<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 March 31, 2002
/ / 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 May 14, 2002: 109,774,213
1
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KEY ENERGY SERVICES, INC.
INDEX
<Table>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
March 31, 2002 (unaudited) and June 30, 2001...............................3
Unaudited Consolidated Statements of
Operations for the Three and Nine Months Ended
March 31, 2002 and 2001....................................................4
Unaudited Consolidated Statements of
Cash Flows for the Three and Nine Months Ended
March 31, 2002 and 2001....................................................5
Unaudited Consolidated Statements of Comprehensive
Income (Loss) for the Three and Nine Months Ended
March 31, 2002 and 2001....................................................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................................................................................36
</Table>
2
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KEY ENERGY SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
MARCH 31, 2002 JUNE 30, 2001
-------------- -------------
(UNAUDITED)
(THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Current assets:
Cash and cash equivalents ................................................................ $ 42,967 $ 2,098
Accounts receivable, net of allowance for doubtful accounts of $4,307 and $4,082,
at March 31, 2002 and June 30, 2001, respectively ...................................... 122,734 177,016
Inventories ............................................................................... 8,712 16,547
Prepaid expenses and other current assets ................................................. 11,959 10,489
----------- -----------
Total current assets ........................................................................ 186,372 206,150
----------- -----------
Property and equipment:
Well servicing equipment .................................................................. 761,629 723,724
Contract drilling equipment ............................................................... 120,456 119,122
Motor vehicles ............................................................................ 69,202 64,907
Oil and natural gas properties and other related equipment, successful efforts
method ................................................................................. 44,616 44,245
Furniture and equipment ................................................................... 32,511 24,865
Buildings and land ........................................................................ 38,809 37,812
----------- -----------
Total property and equipment ................................................................ 1,067,223 1,014,675
Accumulated depreciation and depletion ...................................................... (266,027) (220,959)
----------- -----------
Net property and equipment .................................................................. 801,196 793,716
----------- -----------
Goodwill, net of accumulated amortization of $27,819 at March 31, 2002 and
$28,168 at June 30, 2001 .................................................................. 200,287 189,875
Deferred costs, net ......................................................................... 12,990 17,624
Notes and accounts receivable - related parties ............................................. 521 6,050
Other assets ................................................................................ 30,541 14,869
----------- -----------
Total assets ................................................................................ $ 1,231,907 $ 1,228,284
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................................................... $ 20,521 $ 42,544
Other accrued liabilities ................................................................. 42,299 48,923
Accrued interest .......................................................................... 5,099 16,140
Current portion of long-term debt and capital lease obligations ........................... 8,370 7,946
----------- -----------
Total current liabilities ................................................................... 76,289 115,553
----------- -----------
Long-term debt, less current portion ........................................................ 421,338 470,578
Capital lease obligations, less current portion ............................................. 16,011 15,383
Deferred revenue ............................................................................ 10,651 14,104
Non-current accrued expenses ................................................................ 10,206 8,388
Deferred tax liability ...................................................................... 151,197 127,400
Commitments and contingencies ............................................................... - -
Stockholders' equity:
Common stock, $.10 par value: 200,000,000 shares authorized, 110,067,514 and 101,440,166
shares issued, at March 31, 2002 and June 30, 2001, respectively ....................... 11,007 10,144
Additional paid-in capital ............................................................... 513,378 444,768
Treasury stock, at cost; 416,666 shares at March 31, 2002 and June 30, 2001 .............. (9,682) (9,682)
Accumulated other comprehensive income (loss) ............................................ (44,083) 62
Retained earnings ........................................................................ 75,595 31,586
----------- -----------
Total stockholders' equity .................................................................. 546,215 476,878
----------- -----------
Total liabilities and stockholders' equity .................................................. $ 1,231,907 $ 1,228,284
=========== ===========
</Table>
SEE THE ACCOMPANYING NOTES WHICH ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS.
3
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KEY ENERGY SERVICES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
2002 2001 2002 2001
------------------------------------------------
(THOUSANDS, EXCEPT PER SHARE DATA)
REVENUES:
Well servicing .............................................................. $ 154,062 $ 198,059 $ 552,901 $ 543,274
Contract drilling ........................................................... 14,334 28,259 73,624 74,582
Other ....................................................................... 1,845 1,052 6,290 5,104
---------------------- ----------------------
170,241 227,370 632,815 622,960
---------------------- ----------------------
COSTS AND EXPENSES:
Well servicing .............................................................. 113,032 128,803 368,932 362,814
Contract drilling ........................................................... 11,392 19,730 49,920 55,548
Depreciation, depletion and amortization .................................... 19,889 19,703 57,482 56,160
General and administrative .................................................. 13,694 16,594 42,613 42,926
Interest .................................................................... 9,875 13,453 32,921 44,145
Other expenses .............................................................. 951 1,175 3,286 3,163
Foreign currency transaction loss, Argentina (see Note 10) .................. - - 1,844 -
---------------------- ----------------------
168,833 199,458 556,998 564,756
---------------------- ----------------------
Income before income taxes .................................................. 1,408 27,912 75,817 58,204
Income tax expense .......................................................... (773) (10,325) (28,818) (22,013)
---------------------- ----------------------
Income before extraordinary gain (loss) ..................................... 635 17,587 46,999 36,191
Extraordinary gain (loss) on retirement of debt, less applicable
income tax benefit of $3,207 and $1,833 for the three and nine months ended
March 31, 2002, respectively, and income tax benefit of $98 and income tax
expense of $651, for the three and nine
months ended March 31, 2001, respectively ................................. (5,261) (167) (2,990) 1,098
---------------------- ----------------------
NET INCOME (LOSS) .............................................................. $ (4,626) $ 17,420 $ 44,009 $ 37,289
========= ========= ========= =========
EARNINGS (LOSS) PER SHARE:
Basic - before extraordinary gain (loss) .................................... $ 0.01 $ 0.18 $ 0.45 $ 0.37
Extraordinary gain (loss), net of tax ....................................... (0.05) - (0.03) 0.01
---------------------- ----------------------
Basic - after extraordinary gain (loss) ..................................... $ (0.04) $ 0.18 $ 0.42 $ 0.38
========= ========= ========= =========
Diluted - before extraordinary gain (loss) .................................. $ 0.01 $ 0.17 $ 0.44 $ 0.36
Extraordinary gain (loss), net of tax ....................................... (0.05) - (0.03) 0.01
---------------------- ----------------------
Diluted - after extraordinary gain (loss) ................................... $ (0.04) $ 0.17 $ 0.41 $ 0.37
========= ========= ========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic ....................................................................... 108,551 98,211 104,435 97,537
Diluted ..................................................................... 110,059 103,524 105,781 101,969
</Table>
SEE THE ACCOMPANYING NOTES WHICH ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS.
