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| ITEM 1. | BUSINESS |
ancillary oilfield services.
Key's We also have an ownership interest in a drilling and production services company based in Canada, and, during October 2008, acquired a 26% ownership interest in a drilling and workover services and sub-surface engineering and modeling company based in the Russian Federation.
Data.”
4
For our rig-based services, we typically charge by the hour in the United States and Argentina, and by the job in Mexico.
5
Conversely, as commodity prices decrease, as they have during the second half of 2008, oil and natural gas producers tend to decrease capital spending for workover services.
Oilfield Transportation Services
6
and the wellbore. Production logging can be performed throughout the life of the well to measure temperature, fluid type, flow rate, pressure and other reservoir characteristics. This service helps the operator analyze and monitor well performance and determine when a well may need a workover or further stimulation.
7
8
Equipment Overview
Our
| Region | Swab(1) | Light Duty(2) | Medium Duty(3) | Heavy Duty(4) | Total | ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Appalachia | 2 | 15 | 8 | 1 | 26 | ||||||
| Argentina | 1 | 3 | 31 | 7 | 42 | ||||||
| Ark-La-Tex | 7 | 0 | 51 | 4 | 62 | ||||||
| California | 0 | 86 | 57 | 9 | 152 | ||||||
| Gulf Coast | 2 | 1 | 41 | 11 | 55 | ||||||
| Mexico | 0 | 0 | 2 | 1 | 3 | ||||||
| Mid-Continent | 12 | 13 | 97 | 4 | 126 | ||||||
| Permian Basin | 13 | 36 | 232 | 66 | 347 | ||||||
| Rocky Mountains | 3 | 2 | 47 | 37 | 89 | ||||||
| Southeastern(5) | 6 | 5 | 46 | 16 | 73 | ||||||
| Total | 46 | 161 | 612 | 156 | 975 | ||||||
(1)Swab rigs include rigs used in shallow-depth wells.(2)Light Duty rigs include rigs with rated capacity of less than 90 tons.(3)Medium Duty rigs include rigs with rated capacity of 90 tons to 125 tons.(4)Heavy Duty rigs include rigs with rated capacity of greater than 125 tons.(5)Includes eight inland barge rigs acquired in the acquisition of Moncla Well Service, Inc. and related entities. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations—Acquisitions."
Region | Swab(1) | Light-Duty(2) | Medium-Duty(3) | Heavy-Duty(4) | Total | |||||||||||||||
| Appalachia | 2 | 14 | 8 | 1 | 25 | |||||||||||||||
| Argentina | 1 | 3 | 31 | 7 | 42 | |||||||||||||||
| Ark-La-Tex | 4 | 1 | 36 | 7 | 48 | |||||||||||||||
| California | 0 | 88 | 66 | 20 | 174 | |||||||||||||||
| Gulf Coast | 2 | 0 | 47 | 11 | 60 | |||||||||||||||
| Mexico | 0 | 0 | 11 | 3 | 14 | |||||||||||||||
| Mid-Continent | 10 | 9 | 97 | 4 | 120 | |||||||||||||||
| Permian Basin | 12 | 8 | 216 | 59 | 295 | |||||||||||||||
| Rocky Mountains | 2 | 1 | 47 | 33 | 83 | |||||||||||||||
| Southeastern Marine(5) | 0 | 0 | 3 | 3 | 6 | |||||||||||||||
| Southeastern | 4 | 1 | 41 | 11 | 57 | |||||||||||||||
| Total | 37 | 125 | 603 | 159 | 924 | |||||||||||||||
| (1) | Swab rigs include rigs used in shallow-depth wells. | |
| (2) | Light-duty rigs include rigs with rated capacity of less than 90 tons. | |
| (3) | Medium-duty rigs include rigs with rated capacity of 90 tons to 125 tons. | |
| (4) | Heavy-duty rigs include rigs with rated capacity of greater than 125 tons. The seven heavy-duty rigs in Argentina are drilling rigs. | |
| (5) | Consists of six inland barge rigs. |
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| Region | Vacuum Truck | Winch Truck | Hot Oil Truck | Other | Total | ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Appalachia | 16 | 20 | 0 | 9 | 45 | ||||||
| Argentina | 1 | 15 | 2 | 29 | 47 | ||||||
| Ark-La-Tex | 175 | 26 | 0 | 27 | 228 | ||||||
| California | 24 | 1 | 0 | 44 | 69 | ||||||
| Gulf Coast | 151 | 37 | 0 | 10 | 198 | ||||||
| Mid-Continent | 30 | 16 | 7 | 18 | 71 | ||||||
| Permian Basin | 183 | 25 | 63 | 110 | 381 | ||||||
| Rocky Mountains | 12 | 2 | 0 | 4 | 18 | ||||||
| Southeastern | 0 | 34 | 2 | 2 | 38 | ||||||
| Total | 592 | 176 | 74 | 253 | 1,095 | ||||||
Region | Vacuum Truck | Winch Truck | Hot Oil Truck | Other | Total | |||||||||||||||
| Appalachia | 19 | 21 | 0 | 11 | 51 | |||||||||||||||
| Argentina | 1 | 13 | 2 | 30 | 46 | |||||||||||||||
| Ark-La-Tex | 174 | 25 | 0 | 36 | 235 | |||||||||||||||
| California | 29 | 2 | 0 | 30 | 61 | |||||||||||||||
| Gulf Coast | 158 | 30 | 0 | 8 | 196 | |||||||||||||||
| Mid-Continent | 23 | 14 | 6 | 20 | 63 | |||||||||||||||
| Permian Basin | 181 | 29 | 64 | 110 | 384 | |||||||||||||||
| Rocky Mountains | 13 | 2 | 0 | 6 | 21 | |||||||||||||||
| Southeastern | 0 | 33 | 3 | 6 | 42 | |||||||||||||||
| Total | 598 | 169 | 75 | 257 | 1,099 | |||||||||||||||
| Region | Frac Pumps | Cement Units | Acidizing Units | Nitrogen Units | Total | ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| California | 0 | 8 | 0 | 0 | 8 | ||||||
| Barnett Shale | 41 | 4 | 3 | 0 | 48 | ||||||
| Four Corners | 7 | 3 | 4 | 5 | 19 | ||||||
| Mid-Continent | 18 | 4 | 1 | 0 | 23 | ||||||
| Permian Basin | 20 | 5 | 3 | 2 | 30 | ||||||
| Total | 86 | 24 | 11 | 7 | 128 | ||||||
Region | Frac Pumps | Cement Units | Acidizing Units | Nitrogen Units | Coiled Tubing Units | Total | ||||||||||||||||||
| California | 0 | 9 | 0 | 0 | 8 | 17 | ||||||||||||||||||
| Barnett Shale | 50 | 8 | 7 | 2 | 5 | 72 | ||||||||||||||||||
| Mid-Continent | 13 | 3 | 3 | 0 | 0 | 19 | ||||||||||||||||||
| Permian Basin | 23 | 7 | 8 | 6 | 2 | 46 | ||||||||||||||||||
| Eastern | 0 | 0 | 8 | 6 | 6 | 20 | ||||||||||||||||||
| Rocky Mountains | 0 | 0 | 3 | 2 | 3 | 8 | ||||||||||||||||||
| Total | 86 | 27 | 29 | 16 | 24 | 182 | ||||||||||||||||||
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| Argentina | Mexico | Canada | Total | |||||||||||||
| (In thousands, except for percentages) | ||||||||||||||||
For the year ended December 31, 2008: | ||||||||||||||||
| Revenues | $ | 118,841 | $ | 47,200 | $ | 5,848 | $ | 171,889 | ||||||||
| Percentage of total Revenue | 6.0 | % | 2.4 | % | 0.3 | % | 8.7 | % | ||||||||
For the year ended December 31, 2007: | ||||||||||||||||
| Revenues | $ | 93,925 | $ | 9,041 | $ | 2,938 | $ | 105,904 | ||||||||
| Percentage of total Revenue | 5.7 | % | 0.5 | % | 0.2 | % | 6.4 | % | ||||||||
For the year ended December 31, 2006: | ||||||||||||||||
| Revenues | $ | 78,321 | $ | — | $ | — | $ | 78,321 | ||||||||
| Percentage of total Revenue | 5.1 | % | 0.0 | % | 0.0 | % | 5.1 | % | ||||||||
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Revenue from our international operations during 2007 totaled $105.8 million, or 6.4% of total revenue. Revenue from international operationsinitial public offering for 2006 and 2005 totaled $78.3 million and $68.2 million, respectively.
On September 5,those shares.
December 31, 2008, we held a 48.73% interest in AFTI.
relationships is having an experienced, skilled and well-trained work force. In recent years, many of our larger customers have placed increased emphasis on the safety performance and quality of the crews, equipment and services provided by their contractors. We have devoted, and will continue to devote, substantial resources toward employee safety
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market is left with excess supply, placing additional pressure on our pricing.
13
”
our field employeesthe Company in Argentina are represented by formal unions. While Mexico has a strong petroleum workers union, we are currently only employing non-union workers in Mexico. We have not experienced any material work stoppages associated with labor disputes or grievances and consider our relations with our employeesresponse to be satisfactory. During 2007,market conditions, we experienced an annual domestic employee turnover rate of approximately 41%,42% during 2008, compared to a turnover rate of approximately 45%41% in 2006.2007. The high turnover rate is caused, in part, by the nature of the work, which is physically demanding and sometimes performed in harsh outdoor conditions. 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. Alternatively, some employees may leave Key if they can earn a higher wage with a competitor.
”
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CERCLA liability for cleanup costs. Also, claims may be filed for personal injury and property damage allegedly caused by the release of hazardous substances or other pollutants.
Recent scientific
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liable for oil spills and must establish and maintain evidence of financial responsibility sufficient to cover liabilities related to an oil spill for which such parties could be statutorily responsible. The CWA can impose substantial civil and criminal penalties for non-compliance.
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| ITEM 1A. | RISK FACTORS |
The demand for our services is primarily influenced by currentcompanies, and anticipatedthe recent volatility in oil and natural gas prices. prices, in addition to the deteriorating credit markets and disruptions in the U.S. and global financial systems, may adversely impact our business.
•
| • | the level of development, exploration and production activity of, and corresponding capital spending by, oil and natural gas companies; | |
| • | oil and natural gas production costs; | |
| • | government regulation; and | |
| • | conditions in the worldwide oil and natural gas industry. |
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The inability to maintain our pricing could:
•limitor reduction in ourability to offset rising costs; and•- pricing may have a material negative impact on our
ability to generate greater free cash flow which would be used to expand our business.
Our business involves certain operating risks, which are primarily self-insured, and our insurance may not be adequate to cover all losses or liabilities we might incur in our operations.Increases in industryIndustry capacity may adversely affect our business.employeddeployed by existing service providers to increase their service capacity. We have beenThe new capacity adversely affected by the new capacity as our utilization for 2007rates in 2008, which is down from prior years. Lower utilization of our fleet has led to reduced pricing for our services. ShouldThe combination of overcapacity and declining demand has further exacerbated the pricing pressure for our services. Although oilfield service companies continueare not likely to add significant new capacity under current market conditions, in light of current market conditions and the deteriorating demand for our services, not increase, wethe overcapacity could cause us to experience continued pressure on the pricing of our services and experience lower utilization. This could have a material negative impact on our operating results.An economic downturn may adversely affect our business. There is a concern that the United States may enter into a recession in 2008, and if so, a downturn in the U.S. economy may cause reduced demand for petroleum-based products and natural gas. In addition, during a downturn many oil and natural gas production companies often reduce or delay expenditures to reduce costs, which in turn may cause a reduction in the demand for our services during these periods. If the economic environment should deteriorate, our business, financial condition and results of operations may be adversely impacted.•blow-outs, the uncontrolled flow of natural gas, oil or other well fluids into the atmosphere or an underground formation;•reservoir damage;•fires and explosions;•accidents resulting in serious bodily injury and the loss of life or property;•pollution and other damage to the environment; and•liabilities from accidents or damage by our fleet of trucks, rigs and other equipment.• blow-outs, the uncontrolled flow of natural gas, oil or other well fluids into the atmosphere or an underground formation; • reservoir damage; • fires and explosions; • accidents resulting in serious bodily injury and the loss of life or property; • pollution and other damage to the environment; and • liabilities from accidents or damage by our fleet of trucks, rigs and other equipment. party'sparty’s personnel.
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and Mexico and Canada, as well as investments in a drilling and production services company based in Canada and a drilling and workover services and sub-surface engineering and modeling company based in the Russian Federation. We may expand our operations into other foreign countries. We also have a technology development group in Canada.countries as well. As a result, we are exposed to risks of international operations, including:•increased governmental ownership and regulation of the economy in the markets where we operate;•inflation and adverse economic conditions stemming from governmental attempts to reduce inflation, such as imposition of higher interest rates and wage and price controls;•increased trade barriers, such as higher tariffs and taxes on imports of commodity products;•exposure to foreign currency exchange rates;•exchange controls or other currency restrictions;•war, civil unrest or significant political instability;•expropriation, confiscatory taxation or nationalization of our assets located in the markets where we operate;•governmental policies limiting investments by and returns to foreign investors;•labor unrest and strikes; and•restrictive governmental regulation and bureaucratic delays.• increased governmental ownership and regulation of the economy in the markets where we operate; • inflation and adverse economic conditions stemming from governmental attempts to reduce inflation, such as imposition of higher interest rates and wage and price controls; • increased trade barriers, such as higher tariffs and taxes on imports of commodity products; • exposure to foreign currency exchange rates; • exchange controls or other currency restrictions; • war, civil unrest or significant political instability; • restrictions on repatriation of income or capital; • expropriation, confiscatory taxation, nationalization or other government actions with respect to our assets located in the markets where we operate; • governmental policies limiting investments by and returns to foreign investors; • labor unrest and strikes, including the significant labor-related issues we are currently experiencing in Argentina; • deprivation of contract rights; and • restrictive governmental regulation and bureaucratic delays. •negatively impact our results of operations;•restrict the movement of funds and equipment to and from affected countries; and•inhibit our ability to collect receivables.• negatively impact our results of operations; • restrict the movement of funds and equipment to and from affected countries; and • inhibit our ability to collect receivables. ourwe experienced a lower 42% turnover rate domestically during 2007 improved to approximately 41%. The2008. We believe that the high turnover rate is attributable to 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. We cannot assure that at times of high demand we will be able to retain, recruit and train an adequate number of workers. Potential inability or lack of desire by workers to commute to our facilities and job sites and competition for workers from competitors or other industries are factors that could affect our ability to attract and retain workers. We believe that our wage rates are competitive with the wage rates of our competitors and other potential employers. A significant increase in the wages other employers pay could result in a reduction in our workforce, increases in our wage rates, or both. Either of these events could diminish our profitability and growth potential.
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We rely on a limited number of suppliers for certain materials used in providing our pressure pumping services.KeyView®KeyView® system. The inability to successfully develop and integrate the technology could:•limit our ability to improve our market position;•increase our operating costs; and•limit our ability to recoup the investments made in technology initiatives.• limit our ability to improve our market position; • increase our operating costs; and • limit our ability to recoup the investments made in technology initiatives. PleaseFor additional information, see the discussion under“Governmental Regulations”in“Item 1. "BusinessBusiness.”—Governmental Regulations" for more information.vendors,suppliers, our ability to provide pressure pumping services could be limited.ThePursuit of this strategy may be restricted by the recent deterioration of the credit markets, which may significantly limit the availability of funds for such acquisitions. In addition to restricted funding availability, the success of this strategy will depend on our ability to identify suitable acquisition candidates and to negotiate acceptable financial and other terms. There is no assurance that we will be able to do so. The success of an acquisition depends on our ability to perform adequate diligence before the acquisition and on our ability to integrate the acquisition after it is completed. While we commit significant resources to ensure that we conduct comprehensive due diligence, there can be no assurance that all potential risks and liabilities will be identified in connection with an acquisition. Similarly, while we expect to commit substantial resources, including management time and effort, to integrating acquired businesses into ours, there is no assurance that we will be successful integrating these businesses. In particular, it is important that we arebe able to retain both key personnel of the acquired business and its customer base. A loss of either key personnel or customers could negatively impact the future operating results of the acquired business.
20Debt-Related Risk Factors
This risk is significantly exacerbated by the current economic downturn and related instability in the global and U.S. credit markets.
•refinancing or restructuring our debt;•selling assets;•reducing or delaying acquisitions or capital investments, such as remanufacturing our rigs and related equipment; or•seeking to raise additional capital.
| • | refinancing or restructuring our debt; | |
| • | selling assets; | |
| • | reducing or delaying acquisitions or capital investments, such as remanufacturing our rigs and related equipment; or | |
| • | seeking to raise additional capital. |
future prospects for growth.
| • | making it more difficult for us to satisfy our obligations under our indebtedness and increasing the risk that we may default on our debt obligations; | |
| • | requiring us to dedicate a substantial portion of our cash flow from operations to required payments on indebtedness, thereby reducing the availability of cash flow for working capital, capital expenditures and other general business activities; | |
| • | limiting our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions and general corporate and other activities; | |
| • | limiting management’s flexibility in operating our business; | |
| • | limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; | |
| • | diminishing our ability to withstand successfully a downturn in our business or the economy generally; | |
| • | placing us at a competitive disadvantage against less leveraged competitors; and |
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•making it more difficult for us to satisfy our obligations under our indebtedness and increasing the risk that we may default on our debt obligations;•requiring us to dedicate a substantial portion of our cash flow from operations to required payments on indebtedness, thereby reducing the availability of cash flow for working capital, capital expenditures and other general business activities;•limiting our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions and general corporate and other activities;•limiting management's discretion in operating our business;•limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;•detracting from our ability to withstand successfully a downturn in our business or the economy generally;•placing us at a competitive disadvantage against less leveraged competitors; and
•making us vulnerable to increases in interest rates, because certain debt will vary with prevailing interest rates.
| • | making us vulnerable to increases in interest rates, because certain debt will vary with prevailing interest rates. |
The securities laws require that we supply current annual and quarterly financial statements in order for us to be able to register securities for a public offering or an acquisition. Although we are able to register securities for public offerings and acquisitions, we are not eligible to use "short-form" registration that allows us to incorporate by reference our SEC reports into our registration statements, or to use shelf registration until we have filed all of our periodic reports in a timely manner for a period of twelve months. Therefore, we will be ineligible for short-form or shelf registration until October 2008. Inability to use short-form or shelf registration could increase the costs of selling securities publicly and could significantly delay such sales.
Taxing authorities may determine that we owe additional taxes from previous years.
As a result of the restatement of
WeDuring the past three years, we have identified material weaknesses in our internal control over financial reporting. These material weaknesses, if not corrected, could affect the reliability of our financial statements and have other adverse consequences."material weaknesses"“material weaknesses” in its financial controls. A "material weakness"“material weakness” is a control deficiency, or combination of control deficiencies in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected.
22
•establish a classified Board of Directors, providing for three-year staggered terms of office for all members of our Board;•set limitations on the removal of directors;•provide our Board of Directors the ability to set the number of directors and to fill vacancies on the Board occurring between shareholder meetings; and•set limitations on who may call a special meeting of shareholders.
| • | establish a classified Board of Directors, providing for three-year staggered terms of office for all members of our Board of Directors; | |
| • | set limitations on the removal of directors; | |
| • | provide our Board of Directors the ability to set the number of directors and to fill vacancies on the Board of Directors occurring between shareholder meetings; and | |
| • | set limitations on who may call a special meeting of shareholders. |
| ITEM 1B. | UNRESOLVED STAFF COMMENTS |
| ITEM 2. | PROPERTIES |
office and yard locations. We owned or leased 57 salt water disposal wells, ten of which were inactive at December 31, 2007. The majority of our salt water disposal wells are located in Texas.
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Class Action Lawsuits
Since June 2004,leased properties, as well as active SWD facilities, categorized by business segment and geographic region:
| Well Services | SWD | Pressure | Fishing & | |||||||||||||
Division | (Other Than SWD) | Facilities | Pumping | Rental | ||||||||||||
MID-CONTINENT | ||||||||||||||||
| OWNED | 13 | 0 | 1 | 3 | ||||||||||||
| LEASE | 13 | 1 | 1 | 6 | ||||||||||||
GULF COAST | ||||||||||||||||
| OWNED | 14 | 4 | 0 | 1 | ||||||||||||
| LEASE | 16 | 11 | 0 | 11 | ||||||||||||
ARK-LA-TEX | ||||||||||||||||
| OWNED | 15 | 13 | 1 | 1 | ||||||||||||
| LEASE | 12 | 7 | 1 | 2 | ||||||||||||
APPALACHIA | ||||||||||||||||
| OWNED | 0 | 0 | 0 | 0 | ||||||||||||
| LEASE | 8 | 0 | 1 | 0 | ||||||||||||
PERMIAN BASIN | ||||||||||||||||
| OWNED | 55 | 6 | 0 | 2 | ||||||||||||
| LEASE | 25 | 10 | 1 | 3 | ||||||||||||
ROCKY MOUNTAINS | ||||||||||||||||
| OWNED | 14 | 0 | 0 | 0 | ||||||||||||
| LEASE | 9 | 0 | 5 | 1 | ||||||||||||
CALIFORNIA | ||||||||||||||||
| OWNED | 1 | 0 | 0 | 0 | ||||||||||||
| LEASE | 11 | 0 | 0 | 1 | ||||||||||||
ARGENTINA | ||||||||||||||||
| OWNED | 2 | 0 | 0 | 0 | ||||||||||||
| LEASE | 14 | 0 | 0 | 0 | ||||||||||||
CANADA | ||||||||||||||||
| OWNED | 0 | 0 | 0 | 0 | ||||||||||||
| LEASE | 2 | 0 | 0 | 0 | ||||||||||||
MEXICO | ||||||||||||||||
| OWNED | 0 | 0 | 0 | 0 | ||||||||||||
| LEASE | 2 | 0 | 0 | 0 | ||||||||||||
TOTAL OWNED | 114 | 23 | 2 | 7 | ||||||||||||
TOTAL LEASE | 112 | 29 | 9 | 24 | ||||||||||||
TOTAL | 226 | 52 | 11 | 31 | ||||||||||||
Cause No. MO-04-CV-082;Peter Kaltman, on behalf of himself and all others similarly situated v. Key Energy Services, Inc., Francis D. John, Royce W. Mitchell, Richard J. Alario and James J. Byerlotzer, filednine apartments leased in the United States District Courtand eight apartments leased in Argentina. These apartments are for the Western District of TexasKey employees to use for operational support and business purposes only.
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Cause No. MO-04-CV-083;Malcolm Lord, Individually and on Behalf of all Others Similarly situated v. Key Energy Services, Inc., Francis D. John, Richard J. Alario, James J. Byerlotzer and Royce W. Mitchell, filed in the United States District Court for the Western District of Texas
Cause No. MO-04-CV-090;Celeste Navon, on behalf of herself and all others similarly situated v. Key Energy Services, Inc., Francis John, Royce Mitchell, James Byerlotzer and Richard Alario, filed in the United States District Court for the Western District of Texas
Cause No. MO-04-CV-104;David W. Ortbals, on Behalf of Himself and All Others Similarly situated v. Key Energy Services, Inc., Richard J. Alario, James J. Byerlotzer, Francis D. John, and Royce W. Mitchell, filed in the United States District Court for the Western District of Texas
Cause No. MO-04-CV-0254;Paul E. Steward, on Behalf of Himself and All Others Similarly situated v. Key Energy Services, Inc., Francis D. John and Royce W. Mitchell, filed in the United States District Court for the Western District of Texas
Cause No. MO-04-CV-0227;Garco Investment LLP Individually and on Behalf of all Others Similarly Situated v. Key Energy Services, Inc., Richard J. Alario, James J. Byerlotzer, Francis D. John and Royce W. Mitchell, filed in the United States District Court for the Western District of Texas
These six actions were consolidated into one action. On November 1, 2005, the plaintiffs filed a consolidated amended class action complaint. The complaint was brought on behalf of a putative class of purchasers of our securities between April 29, 2003 and June 4, 2004. The complaint named Key, Francis D. John, Royce W. Mitchell, Richard J. Alario and James J. Byerlotzer as defendants. The complaint generally alleged that we made false and misleading statements and omitted material information from our public statements and SEC reports during the class period in violation of the Securities Exchange Act of 1934, including alleged: (i) overstatement of revenues, net income, and earnings per share, (ii) failure to take write-downs of assets, consisting of primarily idle equipment, (iii) failure to amortize the Company's goodwill, (iv) failure to disclose that the Company lacked adequate internal controls and therefore was unable to ascertain the true financial condition of the Company, (v) material inflation of the Company's financial results at all relevant times, (vi) misrepresentation of the value of acquired businesses, and (vii) failure to disclose misappropriation of funds by employees.
| ITEM 3. | LEGAL PROCEEDINGS |
In addition, four shareholder derivative suits were filed by certain of our shareholders. They are as follows:
Cause No. 2004-CV-44728; Moonlight Investments, LTD. on Behalf of Nominal Defendant Key Energy Services, Inc., v. Francis D. John, Richard J. Alario, James J. Byerlotzer, Royce W. Mitchell, Kevin P. Collins, W. Phillip Marcum, and Ralph S. Michael, III, and Key Energy Services, Inc., filed in the 385th Judicial District Court, Midland County, Texas
Cause No. EP-04-CA-0457;Sandra Weissman, Derivatively on Behalf of Key Energy Services, Inc., v. Francis D. John, David J. Breazzano, Kevin P. Collins, William D. Fertig, W. Phillip Marcum, Ralph S. Michael III, J. Robinson West, James J. Byerlotzer, Royce W. Mitchell, Richard J. Alario and Key Energy Services, Inc., a Maryland Corporation, filed in the United States District Court Western District of Texas
Cause No. EP-04-CA-0456;Daniel Bloom, Derivatively on Behalf of Key Energy Services, Inc., v. Francis D. John, David J. Breazzano, Kevin P. Collins, William D. Fertig, W. Phillip Marcum, Ralph S. Michael III, J. Robinson West, James J. Byerlotzer, Royce W. Mitchell, Richard J. Alario and Key Energy Services, Inc., a Maryland Corporation, filed in the United States District Court Western District of Texas
Cause No. 2007-31254;Sandra Weissman, Derivatively on Behalf of Key Energy Services, Inc., v. Francis D. John, David J. Breazzano, Kevin P. Collins, William D. Fertig, W. Phillip Marcum, Ralph S. Michael III, J. Robinson West, James J. Byerlotzer, Royce W. Mitchell, Richard J. Alario and Key Energy Services, Inc., a Maryland Corporation filed in the 270th Judicial District, Harris County, Texas
The first derivative suit was filed on August 9, 2004 in state court in Midland, Texas. Two other derivative suits were filed in federal court in El Paso, Texas on December 10, 2004 and subsequently transferred to federal court in Midland, Texas and consolidated by agreement of the parties. Following dismissal of those two actions for failure to make a demand, a fourth derivative suit was filed in Texas state court in Harris County, Texas on May 22, 2007. Francis D. John, David J. Breazzano, Kevin P. Collins, William D. Fertig, W. Phillip Marcum, Ralph S. Michael III, J. Robinson West, James J. Byerlotzer, Royce W. Mitchell, and Richard J. Alario were named as defendants in one or more of those actions. The actions were filed by individual shareholders purporting to act on our behalf, asserting various claims against the named officer and director defendants. The derivative actions generally allege the same facts as those in the shareholder class action suits. Those suits also allege breach of fiduciary duty, abuse of control, waste of corporate assets, and unjust enrichment by these defendants.
On September 7, 2007, we reached agreements in principle to settle all pending securities class action and derivative lawsuits in consideration of payments totaling $16.6 million in exchange for full and complete releases for all defendants, of which Key will be required to pay $1,125,000. Final approval of the settlement of the shareholder and class action claims by the court is anticipated to occur in the first quarter of 2008.
Other Matters
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
At our 2007 Annual Meeting of Shareholders held on December 6, 2007, holders of 106,759,477 shares were present in person or by proxy, constituting 80.47% of the outstanding shares of
Election of four Class I Directors. The shareholders elected four Class I Directors to serve for a three year term, expiring in 2010:
| | Votes cast in favor: | Votes withheld: | ||
|---|---|---|---|---|
| Lynn R. Coleman | 100,342,605 | 6,416,872 | ||
| Kevin P. Collins | 93,124,276 | 13,635,201 | ||
| W. Phillip Marcum | 93,386,783 | 13,372,694 | ||
| William F. Owens | 100,345,025 | 6,414,452 |
Four Class II Directors, David J. Breazzano, William D. Fertig, Robert K. Reeves and J. Robinson West, continued in office with terms expiring in 2008. Three Class III Directors, Richard J. Alario, Ralph S. Michael, III and Arlene M. Yocum, continued in office with terms expiring in 2009.
