1 [AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 31, 1999] UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K/A-2 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 1998 ------------- or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----- ----- Commission file number 1-8038 ------ KEY ENERGY SERVICES, INC. (Formerly Key Energy Group, Inc.) (Exact name of registrant as specified in its charter) Maryland 04-2648081 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Two Tower Center, Twentieth Floor, East Brunswick, NJ 08816 ----------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (732) 247-4822 -------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Title of Each Class Name of Each Exchange on Which Registered Common Stock, $.10 par value New York Stock Exchange SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: 7% Convertible Subordinated Debentures Due 2003 5% Convertible Subordinated Notes Due 2004 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the Common Shares held by nonaffiliates of the Registrant as of September 11, 1998 was approximately $154,884,755. Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No --- --- Common Shares outstanding at September 11, 1998: 18,284,048 DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Proxy Statement with respect to the Annual Meeting of Shareholders are incorporated by reference in Part III of this report. 2 KEY ENERGY GROUP, INC. AND SUBSIDIARIES INDEX PART I. Item 1. Business 3 PART II. Item 8. Financial Statements and Supplementary Data. 9 PART IV. Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 51 2 3 KEY ENERGY GROUP, INC. AND SUBSIDIARIES PART I. ITEM 1. BUSINESS. THE COMPANY Key Energy Services, Inc., formerly known as Key Energy Group, Inc. (the "Company" or "Key") is the largest provider of onshore oil and gas well services in the United States and second largest in Argentina. As of June 30, 1998, the Company operated a fleet of 803 well service rigs, 733 oilfield trucks, and 70 drilling rigs (including 16 well service rigs, 28 oilfield trucks, and six drilling rigs in Argentina). As of June 30, 1998, Key's well service and oilfield truck fleets were the largest fleets, respectively, onshore the continental United States. As of June 30, 1998, the Company operated in all major onshore oil and gas producing regions of the continental United States, other than California and in Argentina. Including the consummation of the subsequent acquisitions of Dawson Production Services, Inc. ("Dawson") and the other well servicing companies referred to in "Subsequent Events" below, the Company also operates in California and in the inland waters of the Gulf of Mexico. Including completion of the subsequent acquisitions, the Company operates a fleet of approximately 1,423 well service rigs, 1,121 oilfield trucks, and 71 drilling rigs (including 20 well service rigs, 28 oilfield trucks and six drilling rigs in Argentina). After the subsequent acquisitions, the Company is the world's largest provider of well service rigs. The Company generally provides a full range of maintenance and workover services to major and independent oil and gas companies in all of its operating regions. In addition to maintenance and workover services, Key also provides services which include the completion of newly drilled wells, the recompletion of existing wells (including horizontal recompletions) and the plugging and abandonment of wells at the end of their useful lives. Other services include oil field fluid transportation, storage and disposal services, frac tank rentals, fishing and rental tools, wireline services, air drilling, hot oiling and following the Dawson acquisition, production testing services. In addition, the Company is engaged in contract drilling in several oil and gas producing regions of the continental United States and Argentina, and owns and produces oil and natural gas in the Permian Basin and Texas Panhandle. As of June 30, 1998, the Company conducted operations through eight directly or indirectly wholly-owned subsidiaries; Yale E. Key, Inc. ("Yale E. Key"); WellTech Eastern, Inc. ("WellTech Eastern"); WellTech Mid-Continent, Inc. ("WellTech Mid-Continent"); Odessa Exploration Incorporated ("Odessa Exploration"); Brooks Well Servicing, Inc. ("Brooks"); Key Four Corners, Inc. ("Key Four Corners"); Key Rocky Mountain, Inc. ("Key Rocky Mountain") and Key Energy Drilling, Inc. ("Key Energy Drilling"). In addition, Key operates in Argentina through its wholly-owned subsidiary, Servicios WellTech, S.A. ("Servicios"). Yale E. Key, WellTech Eastern, WellTech Mid-Continent, Brooks, Key Four Corners, Key Rocky Mountain and Servicios provide oil and gas well services. In addition, WellTech Eastern, Key Four Corners, Servicios and Key Energy Drilling provide contract oil and gas well drilling services. Odessa Exploration is engaged in the production of oil and natural gas. SUBSEQUENT EVENTS On September 15, 1998, Midland Acquisition Corporation ("Midland"), a New Jersey corporation and a wholly-owned subsidiary of the Company, completed its cash tender offer (the "Tender Offer") for all outstanding shares of common stock, par value $0.01 per share (the "Dawson Shares"), including the associated common stock purchase rights, of Dawson at a price of $17.50 per Dawson Share. The Tender Offer expired at 8:30 a.m., New York City Time, on Tuesday, September 15, 1998. Midland accepted for payment 10,021,601 Dawson Shares for a total purchase price of approximately $175.4 million. The acceptance of tendered Dawson Shares, together with Dawson Shares previously owned by Midland and the Company prior to the commencement of the Tender Offer resulted in Midland and the Company acquiring approximately 97.0% of the outstanding Dawson Shares. The purchase price for Dawson Shares 3 4 pursuant to the Tender Offer and the merger agreement was determined pursuant to arms-length negotiations between the parties and was based on a variety of factors, including, without limitation, the anticipated earnings and cash flows of Dawson. The Tender Offer was made pursuant to an Agreement and Plan of Merger (the "Merger Agreement"), dated as of August 11, 1998, by and among, Midland, the Company and Dawson. On September 18, 1998, pursuant to the terms of the Merger Agreement, Midland was merged with and into Dawson (the "First Merger") under the laws of the States of New Jersey and Texas and all Dawson Shares not owned by Midland were cancelled and retired and converted into the right to receive $17.50 in cash per Dawson Share. On September 21, 1998, Dawson was merged with and into the Company (the "Second Merger") pursuant to the laws of the States of Maryland and Texas. The total consideration paid for the Dawson Shares pursuant to the Tender Offer and the First Merger was approximately $181.7 million. The Company's source of funds to pay such amount, certain outstanding debt of Dawson and the Company and related fees and expenses was (i) a bridge loan agreement in the amount of $150,000,000, dated as of September 14, 1998, among the Company, Lehman Brothers Inc., as Arranger, and Lehman Commercial Paper Inc., as Administrative Agent, and the other lenders party thereto (the "Bridge Loan Agreement") and (ii) a $550,000,000 Second Amended and Restated Credit Agreement, dated as of June 6, 1997, as amended and restated through September 14, 1998, among the Company, PNC Bank, National Association, as Administrative Agent, Norwest Bank Texas, N.A., as Collateral Agent, PNC Capital Markets, Inc., as Arranger and the other lenders named from time to time parties thereto (the "Second Amended and Restated Credit Agreement"). In connection with the Bridge Loan Agreement, the Company entered into Registration Rights Agreements (the "Registration Rights Agreements") with Lehman Brothers Inc. and Lehman Commercial Paper Inc. pursuant to which the Company agreed to file with the Securities and Exchange Commission (the "Commission") within a certain time period a registration statement with respect to (i) an offer to exchange borrowings under the Bridge Loan Agreement for a new issue of debt securities of the Company, and (ii) the resale of warrants (and the shares of common stock of the Company to be issued upon the exercise of such warrant) to purchase shares of common stock of the Company issued to Lehman Brothers Inc. in connection with the Bridge Loan Agreement. Loans outstanding after one year pursuant to the Bridge Loan Agreement will convert into term loans which may be exchanged by the holders thereof for exchange notes issued pursuant to an Indenture dated as of September 14, 1998 (the "Indenture"), between the Company and The Bank of New York, trustee. At the time the Second Merger was consummated, the Company, its subsidiaries and U.S. Trust Company of Texas, N.A., trustee ("U.S. Trust"), entered into a Supplemental Indenture dated September 21, 1998 (the "Supplemental Indenture"), pursuant to which the Company assumed the obligations of Dawson under the indenture dated February 20, 1997 (the "Dawson Indenture") between Dawson and U.S. Trust, most of the Company's subsidiaries guaranteed those obligations and the notes issued pursuant to the Dawson Indenture were equally and ratably secured with the obligations under the Second Amended and Restated Credit Agreement. Under the terms of the Dawson Indenture, the Company is required to commence a cash tender offer to purchase at 101% of the aggregate principal amount of the outstanding notes (which outstanding amount is $140 million) by mid-October 1998, the source of funds for which will be borrowings under the Second Amended and Restated Credit Agreement. Dawson operates approximately 527 well service rigs, 200 oilfield trucks, and 21 production testing units in South Texas and the Gulf Coast, East Texas and Louisiana, the Permian Basin of West Texas and New Mexico, the Anadarko Basin of Texas and Oklahoma, California, and in the inland waters of the Gulf of Mexico. In addition, subsequent to June 30, 1998, the Company completed the acquisition of five well servicing companies which collectively operate 93 well service rigs (including four in Argentina), one drilling rig, and 188 oilfield trucks. 4 5 GROWTH STRATEGY The domestic well service rig and production service industry has historically been highly fragmented, characterized by a large number of smaller companies which have competed effectively on a local basis in terms of pricing and the quality of services offered. In recent years, many major and independent oil and gas companies have placed increasing emphasis upon not only pricing, but also on safety records and quality management systems of, and the breadth of services offered by, their vendors, including well servicing contractors. This market environment, which requires significant expenditures by smaller companies to meet these increasingly rigorous standards, has forced many smaller well servicing companies to sell their operations to larger competitors. As a result, the industry has seen high levels of consolidation among the competing contractors. Over the past two and one-half years, Key has been the leading consolidator of this industry, completing in excess of fifty acquisitions. This consolidation has led to reduced fragmentation in the market and has led to more predictable demand for well services for the Company and its competitors. Key's management structure is decentralized, which allows for rapid integration of acquisitions and the retention of strong local identities of many of the acquired businesses. The Company, as a result, has developed a growth strategy to: (i) ,subject to restrictions under its credit facilities, identify, negotiate and consummate additional acquisitions of complementary well servicing operations, including rigs, trucking and other ancillary services; (ii) fully-integrate acquisitions into the Company's decentralized organizational structure and thereby attempt to maximize operating margins; (iii) expand business lines and services offered by the Company in existing areas of operations; and (iv) extend the geographic scope and operating environments for the Company's operations. OIL FIELD SERVICES The Company provides a full range of well service rig services, oil field liquid services and other production services necessary to maintain and workover producing oil and gas wells through its subsidiaries, Yale E. Key, WellTech Eastern, WellTech Mid-Continent, Brooks, Key Four Corners, Key Rocky Mountain, and Servicios. These services also include the completion of newly drilled wells, the recompletion of existing wells (including horizontal recompletions) and the plugging and abandonment of wells at the end of their useful lives. Other services include oil field fluid transportation, storage and disposal services, frac tank rentals, fishing and rental tools, wireline services, air drilling, hot oiling, and following the Dawson acquisition, production testing services. The Company has more than 1,000 customers which are either major oil and gas companies or independent producers seeking to optimize performance of oil and gas wells. As of June 30, 1998, of the Company's 803 well service, 299 operate in the Permian Basin of West Texas and New Mexico, 187 in the Mid-Continent Region, 80 in the ArkLaTex Region, 84 in Michigan and the Northeast, 29 in the Four Corners Region, 108 in the Rocky Mountain Region and 16 in Argentina. WELL SERVICE RIG SERVICES. The Company utilizes its fleet to perform four major categories of service to oil and gas operators including: Maintenance Services. Maintenance services are required on producing oil and gas wells to ensure efficient and continuous operation. These services consist of routine mechanical repairs necessary to maintain production from the well, such as repairing parted sucker rods or defective down-hole pumps in an oil well, or replacing defective tubing in an oil or gas well. The Company provides the well service rigs, equipment and crews for these maintenance services. Many of these well service rigs also have pumps and tanks (a workover package) that can be used for circulating fluids into and out of the well. Maintenance jobs are often performed on a series of wells in proximity to each other and typically take less than 48 hours per well. 5 6 Maintenance services are generally required throughout the life of a well. The need for these services does not directly depend on the level of drilling activity and is generally independent of short-term fluctuations in oil and gas prices. Accordingly, maintenance services are generally the most stable type of well service activity. The general level of maintenance, however, is affected by changes in the total number of producing oil and gas wells in the Company's geographic service areas. Workover Services. In addition to periodic maintenance, producing oil and gas wells occasionally require major repairs or modifications, called "workovers." Workover services include extensions of existing wells to drain new formations either through deepening well bores or through drilling of horizontal laterals. In less extensive workovers, the