4
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KEY ENERGY SERVICES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
2002 2001 2002 2001
---------------------------------------------------
(THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ........................................................... $ (4,626) $ 17,420 $ 44,009 $ 37,289
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Depreciation, depletion and amortization .................................. 19,889 19,703 57,482 56,160
Amortization of deferred debt issuance costs and other deferred
costs ................................................................... 277 928 1,266 3,344
Deferred income taxes ..................................................... 3,076 10,325 25,407 22,013
(Gain) loss on sale of assets ............................................. 146 50 (684) 10
Foreign currency transaction loss, Argentina .............................. - - 1,844 -
Extraordinary (gain) loss, net of tax ..................................... 5,261 167 2,990 (1,098)
CHANGE IN ASSETS AND LIABILITIES:
(Increase) decrease in accounts receivable ................................ 23,848 (18,018) 47,059 (39,628)
(Increase) decrease in other current assets ............................... 69 (4,284) (2,428) (2,446)
Increase (decrease) in accounts payable, accrued interest and
accrued expenses ........................................................ (14,963) 11,583 (34,429) 8,267
Other assets and liabilities .............................................. (3,091) (1,189) (9,813) (1,761)
---------------------- ----------------------
Net cash provided by (used in) operating activities ......................... 29,886 36,685 132,703 82,150
---------------------- ----------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures - well servicing ....................................... (13,323) (13,492) (41,635) (30,587)
Capital expenditures - contract drilling .................................... (3,126) (4,913) (14,203) (12,087)
Capital expenditures - other ................................................ (2,064) (5,123) (7,603) (11,215)
Proceeds from sale of fixed assets .......................................... 307 478 3,962 1,430
Acquisitions - well servicing ............................................... (8,202) (270) (16,877) (1,970)
Acquisitions - contract drilling ............................................ - - - (800)
---------------------- ----------------------
Net cash provided by (used in) investing activities ......................... (26,408) (23,320) (76,356) (55,229)
---------------------- ----------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt ................................................. (123,782) (207,241) (308,713) (329,838)
Repayment of capital lease obligations ...................................... (2,732) (1,519) (7,731) (5,868)
Proceeds from long-term debt ................................................ 159,500 199,000 258,500 203,000
Proceeds from equity offering, net of expenses .............................. - - 42,590 -
Proceeds paid for debt issuance costs ....................................... (1,585) (4,372) (1,585) (4,372)
Proceeds from exercise of warrants .......................................... - - - 265
Proceeds from exercise of stock options ..................................... 194 1,275 1,814 2,632
Other ....................................................................... 5 (132) (84) (318)
---------------------- ----------------------
Net cash provided by (used in) financing activities ......................... 31,600 (12,989) (15,209) (134,499)
---------------------- ----------------------
Effect of exchange rates on cash ............................................ (77) - (269) -
Net increase (decrease) in cash and cash equivalents ........................ 35,001 376 40,869 (107,578)
Cash and cash equivalents at beginning of period ............................ 7,966 1,919 2,098 109,873
---------------------- ----------------------
Cash and cash equivalents at end of period .................................. $ 42,967 $ 2,295 $ 42,967 $ 2,295
====================== ======================
</Table>
SEE THE ACCOMPANYING NOTES WHICH ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS.
5
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KEY ENERGY SERVICES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
2002 2001 2002 2001
-----------------------------------------------
(THOUSANDS)
NET INCOME (LOSS) .............................................................. $ (4,626) $ 17,420 $ 44,009 $ 37,289
OTHER COMPREHENSIVE INCOME (LOSS):
Derivative transition adjustment (see Note 7) ............................... - - - (778)
Oil and natural gas derivatives adjustment, net of tax (see Note 7) ......... (459) (29) (102) (81)
Amortization of oil and natural gas derivatives, net of tax (see
Note 7) ................................................................... (323) 153 (511) 445
Foreign currency translation loss, net of tax (see Note 10) ................. (19,308) (61) (43,533) (57)
--------------------- ---------------------
COMPREHENSIVE INCOME (LOSS) .................................................... $(24,716) $ 17,483 $ (137) $ 36,818
===================== =====================
</Table>
SEE THE ACCOMPANYING NOTES WHICH ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS.
6
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KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
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 March 31, 2002 and
for the three and nine month periods ended March 31, 2002 and 2001 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 nine month periods ended March 31,
2002 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 nine month periods ended March 31, 2001 to conform
to the presentation for the three and nine month periods ended March 31, 2002.
The reclassifications consist primarily of reclassifying certain items from
general and administrative expense considered to be direct expenses in nature.