Adoption of 2007 Equity and Cash Incentive Plan. The shareholders adopted the Key Energy Services, Inc. 2007 Equity and Cash Incentive Plan:
Ratification of Independent Registered Public Accounting Firm. The shareholders ratified the selection of Grant Thornton LLP as the Company's independent registered public accounting firm for the current fiscal year:
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market and Share Prices. On October 3, 2007, Key's common stock resumed tradingtraded on the New York Stock Exchange,NYSE, under the symbol "KEG."“KEG.” From April 8, 2005 until October 2, 2007, our stock was quoted on the Pink Sheets Electronic Quotation Service (the "Pink Sheets"“Pink Sheets”) under the symbol "KEGS."“KEGS.” As of February 20, 2008,23, 2009, there were 556537 registered holders of 128,149,793121,210,781 issued and outstanding shares of common stock. The following table sets forth the reported high and low sales price of Key'sKey’s common stock for the periods indicated.
| | High | Low | |||||
|---|---|---|---|---|---|---|---|
| Year Ended December 31, 2007 | |||||||
| 1st Quarter | $ | 16.90 | $ | 14.85 | |||
| 2nd Quarter | 20.07 | 16.52 | |||||
| 3rd Quarter | 18.38 | 13.08 | |||||
| 4th Quarter | 16.95 | 13.25 | |||||
| High | Low | |||||||
Year Ended December 31, 2008 | ||||||||
| 1st Quarter | $ | 14.47 | $ | 11.23 | ||||
| 2nd Quarter | 19.75 | 13.36 | ||||||
| 3rd Quarter | 18.94 | 11.33 | ||||||
| 4th Quarter | 11.14 | 3.58 | ||||||
| | High | Low | |||||
|---|---|---|---|---|---|---|---|
| Year Ended December 31, 2006 | |||||||
| 1st Quarter | $ | 16.50 | $ | 13.46 | |||
| 2nd Quarter | 18.75 | 13.00 | |||||
| 3rd Quarter | 15.85 | 12.75 | |||||
| 4th Quarter | 16.95 | 13.05 | |||||
High Low 1st Quarter $ 16.90 $ 14.85 2nd Quarter 20.07 16.52 3rd Quarter 18.38 13.08 4th Quarter 16.95 13.25 "soliciting material"“soliciting material” or to be "filed"“filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that we specifically incorporate it by reference into such filing.ThisDuring 2008, the Company moved from the Russell 2000 Index to the Russell 1000 Index. For comparative purposes, both the Russell 2000 and the Russell 1000 Indices are reflected in the following performance graph. The peer group is comprised of five other companies with a similar mix of operations and includes Nabors Industries Ltd., Weatherford International Ltd., Basic Energy Services, Inc., Complete Production Services, Inc., and RPC, Inc. The graph below matches the cumulative five-year total return to holders of our common stock with the cumulative total returns of the PHLX Oil Service Sector, the listed Russell Indices and our peer group. The graph assumes that the value of the investment in our common stock
25
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Key Energy Services, Inc., The Russell 1000 Index, The Russell 2000 Index,
The PHLX Oil Service Sector
| * | $100 invested on December 31, 2003 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. |
*$100 invested on December 31, 2002 in stock or index-including reinvestment of dividends.
Dividend Policy.
26
repurchases:
| Total Number of Shares | ||||||||||||
| Purchased as Part of | ||||||||||||
| Total Number | Weighted | Publicly Announced | ||||||||||
| of Shares | Average Price | Plans or | ||||||||||
Period | Purchased | Paid Per Share | Programs | |||||||||
| October 1, 2008 to October 31, 2008 | 1,728,528 | (1) | $ | 6.56 | (2) | 1,725,000 | ||||||
| November 1, 2008 to November 30, 2008 | 522,500 | $ | 5.73 | 522,500 | ||||||||
| December 1, 2008 to December 31, 2008 | 33,463 | (3) | $ | 4.42 | (4) | — | ||||||
| (1) | Includes 3,528 shares repurchased to satisfy tax withholding obligations of certain executive officers upon vesting of restricted stock. | |
| (2) | The price paid per share on the vesting date with respect to the tax withholding repurchases was determined using the closing prices on October 2, 2008 and October 30, 2008, respectively, as quoted on the NYSE. | |
| (3) | Relates to shares repurchased to satisfy tax withholding obligations of certain executive officers upon vesting of restricted stock. | |
| (4) | The price paid per share on the vesting date with respect to the tax withholding repurchases was determined using the closing price on December 19, 2008, as quoted on the NYSE. |
| Period | Total Number of Shares Purchased | Weighted Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Appropriate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs | ||||||
|---|---|---|---|---|---|---|---|---|---|---|
| October 1, 2007 to October 31, 2007 | 3,528 | (1) | $ | 15.64 | (2) | — | — | |||
| November 1, 2007 to November 30, 2007 | 820,400 | (3) | $ | 13.53 | 820,400 | $ | 288.9 million | |||
| December 1, 2007 to December 31, 2007 | 1,554,355 | (4) | $ | 13.81 | (5) | 1,521,000 | $ | 267.8 million | ||
(1)Related to share repurchases made to satisfy tax withholding obligations of certain executive officers upon vesting of restricted stock.(2)The average price paid per share on the vesting date was determined using the closing price of the common stock of the Company as quoted on the Pink Sheets on October 1, 2007 and the closing price of the common stock of the Company as quoted on the NYSE on October 29, 2007.
(3)In October 2007, the Company announced a $300 million share repurchase program. The program expires March 31, 2009.(4)Includes 33,355 shares repurchased to satisfy tax withholding obligations of certain executive officers upon vesting of restricted stock.(5)The price paid per share on the vesting date with respect to the tax withholding repurchases was determined using the average of the closing price and opening price on December 21, 2007 and December 24, 2007, respectively, as quoted on the NYSE.
Equity Compensation Plan Information
| Number of Securities | Weighted Average | Number of Securities Remaining | ||||||||||
| to be Issued Upon | Exercise Price of | Available for Future Issuance | ||||||||||
| Exercise of | Outstanding | Under Equity Compensation | ||||||||||
| Outstanding Options, | Options, Warrants | Plans (Excluding Securities | ||||||||||
| Warrants And Rights | And Rights | Reflected in Column (a)) | ||||||||||
Plan Category | (a) | (b) | (c) | |||||||||
| (In thousands) | (In thousands) | |||||||||||
| Equity compensation plans approved by shareholders(1) | 5,429 | $ | 12.53 | 2,250 | ||||||||
| Equity compensation plans not approved by shareholders(2) | 120 | $ | 8.07 | — | ||||||||
| Total | 5,549 | 2,250 | ||||||||||
| (1) | Represents options and other stock-based awards granted under the Key Energy Group, Inc. 1997 Incentive Plan (the “1997 Incentive Plan”) and the options and other stock-based awards available under the Key Energy Services, Inc. 2007 Equity and Cash Incentive Plan (the “2007 Incentive Plan”). The 1997 Incentive Plan expired in November 2007. | |
| (2) | Represents non-statutory stock options granted outside the 1997 Incentive Plan and the 2007 Incentive Plan. The options have a ten-year term and other terms and conditions as those options granted under the 1997 Incentive Plan. These options were granted during 2000 and 2001. |
27
| Plan Category | Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) | Weighted-average exercise price of outstanding options, warrants and rights (b) | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c) | ||||
|---|---|---|---|---|---|---|---|
| | (in thousands) | | (in thousands) | ||||
| Equity compensation plans approved by shareholders(1) | 4,998 | $ | 11.50 | 4,000 | |||
| Equity compensation plans not approved by shareholders(2) | 180 | $ | 8.10 | — | |||
| Total | 5,178 | 4,000 | |||||
(1)Represents options and other stock-based awards granted under the Key Energy Group, Inc. 1997 Incentive Plan (the "1997 Incentive Plan") and the options and other stock-based awards available under the Key Energy Services, Inc. 2007 Equity and Cash Incentive Plan (the "2007 Incentive Plan"). The 1997 Incentive Plan expired in November 2007.(2)Represents non-statutory stock options granted outside the 1997 Incentive Plan and the 2007 Incentive Plan. The options have a ten-year term and other terms and conditions as those options granted under the 1997 Incentive Plan. These options were granted during 2000 and 2001.
| ITEM 6. | SELECTED FINANCIAL DATA |
The historical selected financial data should be read in conjunction with the historical Consolidated Financial Statements and related notes thereto included in “Item 8. "Consolidated Financial Statements and Supplementary Data."
Consolidated Results of Operations Data:
| | Year Ended December 31, | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2007 | 2006 | 2005 | 2004 | ||||||||||||
| | (in thousands, except per share data) | |||||||||||||||
| Revenues | $ | 1,662,012 | $ | 1,546,177 | $ | 1,190,444 | $ | 987,739 | ||||||||
| Direct expenses | 985,614 | 920,602 | 780,243 | 685,420 | ||||||||||||
| Gross margin | 676,398 | 625,575 | 410,201 | 302,319 | ||||||||||||
| General and administrative expenses | 230,396 | 195,527 | 151,303 | 162,133 | ||||||||||||
| Operating income, before depreciation and amortization | 446,002 | 430,048 | 258,898 | 140,186 | ||||||||||||
| Depreciation and amortization | 129,623 | 126,011 | 111,888 | 103,339 | ||||||||||||
| Interest expense, net of amounts capitalized | 36,207 | 38,927 | 50,299 | 46,206 | ||||||||||||
| Other, net | 4,232 | (9,370 | ) | 12,313 | 19,114 | |||||||||||
| Income (loss) from continuing operations before income taxes | 275,940 | 274,480 | 84,398 | (28,473 | ) | |||||||||||
| Income tax (expense) benefit | (106,768 | ) | (103,447 | ) | (35,320 | ) | 1,890 | |||||||||
| Minority interest | 117 | — | — | — | ||||||||||||
| Income (loss) from continuing operations | 169,289 | 171,033 | 49,078 | (26,583 | ) | |||||||||||
| Discontinued operations, net of tax | — | — | (3,361 | ) | (5,643 | ) | ||||||||||
| Net income (loss) | $ | 169,289 | $ | 171,033 | $ | 45,717 | $ | (32,226 | ) | |||||||
| Income (loss) per common share from continuing operations: | ||||||||||||||||
| Basic | $ | 1.29 | $ | 1.30 | $ | 0.37 | $ | (0.20 | ) | |||||||
| Diluted | $ | 1.27 | $ | 1.28 | $ | 0.37 | $ | (0.20 | ) | |||||||
| Income (loss) per common share from discontinued operations: | ||||||||||||||||
| Basic | $ | — | $ | — | $ | (0.03 | ) | $ | (0.04 | ) | ||||||
| Diluted | $ | — | $ | — | $ | (0.03 | ) | $ | (0.04 | ) | ||||||
| Net income (loss) per common share: | ||||||||||||||||
| Basic | $ | 1.29 | $ | 1.30 | $ | 0.34 | $ | (0.24 | ) | |||||||
| Diluted | $ | 1.27 | $ | 1.28 | $ | 0.34 | $ | (0.24 | ) | |||||||
Cash Flow Data:
| | Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2007 | 2006 | 2005 | 2004 | |||||||||
| | (in thousands) | ||||||||||||
| Net cash provided by operating activities | $ | 249,919 | $ | 258,724 | $ | 218,838 | $ | 69,801 | |||||
| Net cash used in investing activities | (302,847 | ) | (245,647 | ) | (33,218 | ) | (64,081 | ) | |||||
| Net cash provided by (used in) financing activities | 23,240 | (18,634 | ) | (111,213 | ) | (88,277 | ) | ||||||
| Effect of exchange rates on cash | (184 | ) | (238 | ) | (662 | ) | (233 | ) | |||||
Selected Balance Sheet Data:
| | December 31, 2007 | December 31, 2006 | December 31, 2005 | December 31, 2004 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | (in thousands) | |||||||||||
| Working capital | $ | 253,068 | $ | 265,498 | $ | 169,022 | $ | 165,920 | ||||
| Property and equipment, gross | 1,595,225 | 1,279,980 | 1,089,826 | 999,414 | ||||||||
| Property and equipment, net | 911,208 | 694,291 | 610,341 | 597,778 | ||||||||
| Total assets | 1,859,077 | 1,541,398 | 1,329,244 | 1,316,622 | ||||||||
| Long-term debt and capital leases, net of current maturities | 511,614 | 406,080 | 410,781 | 481,047 | ||||||||
| Total liabilities | 970,079 | 810,887 | 775,187 | 810,956 | ||||||||
| Stockholders' equity | 888,998 | 730,511 | 554,057 | 505,666 | ||||||||
| Cash dividends per common share | — | — | — | — | ||||||||
ITEM 7. Management'sManagement’s Discussion and Analysis of Financial Condition and Results of OperationsOperations”and the historical consolidated financial statements and related notes thereto included in“Item 8. Consolidated Financial Statements and Supplementary Data.”
| Year Ended December 31, | ||||||||||||||||||||
| 2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||
| (In thousands, except per share amounts) | ||||||||||||||||||||
| Revenues | $ | 1,972,088 | $ | 1,662,012 | $ | 1,546,177 | $ | 1,190,444 | $ | 987,739 | ||||||||||
| Direct operating expenses | 1,250,327 | 985,614 | 920,602 | 780,243 | 685,420 | |||||||||||||||
| Depreciation and amortization expense | 170,774 | 129,623 | 126,011 | 111,888 | 103,339 | |||||||||||||||
| Impairment of goodwill and equity method investment | 75,137 | — | — | — | — | |||||||||||||||
| General and administrative expenses | 257,707 | 230,396 | 195,527 | 151,303 | 162,133 | |||||||||||||||
| Interest expense, net of amounts capitalized | 41,247 | 36,207 | 38,927 | 50,299 | 46,206 | |||||||||||||||
| Other, net | 2,840 | 4,232 | (9,370 | ) | 12,313 | 19,114 | ||||||||||||||
| Income from continuing operations before income taxes and minority interest | 174,056 | 275,940 | 274,480 | 84,398 | (28,473 | ) | ||||||||||||||
| Income tax (expense) benefit | (90,243 | ) | (106,768 | ) | (103,447 | ) | (35,320 | ) | 1,890 | |||||||||||
| Minority interest | 245 | 117 | — | — | — | |||||||||||||||
| Income from continuing operations | 84,058 | 169,289 | 171,033 | 49,078 | (26,583 | ) | ||||||||||||||
| Discontinued operations, net of tax | — | — | — | (3,361 | ) | (5,643 | ) | |||||||||||||
| Net income (loss) | $ | 84,058 | $ | 169,289 | $ | 171,033 | $ | 45,717 | $ | (32,226 | ) | |||||||||
| Income (loss) per common share from continuing operations: | ||||||||||||||||||||
| Basic | $ | 0.68 | $ | 1.29 | $ | 1.30 | $ | 0.37 | $ | (0.20 | ) | |||||||||
| Diluted | $ | 0.67 | $ | 1.27 | $ | 1.28 | $ | 0.37 | $ | (0.20 | ) | |||||||||
| Income (loss) per common share from discontinued operations: | ||||||||||||||||||||
| Basic | $ | — | $ | — | $ | — | $ | (0.03 | ) | $ | (0.04 | ) | ||||||||
| Diluted | $ | — | $ | — | $ | — | $ | (0.03 | ) | $ | (0.04 | ) | ||||||||
| Net income (loss) per common share: | ||||||||||||||||||||
| Basic | $ | 0.68 | $ | 1.29 | $ | 1.30 | $ | 0.34 | $ | (0.24 | ) | |||||||||
| Diluted | $ | 0.67 | $ | 1.27 | $ | 1.28 | $ | 0.34 | $ | (0.24 | ) | |||||||||
| Year Ended December 31, | ||||||||||||||||||||
| 2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Net cash provided by operating activities | $ | 367,164 | $ | 249,919 | $ | 258,724 | $ | 218,838 | $ | 69,801 | ||||||||||
| Net cash used in investing activities | (329,074 | ) | (302,847 | ) | (245,647 | ) | (33,218 | ) | (64,081 | ) | ||||||||||
| Net cash (used in) provided by financing activities | (7,970 | ) | 23,240 | (18,634 | ) | (111,213 | ) | (88,277 | ) | |||||||||||
| Effect of exchange rates on cash | 4,068 | (184 | ) | (238 | ) | (662 | ) | (233 | ) | |||||||||||
28
| Year Ended December 31, | ||||||||||||||||||||
| 2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Working capital | $ | 285,749 | $ | 253,068 | $ | 265,498 | $ | 169,022 | $ | 165,920 | ||||||||||
| Property and equipment, gross | 1,858,307 | 1,595,225 | 1,279,980 | 1,089,826 | 999,414 | |||||||||||||||
| Property and equipment, net | 1,051,683 | 911,208 | 694,291 | 610,341 | 597,778 | |||||||||||||||
| Total assets | 2,016,923 | 1,859,077 | 1,541,398 | 1,329,244 | 1,316,622 | |||||||||||||||
| Long-term debt and capital leases, net of current maturities | 633,591 | 511,614 | 406,080 | 410,781 | 481,047 | |||||||||||||||
| Total liabilities | 1,156,191 | 970,079 | 810,887 | 775,187 | 810,956 | |||||||||||||||
| Stockholders’ equity | 860,732 | 888,998 | 730,511 | 554,057 | 505,666 | |||||||||||||||
| Cash dividends per common share | — | — | — | — | — | |||||||||||||||
| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Business and Growth Strategies
enhancement of safety and quality.
29
We are currently evaluating a number of geographic-focused acquisition candidates, primarily” in our well servicing segment, and these acquisitions, if completed, would help strengthen our position in several core markets. We may seek to identify other acquisition candidates and we may evaluate acquisition opportunities in either our pressure pumping or fishing and rental services segments. this Item.
services resulted from the overall turmoil in the credit markets that caused many of our customers to begin to slow down their capital spending, and from significant declines in the prices of oil and natural gas. In response to the pending downturn, we took steps during the later part of the third quarter and in the fourth quarter of 2008 to decrease our spending levels and control costs. These steps included targeted reductions in our workforce, reductions in pay and other reductions in our cost structure. We believe that the actions we have already taken will result in significant cost savings in the near term, and we are continuing to implement other cost saving measures during early 2009, including further reductions in our spending levels and capital expenditures, in order to further improve our cost structure.
more capital tomaintain liquidity and provide flexibility for the use of our acquisition and share repurchase programs.capital. Presently, we estimate that we will spend approximately $175.0$130.0 million in capital expenditures in 2008; however, that amount2009, of which we estimate approximately $20.0 million a quarter will be devoted to maintenance of our existing fleet. Our 2009 capital spending could increase if we are awarded additional international work which would require usor recognize an opportunity to build new equipment.
expand our services in a particular market.
International Expansion. We presently operate in Argentina and Mexico and have a technology development group based in Canada. We are evaluating ways in which we can expand internationally. One of our objectives is to redeploy under-utilized assets to international markets. In addition, we will consider strategic international acquisitions in order to establish a presence in a particular market, if appropriate. We have evaluated a number of international markets, and our near-term priority is expansion in Mexico. Long term, we believe opportunities may exist in the Middle East, Russia and Latin America. See Item 1. "Business—Foreign Operations," for further discussion of our current international operations. We also have an investment in IROC Energy Services Corp. in Canada. See Item 8. "Consolidated Financial Statements and Supplementary Data," Note 7—"Investment in IROC Energy Services Corp."
Technology Initiative. We have invested, and will continue to invest, in technology projects that improve operating efficiencies for both ourselves and our customers, improve safety performance of our well service rigs and fluid hauling vehicles and provide opportunities for additional revenue. In 2003, we began deployment of our proprietary well service technology. The KeyView® system captures well-site operating data, thereby allowing customers and ourselves to monitor and analyze information about well servicing, resulting in improved efficiency. At December 31, 2007,2008, we had 220 KeyView® units installed. The KeyView® system increases our and our customers' visibility into activities at the well site. Through this technology, we have the ability to (i) ensure proper rod and tubing make-up which will result$92.7 million in reduced downhole failures, (ii) improve efficiency, through better logistics and planning, and (iii) improve safety. We believe that this system provides us a competitive advantage as it is a patented technology. For a further discussion of the KeyView® system, see Item 1. "Business—Patents, Trade Secrets, Trademarks and Copyrights."
Our technology initiative was expanded with the acquisition of AMI in 2007. AMI designs and produces oilfield service data acquisition, control and information systems. AMI's technology platform and applications facilitate the collection of job performance and related information and digitally distributes the information to customers. AMI contributed to the development of the KeyView® system and will assist in the advancement of this technology.
Expansion of Services Offering. We believe that it is important to have a broad and diverse services offering. For this reason, we have invested in our pressure pumping segment and our fishing and rental segment. In addition, during 2006 we entered the cased-hole electric wireline business in Texas, and we expanded our cased-hole electric wireline operation during 2007. During 2008, we intend to seek opportunities to expand our wireline services to other markets and to expand our project with PEMEX in Mexico. We also have ordered six coiled-tubing units which we expect to receive during the
second quarter of 2008. We believe that some customers prefer to consolidate vendors and we feel that our expanded services offering may provide better opportunities for customer penetration.
Training and Developing Employees. We devote significant resources to the training and professional development of our employees, with a special emphasis on safety. We currently own and operate training centers in Texas, California, Wyoming and Louisiana. In addition, in conjunction with local community colleges, we have two cooperative training centers in New Mexico and Oklahoma. The training centers are used to enhance our employees' understanding of operating and safety procedures. We recognize the historically high turnover rate in the industry in which we operate. We are committed to offering attractive and competitive compensation, benefits and incentive programs for our employees in order to ensure a steady stream of qualified, safety-conscious personnel that are able to provide quality service to our customers.
Current Financial Condition and Liquidity
We believe our current financial condition is strong, and we believe that our current reserves of cash and cash equivalents currentas well as $139.3 million of availability under the revolving portion of our 2007 Senior Secured Credit Facility, and internally generated cash flow from operations are sufficient to finance the cash requirements of our current and future operations and our budgeted capital expenditures for 2008. As of December 31, 2007, we had $58.8 million in cash and short-term investments and $288.9 million of availabilityhave no maturities under our 20078.375% Senior Notes (the “Senior Notes”) until 2014 or required repayments of borrowings on our Senior Secured Credit Facility.
In July 2007, we adopted a near-term capital investment plan to return capital to our shareholders and to make strategic geographic-focused acquisitions. Our Board of Directors subsequently authorized a share repurchase program of up to $300 million which is effective through March 31, 2009. Through December 31, 2007, we repurchased 2,341,400 shares of our common stock for approximately $32.2 million. In addition, through February 20, 2008, we cumulatively had repurchased 5,363,096 shares for approximately $69.8 million. Our repurchase program, as well as the amount and timing of the future repurchases, is subject to market conditions and our financial condition and liquidity.
The capital investment plan also provides for the Company to make acquisitions. During 2007, we completed three acquisitions for approximately $158.0 million in the aggregate, net of cash acquired. Our capital expenditure program for 2008 is expected to total approximately $175.0 million; however, that amount is subject to market conditions, including activity levels, commodity prices and industry capacity. Our focus in 2008 will be maximizing the utilization of our current equipment, however, we may seek to increase our 2008 capital expenditure budget in the event international expansion opportunities develop. See—"Acquisitions."
Our stock repurchase program and acquisition program, as well as planned capital expenditures, are expected to be financed through a combination of cash on hand, cash flow from operations and borrowings under our 2007 Senior Secured Credit Facility.
Performance Measures
In determining the overall health of the oilfield service industry, we believe that the Baker Hughes U.S. land drilling rig count is the best barometer of capital spending and activity levels, since this data is made publicly available on a weekly basis. Historically, our activity levels have been highly correlated to capital spending by oil and natural gas producers. When commodity prices are strong, capital spending by our customers tends to be high, as illustrated by the Baker Hughes U.S. land drilling rig
count. As the following table indicates, the land drilling rig count has increased significantly over the past several years as commodity prices, both oil and natural gas, have increased.
| Year | WTI Cushing Crude Oil(1) | NYMEX Henry Hub Natural Gas(1) | Average Baker Hughes Land Drilling Rigs(2) | |||||
|---|---|---|---|---|---|---|---|---|
| 2002 | $ | 26.18 | $ | 3.37 | 717 | |||
| 2003 | $ | 31.08 | $ | 5.49 | 924 | |||
| 2004 | $ | 41.51 | $ | 6.18 | 1,095 | |||
| 2005 | $ | 56.64 | $ | 9.02 | 1,290 | |||
| 2006 | $ | 66.05 | $ | 6.98 | 1,559 | |||
| 2007 | $ | 72.34 | $ | 7.12 | 1,695 | |||
(1)Represents average crude oil or natural gas price, respectively, for each of the years presented.(2)Source:www.bakerhughes.com
Internally, we measure activity levels primarily through our rig and trucking hours. Generally, as capital spending by oil and natural gas producers increases, demand for our services also rises, resulting in increased rig and trucking services and more hours worked. Conversely, when activity levels decline due to lower spending by oil and natural gas producers, we generally provide fewer rig and trucking services, which results in lower hours worked. We publicly release our monthly rig and trucking hours, and the following table presents our quarterly rig and trucking hours from 2005 through 2007.
| | Rig Hours | Trucking Hours | |||
|---|---|---|---|---|---|
| 2005: | |||||
| First Quarter | 621,228 | 641,841 | |||
| Second Quarter | 661,928 | 635,448 | |||
| Third Quarter | 668,741 | 607,500 | |||
| Fourth Quarter | 646,810 | 594,762 | |||
| Total 2005: | 2,598,707 | 2,479,551 | |||
2006: | |||||
| First Quarter | 663,819 | 609,317 | |||
| Second Quarter | 679,545 | 602,118 | |||
| Third Quarter | 677,271 | 587,129 | |||
| Fourth Quarter | 637,994 | 578,471 | |||
| Total 2006: | 2,658,629 | 2,377,035 | |||
2007: | |||||
| First Quarter | 625,748 | 571,777 | |||
| Second Quarter | 611,890 | 583,074 | |||
| Third Quarter | 597,617 | 570,356 | |||
| Fourth Quarter | 614,444 | 583,191 | |||
| Total 2007: | 2,449,699 | 2,308,398 | |||
In our pressure pumping segment, we track the total number of jobs performed to measure activity levels. The following table presents the types and total number of jobs performed by our pressure pumping services segment for the periods presented.
| Year | Fracturing | Cementing | Acidizing | Other | Total | |||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2005 | 1,329 | 1,558 | 1,057 | 106 | 4,050 | |||||
| 2006 | 1,585 | 1,958 | 639 | 96 | 4,278 | |||||
| 2007 | 2,152 | 2,074 | 481 | 77 | 4,784 |
The majority of our pressure pumping segment revenue (approximately 80 - 85%) is derived from our fracturing jobs.
Operating Environment
2007 Operating Environment
Activity levels in 2007 (as measured by our rig and trucking hours) were lower than 2006 due to increased supply of well service rigs and oilfield trucking assets in the market. Our activity declines occurred despite continued strength of commodity prices, including record high oil prices, and overall industry demand for well services. Rig hours for 2007 totaled 2,449,699, a decrease of 7.9% from 2006. The decrease in activity levels would have been greater absent the impact of the businesses acquired during 2007. The Moncla acquisition included 59 well service rigs and during the fourth quarter those assets contributed approximately 34,000 rig hours.
Our trucking hours totaled 2,308,398, a decrease of 2.9% from 2006. The Baker Hughes land drilling rig count averaged 1,695 in 2007, an increase of approximately 8.7% from an average of 1,559 in 2006. The higher drilling rig count is indicative of the strength of the U.S. marketplace, which is directly associated with the strength of oil and natural gas prices. As of December 31, 2007, the Baker Hughes land drilling rig count totaled 1,719, while in 2007 the WTI Cushing price for light sweet crude averaged $72.34 per barrel and natural gas prices averaged $7.12 per MMbtu.
Our business has been negatively impacted by new industry capacity. In our well servicing segment, both our rig and trucking hours are down year-over-year due primarily to new competition. The new capacity has entered the U.S. market place due to high returns and strong demand for oilfield services. In addition, some of our customers have elected to vertically integrate and have purchased and now operate their own equipment. Activity levels in most of our operating regions are down from 2006; the regions with the most pronounced declines include the Gulf Coast, the Rocky Mountains and East Texas. These regions are characterized by high natural gas production. In response to lower utilization of our assets, during 2007, we reduced pricing for some of our customers. These reductions have taken place in most of our regions and in all of our operating segments.
2008 Operating Environment Outlook
Our activity levels to date in 2008, excluding the contribution of businesses acquired in 2007, are down from last year. However, our business remains strong and we believe that our activity levels will remain stable for the balance of 2008. Our belief is predicated on the fact that commodity prices through February 2008 remain at levels higher than 2007. As of February 15, 2008 crude oil prices were in excess of $90 per barrel while natural gas prices were in excess of $8.50 per MMbtu. At these high prices, we believe customer spending in 2008 could surpass spending in 2007. We also believe that our recent acquisitionsFacility until 2012. Also, in the fourth quarter of 2007 will help offset declines in our other businesses. We also believe that our recent acquisitions in the fourth quarter of 2007 will help offset declines in our other businesses. Because demand for our well servicing, pressure pumping services, and fishing and rental services is generally correlated2009, we are required to commodity prices and drilling activity, our activity levels may be negatively impacted in the event commodity prices decline rapidly or unexpectedly.
Although we believe that demand for our services will be strong because of the high commodity prices, we also believe that our business will continue to face increased competition due to additional industry capacity and new market entrants. We believe that this risk is somewhat mitigated as a number of oilfield service companies, including us, have announced capital spending reductions for 2008. This should reduce the rate of growth of new equipment entering the market. This reduction, combined with higher commodity prices, leads us to believe that 2008 could be as strong, if not stronger, than 2007. Our 2008 budget estimates that our revenues will exceed revenue for 2007. In the event new capacity does not slow, we believe that margin compression could occur in 2008 as increased equipment capacity could result in lower utilization of our assets. Further, an increase in equipment supply could lead to higher labor rates as the demand for people would correspondingly increase.
We also have initiatives underway that we hope will maintain and possibly enhance our margins. These initiatives include a continued focus on safety improvements and reductions in employee turnover. Better safety performance, we believe, will reduce workers compensation expense and help lower our insurance premiums. Additionally, lower employee turnover will help reduce hiring and training costs. We are also seeking to reduce our reliance on third-party consultants and outside legal counsel, to the extent their services were generally attributable to matters arising out of our restatement and financial reporting process. We believe this will help reduce our general and administrative expenses.
We also anticipate that our international operations will expand. We have received additional requests for equipment from our customer in Mexico. Presently, we operate three rigs in Mexico, and we believe that we will send up to eight additional rigs to Mexico during 2008. In addition, we have secured pricing increases in our Argentina division and anticipate that margins for that division should improve in 2008.
Acquisitions
Moncla Acquisition. On October 25, 2007, we purchased all of the outstanding shares and membership interests of Moncla. Moncla operated in Texas, Louisiana, Mississippi, Alabama and Florida. Headquartered in Lafayette, Louisiana, and with offices in Sour Lake, Texas and Sandersville, Mississippi, Moncla operated a total of 59 rigs (including six swabbing units) and had over 900 employees. Moncla's fleet included 37 daylight rigs for well servicing and workovers and eight twenty-four hour rigs for shallow drilling, sidetracking and deep workovers. In addition, the Moncla companies operated eight barge rigs, and owned rig-up, swab, hot oil and anchor trucks, tubing testing units and rental equipment. Revenue attributable to the Moncla business is anticipated to be approximately $140.0 million in 2008.
