equipment:
	Well servicing equipment		928,733			935,911
	Contract drilling equipment		129,510			128,199
	Motor vehicles		78,987			79,110
	Oil and natural gas properties and other related equipment, successful efforts method		48,365			48,362
	Furniture and equipment		53,853			51,349
	Buildings and land		49,274			48,922
Total property and equipment			1,288,722			1,291,853
Accumulated depreciation and depletion			(359,548	)		(335,348	)
Net property and equipment			929,174			956,505
Goodwill, net			337,746			322,270
Deferred costs, net			12,783			13,503
Notes and accounts receivable—related parties			322			251
Other assets			32,096			33,899
Total assets		$	1,492,614		$	1,502,002
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable	$	26,903		$	28,818
	Other accrued liabilities		59,768			57,823
	Accrued interest		5,466			15,226
	Current portion of long-term debt and capital lease obligations		6,637			7,008
Total current liabilities			98,774			108,875
Long-term debt, less current portion			479,300			472,336
Capital lease obligations, less current portion			13,132			14,221
Deferred revenue			7,590			8,460
Non-current accrued expenses			43,922			40,477
Deferred tax liability			150,688			161,265
Commitments and contingencies			—			—
Stockholders' equity:
	Common stock, $0.10 par value: 200,000,000 shares authorized, 128,887,088 and 128,757,963 shares issued at March 31, 2003 and December 31, 2002, respectively		12,899			12,876
	Additional paid-in capital		673,867			673,249
	Treasury stock, at cost: 416,666 shares at March 31, 2003 and December 31, 2002		(9,682	)		(9,682	)
	Accumulated other comprehensive loss		(41,458	)		(45,431	)
	Retained earnings		63,582			65,356
Total stockholders' equity			699,208			696,368
Total liabilities and stockholders' equity		$	1,492,614		$	1,502,002

See the accompanying notes which are an integral part of these consolidated financial statements.

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Key Energy Services, Inc.

Unaudited Consolidated Statements of Operations

			Three Months Ended March 31,
			2003			2002
			(thousands, except per share data)
REVENUES:
	Well servicing		$	197,600		$	154,062
	Contract well drilling			16,153			14,334
	Other			1,371			1,845
Total revenues				215,124			170,241
COSTS AND EXPENSES:
	Well servicing			146,110			113,032
	Contract drilling			11,943			11,392
	Depreciation, depletion and amortization			25,601			19,889
	General and administrative			22,118			13,694
	Interest			11,048			9,875
	Other expenses			915			951
	(Gain) loss on retirement of debt			(2	)		8,468
Total costs and expenses				217,733			177,301
Income (loss) before income taxes				(2,609	)		(7,060	)
Income tax benefit (expense)				835			2,434
NET INCOME (LOSS)			$	(1,774	)	$	(4,626	)
EARNINGS (LOSS) PER SHARE:
	Net income (loss)
		Basic	$	(0.01	)	$	(0.04	)
		Diluted	$	(0.01	)	$	(0.04	)
WEIGHTED AVERAGE SHARES OUTSTANDING:
		Basic		128,399			108,551
		Diluted		128,399			108,551

See the accompanying notes which are an integral part of these consolidated financial statements

4

Key Energy Services, Inc.

Unaudited Consolidated Statements of Cash Flows

			Three Months Ended March 31,
			2003			2002
			(thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
	Net loss		$	(1,774	)	$	(4,626	)
	Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
		Depreciation, depletion and amortization		25,601			19,889
		Amortization of deferred debt issuance costs, discount and premium		776			277
		Deferred income tax expense (benefit)		(895	)		3,076
		Loss on sale of assets		56			146
		(Gain) loss on retirement of debt		(2	)		8,468
	Change in assets and liabilities, net of effects from acquisitions:
		(Increase) decrease in accounts receivable		(10,113	)		23,848
		Decrease in other current assets		50			69
		Decrease in accounts payable, accrued interest and accrued expenses		(10,189	)		(14,963	)
		Other assets and liabilities		4,551			(6,298	)
	Net cash provided by operating activities			8,061			29,886
CASH FLOWS FROM INVESTING ACTIVITIES:
	Capital expenditures—well servicing			(15,693	)		(13,323	)
	Capital expenditures—contract drilling			(930	)		(3,126	)
	Capital expenditures—other			(2,595	)		(2,064	)
	Proceeds from sale of fixed assets			955			307
	Acquisitions—well servicing, net of cash acquired			(559	)		(8,202	)
	Net cash used in investing activities			(18,822	)		(26,408	)
CASH FLOWS FROM FINANCING ACTIVITIES:
	Repayment of long-term debt			(6,065	)		(123,782	)
	Repayment of capital lease obligations			(2,427	)		(2,732	)
	Proceeds from long-term debt			13,000			159,500
	Proceeds paid for debt issuance costs			—			(1,585	)
	Proceeds from exercise of stock options			631			194
	Other			(25	)		5
	Net cash provided by financing activities			5,114			31,600
	Effect of exchange rates on cash			165			(77	)
	Net increase (decrease) in cash and cash equivalents			(5,482	)		35,001
	Cash and cash equivalents at beginning of period			9,044			7,966
	Cash and cash equivalents at end of period			3,562		$	42,967

See the accompanying notes which are an integral part of these consolidated financial statements.

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Key Energy Services, Inc.

Unaudited Consolidated Statements of Comprehensive Income (Loss)

		Three Months Ended March 31,
		2003			2002
		(thousands)
NET LOSS		$	(1,774	)	$	(4,626	)
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
	Oil and natural gas derivatives adjustment, net of tax		(15	)		(459	)
	Amortization of oil and natural gas derivatives, net of tax		677			(323	)
	Foreign currency translation gain (loss), net of tax		3,311			(19,308	)
COMPREHENSIVE INCOME (LOSS), NET OF TAX		$	2,199		$	(24,716	)

See the accompanying notes which are an integral part of these consolidated financial statements.

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KEY ENERGY SERVICES, INC.

Notes to Consolidated Financial Statements

March 31, 2003 and 2002

1.    SUMMARY OF SIGNFICANT ACCOUNTING POLICIES

Basis of Presentation

        The consolidated financial statements of Key Energy Services, Inc. (the "Company", or "Key") and its wholly-owned subsidiaries as of March 31, 2003 and for the three month periods ended March 31, 2003 and 2002 are unaudited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in this Form 10-Q pursuant to the rules and regulations of the Securities and Exchange Commission. However, in the opinion of management, these interim financial statements include all the necessary adjustments to fairly present the results of the interim periods presented. These unaudited interim consolidated financial statements should be read in conjunction with the audited financial statements included in the Company's Transition Report on Form 10-K for the six months ended December 31, 2002. The results of operations for the three month period ended March 31, 2003 are not necessarily indicative of the results of operations for the full fiscal year ending December 31, 2003.