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
MARCH 31, 2002 AND 2001
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
2002 2001 2002 2001
--------- --------- --------- ---------
(THOUSANDS, EXCEPT PER (THOUSANDS, EXCEPT PER
SHARE DATA) SHARE DATA)
BASIC EPS COMPUTATION:
NUMERATOR
Net income before extraordinary gain (loss)........ $ 635 $ 17,587 $ 46,999 $ 36,191
Extraordinary gain (loss), net of tax.............. (5,261) (167) (2,990) 1,098
--------- --------- --------- ---------
Net income (loss).................................. $ (4,626) $ 17,420 $ 44,009 $ 37,289
========= ========= ========= =========
DENOMINATOR
Weighted average common shares outstanding......... 108,551 98,211 104,435 97,537
--------- --------- --------- ---------
BASIC EPS:
Before extraordinary gain (loss)................... $0.01 $0.18 $0.45 $0.37
Extraordinary gain (loss), net of tax.............. (0.05) - (0.03) 0.01
--------- --------- --------- ---------
After extraordinary gain (loss).................... $ (0.04) $ 0.18 $ 0.42 $ 0.38
========= ========= ========= =========
DILUTED EPS COMPUTATION:
NUMERATOR
Net income before extraordinary gain (loss)........ $ 635 $ 17,587 $ 46,999 $ 36,191
Effect of dilutive convertible securities, tax
effected......................................... - - - 8
Extraordinary gain (loss), net of tax.............. (5,261) (167) (2,990) 1,098
--------- --------- --------- ---------
Net income (loss).................................. $ (4,626) $ 17,420 $ 44,009 $ 37,297
========= ========= ========= =========
DENOMINATOR
Weighted average common shares outstanding......... 108,551 98,211 104,435 97,537
Warrants........................................... 388 869 368 781
Stock options...................................... 1,120 4,444 978 3,627
7% Convertible Debentures.......................... - - - 24
--------- --------- --------- ---------
110,059 103,524 105,781 101,969
--------- --------- --------- ---------
DILUTED EPS:
Before extraordinary gain (loss)................... $ 0.01 $ 0.17 $ 0.44 $ 0.36
Extraordinary gain (loss), net of tax.............. (0.05) - (0.03) 0.01
--------- --------- --------- ---------
After extraordinary gain (loss).................... $ (0.04) $ 0.17 $ 0.41 $ 0.37
========= ========= ========= =========
</Table>
The diluted earnings per share calculation (i) for the three month period ended
March 31, 2002 excludes the effects of 1,178,000 stock options and (ii) for the
nine month period ended March 31, 2002 excludes the effects of 1,678,000 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 nine month periods
ended March 31, 2001 excludes the effects of 375,000 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
MARCH 31, 2002 AND 2001
3. STOCKHOLDERS' EQUITY
EQUITY OFFERING
On December 19, 2001, the Company closed a public offering of 5,400,000 shares
of common stock, yielding approximately $43.2 million or $8.00 per share to the
Company, (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 ultimately 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 issued.
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.
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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<Table>
<Caption>
WELL CONTRACT CORPORATE
SERVICING DRILLING /OTHER TOTAL
--------- -------- ------ -----
(THOUSANDS)
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) before extraordinary gain (loss)*.. 11,406 (804) (9,967) 635
Identifiable assets.................................. 679,256 89,795 262,569 1,031,620
Capital expenditures (excluding acquisitions)........ 13,323 3,126 2,064 18,513
THREE MONTHS ENDED MARCH 31, 2001
Operating revenues................................... $ 198,059 $ 28,259 $ 1,052 $ 227,370
Operating profit..................................... 69,256 8,529 (123) 77,662
Depreciation, depletion and amortization............. 16,496 2,009 1,198 19,703
Interest expense..................................... 393 - 13,060 13,453
Net income (loss) before extraordinary gain (loss)*.. 28,919 3,174 (14,506) 17,587
Identifiable assets.................................. 648,019 93,926 256,974 998,919
Capital expenditures (excluding acquisitions)........ 13,492 4,913 5,123 23,528
</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 March 31, 2002 and 2001 were $4.0 million and $13.5 million, respectively.
Operating profits for the Company's foreign operations for the three months
ended March 31, 2002 and 2001 were $0.7 million and $3.5 million, respectively.
The Company had $31.6 million and $84.1 million of identifiable assets as of
March 31, 2002 and 2001, respectively, related to foreign operations.
10
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KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
<Table>
<Caption>
WELL CONTRACT CORPORATE
SERVICING DRILLING /OTHER TOTAL
--------- -------- ------ -----
(THOUSANDS)
NINE MONTHS ENDED MARCH 31, 2002
Operating revenues.................................... $ 552,901 $ 73,624 $ 6,290 $ 632,815
Operating profit...................................... 183,969 23,704 3,004 210,677
Depreciation, depletion and amortization.............. 47,480 6,935 3,067 57,482
Interest expense...................................... 1,209 - 31,712 32,921
Net income (loss) before extraordinary gain (loss)*... 71,673 7,827 (32,501) 46,999
Identifiable assets................................... 679,256 89,795 262,569 1,031,620
Capital expenditures (excluding acquisitions)......... 41,635 14,203 7,603 63,441
NINE MONTHS ENDED MARCH 31, 2001
Operating revenues.................................... $ 543,274 $ 74,582 $ 5,104 $ 622,960
Operating profit...................................... 180,460 19,034 1,941 201,435
Depreciation, depletion and amortization.............. 47,446 5,705 3,009 56,160
Interest expense...................................... 1,496 - 42,649 44,145
Net income (loss) before extraordinary gain (loss)*... 74,885 5,529 (44,223) 36,191
Identifiable assets................................... 648,019 93,926 256,974 998,919
Capital expenditures (excluding acquisitions)......... 30,587 12,087 11,215 53,889
*Net income (loss) includes general and administrative
expenses allocated on a percentage of revenue basis.
</Table>
Operating revenues for the Company's foreign operations for the nine months
ended March 31, 2002 and 2001 were $28.0 million and $40.0 million,
respectively. Operating profits for the Company's foreign operations for the
nine months ended March 31, 2002 and 2001 were $5.4 million and $9.8 million,
respectively. The Company had $31.6 million and $84.1 million of identifiable
assets as of March 31, 2002 and 2001, 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
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
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 $64,000 of the transition
adjustment was recognized in earnings during the three months ended March 31,
2002. The transition adjustment has been completely recognized in earnings. As
of October 1, 2000, the Company has documented the March 30, 2000 collars as
cash flow hedges. As of July 1, 2001, the Company has documented the May 25,
2001 options as cash flow hedges. During the quarter ended March 31, 2002, the
Company recorded a net decrease in net derivative assets of approximately
$749,000, which reduced the balance of net derivative assets to $179,000 and
which included an earnings charge of approximately $2,000 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 No. 138.