The purchase price for Moncla was approximately $146.0 million, which consisted of net assets acquired of $131.3 million and assumed debt of $14.7 million. Amounts transferred at closing consisted of (i) $108.6 million of cash; (ii) the issuance of an unsecured promissory note for $12.5 million that is payable in a lump sum on October 25, 2009, with accrued interest payable on each anniversary date of the closing of the acquisition; and (iii) the issuance of an unsecured promissory note for $10.0 million that is payable in five annual installments of $2.0 million plus accrued interest on each annual anniversary date of the closing of the acquisition. Both promissory notes bear interest at the Federal Funds rate, adjusted annually on the anniversary of the closing date. The long-term debt assumed in the acquisition was repaid simultaneously with the closing of the transaction. The purchase price is subject to a working capital adjustment, which has not been finalized.
The Moncla purchase agreement entitles the former owners of Moncla to receive earnoutmake principal payments on each of the next five anniversary dates of the closing date of the acquisition, of up to $5.0 million (up to $25.0 million in total). The earnout payments are based on the achievement of certain revenue targets and profit percentage targets over the next five years and are payable upon
achieving annual targets or a cumulative target on the fifth anniversary date. These payments represent an additional element of cost of the acquired entity and will be accounted for as an increase to goodwill if and when the contingent payment is made.
Kings Acquisition. On December 7, 2007, we acquired the well service assets and related equipment of Kings. The acquired assets, all of which are located in California, included 36 marketed well service rigs, 10 stacked well service rigs and related support equipment. We anticipate that the acquired assets will contribute revenue of approximately $36 million in 2008. Total consideration paid for the transaction was approximately $45 million in cash, which included consideration for a noncompete agreement with the owner of Kings.
Technology Acquisition. On September 5, 2007, we purchased, through a wholly-owned Canadian subsidiary, all of the outstanding shares of AMI, a privately-held Canadian technology company focused on oilfield service equipment controls, data acquisition, and digital information work flow. The purchase price was $6.6 million in cash and the assumption of approximately $2.9 million in debt, which has since been paid in full. The purchase agreement also provided for deferred cash payments up to a maximum of $1.8totaling $14.5 million related to the retention of key employees. On the date of acquisition, AMI owned a 48% interest in Advanced Flow Technologies, Inc. ("AFTI"), a privately-held Canadian technology company focused on low cost wireless gas well production monitoring. As part of the purchase of AMI we were required to exercise an option to increase AMI's interest in AFTI to 51.46%. The cost to exercise this option was approximately $0.5 million. As a result, through AMI we now own a 51.46% interest in AFTI. In connection with the acquisition of AMI, we became party to a revolving credit agreement with a maximum outstanding amount of $0.9 million. This facility was extinguished in November 2007.
We made no acquisitions during 2005 or 2006.
Discontinued Operations
On January 15, 2005, we completed the sale to Patterson-UTI Energy, Inc. of the majority of our contract drilling assets, which included drilling rigs and associated equipment in the Permian Basin and Four Corners regions and certain rigs from the Rocky Mountain region. In consideration of the sale, we received approximately $60.5 million in cash, after paying all fees related to the sale. The sale included approximately 25 active rigs and 10 stacked rigs as well as a number of rigs which had been classified as either scrap or salvage. The active rigs were mechanical with an average of approximately 700 horsepower and depth ratings of approximately 10,000 feet. As a result of the sale, we treated our drilling business as a discontinued operation for all periods presented and recorded an after-tax loss from discontinued operations of $3.4 million, or $0.03 per diluted share, for the year ended December 31, 2005.
Cash flows from our discontinued operations have been segregated and individually presented for all years in our consolidated statements of cash flows. We do not anticipate that the absence of these cash flows in future periods will have a material adverse impact on our liquidity, results of operations or financial position.
The following table sets forth statements of operations for the years indicated:
| | Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2007 | 2006 | 2005 | ||||||||
| | (in thousands) | ||||||||||
| REVENUES: | |||||||||||
| Well servicing | $ | 1,264,797 | $ | 1,201,228 | $ | 956,457 | |||||
| Pressure pumping | 299,348 | 247,489 | 152,320 | ||||||||
| Fishing and rental | 97,867 | 97,460 | 81,667 | ||||||||
| Total revenues | 1,662,012 | 1,546,177 | 1,190,444 | ||||||||
| COSTS AND EXPENSES: | |||||||||||
| Well servicing | 738,694 | 725,008 | 634,043 | ||||||||
| Pressure pumping | 189,645 | 138,377 | 92,301 | ||||||||
| Fishing and rental | 57,275 | 57,217 | 53,899 | ||||||||
| Depreciation and amortization | 129,623 | 126,011 | 111,888 | ||||||||
| General and administrative | 230,396 | 195,527 | 151,303 | ||||||||
| Interest expense, net of amounts capitalized | 36,207 | 38,927 | 50,299 | ||||||||
| Loss on early extinguishment of debt | 9,557 | — | 20,918 | ||||||||
| Loss (gain) on sale of assets, net | 1,752 | (4,323 | ) | (656 | ) | ||||||
| Interest income | (6,630 | ) | (5,574 | ) | (2,713 | ) | |||||
| Other, net | (447 | ) | 527 | (5,236 | ) | ||||||
| Total costs and expenses, net | 1,386,072 | 1,271,697 | 1,106,046 | ||||||||
| Income from continuing operations before income taxes | 275,940 | 274,480 | 84,398 | ||||||||
| Income tax expense | (106,768 | ) | (103,447 | ) | (35,320 | ) | |||||
| Minority interest | 117 | — | — | ||||||||
| INCOME FROM CONTINUING OPERATIONS | 169,289 | 171,033 | 49,078 | ||||||||
| Loss from discontinued operations, net of tax expense of $4,590 | — | — | (3,361 | ) | |||||||
| NET INCOME | $ | 169,289 | $ | 171,033 | $ | 45,717 | |||||
For the year ended December 31, 2007, our revenue reached a record high. Our revenue for the year ended December 31, 2007 totaled $1.66 billion, which represents a 7.5% increase over the prior year. Our net income for the year totaled $169.3 million, which represents a 1.0% decrease from the prior year while our earnings per fully diluted share totaled $1.27 compared to $1.28 from the prior year.
Impacting our net income and earnings per share for 2007 results were costs associated with the refinancing of our indebtedness in the fourth quarter of 2007. These include a loss related to the early extinguishment of our 2005 Senior Secured Credit Facility (defined herein) which totaled $9.6 million, or $0.04 per fully diluted share, and the termination of two interest rate swaps associated with that debt, which resulted in a loss of $2.3 million, or $0.01 per fully diluted share.
A detailed review of our operations, including a review of our segments, is provided below.
Revenue
Year Ended December 31, 2007 versus Year Ended December 31, 2006
Our revenue for the year ended December 31, 2007 increased $115.8 million, or 7.5%, to $1.66 billion from $1.55 billion for the year ended December 31, 2006. The increase in revenue relates to:
| Revenue (in millions) | Change from 2006 | ||
|---|---|---|---|
| Well servicing segment | $ | 63.5 | |
| Pressure pumping segment | $ | 51.9 | |
| Fishing & rental segment | $ | 0.4 | |
| Total change | $ | 115.8 | |
Businesses acquired during 2007 contributed approximately $26.5 million of the increase in the well servicing segment over 2006. The Moncla transaction included 59 well service rigs, and during the fourth quarter those assets contributed approximately 34,000 rig hours and $23.6 million in revenue. The remaining $2.9 million of revenues from acquired businesses is attributable to AMI. Mexican operations began during the second quarter of 2007 and added $9.0 million in revenue to our well servicing segment. We presently operate three well service rigs in Mexico and the number of rigs in Mexico is anticipated to increase by eight rigs (for a total of 11 rigs) during 2008. Our cased-hole electric wireline activities in our well servicing segment also expanded during the year, providing a $13.7 million increase in revenues as we added additional units to our fleet. We believe this business offers a good growth opportunity and we intend to add additional cased-hole electric wireline units during 2008. Absent these items, overall increases in well servicing segment revenue were driven primarily by the impact of pricing increases that were implemented during the middle of 2006, though we were affected by declines in prices in the second half of 2007. Revenue was also affected by declines in rig and truck hours, as competition in the well servicing sector increased during 2007 and we lost market share to new capacity in the marketplace. Our pressure pumping segment revenue increased as we deployed additional frac pumps and cement units. This allowed us to perform more frac jobs, which is the primary revenue driver in our pressure pumping segment. Revenue in the fishing and rental segment was flat compared to 2006.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
Our revenue for the year ended December 31, 2006 increased $355.7 million, or 29.9%, to $1.55 billion from $1.19 billion for the year ended December 31, 2005. The increase in revenue relates to:
| Revenue (in millions) | Change from 2005 | ||
|---|---|---|---|
| Well servicing segment | $ | 244.7 | |
| Pressure pumping segment | $ | 95.2 | |
| Fishing & rental segment | $ | 15.8 | |
| Total change | $ | 355.7 | |
Our well servicing segment benefited from a 2.3% increase in our rig hours combined with a significant improvement in the pricing for our well service rig services. Our pressure pumping segment revenue increased as we deployed new frac pumps and cement units, adding to our fleet. This allowed us to perform more frac jobs, which is the primary revenue driver in our pressure pumping segment. Fishing and rental revenue increased principally due to higher activity levels and improved pricing.
Direct Costs
Direct costs as a percentage of total revenue improved to 59.3% for the year ended December 31, 2007, compared to 59.5% for the year ended December 31, 2006. Direct costs as a percentage of total revenue improved to 59.5% for the year ended December 31, 2006, compared to 65.5% for the year ended December 31, 2005.
Year ended December 31, 2007 versus Year Ended December 31, 2006
Consolidated direct costs for the year ended December 31, 2007 increased $65.0 million, or 7.1%, to $985.6 million from $920.6 million for the year ended December 31, 2006. The $65.0 million increase is primarily the result of:
| Direct Costs (in millions) | Change from 2006 | |||
|---|---|---|---|---|
| Employee compensation | $ | 25.4 | ||
| Pressure pumping supplies and equipment | $ | 41.6 | ||
| Well service acquisitions | $ | 16.0 | ||
| Self-insurance costs | $ | (21.8 | ) | |
| Other costs | $ | 3.8 | ||
| Total change | $ | 65.0 | ||
Our employee compensation costs, which include salaries, bonuses and related expenses, increased $25.4 million primarily as the result of increased incentive compensation and increased headcount, exclusive of the impact of acquisitions. Wage and bonus increases during the year were necessary, as the market for our labor continues to be extremely competitive. With new competitors entering the market and existing competitors adding equipment capacity, we were forced to increase wage rates in order to maintain our high levels of quality personnel. Supplies and equipment for our pressure pumping segment increased $41.6 million, primarily as a result of increases in the size of our pressure pumping fleet and increases in the costs to purchase and transport materials used in providing services to our customers. Acquisitions in our well services segment added $16.0 million to our direct costs in 2007. Our self-insurance costs, composed of costs associated with workers compensation, vehicular liability exposure, and insurance premiums declined significantly in 2007 as compared to 2006. We have been focused on improving our safety performance, and in 2007 the number and severity of safety-
related accidents declined. We continue to focus on safety improvements and our safety performance is a component of our incentive compensation program.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
Consolidated direct costs for the year ended December 31, 2006 increased $140.4 million, or 18.0%, to $920.6 million from $780.2 million for the year ended December 31, 2005. The $140.4 million increase is primarily the result of:
| Direct Costs (in millions) | Change from 2005 | |||
|---|---|---|---|---|
| Employee compensation | $ | 97.0 | ||
| Well service equipment and supplies | $ | 17.9 | ||
| Pressure pumping equipment and supplies | $ | 36.6 | ||
| Other costs | $ | (11.1 | ) | |
| Total change | $ | 140.4 | ||
Our employee compensation costs, which include salaries, bonuses and related expenses increased $97.0 million, primarily as the result of increased incentive compensation and increased headcount. Wage and bonus increases during the year were necessary, as the market for our labor continues to be extremely competitive. With new competitors entering the market and existing competitors adding equipment capacity, we were forced to increase wage rates in order to maintain our high levels of quality personnel. Supplies and equipment costs for our well servicing operations increased $17.9 million in 2006 compared to 2005, primarily as a result of increases in costs associated with higher activity levels, which results in strong utilization of our equipment and therefore, more wear and tear on our operational assets. Additionally, many of the assets we acquired through acquisitions during the 1994 - 2002 timeframe are beginning to reach the end of their economic useful lives; because of this, these assets require greater repairs and maintenance to keep them productive and operating. The repair and maintenance expense is also a function of our proactive maintenance programs. Supplies and equipment for our pressure pumping operations increased $36.6 million, primarily as a result of increases in the size of our fleet as we added equipment year over year, as well as increases in the costs to purchase and transport sand and chemicals used in our operations. Other costs declined $11.1 million, primarily as a result of reductions in self-insurance costs.
Depreciation and Amortization Expense
Year Ended December 31, 2007 versus Year Ended December 31, 2006
Depreciation and amortization expense increased $3.6 million, or 2.9%, to $129.6 million for the year ended December 31, 2007, compared to $126.0 million for the year ended December 31, 2006. Contributing to the increase in depreciation and amortization expense was depreciation expense associated with our acquisitions during 2007, which totaled approximately $4.8 million, and increased depreciation of approximately $7.7 million related to management's reassessment of the useful lives of certain assets. Excluding the depreciation and amortization expense associated with acquisitions and reassessment of useful lives, our depreciation expense would have declined approximately $8.9 million because the assets we added through various acquisitions during the 1994 to 2002 time period are now reaching the end of their depreciable lives. Depreciation and amortization expense as a percentage of revenue for the year ended December 31, 2007 totaled 7.8%, compared to 8.1% for the year ended December 31, 2006.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
Depreciation and amortization expense increased $14.1 million, or 12.6%, to $126.0 million for the year ended December 31, 2006, compared to $111.9 million for the year ended December 31, 2005. The increase is primarily attributable to a greater fixed asset base, which is due to increased capital expenditures. For the year ended December 31, 2006, our capital expenditures totaled approximately $195.8 million, as compared to $118.1 million for the year ended December 31, 2005. Depreciation and amortization expense as a percentage of revenue for the year ended December 31, 2006 totaled 8.1%, compared to 9.4% for the year ended December 31, 2005.
General and Administrative Expense
Year Ended December 31, 2007 versus Year Ended December 31, 2006
General and administrative ("G&A") expense increased $34.9 million, or 17.8%, to $230.4 million for the year ended December 31, 2007, compared to $195.5 million for the year ended December 31, 2006. The $34.9 million increase is primarily the result of:
| G&A Expense (in millions) | Change from 2006 | ||
|---|---|---|---|
| Employee compensation | $ | 7.5 | |
| Acquisitions | $ | 3.0 | |
| 2006 legal settlement to the Company | $ | 7.5 | |
| Professional fees | $ | 9.6 | |
| Bad debt expense | $ | 1.8 | |
| Other | $ | 5.5 | |
| Total change | $ | 34.9 | |
Employee compensation, exclusive of the impact of acquisitions, which includes salaries, bonuses, equity-based compensation and payroll taxes, increased primarily due to higher equity-based compensation and, to a lesser extent, increased salaries. Equity-based compensation expense, excluding grants made to our outside directors, during 2007 totaled $12.0 million, compared to $5.6 million during 2006. The $6.4 million increase is primarily attributable to awards granted under our Phantom Share Plan at the end of 2006, as well as incremental stock options, restricted stock and stock appreciation rights awarded during 2007 under our 1997 Incentive Plan. G&A expenses added through acquisitions made during 2007 contributed $3.0 million to the increase in costs when compared to 2006.
G&A also increased in 2007, because G&A in 2006 included a $7.5 million benefit from a legal settlement in 2006 that was not repeated during 2007. Professional fees increased approximately $9.6 million during 2007, primarily due to our financial reporting process. Also contributing to the increase in G&A was an additional $1.8 million in bad debt expense and $5.5 million in other G&A costs. G&A expense as a percentage of revenue for the year ended December 31, 2007 totaled 13.9% compared to 12.6% for the year ended December 31, 2006.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
G&A expense increased $44.2 million, or 29.2%, to $195.5 million for the year ended December 31, 2006 compared to $151.3 million for the year ended December 31, 2005. The increases in G&A expense are primarily attributable to:
| G&A Expense (in millions) | Change from 2005 | |||
|---|---|---|---|---|
| Employee compensation | $ | 40.5 | ||
| 2006 legal settlement | $ | (7.5 | ) | |
| Other costs | $ | 11.2 | ||
| Total change | $ | 44.2 | ||
Compensation-related expenses increased primarily due to increased staff, higher equity-based compensation and increased incentive compensation expense. Equity-based compensation expense during 2006 totaled $5.6 million compared to $1.7 million during 2005, primarily due to incremental stock options and restricted stock granted during 2006. The 2006 period also benefited from a $7.5 million legal settlement. With the increases in staff, other general and administrative costs associated with additional employees, including but not limited to office and computer supplies and travel, also increased. These other G&A costs increased $11.2 million in 2006 as compared to 2005. G&A expense as a percentage of revenue for the year ended December 31, 2006 totaled 12.6% compared to 12.7% for the year ended December 31, 2005.
Interest Expense
Year Ended December 31, 2007 versus Year Ended December 31, 2006
Interest expense decreased $2.7 million, or 7.0%, to $36.2 million for the year ended December 31, 2007, compared to $38.9 million for the year ended December 31, 2006. The decrease is primarily the result of the impact of higher capitalized interest as a result of higher capital expenditures. This decrease was partially offset by a one-time $2.3 million cost associated with the settlement of two interest rate swaps that were terminated in connection with the termination of our 2005 Senior Secured Credit Facility in 2007. Interest expense as a percent of revenue for the year ended December 31, 2007 totaled 2.2%, compared to 2.5% for the year ended December 31, 2006. We anticipate that our interest expense will be higher in 2008 as our total debt has increased from the prior year.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
Interest expense decreased $11.4 million, or 22.6%, to $38.9 million for the year ended December 31, 2006, compared to $50.3 million for the year ended December 31, 2005. The decrease was the result of lower interest rates under our 2005 Senior Secured Credit Facility, which was entered into in July 2005 and used to refinance all of our then-outstanding senior notes. The refinancing eliminated the monthly consent fees which were being paid to bondholders due to our failure to file SEC reports. Interest expense as a percentage of revenue for the year ended December 31, 2006 totaled 2.5%, compared to 4.2% for the year ended December 31, 2005.
Loss on Early Extinguishment of Debt
Year Ended December 31, 2007 versus Year Ended December 31, 2006
For the year ended December 31, 2007, we incurred a loss of $9.6 million associated with the termination of our 2005 Senior Secured Credit Facility. During 2007, we issued $425.0 million of Notes and used the proceeds to retire the term loans then outstanding under the 2005 Senior Secured Credit Facility. Concurrently, we entered into the 2007 Senior Secured Credit Facility and terminated the 2005
Senior Secured Credit Facility. The loss represents the write-off of debt issue costs we incurred when we entered into the 2005 Senior Secured Credit Facility.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
For the year ended December 31, 2006, we did not incur any losses associated with the retirement of long-term debt obligations; however, for the year ended December 31, 2005, we incurred losses totaling $20.9 million associated with the termination of our then senior secured credit facility and the redemption or repayment of $425.0 million in senior notes.
Income Taxes
Year Ended December 31, 2007 versus Year Ended December 31, 2006
Our income tax expense was $106.8 million for the year ended December 31, 2007, as compared to income tax expense of $103.4 million for the year ended December 31, 2006. Our effective tax rate in 2007 was 38.7%, as compared to 37.7% in 2006. The increase in income tax and our effective tax rate is primarily attributable to the Texas Margins Tax, which added $5.5 million of state income taxes during 2007. In general, differences between the effective tax rates and the statutory rate of 35% result primarily from the effect of certain foreign and state income taxes and permanent items attributable to book-tax differences.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
Our income tax expense was $103.4 million for the year ended December 31, 2006, as compared to income tax expense from continuing operations of $35.3 million for the year ended December 31, 2005. The increase in income tax was the result of higher taxable income. Our effective tax rate in 2006 was 37.7%, as compared to 41.8% in 2005. In general, differences between the effective tax rates and the statutory rate of 35% result primarily from the effect of certain foreign and state income taxes and permanent items attributable to book-tax differences.
Segment Results
| | Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Segments | |||||||||||
| 2007 | 2006 | 2005 | |||||||||
| | (in thousands, except for percentages) | ||||||||||
| Well Servicing | |||||||||||
| Revenue | $ | 1,264,797 | $ | 1,201,228 | $ | 956,457 | |||||
| Direct Costs | 738,694 | 725,008 | 634,043 | ||||||||
| Gross Profit | 526,103 | 476,220 | 322,414 | ||||||||
| Gross Margin | 41.6 | % | 39.6 | % | 33.7 | % | |||||
Pressure Pumping | |||||||||||
| Revenue | $ | 299,348 | $ | 247,489 | $ | 152,320 | |||||
| Direct Costs | 189,645 | 138,377 | 92,301 | ||||||||
| Gross Profit | 109,703 | 109,112 | 60,019 | ||||||||
| Gross Margin | 36.6 | % | 44.1 | % | 39.4 | % | |||||
Fishing & Rental | |||||||||||
| Revenue | $ | 97,867 | $ | 97,460 | $ | 81,667 | |||||
| Direct Costs | 57,275 | 57,217 | 53,899 | ||||||||
| Gross Profit | 40,592 | 40,243 | 27,768 | ||||||||
| Gross Margin | 41.5 | % | 41.3 | % | 34.0 | % | |||||
Well Servicing Segment
Revenue
Year Ended December 31, 2007 versus Year Ended December 31, 2006
Well servicing segment revenue increased $63.5 million, or 5.3%, to $1.26 billion for the year ended December 31, 2007, compared to revenue of $1.20 billion for the year ended December 31, 2006. The increase in revenue is largely attributable to the impact of the acquisition of Moncla, which contributed $23.6 million, $9.0 million from our contract with PEMEX in Mexico and $13.7 million in higher revenue from our cased-hole electric wireline operations. The remainder of the increase is a result of the full-year impact of pricing increases implemented during the second half of 2006, though revenues were affected by declines in activity levels and reductions from overall peak pricing in the second half of 2007. During the year ended December 31, 2007, our rig hours decreased 7.9% compared to the year ended December 31, 2006 and our trucking hours decreased 2.9% during the comparable period. The decrease in both rig and trucking hours was due primarily to lost market share to new market entrants.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
Well servicing segment revenues increased $244.7 million, or 25.6%, to $1.20 billion for the year ended December 31, 2006, compared to revenue of $956.5 million for the year ended December 31, 2005. The increase in revenue is largely attributable to higher pricing for our well service rigs and modestly higher activity levels. Because of continued high commodity prices and strong demand for maintenance and workover-related services, we implemented multiple price increases during 2006. This resulted in increased revenue year-over-year. Also, during the year ended December 31, 2006, our rig hours increased 2.3% compared to the year ended December 31, 2005, while our trucking hours decreased 4.1% during the comparable period. The decrease in trucking hours was due primarily to lost market share to new market entrants.
Direct Costs
Direct costs as a percent of total well servicing segment revenue improved to 58.4% for the year ended December 31, 2007, compared to 60.4% for the year ended December 31, 2006. Direct costs as a percent of total well servicing segment revenue improved to 60.4% for the year ended December 31, 2006, compared to 66.3% for the year ended December 31, 2005.
Year Ended December 31, 2007 versus Year Ended December 31, 2006
Well servicing direct costs increased $13.7 million, or 1.9%, to $738.7 million for the year ended December 31, 2007, compared to $725.0 million for the year ended December 31, 2006. Acquisitions made during 2007 contributed approximately $16.0 million to the increase in direct costs. Excluding the effect of acquisitions, well servicing direct costs increased as a result of higher employee compensation costs of $17.2 million. Compensation-related expenses increased due to the need to retain our workforce. As a result of new equipment capacity in the marketplace, the demand for labor remains strong and we have implemented programs to retain our personnel, including higher wage rates. Partially offsetting the increased compensation costs was a $22.8 million decrease in costs associated with our self-insurance programs. These costs, which include workers compensation, vehicular liability exposure and insurance premiums declined primarily as a result of improved safety performance and fewer and less severe incidents in 2007 compared to 2006. Other well servicing direct expenses increased approximately $3.3 million.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
Well servicing direct costs increased $91.0 million, or 14.3%, to $725.0 million for the year ended December 31, 2006, compared to $634.0 million for the year ended December 31, 2005. The overall increase in direct costs is largely attributable to higher activity levels. During the year, direct labor costs increased $83.4 million due primarily to higher compensation-related expenses and higher workers compensation expense. Compensation-related expenses increased due to increased headcount, increased payroll hours and higher wages, all of which are attributable to increased demand for our services. Further, because demand for personnel had been very high due to strong market conditions, we increased wage rates for our employees in order to retain our employees and minimize employee turnover. Equipment costs increased $17.9 million during 2006 due primarily to higher repair and maintenance expense and higher supplies expense. This is the result of increased activity levels. Other direct well servicing costs decreased $10.3 million, which is largely attributable to lower self-insurance-related costs.
Pressure Pumping Services Segment
Revenue
Year Ended December 31, 2007 versus Year Ended December 31, 2006
Pressure pumping services ("PPS") segment revenue increased $51.9 million, or 21.0%, to $299.3 million for the year ended December 31, 2007, compared to revenue of $247.5 million for the year ended December 31, 2006. The increase in revenue is attributable to the purchase of incremental pressure pumping equipment and higher activity levels, but was offset somewhat by lower pricing in 2007. Over the course of 2006 and 2007 we purchased additional new pressure pumping equipment to service and satisfy our customers' needs, increasing the size of our fleet. The new equipment resulted in additional services performed, which resulted in higher revenue during 2007. During 2007, we completed 2,152 fracturing jobs and 2,074 cementing jobs as compared to 1,585 and 1,958, respectively, in 2006. Fracturing and cementing jobs accounted for the substantial majority of the PPS segment revenue.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
PPS segment revenues increased $95.2 million, or 62.5%, to $247.5 million for the year ended December 31, 2006, compared to revenue of $152.3 million for the year ended December 31, 2005. The increase in revenue is attributable to the purchase of incremental pressure pumping equipment, higher activity levels and higher pricing for our services. Over the course of 2006 and 2005 we purchased additional new pressure pumping equipment to service and satisfy our customers' needs, increasing the size of our fleet. The new equipment resulted in additional services performed, which resulted in higher revenue during 2006. During 2006, we completed 1,585 fracturing jobs and 1,958 cementing jobs as compared to 1,329 and 1,558, respectively, in 2005. Fracturing and cementing jobs accounted for the substantial majority of the PPS segment revenues.
Direct Costs
Direct costs as a percent of total PPS segment revenue worsened to 63.4% for the year ended December 31, 2007, compared to 55.9% for the year ended December 31, 2006. Direct costs as a percent of total PPS segment revenue improved to 55.9% for the year ended December 31, 2006, compared to 60.6% for the year ended December 31, 2005.
Year Ended December 31, 2007 versus Year Ended December 31, 2006
PPS direct costs increased $51.3 million, or 37.0%, to $189.6 million for the year ended December 31, 2007, compared to $138.4 million for the year ended December 31, 2006. The increase in direct costs is largely attributable to costs associated with increased demand for pressure pumping services and the increased size of our pressure pumping fleet. During 2007, costs related to employee compensation for the pressure pumping segment increased $8.8 million due primarily to expansion of our pressure pumping fleet through the introduction of new equipment, which required us to hire additional personnel and increased wage rates for our crews. Our equipment costs increased $13.2 million from 2006 primarily due to the expansion of our pressure pumping fleet. Additionally, sand, chemical and associated freight costs increased approximately $29.3 million during 2007. These costs relate to the purchase of sand and chemicals used in our operations from our various suppliers and the shipment to our pressure pumping facilities and job locations. As activity levels in our pressure pumping segment increased in 2007, we used greater amounts of sand and chemicals. Additionally, as overall activity in the pressure pumping sector increased during 2007, the costs for the materials and their transportation increased.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
PPS direct costs increased $46.1 million, or 49.9%, to $138.4 million for the year ended December 31, 2006, compared to $92.3 million for the year ended December 31, 2005. The increase in direct costs is largely attributable to costs associated with increased demand for pressure pumping services and the increased size of our pressure pumping fleet. During 2006, direct labor costs increased $9.5 million due primarily to higher compensation-related expenses and higher contract labor costs. Compensation-related expenses increased due to increased headcount, increased payroll hours and higher wages, all of which are attributable to increased demand for our services. Further, because of the expansion of our pressure pumping fleet, we hired additional personnel to operate the new equipment, and because demand for personnel had been high due to strong market conditions, we increased wage rates in order to retain our employees. Equipment costs increased $12.5 million in 2006 due primarily to higher repair and maintenance expense, higher fuel expense and higher supplies expense. These increases are all the result of increased activity levels and the expansion of our pressure pumping fleet. Other direct pressure pumping costs increased $24.1 million. This increase is due primarily to higher sand and chemical product purchases, as well as higher freight costs.
Fishing and Rental Services Segment
Revenue
Year Ended December 31, 2007 versus Year Ended December 31, 2006
Fishing and rental services ("FRS") segment revenue totaled $97.9 million for the year ended December 31, 2007, compared to revenue of $97.5 million for the year ended December 31, 2006. Although the segment benefited from additional rental equipment in 2007, these equipment additions were offset somewhat by lower overall pricing.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
FRS segment revenue increased $15.8 million, or 19.3%, to $97.5 million for the year ended December 31, 2006, compared to revenue of $81.7 million for the year ended December 31, 2005. The increase in revenue is due to higher activity levels and improved pricing for our services. In addition, the FRS segment benefited from the implementation of our management team's turnaround efforts which began during 2005.
Direct Costs
Direct costs as a percent of total FRS segment revenue improved to 58.5% for the year ended December 31, 2007, compared to 58.7% for the year ended December 31, 2006. Direct costs as a percent of total FRS segment revenue improved to 58.7% for the year ended December 31, 2006, compared to 66.0% for the year ended December 31, 2005.
Year Ended December 31, 2007 versus Year Ended December 31, 2006
FRS direct costs were flat at $57.3 million for the year ended December 31, 2007, compared to $57.2 million for the year ended December 31, 2006.
