<Page>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2001
[ ] 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 (I.R.S. Employer
incorporation or organization) Identification No.)
6 DESTA DRIVE, MIDLAND TX 79705
------------------------- -----
(Address of principal executive offices) (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 X No
-
Common Shares outstanding at February 7, 2002: 108,080,196
1
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KEY ENERGY SERVICES, INC.
INDEX
- --------------------------------------------------------------------------------
<Table>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
December 31, 2001 (unaudited) and June 30, 2001...............3
Unaudited Consolidated Statements of
Operations for the Three and Six Months Ended
December 31, 2001 and 2000....................................4
Unaudited Consolidated Statements of
Cash Flows for the Three and Six Months Ended
December 31, 2001 and 2000....................................5
Unaudited Consolidated Statements of Comprehensive
Income for the Three and Six Months Ended
December 31, 2001 and 2000....................................6
Notes to Consolidated Financial Statements....................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations....................22
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................33
Item 2. Changes in Securities and Use of Proceeds........................33
Item 3. Defaults Upon Senior Securities..................................33
Item 4. Submission of Matters to a Vote of Security Holders..............33
Item 5. Other Information................................................33
Item 6. Exhibits and Reports on Form 8-K.................................33
Signatures...................................................................35
</Table>
2
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KEY ENERGY SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31, 2001 JUNE 30, 2001
----------------- ---------------
(UNAUDITED)
(THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Current assets:
Cash and cash equivalents............................................................... $ 7,966 $ 2,098
Accounts receivable, net of allowance for doubtful accounts of $4,590
and $4,082, at December 31, 2001 and June 30, 2001, respectively...................... 149,312 177,016
Inventories............................................................................. 12,249 16,547
Prepaid expenses and other current assets............................................... 10,141 10,489
---------------- ---------------
Total current assets...................................................................... 179,668 206,150
---------------- ---------------
Property and equipment:
Well servicing equipment................................................................ 747,848 723,724
Contract drilling equipment............................................................. 123,022 119,122
Motor vehicles.......................................................................... 68,554 64,907
Oil and natural gas properties and other related equipment, successful efforts method... 44,502 44,245
Furniture and equipment................................................................. 29,396 24,865
Buildings and land...................................................................... 37,970 37,812
---------------- ---------------
Total property and equipment.............................................................. 1,051,292 1,014,675
Accumulated depreciation and depletion.................................................... (250,790) (220,959)
---------------- ---------------
Net property and equipment................................................................ 800,502 793,716
---------------- ---------------
Goodwill, net of accumulated amortization of $27,970 at December 31, 2001
and $28,168 at June 30, 2001............................................................ 193,217 189,875
Deferred costs, net..................................................................... 14,257 17,624
Notes and accounts receivable - related parties......................................... 456 6,050
Other assets............................................................................ 28,253 14,869
---------------- ---------------
Total assets............................................................................ $1,216,353 $1,228,284
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................................ $ 28,675 $ 42,544
Other accrued liabilities................................................................... 40,786 48,923
Accrued interest............................................................................ 14,434 16,140
Current portion of long-term debt and capital lease obligations............................. 8,215 7,946
---------------- --------------
Total current liabilities..................................................................... 92,110 115,553
---------------- --------------
Long-term debt, less current portion.......................................................... 379,269 470,578
Capital lease obligations, less current portion............................................... 16,227 15,383
Deferred revenue.............................................................................. 11,541 14,104
Non-current accrued expenses.................................................................. 9,816 8,388
Deferred tax liability........................................................................ 151,305 127,400
Commitments and contingencies................................................................. - -
Stockholders' equity:
Common stock, $.10 par value: 200,000,000 shares authorized, 108,371,945
and 101,440,166 shares issued, at December 31, 2001 and June 30, 2001, respectively....... 10,837 10,144
Additional paid-in capital................................................................. 498,702 444,768
Treasury stock, at cost; 416,666 shares at December 31, 2001 and June 30, 2001............. (9,682) (9,682)
Accumulated other comprehensive income (loss).............................................. (23,993) 62
Retained earnings (deficit)................................................................ 80,221 31,586
---------------- --------------
Total stockholders' equity.................................................................... 556,085 476,878
---------------- --------------
Total liabilities and stockholders' equity.................................................... $1,216,353 $1,228,284
================ ==============
SEE THE ACCOMPANYING NOTES WHICH ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
</Table>
3
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KEY ENERGY SERVICES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000 2001 2000
------------------------------- -----------------------------
(THOUSANDS, EXCEPT PER SHARE DATA)
REVENUES:
Well servicing.................................................. $186,338 $178,650 $398,839 $345,215
Contract drilling............................................... 25,654 24,178 59,290 46,323
Other........................................................... 1,345 1,083 4,445 4,052
------------------------------- -----------------------------
213,337 203,911 462,574 395,590
------------------------------- -----------------------------
COSTS AND EXPENSES:
Well servicing.................................................. 117,092 118,123 249,872 229,809
Contract drilling............................................... 17,340 18,360 38,528 35,818
Depreciation, depletion and amortization........................ 19,724 18,146 37,593 36,457
General and administrative...................................... 16,755 15,264 34,639 29,631
Bad debt expense................................................ 64 709 308 903
Interest........................................................ 11,097 14,581 23,046 30,692
Other expenses.................................................. 1,150 665 2,335 1,988
Foreign currency transaction loss, Argentina (see Note 10)...... 1,844 - 1,844 -
------------------------------- -----------------------------
185,066 185,848 388,165 365,298
------------------------------- -----------------------------
Income (loss) before income taxes............................... 28,271 18,063 74,409 30,292
Income tax (expense) benefit.................................... (10,903) (6,969) (28,045) (11,688)
------------------------------- -----------------------------
Income (loss) before extraordinary gain (loss).................. 17,368 11,094 46,364 18,604
Extraordinary gain (loss) on retirement of debt, less
applicable income taxes of $1,267 and $1,374 for the three
and six months ended December 31, 2001, respectively, and
income taxes of $41 and $793, for the three and six months
ended December 31, 2000, respectively......................... 2,091 68 2,271 1,265
------------------------------- -----------------------------
NET INCOME (LOSS).................................................. $ 19,459 $ 11,162 $ 48,635 $ 19,869
=============================== =============================
EARNINGS (LOSS) PER SHARE:
Basic -- before extraordinary gain (loss)....................... $ 0.17 $ 0.11 $ 0.45 $ 0.19
Extraordinary gain (loss), net of tax........................... 0.02 - 0.02 0.01
------------------------------- -----------------------------
Basic -- after extraordinary gain (loss)........................ $ 0.19 $ 0.11 $ 0.47 $ 0.20
=============================== =============================
Diluted -- before extraordinary gain (loss)..................... $ 0.17 $ 0.11 $ 0.44 $ 0.19
Extraordinary gain (loss), net of tax........................... 0.02 - 0.02 0.01
------------------------------- -----------------------------
Diluted -- after extraordinary gain (loss)...................... $ 0.19 $ 0.11 $ 0.46 $ 0.20
=============================== =============================
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic........................................................... 103,115 97,534 102,421 97,207
Diluted......................................................... 104,811 100,496 104,357 100,336
SEE THE ACCOMPANYING NOTES WHICH ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
</Table>
4