12
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
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
MARCH 31, 2002 AND 2001
CONDENSED CONSOLIDATING BALANCE SHEETS
<Table>
<Caption>
MARCH 31, 2002
------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------- ------------ ------------
(THOUSANDS)
Assets:
Current assets.................... $ 50,402 $ 126,529 $ 9,441 $ - $ 186,372
Net property and equipment........ 31,147 747,851 22,198 - 801,196
Goodwill, net..................... 3,374 196,192 721 - 200,287
Deferred costs, net............... 12,990 - - - 12,990
Intercompany receivables.......... 565,075 - - (565,075) -
Other assets...................... 22,517 8,545 - - 31,062
--------- ----------- ---------- ----------- -----------
Total assets.......................... $ 685,505 $ 1,079,117 $ 32,360 $ (565,075) $ 1,231,907
========= =========== ========== =========== ===========
Liabilities and equity:
Current liabilities............... $ 32,340 $ 40,954 $ 2,994 $ - $ 76,288
Long-term debt.................... 421,338 - - - 421,338
Capital lease obligations......... 1,160 14,851 - - 16,011
Intercompany payables............. - 541,503 23,572 (565,075) -
Deferred tax liability............ 151,197 - - - 151,197
Other long-term liabilities....... 10,106 10,751 - - 20,857
Stockholders' equity.............. 69,364 471,058 5,794 - 546,216
--------- ----------- ---------- ----------- -----------
Total liabilities and
stockholders' equity.............. $ 685,505 $ 1,079,117 $ 32,360 $ (565,075) $ 1,231,907
========= =========== ========== =========== ===========
</Table>
<Table>
<Caption>
JUNE 30, 2001
------------------------------------------------------------------------
PARENT GUARANTOR NON-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
MARCH 31, 2002 AND 2001
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
<Table>
<Caption>
THREE MONTHS ENDED MARCH 31, 2002
------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES 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..................... 464 18,811 614 - 19,889
General and administrative........ 5,526 7,725 443 - 13,694
Interest.......................... 9,619 276 (20) - 9,875
Argentine foreign currency
transaction loss................. - - - - -
Other expenses.................... - - - - -
--------- ----------- ---------- ---- -----------
Total costs and expenses.............. 15,609 148,817 4,407 - 168,833
--------- ----------- ---------- ---- -----------
Income (loss) before income taxes..... (15,299) 17,082 (375) - 1,408
Income tax (expense) benefit.......... 8,399 (9,378) 206 - (773)
--------- ----------- ---------- ---- -----------
Income (loss) before
extraordinary items.................. (6,900) 7,704 (169) - 635
Extraordinary loss, net of tax........ (5,261) - - - (5,261)
--------- ----------- ---------- ---- -----------
Net income (loss)..................... $ (12,161) $ 7,704 $ (169) $ - $ (4,626)
========= =========== ========== ==== ===========
</Table>
<Table>
<Caption>
THREE MONTHS ENDED MARCH 31, 2001
------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------- ------------ ------------
(THOUSANDS)
Revenues.............................. $ 246 $ 213,650 $ 13,474 $ - $ 227,370
Costs and expenses:
Direct expenses................... - 139,707 10,001 - 149,708
Depreciation, depletion and
amortization..................... 686 17,973 1,044 - 19,703
General and administrative........ 5,333 10,368 893 - 16,594
Interest.......................... 13,060 183 210 - 13,453
Other expenses.................... - - - - -
--------- ----------- ---------- ---- -----------
Total costs and expenses.............. 19,079 168,231 12,148 - 199,458
--------- ----------- ---------- ---- -----------
Income (loss) before income taxes..... (18,833) 45,419 1,326 - 27,912
Income tax (expense) benefit.......... 6,966 (16,801) (490) - (10,325)
--------- ----------- ---------- ---- -----------
Income (loss) before
extraordinary items.................. (11,867) 28,618 836 - 17,587
Extraordinary loss, net of tax........ (167) - - - (167)
--------- ----------- ---------- ---- -----------
Net income (loss)..................... $ (12,034) $ 28,618 $ 836 $ - $ 17,420
========= =========== ========== ==== ===========
</Table>
15
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
<Table>
<Caption>
NINE MONTHS ENDED MARCH 31, 2002
------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------- ------------ ------------
(THOUSANDS)
Revenues........................... $ 1,134 $ 603,656 $ 28,025 $ - $ 632,815
Costs and expenses:
Direct expenses................ - 399,486 22,652 - 422,138
Depreciation, depletion and
amortization.................. 1,204 53,534 2,744 - 57,482
General and administrative..... 15,448 25,213 1,952 - 42,613
Interest....................... 31,711 622 588 - 32,921
Argentine foreign currency
transaction loss.............. - - 1,844 - 1,844
Other expenses................. - - - - -
--------- ----------- ---------- ---- -----------
Total costs and expenses........... 48,363 478,855 29,780 - 556,998
--------- ----------- ---------- ---- -----------
Income (loss) before income taxes.. (47,229) 124,801 (1,755) - 75,817
Income tax (expense) benefit....... 17,951 (47,436) 667 - (28,818)
--------- ----------- ---------- ---- -----------
Income (loss) before
extraordinary items............... (29,278) 77,365 (1,088) - 46,999
Extraordinary loss, net of tax..... (2,990) - - - (2,990)
--------- ----------- ---------- ---- -----------
Net income (loss).................. $ (32,268) $ 77,365 $ (1,088) $ - $ 44,009
========= =========== ========== ==== ===========
</Table>
<Table>
<Caption>
NINE MONTHS ENDED MARCH 31, 2001
------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------- ------------ ------------