Reclassifications

        Certain reclassifications have been made to the consolidated financial statements for the three months ended March 31, 2002 to conform to the presentation for the three months ended March 31, 2003. The reclassifications consist primarily of gains (losses) on the retirement of debt which are now being recorded as operating expenses rather than as extraordinary items in accordance with SFAS 145, which the Company adopted on July 1, 2002 (See Note 11).

2.    ASSET RETIREMENT OBLIGATIONS—SFAS 143

        On July 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations ("SFAS 143"). The new standard requires the Company to recognize a liability for the present value of all legal obligations associated with the retirement of tangible long-lived assets and capitalize an equal amount as a cost of the asset depreciating the additional cost over the estimated useful life of the asset. At March 31, 2003 and December 31, 2002, the asset retirement obligation was $9,344,000 and $9,231,000, respectively, related to expected abandonment costs of its oil and natural gas producing properties and salt water disposal wells. The increase in the balance from December 31, 2002 of $113,000 is due to accretion of the discounted liability.

3.    GOODWILL AND OTHER INTANGIBLE ASSETS—SFAS 142

        The Company follows the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 142 eliminates the amortization for goodwill and other intangible assets with indefinite lives. Intangible assets with lives restricted by contractual, legal, or other means will continue to be amortized over their useful lives. Goodwill and other intangible assets not subject to amortization are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. SFAS 142 requires a two-step process for testing impairment. First, the fair value of each reporting unit is compared to its carrying value to determine whether an indication of impairment exists. If impairment is indicated, then the fair value of the reporting unit's goodwill is determined by allocating the unit's fair value to its assets and liabilities (including any unrecognized intangible assets) as if the reporting unit had been

7

acquired in a business combination. The amount of impairment for goodwill is measured as the excess of its carrying value over its fair value. The Company completed its most recent assessment of goodwill impairment as of June 30, 2002. The assessment did not result in an indication of goodwill impairment.

        Intangible assets subject to amortization under SFAS 142 consist of noncompete agreements and patents. Amortization expense for the noncompete agreements is calculated using the straight-line method over the period of the agreement, ranging from three to seven years. Amortization expense for patents is calculated using the straight-line method over the useful life of the patent, ranging from five to seven years.

        The gross carrying amount of noncompete agreements subject to amortization totaled approximately $15,274,000 and $18,669,000 at March 31, 2003 and December 31, 2002, respectively. Accumulated amortization related to these intangible assets totaled approximately $5,235,000 and $7,511,000 at March 31, 2003 and December 31, 2002, respectively. Amortization expense for the three months ended March 31, 2003 and 2002 was approximately $1,119,000 and $415,000, respectively. Amortization expense for the next five succeeding years is estimated to be approximately $3,582,000, $2,544,000, $1,950,000, $1,597,000 and $343,000.

        The gross carrying amount of patents subject to amortization totaled approximately $2,396,000 and $2,380,000 at March 31, 2003 and December 31, 2002, respectively. Accumulated amortization related to these intangible assets totaled approximately $248,000 and $160,000 as of March 31, 2003 and December 31, 2002, respectively. The Company acquired the patents on July 16, 2002. Amortization expense for the three months ended March 31, 2003 was approximately $88,000. Amortization expense for the next five succeeding years is estimated to be approximately $352,000, $352,000, $352,000, $352,000 and $303,000.

        The Company has identified its reporting segments to be well servicing and contract drilling. Net goodwill allocated to such reporting segments at March 31, 2003 is approximately $323,440,000 and $14,306,000, respectively, and at December 31, 2002 is approximately $307,987,000 and $14,283,000, respectively. The change in the carrying amount of goodwill for the three months ended March 31, 2003 of approximately $15,476,000 relates principally to goodwill from the Q Services acquisition (See Note 6) and the foreign currency translation adjustment for the Company's Argentina operations.

4.    EARNINGS PER SHARE

        The Company accounts for earnings per share based upon Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). Under SFAS 128, basic 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 period. Diluted earnings per common share is based on the increased number of shares that would be outstanding assuming exercise of dilutive

8

stock options and warrants and conversion of dilutive outstanding convertible securities using the "as if converted" method.

			Three Months Ended March 31,
			2003			2002
			(thousands, except per share data)
Basic EPS Computation:
	Numerator
		Net income (loss)	$	(1,774	)	$	(4,626	)
	Denominator
		Weighted average common shares outstanding		128,399			108,551
Basic EPS:
		Net income (loss)	$	(0.01	)	$	(0.04	)
Diluted EPS Computation:
	Numerator
		Net income (loss)	$	(1,774	)	$	(4,626	)
	Denominator
		Weighted average common shares outstanding:		128,399			108,551
Diluted EPS:
		Net income (loss)	$	(0.01	)	$	(0.04	)

        The diluted earnings per share calculations for the three months ended March 31, 2003 and 2002, excludes the effect of the potential exercise of the Company's convertible debt, outstanding warrants and stock options because the effects of such instruments on earnings per share would be anti-dilutive.

5.    STOCK-BASED COMPENSATION

        The Company accounts for stock option grants to employees using the intrinsic value method of accounting prescribed by APB Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." Under the Company's stock incentive plan, the price of the stock on the grant date is the same as the amount an employee must pay to exercise the option to acquire the stock; accordingly, the options have no intrinsic value at grant date, and in accordance with the provisions of APB 25, no compensation cost is recognized.

        Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation," sets forth alternative accounting and disclosure requirements for stock-based compensation arrangements. Companies may continue to follow the provisions of APB 25 to measure and recognize employee stock-based compensation; however, SFAS 123 requires disclosure of pro forma net income and earnings per share that would have been reported under the fair value based recognition provisions of SFAS 123. The following table illustrates the effect on net income and

9

earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation:

		Three Months Ended March 31,
		2003			2002
		(thousands, except per share data)
Net income (loss):
	As reported	$	(1,774	)	$	(4,626	)
	Deduct: Total stock-based employee compensation     expense determined under fair value based method     for all awards, net of tax		(2,313	)		(3,362	)
	Pro forma	$	(4,087	)	$	(7,988	)
Basic earnings per share:
	As reported	$	(0.01	)	$	(0.04	)
	Pro forma	$	(0.03	)	$	(0.07	)
Diluted earnings per share:
	As reported	$	(0.01	)	$	(0.04	)
	Pro forma	$	(0.03	)	$	(0.07	)

6.    Q SERVICES ACQUISITION

        On July 19, 2002, the Company acquired Q Services, Inc. ("QSI") pursuant to an Agreement and Plan of Merger dated May 13, 2002, as amended, by and among the Company, Key Merger Sub, Inc. and QSI. As consideration for the acquisition, the Company issued approximately 17.1 million shares of its common stock to the QSI shareholders and paid approximately $94.2 million in cash at the closing to retire debt and preferred stock of QSI and to satisfy certain other obligations of QSI. In addition to assuming the positive working capital of QSI, the Company incurred other direct acquisition costs and assumed certain other liabilities of QSI, resulting in the Company recording an aggregate purchase price of approximately $250 million. The value of the shares issued was based on the closing price of the Company's common stock on the closing date of $8.75 per share. The results of QSI's operations have been included in the consolidated financial statements since the closing date. Prior to the acquisition, QSI was a privately held corporation conducting field production, pressure pumping, and other service operations in Louisiana, New Mexico, Oklahoma, Texas, and the Gulf of Mexico. The Company and QSI operate in adjacent and or overlapping locations and expect to realize future cost savings and synergies in connection with the merger.