Year Ended December 31, 2006 versus Year Ended December 31, 2005
FRS direct costs increased $3.3 million, or 6.2%, to $57.2 million for the year ended December 31, 2006, compared to $53.9 million for the year ended December 31, 2005. The increase in direct costs is largely attributable to increased demand for our services. During the year, direct labor costs increased $4.2 million from the prior year. The FRS segment recorded higher labor costs due to higher activity levels, and incentive payments increased due to improved financial performance. Equipment costs were essentially flat, declining by $0.2 million while other direct costs decreased $0.7 million.
Liquidity and Capital Resources
Historical Cash Flows
The following table summarizes our cash flows for the years ended December 31, 2007 and 2006:
| | Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|---|
| | 2007 | 2006 | |||||
| | (in thousands) | ||||||
| Net cash provided by operating activities | $ | 249,919 | $ | 258,724 | |||
| Cash paid for capital expenditures | (212,560 | ) | (195,830 | ) | |||
| Cash paid for acquisitions, net of cash acquired | (157,955 | ) | — | ||||
| Cash paid for short-term investments | (121,613 | ) | (83,769 | ) | |||
| Cash proceeds received from sales of short-term investments | 183,177 | 22,294 | |||||
| Other investing activities | 6,104 | 11,658 | |||||
| Repayments of long-term debt and capital leases | (424,751 | ) | (16,975 | ) | |||
| Borrowings of long-term debt, net of cash paid for debt issuance costs | 461,600 | (479 | ) | ||||
| Cash paid to repurchase common stock | (30,454 | ) | (1,180 | ) | |||
| Proceeds received from exercises of stock options | 13,444 | — | |||||
| Other financing activities | 3,401 | — | |||||
| Effect of exchange rates on cash | (184 | ) | (238 | ) | |||
| Net decrease in cash and cash equivalents | $ | (29,872 | ) | $ | (5,795 | ) | |
Sources of Liquidity
Our sources of liquidity include our current cash and short-term investments, availability under our 2007 Senior Secured Credit Facility and internally generated cash flow from operations. During 2007, we refinanced our indebtedness. We issued $425.0 million of Notes and entered into the 2007 Senior Secured Credit Facility. The Notes, which have a coupon of 8.375%, require no prepayment and mature in 2014. The 2007 Senior Secured Credit Facility consists of a revolving credit facility, letter of credit sub-facility and swing line facility of up to an aggregate principal amount of $400.0 million, all of
which mature no later than 2012. As of December 31, 2007, we had $288.9 million available for borrowing under the 2007 Senior Secured Credit Facility. Approximately $50.0 million in borrowings were outstanding under the revolving credit facility, and $61.1 million of letters of credit, issued under the letter of credit sub-facility, were outstanding, which also reduces the availability under the 2007 Senior Secured Credit Facility. We believe that our liquidity position is strong. Our debt totaled $524.0 million as of December 31, 2007, and we believe that this amount is acceptable given our recent financial performance and our belief that industry activity levels in 2008 should remain stable.
Cash Requirements
During 2008, we anticipate our cash requirements to include working capital needs, capital expenditures, acquisitions and the repurchase of shares of our common stock. We believe that our current reserves of cash and short-term investments, our availability under our 2007 Senior Secured Credit Facility and our internally generated cash flow from operations are sufficient to finance the cash requirements of our current and future operations, including our 2008 capital expenditure budget. We do not budget for acquisitions; however, we are continually evaluating opportunities that fit our specific acquisition profile. We expect to finance acquisitions through a combination of cash on hand, cash flow from operations and borrowings under our 2007 Senior Secured Credit Facility. In some limited cases, however, we may elect to use equity as a financing tool.
We anticipate that our capital expenditures in 2008, excluding acquisitions, will be approximately $175.0 million. For the past three years we have devoted significant amounts of our cash flow from operations to support organic growth. From the beginning of 2005 through December 31, 2007, we have cumulatively invested approximately $526.5 million in our rig fleet and equipment, excluding acquisitions. Capital expenditures during the year ended December 31, 2007 were $212.6 million, excluding acquisitions.
In October 2007, our board authorized us to repurchase up to $300.0 million of our outstanding common stock. We may from time to time repurchase shares of our common stock depending on the price of the stock, our liquidity and other considerations. During the year ended December 31, 2007, we repurchased approximately 2.3 million shares of our common stock for $32.2 million through our stock repurchase program. The 2007 Senior Secured Credit Facility permits share repurchases up to $200.0 million and provides that share repurchases in excess of $200.0 million can be made if our debt to capitalization ratio is below 50%. As of December 31, 2007, we would have been permitted to make share repurchases in excess of $200.0 million.
From time to time we acquire businesses that improve our footprint in certain geographic areas, increase our range of products or services or are otherwise strategic to our business. During the year ended December 31, 2007, we used approximately $158.0 million in cash (net of cash acquired) and $22.5 million in notes payable, in business acquisitions.
Outstanding Indebtedness and Working Capital as of December 31, 2007
Our primary debt obligations, other than capital lease obligations and the notes payable incurred in the acquisition of Moncla, as of December 31, 2007, consisted of $425.0 million outstanding principal amount of the Notes and $50.0 million of borrowings under the 2007 Senior Secured Credit Facility.
As of December 31, 2007, we had net working capital (excluding the current portion of long-term debt and capital lease obligations of $12.4 million) of $265.5 million, which includes cash, cash equivalents and short-term investments of $58.8 million, as compared to net working capital (excluding the current portion of long-term debt and capital lease obligations of $15.7 million) of $281.2 million, which includes cash and cash equivalents and short-term investments of $150.1 million, as of December 31, 2006. Our working capital declined from December 31, 2006 to December 31, 2007 primarily as a result of using cash for our acquisitions in the fourth quarter of 2007.
Contractual Obligations
Set forth below is a summary of our contractual obligations as of December 31, 2007. The obligations we pay in future periods reflect certain assumptions, including variability in interest rates on our variable-rate obligations and the duration of our obligations, and actual payments in future periods may vary.
| | Payments Due by Period (in thousands) | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Total | Less than 1 Year (2008) | 1 - 3 Years (2009 - 2011) | 4 - 5 Years (2012 - 2013) | After 5 Years (2014 +) | ||||||||||
| 8.375% Senior Notes due 2014 | $ | 425,000 | $ | — | $ | — | $ | — | $ | 425,000 | |||||
| Interest associated with 8.375% Senior Notes due 2014 | 249,361 | 35,693 | 106,785 | 71,288 | 35,595 | ||||||||||
| Borrowings under 2007 Senior Secured Credit Facility | 50,000 | — | — | 50,000 | — | ||||||||||
| Interest associated with 2007 Senior Secured Credit Facility(1) | 16,015 | 3,242 | 9,699 | 3,074 | — | ||||||||||
| Commitment and availability fees associated with 2007 Senior Secured Credit Facility | 22,266 | 4,453 | 13,360 | 4,453 | — | ||||||||||
| Notes payable—related party, excluding discount | 22,500 | 2,000 | 18,500 | 2,000 | — | ||||||||||
| Interest associated with notes payable—related party(1) | 2,611 | 1,079 | 1,437 | 95 | — | ||||||||||
| Capital lease obligations, excluding interest and executory costs | 26,815 | 10,701 | 15,879 | 235 | — | ||||||||||
| Interest and executory costs associated with capital lease obligations(1) | 4,838 | 2,441 | 2,388 | 9 | — | ||||||||||
| Non-cancellable operating leases | 24,224 | 7,428 | 11,111 | 3,030 | 2,655 | ||||||||||
| Severance liabilities and retention payments | 1,970 | 831 | 1,104 | 27 | 8 | ||||||||||
| FIN 48 liabilities | 6,751 | 782 | 4,039 | 1,930 | — | ||||||||||
| Equity-based compensation liability awards | 5,386 | 1,775 | 3,611 | — | — | ||||||||||
| Earnout payments(2) | 25,000 | 5,000 | 15,000 | 5,000 | — | ||||||||||
| Total | $ | 882,737 | $ | 75,425 | $ | 202,913 | $ | 141,141 | $ | 463,258 | |||||
(1)Interest costs on our floating rate debt were estimated using the rate in effect at December 31, 2007.(2)These amounts assume certain performance targets will be achieved.
Senior Notes
On November 29, 2007, we issued $425.0 million aggregate principal amount of Notes under an indenture, dated as of November 29, 2007 (the "Indenture"), among us, the guarantors party thereto (the "Guarantors") and The Bank of New York Trust Company, N.A., as trustee. The Notes were priced at 100% of their face value to yield 8.375%. Net proceeds, after deducting initial purchasers' discounts and estimated offering expenses, were approximately $416.1 million. We used approximately $394.9 million of the net proceeds to retire our term loans, including accrued and unpaid interest, under the 2005 Senior Secured Credit Facility, with the balance used for general corporate purposes. The 2005 Senior Secured Credit Facility was terminated in connection with our entry into the 2007 Senior Secured Credit Facility described below.
The Notes are general unsecured senior obligations of Key. Accordingly, they will rank effectively subordinate to all of our existing and future secured indebtedness. The Notes are or will be jointly and severally guaranteed on a senior unsecured basis by certain of our existing and future domestic subsidiaries.
Interest on the Notes is payable on June 1 and December 1 of each year, beginning June 1, 2008. The Notes mature on December 1, 2014.
On or after December 1, 2011, the Notes will be subject to redemption at any time and from time to time at our option, in whole or in part, upon not less than 30 nor more than 60 days' notice, at the redemption prices (expressed as percentages of the principal amount redeemed) set forth below, plus
accrued and unpaid interest thereon to the applicable redemption date, if redeemed during the twelve-month period beginning on December 1 of the years indicated below:
| Year | Percentage | ||
|---|---|---|---|
| 2011 | 104.188 | % | |
| 2012 | 102.094 | % | |
| 2013 | 100.000 | % |
Notwithstanding the foregoing, at any time and from time to time before December 1, 2010, we may, on any one or more occasions, redeem up to 35% of the aggregate principal amount of the outstanding Notes at a redemption price of 108.375% of the principal amount thereof, plus accrued and unpaid interest thereon to the redemption date, with the net cash proceeds of any one or more equity offerings; provided that at least 65% of the aggregate principal amount of the Notes issued under the Indenture remains outstanding immediately after each such redemption; and provided, further, that each such redemption shall occur within 180 days of the date of the closing of such equity offering.
In addition, at any time and from time to time prior to December 1, 2011, we may, at our option, redeem all or a portion of the Notes at a redemption price equal to 100% of the principal amount thereof plus the applicable premium (as defined in the Indenture) with respect to the Notes and plus accrued and unpaid interest thereon to the redemption date. If we experience a changediscussion below of control, subject to certain exceptions, we must give holders of the Notes the opportunity to sell to us their Notes, in whole or in part, at a purchase price equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest thereon to the date of purchase.
We are subject to certain negative covenants under the Indenture governing the Notes. The Indenture limits our ability to, among other things:
•sell assets;•pay dividends or make other distributions on capital stock or subordinated indebtedness;•make investments;•incur additional indebtedness or issue preferred stock;•create certain liens;•enter into agreements that restrict dividends or other payments from our subsidiaries to us;•consolidate, merge or transfer all or substantially all of its assets;•engage in transactions with affiliates; and•create unrestricted subsidiaries.
These covenants are subject to certain exceptions and qualifications. In addition, substantially all of the covenants will terminate before the Notes mature if one of two specified ratings agencies assigns the Notes an investment grade rating in the future and no events of default exist under the Indenture. Any covenants that cease to apply to us as a result of achieving an investment grade rating will not be restored, even if the credit rating assigned to the Notes later falls below an investment grade rating.
In connection with the sale of the Notes, we entered into a registration rights agreement with the initial purchasers, pursuant to which we have agreed to file an exchange offer registration statement with the SEC with respect to an offer to exchange the Notes for substantially identical notes that are registered under the Securities Act, and to use reasonable best efforts to cause such registration statement become effective on or prior to November 29, 2008. Additionally, we have agreed to commence the registered exchange offer and to use our reasonable best efforts to issue, on or prior to the date that is 60 days after the date on which the exchange offer registration statement became effective, exchange notes in exchange for all Notes tendered prior thereto in the registered exchange
offer. Under some circumstances, in lieu of a registered exchange offer, we have agreed to file a shelf registration statement to cover resales of the Notes by certain holders thereof and to use reasonable best efforts to keep the shelf registration statement effective for a period of at least two years or such shorter period ending on the earlier of when all of the Notes available for sale thereunder (i) have been sold pursuant thereto and (ii) are no longer restricted securities (as defined in Rule 144 under the Securities Act, or any successor rule thereof). We are required to pay additional interest if we fail to comply with our obligations to register the Notes within the specified time periods.
2007 Senior Secured Credit Facility
Simultaneously with the closing of the offering of the Notes, we entered into a new credit agreement (the "Credit Agreement") with the several lenders from time to time party thereto, Bank of America, N.A., as Paying Agent, Co-Administrative Agent, Swing Line Lender and L/C Issuer, and Wells Fargo Bank, National Association, as Co-Administrative Agent, Swing Line Lender and L/C Issuer. The Credit Agreement provides for a senior secured credit facility (the "2007 Senior Secured Credit Facility") consisting of a revolving credit facility, letter of credit sub-facility and swing line facility of up to an aggregate principal amount of $400.0 million, all of which will mature no later than November 29, 2012. The 2007 Senior Secured Credit Facility and the obligations thereunder are secured by substantially all of the assets of the Company and the Guarantors, and are or will be guaranteed by certain of our existing and future domestic subsidiaries. The 2007 Senior Secured Credit Facility replaced our 2005 Senior Secured Credit Facility, which was terminated in connection with the closing of the offering of the Notes.
The interest rate per annum applicable to the 2007 Senior Secured Credit Facility is, at our option (i) LIBOR plus the applicable margin or (ii) the higher of (x) Bank of America's prime rate and (y) the Federal Funds rate plus 0.5%, plus the applicable margin. The applicable margin for LIBOR loans ranges from 150 to 200 basis points, and the applicable margin for all other loans ranges from 50 to 100 basis points, depending upon our consolidated leverage ratio.
The 2007 Senior Secured Credit Facility contains certain financial covenants, which, among other things, require the maintenance of a consolidated leverage ratio not to exceed 3.50 to 1.00 and a consolidated interest coverage ratio of not less than 3.00 to 1.00, and limit our capital expenditures to $250.0 million per fiscal year, up to 50% of which amount may be carried over for expenditure in the following fiscal year. Each of the ratios referred to above will be calculated quarterly on a consolidated basis for each trailing four fiscal quarter period. In addition, the 2007 Senior Secured Credit Facility contains certain affirmative and negative covenants, including, without limitation, restrictions on (i) liens; (ii) debt, guarantees and other contingent obligations; (iii) mergers and consolidations; (iv) sales, transfers and other dispositions of property or assets; (v) loans, acquisitions, joint ventures and other investments (with acquisitions permitted so long as, after giving pro forma effect thereto, no default or event of default exists under the 2007 Senior Secured Credit Facility, the consolidated leverage ratio does not exceed 2.75 to 1.00, we are in compliance with the consolidated interest coverage ratio and we have at least $25 million of availability under the 2007 Senior Secured Credit Facility); (vi) dividends and other distributions to, and redemptions and repurchases from, equity holders; (vii) prepaying, redeeming or repurchasing subordinated (contractually or structurally) debt; (viii) granting negative pledges other than to the lenders; (ix) changes in the nature of our business; (x) amending organizational documents, or amending or otherwise modifying any debt, any related document or any other material agreement if such amendment or modification would have a material adverse effect; and (xi) changes in accounting policies or reporting practices; in each of the foregoing cases, with certain exceptions. The 2007 Senior Secured Credit Facility permits share repurchase up to $200.0 million and provides that share repurchases in excess of $200.0 million can be made only if our debt to capitalization ratio is below 50%.
We may prepay the 2007 Senior Secured Credit Facility in whole or in part at any time without premium or penalty, subject to certain reimbursements to the lenders for breakage and redeployment costs.
“Moncla Notes Payable” under “Liquidity and Capital Resources” in this Item). We expect to fund our obligations under the Moncla Notes through cash on hand generated by operating activities or borrowing under our Senior Secured Credit Facility.
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| WTI Cushing Crude | NYMEX Henry Hub | Average Baker Hughes Land | ||||||||||
Year | Oil(1) | Natural Gas(1) | Drilling Rigs(2) | |||||||||
| 2002 | $ | 26.18 | $ | 3.37 | 717 | |||||||
| 2003 | $ | 31.08 | $ | 5.49 | 924 | |||||||
| 2004 | $ | 41.51 | $ | 6.18 | 1,095 | |||||||
| 2005 | $ | 56.64 | $ | 9.02 | 1,290 | |||||||
| 2006 | $ | 66.05 | $ | 6.98 | 1,559 | |||||||
| 2007 | $ | 72.34 | $ | 7.12 | 1,695 | |||||||
| 2008 | $ | 99.57 | (3) | $ | 8.90 | (3) | 1,814 | (4) | ||||
| (1) | Represents average crude oil or natural gas price, respectively, for each of the years presented. Source: Bloomberg | |
| (2) | Source:www.bakerhughes.com | |
| (3) | Prices for oil and natural gas declined sharply during the fourth quarter of 2008. The spot prices at February 23, 2009 for WTI-Cushing crude oil and NYMEX Henry Hub natural gas were $39.47 per barrel and $4.20 per Mcf, respectively. | |
| (4) | The land drilling rig count was affected by the drop in commodity prices. The land drilling rig count at January 31, 2009 was 1,412. |
32
| Rig Hours | Trucking Hours | |||||||
| 2008 | ||||||||
| First Quarter | 659,462 | 585,040 | ||||||
| Second Quarter | 701,286 | 603,632 | ||||||
| Third Quarter | 721,285 | 620,885 | ||||||
| Fourth Quarter | 634,772 | 607,004 | ||||||
| Total 2008: | 2,716,805 | 2,416,561 | ||||||
| 2007 | ||||||||
| First Quarter | 625,748 | 571,777 | ||||||
| Second Quarter | 611,890 | 583,074 | ||||||
| Third Quarter | 597,617 | 570,356 | ||||||
| Fourth Quarter | 614,444 | 583,191 | ||||||
| Total 2007: | 2,449,699 | 2,308,398 | ||||||
| 2006 | ||||||||
| First Quarter | 663,819 | 609,317 | ||||||
| Second Quarter | 679,545 | 602,118 | ||||||
| Third Quarter | 677,271 | 587,129 | ||||||
| Fourth Quarter | 637,994 | 578,471 | ||||||
| Total 2006: | 2,658,629 | 2,377,035 | ||||||
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34
35
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (In thousands) | ||||||||||||
REVENUES | $ | 1,972,088 | $ | 1,662,012 | $ | 1,546,177 | ||||||
COSTS AND EXPENSES: | ||||||||||||
| Direct operating expenses | 1,250,327 | 985,614 | 920,602 | |||||||||
| Depreciation and amortization expense | 170,774 | 129,623 | 126,011 | |||||||||
| Impairment of goodwill and equity method investment | 75,137 | — | — | |||||||||
| General and administrative expenses | 257,707 | 230,396 | 195,527 | |||||||||
| Interest expense, net of amounts capitalized | 41,247 | 36,207 | 38,927 | |||||||||
| Loss on early extinguishment of debt | — | 9,557 | — | |||||||||
| (Gain) loss on sale of assets, net | (641 | ) | 1,752 | (4,323 | ) | |||||||
| Interest income | (1,236 | ) | (6,630 | ) | (5,574 | ) | ||||||
| Other expense (income), net | 4,717 | (447 | ) | 527 | ||||||||
| Total costs and expenses, net | 1,798,032 | 1,386,072 | 1,271,697 | |||||||||
| Income before income taxes and minority interest | 174,056 | 275,940 | 274,480 | |||||||||
| Income tax expense | (90,243 | ) | (106,768 | ) | (103,447 | ) | ||||||
| Minority interest | 245 | 117 | — | |||||||||
NET INCOME | $ | 84,058 | $ | 169,289 | $ | 171,033 | ||||||
36
| Change from 2007 | ||||
| Well Servicing segment | $ | 245.1 | ||
| Pressure Pumping segment | 45.6 | |||
| Fishing and Rental segment | 19.4 | |||
| Total change | $ | 310.1 | ||
| Change from 2007 | ||||
| Employee compensation | $ | 125.5 | ||
| Equipment, supplies and maintenance | 58.0 | |||
| Fuel | 33.4 | |||
| Frac sand and chemicals | 29.4 | |||
| Self-insurance | 4.7 | |||
| Other | 13.7 | |||
| Total change | $ | 264.7 | ||
37
38
| Change from 2007 | ||||
| Employee compensation (non-equity) | $ | 27.1 | ||
| Equity-based compensation | 11.3 | |||
| Legal fees and reserves | (2.2 | ) | ||
| Professional fees | (12.3 | ) | ||
| Other | 3.4 | |||
| Total change | $ | 27.3 | ||
39
40
| Change from 2006 | ||||
| Well Servicing segment | $ | 63.5 | ||
| Pressure Pumping segment | 51.9 | |||
| Fishing and Rental segment | 0.4 | |||
| Total change | $ | 115.8 | ||
| Change from 2006 | ||||
| Employee compensation | $ | 25.4 | ||
| Pressure pumping supplies and equipment | 41.6 | |||
| Well service acquisitions | 16.0 | |||
| Self-insurance | (21.8 | ) | ||
| Other | 3.8 | |||
| Total change | $ | 65.0 | ||
41
| Change from 2006 | ||||
| Employee compensation | $ | 7.5 | ||
| Acquisitions | 3.0 | |||
| 2006 legal settlement to the Company | 7.5 | |||
| Professional fees | 9.6 | |||
| Bad debt expense | 1.8 | |||
| Other | 5.5 | |||
| Total change | $ | 34.9 | ||
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| Year Ended December 31, | ||||||||||||
Segments | 2008 | 2007 | Change | |||||||||
| (In thousands, except for percentages) | ||||||||||||
| Well Servicing | ||||||||||||
| Revenue | $ | 1,509,823 | $ | 1,264,797 | $ | 245,026 | ||||||
| Direct operating expenses | 939,893 | 738,694 | 201,199 | |||||||||
| Direct operating expenses, as a percentage of revenue | 62.3 | % | 58.4 | % | ||||||||
| Pressure Pumping | ||||||||||||
| Revenue | $ | 344,993 | $ | 299,348 | $ | 45,645 | ||||||
| Direct operating expenses | 239,833 | 189,645 | 50,188 | |||||||||
| Direct operating expenses, as a percentage of revenue | 69.5 | % | 63.4 | % | ||||||||
| Fishing and Rental | ||||||||||||
| Revenue | $ | 117,272 | $ | 97,867 | $ | 19,405 | ||||||
| Direct operating expenses | 70,601 | 57,275 | 13,326 | |||||||||
| Direct operating expenses, as a percentage of revenue | 60.2 | % | 58.5 | % | ||||||||
| Change from 2007 | ||||
| Employee compensation | $ | 110.9 | ||
| Supplies, equipment and maintenance | 48.9 | |||
| Fuel | 24.6 | |||
| Self-insurance | 3.1 | |||
| Other | 13.7 | |||
| Total change | $ | 201.2 | ||
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| Change from 2007 | ||||
| Frac sand and chemicals | $ | 29.5 | ||
| Employee compensation | 8.1 | |||
| Fuel | 7.2 | |||
| Supplies, equipment and maintenance | 3.6 | |||
| Other | 1.8 | |||
| Total Change | $ | 50.2 | ||
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| Change from 2007 | ||||
| Employee compensation | $ | 6.5 | ||
| Supplies, equipment and maintenance | 5.5 | |||
| Fuel | 1.6 | |||
| Other | (0.3 | ) | ||
| Total Change | $ | 13.3 | ||
| Year Ended December 31, | ||||||||||||
Segments | 2007 | 2006 | Change | |||||||||
| (In thousands, except for percentages) | ||||||||||||
| Well Servicing | ||||||||||||
| Revenue | $ | 1,264,797 | $ | 1,201,228 | $ | 63,569 | ||||||
| Direct operating expenses | 738,694 | 725,008 | 13,686 | |||||||||
| Direct operating expenses, as a percentage of revenue | 58.4 | % | 60.4 | % | ||||||||
| Pressure Pumping | ||||||||||||
| Revenue | $ | 299,348 | $ | 247,489 | $ | 51,859 | ||||||
| Direct operating expenses | 189,645 | 138,377 | 51,268 | |||||||||
| Direct operating expenses, as a percentage of revenue | 63.4 | % | 55.9 | % | ||||||||
| Fishing and Rental | ||||||||||||
| Revenue | $ | 97,867 | $ | 97,460 | $ | 407 | ||||||
| Direct operating expenses | 57,275 | 57,217 | 58 | |||||||||
| Direct operating expenses, as a percentage of revenue | 58.5 | % | 58.7 | % | ||||||||
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| Year Ended December 31, | ||||||||
| 2008 | 2007 | |||||||
| (In thousands) | ||||||||
| Net cash provided by operating activities | $ | 367,164 | $ | 249,919 | ||||
| Cash paid for capital expenditures | (218,994 | ) | (212,560 | ) | ||||
| Cash paid for short-term investments | — | (121,613 | ) | |||||
| Proceeds from the sale of short-term investments | 276 | 183,177 | ||||||
| Investment in Geostream | (19,306 | ) | — | |||||
| Acquisitions, net of cash acquired | (63,457 | ) | (157,955 | ) | ||||
| Acquisition of fixed assets from asset purchases | (34,468 | ) | — | |||||
| Other investing activities, net | 6,875 | 6,104 | ||||||
| Proceeds from long-term debt, net of cash paid for debt issance costs | — | 461,600 | ||||||
| Repayments of capital lease obligations | (11,506 | ) | (424,751 | ) | ||||
| Borrowings under revolving credit facility | 172,813 | — | ||||||
| Payments on revolving credit facility | (35,000 | ) | — | |||||
| Repurchases of common stock | (139,358 | ) | (30,454 | ) | ||||
| Other financing activities, net | 5,081 | 16,845 | ||||||
| Effect of exchange rates on cash | 4,068 | (184 | ) | |||||
| Net increase (decrease) in cash and cash equivalents | $ | 34,188 | $ | (29,872 | ) | |||
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| Principal Payments | ||||
| (In thousands) | ||||
| 2009 | $ | 16,500 | ||
| 2010 | 3,015 | |||
| 2011 | 2,000 | |||
| 2012 | 189,813 | |||
| 2013 | — | |||
| 2014 | 425,000 | |||
| Total principal payments | 636,328 | |||
Year | Percentage | |||
| 2011 | 104.19 | % | ||
| 2012 | 102.09 | % | ||
| 2013 | 100.00 | % | ||
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| • | sell assets; | |
| • | pay dividends or make other distributions on capital stock or subordinated indebtedness; | |
| • | make investments; | |
| • | incur additional indebtedness or issue preferred stock; | |
| • | create certain liens; | |
| • | enter into agreements that restrict dividends or other payments from our subsidiaries to us; | |
| • | consolidate, merge or transfer all or substantially all of our assets; | |
| • | engage in transactions with affiliates; and | |
| • | create unrestricted subsidiaries. |
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2005 Senior Secured Credit Facility
On July 29, 2005, we entered into a $547.3 million credit agreement (the "2005 Senior Secured Credit Facility"), among Key Energy Services, Inc., as Borrower, the several lenders from time to time party thereto, Lehman Brothers Inc., as sole lead arranger and sole book runner, Lehman Commercial Paper Inc., as syndication agent, administrative agent and as collateral agent, and Wells Fargo Foothill, Inc., as revolving administrative agent. The 2005 Senior Secured Credit Facility consisted of (i) a revolving credit facility of up to an aggregate principal amount of $65.0 million, which was to mature on July 29, 2010, (ii) a senior term loan facility in the original aggregate amount of $400.0 million, which was payable in quarterly installments of $1.0 million each commencing March 31, 2006 with the unpaid balance due on June 30, 2012 and (iii) a prefunded letter of credit facility in the aggregate amount of $82.25 million, which was to mature on July 29, 2010. The revolving credit facility included a $25.0 million sub-facility for additional letters of credit. The 2005 Senior Secured Credit Facility was terminated on November 29, 2007 in connection with us entering into the 2007 Senior Secured Credit Facility.
As a result of our failure to timely file annual or quarterly reports with the SEC over the last several years, we do not have an effective shelf registration statement on file. Until we have timely filed all of our SEC reports for at least one year, our access to the public securities markets will be limited. See Item 1A. "Risk Factors" for a discussion of limitations on our ability to use "short-form" registration statements.