(THOUSANDS)
Revenues........................... $ 1,821 $ 581,126 $ 40,013 $ - $ 622,960
Costs and expenses:
Direct expenses................ - 391,239 30,286 - 421,525
Depreciation, depletion and
amortization.................. 1,463 51,668 3,029 - 56,160
General and administrative..... 12,538 27,798 2,590 - 42,926
Interest....................... 42,649 977 519 - 44,145
Other expenses................. - - - - -
--------- ----------- ---------- ---- -----------
Total costs and expenses........... 56,650 471,682 36,424 - 564,756
--------- ----------- ---------- ---- -----------
Income (loss) before income taxes.. (54,829) 109,444 3,589 - 58,204
Income tax (expense) benefit....... 20,736 (41,392) (1,357) - (22,013)
--------- ----------- ---------- ---- -----------
Income (loss) before
extraordinary items............... (34,093) 68,052 2,232 - 36,191
Extraordinary gain, net of tax..... 1,098 - - - 1,098
--------- ----------- ---------- ---- -----------
Net income (loss).................. $ (32,995) $ 68,052 $ 2,232 $ - $ 37,289
========= =========== ========== ==== ===========
</Table>
16
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
<Table>
<Caption>
THREE MONTHS ENDED MARCH 31, 2002
------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------- ------------ ------------
(THOUSANDS)
Net cash provided by operating
activities........................ $ 11,408 $ 16,179 $ 2,299 $ - $ 29,886
Net cash used in investing
activities........................ (11,062) (12,781) (2,565) - (26,408)
Net cash provided by (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
========= =========== ========== ===== ===========
</Table>
<Table>
<Caption>
THREE MONTHS ENDED MARCH 31, 2001
------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------- ------------ ------------
(THOUSANDS)
Net cash provided by operating
activities........................ $ 10,819 $ 22,173 $ 3,693 $ - $ 36,685
Net cash used in investing
activities........................ (5,226) (15,678) (2,416) - (23,320)
Net cash used in financing
activities........................ (11,462) (1,513) (14) - (12,989)
--------- ----------- ---------- ----- -----------
Net increase (decrease) in cash...... (5,869) 4,982 1,263 - 376
Cash at beginning of period.......... 7,477 (6,387) 829 - 1,919
--------- ----------- ---------- ----- -----------
Cash at end of period................ $ 1,608 $ (1,405) $ 2,092 $ - $ 2,295
========= =========== ========== ===== ===========
</Table>
17
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
<Table>
<Caption>
NINE MONTHS ENDED MARCH 31, 2002
------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------- ------------ ------------
(THOUSANDS)
Net cash provided by operating
activities........................ $ 66,569 $ 63,064 $ 3,070 $ - $ 132,703
Net cash used in investing
activities........................ (23,443) (49,009) (3,904) - (76,356)
Net cash used in financing
activities........................ (7,809) (7,387) (13) - (15,209)
Effect of exchange rate changes on
cash.............................. - - (269) - (269)
--------- ----------- ---------- ----- -----------
Net increase (decrease) in cash...... 35,317 6,668 (1,116) - 40,869
Cash at beginning of period.......... 1,647 (2,005) 2,456 - 2,098
--------- ----------- ---------- ----- -----------
Cash at end of period................ $ 36,964 $ 4,663 $ 1,340 $ - $ 42,967
========= =========== ========== ===== ===========
</Table>
<Table>
<Caption>
NINE MONTHS ENDED MARCH 31, 2001
------------------------------------------------------------------------
PARENT GUARANTOR NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------- ------------ ------------
(THOUSANDS)
Net cash provided by operating
activities........................ $ 32,208 $ 42,097 $ 7,845 $ - $ 82,150
Net cash used in investing
activities........................ (13,132) (36,432) (5,665) - (55,229)
Net cash used in financing
activities........................ (128,634) (5,824) (41) - (134,499)
--------- ----------- ---------- ----- -----------
Net increase (decrease) in cash...... (109,558) (159) 2,139 - (107,578)
Cash at beginning of period.......... 111,166 (1,246) (47) - 109,873
--------- ----------- ---------- ----- -----------
Cash at end of period................ $ 1,608 $ (1,405) $ 2,092 $ - $ 2,295
========= =========== ========== ===== ===========
</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 is
measured as the excess of its carrying value over its fair value. The Company
completed its 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.
18
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
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 $11,163,000 and $8,099,000 at March 31, 2002 and June 30,
2001, respectively. Accumulated amortization related to these intangible assets
totaled approximately $5,404,000 and $4,953,000 at March 31, 2002 and June 30,
2001, respectively. Amortization expense for the three months ended March 31,
2002 and 2001 was approximately $415,000 and $379,000, respectively.
Amortization expense for the nine months ended March 31, 2002 and 2001 was
approximately $1,185,000 and $1,107,000, respectively. Amortization expense for
the next five succeeding fiscal years is estimated to be $1,990,000, $1,048,000,
$841,000, $793,000 and $443,000.
The Company has identified its reporting segments to be well servicing and
contract drilling. Goodwill allocated to such reporting segments at March 31,
2002 is $186,175,000 and $14,112,000, respectively. The change in the carrying
amount of goodwill for the three and nine months ended March 31, 2002 of
$7,070,000 and $10,412,000, respectively, relates principally to goodwill from
well servicing assets acquired during the period and the translation adjustment
for Argentina.