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        The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition:

		At July 19, 2002
		(Thousands)
Current assets		$	37,734
Property and equipment			114,519
Intangible assets			3,242
Other assets			344
Goodwill			134,567
	Total assets acquired		290,406
Current liabilities			17,213
Capital lease obligations			77
Non-current accrued expenses			17,908
Deferred tax liability			5,158
	Total liabilities assumed		40,356
Net assets acquired		$	250,050

        The $3,242,000 of intangible assets consists of noncompete agreements which have a weighted-average useful life of approximately two years. The $134,567,000 of goodwill was allocated to the well servicing reporting segment. Of that amount $11,645,000 is expected to be deductible for income taxes.

        During the three months ended March 31, 2003, the Company recorded an adjustment of approximately $25 million to reduce the cost allocated to certain equipment in the preliminary purchase price allocation. The adjustment was based on a preliminary independent third party appraisal of the estimated fair value of the equipment as of the July 2002 acquisition date. The purchase price allocation process will be completed during the quarter ended June 30, 2003 upon receipt of the final appraisal.

        The following unaudited pro forma results of operations have been prepared as though QSI had been acquired on January 1, 2002. Pro forma amounts are not necessarily indicative of the results that may be reported in the future.

	Three Months Ended March 31, 2002
	(thousands, except per share data)
Revenues	$	209,268
Net income (loss)		(3,140	)
Basic earnings (loss) per share	$	(0.02	)

7.    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, results of operations or cash flows of the Company.

8.    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 counter-parties

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to its commodity hedges. The Company only deals with reputable financial institutions as counter-parties and anticipates that such counter-parties 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 counter-parties.

        The Company periodically hedges a portion of its oil and natural gas production through collar and option agreements. The purpose of the hedges is to provide a measure of stability in the volatile environment of oil and natural gas prices and to manage exposure to commodity price risk under existing sales commitments. The Company's risk management objective is to lock in a range of pricing for expected production volumes. This allows the Company to forecast future cash flows within a predictable range. The Company meets this objective by entering into collar and option arrangements which allow for acceptable cap and floor prices. The Company desires a measure of stability to ensure that cash flows do not fall below a certain level.

        The Company does not enter into derivative instruments for any purpose other than for economic hedging. The Company does not speculate using derivative instruments. The Company has identified the following derivative instruments:

        Freestanding Derivatives.    On May 25, 2001, the Company entered into an option arrangement for a 12-month period beginning March 2002 whereby the counter-party will pay if the oil and natural gas prices should fall below the floor index. On May 2, 2002, the Company entered into an option arrangement for a 12-month period beginning March 2003 whereby the counter-party will pay if the oil price should fall below the floor index.

        The Company did not document the May 25, 2001 and May 2, 2002 oil and natural gas options as cash flow hedges until July 1, 2001 and July 1, 2002, respectively. The Company recorded a net decrease in derivative assets of approximately $17,000 and $179,000 during the three months ended March 31, 2003 and 2002, respectively. The Company recorded no ineffectiveness for the three months ended March 31, 2003 and an earnings charge of approximately $9,000 for the three months ended March 31, 2002.

        The following table sets forth the future volumes hedged by year and the weighted-average strike price of the option contracts at March 31, 2003 and 2002:

		Monthly Income			Strike Price Per Bbl/MMbtu
		Oil (Bbls)	Gas (MMbtu)
				Term	Floor		Cap	Fair Value
At March 31, 2003
	Oil Put	4,000	—	Mar 2003-Feb 2004	$	21.00	—	$	17,000
At March 31, 2002
	Oil Put	5,000	—	Mar 2002-Feb 2003	$	22.00	—	$	46,000
	Natural Gas Put	—	75,000	Mar 2002-Feb 2003	$	3.00	—	$	131,000

        (The strike prices for the oil puts are based on the NYMEX spot price for West Texas Intermediate; the strike price for the natural gas put is based on the Inside FERC-El Paso Permian spot price.)

9.    BUSINESS SEGMENT INFORMATION

        The Company's reportable business segments are well servicing and contract drilling. Oil and natural gas production operations are presented in "Corporate/Other".

        Well Servicing:    The Company's operations provide well servicing (ongoing maintenance of existing oil and natural gas wells), workover (major repairs or modifications necessary to optimize the level of

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production from existing oil and natural gas wells) and production services (fluid hauling and fluid storage tank rental, fishing and rental tool services and pressure pumping services).

        Contract Drilling:    The Company provides contract drilling services for major and independent oil companies onshore the continental United States, Argentina and Ontario, Canada.

        The Company's management evaluates the performance of its operating segments based on net income and operating profits (revenues less direct operating expenses). Corporate expenses include general corporate expenses associated with managing all reportable operating segments. Corporate assets consist principally of cash and cash equivalents, deferred debt financing costs and deferred income tax assets.

	Well Servicing		Contract Drilling			Corporate / Other			Total
Three Months Ended March 31, 2003
Operating revenues	$	197,600	$	16,153		$	1,371		$	215,124
Operating profit		51,490		4,210			456			56,156
Depreciation, depletion and amortization		21,550		2,563			1,488			25,601
Interest expense		184		—			10,864			11,048
Net income (loss)*		10,209		49			(12,032	)		(1,774	)
Identifiable assets		808,457		89,370			257,041			1,154,868
Capital expenditures (excluding acquisitions)		15,693		930			2,595			19,218
Three Months Ended March 31, 2002
Operating revenues	$	154,062	$	14,334		$	1,845		$	170,241
Operating profit		41,030		2,942			894			44,866
Depreciation, depletion and amortization		16,453		2,351			1,085			19,889
Interest expense		256		—			9,619			9,875
Net income (loss)*		6,468		(1,070	)		(10,024	)		(4,626	)
Identifiable assets		679,256		89,795			262,569			1,031,620
Capital expenditures (excluding acquisitions)		13,323		3,126			2,064			18,513

*

Net income (loss) for the contract drilling segment includes a portion of well servicing general and administrative expenses allocated on a percentage of revenue basis.

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        Operating revenues for the Company's foreign operations for the three months ended March 31, 2003 and 2002 were $9.6 million and $4.0 million, respectively. Operating profits for the Company's foreign operations for the three months ended March 31, 2003 and 2002 were $4.4 million and $0.7 million, respectively. The Company had $56.2 million and $31.6 million of identifiable assets as of March 31, 2003 and 2002, respectively, related to foreign operations.