Off-Balance Sheet Arrangements
financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
| Payments Due by Period | ||||||||||||||||||||
| Less than 1 Year | 1-3 Years | 4-5 Years | After 5 Years | |||||||||||||||||
| Total | (2009) | (2010-2012) | (2013-2014) | (2015+) | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| 8.375% Senior Notes due 2014 | $ | 425,000 | $ | — | $ | — | $ | 425,000 | $ | — | ||||||||||
| Interest associated with 8.375% Senior Notes due 2014 | 213,668 | 35,595 | 106,883 | 71,190 | — | |||||||||||||||
| Borrowings under Senior Secured Credit Facility | 187,813 | — | 187,813 | — | — | |||||||||||||||
| Interest associated with Senior Secured Credit Facility(1) | 14,238 | 3,507 | 10,731 | — | — | |||||||||||||||
| Commitment and availability fees associated with Senior Secured Credit Facility | 2,480 | 620 | 1,860 | — | — | |||||||||||||||
| Notes payable — related party, excluding discount | 20,500 | 14,500 | 6,000 | — | — | |||||||||||||||
| Interest associated with notes payable — related party(1) | 484 | 304 | 180 | — | — | |||||||||||||||
| Capital lease obligations, excluding interest and executory costs | 23,149 | 9,386 | 13,440 | 323 | — | |||||||||||||||
| Interest and executory costs associated with capital lease obligations(1) | 2,577 | 1,248 | 1,274 | 55 | — | |||||||||||||||
| Other long-term indebtedness | 3,015 | 2,000 | 1,015 | — | — | |||||||||||||||
| Interest associated with other long-term indebtedness | 70 | 60 | 10 | — | — | |||||||||||||||
| Investment in Geostream Services Group(2) | 15,900 | 15,900 | — | — | — | |||||||||||||||
| Non-cancellable operating leases | 28,229 | 6,312 | 14,242 | 5,639 | 2,036 | |||||||||||||||
| FIN 48 liabilities | 5,600 | 3,200 | 1,800 | 600 | — | |||||||||||||||
| Equity based compensation liability awards(3) | 2,556 | 898 | 1,658 | — | — | |||||||||||||||
| Earnout payments(4) | 26,500 | 6,000 | 20,500 | — | — | |||||||||||||||
| Sand purchse contract(5) | 5,176 | 2,545 | 2,631 | — | — | |||||||||||||||
| Total | $ | 976,955 | $ | 102,075 | $ | 370,037 | $ | 502,807 | $ | 2,036 | ||||||||||
| (1) | Interest costs on our floating rate debt were estimated using the rates in effect at December 31, 2008. |
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Critical Accounting Policies
| (2) | Based on the December 31, 2008 exchange rate. | |
| (3) | Based on the Company’s stock price at December 31, 2008. | |
| (4) | These amounts assume certain performance targets will be achieved. | |
| (5) | These amounts assume the minimum required purchase and price for the remaining two years of the contract. |
| • | Consolidated Interest Coverage Ratio — As calculated pursuant to the terms of the Senior Secured Credit Facility, we are required to maintain a ratio of trailing four quarters earnings before interest, tax, depreciation and amortization (“EBITDA”) to interest expense of at least 3.0 to 1.0. At December 31, 2008, the calculated consolidated interest coverage ratio was 11.8 to 1.0. Management believes that the Company will remain in compliance with this covenant through at least the end of 2009. | |
| • | Consolidated Leverage Ratio — As calculated pursuant to the terms of the Senior Secured Credit Facility, we are required to maintain a ratio of total debt to trailing four quarters EBITDA of no greater than 3.5 to 1.0. At December 31, 2008, the calculated consolidated leverage ratio was 1.4 to 1.0. With total qualifying debt of $712.9 million at December 31, 2008, this covenant requires that our trailing four quarters EBITDA meet a minimum threshold of $203.7 million. Management believes that the Company will remain in compliance with the covenant through at least the end of 2009. Should the trailing four quarter EBITDA fall below the required threshold in the future, management may also utilize cash on hand to reduce debt outstanding to lower the EBITDA minimum and maintain compliance with this covenant. |
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principal financial officer.
| • | Estimate of reserves for workers’ compensation, vehicular liability and other self-insured reserves; | |
| • | Accounting for contingencies; | |
| • | Accounting for income taxes; | |
| • | Estimate of fixed asset depreciable lives; | |
| • | Valuation of tangible and intangible assets; and | |
| • | Valuation of equity-based compensation. |
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•Estimate of reserves for workers' compensation, vehicular liability and other self-insured retentions;•Accounting for contingencies;•Accounting for income taxes;•Estimate of fixed asset depreciable lives;•Valuation of tangible and intangible assets; and•Valuation of equity-based compensation.
addition to higher premiums, future insurance coverage may be subject to higher deductibles and coverage restrictions.
57
We follow Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes,"("“SFAS 109"109”), which requires that we account for deferred income taxes using the asset and liability method and provide income taxes for all significant temporary differences. Management determines our current tax liability as well as taxes incurred as a result of current operations, yet deferred until future periods. Current taxes payable represent our liability related to our income tax
return for the current year, while net deferred tax expense or benefit represents the change in the balance of deferred tax assets and liabilities reported on our consolidated balance sheets. Management estimates the changes in both deferred tax assets and liabilities using the basis of assets and liabilities for financial reporting purposes and for enacted rates that management estimates will be in effect when the differences reverse. Further, management makes certain assumptions about the timing of temporary tax differences for the differing treatment of certain items for tax and accounting purposes or whether such differences are permanent. The final determination of our tax liability involves the interpretation of local tax laws, tax treaties, and related authorities in each jurisdiction as well as the significant use of estimates and assumptions regarding the scope of future operations and results achieved and the timing and nature of income earned and expenditures incurred.
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On
59
long-lived assets, such as well-service rigs, drilling rigs, pressure pumping equipment, heavy duty trucks, investments, goodwill and identified intangible assets to evaluate whether our long-lived assets or goodwill may have been impaired.
Impairment tests may be required annually, as with goodwill, or as management identifies certain trigger events such as negative industry or economic trends, changes in our business strategy, and underperformance relative to historical or projected operating results.(“SFAS 144”), is performed based on an undiscounted cash flow analysis. To perform an impairment test, we make judgments, estimates and assumptions regarding long-term forecasts of revenues and expenses relating to assets subject to review or, in the case of goodwill, to our reporting units.review. Market conditions, energy prices, estimated depreciable lives of the assets, discount rate assumptions and legal factors impact our operations and have a significant effect on the estimates of management.
If the analysis determines that the assets of a reporting unit or asset grouping are impaired, then an impairment charge is recorded.
| Year Ended December 31, | |||||||||||||||||||
| | Year Ended December 31, | 2008 | 2007 | 2006 | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2007 | 2006 | 2005 | ||||||||||||||||
| Risk-free interest rate | 4.41 | % | 4.70 | % | 3.80 | % | 2.86 | % | 4.41 | % | 4.70 | % | |||||||
| Expected life of options, years | 6 | 6 | 6 | 6 | 6 | 6 | |||||||||||||
| Expected volatility of the Company's stock price | 39.49 | % | 48.80 | % | 53.85 | % | |||||||||||||
| Expected volatility of the Company’s stock price | 36.86 | % | 39.49 | % | 48.80 | % | |||||||||||||
| Expected dividends | none | none | none | none | none | none | |||||||||||||
with our previous stock option grants. The expected life is less than the term of the option as option holders, in our experience, exercise or forfeit the options during the term of the option.
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exercise of the Warrants. Due to our past failure to file our SEC reports in a timely manner, we dodid not have an effective registration statement covering the Warrants, and have beenwere required to make liquidated damages payments, and will continue to be required to make those payments until such time as we have an effective registration statement on file for exercise of the Warrants or the warrant shares issuable thereunder are eligible for resale without registration pursuant to SEC Rule 144 or otherwise.payments. The requirement to make liquidated damages payments constitutesconstituted an RPA under the provisions of FSPEITF 00-19-2, and as prescribed by the transition provisions of that standard, on January 1, 2007 the Company recorded a pre-tax current liability of approximately $1.0 million, which is equivalent to the payments for the Warrant RPA for one year, with an offsetting adjustment to the opening balance of retained earnings.
Accounting Standards Not Yet Adopted in this Report
In February 2008, the FASB issued FASB Staff Position FIN 157-2 ("FSP FIN 157-2"), which delayed the effective date by which companies must adopt the provisions of SFAS 157. FSP FIN 157-2 defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The adoption of this standard isdid not anticipated to have a material impact on our consolidated financial position, results of operations, or cash flows.
statements.
61
In October 2008, the FASB issued FSPSFAS No. 157-3,Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active(“FSP 157-3”). FSPSFAS 157-3 clarified the application of SFAS 157. FSPSFAS 157-3 demonstrated how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSPSFAS 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued. The implementation of this standard did not have a material impact on our consolidated financial statements.
•Acquisition costs will generally be expensed as incurred;•Noncontrolling interests will be valued at fair value at the acquisition date;•Acquired contingent liabilities will be recorded at fair value aton the acquisition date and,subsequently remeasured at either the higher of such amount or the amount determined under existing guidancefornon-acquired contingencies;•In-process research and developmentcertain arrangements, changes in fair value will berecorded at fair value as an indefinite-lived intangible asset at the acquisition date;•Restructuringrecognized in earnings until settlement; and acquisition-related transaction and restructuring costsassociated with a business combinationwillgenerallybe expensedsubsequent torather than treated as part of theacquisition date; and
•Changes in deferred tax asset valuation allowances and income tax uncertainties aftercost of theacquisition date generally will affect income tax expense.
acquisition. SFAS 141(R) also includes newestablishes disclosure requirements related to enable users to evaluate the nature and financial effects of the business combinations. This statementcombination. SFAS 141(R) applies prospectively to all business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008,2008. SFAS 141(R) may have an impact on our consolidated financial statements. The nature and earlier adoption is prohibited. The Company is still in the process of determining the impactmagnitude of the adoptionspecific impact will depend upon the nature, terms, and size of this standard on the Company's financial position, results of operations, and cash flows.acquisitions consummated after the effective date.
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See Item 8. "Consolidated Financial Statements and Supplementary Data," Note 1—"Organization and Summary of Significant Accounting Policies," for a discussion of accounting pronouncements issued, but not yet adopted and reflected in this report.
Impact of Inflation on Operations
We are of the opinion that inflation has not had a significant impact on Key's business.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
statement.
| ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
As of December 31, 2007,2008, the weighted average interest rate on our outstanding variable-rate debt obligations was 5.9787%4.17%. A hypothetical 10% increase in that rate would increase the annual interest expense on those instruments by approximately $0.6$0.5 million.
For balances denominated in our foreign subsidiaries’ local currency, changes in the value of the subsidiaries’ assets and liabilities due to changes in exchange rates are deferred and accumulated in other comprehensive income until we liquidate our investment. For balances denominated in currencies other than the local currency, our foreign subsidiaries must remeasure the balance at the end of each period to an equivalent amount of local currency, with changes reflected in earnings during the period. A hypothetical 10% decrease in the average value of the U.S. Dollar relative to the value of all of the local currencies for our Argentinean, Mexican and Canadian subsidiaries and our Canadian and Russian investments would increasedecrease our net income by approximately $0.3$1.3 million. Our net assets would be unaffected by such an decrease because the changes in the value of our foreign subsidiaries' assets and liabilities would be offset by changes in accumulated other comprehensive income.
Equity-Based Compensation.
63
Equity-Method Investment in IROC. We currently possess a 19.7% ownership interest in IROC, a publicly-traded Canadian company. We exert significant influence over the operations of IROC, but we do not control it. As such, we account for our investment as an equity-method investment under the guidance provided by Accounting Principles Board Opinion ("APB") No. 18, "The Equity Method of Accounting for Investments in Common Stock" ("APB 18").
An impairment review of our equity method investment in IROC is performed on a quarterly basis to determine if there has been a decline in fair value that is other than temporary. The fair value of the asset is measured using quoted market prices or, in the absence of quoted market prices, fair value is based on an estimate of discounted cash flows. In determining whether the decline is other than temporary, we consider the cyclicality of the industry in which the investment operates, its historical performance, its performance in relation to its peers and the current economic environment. Future conditions in the industry, operating performance and performance in relation to peers and the future economic environment may vary from our current assessment of recoverability. Such future conditions could therefore result in a determination a decline in fair value is other than temporary. IROC's stock price is currently depressed. If we later determine the decline is other than temporary, we would record a write-down in the carrying value of our asset to the then current fair market value.
| ITEM 8. | CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
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As discussed in Note 1 to the consolidated financial statements, effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), "Share Based Payments."
Taxes.
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A.Financial Close and Reporting:The Company determined that a material weakness existed with regard to their financial reporting and close process because the controls that were put in place to ensure completeness, accuracy, timeliness, appropriate valuation and proper presentation and disclosure of financial transactions were not in place until the fourth quarter of 2007. Due to the timing of the Company's controls being put in place, sufficient instances of the operating effectiveness of these controls had not occurred as of December 31, 2007.B.Authorizations of Expenditures:The Company determined that a material weakness existed due to its inability to ensure and evidence that expenditures, covering substantially all aspects
C.Recording of Revenues:The Company determined that a material weakness existed regarding the recording of revenues as their revenue process is heavily dependent on manual reviews and approvals of credit terms, amounts to be billed and recorded and adjustments for bad debts. These manual reviews and approvals could not be adequately substantiated and were not operating effectively as of December 31, 2007.D.Property, Plant & Equipment:The Company determined that a material weakness existed related to the timing of assets placed in service, timing of the recognition of gains and losses for asset dispositions, and the timing of and lack of appropriate approvals for asset dispositions. Due to the design and utilization of the Company's procurement system and practices, certain final costs for an asset may not be captured in a timely manner. As a result of this, the asset may be physically placed in service prior to all cost information being received. This delay in accumulating necessary cost information may delay the timing of when an asset begins being depreciated. Additionally, evidence of appropriate approval for the disposition as well as the timing of the receipt of that information may result in delays in the recording of the disposition to the appropriate reporting periods.E.User Developed Applications:The Company determined that a material weakness existed in the use of certain spreadsheets and database programs. In the course of preparing its consolidated financial statements, the Company employed numerous spreadsheets and database programs ("User Developed Applications"). The User Developed Applications are utilized in calculating estimates, reconciling payroll hours, tracking inventory costs and making cost allocations, among other things. The material weakness is a result of these User Developed Applications not being secured as to access, logical security, changes or data integrity.F.Application Access and Segregation of Duties:The Company determined that material weaknesses existed in four aspects of information technology general controls over security and segregation of duties of their primary financial systems. These include security administration procedures, administrator access privileges, database and file access and password controls. The weaknesses in these information technology general control areas were further evidenced by or related to deficiencies in various access controls at the financial reporting system level, resulting in inappropriate access and segregation of duties issues for significant processes.G.- Payroll: The Company determined that deficiencies surrounding
theirits payroll process, in particular,adequacy of personnel involved in the process,lack of proper documentation concerning hours worked,oremployee master file data and rate changes coupled with deficiencies with reconciliations where payroll or payroll related data was a major component, constituted a material weakness intheirits system of internal controls.In our opinion, because of the effect of the materialweaknessesweakness described above on the achievement of the objectives of the control criteria, Key Energy Services, Inc. and subsidiaries have not maintained effective internal control over financial reporting as of December 31,2007,2008, based on criteria established inInternalControl—Control — Integrated Frameworkissued by COSO.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets, statements of operations, comprehensive income,stockholders'stockholders’ equity, and cash flows of Key Energy Services, Inc. and subsidiaries. The materialweaknessesweakness identified abovewerewas considered in determining the nature, timing, and extent of audit tests applied in our audit of the20072008 consolidated financial statements, and this report does not affect our report dated February26, 2008,24, 2009, which expressed an unqualified opinion on those consolidated financial statements./s/ GRANT THORNTON LLPHouston, TexasDecember 31, 2008 2007 (In thousands, except share amounts) ASSETSCurrent assets:Cash and cash equivalents $ 92,691 $ 58,503 Accounts receivable, net of allowance for doubtful accounts of $11,468 and $13,501, respectively 377,353 343,408 Inventories 34,756 22,849 Prepaid expenses 15,513 12,997 Deferred tax assets 26,623 27,676 Income taxes receivable 4,848 15,796 Other current assets 7,338 6,636 Total current assets559,122 487,865 Property and equipment, gross 1,858,307 1,595,225 Accumulated depreciation (806,624 ) (684,017 ) Property and equipment, net 1,051,683 911,208 Goodwill 320,992 378,550 Other intangible assets, net 42,345 45,894 Deferred financing costs, net 10,489 12,117 Notes and accounts receivable — related parties 336 173 Equity method investments 24,220 11,217 Other assets 7,736 12,053 TOTAL ASSETS$ 2,016,923 $ 1,859,077 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities:Accounts payable $ 46,185 $ 35,159 Accrued liabilities 197,116 183,364 Accrued interest 4,368 3,895 Current portion of capital lease obligations 9,386 10,701 Current notes payable — related parties, net of discount 14,318 1,678 Current portion of long-term debt 2,000 — Total current liabilities273,373 234,797 Capital lease obligations, less current portion 13,763 16,114 Notes payable — related parties, less current portion 6,000 20,500 Long-term debt, less current portion 613,828 475,000 Workers’ compensation, vehicular, health and other insurance claims 43,151 43,818 Deferred tax liabilities 188,581 160,068 Other non-current accrued liabilities 17,495 19,531 Minority interest — 251 Commitments and contingenciesStockholders’ equity:Common stock, $0.10 par value; 200,000,000 shares authorized, 121,305,289 and 131,142,905 shares issued and outstanding, respectively 12,131 13,114 Additional paid-in capital 601,872 704,644 Accumulated other comprehensive loss (46,550 ) (37,981 ) Retained earnings 293,279 209,221 Total stockholders’ equity860,732 888,998 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY$ 2,016,923 $ 1,859,077 Year Ended December 31, 2008 2007 2006 (In thousands, except per share amounts) REVENUES$ 1,972,088 $ 1,662,012 $ 1,546,177 COSTS AND EXPENSES:Direct operating expenses 1,250,327 985,614 920,602 Depreciation and amortization expense 170,774 129,623 126,011 Impairment of goodwill and equity method investment 75,137 — — General and administrative expenses 257,707 230,396 195,527 Interest expense, net of amounts capitalized 41,247 36,207 38,927 Loss on early extinguishment of debt — 9,557 — (Gain) loss on sale of assets, net (641 ) 1,752 (4,323 ) Interest income (1,236 ) (6,630 ) (5,574 ) Other expense (income), net 4,717 (447 ) 527 Total costs and expenses, net 1,798,032 1,386,072 1,271,697 Income before income taxes and minority interest 174,056 275,940 274,480 Income tax expense (90,243 ) (106,768 ) (103,447 ) Minority interest 245 117 — NET INCOME$ 84,058 $ 169,289 $ 171,033 EARNINGS PER SHARE:Basic $ 0.68 $ 1.29 $ 1.30 Diluted $ 0.67 $ 1.27 $ 1.28 WEIGHTED AVERAGE SHARES OUTSTANDING:Basic 124,246 131,194 131,332 Diluted 125,565 133,551 134,064 Year Ended December 31, 2008 2007 2006 (In thousands) NET INCOME$ 84,058 $ 169,289 $ 171,033 OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAX:Foreign currency translation loss, net of tax of $(952), $0, and $0, respectively (8,561 ) (1,281 ) (51 ) Net deferred (loss) gain from cash flow hedges, net of tax of $0, $(115), and $115, respectively — (213 ) 213 Deferred (loss) gain from available for sale investments, net of tax of $0, $(97), and $97, respectively (8 ) (203 ) 181 COMPREHENSIVE INCOME, NET OF TAX$ 75,489 $ 167,592 $ 171,376 Year Ended December 31, 2008 2007 2006 (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES:Net income $ 84,058 $ 169,289 $ 171,033 Adjustments to reconcile net income to net cash provided by operating activities:Minority interest (245 ) (117 ) — Depreciation and amortization expense 170,774 129,623 126,011 Accretion on asset retirement obligations 594 585 508 Income from equity method investments (160 ) (387 ) (416 ) Impairment of goodwill and equity method investment 75,137 — — Amortization of deferred financing costs and discount 2,115 1,680 1,620 Deferred income tax expense 29,747 24,613 6,757 Capitalized interest (6,514 ) (5,296 ) (3,358 ) (Gain) loss on sale of assets (641 ) 1,752 (4,323 ) Loss on early extinguishment of debt — 9,557 — Share-based compensation 24,233 9,355 6,345 Excess tax benefits from share-based compensation (1,733 ) (3,401 ) — Changes in working capital:Accounts receivable (34,906 ) (44,712 ) (60,801 ) Share-based compensation liability awards (516 ) 3,701 — Other current assets (15,622 ) (424 ) 976 Accounts payable, accrued interest and accrued expenses 46,375 (1,360 ) 35,138 Income tax refund receivable — (15,154 ) (642 ) Cash paid for legal settlement with former chief executive officer — (21,200 ) — Other assets and liabilities (5,532 ) (8,185 ) (20,124 ) Net cash provided by operating activities367,164 249,919 258,724 CASH FLOWS FROM INVESTING ACTIVITIES:Capital expenditures (218,994 ) (212,560 ) (195,830 ) Proceeds from sale of fixed assets 7,961 8,427 11,658 Investment in Geostream Services Group (19,306 ) — — Acquisitions, net of cash acquired of $2,017, $2,154, and $0, respectively (63,457 ) (157,955 ) — Acquisition of fixed assets from asset purchases (34,468 ) — — Cash paid for short-term investments — (121,613 ) (83,769 ) Proceeds from the sale of short-term investments 276 183,177 22,294 Acquisition of intangible assets (1,086 ) (2,323 ) — Net cash used in investing activities(329,074 ) (302,847 ) (245,647 ) CASH FLOWS FROM FINANCING ACTIVITIES:Repayments of long-term debt — (396,000 ) (4,000 ) Proceeds from long-term debt — 425,000 — Payments on revolving credit facility (35,000 ) — — Borrowings under revolving credit facility 172,813 50,000 — Repayments of capital lease obligations (11,506 ) (11,316 ) (12,975 ) Repayments of other long-term indebtedness (3,026 ) — — Repayments of debt assumed in acquisition — (17,435 ) — Proceeds paid for deferred financing costs (314 ) (13,400 ) (479 ) Repurchases of common stock (139,358 ) (30,454 ) (1,180 ) Proceeds from exercise of stock options 6,688 13,444 — Excess tax benefits from share-based compensation 1,733 3,401 — Net cash (used in) provided by financing activities(7,970 ) 23,240 (18,634 ) Effect of exchange rates on cash 4,068 (184 ) (238 ) Net increase (decrease) in cash and cash equivalents 34,188 (29,872 ) (5,795 ) Cash and cash equivalents, beginning of period 58,503 88,375 94,170 Cash and cash equivalents, end of period $ 92,691 $ 58,503 $ 88,375 Accumulated Common Stock Additional Other Retained Number of Amount Paid-in Comprehensive (Deficit) Shares at par Capital (Loss) Income Earnings Total (In thousands) BALANCE AT DECEMBER 31, 2005131,334 $ 13,133 $ 706,749 $ (36,627 ) $ (129,198 ) $ 554,057 Comprehensive income, net of tax — — — 343 — 343 Common stock purchases (81 ) (8 ) (1,172 ) — — (1,180 ) Share-based compensation 371 37 6,181 — — 6,218 Tax benefits from share-based compensation — — 40 — — 40 Net income — — — — 171,033 171,033 BALANCE AT DECEMBER 31, 2006131,624 13,162 711,798 (36,284 ) 41,835 730,511 Effect of adoption of FIN 48 — — — — (1,272 ) (1,272 ) Effect of adoption of EITF00-19-2, net of tax— — — — (631 ) (631 ) Adjusted balance, beginning of year131,624 13,162 711,798 (36,284 ) 39,932 728,608 Comprehensive loss, net of tax — — — (1,697 ) — (1,697 ) Common stock purchases (2,414 ) (241 ) (33,161 ) — — (33,402 ) Exercise of stock options 1,592 159 13,285 — — 13,444 Exercise of warrants 23 2 (2 ) — — — Share-based compensation 318 32 9,323 — — 9,355 Tax benefits from share-based compensation — — 3,401 — — 3,401 Net income — — — — 169,289 169,289 BALANCE AT DECEMBER 31, 2007131,143 13,114 704,644 (37,981 ) 209,221 888,998 Comprehensive loss, net of tax — — — (8,569 ) — (8,569 ) Common stock purchases (11,183 ) (1,118 ) (135,291 ) — — (136,409 ) Exercise of stock options 757 76 6,612 — — 6,688 Exercise of warrants 160 16 (16 ) — — — Share-based compensation 428 43 24,190 — — 24,233 Tax benefits from share-based compensation — — 1,733 — — 1,733 Net income — — — — 84,058 84,058 BALANCE AT DECEMBER 31, 2008121,305 $ 12,131 $ 601,872 $ (46,550 ) $ 293,279 $ 860,732 Key Energy Services, Inc. and SubsidiariesNOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Key Energy Services, Inc.is a Maryland corporation. References to "Key,", its wholly-owned subsidiaries and its controlled subsidiaries (collectively, “Key,” the"Company," "we," "our," or "us" are intended to refer to Key Energy Services, Inc.“Company,” “we,” “us,” “its,” andsubsidiaries. We“our”) provide abroad arraycomplete range of well servicesincluding:to major oil companies, foreign national oil companies and independent oil and natural gas production companies, including rig-based wellservicing, oilfield transportationmaintenance, workover, well completion and recompletion services,cased-hole electric wireline services, contract drillingfluid management services, pressure pumpingand well stimulationservices,andfishing and rental services and ancillary oilfield services.Key conducts onshore well servicing operationsWe operate ineverymost major oil and natural gas producingregion in the continental United States. We also provide limited drilling services in the Appalachian Basin with our well servicing equipment. We conduct pressure pumping and cementing operations in a number of major domestic producing regions including California, the Permian Basin, the San Juan Basin, the Mid-Continent region and in the Barnett Shale of North Texas. Our fishing and rental services are located primarily in the Gulf Coast and Permian Basinregions ofTexas,the United States as well asin California and the Mid-Continent region. We also have limited operations offshore.Internationally, we conduct onshore well servicing and contract drilling operationsinternationally in Argentina andduringMexico. We also own a technology development company based in Canada and have equity interests in oilfield service companies in Canada and thesecond quarter of 2007, we began conducting well servicing operations in the Northern region of Mexico. In September 2007, we acquired Advanced Measurements, Inc. ("AMI"), a privately-held Canadian technology company.On October 25, 2007, Key Energy Services, LLC, a Delaware limited liability company and wholly-owned subsidiary of the Company, purchased all of the outstanding shares and membership interests of Moncla Well Service, Inc. and related entities ("Moncla"). In December 2007 we acquired the well servicing assets and related equipment of Kings Oil Tools, a privately-held well servicing company operating in California ("Kings"). See Note 2—"Acquisitions."Russian Federation.
Basis of PresentationThe consolidated financial statements and associated schedules included in this Annual Report onForm 10-K present our financial position, results of operations and cash flows for the periods presented in accordance with generally accepted accounting principles in the United States("GAAP"(“GAAP”).The preparation of these consolidated financial statements requires us to develop estimates and to make assumptions that affect our financial position, results of operations and cash flows. These estimates also impact the nature and extent of our disclosure, if any, of our contingent liabilities. Among other things, we use estimates to (i) analyze assets for possible impairment, (ii) determine depreciable lives for our assets, (iii) assess future tax exposure and realization of deferred tax assets, (iv) determine amounts to accrue for contingencies, (v) value tangible and intangible assets, (vi) assessworkers'workers’ compensation, vehicular liability, self-insured risk accruals and other insurance reserves,and(vii) provide allowances for our uncollectible accountsreceivable.receivable, and (viii) value our equity-based compensation. We review all significant estimates on a recurring basis and record the effect of any necessary adjustments prior to publication of our financial statements. Adjustments made with respect to the use of estimates relate to improved information not previously available. Because of the limitations inherent in this process, our actual results may differ materially from these estimates. We believe that our estimates are reasonable.Certain reclassifications have been made to prior period amounts to conform to current period financial statement classifications.These reclassifications relate to the recasting of prior periods to conform toWe now present our short-term investments in marketable securities as arealignment of certain employment positions that were previously reported as aKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)component of
current assets.direct expenses and that are now reportedother current assets in the accompanying consolidated balance sheets. In prior years, we presented these amounts asgeneral and administrative. These reclassifications had no effect on previously reported income from continuing operations or net income. The following tables summarize the effectsa separate component ofthese reclassifications on previously reported amounts (in thousands):Year Ended December 31, 2006 Amounts as
Previously
ReportedEffect of
ReclassificationsAmounts as
Currently
ReportedWell servicing costs $ 736,014 $ (11,006 ) $ 725,008 Pressure pumping costs 141,743 (3,366 ) 138,377 Fishing and rental costs 60,073 (2,856 ) 57,217 General and administrative costs 178,299 17,228 195,527 Total $ 1,116,129 $ — $ 1,116,129 Year Ended December 31, 2005 Amounts as
Previously
ReportedEffect of
ReclassificationsAmounts as
Currently
ReportedWell servicing costs $ 635,442 $ (1,399 ) $ 634,043 Pressure pumping costs 92,323 (22 ) 92,301 Fishing and rental costs 54,361 (462 ) 53,899 General and administrative costs 149,420 1,883 151,303 Total $ 931,546 $ — $ 931,546 In January 2005 we sold the majority of our contract drilling assets to Patterson-UTI Energy. We present the results of operations and cash flows related to these activities as discontinued operations in our consolidated statements of operations and consolidated statements of cash flows for 2005.We apply the provisions of
EITFEmerging Issues Task Force (“EITF”) Issue04-10,"DeterminingDetermining Whether to Aggregate Operating Segments That Do Not Meet QuantitativeThresholds" ("Thresholds(“EITF04-10"04-10”) for our segment reporting in “Note18—"19. SegmentInformation."Information.” Under the provisions ofEITF 04-10, operating segments that do not individually meet the aggregation criteria described in Statement of Financial Accounting Standards("SFAS"(“SFAS”) No. 131,"DisclosuresDisclosures About Segments of an Enterprise and RelatedInformation" ("Information(“SFAS131"131”), may be combined with other operating segments that do not individually meet the aggregation criteria to form a separate reportable segment. We have combined all of our operating segments that do not individually meet the aggregation criteria established in SFAS 131 to form the"Corporate“Corporate andOther"Other” segment in our segment reporting.Principles of ConsolidationWithin our consolidated financial statements, we include our accounts and the accounts of our majority-owned or controlled subsidiaries. We eliminate intercompany accounts and transactions.We account for ourWhen we have an interest inentitiesan entity for which we do not have significant control or influence,underwe account for that interest using the cost method. When we have an interest in an entity and can exert significant influence but not control, we account for that interest using the equity method.
72Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)As further discussed in“Note2—"2. Acquisitions,"”in September 2007 we completed the acquisition ofAMI,Advanced Measurements, Inc. (“AMI”), a privately-held Canadian company focused on oilfield technology. Prior to the acquisition, AMI owned a portion of another Canadian company, Advanced Flow Technologies, Inc.("AFTI"(“AFTI”). As part of the acquisition, AMI increased its ownership percentage of AFTI to 51.46%.We now consolidateAt December 31, 2007, we consolidated the assets, liabilities, results of operations and cash flows of AFTI into our consolidated financial statements, with the portion of AFTI remaining outside of our control forming a minority interest in our consolidated financial statements.Our ownership of AFTI declined to 48.73% during the fourth quarter of 2008 due to the issuance of additional shares by AFTI. As a result, we deconsolidated AFTI from our consolidated financial statements at December 31, 2008 and accounted for that interest under the equity method.