19
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
The effect of the adoption of SFAS 142 on net income and earnings per share is
as follows:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
2002 2001 2002 2001
--------- --------- --------- ---------
(THOUSANDS, EXCEPT PER (THOUSANDS, EXCEPT PER
SHARE DATA) SHARE DATA)
Reported net income before extraordinary gain (loss).. $ 635 $ 17,587 $ 46,999 $ 36,191
Add back: goodwill amortization...................... - 2,333 - 6,989
--------- --------- --------- ---------
Adjusted net income before extraordinary gain (loss).. 635 19,920 46,999 43,180
Extraordinary gain (loss), net of tax................. (5,261) (167) (2,990) 1,098
--------- --------- --------- ---------
Adjusted net income (loss)............................ $ (4,626) $ 19,753 $ 44,009 $ 44,278
========= ========= ========= =========
BASIC EARNINGS (LOSS) PER SHARE:
Reported net income before extraordinary gain (loss).. $ 0.01 $ 0.18 $ 0.45 $ 0.37
Add back: goodwill amortization...................... - 0.02 - 0.07
--------- --------- --------- ---------
Adjusted net income before extraordinary gain (loss).. $ 0.01 $ 0.20 $ 0.45 $ 0.44
Extraordinary gain (loss), net of tax................. (0.05) - (0.03) 0.01
--------- --------- --------- ---------
Adjusted net income (loss)............................ $ (0.04) $ 0.20 $ 0.42 $ 0.45
========= ========= ========= =========
DILUTED EARNINGS (LOSS) PER SHARE:
Reported net income before extraordinary gain (loss).. $ 0.01 $ 0.17 $ 0.44 $ 0.36
Add back: goodwill amortization...................... - 0.02 - 0.07
--------- --------- --------- ---------
Adjusted net income before extraordinary gain (loss).. $ 0.01 $ 0.19 $ 0.44 $ 0.43
Extraordinary gain (loss), net of tax................. (0.05) - (0.03) 0.01
--------- --------- --------- ---------
Adjusted net income (loss)............................ $ (0.04) $ 0.19 $ 0.41 $ 0.44
========= ========= ========= =========
</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 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
20
<Page>
KEY ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
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 was
indicative of the free floating conversion ratio when the currency market
re-opened on January 11, 2002. At March 31, 2002, the Company used a conversion
ratio of 2.9:1 to translate the assets and liabilities of its Argentine
subsidiary. As a result, a foreign currency translation loss of approximately
$43.5 and $24.2 million is included in other comprehensive income, a component
of stockholders' equity, at March 31, 2002 and December 31, 2001, respectively.
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. After December 31, 2001, revenues and expenses are
translated using the average exchange rate during the reporting period.
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 nine months ended March 31, 2002 were at levels
slightly 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 third 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 MARCH 31, 2002 VERSUS THREE MONTHS ENDED MARCH 31, 2001
The Company's revenue for the three months ended March 31, 2002 decreased
$57,129,000, or 25.1%, to $170,241,000 from $227,370,000 for the three months
ended March 31, 2001. The decrease in the current period reflects lower activity
levels despite improved rates. The Company's net loss for the third quarter of
fiscal 2002 totaled $4,626,000, or $0.04 per dilutive share, versus a net income
of $17,420,000, or $0.17 per dilutive share, for the prior year period.
OPERATING REVENUES
WELL SERVICING. Well servicing revenues for the three months ended March 31,
2002 decreased $43,997,000, or 22.2%, to $154,062,000 from $198,059,000 for the
three months ended March 31, 2001. The decrease in revenues was primarily due to
lower activity levels despite higher rig and fluid hauling rates.
CONTRACT DRILLING. Contract drilling revenues for the three months ended March
31, 2002 decreased $13,925,000, or 49.3%, to $14,334,000 from $28,259,000 for
the three months ended March 31, 2001. The decrease in revenues was primarily
due to lower activity levels and slightly lower rig rates.
OPERATING EXPENSES
WELL SERVICING. Well servicing expenses for the three months ended March 31,
2002 decreased $15,771,000, or 12.2%, to $113,032,000 from $128,803,000 for the
three months ended March 31, 2001. The decrease was primarily due to lower
levels of activity partially offset by higher insurance costs. Well servicing
expenses, as a percentage of well servicing revenue, increased to 73.4% for the
three months ended March 31, 2002 from 65.0% for the three months ended March
31, 2001.
CONTRACT DRILLING. Contract drilling expenses for the three months ended March
31, 2002 decreased $8,338,000, or 42.3%, to $11,392,000 from $19,730,000 for the
three months ended March 31, 2001. The decrease was primarily due to lower
levels of activity. Contract drilling expenses, as a percentage of contract
drilling revenues, increased to 79.5% for the three months ended March 31, 2002
from 69.8% for the three months ended March 31, 2001.
DEPRECIATION, DEPLETION AND AMORTIZATION EXPENSE
The Company's depreciation, depletion and amortization expense for the three
months ended March 31, 2002 increased $186,000, or 0.94%, to $19,889,000 from
$19,703,000 for the three months ended March 31, 2001. 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
March 31, 2002 decreased $2,900,000, or 17.5%, to $13,694,000 from $16,594,000
for the three months ended March 31, 2001. The decrease was primarily due to
reductions in payroll expense. General and administrative expenses, as a
percentage of revenues, increased to 8.0% for the three months ended March 31,
2002 from 7.3% for the three months ended March 31, 2001.
INTEREST EXPENSE
The Company's interest expense for the three months ended March 31, 2002
decreased $3,578,000, or 26.6%, to $9,875,000, from $13,453,000 for the three
months ended March 31, 2001. 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 $568,000 and $743,000 for the three
months ended March 31, 2002 and 2001, respectively.
EXTRAORDINARY LOSS
During the three months ended March 31, 2002, the Company retired $35,518,000 of
its long-term debt, at various discounts and premiums to par value and expensed
the related unamortized debt issuance costs which resulted in a net after-tax
extraordinary loss of $5,261,000. During the three months ended March 31, 2001,
the Company retired $20,000,000 of its long-term debt at a discount, and
expensed the related unamortized debt issuance costs which resulted in a net
after-tax extraordinary loss of $167,000.
INCOME TAXES
The Company's income tax expense for the three months ended March 31, 2002
decreased $9,552,000 to an expense of $773,000 from an expense of $10,325,000
for the three months ended March 31, 2001. The decrease in income tax expense is
due to the decrease in pretax income. The Company's effective tax rate for the
three months ended March 31, 2002 and March 31, 2001 was approximately 55% and
37%, respectively. The effective tax rates vary from the statutory rate of 35%
because of the disallowance of certain goodwill amortization (for the three
months ended March 31, 2001), and other non-deductible expenses, the effects of
state and local taxes, and revisions of the estimated annual effective tax rate.