Company's rigs are used to seal off depleted zones in existing well bores and access previously bypassed productive zones. The Company's workover rigs are also used to convert producing wells to injection wells for enhanced recovery operations. Workover services include major subsurface repairs such as casing repair or replacement, recovery of tubing and removal of foreign objects in the well bore. These extensive workover operations are normally performed by a well service rig with a workover package, which may include rotary drilling equipment, mud pumps, mud tanks and blowout preventers depending upon the particular type of workover operation. Most of the Company's well service rigs are designed for and can be equipped to perform complex workover operations. A workover may last from a few days to several weeks. The demand for workover services is more sensitive to expectations relating to and changes in oil and gas prices than the demand for maintenance services, but not as sensitive as the demand for completion services. When oil and gas prices are low, there is little incentive to perform workovers on wells to increase production and well operators tend to defer such expenditures. As oil and gas prices increase, the level of workover activity tends to increase as operators seek to increase production by enhancing the efficiency of their wells. Completion Services. Completion services prepare a newly drilled well for production. The completion process may involve selectively perforating the well casing to access producing zones, stimulating and testing these zones and installing downhole equipment. The Company provides a well service and workover package rig to assist in this completion process. Newly drilled wells are frequently completed by a well service rig so that an operator can minimize the use of a higher cost drilling rig. The completion process typically requires a few days to several weeks, depending on the nature and type of the completion, and generally requires additional auxiliary equipment which the Company provides for an additional fee. The demand for well completion services is directly related to drilling activity levels, which are highly sensitive to expectations relating to and changes in oil and gas prices. During periods of weak drilling demand, drilling contractors frequently price well completion work competitively compared to a well service rig so that the drilling rig stays on the job. Thus, excess drilling capacity will serve to reduce the amount of completion work available to the well servicing industry. Plugging and Abandonment Services. Well service rigs and workover equipment are also used in the plugging and abandonment of oil and gas wells no longer capable of producing in economic quantities. The demand for oil and gas does not significantly affect the demand for well plugging services. LIQUID SERVICES. The Company provides vacuum truck services, frac tank rentals and salt water disposal services which together provide an integrated mix of liquid services to well site customers. PRODUCTION TESTING SERVICES. Dawson owns 21 gas production testing units that are used to provide services to oil and gas wells located onshore and in inland waters. Dawson performs production testing services for oil and gas producers primarily along the Texas Gulf Coast. Dawson's equipment includes several trailer-mounted manifolds, separators, heater treaters, sand separators, light generators and slickline wireline units. Manifolds are used to reduce the flowing pressure of the well stream to a rate that will easily flow through the production testing equipment. After the 6 7 appropriate well stream rate is achieved, a separator is used to divide the well stream into its respective components -- oil, gas and water. For gas wells, a heater is used to prevent the gas from freezing during flowbacks. Slickline wireline equipment generally is used to lower measurement equipment into a well for several days to retrieve data to determine the characteristics of the reservoir. Dawson uses its production testing units to perform deliverability tests required upon the initial completion of a well and periodically during the productive life of a gas well to determine the maximum production allowable under certain rules of the Texas Railroad Commission, the state oil and gas regulatory agency. In addition, these units are used to clean and test stimulated wells and to measure the pressure, volume and quality of gas and liquids produced by the well. These units also are used to determine the most efficient production flow rate, to run pressure build-up tests that measure the rate of increase of shut-in gas pressure to determine reservoir characteristics and to determine whether a producing formation has been damaged. OTHER PRODUCTION SERVICES. The Company provides production services, which include hot oiler unit services, pipeline installation and testing services, slickline wire-line services and fishing and rental tool services. CONTRACT DRILLING SERVICES The Company, primarily through Key Energy Drilling, owns and operates 71 drilling rigs and provides contract drilling services for major and independent oil companies in most onshore oil and gas producing areas of the continental United States. The Company entered the land drilling business in March 1995 with the acquisition of four drilling rigs from an independent third party and, as the result of subsequent acquisitions, acquired 67 additional land drilling rigs (six of which operate in Argentina). The rigs are generally capable of drilling up to 10,000 feet. PRODUCTION The Company is engaged in the production of oil and natural gas in the Permian Basin area of West Texas through Odessa Exploration. Odessa Exploration acquires and manages interests in producing oil and gas properties for its own account and for drilling partnerships it sponsors. Odessa Exploration acquires producing oil and gas wells and related properties from major and independent producers and, subsequently, either reworks the acquired wells to increase production or forms drilling ventures for additional development wells. Odessa Exploration operates oil and gas wells on behalf of over 250 working interest owners as well as for its own account. FOREIGN OPERATIONS The Company provides oil field services in Argentina through Servicios. As of June 30, 1998, Servicios owned and operated 16 well servicing rigs and six drilling rigs in Argentina. COMPETITION AND OTHER EXTERNAL FACTORS Despite a significant amount of consolidation having occurred, the domestic well service rig and production service industry remains somewhat fragmented and includes a small number of companies that are capable of competing effectively in all or part of the Company's well servicing markets. Nonetheless, the Company believes that it is competitive in terms of pricing, performance, equipment, safety, availability of equipment to meet customer needs and availability of experienced, skilled personnel in those regions in which it operates. In the well servicing market, an important competitive factor in establishing and maintaining long-term customer relationships is having an experienced, skilled and well trained work force. In recent years, many of the Company's larger customers have placed emphasis not only on pricing, but also on safety records and quality management systems of contractors. The Company believes that such factors will be 7 8 of increased importance in the future. The Company has directed substantial resources toward employee safety and training programs, as well as its employee review process. While the Company's efforts in these areas are not unique, many competitors, particularly small contractors, have not undertaken similar training programs for their employees. Management believes that the Company's safety record and reputation for quality equipment and service are among the best in the industry. The Company acquires oil and gas properties from independent and major oil companies and competes with other independent and integrated oil companies for the acquisition of these properties. The Company also competes with other local oil and gas drilling contractors, as well as national oil and gas drilling companies. As with oil field services, the need for drilling oil and gas wells fluctuates, in part, based on the price of, and demand for, oil and natural gas. The Company serves over 1,000 customers in most oil and gas producing regions of the continental United States and Argentina. The Company had no single customer in fiscal 1998 that provided 10% or more of consolidated revenues. The need for oilfield services fluctuates, in part, in relation to the demand for oil and natural gas. As demand for those commodities increases, service and maintenance requirements increase as oil and natural gas producers attempt to maximize the producing efficiency of their wells in a higher priced environment. EMPLOYEES As of June 30, 1998, the Company employed 5,601 persons (4,982 in well service operations, 12 in oil and gas production, 587 in contract drilling operations and 20 in corporate). The Company's employees are not represented by a labor union or collective bargaining agent. The Company has experienced no work stoppages associated with labor disputes or grievances and considers its relations with its employees to be satisfactory. The Company historically has experienced an annual employee turnover rate of over 50%. The high turnover rate is caused by the nature of the work, which is physically demanding and performed outdoors. As a result, workers may choose to pursue employment in fields that offer a more desirable work environment at wage rates that are competitive with ours. Although the Company currently is downsizing its workforce, the Company cannot assure that at times of high demand it will be able to recruit and train workers. Potential inability or lack of desire by workers to commute to the Company's facilities and job sites and competition for workers from other industries are factors that could affect the Company's ability to attract workers. The Company believes that its wage rates are competitive with the wage rates of its competitors and other potential employers. A significant increase in the wages other employers pay could result in a reduction in the Company's workforce, increases in its wage rates, or both. Either of these events could diminish the Company's profitability and growth potential. REGULATIONS The oilfield service operations and the oil and gas production and drilling activities of the Company are subject to various local, state and federal laws and regulations intended to protect the environment. The Company's operations routinely involve the handling of waste materials, some of which are classified as hazardous substances. Consequently, the regulations applicable to the Company's operations include those with respect to containment, disposal and controlling the discharge of any hazardous oil field waste and other non-hazardous waste material into the environment, requiring removal and cleanup under certain circumstances, or otherwise relating to the protection of the environment. Laws and regulations protecting the environment have become more stringent in recent years, and may in certain circumstances impose "strict liability," rendering a party liable for environmental damage without regard to negligence or fault on the part of such party. Such laws and regulations may expose the Company to liability for the conduct of, or conditions caused by, others, or for acts of the Company which were in compliance with all applicable laws at the times such acts were performed. Management of the Company believes that it is in substantial compliance with all material federal, state and local regulations as they relate to the 8 9 environment. Although the Company has incurred certain costs in complying with environmental laws and regulations, such amounts have not been material to the Company's financial results during the three past fiscal years. Management believes that the Company is in substantial compliance with all known material local, state and federal safety guidelines and regulations. In order to comply with such safety guidelines and regulations and increase employee awareness of on-the-job safety, the Company employs seven safety officers. The Company also has a safety training and education center that is used by it for continued safety training and awareness. 9 10 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Presented herein are the consolidated financial statements of Key Energy Group, Inc. and Subsidiaries as of June 30, 1998 and 1997 and the years ended June 30, 1998, 1997 and 1996. Also, included is the report of KPMG LLP, independent certified public accountants, on such consolidated financial statements as of June 30, 1998 and 1997 and for the years ended June 30, 1998, 1997 and 1996. INDEX TO FINANCIAL STATEMENTS Page ---- Consolidated Balance Sheets.............................. 11 Consolidated Statements of Operations ................... 12 Consolidated Statements of Cash Flows ................... 13 Consolidated Statements of Stockholders' Equity ......... 14 Notes to Consolidated Financial Statements .............. 15 Independent Auditors' Report ............................ 44 10 11 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Consolidated Balance Sheets June 30, June 30, (Thousands, except share and per share data) 1998 1997 - -------------------------------------------- -------- -------- ASSETS Current Assets: Cash $25,265 $41,704 Accounts receivable, net of allowance for doubtful accounts ( $2,843 - 1998, $1,552 - 1997) 82,406 45,230 Inventories 13,315 5,171 Deferred tax asset 1,203 -- Prepaid income taxes 537 -- Prepaid expenses and other current assets 4,831 1,228 -------- -------- Total Current Assets 127,557 93,333 -------- -------- Property and Equipment: Oilfield service equipment 400,731 176,326 Oil and gas well drilling equipment 61,629 6,319 Motor vehicles 19,748 10,569 Oil and gas properties and other related equipment, successful efforts method 42,638 23,622 Furniture and equipment 5,333 1,661 Buildings and land 17,458 8,758 -------- -------- 547,537 227,255 Accumulated depreciation & depletion (48,385) (19,069) -------- -------- Net Property and Equipment 499,152 208,186 -------- -------- Goodwill, net of amortization ($2,264 - 1998; $822 - 1997) 44,936 9,256 Other Assets 26,995 9,320 -------- -------- Total Assets $698,640 $320,095 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $20,124 $15,339 Other accrued liabilities 22,239 12,507 Accrued interest 3,818 2,102 Accrued income taxes -- 1,664 Deferred tax liability -- 126 Current portion of long-term debt 1,848 1,404 -------- -------- Total Current Liabilities 48,029 33,142 -------- -------- Long-term debt, less current portion 397,931 172,763 Non-current accrued expenses 4,812 4,017 Deferred tax liability 92,940 35,738 Minority interest - 1,256 Stockholders' equity: Common stock, $.10 par value; 100,000,000 shares authorized, 18,684,479 and 12,297,752 shares issued, respectively at June 30, 1998 and 1997, respectively 1,868 1,230 Additional paid-in capital 119,303 55,031 Treasury stock, at cost; 416,666 shares at June 30, 1998 and none at June 30, 1997 (9,682) -- Unrealized gain on available-for-sale securities 2,346 -- Retained earnings 41,093 16,918 -------- -------- Total Stockholders' Equity 154,928 73,179 -------- -------- Total Liabilities and Stockholders' Equity $698,640 $320,095 ======== ======== See the accompanying notes which are an integral part of these consolidated financial statements. 