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KEY ENERGY SERVICES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000 2001 2000
------------------------------------------------------------------
(THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................... $ 19,459 $ 11,162 $ 48,635 $ 19,869
ADJUSTMENTS TO RECONCILE INCOME FROM OPERATIONS TO
NET CASH PROVIDED BY (USED IN) OPERATIONS:
Depreciation, depletion and amortization.................. 19,724 18,146 37,593 36,457
Bad debt expense.......................................... 64 709 308 903
Amortization of deferred debt issuance costs
and other deferred costs................................ 398 1,008 989 2,416
Deferred income taxes..................................... 7,731 6,969 22,331 11,688
(Gain) loss on sale of assets............................. 232 (41) (830) (40)
Foreign currency transaction loss, Argentina.............. 1,844 - 1,844 -
Extraordinary (gain) loss, net of tax..................... (2,091) (68) (2,271) (1,265)
CHANGE IN ASSETS AND LIABILITIES:
(Increase) decrease in accounts receivable................ 31,047 (7,062) 22,903 (22,513)
(Increase) decrease in other current assets............... (2,327) (2,548) (2,497) 1,838
Increase (decrease) in accounts payable,
accrued interest and accrued expenses................... (17,478) 4,870 (19,466) (3,316)
Other assets and liabilities.............................. (1,017) (38) (6,722) (572)
---------------------------------- ------------------------------
Net cash provided by (used in) operating activities......... 57,586 33,107 102,817 45,465
---------------------------------- ------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures - well servicing....................... (16,418) (9,093) (28,312) (17,095)
Capital expenditures - contract drilling.................... (2,923) (4,041) (11,077) (7,174)
Capital expenditures - other................................ (2,412) (3,942) (5,539) (6,092)
Proceeds from sale of fixed assets.......................... 239 850 3,655 952
Acquisitions - well servicing............................... (6,002) (1,700) (8,675) (1,700)
Acquisitions - contract drilling............................ - (800) - (800)
---------------------------------- ------------------------------
Net cash provided by (used in) investing activities......... (27,516) (18,726) (49,948) (31,909)
---------------------------------- ------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt................................. (118,441) (13,812) (184,931) (122,597)
Repayment of capital lease obligations...................... (2,544) (2,559) (4,999) (4,349)
Borrowings under line-of-credit............................. 53,000 - 99,000 4,000
Proceeds from equity offering, net of expenses.............. 42,590 - 42,590 -
Proceeds from exercise of warrants.......................... - 265 - 265
Proceeds from exercise of stock options..................... 1,079 1,024 1,620 1,357
Other....................................................... (89) (15) (89) (186)
---------------------------------- ------------------------------
Net cash provided by (used in) financing activities......... (24,405) (15,097) (46,809) (121,510)
---------------------------------- ------------------------------
Effect of exchange rate changes on cash..................... (192) - (192) -
---------------------------------- ------------------------------
Net increase (decrease) in cash and cash equivalents........ 5,473 (716) 5,868 (107,954)
Cash and cash equivalents at beginning of period............ 2,493 2,635 2,098 109,873
---------------------------------- ------------------------------
Cash and cash equivalents at end of period.................. $ 7,966 $ 1,919 $ 7,966 $ 1,919
================================== ==============================
SEE THE ACCOMPANYING NOTES WHICH ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
</Table>
5
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KEY ENERGY SERVICES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000 2001 2000
--------------------------------------------------------
(THOUSANDS)
NET INCOME (LOSS)....................................................... $ 19,459 $11,162 $ 48,635 $19,869
OTHER COMPREHENSIVE INCOME (LOSS):
Derivative transition adjustment (see Note 7)........................ - - - (778)
Oil and natural gas derivatives adjustment, net of tax (see Note 7).. 180 (52) 357 (52)
Amortization of oil and natural gas derivatives, net of tax (see
Note 7)............................................................ (154) 146 (188) 292
Foreign currency translation gain (loss), net of tax (see Note 10)... (24,202) - (24,224) 4
-------------------------- ----------------------------
COMPREHENSIVE INCOME (LOSS)............................................. $ (4,717) $11,256 $ 24,580 $19,335
========================== ============================
SEE THE ACCOMPANYING NOTES WHICH ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
</Table>
6
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KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT 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 December 31, 2001
and for the three and six month periods ended December 31, 2001 and 2000 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 Annual Report on Form 10-K for the fiscal year ended June 30, 2001.
The results of operations for the three and six month periods ended December 31,
2001 are not necessarily indicative of the results of operations for the full
fiscal year ending June 30, 2002.
RECLASSIFICATIONS
Certain reclassifications have been made to the consolidated financial
statements for the three and six month periods ended December 31, 2000 to
conform to the presentation for the three and six month periods ended December
31, 2001. The reclassifications consist primarily of reclassifying oil and
natural gas production revenues and expenses. Oil and natural gas production
revenues and related expenses have been reclassified to other revenues and other
expenses because the Company does not believe this business segment is material
to the Company's consolidated financial statements.
2. 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 stock options and warrants and conversion of dilutive
outstanding convertible securities using the "as if converted" method.
7
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KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000 2001 2000
--------------------------- ---------------------------
(THOUSANDS, EXCEPT PER (THOUSANDS, EXCEPT PER
SHARE DATA) SHARE DATA)
BASIC EPS COMPUTATION:
NUMERATOR
Net income (loss) before extraordinary gain (loss). $ 17,368 $ 11,094 $ 46,364 $ 18,604
Extraordinary gain (loss), net of tax.............. 2,091 68 2,271 1,265
--------------------------- ---------------------------
Net income (loss).................................. $ 19,459 $ 11,162 $ 48,635 $ 19,869
=========================== ===========================
DENOMINATOR
Weighted average common shares outstanding......... 103,115 97,534 102,421 97,207
--------------------------- ---------------------------
BASIC EPS:
Before extraordinary gain (loss)................... $ 0.17 $ 0.11 $ 0.45 $ 0.19
Extraordinary gain (loss), net of tax.............. 0.02 - 0.02 0.01
--------------------------- ---------------------------
After extraordinary gain (loss).................... $ 0.19 $ 0.11 $ 0.47 $ 0.20
=========================== ===========================
DILUTED EPS COMPUTATION:
NUMERATOR
Net income (loss) before extraordinary gain (loss). $ 17,368 $ 11,094 $ 46,364 $ 18,604
Effect of dilutive convertible securities, tax
effected......................................... - 4 - 26
Extraordinary gain (loss), net of tax.............. 2,091 68 2,271 1,265
--------------------------- ---------------------------
Net income (loss).................................. $ 19,459 $ 11,166 $ 48,635 $ 19,895
=========================== ===========================
DENOMINATOR
Weighted average common shares outstanding......... 103,115 97,534 102,421 97,207
Warrants........................................... 526 80 552 91
Stock options...................................... 1,170 2,882 1,384 3,003
7% Convertible Debentures.......................... - - - 35
--------------------------- ---------------------------
104,811 100,496 104,357 100,336
--------------------------- ---------------------------
DILUTED EPS:
Before extraordinary gain (loss)................... $ 0.17 $ 0.11 $ 0.44 $ 0.19
Extraordinary gain (loss), net of tax.............. 0.02 - 0.02 0.01
--------------------------- ---------------------------
After extraordinary gain (loss).................... $ 0.19 $ 0.11 $ 0.46 $ 0.20
=========================== ===========================
</Table>
The diluted earnings per share calculation (i) for the three month period ended
December 31, 2001 excludes the effects of 3,588,000 stock options and (ii) for
the six month period ended December 31, 2000 excludes the effects of 1,463,000
stock options. Both calculations exclude the effects of the conversion of the
Company's 5% Convertible Subordinated Notes. The effects of such options and
convertible notes on earnings per share would be anti-dilutive.
The diluted earnings per share calculation for the three and six month
periods ended December 31, 2000 excludes the effects of 1,175,000 stock
options and the effects of the conversion of the Company's 5% Convertible
Subordinated Notes because the effects of such options and convertible notes
on earnings per share would be anti-dilutive.
8
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KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
3. STOCKHOLDERS' EQUITY
EQUITY OFFERING
On December 19, 2001, the Company closed an "at-the-market" public offering
of 5,400,000 shares of common stock, yielding net proceeds to the Company of
approximately $43.2 million or $8.00 per share (the "Equity Offering"). Net
proceeds from the Equity Offering of approximately $42.6 million were used to
temporarily reduce amounts outstanding under the Company's revolving line of
credit. The net proceeds of the Equity Offering were ultimiately used in
January, 2002 to redeem a portion of the Company's 14% Senior Subordinated
Notes fully utilizing the Company's equity "claw-back" rights for up to 35%
of the original $150 million in issue.