NINE MONTHS ENDED MARCH 31, 2002 VERSUS NINE MONTHS ENDED MARCH 31, 2001
The Company's revenue for the nine months ended March 31, 2002 increased
$9,855,000, or 1.6%, to $632,815,000 from $622,960,000 for the nine months ended
March 31, 2001. The increase in the current period reflects improved rates.
The Company's net income for the first nine months of fiscal 2002 totaled
$44,009,000, or $0.41 per dilutive share, versus a net income of $37,289,000,
or $0.37 per dilutive share, for the prior year period.
24
<Page>
OPERATING REVENUES
WELL SERVICING. Well servicing revenues for the nine months ended March 31, 2002
increased $9,627,000, or 1.8%, to $552,901,000 from $543,274,000 for the nine
months ended March 31, 2001. 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 nine months ended March
31, 2002 decreased $958,000, or 1.3%, to $73,624,000 from $74,582,000 for the
nine months ended March 31, 2001. The decrease in revenues was primarily due to
lower activity levels and slightly lower rig rates.
OPERATING EXPENSES
WELL SERVICING. Well servicing expenses for the nine months ended March 31, 2002
increased $6,118,000, or 1.7% to $368,932,000 from $362,814,000 for the nine
months ended March 31, 2001. The increase was primarily due to a higher level of
activity, increased wages and insurance costs. Well servicing expenses, as a
percentage of well servicing revenue, decreased to 66.7% for the nine months
ended March 31, 2002 from 66.8% for the nine months ended March 31, 2001.
CONTRACT DRILLING. Contract drilling expenses for the nine months ended March
31, 2002 decreased $5,628,000, or 10.1%, to $49,920,000 from $55,548,000 for the
nine months ended March 31, 2001. The decrease was primarily due to lower
activity levels. Contract drilling expenses, as a percentage of contract
drilling revenues, decreased to 67.8% for the nine months ended March 31, 2002
from 74.5% for the nine months ended March 31, 2001.
DEPRECIATION, DEPLETION AND AMORTIZATION EXPENSE
The Company's depreciation, depletion and amortization expense for the nine
months ended March 31, 2002 increased $1,322,000, or 2.4%, to $57,482,000 from
$56,160,000 for the nine months ended March 31, 2001. 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.
GENERAL AND ADMINISTRATIVE EXPENSES
The Company's general and administrative expenses for the nine months ended
March 31, 2002 increased $313,000, or .73%, to $42,613,000 from $42,926,000 for
the nine months ended March 31, 2001. 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 partially
offset by reductions in payroll expense. General and administrative expenses,
25
<Page>
as a percentage of revenues, decreased 6.7% for the nine months ended March 31,
2002 from 6.9% for the nine months ended March 31, 2001.
INTEREST EXPENSE
The Company's interest expense for the nine months ended March 31, 2002
decreased $11,224,000 or 25.4%, to $32,921,000, from $44,145,000 for the nine
months ended March 31, 2001. 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 $1,961,000 and $2,787,000 for the nine
months ended March 31, 2002 and 2001, respectively.
FOREIGN CURRENCY TRANSACTION LOSS
During the nine months ended March 31, 2002, 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 / LOSS
During the nine months ended March 31, 2002, the Company retired $150,376,000 of
its long-term debt, at various discounts and premiums to par value and expensed
the related unamortized debt issuance costs which resulted in a net after-tax
extraordinary loss of $2,990,000. During the nine months ended March 31, 2001,
the Company retired $33,996,000 of its long-term debt at a discount, and
expensed the related unamortized debt issuance costs which resulted in a net
after-tax extraordinary gain of $1,098,000.
INCOME TAXES
The Company's income tax expense for the nine months ended March 31, 2002
increased $6,805,000 to an expense of $28,818,000 from an expense of $22,013,000
for the nine months ended March 31, 2001. The increase in income tax expense is
due to the increase in pretax income. The Company's effective tax rate for the
nine months ended March 31, 2002 and March 31, 2001 was 38%. The effective tax
rates vary from the statutory rate of 35% principally because of the
disallowance of certain goodwill amortization (for the nine months ended March
31, 2001), 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.
26
<Page>
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 March 31, 2002, 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
$30,000,000 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 March 31, 2002, no funds were outstanding under the
revolving loan facility and approximately $14,479,000 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 funds were repaid with the issuance of additional
8 3/8% Notes in March 2002.
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.
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
then outstanding. On March 1, 2002, the Company completed a private placement of
an additional $100,000,000 of 8 3/8% Senior Notes due 2008 at 101.5% of par.
The cash proceeds from the private placement, net of fees and expenses, were
used to repay all of the remaining balance of the revolving loan facility
under the Senior Credit Facility. The 8 3/8% Senior Notes are subordinate to
the Company's senior
27
<Page>
indebtedness which includes borrowings under the Senior Credit Facility and the
Dawson 9 3/8% Senior Notes. At March 31, 2002, $275,000,000 principal amount of
the 8 3/8% Senior Notes remained outstanding.
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. As of March 31, 2002, 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
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. 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 an extraordinary loss before taxes of approximately
$8,468,000. At March 31, 2002, $97,500,000 principal amount of the 14% Senior
Subordinated Notes remained outstanding.
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 Company's common
stock at a conversion price of $38.50 per share, subject to certain adjustments.
During the quarter ended March 31, 2002, the Company repurchased (and canceled)
$115,000 principal amount of the 5% Convertible Subordinated Notes, leaving
$50,237,000 principal amount of the 5% Convertible Subordinated Notes
outstanding at March 31, 2002.
28
<Page>
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"), Statement of Financial Accounting Standards No. 144,
Accounting for the Impairment of Disposal of Long-Lived Assets ("SFAS 144"), and
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"). SFAS 143 establishes requirements for the accounting
for removal costs associated with asset retirements. SFAS 144 addresses
financial accounting and reporting for the impairment of disposal of long-lived
assets. SFAS 145 rescinds Statement No. 4, which required all gains and losses
from extinguishment of debt to be aggregated and classified as an extraordinary
item and amends Statement No. 13 to require that certain lease modifications
that have economic effects similar to sale-leaseback transactions be accounted
for in the same manner as sale-leaseback transactions. SFAS 143 is effective for
29
<Page>
fiscal years beginning after June 15, 2002, with earlier adoption encouraged.