10.    CONDENSED CONSOLIDATING FINANCIAL INFORMATION

        The Company's senior notes are guaranteed by all of the Company's subsidiaries (except for its foreign subsidiaries operating in Argentina and Canada), all of which are wholly-owned. The guarantees are joint and several, full, complete and unconditional. There are currently no restrictions on the ability of the subsidiary guarantors to transfer funds to the parent company.

        The accompanying condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 "Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered." The information is not intended to present the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with accounting principles generally accepted in the United States of America.

CONDENSED CONSOLIDATING BALANCE SHEET

		March 31, 2003
		Parent Company		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Consolidated
		(thousands)
Assets:
	Current assets	$	11,263	$	153,648	$	15,582	$	—		$	180,493
	Net property and equipment		45,026		862,493		21,655		—			929,174
	Goodwill, net		3,431		333,602		713		—			337,746
	Deferred costs, net		12,783		—		—		—			12,783
	Inter-company receivables		742,567		—		—		(742,567	)		—
	Other assets		19,220		13,198		—		—			32,418
Total assets		$	834,290	$	1,362,941	$	37,950	$	(742,567	)	$	1,492,614
Liabilities and equity:
	Current liabilities	$	35,670	$	59,277	$	3,827	$	—		$	98,774
	Long-term debt		479,300		—		—		—			479,300
	Capital lease obligations		1,671		11,461		—		—			13,132
	Inter-company payables		—		721,868		20,699		(742,567	)		—
	Deferred tax liability		150,688		—		—		—			150,688
	Other long-term liabilities		19,483		31,933		96		—			51,512
	Stockholders' equity		147,478		538,402		13,328		—			699,208
Total liabilities and stockholders' equity		$	834,290	$	1,362,941	$	37,950	$	(742,567	)	$	1,492,614

14

CONDENSED CONSOLIDATING BALANCE SHEET

		December 31, 2002
		Parent Company		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Consolidated
		(thousands)
Assets:
	Current assets	$	17,716	$	143,579	$	14,279	$	—		$	175,574
	Net property and equipment		43,134		893,775		19,596		—			956,505
	Goodwill, net		3,431		318,208		631		—			322,270
	Deferred costs, net		13,503		—		—		—			13,503
	Inter-company receivables		760,990		—		—		(760,990	)		—
	Other assets		19,687		14,463		—		—			34,150
Total assets		$	858,461	$	1,370,025	$	34,506	$	(760,990	)	$	1,502,002
Liabilities and equity:
	Current liabilities	$	50,644	$	54,528	$	3,703	$	—		$	108,875
	Long-term debt		472,336		—		—		—			472,336
	Capital lease obligations		1,648		12,573		—		—			14,221
	Inter-company payables		—		739,842		21,148		(760,990	)		—
	Deferred tax liability		161,265		—		—		—			161,265
	Other long-term liabilities		28,530		20,314		93		—			48,937
	Stockholders' equity		144,038		542,768		9,562		—			696,368
Total liabilities and stockholders' equity		$	858,461	$	1,370,025	$	34,506	$	(760,990	)	$	1,502,002

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

		Three Months Ended March 31, 2003
		Parent Company			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Consolidated
		(thousands)
Revenues		$	68		$	209,084		$	5,972		$	—	$	215,124
Costs and expenses:
	Direct expenses		—			154,578			4,390			—		158,968
	Depreciation, depletion and amortization expense		915			24,188			498			—		25,601
	General and administrative expense		8,763			12,911			444			—		22,118
	Interest		10,864			145			39			—		11,048
	Gain on retirement of debt		(2	)		—			—			—		(2	)
Total costs and expenses			20,540			191,822			5,371			—		217,733
Income (loss) before income taxes			(20,472	)		17,262			601			—		(2,609	)
Income tax (expense) benefit			6,552			(5,525	)		(192	)		—		835
Net income (loss)		$	(13,920	)	$	11,737		$	409		$	—	$	(1,774	)

15

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

		Three Months Ended March 31, 2002
		Parent Company			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Consolidated
		(thousands)
Revenues		$	310		$	165,899		$	4,032		$	—	$	170,241
Costs and expenses:
	Direct expenses		—			122,005			3,370			—		125,375
	Depreciation, depletion and amortization expense		464			18,811			614			—		19,889
	General and administrative expense		5,526			7,725			443			—		13,694
	Interest		9,619			276			(20	)		—		9,875
	Loss on retirement of debt		8,468			—			—			—		8,468
Total costs and expenses			24,077			148,817			4,407			—		177,301
Income (loss) before income taxes			(23,767	)		17,082			(375	)		—		(7,060	)
Income tax (expense) benefit			8,195			(5,890	)		129			—		2,434
Net income (loss)		$	(15,572	)	$	11,192		$	(246	)	$	—	$	(4,626	)

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

	Three Months Ended March 31, 2003
	Parent Company			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Consolidated
	(thousands)
Net cash provided (used) by operating activities	$	(10,684	)	$	16,174		$	2,571		$	—	$	8,061
Net cash provided (used) in investing activities		(3,071	)		(14,445	)		(1,306	)		—		(18,822	)
Net cash provided (used) in financing activities		7,301			(2,187	)		—			—		5,114
Effect of exchange rate changes on cash		—			—			165			—		165
Net increase (decrease) in cash		(6,454	)		102			870			—		(5,482	)
Cash at beginning of period		5,183			908			2,953			—		9,044
Cash at end of period	$	(1,271	)	$	1,010			3,823		$	—	$	3,562

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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

	Three Months Ended March 31, 2002
	Parent Company			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Consolidated
	(thousands)
Net cash provided (used) by operating activities	$	11,408		$	16,179		$	2,299		$	—	$	29,886
Net cash provided (used) in investing activities		(11,062	)		(12,781	)		(2,565	)		—		(26,408	)
Net cash provided (used) in financing activities		34,111	)		(2,511	)		—			—		31,600
Effect of exchange rate changes on cash		—			—			(77	)		—		(77	)
Net increase (decrease) in cash		34,457			887			(343	)		—		35,001
Cash at beginning of period		2,507			3,776			1,683			—		7,966
Cash at end of period	$	36,964		$	4,663			1,340		$	—	$	42,967

11.    GAINS (LOSSES) ON RETIREMENT OF DEBT—SFAS 145

        On July 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). The provisions of SFAS 145, which are currently applicable to the Company, rescind Statement No. 4, which required all gains and losses from extinguishment of debt to be aggregated and classified as an extraordinary item, and instead requires that such gains and losses be reported in operating income. The Company now records gains and losses from the extinguishment of debt in operating income and has reclassified such gains and losses in the financial statements for the three months ended March 31, 2002 to conform to the presentation for the three months ended March 31, 2003.

12.    SUBSEQUENT EVENT—SENIOR NOTES OFFERING

        On May 14, 2003, the Company completed a public offering of $150,000,000 of its 6³/8% Senior Notes due 2013. The cash proceeds from the debt offering, net of fees and expenses, will be used to repay the balance of the revolving loan facility then outstanding under the Company's senior credit facility, with the remainder to be used for general corporate purposes, including further debt retirement.