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, results of operations or cash flows of the Company.
5. INDUSTRY SEGMENT INFORMATION
The Company's reportable business segments are well servicing and contract
drilling. Oil and natural gas production operations were previously separately
presented as a reportable business segment and are now included in
"corporate/other".
WELL SERVICING: The Company's operations provide well servicing (ongoing
maintenance of existing oil and natural gas wells), completions, workover (major
repairs or modifications necessary to optimize the level of production from
existing oil and natural gas wells) and production services (fluid hauling and
fluid storage tank rental).
CONTRACT DRILLING: The Company provides contract drilling services for major and
independent oil companies onshore the continental United States, Argentina and
Ontario, Canada.
9
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KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
<Table>
<Caption>
WELL CONTRACT CORPORATE
SERVICING DRILLING /OTHER TOTAL
--------- -------- ------ -----
(THOUSANDS)
THREE MONTHS ENDED DECEMBER 31, 2001
Operating revenues .................................. $186,338 $25,654 $ 1,345 $ 213,337
Operating profit .................................... 69,246 8,314 195 77,755
Depreciation, depletion and amortization ............ 16,470 2,204 1,050 19,724
Interest expense .................................... 405 - 10,692 11,097
Net income (loss) before extraordinary gain (loss)* . 26,546 2,555 (11,733) 17,368
Identifiable assets ................................. 673,162 94,693 255,281 1,023,136
Capital expenditures (excluding acquisitions) ....... 16,418 2,923 2,412 21,753
THREE MONTHS ENDED DECEMBER 31, 2000
Operating revenues .................................. $178,650 $24,178 $ 1,083 $ 203,911
Operating profit .................................... 60,527 5,818 418 66,763
Depreciation, depletion and amortization ............ 15,261 1,890 995 18,146
Interest expense .................................... 446 - 14,135 14,581
Net income (loss) before extraordinary gain (loss)* . 24,720 1,208 (14,834) 11,094
Identifiable assets ................................. 639,979 91,066 233,019 964,064
Capital expenditures (excluding acquisitions) ....... 9,093 4,041 3,942 17,076
</Table>
*Net income (loss) includes general and administrative
expenses allocated on a percentage of revenue basis.
Operating revenues for the Company's foreign operations for the three months
ended December 31, 2001 and 2000 were $11.9 million and $13.3 million,
respectively. Operating profits for the Company's foreign operations for the
three months ended December 31, 2001 and 2000 were $2.1 million and $3.2
million, respectively. The Company had $56.1 million and $75.3 million of
identifiable assets as of December 31, 2001 and 2000, respectively, related to
foreign operations.
10
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KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
<Table>
<Caption>
WELL CONTRACT CORPORATE
SERVICING DRILLING /OTHER TOTAL
--------- -------- ------ -----
(THOUSANDS)
SIX MONTHS ENDED DECEMBER 31, 2001
Operating revenues ................................ $398,839 $59,290 $ 4,445 $ 462,574
Operating profit .................................. 148,967 20,762 2,110 171,839
Depreciation, depletion and amortization .......... 31,027 4,584 1,982 37,593
Interest expense .................................. 953 - 22,093 23,046
Net income (loss) before extraordinary gain (loss)* 61,091 7,863 (22,590) 46,364
Identifiable assets ............................... 673,162 94,693 255,281 1,023,136
Capital expenditures (excluding acquisitions) ..... 28,312 11,077 5,539 44,928
SIX MONTHS ENDED DECEMBER 31, 2000
Operating revenues ................................ $345,215 $46,323 $ 4,052 $ 395,590
Operating profit .................................. 115,406 10,505 2,064 127,975
Depreciation, depletion and amortization .......... 30,950 3,696 1,811 36,457
Interest expense .................................. 1,103 - 29,589 30,692
Net income (loss) before extraordinary gain (loss)* 46,499 1,861 (29,756) 18,604
Identifiable assets ............................... 639,979 91,066 233,019 964,064
Capital expenditures (excluding acquisitions) ..... 17,095 7,174 6,092 30,361
</Table>
*Net income (loss) includes general and administrative
expenses allocated on a percentage of revenue basis.
Operating revenues for the Company's foreign operations for the six months ended
December 31, 2001 and 2000 were $23.9 million and $26.5 million, respectively.
Operating profits for the Company's foreign operations for the six months ended
December 31, 2001 and 2000 were $4.7 million and $6.2 million, respectively. The
Company had $56.1 million and $75.3 million of identifiable assets as of
December 31, 2001 and 2000, respectively, related to foreign operations.
6. VOLUMETRIC PRODUCTION PAYMENT
In March 2000, Key sold a portion of its future oil and natural gas production
from Odessa Exploration Incorporated, its wholly owned subsidiary, for gross
proceeds of $20 million pursuant to an agreement under which the purchaser is
entitled to receive a portion of the production from certain oil and natural gas
properties over the six year period ending February 28, 2006 in amounts starting
at 10,000 barrels of oil per month and declining to 3,500 barrels of oil per
month and starting at 122,100 Mmbtu of natural gas per month and declining to
58,800 Mmbtu of natural gas per month. The total volume of the forward sale is
approximately 486,000 barrels of oil and 6,135,000 Mmbtu of natural gas.
7. DERIVATIVE 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-
11
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KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
parties 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 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.
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 March 30, 2000 the Company entered into a collar
arrangement for a 22-month period whereby the Company will pay if the specified
price is above the cap index and the counter-party will pay if the price should
fall below the floor index. The hedge defines a range of cash flows bounded by
the cap and floor prices. 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 should the price fall below the floor index. The Company desires a
measure of stability to ensure that cash flows do not fall below a certain
level.
Prior to the adoption of Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities, ("SFAS No. 133"),
as amended by SFAS No. 137 and 138, these collars were accounted for as cash
flow type hedges. Accordingly, the July 1, 2000 transition adjustment resulted
in recording a $778,000 liability for the fair value of the collars to
accumulated other comprehensive income. Approximately $97,000 of the transition
adjustment was recognized in earnings during the three months ended December 31,
2001. The unamortized balance of the transition adjustment, approximately
$64,000, will be recognized in earnings over the next three months. As of July
1, 2001, the Company has documented the May 25, 2001 options as cash flow
hedges. During the quarter ended December 31, 2001, the Company recorded a net
decrease in net derivative assets of approximately $105,000, which included an
earnings charge of approximately $392,000 from ineffectiveness.
EMBEDDED DERIVATIVES. The Company is party to a volumetric production payment of
which certain terms meet the definition of an embedded derivative under SFAS No.
133. Effective July 1, 2000, the Company has determined and documented that the
production payment is excluded from the scope of SFAS No. 133 under the normal
purchases/sales exclusion as set forth in SFAS 138.
12
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
8. CONDENSED CONSOLIDATING FINANCIAL INFORMATION
The Company's senior notes are guaranteed by all of the Company's subsidiaries
(except for the foreign subsidiaries), 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 generally accepted accounting principles.