SFAS 144 is effective for fiscal years beginning after December 15, 2001 and
interim periods within those fiscal years. SFAS 145 is effective for fiscal
years beginning after May 15, 2002, with earlier adoption encouraged. 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 March 31, 2002, the Company had long-term debt and capital lease obligations
outstanding of $445,720,000. Of this amount $421,638,000, or 95%, bears interest
at fixed rates as follows:
<Table>
<Caption>
BALANCE AT
MARCH 31, 2002
--------------
(THOUSANDS)
8 3/8% Senior Notes Due 2008..................................................... $ 276,482
14% Senior Subordinated Notes Due 2009........................................... 94,216
5% Convertible Subordinated Notes Due 2004....................................... 50,237
Other (rates generally ranging from 8.0% to 9 3/8%).............................. 703
----------
$ 421,638
==========
</Table>
The remaining $24,082,000 of long-term debt and capital lease obligations
outstanding as of March 31, 2002 bears interest at floating rates which averaged
approximately 4.8% at March 31, 2002. A 10% increase in short-term interest
rates on the floating-rate debt outstanding at March 31, 2002 would equal
approximately 48 basis points. Such an increase in interest rates would increase
Key's fiscal 2002 interest expense by approximately $100,000 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.
30
<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 March 31, 2002 and December 31, 2001, using the
applicable free market conversion ratio of 2.9:1 and 1.6:1, respectively. 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 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 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 March 31, 2002, 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 42% and 34%, respectively, of estimated 2002
calendar year total production. A 10% variation in
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<Page>
the market price of oil or natural gas from their levels at March 31, 2002 would
not have a material impact on the Company's net assets, net earnings or cash
flows (as derived from the 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, 2002:
<Table>
<Caption>
MONTHLY VOLUMES STRIKE PRICE
---------------
NATURAL PER BBL/MMBTU
OIL GAS -------------
(BBLS) (MMBTUS) TERM FLOOR CAP FAIR VALUE
------ -------- ---- ----- --- ----------
At March 31, 2002
Oil Puts........... 5,000 - Mar 2002-Feb 2003 $22.00 - $ 46,000
Natural Gas Puts... - 75,000 Mar 2002-Feb 2003 $ 3.00 - $131,000
</Table>
(The strike prices for oil puts are based on the NYMEX spot price for West
Texas Intermediate; the strike prices for the natural gas puts are based on
the Inside FERC-El Paso Permian spot price.)
32
<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.
On January 31, 2002, a meeting of the holders of Common Stock was held
to elect the Company's Board of Directors. Only the holders of record as of the
close of business on December 28, 2001 (the "Record Date") were entitled to
notice of and to vote at the meeting and at any adjournment thereof. On the
Record Date, the outstanding number of shares entitled to vote consisted of
107,955,279 shares of the Company's common stock. The stockholders took the
following action at the meeting:
Elected the following seven Directors, with the votes indicated
opposite each director's name:
<Table>
<Caption>
For Against
---------- ---------
Francis D. John 96,043,005 2,723,271
David J. Breazzano 98,128,160 638,116
Kevin P. Collins 98,120,919 645,357
William D. Fertig 94,574,643 4,191,633
W. Phillip Marcum 98,121,494 644,782
J. Robinson West 98,097,445 651,832
Morton Wolkowitz 98,121,435 644,841
</Table>
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
1.1 Underwriting Agreement, dated February 22, 2002, among
Registrant and Lehman Brothers Inc., Bear Stearns &
Co. Inc. and First Albany Corporation (Incorporated by
reference to Exhibit 1.1
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<Page>
of the Company's Current Report on Form 8-K dated
February 27, 2002, File No. 1-8038).
4.1 Indenture dated as of February 22, 2002 among the
Registrant and U.S. Bank National Association
(Incorporated by reference to Exhibit 4.1 of the
Company's Current Report on Form 8-K dated February
27, 2002, File No. 1-8038).
4.2 First Supplemental Indenture dated March 1, 2002 among
the Registrant, the Guarantors (as defined therein)
and U.S. Bank National Association (Incorporated by
reference to Exhibit 4.1 of the Company's Current
Report on Form 8-K dated March 1, 2002, File No.
1-8038).
10.1 Eleventh 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 Registrant, 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 Current Report on
Form 8-K dated February 27, 2002, File No. 1-8038).
10.2 Twelfth 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 Registrant, 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 10.2 of the Company's Current Report on
Form 8-K dated February 27, 2002, File No. 1-8038).
*10.3 Employment Agreement between Key Energy Services, Inc.
and Thomas K. Grundman dated February 15, 2002.
25.1 Statement of Eligibility of Trustee, U.S. Bank
National Association, a national banking association,
on Form T-1 (Incorporated by reference to Exhibit 25.1
of the Company's Current Report on Form 8-K dated
February 27, 2002, File No. 1-8038).
(b) The Company filed the following reports on Form 8-K during the
quarter ended March 31, 2002:
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<Page>
(i) Current report on Form 8-K dated February 20, 2002 filed to
report recent developments regarding the Company's Argentina
operations.
(ii) Current report on Form 8-K dated February 27, 2002 filed to
report the offering of up to $100,000 of the Company's 8 3/8%
Series C Notes due 2008.
(iii) Current report on Form 8-K dated March 1, 2002 filed to
report the Supplemental Indenture for the 8 3/8% Series C Notes
of the Company.
- ----------
* Filed herewith.
35
<Page>
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, 2002 By: /s/ FRANCIS D. JOHN
--------------------------------------
Francis D. John
President and Chief Executive Officer
Dated: May 15, 2002 By: /s/ ROYCE W. MITCHELL
--------------------------------------
Royce W. Mitchell
Chief Financial Officer and
Chief Accounting Officer
36