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

NOTE REGARDING FORWARD—LOOKING STATEMENTS

        The statements in this document that relate to matters that are not historical facts are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this document and the documents incorporated by reference, words such as "anticipate," "believe," "expect," "plan," "intend," "estimate," "project," "will," "could," "may," "predict" and similar expressions are intended to identify forward-looking statements. Further events and actual results may differ materially from the results set forth in or implied in the forward-looking statements. Factors that might cause such a difference include:

•

fluctuations in world-wide prices and demand for oil and natural gas;



•

fluctuations in level of oil and natural gas exploration and development activities;



•

fluctuations in the demand for well servicing, contract drilling and ancillary oilfield services;



•

the existence of competitors, technological changes and developments in the industry;



•

the existence of operating risks inherent in the well servicing, contract drilling and ancillary oilfield services; and



•

general economic conditions, the existence of regulatory uncertainties, and the possibility of political instability in any of the countries in which Key does business, in addition to other matters discussed herein.

        These forward looking-statements speak only as of the date of this report and Key disclaims any duty or obligation to update the forward looking statement in this report.

        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 consolidated financial statements and related notes appearing elsewhere in this report. As used in this Item 2, references to composite well servicing rig rates means, for a given period, the total well servicing revenues for that period divided by the total well servicing hours for that period. As used in this Item 2, references to composite contract drilling rig rates means, for a given period, the total contract drilling revenues for that period divided by the total contract drilling hours for that period. As used in this Item 2, references to composite truck rates means, for a given period, the total trucking revenues for that period divided by the total trucking hours for that period.

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RESULTS OF OPERATIONS

        The Company's results of operations for the first quarter of fiscal 2003 reflect the impact of continued improvement in industry conditions resulting from continued strength in natural gas prices.

THREE MONTHS ENDED MARCH 31, 2003 VERSUS THREE MONTHS ENDED MARCH 31, 2002

        The Company's revenue for the three months ended March 31, 2003 increased $44,883,000, or 26%, to $215,124,000 from $170,241,000 for the three months ended March 31, 2002. For the three months ended March 31, 2003, the Company incurred a net loss of $1,774,000, an improvement of $2,852,000, or 62%, from a net loss of $4,626,000 for the three months ended March 31, 2002. The increase in revenues and decrease in net loss is principally due to increasing levels of activity and the acquisition of QSI, partially offset by lower composite truck rates and inclement weather in the form of heavy ice and snow storms during the last two weeks of February and early March. Overall rig hours for the three months ended March 31, 2003 increased approximately 7% compared to overall rig hours for the three months ended March 31, 2002. Trucking hours for the three months ended March 31, 2003 increased 51% compared to trucking hours for the three months ended March 31, 2002 principally due to the acquisition of QSI and improved activity levels. However, composite truck rates for the three months ended March 31, 2003 declined approximately 7% compared to composite truck rates for the three months ended March 31, 2002. Contributing to the net loss for the three months ended March 31, 2003, were costs of approximately $1,100,000 associated with the closure of two of the Company's pressure pumping facilities and additional repair and maintenance costs incurred by the Company as it took advantage of weather-related downtime.

Operating Revenues

        Well Servicing.    Well servicing revenues for the three months ended March 31, 2003 increased $43,538,000, or 28%, to $197,600,000 from $154,062,000 for the three months ended March 31, 2002. The increase in revenues was primarily due to an increase in activity and the acquisition of QSI partially offset by declines in composite truck rates. Well servicing hours for the three months ended March 31, 2003 increased 7% compared to well servicing hours for the three months ended March 31, 2002, while composite well servicing rig rates declined by approximately 1% for the three months ended March 31, 2003 compared to well servicing rig rates for the three months ended March 31, 2002. While trucking hours for the three months ended March 31, 2003 increased approximately 51% compared to trucking hours for the three months ended March 31, 2002, composite truck rates for the three months ended March 31, 2003 decreased by approximately 7% compared to composite truck rates for the three months ended March 31, 2002.

        Contract Drilling.    Contract drilling revenues for the three months ended March 31, 2003 increased $1,819,000, or 13%, to $16,153,000 from $14,334,000 for the three months ended March 31, 2002. The increase in revenues was primarily due to an increase in composite contract drilling rig rates and a slight improvement in contract drilling hours. Contract drilling hours for the three months ended March 31, 2003 increased 2% compared to contract drilling hours for the three months ended March 31, 2002, while composite contract drilling rig rates for the three months ended March 31, 2003 increased by approximately 10% for the three months ended March 31, 2003 compared to composite contract drilling rig rates for the three months ended March 31, 2002.

Operating Expenses

        Well Servicing.    Well servicing expenses for the three months ended March 31, 2003 increased $33,078,000, or 29%, to $146,110,000 from $113,032,000 for the three months ended March 31, 2002. The increase was primarily due to increased levels of activity and related repair and maintenance costs, the acquisition of QSI and higher insurance costs, primarily in workers' compensation. Well servicing

19

expenses, as a percentage of well servicing revenue, increased from 73% for the three months ended March 31, 2002 to 74% for the three months ended March 31, 2003.

        Contract Drilling.    Contract drilling expenses for the three months ended March 31, 2003 increased $551,000, or 5%, to $11,943,000 from $11,392,000 for the three months ended March 31, 2002. The increase was primarily due to increased levels of activity and related repair and maintenance costs and higher insurance costs primarily in workers' compensation. Contract drilling expenses, as a percentage of contract drilling revenues, decreased from 79% for the three months ended March 31, 2002 to 74% for the three months ended March 31, 2003.

Depreciation, Depletion and Amortization Expense

        The Company's depreciation, depletion and amortization expense for the three months ended March 31, 2003 increased $5,712,000, or 29%, to $25,601,000 from $19,889,000 for the three months ended March 31, 2002. The increase is primarily due to the acquisition of QSI, which added approximately $117,761,000 in net depreciable assets and to a lesser extent by the Company's ongoing capital expenditure program, which includes remanufacturing of well service and contract drilling equipment and the Company's technology initiative.

General and Administrative Expenses

        The Company's general and administrative expenses for the three months ended March 31, 2003 increased $8,424,000, or 62%, to $22,118,000 from $13,694,000 for the three months ended March 31, 2002. The increase was primarily due to the acquisition of QSI, consolidation and severance costs associated with the closure of two of the Company's pressure pumping facilities and relocation of related equipment to higher margin locations, and increases in personnel supporting the implementation of information technology initiatives. General and administrative expenses, as a percentage of revenues, increased from 8% for the three months ended March 31, 2002 to 10% for the three months ended March 31, 2003.

Interest Expense

        The Company's interest expense for the three months ended March 31, 2003 increased $1,173,000, or 12%, to $11,048,000 from $9,875,000 for the three months ended March 31, 2002. The increase was primarily due to higher average long term debt in the quarter ended March 31, 2003 as compared to March 31, 2002 resulting from the borrowing under the revolver related to the QSI acquisition. Included in interest expense was the amortization of deferred debt issuance costs, discount and premium of approximately $776,000 and $277,000 for the three months ended March 31, 2003 and 2002, respectively.