13
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 and 2000
<Table>
<Caption>
CONDENSED CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 2001
-----------------------------------------------------------------------
NON-
PARENT GUARANTOR GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---------- ------------ ------------- ------------ ------------
(THOUSANDS)
Assets:
Current assets .............. $ 13,689 $ 145,963 $ 20,422 $ -- $ 180,074
Net property and equipment... 25,716 739,181 35,605 -- 800,502
Goodwill, net ............... 3,502 188,389 1,326 -- 193,217
Deferred costs, net ......... 14,257 -- -- -- 14,257
Intercompany receivables .... 578,459 -- -- (578,459) --
Other assets ................ 21,470 6,772 61 -- 28,303
---------- ---------- ---------- --------- ----------
Total assets .................. $ 657,093 $1,080,305 $ 57,414 $(578,459) $1,216,353
========== ========== ========== ========= ==========
Liabilities and equity:
Current liabilities ......... $ 31,603 $ 52,910 $ 7,592 $ -- $ 92,105
Long-term debt .............. 379,269 -- -- -- 379,269
Capital lease obligations.... 352 15,875 -- -- 16,227
Intercompany payables ....... -- 538,818 39,641 (578,459) --
Deferred tax liability ...... 151,305 -- -- -- 151,305
Other long-term liabilities.. 9,716 11,641 -- -- 21,357
Stockholders' equity ........ 84,848 461,061 10,181 -- 556,090
---------- ---------- ---------- --------- ----------
Total liabilities and
stockholders' equity......... $ 657,093 $1,080,305 $ 57,414 $(578,459) $1,216,353
========== ========== ========== ========= ==========
<Caption>
JUNE 30, 2001
-----------------------------------------------------------------------
NON-
PARENT GUARANTOR GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---------- ------------ ------------- ------------ ------------
(THOUSANDS)
Assets:
Current assets .............. $ 10,680 $ 165,653 $ 29,817 $ -- $ 206,150
Net property and equipment... 21,418 717,989 54,309 -- 793,716
Goodwill, net ............... 3,374 184,379 2,122 -- 189,875
Deferred costs, net ......... 17,624 -- -- -- 17,624
Intercompany receivables .... 664,592 -- -- (664,592) --
Other assets ................ 15,303 5,616 -- -- 20,919
---------- ---------- ---------- --------- ----------
Total assets .................. $ 732,991 $1,073,637 $ 86,248 $(664,592) $1,228,284
========== ========== ========== ========= ==========
Liabilities and equity:
Current liabilities ......... $ 35,671 $ 64,679 $ 15,203 $ -- $ 115,553
Long-term debt .............. 470,578 -- -- -- 470,578
Capital lease obligations ... 90 15,331 (38) -- 15,383
Intercompany payables ....... -- 608,764 55,828 (664,592) --
Deferred tax liability ...... 127,400 -- -- -- 127,400
Other long-term liabilities.. 8,240 14,252 -- -- 22,492
Stockholders' equity ........ 91,012 370,611 15,255 -- 476,878
---------- ---------- ---------- --------- ----------
Total liabilities and
stockholders' equity ........ $ 732,991 $1,073,637 $ 86,248 $(664,592) $1,228,284
========== ========== ========== ========= ==========
</Table>
14
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 and 2000
<Table>
<Caption>
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 2001
-----------------------------------------------------------------------
NON-
PARENT GUARANTOR GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------- ------------ ------------ ------------ ------------
(THOUSANDS)
Revenues.................................. $ 329 $201,119 $11,889 $ - $213,337
Costs and expenses:
Direct expenses......................... - 125,799 9,783 - 135,582
Depreciation, depletion and
amortization.......................... 429 18,283 1,012 - 19,724
General and administrative.............. 5,137 10,854 764 - 16,755
Interest................................ 10,692 136 269 - 11,097
Argentine foreign currency
transaction loss........................ - - 1,844 - 1,844
Other expenses.......................... - 64 - - 64
-------- -------- ------- ---- --------
Total costs and expenses.................. 16,258 155,136 13,672 - 185,066
-------- -------- ------- ---- --------
Income (loss) before income taxes......... (15,929) 45,983 (1,783) - 28,271
Income tax (expense) benefit.............. 6,145 (17,736) 688 - (10,903)
-------- -------- ------- ---- --------
Income (loss) before extraordinary items.. (9,784) 28,247 (1,095) - 17,368
Extraordinary items, net of tax........... 2,091 - - - 2,091
-------- -------- ------- ---- --------
Net income (loss)......................... $ (7,693) $ 28,247 $(1,095) $ - $ 19,459
======== ======== ======= ==== ========
<Caption>
THREE MONTHS ENDED DECEMBER 31, 2000
-----------------------------------------------------------------------
NON-
PARENT GUARANTOR GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------- ------------ ------------- ------------ ------------
(THOUSANDS)
Revenues.................................. $ 195 $190,404 $13,312 $ - $203,911
Costs and expenses:
Direct expenses......................... - 127,013 10,135 - 137,148
Depreciation, depletion and
amortization............................ 474 16,653 1,019 - 18,146
General and administrative.............. 3,230 11,152 882 - 15,264
Interest................................ 14,135 389 57 - 14,581
Other expenses.......................... 311 398 - - 709
-------- -------- ------- ---- --------
Total costs and expenses.................. 18,150 155,605 12,093 - 185,848
-------- -------- ------- ---- --------
Income (loss) before income taxes......... (17,955) 34,799 1,219 - 18,063
Income tax (expense) benefit.............. 6,927 (13,426) (470) - (6,969)
-------- -------- ------- ---- --------
Income (loss) before
extraordinary items..................... (11,028) 21,373 749 - 11,094
Extraordinary items, net of tax........... 68 - - - 68
-------- -------- ------- ---- --------
Net income (loss)......................... $(10,960) $ 21,373 $ 749 $ - $ 11,162
======== ======== ======= ==== ========
</Table>
15
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
<Table>
<Caption>
SIX MONTHS ENDED DECEMBER 31, 2001
-------------------------------------------------------------------------------
NON-
PARENT GUARANTOR GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- --------------- -------------- --------------- ----------------
(THOUSANDS)
Revenues........................... $ 822 $437,760 $23,992 $ - $462,574
Costs and expenses:
Direct expenses................ - 271,449 19,286 - 290,735
Depreciation, depletion and
amortization................... 740 34,791 2,062 - 37,593
General and administrative..... 10,465 22,606 1,568 - 34,639
Interest....................... 22,093 341 612 - 23,046
Argentine foreign currency
transaction loss............... - - 1,844 - 1,844
Other expenses................. - 308 - - 308
-------------- --------------- -------------- --------------- ----------------
Total costs and expenses........... 33,298 329,495 25,372 - 388,165
-------------- --------------- -------------- --------------- ----------------
Income (loss) before income taxes.. (32,476) 108,265 (1,380) - 74,409
Income tax (expense) benefit....... 12,292 (40,784) 537 - (28,045)
-------------- --------------- -------------- --------------- ----------------
Income (loss) before (20,184) 67,391 (843) - 46,364
extraordinary items..............
Extraordinary items, net of tax.... 2,271 - - - 2,271
-------------- --------------- -------------- --------------- ----------------
Net income (loss).................. $(17,913) $ 67,391 $ (843) $ - $ 48,635
============== =============== ============== =============== ================
SIX MONTHS ENDED DECEMBER 31, 2000
-------------------------------------------------------------------------------
NON-
PARENT GUARANTOR GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- --------------- -------------- --------------- ----------------
(THOUSANDS)
Revenues........................... $ 1,574 $367,477 $26,539 $ - $395,590
Costs and expenses:
Direct expenses................ - 247,299 20,316 - 267,615
Depreciation, depletion and
amortization................... 778 33,695 1,984 - 36,457
General and administrative..... 6,985 20,932 1,714 - 29,631
Interest....................... 29,589 793 310 - 30,692
Other expenses................. 311 592 - - 903
-------------- --------------- -------------- --------------- ----------------
Total costs and expenses........... 37,663 303,311 24,324 - 365,298
-------------- --------------- -------------- --------------- ----------------
Income (loss) before income taxes.. (36,089) 64,166 2,215 - 30,292
Income tax (expense) benefit....... 13,925 (24,759) (854) - (11,688)
-------------- --------------- -------------- --------------- ----------------
Income (loss) before (22,164) 39,407 1,361 - 18,604
extraordinary items..............