We apply Financial Accounting Standards Board("FASB"(“FASB”) Interpretation("FIN"(“FIN”) No. 46,"ConsolidationConsolidation of Variable InterestEntities—Entities — an Interpretation of ARB No. 51 (Revised 2003)" ("(“FIN 46(R)"”) when determining whether or not to consolidate a Variable Interest Entity("VIE"(“VIE”). FIN 46(R) requires that an equity investor in a VIE have significant equity at risk (generally a minimum of 10%) and hold a controlling interest, evidenced by voting rights, and absorb a majority of theentity'sentity’s expected losses, receive a majority of theentity'sentity’s expected returns, or both. If the equity investor is unable to evidence these characteristics, the entity that retains these ownership characteristics will be required to consolidate the VIE.We have determined that we do not have an interest in a VIE, and as such we are not the primary beneficiary of a variable interest in a VIE and are not the holder of a significant variable interest in a VIE.
Revenue RecognitionRevenue is recognizedWe recognize revenue when all of the following criteria established in the Securities and Exchange Commission (the “SEC”) Staff Accounting Bulletin (“SAB”) No. 101,Revenue Recognition in Financial Statements(“SAB 101”), as amended by SAB No. 104,Revenue Recognition(“SAB 104”), have been met: (i) evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the price to the customer is fixed and determinable and (iv) collectibility is reasonably assured.•Evidence of an arrangement exists when a final understanding between the Company and its customer has occurred, and is generally evidenced by a signed customer purchase order, field ticket, supplier contract, or master service agreement.•Delivery has occurred or services have been rendered when the Company has completed what is required pursuant to the terms of the arrangement and is generally evidenced by a customer signed field ticket or service log.•The price to the customer is fixed and determinable when the amount that is required to be paid is agreed upon. Evidence of the price being fixed and determinable is generally evidenced by contractual terms, a Company price book, a signed customer purchase order, or a signed customer field ticket.•Collectibility is reasonably assured as a result of the Company screening its customers and providing goods and services to customers that have been granted credit terms in accordance with the Company's credit policy.
• Evidence of an arrangement exists when a final understanding between the Company and its customer has occurred, and can be evidenced by a completed customer purchase order, field ticket, supplier contract, or master service agreement. • Delivery has occurred or services have been rendered when the Company has completed what is required pursuant to the terms of the arrangement and can be evidenced by a completed field ticket or service log. • The price to the customer is fixed and determinable when the amount that is required to be paid is agreed upon. Evidence of the price being fixed and determinable is evidenced by contractual terms, a Company price book, a completed customer purchase order, or a completed customer field ticket. • Collectibility is reasonably assured as a result of the Company screening its customers and providing goods and services to customers that have been granted credit terms in accordance with the Company’s credit policy. In accordance with EITF IssueNo. 06-03,"HowHow Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (That is, Gross versus Net Presentation)" ("(“EITF06-03"06-03”), we present our revenues net of any sales taxes collected by us from our customers that are required to be remitted to local or state governmental taxing authorities.
73Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Cash and Cash EquivalentsWe consider short-term investments with an original maturity of less than three months to be cash equivalents. None of our cash is restricted, and we have not entered into any compensating balanceKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)arrangements. However, at December 31,
2007,2008, all of our obligations underthe 2007our Senior Secured Credit Facility(hereinafter defined)were secured by most of our assets, including assets held by our subsidiaries, which includes our cash and cash equivalents. We restrict investment of cash to financial institutions with high credit standing and limit the amount of credit exposure to any one financial institution.We maintain our cash in bank deposit and brokerage accounts which exceed federally insured limits. As of December 31,2007, approximately $9.3 million2008, accounts were guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000 and substantially all of the Company’s accounts held deposits in excess of the FDIC limits.Certain of our cash accounts are zero-balance controlled disbursement accounts that do not have right of offset against our other cash balances. In accordance with FIN No. 39,Offsetting of Amounts Related to Certain Contracts, an Interpretation of APB No. 10 andcash equivalents was held in bank accounts located in foreign countries, representing approximately 15.9% of total cash and cash equivalents. OfFASB Statement No. 105(“FIN 39”), we present thetotal amount held in foreign bankoutstanding checks written against these zero-balance accounts as a component ofDecember 31, 2007, approximately $4.4 million was locatedaccounts payable inArgentina, $0.3 million was located in Canada, and approximately $4.5 million was held in Mexico, withtheremaining $0.1 million located in other countries.accompanying consolidated balance sheets.
Investment in Debt and Equity SecuritiesWe account for investments in debt and equity securities under the provisions of SFAS No. 115,"AccountingAccounting for Certain Investments in Debt and EquitySecurities" ("Securities(“SFAS115"115”). Under SFAS 115, investments are classified as either"trading," "available“trading,” “available for sale,"” or"held“held to maturity,"” depending onmanagement'smanagement’s intent regarding the investment.Securities classified as"trading"“trading” are carried at fair value, with any unrealized holding gains or losses reported currently in earnings. Securities classified as"available“available forsale"sale” or"held“held tomaturity"maturity” are carried at fair value, with any unrealized holding gains or losses, net of tax, reported as a separate component ofshareholders'shareholders’ equity in other comprehensive income.As of December 31, 2007 and 2006, the Company had no investments in debt or equity securities that were classified as "trading" or "held to maturity." In the third quarter of 2006, the Company began investing in Auction-Rate Securities ("ARS") and Variable-Rate Demand Notes ("VRDN"). These are investments in long-term bonds whose returns are tied to short-term interest rates that are periodically reset, with periods ranging from 7 days to 6 months. As a result of the long-term nature of the underlying security (bonds with contractual lives ranging from 20 to 30 years), the Company accounts for ARS and VRDN investments as "available for sale" securities. As of December 31, 2007 and 2006, the aggregate value of our investments in ARS and VRDN was zero and $44.4 million, respectively. We sold all of our ARS and VRDN investments during the third quarter of 2007 and used the proceeds to fund part of our acquisition of Moncla (see Note 2—"Acquisitions").In addition to the ARS and VRDN investments, the Company also began investing in 270-day commercial paper and certain other bond investments. These instruments are treated as "available for sale" securities and are carried at fair value as short-term investments on the Company's consolidated balance sheets, because their maturity dates are within one year of the date of investment. Any unrealized holding gains or losses on these securities are recorded net of tax as a separate component of stockholders' equity in other comprehensive income until the date of maturity, at which point any gains or losses are reclassified into earnings. We use the specific identification method when determining the amount of realized gain or loss upon the date of maturity. The aggregate fair value of our available for sale investments was approximately $0.3 million and $61.8 million as of December 31, 2007 and 2006, respectively.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)Accounts Receivable and Allowance for Doubtful AccountsHistorically, our credit losses have not been material.We establish provisions for losses on accounts receivable if we determine that we will not collect all or part of the outstanding balances. We regularly review collectibility and establish or adjust our allowance as necessary using the specific identification method.From time to time we are entitled to proceeds under our insurance policies, and in accordance with FIN No. 39,"Offsetting of Amounts Related to Certain Contracts, an Interpretation of APB No. 10 and FASB Statement No. 105" ("FIN 39"),we present insurance receivables gross on our balance sheet as a component of accounts receivable, separate from the corresponding liability.Concentration of Credit Risk and Significant CustomersKey'sKey’s customers include major oil and natural gas production companies, independent oil and natural gas production companies, and foreign national oil and natural gas production companies. We perform ongoing credit evaluations of our customers and usually do not require material collateral. We maintain reserves for potential credit losses when necessary. Our results of operations and financial condition should be considered in light of the fluctuations in demand experienced by oilfield service companies as changes in oil and gas producers’ expenditures and budgets occur. These fluctuations can impact our results of operations and financial condition as supply and demand factors directly affect utilization and hours which are the primary determinants of our net cash provided by operating activities.For all periods presented, no single customer accounted for more than ten percent of our consolidatedrevenues.revenue.
74Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)InventoriesInventories, which consist primarily of equipment parts for use in our well servicing operations, sand and chemicals for our pressure pumping operations, and supplies held for consumption, are valued at the lower of average cost or market.Property and EquipmentProperty and equipment are carried at cost less accumulated depreciation. Depreciation is provided for our assets over the estimated depreciable lives of the assets using the straight-line method. We depreciate our operational assets over their depreciable lives to their salvage value, which is a fair value higher than theassets'assets’ value as scrap.Generally, salvageSalvage value approximates 10% of an operationalasset'sasset’s acquisition cost. When an operational asset is stacked or taken out of service, we review its physical condition, depreciable life and ultimate salvage value to determine if the asset is no longer operable and whether the remaining depreciable life and salvage value should be adjusted.The Company leases certain of its operating assets under capital lease obligations whose terms generally run from 55 to 60 months.Change in Estimate of Useful Lives.. In the first quarter of 2007, management reassessed the estimated useful lives assigned to all of theCompany'sCompany’s equipment in light of the higher activity and utilization levels experienceddue to recent market conditions.in 2006 and early 2007. As a result, the maximum estimated useful lives of certain assets were adjusted to reflect higher annual utilization. As a result, the useful life expected for a well service rig was reduced from an average expected life of 17 years to 15 years. With respect to oilfield trucks, trailers and related equipment the expected life was reduced from an average expected life of 15 years to 12 years. Management also determined that the life assigned to a self-remanufactured well service rig should be the same as the15-year life assigned to a newly constructed well service rig acquired from third parties.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)The following table identifies the impact of this change in depreciation and amortization expense for the year ended December 31, 2007 (in thousands):Year Ended
December 31, 2007Depreciation and amortization using prior lives $ 121,960 Impact of change 7,663 Depreciation and amortization, as reported $ 129,623
Diluted earnings per share using prior lives
$
1.33
Impact of change on diluted earnings per share (0.06 ) Diluted earnings per share, as reported $ 1.27 As of December 31,
2007,2008, the estimated useful lives of theCompany'sCompany’s asset classes are as follows:DescriptionYears Well service rigs and components 3–153-15 Oilfield trucks, trailerspressure pumping equipment, and related equipment7–127-12 Motor vehicles 3–53-5 Fishing and rental tools 4–104-10 Disposal wells 15–3015-30 Furniture and equipment 3–73-7 Buildings and improvements 15–3015-30 The Company leases certain of its operating assets under capital lease obligations whose terms run from 55 to 60 months. These assets are depreciated over their estimated useful lives or the term of the capital lease obligation, whichever is shorter.We apply SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets(“SFAS 144”) in reviewing our long-lived assets for possible impairment. This statement requires that long-lived assets held and used by us, including 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. For purposes of testing for impairment, we group our long-lived assets into divisions, which are based on geographical regions or the services provided. We then compare the estimated future cash flows of each division to the division’s net carrying value. The division level represents the lowest level for which identifiable cash flows are available. We would record an impairment charge, reducing the division’s net carrying value to an estimated fair value, if its estimated future cash flows were less than the division’s net carrying value. “Trigger events,” as defined in SFAS 144, that cause us to evaluate our fixed assets for recoverability and possible impairment may include changes in market conditions, such as adverse movements in the prices of oil and natural gas, which could reduce the fair value of certain of our property and equipment. The development of
75Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)future cash flows and the determination of fair value for a division involves significant judgment and estimates. During 2007 and 2006, no trigger events were identified by management. During the fourth quarter of 2008, the impairment of the Company’s goodwill was identified as a trigger event by management. As a result, an undiscounted cash flow analysis was performed for our long-lived assets, and no impairment was indicated.Asset Retirement ObligationsIn connection with our well servicing activities, we operate a number of salt water disposal ("SWD") facilities. Our operations involve the transportation, handling and disposal of fluids in our SWD facilities that are by-products of the drilling process, some of which have been determined to be harmful to the environment. SWD facilities used in connection with our fluid hauling operations are subject to future costs associated with the abandonment of these properties. As a result, we have incurred costs associated with the proper storage and disposal of these materials.In accordance with SFAS No. 143,"AccountingAccounting for Asset RetirementObligations" ("Obligations(“SFAS143"143”), we recognize a liability for the fair value of all legal obligations associated with the retirement of tangible long-lived assets and capitalize an equal amount as a cost of the asset. We depreciate the additional cost over the estimated useful life of the assets. Our obligations to perform our asset retirement activities are unconditional, despite the uncertainties that may exist surrounding an individual retirement activity. Accordingly, we recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. Significant judgment is involved in estimating future cash flows associated with such obligations, as well as the ultimate timing of those cash flows. If our estimates of the amount or timing of the cash flows change, such changes may have a material impact on our results of operations.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)Annual amortization of the assets associated with the asset retirement obligations was $0.6 million, $0.5 million and $0.5 million for the years ended December 31, 2007, 2006 and 2005, respectively. A summary of changes in our asset retirement obligations is as follows (in thousands):Balance at January 1, 2006 $ 9,634
Additions
155
Costs incurred (568 ) Accretion expense 508 Disposals (107 ) Balance at December 31, 2006 $ 9,622
Additions
12
Costs incurred (576 ) Accretion expense 585 Disposals (345 ) Balance at December 31, 2007 $ 9,298 Long-livedSee“Note 7. AssetImpairmentsWe apply SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144") in reviewing our long-lived assets for possible impairment. This statement requires that long-lived assets held and used by us, including 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. For purposes of testing for impairment, we group our long-lived assets into divisions, which are based on geographical regions, and in some cases the services provided. We then compare the estimated future cash flows of each division to the division's net carrying value. The division level represents the lowest level for which identifiable cash flows are available. We would record an impairment charge, reducing the division's net carrying value to an estimated fair value, if its estimated future cash flows were less than the division's net carrying value. "Trigger events," as defined in SFAS 144, that cause us to evaluate our fixed assets for recoverability and possible impairment may include changes in market conditions, such as adverse movements in the prices of oil and natural gas, which could reduce the fair value of certain of our property and equipment. The development of future cash flows and the determination of fair value for a division involves significant judgment and estimates. During 2007, 2006, and 2005, no trigger events were identified by management.Retirement Obligations.”
Capitalized InterestInterest is capitalized on the average amount of accumulated expenditures forequipment that is undergoingmajormodifications and reconstruction prior to being placed into service. Interest is capitalizedcapital projects using an effective interest rate based on related debt until theequipment isunderlying assets are placed into service.Key Energy Services, Inc.The capitalized interest is added to the cost of the assets andSubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)amortized to depreciation and amortization expense over the useful life of the assets. It is included in the depreciation and amortization line in the accompanying consolidated statements of operations.
Long-Term DebtGains and Losses on the Early Extinguishment of Debt.We record gains and losses from the extinguishment of debt as a part of continuing operations. As further discussed in Note 11—"Long-Term Debt," we recognized a loss of approximately $9.6 million during the fourth quarter of 2007Deferred financing costs associated withthe termination of our 2005 Senior Secured Credit Facility (hereinafter defined). During 2005 we recognized losses on the early extinguishment of debt of approximately $20.9 million in connection with the retirement of our 2003 Senior Secured Credit Facility (hereinafter defined), 6.375% Senior Notes due 2013 and 8.375% Senior Notes due 2008.Deferred Financing Costs.In connection with ourlong-term debtwe capitalized costsare carried at cost andexpensesare expensed over the term ofapproximately $13.4 million, $0.5 million and $13.2 million fortheyears ended December 31, 2007, 2006 and 2005, respectively.applicable long-term debt facility or the term of the notes. These costs are amortized to interest expense using the effective interest method over the life of the related debt instrument. When the related debt instrument is retired, any remaining unamortized costs are included in the determination of the gain or loss on the extinguishment of the debt.Amortization of deferred financing costs totaled $1.7 million, $1.6 millionWe record gains and$1.4 million for the years ended December 31, 2007, 2006 and 2005, respectively. Unamortized debt issuance costs written off and included in the determination of the gain or loss onlosses from the extinguishment of debtwere $9.6 million, zero, and $8.0 million for the years ended December 31, 2007, 2006 and 2005, respectively.as a part of continuing operations. See“Note 12. Long-Term Debt.”
Goodwill and Other Intangible AssetsGoodwill results from businessacquisitionscombinations and represents the excess of acquisition costs over the fair value of the net assets acquired. We account for goodwill and other intangible assets under the provisions of SFAS No. 142,"GoodwillAccounting for Goodwill andOtherIntangibleAssets" ("Assets(“SFAS142"142”). Goodwill and other intangible assets not subject to amortization are tested for impairment annuallyon December 31,or more frequently if events or changes in circumstances indicate that the asset might be impaired.SFAS 142 requiresThe test for impairment of indefinite-lived intangibles is atwo-step process for testing impairment. First,two step test. In the first step of the test, a fair value is calculated for each ofeachthe Company’s reportingunitunits, and that fair value is compared toitsthe carrying valueto determine whether an indicationofimpairment exists.the reporting unit, including the reporting unit’s goodwill. Ifimpairment is indicated, thenthe fair value of the reportingunit'sunit exceeds its carrying value, there is no impairment, and the second step of the test is not performed. If the carrying value exceeds the fair value for the reporting unit, then the second step of the test is required.The second step of the test compares the implied fair value of the reporting unit’s goodwill to its carrying value. The implied fair value of the reporting unit’s goodwill is determinedby allocatingin theunit's fair value to its assets and liabilities (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. The amount of impairment for goodwill is measuredsame manner as theexcess of its carrying value over its fair value. We conduct annual impairment assessments, the most recent as of December 31, 2007. The assessments did not result in an indication of goodwill impairment.amount
76Our major classes of intangible assets subject to amortization under SFAS 142 consist of noncompete agreements, patents and trademarks, customer backlog, customer relationships and developed technology. Amortization expense for our noncompete agreements, patents and trademarks, and developed technology is calculated using the straight-line method over the period of the agreement or the estimated economic useful live of the intangible asset. Intangible assets related to customer relationships are amortized utilizing the estimated pattern of the consumption of the economic benefit over their estimated lives.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)of goodwill recognized in a business combination, with the purchase price being equal to the fair value of the reporting unit. If the implied fair value of the reporting unit’s goodwill is in excess of its carrying value, no impairment is recorded. If the carrying value is in excess of the implied fair value, an impairment equal to the excess is recorded.To assist management in the preparation and analysis of the valuation of the Company’s reporting units, management utilized the services of a third-party valuation consultant, who reviewed management’s estimates, assumptions and calculations. The ultimate conclusions of the valuation techniques remain the sole responsibility of the Company’s management. The Company conducts its annual impairment test on December 31 of each year. For the annual test completed as of December 31, 2008, an impairment of the Company’s goodwill was indicated. While this test is required on an annual basis, it also can be required more frequently based on changes in external factors. We do not currently expect that additional tests would result in additional charges, but the determination of the fair value used in the test is heavily impacted by the market prices of our equity and debt securities. See“Note 5. Goodwill and Other Intangible Assets.”1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)Internal-Use SoftwareAs required by Statement of Position (“SOP”)No. 98-1,Accounting for the Costs of Computer Software Developed or Obtained for Internal Use(“SOP 98-1”), we capitalize costs incurred during the application development stage of internal-use software and amortize these costs over its estimated useful life, generally five years. Costs incurred related to selection or maintenance of internal-use software are expensed as incurred. See“Note 4. Property and Equipment.”Derivative Instruments and Hedging ActivitiesThe Company applies SFAS No. 133,"AccountingAccounting for Derivative Instruments and HedgingActivities" ("Activities(“SFAS133"133”), as amended,by SFAS No. 137, SFAS No. 138 and SFAS No. 149 ("SFAS 137," "SFAS 138," and "SFAS 149," respectively)in accounting for derivative instruments. SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. It requires the recognition of all derivative instruments as assets and liabilities on the balance sheet and measurement of those instruments at fair value. The accounting treatment of changes in fair value is dependent upon whether or not a derivative instrument is designated as a hedge, and if so, the type of hedge. To account for a financial instrument as a hedge, the contract must meet the following criteria: the underlying asset or liability must expose a company to risk that is not offset in another asset or liability, the hedging contract must reduce that risk, and the instrument must be properly designated as a hedge at the inception of the contract and throughout the contract period. To be an effective hedge, there must be a high correlation between changes in the fair value of the financial instrument and the fair value of the underlying asset or liability, such that changes in the market value of the financial instrument would be offset by the effect of price changes on the exposed items. For derivatives designated as cash flow hedges, the effective portion of the change in the fair value of the hedging instrument is recognized in other comprehensive income until the hedged item is recognized in earnings. Any ineffective portion of changes in the fair value of the hedging instrument is recognized currently in earnings.For all derivative contracts entered into, the Company analyzes the derivative contracts for embedded instruments and accounts for those instruments based on current guidance.
During the years ended December 31, 2007 and 2006, the Company had interest rate swaps and foreign currency instruments thatqualifyqualified as derivative instruments under SFAS 133. During 2008, the Company had no derivative instruments. See“Note9—"10. Derivative FinancialInstruments"Instruments”for further discussion.
77Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)LitigationWhen estimating our liabilities related to litigation, we take into account all available facts and circumstances in order to determine whether a loss is probable and reasonably estimable in accordance with SFAS No. 5,"AccountingAccounting forContingencies" ("Contingencies(“SFAS5"5”).Various suits and claims arisingfromin the ordinary course of business are pending against us. Due in part to the locations where we conduct business in the continental United States, we are often subject to jury verdicts and arbitration hearings that result in outcomes in favor of the plaintiffs. Wedo not believe thatcontinually assess our contingent liabilities, including potential litigation liabilities, as well as thedispositionadequacy ofanyour accruals and our need for the disclosure of theseitems will result initems. In accordance with SFAS 5 we establish amaterial adverse impact on our consolidated financial position, results of operations or cash flows.provision for a contingent liability when it is probable that a liability has been incurred and the amount is able to be estimated. See“Note12—"13. Commitments andContingencies" for a description of other currently pending litigation.Contingencies.”
EnvironmentalOur operations are subject to various federal, state and local laws and regulations intended to protect the environment. Our operations routinely involve the storage, handling, transport and disposal of bulk waste materials, some of which contain oil, contaminants, and regulated substances. Various environmental laws and regulations require prevention, and where necessary, cleanup of spills and leaks of such materials, and some of our operations must obtain permits limiting the discharge of materials. Failure to comply with such environmental requirements or permits may result in fines and penalties, remediation orders and revocation of permits. Laws and regulations have become more stringent over the years, and in certain circumstances may impose"strict“strict liability,"” rendering us liable forKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)environmental damage without regard to negligence or fault on our part. Cleanup costs, penalties, and other damages arising as a result of environmental laws and costs associated with changes in environmental laws and regulations, could be substantial and could have a material adverse effect on our financial condition, results of operations and cash flows. From time to time, claims have been made and litigation has been brought against us under such laws. 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.
LiabilitiesFor environmental reserve matters, including remediation efforts forexpenditures of a non-capital naturecurrent locations and those relating to previously-disposed properties, we record liabilities when our remediation efforts arerecorded when environmental assessment and/or remediation isprobable and the costs to conduct such remediation efforts can be reasonably estimated. While our litigation reserves reflect the application of our insurance coverage, our environmental reserves do not reflect management’s assessment of the insurance coverage that may apply to the matters at issue. See“Note12—"13. Commitments andContingencies"Contingencies”for further discussion.GuaranteesSelf InsuranceWeaccountare largely self-insured forguarantees under FIN No. 45, "Guarantor's Accountingphysical damage to our equipment, automobiles andDisclosure Requirements for Guarantees, Including Indirect Guaranteesrigs. Our accruals that we maintain on our consolidated balance sheet relate to these deductibles and self-insured retentions, which we estimate through the use ofIndebtednesshistorical claims data and trend analysis. The actual outcome ofOthers" ("FIN 45"). In November 2005,any claim could differ significantly from estimated amounts. We adjust loss estimates in theFASB issued FASB Staff Position No. 45-3, "Applicationcalculation ofFASB Interpretation No. 45 to Minimum Revenue Guarantees Granted to Business or Its Owners" ("FSP FIN 45-3"). It served as an amendment to FIN 45 by adding minimum revenue guarantees to the list of examples of contracts to which FIN 45 applies. Under FSP FIN 45-3, a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. FSP FIN 45-3 is effective for new minimum revenue guarantees issued or modified on or after January 1, 2006. As of December 31, 2007these accruals, based upon actual claim settlements and2006, the Company had no guarantees that were accounted for under the guidance provided by FIN 45 and FSP FIN 45-3.reported claims.
Income TaxesWe accountIn accounting for income taxes,based uponwe follow SFAS No. 109,"AccountingAccounting for IncomeTaxes" ("Taxes(“SFAS109"109”). Under SFAS 109,, which requires that we account for deferred income taxes using the asset and liability method and provide income taxes for all significant temporary differences. Management determines our current tax liability as well as taxes incurred as a result of current operations, but which are deferred until future periods. Current taxes payable represent our liability related to our income tax return for the current year, while net deferred tax
78Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)expense or benefit represents the change in the balance of deferred tax assets and liabilitiesare recognized forreported on our consolidated balance sheets. Management estimates thefuture 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 statutory tax rates expected to apply to taxable incomechanges inthe years in which those temporary differences are expected to be recovered or settled. The effect onboth deferred tax assets and liabilities using the basis ofa change in tax rate is recognized in income in the period that includes the statutory enactment date. A valuation allowance for deferred taxassetsis recognized when it is more likely than not that the benefit of deferred tax assets will not be realized.Weandour eligible subsidiaries file a consolidated U.S. federal income tax return. Certain foreign subsidiaries that are consolidatedliabilities for financial reporting purposes and for enacted rates that management estimates will be in effect when the differences reverse. Further, management makes certain assumptions about the timing of temporary tax differences for the differing treatment of certain items for tax and accounting purposes or whether such differences arenot eligible to be included in the consolidated U.S. federal income tax return and are subject to the jurisdiction of a number of taxing authorities. The income earned in the various jurisdictions is taxed on differing bases.permanent. The final determination of our tax liability involves the interpretation of local tax laws, tax treaties, and related authorities in each jurisdiction as well as the significant use of estimates and assumptions regarding the scope of future operations and results achieved and the timing and nature of income earned and expenditures incurred.Wefile separateestablish valuation allowances to reduce deferred tax assets if we determine that it is more likely than not (e.g., a likelihood of more than 50%) that some portion or all of the deferred tax assets will not be realized in future periods. To assess the likelihood, we use estimates and judgment regarding our future taxable income,tax returns inas well as thecountriesjurisdiction in whichthese foreign subsidiaries operate. We have not madethis taxable income is generated, to determine whether a valuation allowance is required. Such evidence can include our current financial position, our results of operations, both actual and forecasted results, theelectionreversal of deferred tax liabilities, and tax planning strategies asdescribed in Accounting Principles Board ("APB") Opinion No. 23, "Accountingwell as the current and forecasted business economics of our industry. Additionally, we record reserves forIncome Taxes—Special Areas," that earnings from foreign entities will be reinvested indefinitely. Our foreign subsidiaries had negative earnings and profits as ofKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)December 31, 2007 and 2006. Accordingly, no deferred taxes are provided on that subsidiary's current earnings during those years.FIN No. 48 and FSP FIN 48-1.In June 2006, the FASB issued FIN No. 48, "Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109" ("FIN 48"), which provides clarification of SFAS 109 with respect to the recognition of income tax benefits ofuncertain tax positionsin financial statements. FIN 48 requiresthatuncertain tax positions be reviewed and assessed, with recognition and measurementare subject to management judgment related to the resolution of the taxbenefit based on a "more likely than not" standard.In May 2007positions and completion of audits by tax authorities in theFASB issued FASB Staff Position No. FIN 48-1, "Definitiondomestic and international tax jurisdictions in which we operate.The Company is subject to the revised Texas Franchise tax. The revised Texas Franchise tax is an income tax equal to one percent ofa Settlement in FASB Interpretation No. 48" ("FSP FIN 48-1"). FSP FIN 48-1 provides guidance on how an enterprise should determine whether a tax position is effectively settledTexas-sourced revenue reduced by the greater of (a) cost of goods sold (as defined by Texas law), (b) compensation (as defined by Texas law), or (c) thirty percent of the Texas-sourced revenue. We account for thepurpose of recognizing previously unrecognizedrevised Texas Franchise taxbenefits. In determining whetherin accordance with SFAS 109, as the tax is derived from atax position has been effectively settled, entities must evaluate (i) whether taxing authorities have completed their examination procedures; (ii) whether the entity intends to appeal or litigate any aspect of a tax position included in a completed evaluation; and (iii) whether it is remotetaxable base thata taxing authority would examine or re-examine any aspect of a taxing position. FSP FIN 48-1 is to be applied upon the initial adoption of FIN 48. We recognize accrued interest and penalties related to unrecognized tax benefits as a componentconsists of incometax expense.We adopted the provisions of FIN 48 and FSP FIN 48-1 on January 1, 2007 and recorded a $1.3 million decrease to the balance of our retained earnings as of January 1, 2007 to reflect the cumulative effect of adopting these standards.less deductible expenses.See“Note10—"11. IncomeTaxes"Taxes”for further discussion ofthe impactaccounting for our income taxes, changes in our valuation allowance, components ofthe adoptionour tax rate reconciliation and realization ofthese standards.loss carryforwards.