Gain (Loss) on Retirement of Debt

        During the three months ended March 31, 2003, the Company repurchased approximately $55,000 of its long-term debt at a discount, which resulted in a gain of $2,000. During the three months ended March 31, 2002, the Company repurchased approximately $35,518,000 of its long-term debt at a premium and expensed related debt issuance costs which resulted in a loss of $8,468,000. On July 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). The new standard rescinds Statement No. 4, which required all gains and losses from extinguishment of debt to be recorded as extraordinary items.

20

Income Taxes

        The Company's income tax benefit for the three months ended March 31, 2003 decreased $1,599,000 to a benefit of $835,000 from a benefit of $2,434,000 for the three months ended March 31, 2002. The Company's effective tax rate for the three months ended March 31, 2003 and 2002 was 32% and 34%, respectively. The effective tax rates are different from the statutory rate of 35% because of non-deductible expenses and the effects of state and local taxes.

Cash Flows

        The Company's net cash provided by operating activities for the three months ended March 31, 2003 decreased $21,825,000 to $8,061,000 from $29,886,000 for the three months ended March 31, 2002. The decrease was primarily due to the increase in accounts receivable from the three months ended March 31, 2002 compared to the three months ended March 31, 2003 resulting from increased activity levels.

        The Company's net cash used in investing activities for the three months ended March 31, 2003 decreased $7,586,000 to $18,822,000 from $26,408,000 for the three months ended March 31, 2002. The decrease from the three months ended March 31, 2002 compared to the three months ended March 31, 2003 was due to the completion of several minor acquisitions during the three months ended March 31, 2002 and minimal acquisition activity in the three months ended March 31, 2003.

        The Company's net cash provided by financing activities for the three months ended March 31, 2003 decreased $26,486,000 to $5,114,000 from $31,600,000 for the three months ended March 31, 2002. During the three months ended March 31, 2003, there was minimal debt principal activity as compared to the three months ended March 31, 2002. During the three months ended March 31, 2002, the Company repurchased approximately $35,403,000 of its 14% Senior Subordinated Notes using the net proceeds from the Company's December 2001 equity offering and repaid approximately $45 million in borrowings under its revolver using proceeds from the Company's March 2002 senior notes offering.

        The effect of exchange rates on cash for the three months ended March 31, 2003 and 2002 was a source of $165,000 and a use of $77,000, respectively. This was principally the result of the change in exchange rates of the Argentine peso for the corresponding periods.

LIQUIDITY AND CAPITAL RESOURCES

        The Company has historically funded its operations, acquisitions, capital expenditures and working capital requirements from cash flow from operations, bank borrowings and the issuance of equity and long-term debt. The Company believes that its current reserves of cash and cash equivalents, availability of its existing credit lines, access to capital markets and internally generated cash flows from operations are sufficient to finance the cash requirements of its current cash and future operations, acquisitions and capital expenditures.

LONG-TERM DEBT

        Other than capital lease obligations and miscellaneous notes payable, as of March 31, 2003, the Company's long-term debt was comprised of (i) a senior credit facility, (ii) a series of 8³/8% Senior Notes Due 2008, (iii) a series of 14% Senior Subordinated Notes Due 2009, and (iv) a series of 5% Convertible Subordinated Notes Due 2004.

Senior Credit Facility

        On July 15, 2002, the Company entered into a Third Amended and Restated Credit Agreement, as subsequently amended (the "Senior Credit Facility"). The Senior Credit Facility consists of a $150,000,000 revolving loan facility with a $75,000,000 sublimit for letters of credit. The loans are

21

secured by most of the tangible and intangible assets of the Company. The revolving loan commitment will terminate on July 15, 2005 and all revolving loans must be paid on or before that date. The revolving loans bear interest based upon, at the Company's option, the prime rate plus a variable margin of 0.00% to 1.00% or a Eurodollar rate plus a variable margin of 1.75% to 3.00%. The Senior Credit Facility has customary affirmative and negative covenants including a maximum leverage ratio, a minimum fixed charge coverage ratio and a minimum net worth, as well as limitations on liens and indebtedness and restrictions on dividends, acquisitions and dispositions. As of March 31, 2003, the Company was in compliance with all covenants contained in the Senior Credit Facility.

        As of March 31, 2003, approximately $59,000,000 was outstanding under the revolving loan facility and approximately $38,823,000 of letters of credit related to workers' compensation insurance were outstanding. The Company drew down approximately $53 million on July 19, 2002 in connection with the acquisition of QSI.

8³/8% Senior Notes

        On March 6, 2001, the Company completed a private placement of $175,000,000 of 8³/8% Senior Notes due 2008 (the "8³/8% Senior Notes"). The net cash proceeds from the private placement were used to repay all of the remaining balance of the original term loans under the Company's then outstanding senior credit facility (the "Prior Senior Credit Facility") and a portion of the revolving loan facility under the Prior Senior Credit Facility then outstanding. On March 1, 2002, the Company completed a public offering of an additional $100,000,000 of 8³/8% Senior Notes due 2008. The net cash proceeds from the public offering were used to repay all of the remaining balance of the revolving loan facility under the Prior Senior Credit Facility. The 8³/8% Senior Notes are senior unsecured obligations and are fully and unconditionally guaranteed by all of the Company's subsidiaries (except for its foreign subsidiaries operating in Argentina and Canada). The 8³/8% Senior Notes are effectively subordinated to Key's secured indebtedness, which includes borrowings under the Senior Credit Facility.

        On and after March 1, 2005, the Company may redeem some or all of the 8³/8% Senior Notes at any time at varying redemption prices in excess of par, plus accrued interest. In addition, before March 1, 2004, the Company may redeem up to 35% of the aggregate principal amount of the 8³/8% Senior Notes with the proceeds of certain sales of equity at 108.375% of par plus accrued interest.

        At March 31, 2003, $275,000,000 principal amount of the 8³/8% Senior Notes remained outstanding. The 8³/8% Senior Notes require semi-annual interest payments on March 1 and September 1 of each year. Interest of approximately $11,516,000 was paid on March 1, 2003. As of March 31, 2003, the Company was in compliance with all covenants contained in the 8³/8% Senior Notes.

14% Senior Subordinated Notes

        On January 22, 1999, the Company completed the private placement of 150,000 units (the "Units") consisting of $150,000,000 of 14% Senior Subordinated Notes due 2009 (the "14% Senior Subordinated Notes") and 150,000 warrants to purchase 2,173,433 shares of the Company's common stock at an exercise price of $4.88125 per share (the "Unit Warrants"). The net cash proceeds from the private placement were used to repay substantially all of the remaining $148,600,000 principal amount (plus accrued interest) owed under the Company's bridge loan facility arranged in connection with the acquisition of Dawson Production Services, Inc. ("Dawson").