11 12 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Operations Year Ended Year Ended Year Ended (Thousands, except per share data) June 30, 1998 June 30, 1997 June 30, 1996 ------------- ------------- ------------- REVENUES: Oilfield services $ 374,845 $ 144,385 $ 55,933 Oil and gas well drilling 35,095 9,956 6,188 Oil and gas 7,030 6,975 3,554 Other, net 3,076 1,109 182 ------------- ------------- ------------- 420,046 162,425 65,857 ------------- ------------- ------------- COSTS AND EXPENSES: Oilfield services 259,495 100,366 40,737 Oil and gas well drilling 26,473 8,155 5,030 Oil and gas 2,983 2,729 1,195 Depreciation, depletion and amortization 31,001 11,076 4,701 General and administrative 39,813 17,545 6,142 Interest 21,476 7,879 2,477 ------------- ------------- ------------- 381,241 147,750 60,282 ------------- ------------- ------------- Income before income taxes and minority interest 38,805 14,675 5,575 Income tax expense 14,630 5,573 1,888 Minority interest in net income -- 4 101 ------------- ------------- ------------- NET INCOME $ 24,175 $ 9,098 $ 3,586 ============= ============= ============= EARNINGS PER SHARE : Basic $ 1.41 $ 0.81 $ 0.46 Diluted $ 1.23 $ 0.66 $ 0.45 ============= ============= ============= WEIGHTED AVERAGE SHARES OUTSTANDING: Basic 17,153 11,216 7,789 Diluted 24,024 17,632 7,941 ============= ============= ============= See the accompanying notes which are an integral part of these consolidated financial statements. 12 13 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Year Ended Year Ended Year Ended June 30, June 30, June 30, (Thousands) 1998 1997 1996 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 24,175 $ 9,098 $ 3,586 Adjustments to reconcile income from operations to net cash provided by operations: Depreciation, depletion and amortization 31,001 11,076 4,701 Amortization of deferred debt costs 2,006 Deferred income taxes 7,287 4,180 1,618 Minority interest in net income -- 4 101 Gain on sale of assets (189) (235) (186) Other non-cash items 1,313 -- 6 Change in assets and liabilities net of effects from the acquisitions: (Increase) in accounts receivable (3,173) (14,904) (2,180) (Increase) decrease in other current assets (4,051) (2,811) 765 Decrease in accounts payable, accrued interest and accrued expenses (17,444) (5,565) (1,293) Other assets and liabilities (6,576) 1,313 3 ------------ ------------ ------------ Net cash provided by operating activities 34,349 2,156 7,121 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures - Well service operations (44,284) (15,084) (5,188) Capital expenditures - Oil and gas operations (7,849) (8,188) (1,879) Capital expenditures - Oil and gas well drilling operations (5,385) (1,483) (598) Capital expenditures - Other (1,748) -- -- Proceeds from sale of fixed assets 1,279 3,159 574 Cash received in acquisitions 2,903 2,342 1,168 Acquisitions - Well service operations (172,536) (62,808) -- Acquisitions - Oil and gas well drilling (49,440) -- -- Acquisitions - Oil and gas operations (9,298) -- (7,895) Purchase of Marketable equity securities (9,979) -- -- Acquisitions - minority interest (3,426) -- -- Redemption of restricted marketable securities -- -- 267 ------------ ------------ ------------ Net cash used in investing activities (299,763) (82,062) (13,551) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on debt (6,087) (1,772) (2,601) Repayment of long-term debt (231,337) (47,815) -- Borrowings under line-of-credit 280,770 120,000 1,100 Proceeds from stock options exercised 1,042 141 -- Proceeds from warrants exercised 4,223 1,362 -- Purchase of treasury stock (9,682) -- -- Proceeds from convertible subordinated debentures -- 52,000 -- Proceeds from long-term commercial paper debt 216,000 -- -- Proceeds paid for debt issuance costs (9,270) (7,389) -- Proceeds from other long-term debt 3,316 872 10,867 ------------ ------------ ------------ Net cash provided by financing activities 248,975 117,399 9,366 ------------ ------------ ------------ Net increase (decrease) in cash (16,439) 37,493 2,936 Cash at beginning of period 41,704 4,211 1,275 ------------ ------------ ------------ Cash at end of period $ 25,265 $ 41,704 $ 4,211 ============ ============ ============ See the accompanying notes which are an integral part of these consolidated financial statements. 13 14 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity COMMON STOCK --------------------- (Thousands) UNREALIZED GAIN ON NUMBER OF ADDITIONAL AVAILABLE SHARES AMOUNT PAID-IN TREASURY RETAINED FOR SALE OUTSTANDING AT PAR CAPITAL STOCK EARNINGS SECURITIES TOTAL --------- --------- --------- --------- --------- --------- --------- BALANCE AT JUNE 30, 1995 6,914 $ 691 $ 15,186 $ -- $ 4,234 $ -- $ 20,111 --------- --------- --------- --------- --------- --------- --------- Issuance of common stock for WellTech Merger 3,500 350 17,577 -- -- -- 17,927 Net income -- -- -- -- 3,586 -- 3,586 --------- --------- --------- --------- --------- --------- --------- BALANCE AT JUNE 30, 1996 10,414 $ 1,041 $ 32,763 -- $ 7,820 -- $ 41,624 ========= ========= ========= ========= ========= ========= ========= Issuance of common stock for Brownlee Well Service stock 61 6 665 -- -- -- 671 Issuance of common stock for Woodward Well Service stock 75 8 555 -- -- -- 563 Issuance of common stock for Brooks Well Service stock 918 92 11,033 -- -- -- 11,125 Issuance of common stock for Enerair Oilwell Service assets 4 -- 48 -- -- -- 48 Issuance of common stock for Cobra Well Service stock 175 18 2,368 -- -- -- 2,386 Issuance of common stock for Tri-State Well Service assets 84 8 992 -- -- -- 1,000 Issuance of common stock for Kal-Con Well Service assets and stock 78 8 1,103 -- -- -- 1,111 Issuance of common stock for Well-Co Well Service stock 240 24 4,026 -- -- -- 4,050 Exercise of warrants 221 22 1,340 -- -- -- 1,362 Exercise of options 28 3 138 -- -- -- 141 Net income -- -- -- -- 9,098 -- 9,098 --------- --------- --------- --------- --------- --------- --------- BALANCE AT JUNE 30, 1997 12,298 $ 1,230 $ 55,031 -- $ 16,918 -- $ 73,179 ========= ========= ========= ========= ========= ========= ========= Issuance of common stock for Big A Well Service assets 125 12 4,066 -- -- -- 4,078 Issuance of common stock for Critchfield Well Service assets and stock 240 24 5,736 -- -- -- 5,760 Issuance of common stock for Sitton Drilling stock 100 10 2,159 -- -- -- 2,169 Issuance of common stock for Gibson Well Service assets 100 10 1,846 -- -- -- 1,856 Exercise of warrants 609 61 4,162 -- -- -- 4,223 Exercise of options 209 21 1,021 -- -- -- 1,042 Conversion of 7% Notes 5,062 506 45,282 -- -- -- 45,788 Purchase of treasury stock - 416,666 shares (417) -- -- (9,682) -- -- (9,682) Mark to market of available for sale securities 2,346 2,346 Other (59) (6) (6) Net income -- -- -- -- 24,175 -- 24,175 --------- --------- --------- --------- --------- --------- --------- BALANCE AT JUNE 30, 1998 18,267 $ 1,868 $ 119,303 $ (9,682) $ 41,093 $ 2,346 $ 154,928 ========= ========= ========= ========= ========= ========= ========= See the accompanying notes which are an integral part of these consolidated financial statements. 14 15 KEY ENERGY GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 1998, 1997 and 1996 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY Key Energy Group, Inc. herein after referred to as the "Company" or "Key", was organized in April 1977, and commenced operations in July 1978. Results of operations for the twelve months ended June 30, 1998, 1997 and 1996 include the Company's oilfield service operations conducted by its wholly-owned subsidiary, Yale E. Key, Inc., ("Yale E. Key"), the Company's oil and gas exploration and production wholly-owned subsidiary, Odessa Exploration Incorporated ("Odessa Exploration"), and the Company's oil and gas well drilling operations conducted by the Company's wholly-owned subsidiary, Key Energy Drilling, Inc. ("Key Energy Drilling"). Also included in the results of operations for the fiscal year ended June 30, 1998 and 1997 and approximately three months for the fiscal year ended June 30, 1996 are those operating results from the Company's wholly-owned subsidiary; WellTech Eastern, Inc. ("WellTech Eastern") which currently holds the assets acquired in the merger with WellTech, Inc. ("WellTech"), on March 26, 1996 (see Note 2). In addition, as a result of the Welltech acquisition, the Company acquired 63% ownership in Servicios WellTech, S.A. ("Servicios"), an Argentina corporation. In July 1997, the Company acquired the remaining 37% ownership in Servicios. Servicios conducts oilfield services operations in Argentina and was consolidated with a minority interest prior to July 1997. In addition, results of operations for a portion of the fiscal year ended June 30, 1998 are those operating results from the Company's wholly-owned subsidiaries, Key Rocky Mountain, Inc. ("Key Rocky Mountain") and Key Four Corners, Inc. ("Key Four Corners"), both of which were formed as the result of several acquisitions during the fiscal year ended June 30, 1998. (see Note 2) BASIS OF PRESENTATION The Company's consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant inter-company transactions and balances have been eliminated. The accounting policies presented below have been followed in preparing the accompanying consolidated financial statements. ESTIMATES AND UNCERTAINTIES Preparation of the accompanying consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. INVENTORIES Inventories, which consist primarily of well service parts and supplies and those parts and supplies held for sale at the Company's various retail supply stores, are valued at the lower of average cost or market. PROPERTY AND EQUIPMENT The Company provides for depreciation and amortization of well service and related equipment using the straight-line method, with an overall average salvage value of approximately 10%, over the following estimated useful lives of the assets: (table follows on next page) 15 16 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Description Years ----------- ----- Oilfield service equipment 3 - 20 Motor vehicles 3 - 7 Furniture and equipment 3 - 10 Buildings and improvements 10 - 40 Gas processing facilities 10 Upon disposition or retirement of property and equipment, the cost and related accumulated depreciation are removed from the accounts and the gain or loss thereon, if any, is included in the results of operations. Odessa Exploration utilizes the successful efforts method of accounting for its oil and gas properties. Under this method, all costs associated with productive wells and nonproductive development wells are capitalized, while nonproductive exploration costs and geological and geophysical costs (if any), are expensed. Capitalized costs relating to proved properties are depleted using the unit-of-production method. Upon disposition, the carrying amounts of properties sold or otherwise disposed of and the related allowance for depletion are eliminated from the accounts and any gain/loss is included in results of operations. As of July 1, 1997 the Company changed their method of calculating depreciation on its oil and gas well drilling rigs from the straight-line method to the units-of-production method. The new method takes into consideration the number of days the rigs are actually in service each month and depreciation is recorded for at least 15 days each month for each rig that is available for service. The Company believes the new method will more appropriately reflect its financial results by better matching of revenues with expenses and to better reflect how the assets are to be used over time. The effect of this change on net income for 1998, 1997 and 1996 was not material. ENVIRONMENTAL The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and/or remediation is probable, and the costs can be reasonably estimated. OTHER ASSETS AND GOODWILL Other assets consist primarily of goodwill, capitalized debt issuance costs, investment in common stock (accounted for using the cost-method) and security and escrow deposits from Key's workers' compensation retrospective insurance program, in addition to an interest, (approximately 13%), in an insurance company (the insurance company is affiliated with Key's workers' compensation carrier). Marketable equity securities are deemed by management to be available for sale and are classified in the consolidated balance sheet at fair value of approximately $12,325,000 as other long-term assets with net unrealized gains of approximately $2,346,000 reported within stockholders equity. At June 30, 1998, 1997 and 1996, the Company classified as goodwill the cost in excess of fair value of the net tangible assets acquired in purchase transactions. Goodwill of $37,122,000 was added in 1998. Goodwill is being amortized on a straight-line basis over ten to twenty-five years. Management continually evaluates 16 17 KEY ENERGY GROUP, INC. AND SUBSIDIARIES whether events or circumstances have occurred that indicate the remaining useful life of goodwill may warrant revision or the remaining balance of goodwill may not be recoverable. Goodwill amortization expense totaled $1,442,000 for fiscal 1998 and $622,000 for fiscal 1997 and $100,000 for fiscal 1996. Debt issuance costs are amortized over the term of the applicable debt and such amortization is classified as interest expense. Amortization of debt issuance costs totaled $2,006,000 and $344,000 for the fiscal years ended 1998 and 1997, respectively. EARNINGS PER SHARE The Company accounts for earnings per share 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 year. Diluted earnings per common share is based on the increased number of shares that would be outstanding assuming conversion of dilutive outstanding convertible securities using the "as if converted" method. The share effect related to some employees and directors stock options is omitted for each of the years presented and the share effect related to the 5% convertible notes is omitted for the year ended June 30, 1996 because they are anti-dilutive to the periods presented. YEAR ENDED (THOUSANDS, EXCEPT PER SHARE DATA) --------------------------------- 6/30/98 6/30/97 6/30/96 --------- --------- --------- BASIC EPS COMPUTATION: Numerator- Net Income $ 24,175 $ 9,098 $ 3,586 Denominator- Weighted Average Common Shares Outstanding 17,153 11,216 7,789 BASIC EPS $ 1.41 $ 0.81 $ 0.46 DILUTED EPS COMPUTATION: Numerator- Net Income $ 24,175 $ 9,098 $ 3,586 Effect of dilutive securities, tax effected: Convertible Securities 5,331 2,578 -- --------- --------- --------- $ 29,506 $ 11,676 $ 3,586 --------- --------- --------- Denominator- Weighted Average Common Shares Outstanding: 17,153 11,216 7,789 Warrants 141 340 -- Stock options 1,266 743 152 7% Convertible Debentures 1,191 5,333 -- 5% Convertible Debentures 4,273 -- -- --------- --------- --------- 24,024 17,632 7,941 --------- --------- --------- DILUTED EPS $ 1.23 $ 0.66 $ 0.45 17 18 KEY ENERGY GROUP, INC. SUBSIDIARIES INCOME TAXES The Company accounts for income taxes based upon Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date. A valuation allowance for deferred tax assets is recognized when it is "more likely than not" that the benefit of deferred tax assets will not be realized. The Company and its eligible subsidiaries file a consolidated U. S. federal income tax return. Certain subsidiaries that are consolidated for financial reporting purposes are not eligible to be included in the consolidated U. S. federal income tax return and separate provisions for income taxes have been determined for these entities or groups of entities. CONCENTRATION OF CREDIT RISK Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of temporary cash investments and trade receivables. The Company restricts investment of temporary cash investments to financial institutions with high credit standing and by policy limits the amount of credit exposure to any one financial institution. The Company's customer base consists primarily of multi-national, foreign national and independent oil and natural gas producers. See Note 12 for additional information regarding customers which accounted for more than 10% of consolidated revenues. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on its trade receivables. Such credit risk is considered by management to be limited due to the large number of customers comprising the Company's customer base. The Company maintains reserves for potential credit losses, and such losses have been within management's expectations. IMPACT OF SFAS 121 On July 1, 1996, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121 - Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of ("FAS 121"). This Statement requires that long-lived assets, goodwill and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Adoption of this Statement did not have an impact on the Company's consolidated financial position, results of operations, or liquidity. STOCK-BASED COMPENSATION The Company accounts for employee stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"). Accordingly, the company has only adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 123"). See Note 8 for the pro forma disclosures of compensation expense determined under the fair-value provisions of SFAS 123. CASH AND CASH EQUIVALENTS For cash flow purposes, the Company considers all unrestricted highly liquid investments with less than a three month maturity when purchased as cash equivalents. 18 19 KEY ENERGY GROUP, INC. AND SUBSIDIARIES RECLASSIFICATIONS Certain reclassifications have been made to the fiscal 1997 and 1996 consolidated financial statements to conform to the fiscal 1998 presentation. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS The Financial Accounting Standards Board has recently issued the following accounting standards which will be adopted by the Company in the future: Statement of Financial Accounting Standards No. 130 ("SFAS 130") - Reporting Comprehensive Income, is effective for fiscal years beginning after December 15, 1997. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. Specifially, SFAS 130 requires that an enterprise (i) classify items of other comprehensive income by their nature in a financial statement and (ii) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The Company will adopt SFAS 130 in the first quarter of its fiscal year ended June 30, 1999. Statement of Financial Accounting Standards No. 131 ("SFAS 131") - Disclosures about Segments of an Enterprise and Related Information, is effective for financial statements for periods beginning after December 15, 1997. SFAS 131 establishes standards for the way that company's report information about operating segments in annual financial statements and requires that those company's report selected information about operating segments in interim financial reports issued to shareholders. This statement also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS 131 need not be applied to interim financial statements in the initial year of its application. However, comparative information for interim periods in the initial year of application is to be reported in the financial statements for interim periods in the second year of application. The Company will adopt SFAS 131 for the fiscal year ended June 30, 1999. Impact of Inflation on Operations Although in our complex environment it is extremely difficult to make an accurate assessment of the impact of inflation on the Company's operations, management is of the opinion that inflation has not had a significant impact on its business. 2. BUSINESS AND PROPERTY ACQUISITIONS The following acquisitions have been completed during fiscal 1998 are included in the Company's results of operations for the twelve months ended June 30, 1998. Each of the acquisitions were accounted for using the purchase method of accounting. Unless otherwise noted, the purchase prices specified below are based on cash paid and/or the fair value of the Company's common stock, par value $0.10 (the "Common Stock"). Transportes Dimopulos S.R.L. On June 5, 1998, the Company completed the acquisition of Transportes Dimopulos S.R.L. ("Transportes") which operates in Argentina. Transportes was acquired for approximately $2.2 million in cash and future obligations, and included approximately 28 oilfield service trucks and trailers, all located in Argentina. The operating results of Transportes are included in the Company's results of operations effective June 5, 1998. Watson Truck & Supply, Inc. On May 19, 1998, the Company completed the acquisition of certain assets of Watson Truck & Supply, Inc. ("Watson") for approximately $2.6 million in cash. The asset purchased included a repair and refurbishment 19 20 KEY ENERGY GROUP, INC. AND SUBSIDIARIES facility and a supply store in Mills, Wyoming. The operating results of Watson are included in the Company's results of operations effective June 1, 1998. Lakota Drilling Company On May 22, 1998, the Company completed the acquisition of the assets of Lakota Drilling Company ("Lakota") for approximately $12 million in cash. Lakota operates seven drilling rigs in the Permian Basin region of West Texas. The operating results of Lakota are included in the Company's results of operations effective June 1, 1998. Odessa Exploration Properties On June 14, 1998, Odessa Exploration completed the purchase of approximately $8.7 million of oil and gas producing and undeveloped properties from a group of sellers unrelated to the Company. JPF Well Service, Inc. and JPF Lease Service, Inc. On April 20, 1998, the Company completed the acquisition of the assets of JPF Well Service, Inc. and JPF Lease Service, Inc. (collectively, "JPF") for approximately $6.2 million in cash. JPF operates nine well service rigs and oilfield construction equipment in Southeast Texas. The operating results of JPF are included in the Company's results of operations effective April 20, 1998. Edwards Transport, Inc. On March 27, 1998, the Company completed the acquisition of the assets of Edwards Transport, Inc. ("Edwards") for approximately $3.0 million in cash. Edwards operates fifteen vacuum and pump trucks in West Texas. The operating results of Edwards are included in the Company's results of operations effective April 1, 1998. Lundy Vacuum Service, Inc. On March 3, 1998, the Company completed the acquisition of the assets of Lundy Vacuum Service, Inc. ("Lundy") for approximately $1.4 million in cash. Lundy operates eight vacuum trucks, other oilfield fluid hauling trucks and an oilfield construction site business in East Texas. The operating results of Lundy are included in the Company's results of operations effective March 3, 1998. Lauffer Well Service, Inc. On March 2, 1998, the Company completed the acquisition of the assets of Lauffer Well Service, Inc. ("Lauffer") for approximately $400,000 in cash. Lauffer operates four well service rigs in Kentucky. The operating results of Lauffer are included in the Company's results of operations effective March 2, 1998. Updike Brothers, Inc. On February 6, 1998, the Company completed the acquisition of Updike Brothers, Inc. ("Updike") for approximately $10.6 million in cash. Updike operates 25 well service rigs in Wyoming. The operating results of Updike are included in the Company's results of operations effective February 6, 1998. Four Corners Drilling Company On February 4, 1998, the Company completed the acquisition of the assets of Four Corners Drilling Company ("Four Corners") for approximately $10.0 million in cash. Four Corners owns 12 drilling rigs in the four corners region of the Southwestern United States. The operating results of Four Corners are included in the Company's results of operations effective February 4, 1998. 20 21 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Kingsley Enterprises, Inc. d/b/a Legacy Drilling Co. On January 30, 1998, the Company completed the acquisition of Kingley Enterprises, Inc. d/b/a Legacy Drilling Co. ("Legacy") for approximately $2.6 million in cash. Legacy operates four drilling rigs in the Permian Basin region of West Texas. The operating results of Legacy are included in the Company's results of operations effective February 1, 1998. Circle M Vacuum Services, Inc. On January 30, 1998, the Company completed the acquisition of the assets of Circle M Vacuum Services, Inc. ("Circle M") for approximately $800,000 in cash. Circle M operates four vacuum trucks, trailers and a salt water disposal well in Southeast Texas. The operating results of Circle M are included in the Company's results of operations effective February 1, 1998. Hot Oil Plus, Inc. On January 29, 1998, the Company completed the acquisition of the assets of Hot Oil Plus, Inc. ("Hot Oil Plus") for approximately $2.2 million in cash. Hot Oil Plus operates eight hot oil trucks, a pump truck and a steam heater in Southeast Texas. The operating results of Hot Oil Plus are included in the Company's results of operations effective February 1, 1998. J.W. Gibson Well Service Company On January 8, 1998, the Company completed the acquisition of J.W. Gibson Well Service Company ("Gibson") for approximately $25.8 million, consisting of $23.9 million in cash, 100,000 shares of Common Stock and warrants to acquire 265,000 shares of Common Stock at an exercise price of $18.00 per share, subject to certain adjustments. Gibson operates 74 well service rigs and related equipment in eight states. From August 1, 1997 through the closing of the acquisition, the Company managed the operations of Gibson pursuant to an interim operating agreement. Under the operating agreement, the Company received a management fee equal to the operating income from Gibson's operations less $25,000 per month and received a one-time management fee of $300,000. The total management fee earned from August 1, 1997 through September 30, 1997 of $361,000 is classified as other revenue in the consolidated statement of operations. The operating results of Gibson are included in the Company's consolidated results of operations effective January 8, 1998. The payment of the management fee was not contingent upon closing of this transaction. Sitton Drilling Co. On January 1, 1998, the Company completed the acquisition of Sitton Drilling Co. ("Sitton") for approximately $15.0 million, including $12.9 million in cash and 100,000 shares of Common Stock. Sitton operates five drilling rigs in the Permian Basin region of West Texas. The operating results of Sitton are included in the Company's results of operations effective January 1, 1998. Wellcorps, L.L.C., White Rhino Drilling, Inc. and S&R Cable, Inc. On December 2, 1997, the Company completed the acquisition of the assets of Wellcorps, L.L.C., White Rhino Drilling, Inc. and S&R Cable, Inc. (collectively the "Critchfield Assets") for approximately $8.4 million, consisting of $2.7 million in cash and 240,000 shares of Common Stock. The Critchfield Assets consist of five land drilling rigs, five well service rigs and other related equipment in Michigan. The operating results of Critchfield Assets are included in the Company's results of operations effective December 2, 1997. 21 22 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Win-Tex Drilling Co., Inc. and Win-Tex Trucking Corporation On November 24, 1997, the Company completed the acquisition of Win-Tex Drilling Co., Inc. and Win-Tex Trucking Corporation ("Win-Tex") for approximately $6.5 million in cash. Win-Tex operates six land drilling rigs, trucks, trailers and related equipment in West Texas. The operating results of Win-Tex are included in the Company's results of operations effective December 1, 1997. Jeter Service Co. On November 18, 1997, the Company completed the acquisition of Jeter Service Co. ("Jeter") for approximately $6.7 million in cash. Jeter operates 15 well service rigs, an oilfield supply store and an oilfield location construction/maintenance business with 15 trucks and other related equipment in Oklahoma. The operating results of Jeter are included in the Company's results of operations effective December 1, 1997. GSI Trucking Company, Inc., Kahlden Production Services, Inc. and McCurdy Well Service, Inc. On October 3, 1997, the Company acquired certain assets of GSI Trucking Company, Inc., Kahlden Production Services, Inc. and McCurdy Well Service, Inc. ("GSI, Kahlden and McCurdy") for approximately $1.8 million in cash. GSI, Kahlden and McCurdy operate 12 fluid and 5 equipment hauling trucks in Southeast Texas. The operating results of GSI, Kahlden and McCurdy are included in the Company's results of operations effective October 3, 1997. Big A Well Service Co., Sunco Trucking Co. and Justis Supply Co., Inc. On October 1, 1997, the Company completed the acquisition of substantially all of the assets of Big A Well Service Co., Sunco Trucking Co. and Justis Supply Co., Inc. (collectively "Big A/Sunco") for approximately $31.1 million, consisting of $27 million in cash and 125,000 shares of Common Stock. Big A/Sunco operates 25 well service rigs, four drilling rigs, 75 oilfield trucks, related equipment and a machine shop/supply store in the Four Corners region of the Southwestern United States. The operating results of Big A/Sunco are included in the Company's results of operations effective October 1, 1997. Frontier Well Service, Inc. On September 30, 1997, the Company completed the acquisition of Frontier Well Service, Inc. ("Frontier") for approximately $3.5 million in cash. Frontier operates 12 well service rigs and related equipment in Wyoming. The operating results of Frontier are included in the Company's results of operations effective October 1, 1997. Dunbar Well Service, Inc. On September 29, 1997, the Company completed the acquisition of Dunbar Well Service, Inc. ("Dunbar") for approximately $11.8 million in cash. Dunbar operates 38 