Earnings Per ShareWe present earnings per share information in accordance with the provisions of SFAS No. 128,"EarningsEarnings PerShare" ("Share(“SFAS128"128”). Under SFAS 128, basic earnings per common share is determined by dividing net earnings applicable to common stock by the weighted average number ofshares ofcommonstockshares actually outstanding during theyear.period. Diluted earnings per common share is based on the increased number of shares that would be outstanding assuming conversionor exerciseof dilutive outstanding convertible securitiesor stock optionsusing the"astreasury stock and “as ifconverted" method.converted” methods. See“Note5—"6. Earnings PerShare"Share”for further discussion.Stock-BasedShare-Based CompensationWe account forstock-basedshare-based compensation under the provisions of SFAS No. 123 (revised 2004),"Share-Based Payment" ("Share-Based Payment(“SFAS 123(R)"”), which we adopted on January 1, 2006.Prior to January 1, 2006, we accounted for share-based payments under the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), which allowed companies to continue to use the intrinsic value methods established by APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25").We adopted SFAS 123(R) using the modified prospective transition method, and no cumulative effect was recorded on the adoption date of SFAS 123(R). We recordstock-basedshare-based compensationaccording to the salary classification of the award recipient, primarilyas a component of general and administrative expense. See“Note 17. Share-Based Compensation”for further discussion.Foreign Currency Gains and LossesWe follow a translation policy in accordance with SFAS No. 52,Foreign Currency Translation(“SFAS 52”). In our international locations in Argentina, Mexico and Canada where the local currency is the functional currency, assets and liabilities are translated at the rates of exchange on the balance sheet date, while income and expense items are translated at average rates of exchange during the year. The resulting
79Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)SFAS 123 set forth alternative accounting and disclosure requirements for stock-based compensation arrangements. Companies were permitted to continue following the provisions of APB 25 to measure and recognize employee stock-based compensation prior to January 1, 2006; however, SFAS 123 required disclosure of pro forma net income and earnings per share that would have been reported under the fair value recognition provisions of SFAS 123. The table below illustrates the effect on net income and earnings per share if we had applied the fair value recognition principles of SFAS 123 to stock-based employee compensation in 2005. As noted above, while we followed the guidance established by APB 25 to measure stock-based compensation during that year, the stock-based compensation expense included in net income in the table below represents the compensation expense for 875,180 options, net of forfeitures, that were granted in prior years at strike prices ranging from $0.10 to $2.53 below the market price of our common stock on the date of grant. During the years in which we applied APB 25, we elected to amortize any compensation cost on a straight-line basis over the vesting period of the award, in accordance with FIN No. 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Optiongains orAward Plans, an Interpretation of APB Opinions No. 15 and 25" ("FIN 28"). After the adoption of SFAS 123(R), we elected to amortize compensation cost associated with the fair value of equity-based awards over the vesting period of the award based on graded vesting using the straight-line attribution method.Year Ended
December 31, 2005(in thousands, except per
share amounts)Net income: As reported $ 45,717
Add: stock-based compensation expense included in reported net income, net of related tax effects of $955
1,643
Deduct: total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects of $1,919
(2,473
)Pro forma net income $ 44,887
Basic earnings per share:
As reported $ 0.34 Pro forma $ 0.34
Diluted earnings per share:
As reported $ 0.34 Pro forma $ 0.33 For additional information regarding the computations presented above, see Note 16—"Equity-Based Compensation."In June 2005, the Company began granting shares of common stock to its non-employee directors and restricted stock to certain of its employees. These awards have vesting periods ranging from zero to three years. Subject to the provisions of SFAS 123(R), the Company recognizes expense in earnings related to these awards equal to the fair value of the shares vesting during the period, net of actual and estimated forfeitures.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)In December 2006, the Company began granting "Phantom Shares" to certain of its employees, which vest ratably over a four-year periodlosses arising from thedatetranslation ofgrant. The Phantom Shares convey the right to the grantee to receive a cash payment on each anniversary of the grant date equal to the fair market value of the Phantom Shares vesting on that date. Grantees are not permitted to defer the payout to a later date. The Phantom Shares qualify as "liability" awards under SFAS 123(R) and the Companyaccountsfor these awards at fair value, with the fair value of the Phantom Shares recorded as a liability in our consolidated balance sheets. Changes in the fair value of the liability, net of actual and estimated forfeitures, are recorded in earnings as compensation expense.In August 2007, the Company issued stock appreciation rights ("SARs") to its executive officers. Each SAR award has a ten-year term from the date of grant and vests in equal annual installments on the first, second and third anniversaries of the date of grant. Upon the exercise of a SAR, the recipient will receive an amount equal to the difference between the exercise price and the fair market value of a share of the Company's common stock on the date of exercise multiplied by the number of shares of common stock for which the SAR was exercised. All payments will be made in shares of the Company's common stock. Prior to exercise, the SAR does not entitle the recipient to receive any shares of the Company's common stock and does not provide the recipient with any voting or other stockholder rights. The Company accounts for SARs as equity awards under SFAS 123(R) and recognizes compensation expense over the vesting period of the award based on their fair value on the date of issuance, net of estimated and actual forfeitures.Foreign Currency Gains and LossesThe local currency is the functional currency for our foreign operations in Argentina, Mexico and Canada. The cumulative translation gains and losses resulting from translating each foreign subsidiary's financial statementsfrom the functional currency to the U.S.dollarsDollar are included as a separate component ofstockholders'stockholders’ equity in other comprehensive income until a partial or complete sale or liquidation of our net investment in the foreign entity.From time to time our foreign subsidiaries may enter into transactions that are denominated in currencies other than their functional currency. These transactions are initially recorded in the functional currency of that subsidiary based on the applicable exchange rate in effect on the date of the transaction. At the end of each month, these transactions are remeasured to an equivalent amount of the functional currency based on the applicable exchange rates in effect at that time. Any adjustment required to remeasure a transaction to the equivalent amount of the functional currency at the end of the month is recorded in the income or loss of the foreign subsidiary as a component of other income and expense. See“Note13—"Foreign Currency Translation."14. Accumulated Other Comprehensive Loss.”
Comprehensive IncomeWe report and display comprehensive income in accordance with SFAS No. 130,Reporting Comprehensive Income(“SFAS 130”), which establishes standards for reporting and displaying comprehensive income and its components. SFAS 130 requires enterprises to display comprehensive income and its components in the enterprise’s financial statements, to classify items of comprehensive income by their nature in the financial statements and to display the accumulated balance of other comprehensive income separately in shareholders’ equity.LeasesWe account for leases in accordance with SFAS No. 13,"AccountingAccounting forLeases" ("Leases(“SFAS13"13”). Certain of our operating lease agreements are structured to include scheduled and specified rent increases over the term of the lease agreement. These increases may be the result of an inducement or"rent holiday"“rent holiday” conveyed to us early in the lease, or are included to reflect the anticipated effects of inflation. We apply the provisions of FASB Technical Bulletin (“FTB”)No. 85-3,"AccountingAccounting for Operating Leases with Scheduled RentIncreases" ("Increases(“FTB85-3"85-3”), when accounting for scheduled and specified rent increases. FTB85-3 provides that the effects of scheduled and specified rent increases should be recognized on a straight-line basis over the lease term unless another systematic and rational allocationKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)basis is more representative of the time pattern in which the leased property is physically employed. We recognize scheduled and specified rent increases on a straight-line basis over the term of the lease agreement.
In addition, certain of our operating lease agreements contain incentives to induce us to enter into the lease agreement, such as up-front cash payments to us, payment by the lessor of our costs, such as moving expenses, or the assumption by the lessor of our pre-existing lease agreements with third parties. Any payments made to us or on our behalf represent incentives that we consider to be a reduction of our rent expense, and are recognized on a straight-line basis over the term of the lease agreement. We amortize leasehold improvements on our operating leases over the shorter of their economic lives or the lease term.New Accounting StandardsAffectingAdopted in this ReportFIN 48 and FSPFIN 48-1. In June 2006, the FASB issued FIN No. 48,Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109(“FIN 48”), which provides clarification of SFAS 109 with respect to the recognition of income tax benefits of uncertain tax positions in financial statements. FIN 48 requires that uncertain tax positions be reviewed and assessed, with recognition and measurement of the tax benefit based on a"more“more likely thannot"not” standard.In May 2007 the FASB issuedFSP FIN 48-1. FSPFASB Staff Position (“FSP”)FIN 48-1 (“FSPFIN 48-1”). FSPFIN 48-1 provides guidance on how an enterprise should determine whether a tax position is effectively settled for the
80Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)purpose of recognizing previously unrecognized tax benefits. In determining whether a tax position has been effectively settled, entities must evaluate (i) whether taxing authorities have completed their examination procedures; (ii) whether the entity intends to appeal or litigate any aspect of a tax position included in a completed evaluation; and (iii) whether it is remote that a taxing authority would examine or re-examine any aspect of a taxing position. FSPFIN 48-1 is to be applied upon the initial adoption of FIN 48.We adopted the provisions of FIN 48 and FSPFIN 48-1 on January 1, 2007 and recorded a $1.3 million decrease to the balance of our retained earnings as of January 1, 2007 to reflect the cumulative effect of adopting these standards.See Note 10—"Income Taxes" for further discussion of the impact of the adoption of these standards.FSPFSPEITF 00-19-2. In December 2006, the FASB issuedFASB Staff Position No.FSPEITF 00-19-2,"AccountingAccounting for Registration PaymentArrangements" ("Arrangements(“FSPEITF00-19-2"00-19-2”). FSPEITF 00-19-2 addresses accounting for Registration Payment Arrangements("RPAs"(“RPAs”), which are provisions within financial instruments such as equity shares, warrants or debt instrumentsinby which the issuer agrees to file a registration statement and to have that registration statement declared effective by theSecurities and Exchange Commission (the "SEC")SEC within a specified grace period. If the registration statement is not declared effective within the grace period or its effectiveness is not maintained for the period of time specified in the RPA, the issuer must compensate its counterparty. The FASB Staff concluded that the contingent obligation to make future payments or otherwise transfer consideration under a RPA should be recognized as a liability and measured in accordance with SFAS 5 andFASB InterpretationFIN No. 14,"ReasonableReasonable Estimation of the Amount of a Loss", and that the RPA should be recognized and measured separately from the instrument to which the RPA is attached.In January 1999, the Company completed the private placement of 150,000 units consisting of $150.0 million of 14% Senior Subordinated Notes due January 25, 2009 (the"14%“14% Senior SubordinatedNotes"Notes”) and 150,000 warrants to purchase an aggregate of approximately 2.2 million shares of theCompany'sCompany’s common stock at an exercise price of $4.88125 per share (the"Warrants"“Warrants”).As ofKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)December 31, 2007, 65,000 Warrants had been exercised, leaving 85,000 Warrants outstanding that were exercisable for an aggregate of approximately 1.2 million shares.Under the terms of the Warrants, wearewere required to maintain an effective registration statement covering the shares of common stock issuable uponexercise. If we are unable to maintain an effective registration statement, we are required to make semiannual liquidated damages payments for periods in which an effective registration statement is not maintained.exercise of the Warrants. Due to our past failure to file our SEC reports in a timely manner, we
dodid not have an effective registration statement covering the Warrants, andhave beenwere required to make liquidated damagespayments, and will continue to be required to make those payments until such time as we have an effective registration statement on file for exercise of the Warrants or the warrant shares issuable thereunder are eligible for resale without registration pursuant to SEC Rule 144 or otherwise.payments. The requirement to make liquidated damages paymentsconstitutesconstituted an RPA under the provisions of FSPEITF 00-19-2, and as prescribed by the transition provisions of that standard, on January 1, 2007 the Company recorded a pre-tax current liability of approximately $1.0 million, which is equivalent to the payments for the Warrant RPA for one year, with an offsetting adjustment to the opening balance of retained earnings.Accounting Standards Not Yet Adopted in this ReportSFAS 157. In September 2006, the FASB issued SFAS No. 157,"FairFair ValueMeasurements" ("Measurements(“SFAS157"157”). SFAS 157 establishes a framework for measuring fair value and requires expanded disclosure about the information used to measure fair value. The statement applies whenever other statements require or permit assets or liabilities to be measured at fair value, and does not expand the use of fair value accounting in any new circumstances.In February 2008, the FASB issued FASB Staff Position FIN 157-2 ("FSP FIN 157-2"), which delayed the effective date by which companies must adopt the provisions of SFAS 157. FSP FIN 157-2 defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.The adoption of this standardisdid notanticipated tohave a material impact on our consolidated financialposition, results of operations, or cash flows.statements.
SFAS 159.In February 2007, the FASB issued SFASThe Company adopted Statement of Financial Accounting Standards No. 159,"TheThe Fair Value Option for Financial Assets and Liabilities, including an amendment of FASB Statement No.115" ("115(“SFAS159"159”)., on January 1, 2008. SFAS 159 permits companies to choose, at specified election dates, to measure eligible items at fair value (the"Fair“Fair ValueOption"Option”). Companies choosing such an electionwouldreport unrealized gains and losses on items for which the Fair Value Option has been elected in earnings at each subsequent reporting period.This standard is effective as of the beginning of the first fiscal year that begins after November 15, 2007. We adopted the provisions of this standard on January 1, 2008.We did not elect to measure any of our financial assets or liabilities using the Fair Value Option. We will assess at each measurement date whether to use the Fair Value Option on any future financial assets or liabilities as permitted pursuant to the provisions of SFAS 159.FSPSFAS 157-3. In October 2008, the FASB issued FSPSFAS No. 157-3,Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active(“FSP 157-3”).FSP 157-3 clarified the
81Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)application of SFAS 157.FSP 157-3 demonstrated how the fair value of a financial asset is determined when the market for that financial asset is inactive.FSP 157-3 was effective upon issuance, including for prior periods for which financial statements had not been issued. The implementation of this standard did not have a material impact on our consolidated financial statements.Accounting Standards Not Yet Adopted in this ReportFSPSFAS 142-3. In April 2008, the FASB issued FSPSFAS No. 142-3,Determination of Useful Life of Intangible Assets(“FSP 142-3”).FSP 142-3 amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142.FSP 142-3 also requires expanded disclosure regarding the determination of intangible asset useful lives.FSP 142-3 is effective for fiscal years beginning after December 15, 2008. Earlier adoption is not permitted. We are currently evaluating the potential impact the adoption ofFSP 142-3 will have on our consolidated financial statements.SFAS 161. In March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities(“SFAS 161”). SFAS 161 amends and expands the disclosure requirements of SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, and requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. This statement is effective for financial statements issued for fiscal periods beginning after November 15, 2008. Early application is encouraged. The Company currently has no financial instruments that qualify as derivatives, and we do not expect that the adoption of this standard will have a material impact on the Company’s financial position, results of operations and cash flows.FSPSFAS 157-2. In February 2008, the FASB issued FSPSFAS No. 157-2,Effective Date of FASB Statement No. 157(“FSP 157-2”), to partially defer SFAS 157. FSPSFAS 157-2 defers the effective date of SFAS 157 for nonfinancial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. We are currently evaluating the impact of adopting the provisions of SFAS 157 as it relates to nonfinancial assets and liabilities.SFAS 141(R). In December 2007, the FASB issued SFAS No. 141 (Revised 2007),"Business Combinations" ("Business Combinations(“SFAS 141(R)"”). SFAS 141(R)will significantly changeestablishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements theaccounting for business combinations. Underidentifiable assets acquired, liabilities assumed and any noncontrolling interests in the acquiree, as well as the goodwill acquired. Significant changes from current practice resulting from SFAS 141(R) include the expansion of the definitions of a “business” and a “business combination.” For all business combinations (whether partial, full or step acquisitions),an acquiring entitythe acquirer will record 100% of all assets and liabilities of the acquired business, including goodwill, at their fair values; contingent consideration will berequired to recognize all the assets andKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)liabilities assumed in a transactionrecognized atthe acquisition-dateits fair valuewith limited exceptions. Specific changes in SFAS 141(R) from previously issued guidance include:•Acquisition costs will generally be expensed as incurred;•Noncontrolling interests will be valued at fair value at the acquisition date;•Acquired contingent liabilities will be recorded at fair value aton the acquisition date and,subsequently remeasured at either the higher of such amount or the amount determined under existing guidancefornon-acquired contingencies;•In-process research and developmentcertain arrangements, changes in fair value will berecorded at fair value as an indefinite-lived intangible asset at the acquisition date;•Restructuringrecognized in earnings until settlement; and acquisition-related transaction and restructuring costsassociated with a business combinationwillgenerallybe expensedsubsequent torather than treated as part of theacquisition date; and•Changes in deferred tax asset valuation allowances and income tax uncertainties aftercost of theacquisition date generally will affect income tax expense.
acquisition. SFAS 141(R) also
includes newestablishes disclosure requirementsrelatedto enable users to evaluate the nature and financial effects of the businesscombinations. This statementcombination. SFAS 141(R) applies prospectively toallbusiness combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15,2008,2008. SFAS 141(R) may have an impact on our consolidated financial statements. The nature andearlier adoption is prohibited. The Company is still in the process of determining the impactmagnitude of theadoptionspecific impact will depend upon the nature, terms, and size of thestandard onacquisitions consummated after theCompany's financial position, results of operations, and cash flows.effective date.
SFAS 160. In December 2007, the FASB issued SFAS No. 160,"NoncontrollingNoncontrolling Interests in Consolidated FinancialStatements: anStatements — An amendment of ARB No.51" ("51(“SFAS160"160”). SFAS 160establishes newamends Accounting Research Bulletin No. 51,Consolidated Financial Statements, to establish accounting and reporting standards for the
82Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)noncontrolling interest(formerly referred to as "minority interests")in a subsidiary and for the deconsolidation of a subsidiary.Specifically, this statement requires the recognition ofIt clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as minority interest, is a third-party ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financialstatements and separate fromstatements. Among other requirements, SFAS 160 requires theparent's equity. The amountconsolidated statement ofnetincome to be reported at amounts that include the amounts attributable toaboth the parent and the noncontrollinginterest will be included in consolidated net incomeinterest. SFAS 160 also requires disclosure on the face of the consolidated statement of incomestatement. SFAS 160 clarifies that changes in a parent's ownership interest in a subsidiary that do not result in deconsolidation are equity transactions ifof theparent retains its controlling financial interest. In addition, SFAS 160 requires that a parent recognize a gain or loss inamounts of consolidated net incomewhen a subsidiary is deconsolidated. Such gains or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests ofattributable to the parent anditsto the noncontrolling interest. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15,2008,2008. Earlier adoption is not permitted. We are currently evaluating the potential impact of this statement.NOTE 2. ACQUISITIONS From time to time, the Company may acquire businesses or assets that are consistent withearly adoption prohibited. The Company is stillits long-term growth strategy. Results of operations for acquisitions are included in theprocessCompany’s financial statements beginning from the date ofdeterminingacquisition. Acquisitions through December 31, 2008 are accounted for using theimpactpurchase method of accounting and the purchase price is allocated to the assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. Final valuations of assets and liabilities are obtained and recorded as soon as practicable and within one year from the date of theadoptionacquisition. Purchase price allocations that have not yet been finalized are based on preliminary information and are subject to change when final fair value determinations are made for the assets acquired and liabilities assumed.Acquisitions completed during 2008Tri-Energy Services, LLC. On January 17, 2008, the Company purchased the fishing and rental assets ofthis standard onTri-Energy Services, LLC (“Tri-Energy”) for approximately $1.9 million in cash. These assets were integrated into our fishing and rental segment. The equity interests of Tri-Energy are owned by employees of theCompany's financial position, resultsCompany who joined the Company in October 2007 in connection with the earlier acquisition in 2007 ofoperations, and cash flows.2. ACQUISITIONSMoncla Well Service, Inc. and related entities
On October 25, 2007, we completed our acquisition of Moncla, which operates in Texas, Louisiana, Mississippi, Alabama, and Florida. Collectively, the Moncla assets included daylight rigs for well servicing and workovers and twenty-four hour rigs for shallow drilling, sidetracking and deep workovers. In addition, Moncla operated barge rigs, and owned rig-up, swab, hot oil and anchor trucks, tubingKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. ACQUISITIONS (Continued)testing units and rental equipment. The Moncla acquisition was made in order to expand our service offerings and meet our customers' service needs in Texas, Louisiana, Mississippi, Alabama and Florida.(collectively, “Moncla”). The purchase price was allocated to the tangible and intangible assets purchased and the acquisition of the Tri-Energy assets was accounted for
Moncla was approximately $146.0 million, which consistedas an asset purchase and did not result in the establishment ofnetgoodwill. The assets acquired include an identifiable intangible asset of$131.3$1.1 million related to customer relationships andassumed debt of $14.7 million. Amounts transferred at closing consisted of (i) $108.6 million of cash; (ii)is subject to amortization under SFAS No. 142. The asset will be amortized on a straight-line basis over two years from theissuance of an unsecured promissory note for $12.5 million that is payable in a lump sum on October 25, 2009, with accrued interest payable on each anniversary dateacquisition date.Western Drilling, LLC. On April 3, 2008, the Company purchased all of theclosingoutstanding equity interests ofthe acquisition;Western Drilling, LLC (“Western”), a privately-owned company based in California that operated 22 working well service rigs, three stacked well service rigs and(iii) the issuance of an unsecured promissory note for $10.0 million that is payable in five annual installments of $2.0 million plus accrued interest on each annual anniversary date of the closing of the acquisition. Both promissory notes bear interest at the Federal Funds rate, adjusted annually on the anniversary of the closing date. The long-term debt assumedequipment used in theacquisition was repaid simultaneously withworkover and rig relocation process. We acquired Western to increase our service footprint in theclosing of the transaction.California market.The purchase priceiswas $51.5 million in cash and was paid on April 3, 2008. The purchase price was subject to a working capital adjustmentwhich has not been finalized.The Moncla purchase agreement entitles the former owners of Moncla to receive earnout payments, on each of the next five anniversary dates of45 days from the closing date of the acquisition that resulted in additional consideration paid ofup to $5.0 million (up to $25.0$0.1 million intotal).May 2008. Theearnout payments are basedCompany also incurred direct transaction costs of approximately $0.4 million. The acquisition was funded by borrowings of $50.0 million under the Company’s Senior Secured Credit Facility (see“Note 12. Long-Term Debt”) and cash onthe achievementhand.The acquisition ofcertain revenue targets and profit percentage targets over the next five years and are payable upon achieving annual targets or a cumulative target on the fifth anniversary date. These payments represent an additional element of cost of the acquired entity and will beWestern was accounted for asan increase to goodwill if and when the contingent payment is made.a business combination. The total purchase price was allocated to
Moncla's net tangiblethe assets acquired andidentifiable intangible assetsliabilities assumed based on their estimated fair values. The excess of the purchase price over the fair value of net assets acquired was recorded as goodwill. Thepreliminaryallocation of the purchase price was based upon preliminary valuations and estimates, andthese areis subject to change as the valuations are finalized. The primaryareasarea of the purchase price allocationwhich arethat is not yet finalizedrelaterelates toidentifiable intangible assets, completion of the analysis of the acquired tax bases of the assets,pre-merger
83Key Energy Services, Inc. andpre-merger contingencies related to environmental exposures.SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)contingencies. The final valuationof net assetsis expected to be completed no later than thefourthfirst quarter of2008.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. ACQUISITIONS (Continued)2009. The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed on the date of the Western acquisition (in thousands):
Cash $ 1,527 Other current assets 28,633 Property and equipment 101,862 Goodwill 34,339 Intangible assets 28,273 Other assets 271 Total assets acquired 194,905
Current liabilities
21,548Long-term debt and capital leases 14,765 Other liabilities 671 Deferred tax liability 26,590 Total liabilities assumed 63,574 Net assets acquired $ 131,331 The preliminary allocation of the purchase price is based upon the fair values of assets and liabilities acquired.Cash $ 687 Other current assets 6,839 Property and equipment 30,162 Goodwill 8,166 Intangible assets 9,000 Other assets 132 Total assets acquired 54,986 Current liabilities 2,979 Total liabilities assumed 2,979 Net assets acquired $ 52,007 The fair values of property and equipment were determined using a marketapproach, depending on the asset being valued.approach. The fair values of identified intangible assets were determined using an income approach to measure the present worth of anticipated future economic benefits.WeThe Company also performed an economic obsolescence analysis to confirm the values identified through theaboveaforementioned methods. The allocation is still preliminary at this time, and may potentially change by a material amount once the purchaseaccountingprice allocation is finalized.Goodwill was recognized as part of the acquisition ofMonclaWestern as the purchase price exceeded the fair value of the acquired assets and assumed liabilities.We believe thatThe Company believes the goodwill associated with theMonclaWestern acquisition is related to the acquired workforce,andpotential future expansion of the Western service offerings, and the ability to expand our service offerings. Therefore, it was not allocated to the acquired assets andliabilities acquired.Allassumed liabilities.The acquired identifiable intangible asset ofthe $28.3$9.0 millionof acquired identified intangible assetsis related to customer relationships and is subject to amortization under SFAS142 and has a weighted-average remaining useful life of approximately nine years. These intangible assets relate to customer relationships of $25.1 million and noncompete agreements of $3.2 million.No. 142. Thenoncompete agreements will be amortized to expense on a straight-line basis over the expected duration of the respective agreement. The intangible asset associated withcustomer relationships will be amortized as the value of the relationships are realized using rates of6.56%17%,31.33%19%,19.49%15%,12.74%12%,8.78%9%, 7%, 6%, 5%, 4%, 3%, 2% and21.10%1% for2007,20082009, 2010, 2011 and the remaining periods,through 2019, respectively. The$34.3$8.2 million of goodwill associated with the purchase ofMoncla has beenWestern was allocated to our well servicingsegment;segment, and the assets and results ofthat amount, approximately $25.6operations subsequent to April 3, 2008 have also been integrated into the well servicing segment. Of the goodwill recorded, $8.2 million is expected to be deductible for income tax purposes.Hydra-Walk, Inc. On May 30, 2008, the Company purchased all of the outstanding stock of Hydra-Walk, Inc. (“Hydra-Walk”) for approximately $10.3 million in cash and a performance earn-out of up to $2.0 million over two years from the acquisition date if certain financial and operational performance measures are met. Additionally, during the third quarter of 2008 the Company paid approximately $0.2 million in additional consideration related to a holdback amount that was withheld from the seller pending the completion of a seller closing requirement. Thefollowing presentspurchase price was also subject to a post-closing working capital adjustment of less than $0.1 million that was paid during theconsolidated financial informationthird quarter of 2008. The Company incurred direct transaction costs of approximately $0.1 million. The Company retained approximately $1.1 million of Hydra-Walk’s net working capital as a result of the transaction and did not assume any debt of Hydra-Walk.Hydra-Walk is a leading provider of pipe handling solutions for theCompanyoil and gas industry and operates over 80 automated pipe handling units in Oklahoma, Texas and Wyoming. We acquired Hydra-Walk to expand the level of integrated well servicing services we are able to provide customers. The assets and results of operations for Hydra-Walk were integrated into our fishing and rental segment beginning ona pro forma basis, assuming the acquisition of Moncla had occurred as of January 1, 2006. The historical financial information has been adjusted to give effect to pro forma items that are directly attributable to the acquisition and expected to have a continuing impact on the consolidated results. These items include adjustments to record incremental amortization and depreciation expense related to the increase in fairMay 31, 2008.
84Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)2. ACQUISITIONS (Continued)The acquisition of Hydra-Walk was accounted for as a business combination and the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair value of net assets acquired was recorded as goodwill. The allocation of the purchase price was based upon preliminary valuations and estimates, and is subject to change as valuations are finalized. The primary area of the purchase price allocation that is not yet finalized relates to pre-merger contingencies. The final valuation is expected to be completed no later than the second quarter of 2009.This business combination resulted in the acquisition of $3.7 million of tangible assets, $4.5 million of intangible assets and $1.3 million of goodwill. The fair values of tangible assets were determined using a market approach. The fair values of intangible assets were determined using an income approach to measure the present worth of anticipated future economic benefits. The Company also performed an economic obsolescence analysis to confirm the values identified through the aforementioned methods. The allocation is still preliminary at this time and may potentially change by a material amount once the purchase price allocation is finalized.The acquired identifiable intangible assets of $4.5 million relate to customer relationships, a tradename and a non-compete agreement. These intangible assets are subject to amortization under SFAS 142. The customer relationships asset of $4.0 million will be amortized as the value of the relationships are realized using rates of 19%, 24%, 17%, 13%, 9%, 6%, 4%, 3%, 3% and 2% for 2008 through 2017, respectively. The tradename asset of $0.4 million will be amortized straight-line over 10 years and the non-compete agreement asset will be amortized straight-line over 3 years.Goodwill of $1.3 million has been recognized as part of the purchase price allocation as the purchase price exceeded the fair value of the acquired assetsto reflect change in depreciation methodology,andto reclassify certain items to conformassumed liabilities. The Company believes the goodwill associated with the Hydra-Walk acquisition is related to theCompany's financial reporting presentation.acquired workforce and potential expansion of our service offerings. Therefore, it was not allocated to the acquired assets and assumed liabilities. The
unaudited financial information set forth below$1.3 million of goodwill was allocated to our fishing and rental segment and $1.3 million is expected to be deductible for income tax purposes.As of December 31, 2008, the Hydra-Walk operations had met performance earn-out requirements that resulted in additional consideration of $0.5 million which has beencompiled from historical financial statementsrecorded as additional goodwill.Leader Energy Services Ltd. On July 22, 2008, the Company acquired all of the United States-based assets of Leader Energy Services Ltd. (“Leader”), a Canadian company, for consideration of $34.6 million in cash. The acquired assets include nine coiled tubing units, seven nitrogen trucks, twelve pumping trucks and otherinformation, but is not necessarily indicativeancillary equipment. Additionally, the Company paid approximately $0.7 million for supplies and inventory used in pressure pumping operations. The Company also incurred direct transaction costs of approximately $0.1 million. The purchase price was allocated to the tangible assets acquired. The acquisition of theresults that actually would have been achieved hadLeader assets was accounted for as an asset purchase as the assets acquired did not constitute a business and therefore did not result in the establishment of goodwill. The Company did not identify any acquired intangible assets. The Leader assets were integrated into our pressure pumping segment.Acquisitions completed during 2007AMI. On September 5, 2007, the Company acquired AMI, which operates in Canada and is a technology company focused on oilfield service equipment controls, data acquisition and digital information flow. The purchase price was $6.6 million in cash and $2.9 million in assumed debt and was paid in September 2007. During the nine months ended September 30, 2008, the Company refined its fair value allocation of the assets acquired and liabilities assumed by increasing its deferred tax asset balance by $0.3 million and decreasing its deferred tax liability balance by $1.0 million. These changes were offset by a corresponding net decrease to goodwill of $1.3 million. During 2008, but prior to the anniversary of the acquisition, the Company made additional payments to settle its working capital adjustment with the former owners of AMI and incurred
85Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)additional transaction costs directly related to the business combination. These payments totaled $1.3 million and resulted in additional goodwill of $1.3 million. The purchase price allocation was completed during the third quarter of 2008.Moncla. On October 25, 2007, the Company acquired Moncla, which operated well service rigs, barges and ancillary equipment in the southeastern United States for total consideration of $146.0 million. During 2008, the Company refined its fair value allocation of the assets acquired and liabilities assumed by increasing the working capital accounts (excluding deferred tax assets) by $2.2 million, decreasing the fair value of the well service assets acquired by $3.6 million, decreasing the deferred tax and other long-term asset balances by $0.4 million, increasing its long-term deferred tax liability balance by $2.1 million and incurring additional fees related to the closing of the transactionoccurred onof less than $0.2 million. The Company also paid additional purchase consideration of $0.8 million during thedates indicated or that may be achievedthird quarter of 2008. These changes were offset with a corresponding net increase to goodwill of $4.9 million. The purchase price allocation was finalized in thefuture.Year Ended December 31, 2007 2006 As reported Proforma
AdjustmentsProforma As reported Proforma
AdjustmentsProforma (in thousands, except for per share data) (unaudited) Revenues $ 1,662,012 $ 105,341 $ 1,767,353 $ 1,546,177 $ 104,282 $ 1,650,459 Net income $ 169,289 $ 7,418 $ 176,707 $ 171,033 $ 5,338 $ 176,371
Basic earnings per share
$
1.29
$
0.06
$
1.35
$
1.30
$
0.04
$
1.34Diluted earnings per share $ 1.27 $ 0.05 $ 1.32 $ 1.28 $ 0.04 $ 1.32 fourth quarter of 2008.