        On and after January 15, 2004, the Company may redeem some or all of the 14% Senior Subordinated Notes at any time at varying redemption prices in excess of par, plus accrued interest. In addition, before January 15, 2002, the Company was allowed to redeem up to 35% of the aggregate principal amount of the 14% Senior Subordinated Notes at 114% of par plus accrued interest with the proceeds of certain sales of equity. During the year ended June 30, 2001, the Company exercised its right of redemption for $10,313,000 principal amount of the 14% Senior Subordinated Notes at a price

22

of 114% of the principal amount plus accrued interest. This transaction resulted in a loss of approximately $2,561,000. On January 14, 2002, the Company exercised its right of redemption for $35,403,000 principal amount of the 14% Senior Subordinated Notes at a price of 114% of the principal amount plus accrued interest. This transaction resulted in a loss of approximately $8,468,000. Also, during the year ended June 30, 2002, the Company purchased and canceled $6,784,000 principal amount of the 14% Senior Subordinated Notes at a price of 116% of the principal amount plus accrued interest. These transactions resulted in a loss of approximately $1,821,000.

        The Unit Warrants have separated from the 14% Senior Subordinated Notes and became exercisable on January 25, 2000. On the date of issuance, the value of the Unit Warrants was estimated at $7,434,000 and is classified as a discount to the 14% Senior Subordinated Notes on the Company's consolidated balance sheet. The discount is being amortized to interest expense over the term of the 14% Senior Subordinated Notes. The 14% Senior Subordinated Notes mature and the Unit Warrants expire on January 15, 2009. The 14% Senior Subordinated Notes are subordinate to the Company's senior indebtedness, which includes borrowings under the Senior Credit Facility and the 8³/8% Senior Notes. The Senior Subordinated Notes are fully and unconditionally guaranteed by the Company's subsidiaries (except for its foreign subsidiaries operating in Argentina and Canada).

        At March 31, 2003, $97,500,000 principal amount of the 14% Senior Subordinated Notes remained outstanding. The 14% Senior Subordinated Notes pay interest semi-annually on January 15 and July 15 of each year. Interest of approximately $6,825,000 was paid on January 15, 2003. As of March 31, 2003, 63,500 Unit Warrants had been exercised, producing approximately $4,173,000 of proceeds to the Company and leaving 86,500 Unit Warrants outstanding. As of March 31, 2003, the Company was in compliance with all covenants contained in the 14% Senior Subordinated Notes.

5% Convertible Subordinated Notes

        In 1997, the Company completed a private placement of $216,000,000 of 5% Convertible Subordinated Notes due 2004 (the "5% Convertible Subordinated Notes"). The 5% Convertible Subordinated Notes are subordinate to the Company's senior indebtedness which includes borrowings under the Senior Credit Facility, the 14% Senior Subordinated Notes and the 8³/8% Senior Notes. The 5% Convertible Subordinated Notes are convertible, at the holder's option, into shares of the Company's common stock at a conversion price of $38.50 per share, subject to certain adjustments. The 5% Convertible Subordinated Notes are redeemable, at the Company's option, on and after September 15, 2000, in whole or part, together with accrued and unpaid interest. The initial redemption price is 102.86% for the year beginning September 15, 2000 and declines ratably thereafter on an annual basis.

23

        During the three months ended March 31, 2003, the Company repurchased (and canceled) approximately $55,000 principal amount of the 5% Convertible Subordinated Notes, leaving $49,499,000 outstanding as of March 31, 2003. These repurchases resulted in a gain of approximately $2,000. Interest on the 5% Convertible Subordinated Notes is payable on March 15 and September 15 of each year. Interest of approximately $1,237,000 was paid on March 15, 2003. As of March 31, 2003, the Company was in compliance with all covenants contained in the 5% Convertible Subordinated Notes.

CRITICAL ACCOUNTING POLICIES

        The Company follows certain significant accounting policies when preparing its consolidated financial statements. A complete summary of these policies is included in Note 1 to the consolidated financial statements included in the Company's Transition Report on Form 10-K as of and for the six months ended December 31, 2002.

        Certain of the policies require management to make significant and subjective estimates which are sensitive to deviations of actual results from management's assumptions. In particular, management makes estimates regarding the fair value of the Company's reporting units in assessing potential impairment of goodwill. In addition, the Company makes estimates regarding future undiscounted cash flows from the future use of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable.

        In assessing impairment of goodwill, the Company has used estimates and assumptions in estimating the fair value of its reporting units. Actual future results could be different than the estimates and assumptions used. Events or circumstances which might lead to an indication of impairment of goodwill would include, but might not be limited to, prolonged decreases in expectations of long-term well servicing and/or drilling activity or rates brought about by prolonged decreases in oil or natural gas prices, changes in government regulation of the oil and natural gas industry or other events which could affect the level of activity of exploration and production companies.

        In assessing impairment of long-lived assets other than goodwill where there has been a change in circumstances indicating that the carrying amount of a long-lived asset may not be recoverable, the Company has estimated future undiscounted net cash flows from use of the asset based on actual historical results and expectations about future economic circumstances including oil and natural gas prices and operating costs. The estimate of future net cash flows from use of the asset could change if actual prices and costs differ due to industry conditions or other factors affecting the Company's performance.

RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS

        In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 ("FIN 46"). FIN 46 addresses the consolidation by business enterprises of variable interest entities as defined in FIN 46. FIN 46 applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. The application of FIN 46 is not expected to have a material effect on the Company's financial statements. FIN 46 requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that the Company will consolidate or disclose information about variable interest entities FIN 46 becomes effective.

        In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS 149 amendments require that contracts with comparable characteristics be accounted for similarly, clarifies when a contract with an initial investment meets the characteristic of a derivative and clarifies when a derivative requires special reporting in the statement of cash flows. SFAS 149 is effective for hedging relationships designated and for contracts entered into or modified after June 30, 2003, except for

24

provisions that relate to SFAS 133 Statement Implementation Issues that have been effective for fiscal quarters prior to June 15, 2003, which should be applied in accordance with their respective effective dates, and certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not exist, which should be applied to existing contracts as well as new contracts entered into after June 30, 2003. The application of SFAS 149 is not expected to have a material effect on the Company's consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        Special Note: Certain statements set forth below under this caption constitute "forward-looking statements". See "Special Note Regarding Forward-Looking Statements" for additional factors relating to such statements.

        The primary objective of the following information is to provide forward-looking quantitative and qualitative information about the Keys's potential exposure to market risk. The term "market risk" refers to the risk of loss arising from adverse changes in foreign currency exchange, interest rates and oil and natural gas prices. The disclosures are not meant to be precise indicators of expected future losses, but rather indicators of reasonably possible losses. This forward-looking information provides indicators of how the Company views and manages its ongoing market risk exposures.