well service rigs and related equipment in Wyoming. The operating results of Dunbar are included in the Company's results of operations effective October 1, 1997. BRW Drilling, Inc. On September 25, 1997, the Company completed the acquisition of BRW Drilling, Inc. ("BRW") for approximately $14.6 million in cash. BRW operates seven drilling rigs and related equipment in the Permian Basin region of West Texas and Eastern New Mexico. The operating results of BRW are included in the Company's results of operations effective October 1, 1997. Landmark Fishing & Rental, Inc. On September 16, 1997, the Company completed the acquisition of Landmark Fishing & Rental, Inc. ("Landmark") for approximately $3.8 million in cash. Landmark operates a rental tool business in Western 22 23 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Oklahoma and the Texas Panhandle. The operating results of Landmark are included in the Company's results of operations effective September 16, 1997. Waco Oil & Gas Co., Inc. On September 1, 1997, the Company completed the acquisition of certain assets of Waco Oil & Gas Co., Inc. ("Waco") for approximately $7.0 million in cash. The Waco assets included 12 well service rigs, three drilling rigs, 33 oilfield trucks operated in West Virginia. Following the consummation of the acquisition, the three drilling rigs acquired from Waco were sold to an independent third party for $2.3 million in cash. No gain or loss was recognized in the sale of these rigs. The operating results of Waco are included in the Company's results of operations effective September 23, 1997. Ram Oil Well Service, Inc. and Rowland Trucking Co., Inc. On September 1, 1997, the Company completed the acquisition of Ram Oil Well Service, Inc. and Rowland Trucking Co., Inc. ("Ram/Rowland") for $21.5 million in cash. Ram/Rowland operates 17 well service rigs, 93 oilfield trucks, 290 frac tanks, three disposal and brine wells, and dirt construction equipment in the Permian Basin region of West Texas and Southeastern New Mexico. The operating results of Ram/Rowland are included in the Company's results of operations effective September 1, 1997. Mosley Well Service, Inc. On August 22, 1997, the Company completed the acquisition of Mosley Well Service, Inc., ("Mosley"), which operates 36 well service rigs and related equipment in East Texas, Northern Louisiana and Arkansas, for approximately $17.2 million in cash. The operating results of Mosley are included in the Company's results of operations effective August 22, 1997. Kenting Holdings (Argentina) S.A. On July 30, 1997, the Company completed the acquisition of Kenting Holdings (Argentina) S.A. ("Kenting") for approximately $10.1 million in cash. Kenting is the sole shareholder of Kenting Drilling (Argentina) S.A. which operates six well service rigs, three drilling rigs and related equipment in Argentina. The operating results of Kenting are included in the Company's results of operations effective August 1, 1997. Patrick Well Service, Inc. On July 17, 1997, the Company completed the acquisition of Patrick Well Service, Inc. ("Patrick") for approximately $7.0 million in cash. Patrick operates 29 well service rigs and related equipment in Southwest Kansas, Oklahoma and Southeast Colorado. The operating results of Patrick are included in the Company's results of operations effective August 1, 1997. Servicios WellTech S.A. On July 1, 1997, the Company purchased the remaining 37% minority interest in Servicios WellTech S.A. ("Servicios") from two unrelated parties for approximately $3.4 million in cash. As a result of the purchase, the Company now owns 100% of Servicios. The operating results of the remaining minority interest in Servicios are included in the Company's results of operations effective July 1, 1997. 23 24 KEY ENERGY GROUP, INC. AND SUBSIDIARIES ACQUISITION COMPLETED PRIOR TO JUNE 30, 1997 Well-Co Oil Service. Inc. On June 26, 1997, the Company completed its acquisition of Well-Co Oil Service, Inc. ("Well-Co") which operates 79 well service rigs and related equipment in west Texas. Well-Co was acquired for $17.5 million in cash and 240,000 shares of the Company's common stock. The results of operations of Well-Co are included in the Company's results of operations effective June 26, 1997. Phoenix Well Service, Inc. On June 10, 1997, the Company completed its acquisition of Phoenix Well Service, Inc. ("Phoenix") which operates 11 well service rigs and related equipment in west Texas. Phoenix was acquired for $2.3 million in cash. The results of operations of Phoenix are included in the Company's results of operations effective June 26, 1997. Southwest Oilfield Services, Inc. On June 10, 1997, the Company completed its acquisition of Southwest Oilfield Services, Inc. ("Southwest") which operates 3 well service rigs and related equipment in western Oklahoma. Southwest was acquired for $455,000 in cash. The results of operations of Southwest are included in the Company's results of operations effective June 10, 1997. Wireline and Excavation Assets On May 1, 1997, the Company completed an acquisition of ten wireline units and related equipment for approximately $600,000 in cash. On May 5, 1997, the Company completed its acquisition of several dump trucks and related excavation equipment for $410,000 in cash. The results of operations of these assets are included in the Company's results of operations effective May 1, 1997. Shreve's Well Service On April 18, 1997, the Company completed its acquisition of the assets of Shreve's Well Service, Inc. ("Shreve's") which operated in West Virginia. Shreve's assets were acquired for $550,000 in cash and included five well service rigs and related equipment. The results of operations of Shreve's are included in the Company's results of operations effective May 1, 1997. Argentine Drilling Rigs On April 16, 1997, the Company acquired three drilling rigs and related equipment in Argentina from Drillers, Inc. for $1.5 million in cash. The drilling rigs will be operated by WellTech Servicios, the Company's Argentine subsidiary. Diamond Well Service On April 3, 1997, the Company completed the acquisition of the assets of Diamond Well Service, Inc. ("Diamond") for $675,000 in cash. The Diamond assets included four oilwell service rigs and related equipment in Oklahoma. The results of operations of Diamond are included in the Company's results of operations effective April 1, 1997. Kalkaska Construction Service, Inc. ,Kalkaska Oilfield Service, Inc. and Elder Well Service, Inc. On March 31, 1997, the Company completed the acquisition of the assets of Kalkaska Construction Service, Inc., Kalkaska Oilfield Service, Inc. ("KalCon") and Elder Well Service, Inc. ("Elder"), both based in Michigan. The KalCon assets included 40 vacuum (fluid transport) trucks, 40 trucks used in oilfield 24 25 KEY ENERGY GROUP, INC. AND SUBSIDIARIES equipment hauling, seven saltwater disposal wells and other oilfield related equipment, and were acquired for approximately $8.5 million in cash and 77,998 shares of the Company's common stock. The Elder assets included six well service rigs and related equipment and were acquired for $609,000 in cash. The operating results of KalCon and Elder are included in the Company's results of operations effective April 1, 1997. T.S.T. Paraffin Service Co., Inc. On March 27, 1997, the Company completed the acquisition of T.S.T. Paraffin Service Co., Inc. ("TST") for $8.7 million in cash. TST operates approximately 61 trucks, 22 hot oil units and other related equipment in west Texas. The operating results of TST are included in the Company's results of operations effective April 1, 1997. Tri-State Wellhead & Valve, Inc. The Company completed its acquisition of the assets of Tri-State Wellhead & Valve, Inc. ("Tri-State") on March 17, 1997 for $550,000 in cash and 83,770 shares of the Company's common stock. The Tri-State assets consisted of a wellhead equipment rental business and five well service rigs. The operating results from these assets are included in the Company's results of operations effective April 1, 1997. Cobra Industries, Inc. Effective as of January 13, 1997, the Company completed the purchase of Cobra Industries, Inc. ("Cobra") for $5 million in cash and 175,000 shares of the Company's common stock. Cobra operates 26 well service rigs in southeastern New Mexico. The operating results from Cobra are included in the Company's results of operations effective February 1, 1997. Talon Trucking Co. Effective as of January 7, 1997, the Company completed the acquisition of the assets of Talon Trucking Co. ("Talon") for $2.7 million in cash. Talon operated three well service rigs, 21 trucks and related fluid transportation and disposal assets in Oklahoma. The operating results from these assets are included in the Company's results of operations effective January 7, 1997. B&L Hotshot, Inc. Effective as of December 13, 1996, the Company completed the acquisition of B&L Hotshot, Inc. and affiliated entities ("B&L) for $4.9 million in cash. B&L provides trucking and related services for oil and natural gas wells in Michigan. The operating results from B&L are included in the Company's results of operations effective January 1, 1997. Brooks Well Servicing, Inc. Effective as of December 1, 1996, the Company completed the acquisition of Brooks Well Servicing, Inc. ("Brooks") for 917,500 shares of the Company's common stock. Brooks was a wholly-owned subsidiary of Hunt Oil Company and operated 32 well service rigs and ancillary equipment in east Texas. The operating results from Brooks are included in the Company's results of operations effective December 1, 1996. Hitwell Surveys, Inc. Effective as of December 2, 1996, the Company completed the purchase of Hitwell Surveys, Inc. ("Hitwell") for approximately $1.3 million in cash. Hitwell operates eight well logging and perforating trucks in the Appalachian Basin and Michigan. The operating results from Hitwell are included in the Company's results of operations effective December 1, 1996. 25 26 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Energy Air Drilling Services Co. Effective as of November 1, 1996, the Company completed the acquisition of certain assets of Energy Air Drilling Services Co. ("Energy Air") for $500,000 in cash and 4,386 shares of the Company's common stock. Energy Air operated four air drilling packages in west Texas. Brownlee Well Service Inc. Effective as of October 24, 1996, the Company completed the purchase of Brownlee Well Service, Inc. ("Brownlee") and Integrity Fishing and Rental Tools Inc., ("Integrity"). Consideration for the acquisition was $6.5 million in cash and 61,069 shares of the Company's common stock. Brownlee and Integrity operate 16 well service rigs with ancillary equipment and a variety of oilfield fishing tools in west Texas. The operating results from Brownlee are included in the Company's results of operations effective November 1, 1996. Woodward Well Service, Inc Effective as of October 1, 1996, the Company completed the acquisition of Woodward Well Service, Inc. ("Woodward") for 75,000 shares of the Company's common stock and approximately $100,000 in cash, most of which is payable over a four-year period. Woodward operated five well service units in Oklahoma. The operating results from Woodward are included in the Company's results of operations effective October 1, 1996. ACQUISITIONS COMPLETED PRIOR TO JUNE 30, 1996 Odessa Exploration Properties In April of 1996, Odessa Exploration purchased approximately $6.9 million in cash of oil and gas producing properties from an unrelated company using proceeds from bank borrowings, which indebtedness was subsequently repaid. WellTech, Inc. On March 26, 1996, the Company completed the merger of WellTech, Inc. ("WellTech") into the Company. The net consideration for the merger was 3,500,000 shares of the Company's common stock and warrants to purchase 500,000 additional shares of Common Stock at an exercise price of $6.75 per share. WellTech conducted oil and gas well servicing operations in the Mid-Continent and Northeast areas of the United States and in Argentina. 26 27 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Pro Forma Results of Operations--(unaudited) The following unaudited pro forma results of operations have been prepared as though Well-Co, Cobra, T.S.T., Ram/Rowland, Coleman, Dunbar, Gibson, Updike and Lakota had been acquired on July 1, 1996. Proforma amounts are not necessarily indicative of the results that may be reported in the future. YEAR ENDED (THOUSANDS, EXCEPT PER SHARE DATA) JUNE 30, 1998 JUNE 30, 1997 -------------------------------- -------------- ------------- Revenues $ 459,764 $ 316,656 Net income 26,075 13,342 Basic earnings per share $ 1.52 $ 1.19 3. OTHER ASSETS Other assets consist of the following: June 30, (Thousands) 1998 1997 ------------ ------- ------- Investment in securities $12,325 $ -- Workers compensation security deposits 1,418 1,817 Debt issuance costs (net of amortization; 1998 - $2,350, 1997 - $344) 11,869 7,045 Other 1,383 458 ------- ------- $26,995 $ 9,320 ======= ======= 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 effect to the consolidated financial position, liquidity, capital resources, resources of future results of operations of the Company. During 1995 and subsequent fiscal years, the Company entered into employment agreements with certain of its officers. These employment agreements generally run for two fiscal years, but can be automatically be extended on a yearly basis unless terminated by the Company or the applicable officer. In addition to providing a base salary for each officer, the employment agreements provide for severance payments for each officer varying from 12 to 24 months of the officers base salary. The current annual base salaries for the officers covered under such employment agreements total approximately $1,189,000. 