Extraordinary items, net of tax.... 1,265 - - - 1,265
-------------- --------------- -------------- --------------- ----------------
Net income (loss).................. $(20,899) $ 39,407 $ 1,361 $ - $ 19,869
============== =============== ============== =============== ================
</Table>
16
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
<Table>
<Caption>
THREE MONTHS ENDED DECEMBER 31, 2001
-------------------------------------------------------------------------------
NON-
PARENT GUARANTOR GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- --------------- -------------- --------------- ----------------
(THOUSANDS)
Net cash provided by (used in)
operating activities.............. $ 34,549 $ 21,084 $ 1,953 $ - $ 57,586
Net cash provided by (used in)
investing activities.............. (7,431) (18,862) (1,223) - (27,516)
Net cash provided by (used in)
financing activities.............. (21,963) (2,442) - - (24,405)
Effect of exchange rate changes on - - (192) - (192)
cash..............................
-------------- --------------- -------------- --------------- ----------------
Net increase (decrease) in cash...... 5,155 (220) 538 - 5,473
Cash at beginning of period.......... (2,648) 3,996 1,145 - 2,493
-------------- --------------- -------------- --------------- ----------------
Cash at end of period................ $ 2,507 $ 3,776 $ 1,683 $ - $ 7,966
============== =============== ============== =============== ================
THREE MONTHS ENDED DECEMBER 31, 2001
-------------------------------------------------------------------------------
NON-
PARENT GUARANTOR GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- --------------- -------------- --------------- ----------------
(THOUSANDS)
Net cash provided by (used in)
operating activities............. $ 20,880 $ 10,175 $ 2,052 $ - $ 33,107
Net cash provided by (used in)
investing activities............. (5,933) (10,658) (2,135) - (18,726)
Net cash provided by (used in) in
financing activities............. (12,544) (2,540) (13) - (15,097)
-------------- --------------- -------------- --------------- ----------------
Net increase (decrease) in cash..... 2,403 (3,023) (96) - (716)
Cash at beginning of period......... 5,074 (3,364) 925 - 2,635
-------------- --------------- -------------- --------------- ----------------
Cash at end of period............... $ 7,477 $ (6,387) $ 829 $ - $ 1,919
============== =============== ============== =============== ================
</Table>
17
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
<Table>
<Caption>
SIX MONTHS ENDED DECEMBER 31, 2001
-------------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- --------------- -------------- --------------- ----------------
(THOUSANDS)
Net cash provided by (used in)
operating activities.............. $ 55,161 $ 46,885 $ 771 $ - $102,817
Net cash provided by (used in)
investing activities.............. (12,381) (36,228) (1,339) - (49,948)
Net cash provided by (used in)
financing activities.............. (41,920) (4,876) (13) - (46,809)
Effect of exchange rate changes on - - (192) - (192)
cash..............................
-------------- --------------- -------------- --------------- ----------------
Net increase (decrease) in cash...... 860 5,781 (773) - 5,868
Cash at beginning of period.......... 1,647 (2,005) 2,456 - 2,098
-------------- --------------- -------------- --------------- ----------------
Cash at end of period................ $ 2,507 $ 3,776 $ 1,683 $ - $ 7,966
============== =============== ============== =============== ================
</Table>
<Table>
<Caption>
SIX MONTHS ENDED DECEMBER 31, 2000
-------------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------- --------------- -------------- --------------- ----------------
(THOUSANDS)
Net cash provided by (used in)
operating activities.............. $ 21,389 $ 19,924 $ 4,152 $ - $ 45,465
Net cash provided by (used in)
investing activities.............. (7,906) (20,754) (3,249) - (31,909)
Net cash provided by (used in)
financing activities.............. (117,172) (4,311) (27) - (121,510)
-------------- --------------- -------------- --------------- ----------------
Net increase (decrease) in cash...... (103,689) (5,141) 876 - (107,954)
Cash at beginning of period.......... 111,166 (1,246) (47) - 109,873
-------------- --------------- -------------- --------------- ----------------
Cash at end of period................ $ 7,477 $ (6,387) $ 829 $ - $ 1,919
============== =============== ============== =============== ================
</Table>
9. GOODWILL AND OTHER INTANGIBLE ASSETS - ADOPTION OF SFAS 142
The Company has adopted Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets ("SFAS 142") on July 1, 2001. 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 acquired in a business
combination. The amount of impairment for goodwill and other intangible
assets is measured as the excess of its carrying value over its fair value.
The Company completed its
18
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
assessment of goodwill impairment during the three months ended December 31,
2001, as allowed by SFAS 142. The assessment did not result in an indication of
goodwill impairment.
Intangible assets subject to amortization under SFAS 142 consist of noncompete
agreements. Amortization expense is calculated using the straight-line method
over the period of the agreement, ranging from 3 to 5 years.
The gross carrying amount of noncompete agreements subject to amortization
totaled approximately $8,863,000 and $8,099,000 at December 31, 2001 and June
30, 2001, respectively. Accumulated amortization related to these intangible
assets totaled approximately $4,986,000 and $4,953,000 at December 31, 2001 and
June 30, 2001, respectively. Amortization expense for the three months ended
December 31, 2001 and 2000 was approximately $370,000 and $244,000,
respectively. Amortization expense for the six months ended December 31, 2001
and 2000 was approximately $770,000 and $729,000. Amortization expense for the
next five fiscal years is estimated to be $1,783,000, $1,054,000, $400,000,
$373,000 and $267,000.
The Company has identified its reporting segments to be well servicing and
contract drilling. Goodwill allocated to such reporting segments at December 31,
2001 is $178,952,000 and $14,265,000, respectively. The change in the carrying
amount of goodwill for the three and six months ended December 31, 2001 of
$2,238,000 and $3,144,000, respectively, relates principally to goodwill from
well servicing assets acquired during the period and the translation adjustment
for Argentina at December 31, 2001.
19
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
The effect of the adoption of SFAS 142 on net income and earnings per share is
as follows:
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000 2001 2000
-------------- ------------ ------------ --------------
(THOUSANDS, EXCEPT PER (THOUSANDS, EXCEPT PER
SHARE DATA) SHARE DATA)
Reported net income (loss) before extraordinary gain
(loss).............................................. $17,368 $11,094 $46,364 $18,604
Add back: goodwill amortization...................... - 2,204 - 4,655
-------------- ------------ ------------- -------------
Adjusted net income (loss) before extraordinary gain
(loss).............................................. 17,368 13,298 46,364 23,259
Extraordinary gain (loss), net of tax................. 2,091 68 2,271 1,265
-------------- ------------ ------------- -------------
Adjusted net income (loss)............................ $19,459 $13,366 $48,635 $24,524
============== ============ ============= =============
BASIC EARNINGS (LOSS) PER SHARE:
Reported net income (loss) before extraordinary gain
(loss).............................................. $0.17 $0.11 $0.45 $0.19
Add back: goodwill amortization...................... - 0.02 - 0.05
-------------- ------------ ------------- -------------
Adjusted net income (loss) before extraordinary gain
(loss).............................................. $0.17 $0.13 $0.45 $0.24
Extraordinary gain (loss), net of tax................. 0.02 - 0.02 0.01
-------------- ------------ ------------- -------------
Adjusted net income (loss)............................ $0.19 $0.13 $0.47 $0.25
============== ============ ============= =============
DILUTED EARNINGS (LOSS) PER SHARE:
Reported net income (loss) before extraordinary gain
(loss).............................................. $0.17 $0.11 $0.45 $0.19
Add back: goodwill amortization...................... - 0.02 - 0.05
-------------- ------------ ------------- -------------
Adjusted net income (loss) before extraordinary gain
(loss).............................................. $0.17 $0.13 $0.45 $0.24
Extraordinary gain (loss), net of tax................. 0.02 - 0.02 0.01
-------------- ------------ ------------- -------------
Adjusted net income (loss)............................ $0.19 $0.13 $0.47 $0.25
============== ============ ============= =============
</Table>
10. ARGENTINA FOREIGN CURRENCY TRANSACTION LOSS
The local currency is the functional currency for all of the Company's foreign
operations (Argentina and Canada). The cumulative translation gains and losses,
resulting from translating each foreign subsidiary's financial statements from
the functional currency to U.S. dollars are included in other comprehensive
income and accumulated in stockholders' equity until a partial or complete sale
or liquidation of the Company's net investment in the foreign entity.