INTEREST RATE RISK

        At March 31, 2003, the Company had long-term debt and capital lease obligations outstanding of approximately $499,069,000. Of this amount, approximately $420,365,000 or 84%, bears interest at fixed rates as follows:

	At March 31, 2003
	(thousands)
83/8% Senior Notes Due 2008	$	276,278
14% Senior Subordinated Notes Due 2009		94,494
5% Convertible Subordinated Notes Due 2004		49,499
Other (rates approximate 8.0%)		94
	$	420,365

        The remaining $78,704,000 of long-term debt and capital lease obligations outstanding as of March 31, 2003 bears interest at floating rates, which averaged approximately 4.1% at March 31, 2003. A 10% increase in short-term interest rates on the floating-rate debt outstanding at March 31, 2003 would equal approximately 41 basis points. Such an increase in interest rates would increase Key's 2003 annual interest expense by approximately $300,000 assuming borrowed amounts remain outstanding.

        The above sensitivity analysis for interest rate risk excludes accounts receivable, accounts payable and accrued liabilities because of the short-term maturity of such instruments.

FOREIGN CURRENCY RISK

        During the year ended June 30, 2002, the Argentine government suspended the law tying the Argentine peso to the U.S. dollar at the conversion ratio of 1:1 and created a dual currency system in Argentina. Key's net assets of its Argentina subsidiaries are based on the U.S. dollar equivalent of such amounts measured in Argentine pesos as of March 31, 2003 and December 31, 2002. Assets and liabilities of the Argentine operations were translated to U.S. dollars at March 31, 2003 and December 31, 2002 using the applicable free market conversion ratio of 3.0:1 and 3.4:1, respectively, and will be translated at future dates using the applicable free market conversion ratio on such dates. Key's net earnings and cash flows from its Argentina subsidiaries are based on the U.S. dollar

25

equivalent of such amounts measured in Argentine pesos. Revenues, expenses and cash flows will be translated using the average exchange rates.

        The change in the Argentine peso to the U.S. dollar exchange rate since December 31, 2002 has increased stockholders' equity by approximately $3,179,000, through a credit to other comprehensive loss through March 31, 2003.

        Key's net assets, net earnings and cash flows from its Canadian subsidiary are based on the U.S. dollar equivalent of such amounts measured in Canadian dollars. Assets and liabilities of the Canadian operations are translated to U.S. dollars using the applicable exchange rate as of the end of a reporting period. Revenues and expenses are translated using the average exchange rate during the reporting period.

        A 10% change in the Canadian-to-U.S. Dollar exchange rate would not be material to the net assets, net earnings or cash flows of the Company.

        Key's net assets, net earnings and cash flows from its Egyptian subsidiary are based on the U.S. dollar. Foreign currency transactions are included in determination of net income for the period.

COMMODITY PRICE RISK

        Key's major market risk exposure for its oil and natural gas production operations is in the pricing applicable to its oil and natural gas sales. Realized pricing is primarily driven by the prevailing worldwide price for crude oil and spot market prices for natural gas. Pricing for oil and natural gas production has been volatile and unpredictable for many years.

        The Company periodically hedges a portion of its oil and natural gas production through collar and option agreements. The purpose of the hedges is to provide a measure of stability in the volatile environment of oil and natural gas prices and to manage exposure to commodity price risk under existing sales commitments. The Company's risk management objective is to lock in a range of pricing for expected production volumes. This allows the Company to forecast future earnings within a predictable range. The Company meets this objective by entering into collar and option arrangements which allow for acceptable cap and floor prices.

        As of March 31, 2003, Key had an oil put option in place, as detailed in the following table. Hedged oil volumes as a percentage of actual production was 41%, for the three months ended March 31, 2003. A 10% variation in the market price of oil or natural gas from their levels at March 31, 2003 would have no material impact on the Company's net assets, net earnings or cash flows (as derived from commodity option contracts).

        The following table sets forth the future volumes hedged by year and the weighted-average strike price of the option contracts at March 31, 2003 and 2002:

		Monthly Income			Strike Price Per Bbl/MMbtu
		Oil (Bbls)	Gas (MMbtu)
				Term	Floor		Cap	Fair Value
At March 31, 2003
	Oil Put	4,000	—	Mar 2003-Feb 2004	$	21.00	—	$	17,000
At March 31, 2002
	Oil Put	5,000	—	Mar 2002-Feb 2003	$	22.00	—	$	46,000
	Natural Gas Put	—	75,000	Mar 2002-Feb 2003	$	3.00	—	$	131,000

(The strike prices for the oil puts are based on the NYMEX spot price for West Texas Intermediate; the strike price for the natural gas put is based on the Inside FERC-El Paso Permian spot price.)

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ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES

(a)

Evaluation of Disclosure Controls and Procedures

Within the 90-day period prior to the filing date of this Quarterly Report on Form 10-Q, the Company, under the supervision, and with the participation, of its management, including its principal executive officer and principal financial officer, performed an evaluation of the design and operation of the Company's disclosure controls and procedures (as defined in Securities and Exchange Act Rule 13a-14(c)). Based on that evaluation, the Company's principal executive officer and principal financial officer concluded that such disclosure controls and procedures are effective to ensure that material information relating to the Company, including its consolidated subsidiaries, is accumulated and communicated to the Company's management and made known to the principal executive officer and principal financial officer, particularly during the period for which this periodic report was being prepared.

(b)

Changes in Internal Controls

There were no significant changes in the Company's internal controls during the three month period ended March 31, 2003 nor did any other factors exist that could significantly affect such controls through the date of this report.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

        None.

Item 2. Changes in Securities and Use of Proceeds.

        None.

Item 3. Defaults Upon Senior Securities.

        None.

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

        None.

Item 5. Other Information

        None.

Item 6. Exhibits and Reports on Form 8-K.

(a)

Exhibits



99.1*

Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*

Filed herewith.

(b)

Reports on Form 8-K

The Company filed the following reports on Form 8-K during the quarter ended March 31, 2003:

(i)

Current Report on Form 8-K dated January 31, 2003 filed to report the updated pro forma information with respect to the acquisition of Q Services, Inc.

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SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	KEY ENERGY SERVICES, INC.
Dated: May 15, 2003	By	/s/  FRANCIS D. JOHN      President and Chief Executive Officer
Dated: May 15, 2003	By	/s/  ROYCE W. MITCHELL      Chief Financial Officer

29

I, Francis D. John, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of Key Energy Services, Inc.;



2.

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; and



3.

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in the quarterly report.



4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:



a)

designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;



b)

evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of the quarterly report (the "Evaluation Date"); and



c)

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;



5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors:



a)

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weakness in internal controls; and



b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and



6.

The registrant's other certifying officers and I have indicated in the quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated: May 15, 2003 By /s/  FRANCIS D. JOHN      Chief Executive Officer

30

I, Royce W. Mitchell, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of Key Energy Services, Inc.;



2.

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; and



3.

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in the quarterly report.



4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:



a)

designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;



b)

evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of the quarterly report (the "Evaluation Date"); and



c)

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;



5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors:



a)

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weakness in internal controls; and



b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and



6.

The registrant's other certifying officers and I have indicated in the quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated: May 15, 2003 By /s/  ROYCE W. MITCHELL      Chief Financial Officer

31