5. LONG-TERM DEBT The components of long-term debt are as follows: June 30, (Thousands) 1998 1997 ----------- -------- -------- PNC Credit Facility (i) $172,000 $120,000 5% Subordinated Debentures (ii) 216,000 -- 7% Subordinated Debentures (iii) 4,600 52,000 Other notes payable (iv) 7,179 2,167 -------- -------- 399,779 174,167 Less current portion 1,848 1,404 -------- -------- Long-term debt $397,931 $172,763 ======== ======== 27 28 KEY ENERGY GROUP, INC. AND SUBSIDIARIES (i) PNC CREDIT FACILITY On June 6, 1997, the Company entered into an agreement (the "Initial Credit Agreement") with PNC Bank, N.A. ("PNC"), as administrative agent, and a syndication of other lenders pursuant to which the lenders provided a $255 million credit facility, consisting of a $120 million seven-year term loan and a $135 million five-year revolver. The interest rate on the term loan was LIBOR plus 2.75 percent. The interest rate on the revolver varied based on LIBOR and the level of the Company's indebtedness. The Initial Credit Agreement contained certain restrictive covenants and required the Company to maintain certain financial ratios. On September 25, 1997, the Company repaid the term loan and a portion of the then outstanding amounts under the revolver by applying the proceeds from the initial and second closings of the Company's private placement of $216 million of 5% Convertible Subordinated Notes (discussed below). Effective November 6, 1997, the Company entered into an Amended and Restated Credit Agreement with PNC (the "Amended PNC Credit Agreement"), as administrative agent and lender, pursuant to which PNC agreed to make revolving credit loans of up to a maximum loan commitment of $200 million. The maximum commitment decreases to $175 million on November 6, 2000 and to $125 million on November 6, 2001. The loan commitment terminates on November 6, 2002. Borrowings under the credit facility may be either (i) Eurodollar Loans with interest currently payable quarterly at LIBOR plus 1.25% subject to adjustment based on certain financial ratios, (ii) Base Rate Loans with interest payable quarterly at the greater of PNC Prime Rate or the Federal Funds Effective Rate plus 1/2 %, or (iii) a combination thereof, at the Company's option. The Amended PNC Credit Agreement contains certain restrictive covenants and requires the Company to maintain certain financial ratios. A change of control of the Company, as defined in the Amended PNC Credit Agreement, is an event of default. Borrowings under the Amended PNC Credit Agreement are secured by substantially all of the assets of the Company and its domestic subsidiaries. Effective December 3, 1997, PNC completed the syndication of the Amended PNC Credit Agreement. In connection therewith, PNC, as administrative agent, a syndication of lenders and the Company entered into a First Amendment to the Amended PNC Credit Agreement providing for, among other things, an increase in the maximum commitment to $250 million from $200 million. In connection with the acquisition of Dawson, the total consideration paid for the Dawson Shares pursuant to the Tender Offer and the First Merger was approximately $181.7 million. The Company's source of funds to pay such amount, certain outstanding debt of Dawson and the Company and related fees and expenses was (i) a bridge loan agreement in the amount of $150,000,000, dated as of September 14, 1998, among the Company, Lehman Brothers Inc., as Arranger, and Lehman Commercial Paper Inc., as Administrative Agent, and the other lenders party thereto (the "Bridge Loan Agreement") and (ii) a $550,000,000 Second Amended and Restated Credit Agreement, dated as of June 6, 1997, as amended and restated through September 14, 1998, among the Company, PNC Bank, National Association, as Administrative Agent, Norwest Bank Texas, N.A., as Collateral Agent, PNC Capital Markets, Inc., as Arranger and the other lenders named from time to time parties thereto (the "Second Amended and Restated Credit Agreement"). In connection with the Bridge Loan Agreement, the Company entered into Registration Rights Agreements (the "Registration Rights Agreements") with Lehman Brothers Inc. and Lehman Commercial Paper Inc. pursuant to which the Company agreed to file with the Securities and Exchange Commission (the "Commission") within a certain time period a registration statement with respect to (i) an offer to exchange borrowings under the Bridge Loan Agreement for a new issue of debt securities of the Company, and (ii) the resale of warrants (and the shares of common stock of the Company to be issued upon the exercise of such warrant) to purchase shares of common stock of the Company issued to Lehman Brothers Inc. in connection with the Bridge Loan Agreement. Loans outstanding after one year pursuant to the Bridge Loan Agreement will convert into term loans which may be exchanged by the holders thereof for exchange notes issued pursuant to an Indenture dated as of September 14, 1998 (the "Indenture"), between the Company and The Bank of New York, trustee. 28 29 KEY ENERGY GROUP, INC. AND SUBSIDIARIES In addition, the Company, its subsidiaries and U.S. Trust Company of Texas, N.A., trustee ("U.S. Trust"), entered into a Supplemental Indenture dated September 21, 1998 (the "Supplemental Indenture"), pursuant to which the Company assumed the obligations of Dawson under the Indenture dated February 20, 1997 (the "Dawson Indenture") between Dawson and U.S. Trust, most of the Company's subsidiaries guarantied those obligations and the notes issued pursuant to the Dawson Indenture were equally and ratably secured with the obligations under the Second Amended and Restated Credit Agreement. Under the terms of the Dawson Indenture, the Company is required to commence a cash tender offer to purchase at 101% of the aggregate principal amount of the outstanding notes (which outstanding amount is $140 million) by mid-October 1998, the source of funds for which will be borrowings under the Second Amended and Restated Credit Agreement. Additionally, the Company has outstanding letters of credit of $2,612,000 as of fiscal 1998 and 1997, related to its workers compensation insurance. Also, the Company is contractually restricted from paying dividends under the terms of the Bridge Loan Agreement and the First Amendment to the Amended PNC Credit Agreement. (ii) 5% CONVERTIBLE SUBORDINATED NOTES On September 25, 1997, the Company completed an initial closing of its private placement of $200 million of 5% Convertible Subordinated Notes due 2004 (the "Notes"). On October 7, 1997, the Company completed a second closing of its private placement of an additional $16 million of Notes pursuant to the exercise of the remaining portion of the over-allotment option granted to the initial purchasers of Notes. The placements were made as private offerings pursuant to Rule 144A and Regulation S under the Securities Act. The Notes are subordinate to the Company's senior indebtedness, which, as defined in the indenture under which the Notes were issued, includes the borrowings under the Amended PNC Credit Agreement, as amended. The Notes are convertible, at the holder's option, into shares of Common Stock at a conversion price of $38.50 per share, subject to certain adjustments. The Notes are redeemable, at the Company's option, on or after September 15, 2000, in whole or part, together with accrued and unpaid interest. The initial redemption price is 102.86% for the year beginning September 15, 2000 and declines ratably thereafter on an annual basis. In the event of a change in control of the Company, as defined in the indenture under which the Notes were issued, each holder of Notes will have the right, at the holder's option, to require the Company to repurchase all or any part of the holder's Notes, within 60 days of such event, at a price equal to 100% of the principal amount thereof, together with accrued and unpaid interest thereon. Proceeds from the placement of the Notes were used to repay balances under the Company's credit facilities (see above). At June 30, 1998, $216,000,000 principal amount of the Notes was outstanding. Interest on the Notes is payable on March 15 and September 15. Interest of approximately $5.1 million was paid on March 15, 1998. (iii) 7% CONVERTIBLE SUBORDINATED DEBENTURES In July 1996, the Company completed a $52,000,000 private offering of 7% Convertible Subordinated Debentures due 2003 (the "Debentures") pursuant to Rule 144A under the Securities Act of 1933, as amended (the "Securities Act"). The Debentures are subordinate to the Company's senior indebtedness, which as defined in the indenture pursuant to which the Debentures were issued includes the borrowings under the Amended PNC Credit Agreement, as amended. The Debentures are convertible, at any time prior to maturity, at the holders' option, into shares of Common Stock at a conversion price of $9.75 per share, subject to certain adjustments. In addition, Debenture holders who convert prior to July 1, 1999 will be entitled to receive a payment, in cash or Common Stock (at the 29 30 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Company's option), generally equal to 50% of the interest otherwise payable from the date of conversion through July 1, 1999. The Debentures are redeemable, at the option of the Company, on or after July 15, 1999, at a redemption price of 104%, decreasing 1% per year on each anniversary date thereafter. In the event of a change in control of the Company, as defined in the indenture under which the Debentures were issued, each holder of Debentures will have the right, at the holder's option, to require the Company to repurchase all or any part of the holder's Debentures within 60 days of such event at a price equal to 100% of the principal amount thereof, together with accrued and unpaid interest thereon. As of June 30, 1998, $47,400,000 in principal amount of the Debentures had been converted into 4,861,538 shares of common stock at the option of the holders. An additional 165,423 shares of common stock were issued representing 50% of the interest otherwise payable from the date of conversion through July 1, 1999 and an additional 35,408 shares of common stock were issued as an inducement to convert. The issuance of an additional 165,423 shares of common stock, representing 50% of the interest otherwise payable from the date of conversion through July 1, 1999, were treated as an equity transaction due to their inclusion as conversion privileges included in the terms of the indentures at issuance. The fair value of the additional 35,408 shares of common stock issued as inducement to convert was $710,186 and is recorded as interest expense in the consolidated statement of operations. In addition, the proportional amount of unamortized debt issuance costs associated with the converted Debentures was charged to additional paid-in capital at the time of conversion. At June 30, 1998, $4,600,000 principal amount of the Debentures remained outstanding. Interest on the Debentures is payable on January 1 and July 1 of each year. (IV) OTHER NOTES PAYABLE At June 30, 1998, other notes payable consist primarily of capital leases for automotive equipment and equipment leases with varying interest rates and principal and interest payments. Presented below is a schedule of the repayment requirements of long-term debt for each of the next five years and thereafter as of June 30, 1998: (in thousands) Fiscal year Principal Ended Amount ------------ -------- 1999 $ 1,848 2000 2,194 2001 1,417 2002 991 2003 177,329 -------- Thereafter 216,000 ======== $399,779 6. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, other current assets and other current liabilities approximates fair value because of the short maturity of these instruments. Marketable equity securities with a total cost of approximately $9,961,000 are deemed by management to be available for sale and are classified in the consolidated balance sheet at fair value of approximately $12,307,000 as other long-term assets with net unrealized gains of approximately $2,346,000 reported within stockholders equity. 30 31 KEY ENERGY GROUP, INC. AND SUBSIDIARIES The fair value of the Company's borrowing under its PNC Credit Facility approximates the carrying amount as of June 30, 1998 and 1997, based on the borrowing rates currently estimated to be available to the Company for loans with similar terms. The 7% subordinated convertible debentures have a carrying value of $4.6 million and $52 million and a fair value of approximately $6.7 million and $98.9 million at June 30, 1998 and 1997, respectively. In addition, the 5% Notes have a carrying value of $216 million and a fair value of approximately $164.1 million at June 30, 1998. The fair value of these debentures was estimated using quoted market prices. 7. OTHER ACCRUED LIABILITIES Other accrued liabilities consist of the following: June 30, (Thousands) 1998 1997 ----------- ------- ------- Accrued payroll and taxes $10,852 $ 6,674 Unvouchered accounts payable 3,428 -- Group medical insurance 695 891 Workers compensation 794 1,683 State sales, use and other taxes 1,030 247 Gas imbalance - deferred income -- 155 Oil and Gas revenue distribution 201 145 Acquisition and reorganization accrual 2,066 838 401(k) monies payable 405 -- Other 2,768 1,874 ------- ------- Total $22,239 $12,507 ======= ======= 8. STOCKHOLDERS' EQUITY On January 13, 1998 the Company's shareholders approved the Key Energy Group, Inc. 1997 Incentive Plan (the "1997 Incentive Plan"). The 1997 Incentive Plan is an amendment and restatement of the plans formerly known as the "Key Energy Group, Inc. 1995 Stock Option Plan" (the "1995 Option Plan") and the "Key Energy Group, Inc. 1995 Outside Directors Stock Option Plan" (the "1995 Directors Plan") (collectively, the "Prior Plans"). All options previously granted under the Prior Plans and outstanding as of November 17, 1997 (the date on which the Company's board of directors adopted the plan) were assumed and continued, without modification, under the 1997 Incentive Plan. Under the 1997 Incentive Plan, the Company may grant the following awards to key employees, Directors who are not employees ("Outside Directors") and consultants of the Company, its controlled subsidiaries, and its parent corporation, if any: (i) incentive stock options ("ISOs") as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), (ii) "nonstatutory" stock options ("NSOs"), (iii) stock appreciation rights ("SARs"), (iv) shares of the restricted stock, (v) performance shares and performance units, (vi) other stock-based awards and (vii) supplemental tax bonuses (collectively, ("Incentive Awards"). ISOs and NSOs are sometimes referred to collectively herein as "Options". The Company may grant Incentive Awards covering an aggregate of the greater of (i) 3,000,000 shares of the Company's Common Stock and (ii) 10% of the shares of Common Stock issued and outstanding on the last day of each calendar quarter, provided, however, that a decrease in the number of issued and outstanding shares of Common Stock from the previous calendar quarter shall not result in a decrease in Common Stock available for issuance under the 1997 Incentive Plan. Up to 3,000,000 shares of Common Stock shall be available for Incentive Stock Options. 