Since 1991, the Argentine peso has been tied to the U.S. dollar at a
conversion ratio of 1:1. However, in December 2001, the Government of
Argentina announced an exchange holiday and, as a result, Argentine pesos
could not be exchanged into other currencies at December 31, 2001. On
20
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
January 5 and 6, 2002, the Argentine Congress and Senate gave the President
of Argentina emergency powers and the ability to suspend the law that created
the fixed conversion ratio of 1:1. The Government subsequently announced the
creation of a dual currency system in which certain qualifying transactions
will be settled at an expected fixed conversion ratio of 1.4:1 while all
other transactions will be settled using a free floating market conversion
ratio. Under existing guidance, dividends would not receive the fixed
conversion ratio. On January 11, 2002, the exchange holiday was lifted,
making it possible again to buy and sell Argentine pesos. Banks were legally
allowed to exchange currencies, but transactions were limited and generally
took place at exchange houses. These transactions were conducted primarily by
individuals as opposed to commercial transactions, and occurred at free
conversion ratios ranging between 1.6:1 and 1.7:1.
Due to the events described above, which resulted in the temporary lack of
exchangeability of the two currencies at December 31, 2001, the Company has
translated the assets and liabilities of its Argentine subsidiary at December
31, 2001 using a conversion ratio of 1.6:1, which management believes is
indicative of the free floating conversion ratio when the currency market
re-opened on January 11, 2002. As a result, a foreign currency translation
loss of approximately $24.2 million is included in other comprehensive
income, a component of stockholders' equity, in the accompanying December 31,
2001 consolidated balance sheet. Since the 1:1 conversion ratio was in
existence prior to December 2001, income statement and cash flows information
has been translated using the historical 1:1 conversion ratio.
Additionally, the Argentine government has indicated that as part of its
monetary policy changes, it will re-denominate certain consumer loans from U.S.
dollar-denominated to Argentine peso-denominated. As a result, the Company
recorded a foreign currency transaction loss of $1.8 million in the three months
ended December 31, 2001 related to accounts receivable subject to certain U.S.
dollar-denominated contracts held by its Argentine subsidiary which are subject
to re-denomination. These receivables are subject to additional negotiation with
the Company's customers which may result in recovery of a portion of this loss.
21
<Page>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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. Future 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 the 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 well servicing, contract
drilling and ancillary oilfield services; and
- general economic conditions, the existence of regulatory uncertainties,
the possibility of political or currency instability in any of the
countries in which the Company does business, in addition to the other
matters discussed herein.
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.
RESULTS OF OPERATIONS
As the more detailed discussions below illustrate, the Company's revenues, net
income and cash flow for the six months ended December 31, 2001 were at levels
significantly higher than for the same period in fiscal 2001. As oil and natural
gas prices have weakened, activity levels in both the well servicing and
drilling segments have declined as reflected in our second quarter results.
Results for the remainder of fiscal 2002 will clearly be influenced by the
demand for and pricing of natural gas and oil.
22
<Page>
THREE MONTHS ENDED DECEMBER 31, 2001 VERSUS THREE MONTHS ENDED DECEMBER 31, 2000
The Company's revenue for the three months ended December 31, 2001 increased
$9,426,000, or 4.6%, to $213,337,000 from $203,911,000 for the three months
ended December 31, 2000. The increase in the current period reflects improved
rates despite lower activity levels. The Company's net income for the second
quarter of fiscal 2002 totaled $19,459,000, or $0.19 per dilutive share, versus
a net income of $11,162,000, or $0.11 per dilutive share, for the prior year
period.
OPERATING REVENUES
WELL SERVICING. Well servicing revenues for the three months ended December 31,
2001 increased $7,688,000, or 4.3%, to $186,338,000 from $178,650,000 for the
three months ended December 31, 2000. The increase in revenues was primarily due
to higher rig and fluid hauling rates despite lower activity levels.
CONTRACT DRILLING. Contract drilling revenues for the three months ended
December 31, 2001 increased $1,476,000, or 6.1%, to $25,654,000 from $24,178,000
for the three months ended December 31, 2000. The increase in revenues was
primarily due to higher rig rates despite lower activity levels.
OPERATING EXPENSES
WELL SERVICING. Well servicing expenses for the three months ended December 31,
2001 decreased $1,031,000, or 0.87%, to $117,092,000 from $118,123,000 for the
three months ended December 31, 2000. The decrease was primarily due to
marginally lower levels of activity. Well servicing expenses, as a percentage of
well servicing revenue, decreased to 62.8% for the three months ended December
31, 2001 from 66.1% for the three months ended December 31, 2000.
CONTRACT DRILLING. Contract drilling expenses for the three months ended
December 31, 2001 decreased $1,020,000, or 5.6%, to $17,340,000 from $18,360,000
for the three months ended December 31, 2000. The decrease was primarily due to
lower levels of activity. Contract drilling expenses, as a percentage of
contract drilling revenues, decreased to 67.6% for the three months ended
December 31, 2001 from 75.9% for the three months ended December 31, 2000.
DEPRECIATION, DEPLETION AND AMORTIZATION EXPENSE
The Company's depreciation, depletion and amortization expense for the three
months ended December 31, 2001 increased $1,578,000, or 8.7%, to $19,724,000
from $18,146,000 for the three months ended December 31, 2000. The increase is
due to recent acquisitions and increased capital expenditures during the past
twelve months as the Company continued major refurbishments of well servicing
and contract drilling equipment partially offset by discontinued amortization of
goodwill because of the Company's adoption of SFAS 142.
23
<Page>
GENERAL AND ADMINISTRATIVE EXPENSES
The Company's general and administrative expenses for the three months ended
December 31, 2001 increased $1,491,000, or 9.8%, to $16,755,000 from $15,264,000
for the three months ended December 31, 2000. The increase was due to higher
administrative costs related to growth of the Company's operations and reflects
additional resources in technology and internal control functions. General and
administrative expenses, as a percentage of revenues, increased to 7.9% for the
three months ended December 31, 2001 from 7.5% for the three months ended
December 31, 2000.
INTEREST EXPENSE
The Company's interest expense for the three months ended December 31, 2001
decreased $3,484,000, or 23.9%, to $11,097,000, from $14,581,000 for the three
months ended December 31, 2000. The decrease was primarily due to a significant
reduction in the Company's long-term debt using operating cash flow, and to a
lesser extent, lower interest rates. Included in the interest expense was the
amortization of debt issuance costs of $654,000 and $822,000 for the three
months ended December 31, 2001 and 2000, respectively.
BAD DEBT EXPENSE
The Company's bad debt expense for the three months ended December 31, 2001
decreased $645,000, or 91%, to $64,000 from $709,000 for the three months ended
December 31, 2000. The Company continues to carefully monitor credit risk
associated with our customers.
FOREIGN CURRENCY TRANSACTION LOSS
During the three months ended December 31, 2001, the Company recorded an
Argentine foreign currency transaction loss of approximately $1,844,000 related
to dollar-denominated receivables resulting from the recent devaluation of
Argentina's currency.
EXTRAORDINARY GAIN
During the three months ended December 31, 2001, the Company retired $61,581,000
of its long-term debt, and expensed the related unamortized debt issuance costs
which resulted in a net after-tax extraordinary gain of $2,091,000. During the
three months ended December 31, 2000, the Company retired $3,000,000 of its
long-term debt, and expensed the related unamortized debt issuance costs which
resulted in a net after-tax extraordinary gain of $68,000.
INCOME TAXES
The Company's income tax expense for the three months ended December 31, 2001
increased $3,934,000 to an expense of $10,903,000 from an expense of $6,969,000
for the three months ended December 31, 2000. The increase in income tax expense
is due to the increase in pretax income. The Company's effective tax rate for
the three months ended December 31, 2001 and
24
<Page>
December 31, 2000 was approximately 38%. The effective tax rates vary from the
statutory rate of 35% because of the disallowance of certain goodwill
amortization (for the three months ended December 31, 2000), and other
non-deductible expenses and the effects of state and local taxes.