31 32 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Any shares of Common Stock that are issued and are forfeited or are subject to Incentive Awards under the 1997 Incentive Plan that expire or terminate for any reason will remain available for issuance with respect to the granting of Incentive Awards during the term of the 1997 Incentive Plan, except as may otherwise be provided by applicable law. Shares of Common Stock issued under the 1997 Incentive Plan may be either newly issued or treasury shares, including shares of Common Stock that the Company receives in connection with the exercise of an Incentive Awards. The number and kind of securities that may be issued under the 1997 Incentive Plan and pursuant to then outstanding Incentive Awards are subject to adjustments to prevent enlargement or dilution of rights resulting from stock dividends, stock splits, recapitalizations, reorganization or similar transactions. The maximum number of shares of Common Stock subject to Incentive Awards that may be granted or that may vest, as applicable, to any one Covered Employee (defined below) during any calendar year shall be 500,000 shares, subject to adjustment under the provisions of the 1997 Incentive Plan. The maximum aggregate cash payout subject to Incentive Awards (including SARs, performance units and performance shares payable in cash, or other stock-based awards payable in cash) that may be granted to any one Covered Employee during any calendar year is $2,500,000. For purposes of the 1997 Incentive Plan, "Covered Employees" means a named executive officer who is one of the group covered employees as defined in Section 162(m) of the Code and the regulation promulgated thereunder (ie., generally the chief executive officer and the other four most highly compensated executives for a given year.) The 1997 Incentive Plan is administrated by the Compensation Committee appointed by the Board of Directors (the "Committee") consisting of not less than two directors each of whom is (i) an "outside director" under Section 162(m) of the Code and (ii) a "non-employee director" under Rule 16b-3 of the Securities Exchange Act of 1934 . The following table summarizes the stock option activity related to the Company's plans: Price Shares Per Share ---------- ---------- Outstanding, July 1, 1995 -- -- Granted 1,075,000 $ 5.00 ---------- Outstanding, June 30, 1996 1,075,000 ---------- Granted 175,000 $ 7.50 Granted 175,000 $ 8.313 Granted 50,000 $ 8.375 Granted 25,000 $ 8.50 Granted 25,000 $ 11.125 Granted 535,000 $ 13.25 Granted 25,000 $ 14.50 Granted 50,000 $ 16.875 Canceled (27,000) $ 5.00 Exercised (28,000) $ 5.00 ---------- Outstanding, June 30, 1997 2,080,000 ---------- Granted 20,000 $ 18.125 Granted 250,000 $ 20.4375 Granted 15,000 $ 20.50 Granted 116,000 $ 15.00 Granted 15,000 $ 16.00 Exercised (209,000) $ 5.00 ---------- Outstanding, June 30, 1998 2,287,000 ========== The Company applies APB 25 and related Interpretations in accounting for its stock option awards. Accordingly, no compensation expense has been recognized for its stock option awards. If compensation 32 33 KEY ENERGY GROUP, INC. AND SUBSIDIARIES expense for the stock option awards had been determined consistent with SFAS 123, the Company's net income and net income per share, for the years ended June 30, 1998 and 1997 would have been adjusted to the following pro forma amounts: (unaudited) YEAR ENDED JUNE 30, 1998 1997 ---- ---- Net income (in thousands) $ 22,452 $ 8,680 Basic net income per share $ 1.31 $ 0.71 Diluted net income per share $ 1.14 $ 0.61 The pro forma net income and pro forma net income per share amounts noted above are not likely to be representative of the pro forma amounts to be reported in future years. Pro forma adjustments in future years will include compensation expense associated with the options granted in fiscal year 1998 and 1997 plus compensation expense associated with any options awarded in future years. As a result, such pro forma compensation expense is likely to be higher than the levels reflected for 1998 and 1997 if any options are awarded in future years. Under SFAS 123, the fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grant in 1998 and 1997: 1998 1997 ---- ---- Risk-free interest rate 5.79% 6.59% Expected life 5 years 5 years Expected volatility 136% 28% Expected dividend yield 0% 0% The total fair value of options granted at June 30, 1998 and 1997 is $14,098,000 and $6,541,000, respectively. 9. INCOME TAXES Components of income tax expense are as follows: Fiscal Year Ended June 30, (Thousands) 1998 1997 1996 ---------- ------- ------- ------- Federal and State: Current $ 7,343 $ 1,664 $ 270 Deferred 7,287 3,836 1,618 ------- ------- ------- $14,630 $ 5,500 $ 1,888 ======= ======= ======= Income tax expense differs from amounts computed by applying the statutory federal rate as follows: Fiscal Year Ended June 30, (Thousands) 1998 1997 1996 ----------- ---- ---- ---- Income tax computed at Statutory rate 35.0% 35.0% 34.0% Amortization of goodwill disallowance 1.1 1.5 -- Meals and entertainment disallowance 0.7 0.8 1.7 State taxes 0.7 .2 -- Other 0.2 0.4 (1.8) ---- ---- ---- 37.7% 37.9% 33.9% ==== ==== ==== 33 34 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Deferred tax assets (liabilities) are comprised of the following : Fiscal Year Ended June 30, (Thousands) 1998 1997 1996 -------- -------- -------- Net operating loss and tax credit carry-forwards $ 5,564 $ 4,628 $ 6,293 Property and equipment (99,664) (40,410) (10,942) Other 2,363 (82) 95 -------- -------- -------- Net deferred tax liability $ 91,737 $(35,864) $ (4,554) ======== ======== ======== A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Based on expectations for the future, management has determined that taxable income of the Company will more likely than not be sufficient to fully utilize available carryforwards prior to their ultimate expiration. The Company estimates that as of June 30, 1998, the Company will have available approximately $3,290,000 of net operating loss carryforwards (which begin to expire in 2001). The net operating loss carryforwards are subject to an annual limitation of approximately $940,000, under Sections 382 and 383 of the Internal Revenue Code. 10. LEASING ARRANGEMENTS Among other leases, the Company (primarily its subsidiaries) leases certain automotive equipment under non-cancelable operating leases which expire at various dates through 2002. The term of the operating leases generally run from 36 to 60 months with varying payment dates throughout each month. In addition, in the case of Yale E. Key, each lease includes an option to purchase the equipment and an excess mileage charge as defined in the leases. As of June 30, 1998, the future minimum lease payments under non-cancelable operating leases, in thousands, are as follows: Lease Fiscal Year Payments Ending June 30, (thousands) 1999 $ 7,249 2000 6,022 2001 3,492 2002 1,641 2003 660 ------- $19,064 ======= Operating lease expense was approximately $8,002,000, $5,299,000, and $2,897,000, for the fiscal years ended June 30, 1998, 1997 and 1996, respectively. 11. EMPLOYEE BENEFIT PLANS Prior to January 1, 1998, the Company maintained two 401(k) plans (the "Old Plans") for its employees such that employees of WellTech Eastern were eligible for participation in one Plan (the "WellTech 401(k) Plan"), while all other employees were eligible for participation in the other Plan (the "Key 401(k) Plan"). At January 1, 1998, the Company merged the two Old Plans into one plan (the "New Plan"). Both the Old Plans and the New Plan cover substantially all employees of the Company. 34 35 KEY ENERGY GROUP, INC. AND SUBSIDIARIES After January 1, 1998, under the New Plan, the Company matches 100% of the employees' contributions up to a maximum of $1,000 per participant per year. Contributions to the New Plan after January 1, 1998 totaled $699,108. Prior to January 1, 1998, under the Old Plans, the Company matched employees' contributions up to 10% of the employees' contribution to the Key 401(k) Plan. These contributions totaled approximately $36,000, $35,000 and $19,000 for the six month period ended December 31, 1997 and the years ended June 30, 1997 and 1996, respectively. Additionally, the Company contributed $172,401 and $300,000 into the WellTech 401(k) Plan for the six month period ended December 31, 1997 and the year ended June 30, 1997, respectively . The Company matched employee contributions up to 50% (to a maximum of $1,000 per employee) of the employees' contributions to the WellTech 401(k) Plan. 12. MAJOR CUSTOMERS Sales to customers representing 10% or more of consolidated revenues for the years ended June 30, 1997, 1996 were as follows: Fiscal Year Ended June 30, 1997 1996 ---- ---- Customer A 13% 20% Customer B 7% 11% The Company did not have any one customer which represented 10% or more of consolidated revenues for the fiscal year ended June 30, 1998. 13. TRANSACTIONS WITH RELATED PARTIES WellTech Eastern paid $108,000 and $78,000 for the years ended June 30, 1998 and 1997, respectively, for office/yard rental expense in which an officer of the Company and WellTech Eastern has an interest. In the opinion of the Board of Directors of the Company, based on the Board's review of competitive bids, this transaction was on terms at least as favorable to the Company as could have been obtained from a third party. Odessa Exploration paid $702,000 for the year ended June 30, 1998 for certain oil and gas assets in a transaction involving a company, the president of which is an outside director of the Company. At June 30, 1998, the Company owed $300,000 to the same company. 14. CONCENTRATIONS OF CREDIT RISK The Company has a concentration of customers in the oil and gas industry. Substantially all of the Company's customers are major integrated oil companies, major independent producers of oil and gas and smaller independent producers. This may affect the Company's overall exposure to credit risk either positively or negatively, in as much as its customers are effected by economic conditions in the oil and gas industry, which has historically been cyclical. However, accounts receivable are well diversified among many customers and a significant portion of the receivables are from major oil companies, which management believes minimizes potential credit risk. Historically, credit losses have been insignificant. Receivables are generally not collateralized, although the Company may generally secure a receivable at any time by filing a mechanic's and material-mans' lien on the well serviced. 35 36 KEY ENERGY GROUP, INC. AND SUBSIDIARIES 15. BUSINESS SEGMENT INFORMATION Information about the Company's operations by business segment is as follows: Year Ended June 30, (Thousands) 1998 1997 1996 - ------------ --------- --------- --------- Identifiable assets: Oilfield services $ 513,583 $ 242,001 $ 94,962 Oil and gas well drilling services 84,579 8,365 5,583 Oil and gas 39,047 23,544 18,170 General corporate 61,431 46,185 3,007 --------- --------- --------- $ 698,640 $ 320,095 $ 121,722 ========= ========= ========= Capital expenditures (excluding acquisitions): Oilfield services $ 44,284 $ 15,084 $ 5,188 Oil and gas well drilling services 5,385 1,483 598 Oil and gas 7,849 8,188 1,879 --------- --------- --------- $ 57,518 $ 24,755 $ 7,665 ========= ========= ========= Depreciation, depletion and amortization: Oilfield services $ 26,060 $ 9,198 $ 3,862 Oil and gas well drilling services 2,450 436 221 Oil and gas 2,043 870 618 General corporate 448 572 -- --------- --------- --------- $ 31,001 $ 11,076 $ 4,701 ========= ========= ========= Income before interest, taxes and minority interest in income: Oilfield services $ 6,718 $ 21,642 $ 58,082 Oil and gas well drilling services 640 1,036 4,861 Oil and gas 1,177 2,533 1,064 General corporate (483) (2,657) (3,726) --------- --------- --------- $ 8,052 $ 22,544 $ 60,281 ========= ========= ========= The Company's oilfield services subsidiaries operate a variety of oilfield service equipment including workover rigs, hot oil units, transports and various other oilfield servicing equipment. In addition, they perform a variety of other oilfield services including fishing tools, frac tanks and blow-out preventers. Oil and gas production is conducted by Odessa Exploration. Odessa Exploration acquires and manages interests in producing oil and gas properties for its own account and for its sponsored investors. Odessa Exploration is engaged in the drilling and production of oil and natural gas in the United States. Odessa Exploration acquires producing oil and gas properties from major and independent producers. After acquisition, Odessa Exploration may either rework the acquired wells to increase production and/or form drilling partnerships for additional development wells. Oil and gas well drilling services are conducted primarily by Key Energy Drilling. Key Energy Drilling operates forty drilling rigs which drill for oil and gas in the West Texas and New Mexico area. 36 37 KEY ENERGY GROUP, INC AND SUBSIDIARIES 16. SUBSEQUENT EVENTS. ACQUISITIONS COMPLETED AFTER JUNE 30, 1998 The following acquisitions have been completed after June 30, 1998 and are not included in the Company's results of operations for the twelve months ended June 30, 1998. Colorado Well Service, Inc. On July 15, 1998, the Company closed the acquisition of the assets of Colorado Well Service, Inc. ("Colorado") for approximately $6.5 million in cash. Colorado operates seventeen well service rigs and one drilling rig in Utah and Colorado. TransTexas Assets On August 19, 1998, the Company completed the acquisition of certain oilfield service assets of TransTexas Gas Corporation ("TransTexas") for approximately $20.5 million in cash and future obligations. The TransTexas assets are based in Laredo, Texas and include nine well service rigs, approximately 80 oilfield service trucks and 173 frac and other tanks. Flint Asset Purchase On September 16, 1998, the Company closed the acquisition of certain assets of Flint Engineering & Construction Co., a subsidiary of Flint Industries, Inc. ("Flint") for approximately $11.9 million in cash. Flint operates 55 well service rigs and 25 oilfield trucks in the Rocky Mountains, Four Corners Area, MidContinent Region, Permian Basin and ArkLaTex Region. Iceberg, S.A. On September 24, 1998, the Company closed the acquisition of the assets of Iceberg, S.A. ("Iceberg") for approximately $4.4 million in cash. Iceberg operates four well service rigs in Comodoro Rivadavia, Argentina. HSI Group On September 24, 1998, the Company closed the acquisition of substantially all of the operating assets of Hellums Services II, Inc., Superior Completion Services, Inc., South Texas Disposal, Inc. and Elsik II, Inc. ("HSI Group") for $47.9 million in cash. HSI Group operates, among other assets, approximately 80 oilfield trucks and eight well service rigs in South Texas. Dawson Production Services Inc. On September 15, 1998, Midland Acquisition Corporation ("Midland"), a New Jersey corporation and a wholly-owned subsidiary of the Company, completed its cash tender offer (the "Tender Offer") for all outstanding shares of common stock, par value $0.01 per share (the "Dawson Shares"), including the associated common stock purchase rights, of Dawson at a price of $17.50 per share. The Tender Offer expired at 8:30 a.m., New York City Time, on Tuesday, September 15, 1998. Midland accepted for payment 10,021,601 Dawson Shares for a total purchase price of approximately $175.4 million. The acceptance of tendered Dawson Shares, together with Dawson Shares previously owned by Midland and the Company prior to the commencement of the Tender Offer resulted in Midland and the Company acquiring approximately 97.0% of the outstanding Dawson Shares. The purchase price for Dawson Shares pursuant to the Tender Offer and the merger agreement was determined pursuant to arms-length negotiations between the parties and was based on a variety of factors, including, without limitation, the anticipated earnings and cash flows of Dawson. 