SIX MONTHS ENDED DECEMBER 31, 2001 VERSUS SIX MONTHS ENDED DECEMBER 31, 2000
The Company's revenue for the six months ended December 31, 2001 increased
$66,984,000, or 16.9%, to $462,574,000 from $395,590,000 for the six months
ended December 31, 2000. The increase in the current period reflects higher
activity levels and improved rates. The Company's net income for the first six
months of fiscal 2002 totaled $48,635,000, or $0.46 per dilutive share, versus a
net income of $19,869,000, or $0.20 per dilutive share, for the prior year
period.
OPERATING REVENUES
WELL SERVICING. Well servicing revenues for the six months ended December 31,
2001 increased $53,624,000, or 15.5%, to $398,839,000 from $345,215,000 for the
six months ended December 31, 2000. The increase in revenues was primarily due
to higher levels of activity and higher rig and fluid hauling rates.
CONTRACT DRILLING. Contract drilling revenues for the six months ended December
31, 2001 increased $12,967,000, or 28.0%, to $59,290,000 from $46,323,000 for
the six months ended December 31, 2000. The increase in revenues was primarily
due to higher rig rates despite lower activity levels.
OPERATING EXPENSES
WELL SERVICING. Well servicing expenses for the six months ended December 31,
2001 increased $20,063,000, or 8.7%, to $249,872,000 from $229,809,000 for the
six months ended December 31, 2000. The increase was primarily due to a higher
level of activity and increased wages. Well servicing expenses, as a percentage
of well servicing revenue, decreased to 62.6% for the six months ended December
31, 2001 from 66.6% for the six months ended December 31, 2000.
CONTRACT DRILLING. Contract drilling expenses for the six months ended December
31, 2001 increased $2,710,000, or 7.6%, to $38,528,000 from $35,818,000 for the
six months ended December 31, 2000. The increase was primarily due to higher
wages. Contract drilling expenses, as a percentage of contract drilling
revenues, decreased to 65.0% for the six months ended December 31, 2001 from
77.3% for the six months ended December 31, 2000.
DEPRECIATION, DEPLETION AND AMORTIZATION EXPENSE
The Company's depreciation, depletion and amortization expense for the six
months ended December 31, 2001 increased $1,136,000, or 3.1%, to $37,593,000
from $36,457,000 for the six months ended December 31, 2000. The increase is due
to recent acquisitions and increased capital expenditures during the past twelve
months as the Company continued major
25
<Page>
refurbishments of well servicing and contract drilling equipment partially
offset by discontinued amortization of goodwill because of the Company's
adoption of SFAS 142.
GENERAL AND ADMINISTRATIVE EXPENSES
The Company's general and administrative expenses for the six months ended
December 31, 2001 increased $5,008,000, or 16.9%, to $34,639,000 from
$29,631,000 for the six months ended December 31, 2000. The increase was due
to higher administrative costs related to growth of the Company's operations
and reflects additional resources in technology and internal control
functions. General and administrative expenses, as a percentage of revenues,
remained constant at 7.5% for the six months ended December 31, 2001 and
December 31, 2000.
INTEREST EXPENSE
The Company's interest expense for the six months ended December 31, 2001
decreased $7,646,000, or 24.9%, to $23,046,000, from $30,692,000 for the six
months ended December 31, 2000. The decrease was primarily due to a significant
reduction in the Company's long-term debt using operating cash flow, and to a
lesser extent, lower interest rates. Included in the interest expense was the
amortization of debt issuance costs of $1,393,000 and $2,044,000 for the six
months ended December 31, 2001 and 2000, respectively.
BAD DEBT EXPENSE
The Company's bad debt expense for the six months ended December 31, 2001
decreased $595,000, or 65.9%, to $308,000 from $903,000 for the six months ended
December 31, 2000. The Company continues to carefully monitor credit risk
associated with our customers.
FOREIGN CURRENCY TRANSACTION LOSS
During the six months ended December 31, 2001, the Company recorded an Argentine
foreign currency transaction loss of approximately $1,844,000 related to
dollar-denominated receivables resulting from the recent devaluation of
Argentina's currency.
EXTRAORDINARY GAIN
During the six months ended December 31, 2001, the Company retired
$114,858,000 of its long-term debt, and expensed the related unamortized debt
issuance costs which resulted in a net after-tax extraordinary gain of
$2,271,000. During the six months ended December 31, 2000, the Company
retired $81,544,000 of its long-term debt, and expensed the related
unamortized debt issuance costs which resulted in a net after-tax
extraordinary gain of $1,265,000.
INCOME TAXES
The Company's income tax expense for the six months ended December 31, 2001
increased $16,357,000 to an expense of $28,045,000 from a expense of $11,688,000
for the six months
26
<Page>
ended December 31, 2000. The increase in income tax expense is due to the
increase in pretax income. The Company's effective tax rate for the six
months ended December 31, 2001 and December 31, 2000 was 38% and 39%,
respectively. The effective tax rates vary from the statutory rate of 35%
because of the disallowance of certain goodwill amortization (for the six
months ended December 31, 2000), and other non-deductible expenses and the
effects of state and local taxes.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically funded its operations, acquisitions, capital
expenditures and working capital requirements using cash flow from operations,
bank borrowings and the issuance of equity and long-term debt. The Company
believes that the current reserves of cash and cash equivalents, access to our
existing credit lines, access to capital markets and internally generated cash
flow from operations are and will be sufficient to finance the cash requirements
of our current and future operations.
CAPITAL EXPENDITURES
Capital expenditures for fiscal 2002 have been and will be directed toward
selectively refurbishing our assets as business conditions warrant. The Company
will continue to evaluate opportunities to acquire or divest assets or
businesses to enhance the Company's primary operations. Such capital
expenditures, acquisitions and divestitures are at the discretion of the Company
and will depend on management's view of market conditions as well as other
factors.
LONG-TERM DEBT
SENIOR CREDIT FACILITY
As of December 31, 2001, the Company had a senior credit facility (the "Senior
Credit Facility") with a syndicate of banks led by PNC Bank, N.A. which
consisted of a $100,000,000 revolving loan facility. In addition, up to
$20,000,000 of letters of credit can be issued under the Senior Credit Facility,
but any outstanding letters of credit reduce the borrowing availability under
the revolving loan facility. The commitment to make revolving loans will reduce
to $75,000,000 on September 14, 2002. The revolving loan commitment will
terminate on September 14, 2003, and all revolving loans must be paid on or
before that date. As of December 31, 2001, approximately $25,000,000 was drawn
under the revolving loan facility and approximately $12,000,000 of letters of
credit related to workman's compensation insurance were outstanding. The Company
drew down approximately $43 million on January 14, 2002 in order to redeem the
14% Senior Subordinated Notes.
The revolving loan bears interest based upon, at the Company's option, the prime
rate plus a variable margin of 0.75% to 2.00% or a Eurodollar rate plus a
variable margin of 2.25% to 3.50%. The Senior Credit Facility has customary
affirmative and negative covenants including a maximum debt to capitalization
ratio, a minimum interest coverage ratio, a maximum senior leverage ratio, a
minimum net worth and minimum EBITDA as well as restrictions on capital
expenditures, acquisitions and dispositions.
27
<Page>
8 3/8% SENIOR NOTES
On March 6, 2001, the Company completed a private placement of $175,000,000 of
8 3/8% Senior Notes due 2008 (the "8 3/8% Senior Notes"). The cash proceeds from
the private placement, net of fees and expenses, were used to repay all of the
remaining balance of the Tranche B term loan under the Senior Credit Facility,
and a portion of the revolving loan facility under the Senior Credit Facility.