37 38 KEY ENERGY GROUP, INC. AND SUBSIDIARIES The Tender Offer was made pursuant to an Agreement and Plan of Merger (the "Merger Agreement"), dated as of August 11, 1998, by and among, Midland, the Company and Dawson. On September 18, 1998, pursuant to the terms of the Merger Agreement, Midland was merged with and into Dawson (the "First Merger") under the laws of the States of New Jersey and Texas and all Dawson Shares not owned by Midland were cancelled and retired and converted into the right to receive $17.50 in cash. On September 21, 1998, Dawson was merged with and into the Company (the "Second Merger") pursuant to the laws of the States of Maryland and Texas. The total consideration paid for the Dawson Shares pursuant to the Tender Offer and the First Merger was approximately $181.7 million. Dawson operates approximately 527 well service rigs, 200 oilfield trucks, and 21 production testing units in South Texas and the Gulf Coast, East Texas and Louisiana, the Permian Basin of West Texas and New Mexico, the Anadarko Basin of Texas and Oklahoma, California, and in the inland waters of the Gulf of Mexico. 17. CASH FLOW DISCLOSURES Supplemental cash flow disclosures for the years ended June 30, 1998, 1997 and 1996 are presented below: Year Ended June 30, (Thousands) 1998 1997 1996 ----------- ----------- ----------- ----------- Interest paid $ 16,441 $ 5,850 $ 2,205 Taxes paid 9,024 -- 391 Supplemental schedule detailing the purchase price of acquisitions including non-cash consideration paid for the year ended June 30, 1996 is presented below: (thousands) ----------- Fair value of Common Stock issued for WellTech, Inc. $17,929 Assumption of Welltech, Inc. Working capital deficit 1,734 Assumption of Welltech, Inc. non-current liabilities and debt 27,570 Acquisition of WellTech, Inc. property and equipment 47,455 Supplemental schedule detailing the purchase price of acquisitions including non-cash consideration paid for the year ended June 30, 1997 is presented below (in thousands): FAIR VALUE ACQUISITION OF ISSUED ASSUMPTION OF ASSUMPTION OF OF PROPERTY ACQUISITION COMMON STOCK DEBT LIABILITIES AND EQUIPMENT - ----------- ------------ -------------- -------------- -------------- Brownlee Well Service Inc. $ 671 $ 1,948 $ 3,558 $ 11,234 Woodward Well Service, Inc. 563 80 771 1,351 Brooks Well Servicing, Inc. 11,125 -- 6,291 16,935 Hitwell Surveys, Inc. -- 176 1,425 2,655 B&L Hotshot, Inc. -- -- 175 4,575 Energy Air Drilling Services Co. 48 150 -- 700 Talon Trucking Co. -- -- -- 2,700 Cobra Industries, Inc. 2,386 625 3,867 10,171 T.S.T Paraffin Service Co., Inc. -- 70 3,599 10,035 Tri-State Wellhead & Valve, Inc. 1,000 -- -- 1,339 38 39 KEY ENERGY GROUP, INC. AND SUBSIDIARIES Kalkaska Construction Service, Inc. 1,111 -- 1,187 10,711 Well-Co Oil Service, Inc. 4,050 599 11,337 28,463 Shreve's Well Service -- -- 50 600 Youngs Wireline -- -- 225 744 Phoenix Well Service -- 410 1,761 3,897 Elder Well Service, Inc. -- -- 40 649 Diamond Well Service, Inc. -- -- -- 675 Southwest Oilfield Services, Inc. -- -- -- 455 Edco Well Service -- -- 50 460 Supplemental schedule detailing the purchase price of acquisitions including non-cash consideration paid for the year ended June 30, 1998 is presented below (in thousands): FAIR VALUE ACQUISITION OF ISSUED ASSUMPTION OF ASSUMPTION OF OF PROPERTY ACQUISITION COMMON STOCK DEBT LIABILITIES AND EQUIPMENT - ----------- ------------ ---- ----------- ------------- Watson Truck & Supply, Inc. $ -- $ -- $ 100 $ 1,370 Lakota Drilling Company -- -- 6 11,900 JPF Well Service, Inc. and JPF Lease Service, Inc. -- -- 6 4,500 Edwards Transport, Inc. -- -- -- 1,037 Lundy Vacuum Service, Inc. -- -- -- 1,061 Lauffer Well Service, Inc. -- -- 50 350 Updike Brothers, Inc. -- 1,197 7,748 10,595 Four Corners Drilling Company -- -- 150 9,600 Kingsley Enterprises, Inc. -- 300 3,692 4,866 Circle M Vacuum Services, Inc. -- -- -- 700 Hot Oil Plus, Inc. -- 200 -- 1,900 J.W. Gibson Well Service Company 1,856 -- 4,532 22,214 Sitton Drilling Co. 2,169 -- 4,071 10,642 Wellcorps, L.L.C., White Rhino Drilling, Inc. and S&R Cable, Inc. 5,760 -- 500 6,439 Jeter Service Co. -- 1,802 3,686 6,553 GSI Trucking Company, Inc., Kahlden Production Services, Inc. and McCurdy Well Service, Inc. -- 51 -- 1,181 Big A Well Service Co., Sunco Trucking Co. and Justis Supply Co., Inc 4,078 359 2,504 24,618 Frontier Well Service, Inc. -- -- 2,118 5,478 Dunbar Well Service, Inc. -- -- 6,273 15,206 BRW Drilling, Inc. -- 1,919 6,194 14,140 Landmark Fishing & Rental, Inc. -- 539 2,386 5,180 Waco Oil & Gas Co., Inc. -- -- 500 7,644 Ram Oil Well Service, Inc. and Rowland Trucking Co., Inc. -- -- 7,669 19,918 Mosley Well Service, Inc. -- 933 406 25,246 Kenting Holdings (Argentina) S.A -- -- -- -- Patrick Well Service, Inc. -- 563 625 9,263 Win-Tex Drilling and Trucking -- 295 3,942 7,392 39 40 KEY ENERGY GROUP, INC. AND SUBSIDIARIES 18. UNAUDITED SUPPLEMENTARY INFORMATION - QUARTERLY RESULTS OF OPERATIONS Summarized quarterly financial data for 1998 and 1997 are as follows: FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- (in thousands, except per share amounts) 1998 Revenues . . . . . . . . . . . . . . . . $ 75,399 $109,595 $120,724 $114,328 Earnings from operations . . . . . . . . 22,780 33,960 37,281 37,074 Net earnings . . . . . . . . . . . . . . 4,111 7,345 7,082 5,637 Earnings per share . . . . . . . . . . . .29 .40 .39 .31 Weighted average common shares and equivalents outstanding . . . . . 14,126 18,151 18,295 18,261 1997 Revenues . . . . . . . . . . . . . . . . $ 31,462 $ 36,197 $ 43,050 $ 52,921 Earnings from operations . . . . . . . . 2,396 3,022 3,563 5,621 Net earnings . . . . . . . . . . . . . . 1,554 2,043 2,365 3,136 Earnings per share . . . . . . . . . . . .15 .19 .20 .26 Weighted average common shares and equivalents outstanding . . . . . 10,425 10,850 11,612 11,979 The Company did not perform physical inventories at the end of each fiscal quarter of 1997. Therefore, although year-end fiscal inventories were correct as of the fiscal year ended June 30, 1997, fourth quarter results may not be reflective of actual results due to this adjustment. In addition, since the Company did not perform physical inventories at the end of each quarter, so inventories on the Company's quarterly financial statements for each quarter may not be reflective of actual results. Because the timing of this error cannot be accurately determined, no restatement of any 1997 quarterly reports on Form 10-Q were done. Amounts reported for the first quarter of 1998 differ from the amounts previously reported on Form 10-Q, filed for the quarter ended September 30, 1997, due to non-cash adjustments recorded in the fourth quarter which are associated with the 7% debentures converted in the first quarter of fiscal year 1998. 40 41 KEY ENERGY GROUP, INC. AND SUBSIDIARIES 19. SUPPLEMENTAL INFORMATION ON OIL AND GAS ACTIVITIES (unaudited) Information concerning the Company's oil and activities was not significant, as defined under SFAS 69, for the fiscal years ended June 30, 1997 and 1998. Such activities were, however, significant for the fiscal year ended June 30, 1996. Capitalized Costs: June 30, (in thousands) 1996 - -------------- -------- Proved properties $ 17,290 Unproved properties -- Less accumulated depletion (1,364) -------- Net capitalized costs $ 15,926 ======== Costs Incurred: June 30, (in thousands) 1996 - -------------- -------- Proved property acquisition costs $ 7,786 Development costs 1,848 -------- Total costs incurred $ 9,634 ======== Results of Operations: June 30, (in thousands) 1996 - -------------- -------- Oil and gas sales $ 3,555 Production costs, including production taxes (1,350) Depletion (598) Income taxes(a) (546) -------- Results of operations for oil and gas producing activities(b) $ 1,061 ======== - ------------------- (a) Computed at the statutory rate of 35%. (b) Excludes corporate overhead and financing costs. Oil and Gas Reserve Information Estimates of Odessa Exploration's proved oil and gas reserves as of June 30, 1996 were prepared by the Company and reviewed by an independent petroleum reservoir engineering firm. Estimates were made in accordance with guidelines established by the Securities and Exchange Commission. Proved oil and gas reserves are the estimated quantities of crude oil and natural gas which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic conditions, i.e., prices and costs as of the date the estimate is made. Prices utilized reflect 41 42 KEY ENERGY GROUP, INC. AND SUBSIDIARIES consideration of changes in existing prices provided by contractual arrangements, if any, but not of escalations based upon future conditions. The reserve estimates are presented utilizing an average oil price of $19.17 Bbl and an average natural gas price of $1.85 Mcf as of June 30, 1996. Proved developed oil and gas reserves are reserves that can be expected to be recovered through existing equipment and operating methods. Proved undeveloped oil and gas reserves are proved reserves that are expected to be recovered from new wells on undrilled acreage or from existing wells where a relatively major expenditure is required for recompletion or secondary or tertiary recovery. Reserves assigned to undrilled acreage are limited to those drilling units that offset productive units reasonably certain of production when drilled. Odessa Exploration's estimate of reserves has not been filed with or included in reports to any federal agency other than the Securities and Exchange Commission. Oil and gas reserve quantity estimates are subject to numerous uncertainties inherent in the estimation of quantities of proved reserves and in the projection of future rates of production and the timing of development expenditures. The accuracy of such estimates is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of subsequent drilling, testing and production may cause either upward or downward revision of previous estimates. Further, the volumes considered to be commercially recoverable fluctuate with changes in prices and operating costs. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries are more imprecise than those of currently producing oil and gas properties. Accordingly, these estimates are expected to change as additional information becomes available in the future. Oil and Gas Producing Activities: Oil and Natural Condensate Gas ----------- ----------- (Bbls) (Mcf) ----------- ----------- Proved Reserves: Balance, June 30, 1995 1,682,217 13,998,060 Revisions of previous estimates 438,142 6,313,118 Purchases of minerals-in-place 3,162,099 16,456,993 Production (97,130) (1,026,577) ----------- ----------- Balance, June 30, 1996 5,185,328 35,741,594 =========== =========== Proved Developed Reserves: June 30, 1996 2,727,967 24,517,362 =========== =========== 42 43 JEY ENERGY GROUP, INC. AND SUBSIDIARIES Standardized Measure of Discounted Future Cash Flows The following schedules present estimates of the standardized measure of discounted future net cash flows from the Company's proved reserves as of June 30, 1996, and an analysis of the changes in these amounts for the year ended June 30, 1996. Estimated future cash flows are determined using year-end prices adjusted only for fixed and determinable increases for natural gas provided by contractual agreement (if any). Estimated future production and development costs are based on economic conditions at year-end. Future federal income taxes are computed by applying the statutory federal income tax rate of 35% to the difference between the future pretax net cash flows and the tax basis of proved oil and gas properties, after considering investment tax credits and net operating loss carry-forwards (if any), associated with these properties. Discounted future cash flow estimates like those shown below are not intended to represent estimates of the fair value of oil and gas properties. Estimates of fair value should also consider probable reserves, anticipated future oil and gas prices, interest rates, changes in development and production costs and risks associated with future production. Because of these and other considerations, any estimate of fair value is necessarily subjective and imprecise. (in thousands) June 30, 1996 - -------------- -------------- Standardized Measure: Future cash inflows $ 171,000 Future production costs (61,521) Future development costs (15,495) Future income taxes (12,092) -------------- Future after-tax net cash flows 81,892 10% annual discount (42,188) -------------- Standardized Measure $ 39,704 ============== Standardized Measure, June 30, 1995 $ 15,158 Oil and gas sales, net of production costs (2,205) Purchases of minerals in place 24,216 Net change in income taxes 75 Accretion of discount 2,142 Revision of quantity estimates 6,189 Change in future development costs (982) Extensions and discoveries 2,952 Net change in sales prices 1,397 Changes in production rates (timing) and other (9,238) -------------- Standardized Measure, June 30, 1996 $ 39,704 ============== 43 44 KEY ENERGY GROUP, INC. AND SUBSIDIARIES INDEPENDENT AUDITORS' REPORT To The Board of Directors and Stockholders Key Energy Group, Inc. We have audited the accompanying consolidated balance sheets of Key Energy Group, Inc. and Subsidiaries as of June 30, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended June 30, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Key Energy Group, Inc. and Subsidiaries as of June 30, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1998, in conformity with generally accepted accounting principles. KPMG LLP Midland, Texas September 1, 1998 44 45 KEY ENERGY GROUP, INC. AND SUBSIDIARIES PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K. (a) Index to Exhibits The following documents are filed as part of this report: (1) See Index to Financial Statements set forth in Item 8. (2) Financial Statements Schedules: [None] (3) Exhibits: 23.1 Consent of KPMG LLP 45 46 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. KEY ENERGY SERVICES, INC. (Registrant) Dated: March 30, 1999 By /s/ FRANCIS D. JOHN --------------------------------- Francis D. John President and Chief Executive Officer Dated: March 30, 1999 By /s/ STEPHEN E. MCGREGOR --------------------------------- Stephen E. McGregor Executive Vice President, Chief Financial Officer and Treasurer Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Dated: March 30, 1999 By /s/ FRANCIS D. JOHN -------------------------------- Francis D. John President, Chief Executive Officer and Director Dated: March 30, 1999 By /s/ MORTON WOLKOWITZ --------------------------------- Morton Wolkowitz Director Dated: March 30, 1999 By /s/ DAVID J. BREAZZANO --------------------------------- David J. Breazzano Director Dated: March 30, 1999 By /s/ WILLIAM MANLY --------------------------------- William Manly Director Dated: March 30, 1999 By /s/ KEVIN P. COLLINS --------------------------------- Kevin P. Collins Director Dated: March 30, 1999 By /s/ W. PHILLIP MARCUM --------------------------------- W. Phillip Marcum Director Dated: March 30, 1999 By /s/ DANNY R. EVATT --------------------------------- Danny R. Evatt Vice President of Financial Operations (Principal Accounting Officer) Dated: March 30, 1999 By /s/ STEPHEN E. McGREGOR --------------------------------- Stephen E. McGregor Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) 46