The 8 3/8% Senior Notes are subordinate to the Company's senior indebtedness
which includes borrowings under the Senior Credit Facility and the Dawson 9 3/8%
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
(as subsequently adjusted) 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"). The 14% Senior Subordinated Notes
are subordinate to the Company's senior indebtedness which includes borrowings
under the Senior Credit Facility, the Dawson 9 3/8% Senior Notes and the 8 3/8%
Senior Notes. The Unit Warrants have separated from the 14% Senior Subordinated
Notes and became exercisable on January 25, 2000. At December 31, 2001,
$132,903,000 principal amount of the 14% Senior Subordinated Notes remained
outstanding. As of December 31, 2001, 63,500 Unit Warrants had been exercised
leaving 86,500 Unit Warrants outstanding.
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
may redeem up to 35% of the aggregate principal amount of the 14% Senior
Subordinated Notes with the proceeds of certain sales of equity at 114% of par
plus accrued interest. 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, leaving
$97,500,000 principal amount outstanding as of January 15, 2002. This
transaction resulted in an extraordinary loss before taxes of approximately
$8,468,000.
5% CONVERTIBLE SUBORDINATED NOTES
In late September and early October 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, the Dawson 9 3/8%
Senior Notes, and the 8 3/8% Senior Notes. The 5% Convertible Subordinated Notes
are convertible, at the holder's option, into shares of the
28
<Page>
Company's common stock at a conversion price of $38.50 per share, subject to
certain adjustments. During the quarter ended December 31, 2001, the Company
repurchased (and canceled) $61,581,000 principal amount of the 5% Convertible
Subordinated Notes, leaving $50,352,000 principal amount of the 5% Convertible
Subordinated Notes outstanding at December 31, 2001.
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 Annual Report on Form 10-K.
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
Recently the Financial Accounting Standards Board, ("FASB") issued Statement of
Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations ("SFAS 143"), and Statement of Financial Accounting Standards No.
144, Accounting for the Impairment of Disposal of Long-Lived Assets ("SFAS
144"). SFAS 143 establishes requirements for the accounting for removal costs
associated with asset retirements and SFAS 144 addresses financial accounting
and reporting for the impairment of disposal of long-lived assets. SFAS 143 is
effective for fiscal years beginning after June 15, 2002, with earlier adoption
encouraged, and SFAS 144 is effective for fiscal years beginning after December
15, 2001 and interim periods
29
<Page>
within those fiscal years. The Company is currently assessing the impact of
these standards on its 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 Company'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 December 31, 2001, the Company had long-term debt and capital lease
obligations outstanding of $403,711,000. Of this amount $354,634,000 or 88%,
bears interest at fixed rates as follows:
<Table>
<Caption>
BALANCE AT DECEMBER 31,
2001
--------------------------
(THOUSANDS)
8 3/8% Senior Notes Due 2008..................................................... $175,000
14% Senior Subordinated Notes Due 2009........................................... 128,263
5% Convertible Subordinated Notes Due 2004....................................... 50,352
Other (rates generally ranging from 8.0% to 8.5%)................................ 1,019
--------------------------
$354,634
==========================
</Table>
The remaining $49,077,000 of long-term debt and capital lease obligations
outstanding as of December 31, 2001 bears interest at floating rates which
averaged approximately 5.9% at December 31, 2001. A 10% increase in short-term
interest rates on the floating-rate debt outstanding at December 31, 2001 would
equal approximately 59 basis points. Such an increase in interest rates would
increase Key's fiscal 2002 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.
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<Page>
FOREIGN CURRENCY RISK
Recently, 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 from its Argentina subsidiaries are
based on the U.S. dollar equivalent of such amounts measured in Argentine
pesos as of December 31, 2001. Assets and liabilities of the Argentine
operations were translated to U.S. dollars at December 31, 2001, using the
applicable free market conversion ratio of 1.6:1. Key's net earnings and cash
flows from its Argentina subsidiaries were tied to the U.S. dollar for the
six months ended December 31, 2001 and will be based on the U.S. dollar
equivalent of such amounts measured in Argentine pesos for periods after
December 31, 2001. Revenues, expenses and cash flow will be translated using
the average exchange rates during the periods after December 31, 2001. See
Note 10 to the consolidated financial statements.
A 10% change in the Argentine peso to the U.S. dollar exchange rate would not be
material to the net assets, net earnings or cash flows of Key.
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, expenses and cash flow 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 Key.
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 for natural gas. Pricing for oil and natural gas production
has been volatile and unpredictable for several 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 December 31, 2001, Key had oil and natural gas price collars and put
options in place, as detailed in the following table. The total fiscal 2002
hedged oil and natural gas volumes represent 37% and 30%, respectively, of 2001
calendar year total production. A 10% variation in the market price of oil or
natural gas from their levels at December 31, 2001 would have no material impact
on the Company's net assets, net earnings or cash flows (as derived from the
commodity option contracts).
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<Page>
The following table sets forth the future volumes hedged by year and the
weighted-average strike price of the option contracts at December 31, 2001:
<Table>
<Caption>
MONTHLY VOLUMES STRIKE PRICE
--------------- ------------
NATURAL PER BBL/MMBTU
OIL GAS -------------
(BBLS) (MMBTUS) TERM FLOOR CAP FAIR VALUE
------ -------- ---- ----- --- ----------
At December 31, 2001
Oil Collars........ 5,000 - Mar 2001-Feb 2002 $19.70 $23.70 $ 7,000
Oil Puts........... 5,000 - Mar 2002-Feb 2003 22.00 - 169,000
Natural Gas Collars - 40,000 Mar 2001-Feb 2002 2.40 2.91 3,000
Natural Gas Puts... - 75,000 Mar 2002-Feb 2003 3.00 - 746,000
</Table>
(The strike prices for oil are based on the NYMEX spot price for West
Texas Intermediate; the strike prices for the natural gas collars are
based on the Inside FERC-West Texas Waha spot price; the strike prices
for the natural gas puts are based on the Inside FERC-El Paso Permian
spot price.)
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<Page>
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
10.1 Tenth Amendment to the Second Amended and
Restated Credit Agreement, dated as of June 6,
1997, as amended and restated through September
14, 1998 and as further amended, among Key
Energy Group, Inc. (now known as Key Energy
Services, Inc.), the several Lenders from time
to time parties thereto, PNC Bank, National
Association, as Administrative Agent, Norwest
Bank Texas, N.A., as Collateral Agent and PNC
Capital Markets, Inc., as Arranger.
(Incorporated by reference to Exhibit 10.1 of
the Company's Form 8-K filed on December 19,
2001, File No. 1-8038.)
10.2 Underwriting Agreement, dated December 13, 2001,
between the Registrant and Lehman Brothers Inc.
(Incorporated by reference to Exhibit 1.1 of the
Company's Form 8-K filed on December 19, 2001,
File No. 1-8038.)
*10.3 Employment agreement between Key Energy Services,
Inc. and Royce W. Mitchell dated December 31,
2001.
*10.4 Employment agreement between Key Energy Services,
Inc. and James Byerlotzer dated December 31,
2001.
33
<Page>
*10.5 First Amendment to Second Amended and Restated
Employment Agreement between Francis D. John and
Key Energy Services, Inc. dated December 31, 2001
(b) The Company filed the following reports on Form 8-K during the
quarter ended December 31, 2001:
(i) Current report on Form 8-K dated November 26, 2001
filed to report the resignation of William D. Manly
from the Board of Directors and the appointment of
J. Robinson West to the Board of Directors.
(ii) Current report on Form 8-K dated December 19, 2001
filed to report the public offering of 5,400,000 shares of
the Company's common stock and also to report certain
management changes.
----------------------
* Filed herewith.
34
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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: February ___, 2002 By: /s/ FRANCIS D. JOHN
----------------------------------
Francis D. John
President and Chief Executive Officer
Dated: February ___, 2002 By: /s/ ROYCE W. MITCHELL
-----------------------------
Royce W. Mitchell
Chief Financial Officer and
Chief Accounting Officer
35