Kings OilTools, Inc.Tools. On December 7, 2007, the Company acquired the well service assets and related equipment of Kings Oil Tools, Inc. (“Kings”), a California-based well service
company. The acquired assets, all of which are located in California, include 36 marketed well service rigs, 10 stacked well service rigs and related support equipment. We made this acquisition to expand our business in California. Total consideration paidcompany forthe transaction wasapproximately $45.1million in cash, including transaction-related costs. We analyzed this acquisition as required under SFAS No. 141, "Business Combinations" ("SFAS 141"), and determined thatmillion. During theacquired assets and facts and circumstances of this transaction metnine months ended September 30, 2008, thecriteria of a "business" as that term is defined under EITF 98-3, "Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business" ("EITF 98-3"), and have accounted for this asset purchase as a business combination.The following table summarizes the preliminary estimatedCompany revised its fairvaluesvalue allocation of the assets acquired and liabilities assumedonby increasing thedatefair value ofacquisition (in thousands):Property and equipment $ 17,563 Goodwill 18,958 Intangible assets 11,000 Total assets acquired 47,521
Current liabilities
2,400Net assets acquired $ 45,121 the well service assets acquired by $1.6 million, increasing the deferred tax assets by $0.4 million, decreasing the fair value of working capital accounts by $0.1 million and incurring additional fees related to the closing of the transaction of $0.1 million. These changes were offset with a corresponding net decrease to goodwill for $1.7 million. The
preliminary allocation ofpurchase priceto specific assets and liabilities is based uponallocation was finalized in thefair valuesfourth quarter ofidentified assets and liabilities acquired. The fair values of property and equipment was determined for property and equipment using a market or cost approach, depending on the asset being valued. The allocation is still preliminary at this time, and may potentially change by a material amount2008 .Acquisitions completed during 2006We made no acquisitions during 2006.NOTE 3. OTHER CURRENT AND NON-CURRENT LIABILITIES December 31, 2008 2007 (In thousands) Current Accrued Liabilities:Accrued payroll, taxes and employee benefits $ 67,408 $ 55,486 Accrued operating expenditures 50,833 52,180 Income, sales, use and other taxes 41,003 35,310 Self-insurance reserve 25,724 25,208 Unsettled legal claims 4,550 6,783 Phantom share liability 902 2,458 Other 6,696 5,939 Total $ 197,116 $ 183,364
86Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)2. ACQUISITIONS (Continued)as our purchase accountingDecember 31, 2008 2007 (In thousands) Non-Current Accrued Liabilities:Asset retirement obligations $ 9,348 $ 9,298 Environmental liabilities 3,004 3,090 Accrued rent 2,497 2,829 Accrued income taxes 1,359 2,705 Phantom share liability 478 896 Other 809 713 Total $ 17,495 $ 19,531 NOTE 4. PROPERTY AND EQUIPMENT Property and equipment consists of the following:December 31, 2008 2007 (In thousands) Major classes of property and equipment:Well servicing equipment $ 1,431,624 $ 1,200,069 Disposal wells 60,508 56,576 Motor vehicles 125,031 112,986 Furniture and equipment 81,129 73,032 Buildings and land 71,014 64,258 Work in progress 89,001 88,304 Gross property and equipment 1,858,307 1,595,225 Accumulated depreciation (806,624 ) (684,017 ) Net property and equipment $ 1,051,683 $ 911,208 The Company capitalizes costs incurred during the application development stage of internal-use software. These costs are capitalized to work in progress until such time the application isfinalized. We believe certain customer-related intangibles were also acquiredput inthis purchaseservice. For the years ended December 31, 2008, 2007 andare utilizing an income approach to value these items as we have not completed our analysis and valuation. However, we have not allocated any purchase price to this asset2006 the Company capitalized costs in thefinancial statements. We anticipate finalizing our allocationamount ofpurchase price in$4.5 million, $1.9 million, and zero, respectively.Interest is capitalized on thesecond quarteraverage amount of accumulated expenditures for major capital projects using an effective interest rate based on related debt until the underlying assets are placed into service. Capitalized interest for the years ended December 31, 2008,once our valuation of the intangible assets is completed.2007 and 2006 was $6.5 million, $5.3 million and $3.4 million, respectively.87
Goodwill has been recognized as part of the acquisition of the assets of Kings as the purchase price exceeded the fair value of the acquired assets and liabilities absent the allocation of value to identified intangible assets. We believe that the goodwill associated with the acquisition is related primarily to the acquired workforce. Therefore, it was not allocated to the assets and liabilities acquired.All of the $11.0 million of acquired intangible assets is related to a noncompete agreement and subject to amortization under SFAS 142 and has a weighted-average remaining useful life of 5 years. The $19.0 million of purchase price preliminarily associated with goodwill has been allocated to our well servicing segment. The entire amount is expected to be deductible for income tax purposes. We are not including the pro-forma effect of this acquisition because the impact is not material to our results of operations.Advanced Measurements, Inc.On September 5, 2007, the Company, through a wholly-owned Canadian subsidiary, purchased all of the outstanding shares of AMI, a privately-held Canadian technology company focused on oilfield service equipment controls, data acquisition, and digital information work flow. We made this acquisition in order to improve our access to oilfield services technology.The purchase price was approximately $6.6 million in cash and approximately $2.9 million of assumed debt, which was repaid in September and November 2007. The purchase agreement also provided for deferred cash payments of up to $1.8 million related to the retention of key AMI employees. These deferred payments will be recognized as an expense over the period that the services are rendered.On the date of acquisition, AMI owned a 48% interest in AFTI, a privately-held Canadian technology company focused on low-cost wireless gas well production monitoring. As part of the purchase of AMI, we were required to exercise an option to increase AMI's interest in AFTI to 51.46%. The cost to exercise this option was approximately $0.5 million. As a result, through our acquisition of AMI we now own a 51.46% interest in AFTI, and we consolidate AFTI into our financial statements, with the remaining 48.54% representing a minority interest.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)2. ACQUISITIONS (Continued)The Company is obligated under various capital leases for certain vehicles and equipment that expire at various dates during the next five years. The carrying value of assets acquired under capital leases consists of the following:December 31, 2008 2007 (In thousands) Well servicing equipment $ 20,442 $ 19,687 Motor vehicles 9,271 5,938 Total $ 29,713 $ 25,625 Depreciation of assets held under capital leases of approximately $4.3 million, $5.9 million and $6.0 million for the years ended December 31, 2008, 2007 and 2006, respectively, and is included in depreciation and amortization expense in the accompanying consolidated statements of operations.NOTE 5. GOODWILL AND OTHER INTANGIBLE ASSETS The following table summarizesthe preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (in thousands):Cash $ 672 Other current assets 3,240 Property and equipment 388 Goodwill 4,523 Intangible assets 5,894 Other assets 824 Total assets acquired 15,541
Current liabilities
2,246Long-term debt and capital leases 2,884 Deferred tax liability 2,804 Total liabilities assumed 7,934 Minority interest 357 Net assets acquired $ 7,250 The preliminary allocation of the purchase price is based upon the fair values of assets and liabilities acquired. The fair values of identified intangible assets were determined using an income approach to measure the present worth of anticipated economic benefits. We also performed a business enterprise valuation to confirm the values identified through the income approach. Goodwill was recognized as part of the acquisition of AMI as the purchase price exceeded the fair value of the acquired assets and liabilities. We believe that the goodwill associated with the AMI acquisition is related to the acquired workforce and the potential future development of technology by this workforce. Therefore, it was not allocated to the assets and liabilities acquired.All of the $5.9 million of acquired identified intangible assets is subject to amortization under SFAS 142 and has a weighted-average remaining useful life of approximately 3.6 years. The intangible assets identified relate to developed technology ($4.8 million), customer backlog ($1.0 million) and noncompete agreements ($0.1 million). The $4.5 million of goodwill associated with the purchase has been allocated to our well servicing segment, as the technologies developed are anticipated to benefit these operations; of that amount, none is expected to be deductible for income tax purposes.The preliminary allocation of the purchase price was based upon preliminary valuations and estimates, and these are subject to change as the valuations are finalized. The primary areas of the purchase price allocation which are not yet finalized relate to the completion of the analysis of the acquired tax bases of the assets. The final valuation of net assets is expected to be completed no later than the third quarter of 2008.In connection with the acquisition of AMI, we also became party to a revolving credit agreement with a maximum outstanding amount of $0.9 million. This facility was extinguished in November 2007, and the outstanding balance was paid with cash.We are not including the pro-forma effect of this acquisition because the impact is not material to our results of operations.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)3. SUPPLEMENTAL FINANCIAL INFORMATIONDecember 31, 2007 2006 (in thousands) Current accrued liabilities: Accrued payroll, taxes and employee benefits $ 56,744 $ 58,904 Accrued operating expenditures 52,180 41,856 Income, sales, use and other taxes 35,310 30,282 Self-insurance reserves 25,208 24,378 Unsettled legal claims 6,783 28,754 Phantom share liability 2,458 — Assumed executory contract 1,120 — Deferred revenue 976 — Other 2,585 5,396 Total $ 183,364 $ 189,570 December 31, 2007 2006 (in thousands) Non-current accrued liabilities: Asset retirement obligations $ 9,298 $ 9,622 Environmental liabilities 3,090 4,683 Accrued rent 2,829 3,241 Accrued income taxes 2,705 2,507 Phantom share liability 896 — Other 713 1,203 Total $ 19,531 $ 21,256 December 31, 2007 2006 (in thousands) Major classes of property and equipment: Well servicing equipment $ 1,200,069 $ 950,952 Disposal wells 56,576 47,942 Motor vehicles 112,986 105,858 Furniture and fixtures 73,032 78,143 Buildings and land 64,258 58,786 Work in progress 88,304 38,299 Gross property and equipment 1,595,225 1,279,980 Accumulated depreciation (684,017 ) (585,689 ) Net property and equipment $ 911,208 $ 694,291 Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)3. SUPPLEMENTAL FINANCIAL INFORMATION (Continued)December 31, 2007 2006 (in thousands) Carrying values of assets leased under capital lease obligations: Well servicing equipment $ 19,687 $ 23,713 Motor vehicles 5,938 2,589 Total $ 25,625 $ 26,302 December 31, 2007 2006 (in thousands) Deferred financing costs: Gross carrying value $ 12,262 $ 12,042 Accumulated amortization (145 ) (2,090 ) Net carrying value $ 12,117 $ 9,952 Year Ended December 31, 2007 2006 2005 (in thousands) Noncash investing and financing activities: Property and equipment acquired under captial lease obligations $ 12,003 $ 15,349 $ 18,267 Equity investment in IROC Systems Corp — — 9,019 Asset retirement obligations 12 155 119 Unrealized gain on short-term investments — 328 — Unrealized gain on cash flow hedges — 185 — Capital lease portion of sale-leaseback transactions — — 4,663 Deferred gain on sale-leaseback transactions — — 1,094 Accrued repurchases of common stock 2,949 — — Debt assumed and issued in acquisitions 40,149 — —
Supplemental cash flow information:
Cash paid for interest $ 38,457 $ 44,534 $ 54,007 Cash paid for taxes 96,327 99,048 17,156 Cash paid for interest includes cash payments for interest on our long-term debt and capital lease obligations, commitment and agency fees paid, and cash paid to settle the interest rate swaps associated with the termination of our 2005 Senior Secured Credit Facility.Included in the 2007 consolidated statement of cash flows are approximately $21.2 million in cash outflows related to the settlement of litigation with our former chief executive officer. The amount was previously accrued for in 2004.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)4. GOODWILL AND OTHER INTANGIBLE ASSETSThe following table presents a summarization ofthe activity in our goodwill accounts for the years ended December 31,20072008 and2006:2007:Pressure Fishing and Well Servicing Pumping Rental Services Segment Segment Segment Total (In thousands) Balance at December 31, 2006 $ 252,975 $ 49,036 $ 18,901 $ 320,912 Goodwill acquired during the period 57,820 — — 57,820 Impact of foreign currency translation (182 ) — — (182 ) Balance at December 31, 2007 310,613 49,036 18,901 378,550 Goodwill acquired during the period 8,970 1,815 10,785 Purchase price allocation and other adjustments, net 2,376 — — 2,376 Impairment of goodwill — (49,036 ) (20,716 ) (69,752 ) Impact of foreign currency translation (967 ) — — (967 ) Balance at December 31, 2008 $ 320,992 $ — $ — $ 320,992
88Well Servicing Segment Pressure Pumping Segment Fishing and Rental Segment Total (in thousands) December 31, 2005 $ 254,116 $ 47,905 $ 18,901 $ 320,922 Goodwill acquired during period — — — — Foreign currency translation and other (10 ) — — (10 ) December 31, 2006 $ 254,106 $ 47,905 $ 18,901 $ 320,912 Goodwill acquired during period 57,820 — — 57,820 Foreign currency translation and other (182 ) — — (182 ) December 31, 2007 $ 311,744 $ 47,905 $ 18,901 $ 378,550 Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following tables present the gross carrying values and accumulated amortization of our identified intangible assets with determinable lives that are subject to amortization under SFAS 142 as of December 31,20072008 and2006:December 31, 2007 2006 (in thousands) Noncompete agreements: Gross carrying value $ 18,402 $ 9,401 Accumulated amortization (2,772 ) (7,886 ) Net carrying value $ 15,630 $ 1,515 Patents and trademarks: Gross carrying value $ 4,150 $ 4,296 Accumulated amortization (2,526 ) (2,465 ) Net carrying value $ 1,624 $ 1,831 Customer relationships: Gross carrying value $ 25,139 $ — Accumulated amortization (1,649 ) — Net carrying value $ 23,490 $ — Customer backlog: Gross carrying value $ 999 $ — Accumulated amortization (214 ) — Net carrying value $ 785 $ — Developed technology: Gross carrying value $ 4,762 $ — Accumulated amortization (397 ) — Net carrying value $ 4,365 $ — Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)4. GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)December 31, 2008 2007 (In thousands) Noncompete agreements:Gross carrying value $ 16,309 $ 18,402 Accumulated amortization (4,699 ) (2,772 ) Net carrying value $ 11,610 $ 15,630 Patents and trademarks:Gross carrying value $ 4,391 $ 4,150 Accumulated amortization (3,114 ) (2,526 ) Net carrying value $ 1,277 $ 1,624 Customer relationships:Gross carrying value $ 39,225 $ 25,139 Accumulated amortization (12,359 ) (1,649 ) Net carrying value $ 26,866 $ 23,490 Customer backlog:Gross carrying value $ 622 $ 999 Accumulated amortization (207 ) (214 ) Net carrying value $ 415 $ 785 Developed technology:Gross carrying value $ 3,598 $ 4,762 Accumulated amortization (1,421 ) (397 ) Net carrying value $ 2,177 $ 4,365 Amortization expense for our intangible assets with determinable lives was as follows:Year Ended December 31, Year Ended December 31, 2008 2007 2006 2007 2006 2005 (In thousands) (in thousands) Noncompete agreements Noncompete agreements $ 1,919 $ 2,202 $ 2,955 $ 4,108 $ 1,919 $ 2,202 Patents and trademarks Patents and trademarks 774 713 642 748 774 713 Customer relationships Customer relationships 1,649 — — 10,710 1,649 — Customer backlog Customer backlog 210 — — 252 210 — Developed technology Developed technology 389 — — 1,803 389 — Total intangible asset amortization expense $ 17,621 $ 4,941 $ 2,915 Total intangible asset amortization expense $ 4,941 $ 2,915 $ 3,597
89Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The weighted average remaining amortization periods and expected amortization expense for the next five years for our intangible assets are as follows:Weighted average
remaining
amortization
period (years)Expected Amortization Expense 2008 2009 2010 2011 2012 (in thousands) Noncompete agreements 4.8 $ 4,091 $ 3,192 $ 2,622 $ 2,606 $ 2,389 Patents and trademarks 2.9 724 449 233 163 55 Customer relationships 9.8 7,877 4,900 3,201 2,208 1,648 Customer backlog 3.3 268 194 194 129 — Developed technology 3.7 1,191 1,191 1,191 792 — Total $ 14,151 $ 9,926 $ 7,441 $ 5,898 $ 4,092 IncludedWeighted Average Remaining Amortization Expected Amortization Expense Period (Years) 2009 2010 2011 2012 2013 (In thousands) Noncompete agreements 5.9 $ 3,221 $ 2,652 $ 2,620 $ 2,423 $ 406 Patents and trademarks 4.5 489 273 203 96 40 Customer relationships 9.3 8,113 5,232 3,808 2,818 2,069 Customer backlog 2.3 797 668 423 — — Developed technology 2.8 156 156 104 — — Total intangible asset amortization expense $ 12,776 $ 8,981 $ 7,158 $ 5,337 $ 2,515 Certain of our intangible assets are denominated incapitalized costscurrencies other than U.S. Dollars and as such the values of these assets are subject to fluctuations associated withnoncompete agreements during 2007changes in exchange rates. Additionally, certain of these assets are also subject to purchase accounting adjustments. The estimated fair values of intangible assets obtained through acquisitions consummated in the preceding twelve months are based on preliminary information which isapproximately $1.8 million relatedsubject toa two-year noncompete agreementchange until final valuations are obtained.We perform annual impairment tests associated with ourformer chief executive officer. Throughgoodwill on December 31 of each year, or more frequently if circumstances warrant, as dictated by SFAS 142. As of December 31, 2008, 2007amortizationand 2006, we had three reporting units as determined and identified by SFAS 142.We estimate the fair values of our reporting units using three common valuation techniques — the discounted cash flow method, the guideline company method, and the similar transaction method. The Company’s management assigns a weighting to the results of each method based on the facts and circumstances that exist at the assessment date. The discounted cash flows for each reporting unit being tested are based on the Company’s financial budgets and forecasts, as well as management’s beliefs about the long-term growth patterns of the reporting units. For the 2008 future cash flow projections were discounted at rates ranging from 14% to 15% and terminal growth rates of approximately 3%. As part of the assessment, management also considered the current market capitalization of the Company, based on publicly available information and adjusted for an estimate of a control premium, in assessing the reasonableness of the fair values of the reporting units based on the results of the valuation models.To assist management in the preparation and analysis of the valuation of the Company’s reporting units, management utilized the services of a third-party valuation consultant, who reviewed management’s estimates, assumptions and calculations. The ultimate conclusions of the valuation techniques remain the sole responsibility of the Company’s management. The Company conducts its annual impairment test on December 31 of each year. Upon completion of the 2007 and 2006 assessments, no impairment was indicated since the estimated fair values of the reporting units were in excess of their carrying values. Upon completion of the 2008 assessment, we determined that the fair value associated with the reporting units comprising our pressure pumping and fishing and rental reportable segments was less than the carrying value of the reporting units of those segments, indicating potential impairment. Because indicators of impairment existed for these reporting units, we performed step two of the SFAS 142 impairment test for those units. While thisnoncompete agreement was approximately $0.4 million. This noncompete agreement expirestest is required onJuly 1, 2009.
an annual basis, it also can be required more frequently based on changes in external factors. We do not currently expect that additional tests would result in any additional charges, but the determination of fair value used in the test is heavily impacted by the market prices of our equity and debt securities.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)5. EARNINGS PER SHAREIn accordance with SFAS 142, the implied fair value of the goodwill of the reporting units being tested was determined in the same manner as a hypothetical business combination, with the fair value of the reporting unit representing the purchase price. As a result of the calculations of step two of the test, we determined that the goodwill of the reporting units comprising our pressure pumping and fishing and rental segments was impaired, and that the amount of the impairment loss was greater than the current carrying value of those reporting units’ goodwill. As such, we recorded a pre-tax impairment charge of approximately $49.0 million and $20.7 million for our pressure pumping and fishing and rental segments, respectively, during the fourth quarter of 2008.NOTE 6. EARNINGS PER SHARE The following table presents our basic and diluted earnings per share for the years ended December 31, 2008, 20072006and2005:Year Ended December 31, 2007 2006 2005 (in thousands, except per share data) Basic Earnings per Share Computation: Numerator Income from continuing operations $ 169,289 $ 171,033 $ 49,078 Discontinued operations, net of tax — — (3,361 ) Net income $ 169,289 $ 171,033 $ 45,717 Denominator Weighted average shares outstanding 131,194 131,332 131,075
Basic Earnings per Share:
Income from continuing operations $ 1.29 $ 1.30 $ 0.37 Discontinued operations, net of tax — — (0.03 ) Net income $ 1.29 $ 1.30 $ 0.34 Diluted Earnings per Share Computation: Numerator Income from continuing operations $ 169,289 $ 171,033 $ 49,078 Discontinued operations, net of tax — — (3,361 ) Net income $ 169,289 $ 171,033 $ 45,717 Denominator Weighted average shares outstanding 131,194 131,332 131,075 Dilutive effect from stock options 1,518 2,180 2,017 Dilutive effect from unvested restricted stock 256 — — Dilutive effect from warrants 565 552 503 Dilutive effect from stock appreciation rights 18 — — 133,551 134,064 133,595 Diluted Earnings per Share: Income from continuing operations $ 1.27 $ 1.28 $ 0.37 Discontinued operations, net of tax — — (0.03 ) Net income $ 1.27 $ 1.28 $ 0.34 2006:
Year Ended December 31, 2008 2007 2006 (In thousands, except per share data) Basic EPS Computation:NumeratorNet income $ 84,058 $ 169,289 $ 171,033 DenominatorWeighted average shares outstanding 124,246 131,194 131,332 Basic earnings per share $ 0.68 $ 1.29 $ 1.30 Diluted EPS Computation:NumeratorNet income $ 84,058 $ 169,289 $ 171,033 DenominatorWeighted average shares outstanding 124,246 131,194 131,332 Stock options 555 1,518 2,180 Restricted stock 254 256 — Warrants 506 565 552 Stock appreciation rights 4 18 — 125,565 133,551 134,064 Diluted earnings per share $ 0.67 $ 1.27 $ 1.28 Stock options, warrants and stock appreciation rights are included in the computation of diluted earnings per share using the treasury stock method. Restricted stock grants are legally considered issued and outstanding, but are included in basic and diluted earnings per share only to the extent that they are vested. Unvested restricted stock is included in the computation of diluted earnings per share using the treasury stock method. The diluted earnings per share calculation for the years ended December 31, 2008, 2007 and 2006 exclude the potential exercise of 2.6 million, 0.5 million and20050.4 million stock options, respectively, because the effects of such exercises on earnings per share in those periods would be anti-dilutive. The diluted earnings per share calculation for the year ended December 31, 2008 excludesoptions to purchase 495,875, 381,750 and 266,875 sharesthe potential exercise of 0.4 million stock-settled stock appreciation rights (“SARs”) because theCompany's common stock at weighted average exercise priceseffects of$14.78, $15.08, and $12.88,Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)5. EARNINGS PER SHARE (Continued)respectively,such exercises on earnings per share in those periods would be anti-dilutive. Shares are considered anti-dilutive because their exercise prices exceeded the average price of theCompany'sCompany’s stock during thoseyearsyears.
91Key Energy Services, Inc. andwould therefore be anti-dilutive.Subsidiaries
6. SALE-LEASEBACK TRANSACTIONSNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)We lease certain equipment such as tractors, trailers, frac tanks and forklifts from financial institutions under master lease agreements. Under our former master lease agreements, we were required to provide current annual and quarterly financial reportsThere have been no material changes in share amounts subsequent to thelessors. Due to our inability to provide audited financial statementsbalance sheet date that would have a material impact on the earnings per share calculation for the year ended December 31,20032008.NOTE 7. ASSET RETIREMENT OBLIGATIONS In connection with our well servicing activities, we operate a number of saltwater disposal (“SWD”) facilities. Our operations involve the transportation, handling andsubsequent periods, we were required to seek waivers and amendments fromdisposal of fluids in ourequipment lessors or pay off the outstanding leases. Some lessors refused to grant these waivers and demanded settlementSWD facilities that are by-products of theobligationdrilling process, some of which have been determined to be harmful to the environment. SWD facilities used in connection with our fluid hauling operations are subject to future costs associated with the abandonment of these properties. As a result, we have incurred costs associated with the proper storage andour purchasedisposal of these materials.Annual amortization of theequipment.We entered into two new master lease agreements on August 31, 2005 and October 14, 2005assets associated witha new lessor. Some oftheequipment, whichasset retirement obligations wasbeing leased from lessors that demanded settlement, was sold to this new lessor and subsequently leased back from that lessor, which we account for as capital leases. We received an aggregate amount of $5.8$0.6 million,in proceeds from the sale-leaseback transactions. We realized a gain of $1.1 million on one of the sale-leaseback transactions, which is being amortized over the term of the new lease. Amounts recognized in earnings related to the amortization of this deferred gain were $0.2 million, $0.2$0.6 million and$0.1$0.5 million for the years ended December 31, 2008, 2007 and 2006,and 2005,respectively.On the other sale-leaseback transaction, we realized a lossA summary ofless than $0.1 million, which was immediately recognizedchanges inearnings.our asset retirement obligations is as follows (in thousands):
Balance at December 31, 2006 $ 9,622 Additions 12 Costs incurred (576 ) Accretion expense 585 Disposals (345 ) Balance at December 31, 2007 9,298 Additions 397 Costs incurred (462 ) Accretion expense 594 Disposals (478 ) Balance at December 31, 2008 $ 9,349 NOTE 8. EQUITY METHOD INVESTMENTS 7. INVESTMENT IN IROC ENERGY SERVICES CORP.On July 22, 2004, we entered into an agreement (the "IROC Agreement") withIROC Energy Services Corp., an Alberta-based oilfield services company ("IROC"), to sell IROC ten remanufactured Skytop well service rigs, along with supporting equipment and inventory. We began delivery of the rigs in the fall of 2004, and these rigs are operated by IROC in Western Canada. The purchase price for the rigs was $7.0 million USD. This amount was converted at an agreed exchange rate of 0.7634 to $9.17 million CDN, and was paid by way of the issuance of 8,187,058 common shares of IROC stock at a deemed issuance price of $1.12 CDN per share. The final four rigs were delivered in 2005, and we recognized a gain of $1.9 million upon delivery, which represents the difference between the aggregate carrying value of the delivered rigs and the fair market value on the delivery date of the IROC shares we received as consideration for those four rigs.In July 2005, we sold additional well service rig support equipment to IROC for $0.9 million USD. This amount was converted at an agreed exchange rate of 0.7937 to $1.1 million CDN, and was paid by way of the issuance of 547,411 shares of IROC common stock (the "Additional Shares") at a deemed issuance price of $2.09 CDN per share. We recognized a gain of $0.7 million related to this transaction, which represents the difference between the carrying value of the transferred equipment and the fair value of the Additional Shares on the transaction date.As of December 31, 2008 and 2007, we owned approximately 8.7 million shares of IROCcommon stock, which representsEnergy Services Corp. (“IROC”), an Alberta-based oilfield services company. This represented approximately 19.7% ofIROC's sharesIROC’s outstanding common stock onthat date. On September 15, 2005, IROC completed a private placement of a series of unsecured non-convertible debentures, which also included 1,050,000 warrants to purchase common shares of IROC. Exercises of these warrants are potentially dilutive of Key's ownership percentage in IROC.December 31, 2008 and 2007. IROC shares trade on the Toronto Venture StockKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)7. INVESTMENT IN IROC ENERGY SERVICES CORP. (Continued)Exchange and had a closing price of $0.54 CDN and $0.74 CDN per share on December 31,
2007. Pursuant to the terms of the IROC Agreement,2008 and 2007, respectively. Mr. William Austin, ourChief Financial Officer,former chief financial officer, and Mr. Newton W. Wilson III, ourGeneral Counsel, were appointed toChief Operating Officer, serve on the board of directors of IROC.WeThrough December 31, 2008, we have significant influence over the operations of IROC through our ownership interest and representation on IROC’s board of directors, but we do not control it. We account for our investment in IROC using the equity method.The value of ourOur investment in IROCis recorded in our consolidated balance sheetstotaled $3.7 million and $11.2 million asa non-current asset.of December 31, 2008 and 2007, respectively. Thepro ratapro-rata share ofIROC'sIROC’s earnings and losses to which we are entitledareis recorded in our consolidated statements of operations as a component of other income and expense, with an offsetting increase or decrease to the carrying value of our investment, as appropriate. Any earnings distributed back to us from IROC in the form of dividends would result in a decrease in the carrying value of our equity investment. The value of our investment may also increase or decrease each period due to changes in the exchange rate between the U.S. Dollar and Canadian Dollar.
92Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Changes in the value of our investment due to fluctuations in exchange rates are offset by accumulated other comprehensive income.IROC had net income of approximately$2.0$0.8 million,$1.8$2.0 million and $1.8 millionUSDU.S. Dollars for the years ended December 31,2007, 2006 and 2005, respectively. IROC's total assets as of December 31, 2007 and 2006 were $140.5 million and $76.9 million USD, respectively. Our investment in IROC totaled $11.2 million and $10.7 million at December 31,2008, 2007 and 2006, respectively. In addition to our pro-rata share ofIROC'sIROC’s net income, the value of our investmentincreased during 2007 due tochanges based on thestrengtheningexchange rate between the U.S. and Canadian dollars. During the fourth quarter of 2008 the U.S. Dollar strengthened significantly against the Canadiandollar againstDollar, reducing theU.S. dollar.value of our investment. Thisincreasedecrease was offset in accumulated other comprehensive income.During the years ended December 31, 2008, 20072006,and2005,2006, we recorded$0.4$0.2 million, $0.4 million and$0.5$0.4 million, respectively, of equity income related to our investment in IROC. During the years ended December 31, 2008, 20072006and2005,2006, no earnings were distributed to us by IROC. Only distributed earnings or any gains or losses arising from the disposal of our investment are reportable for income tax purposes; as a result, the amounts we record for our pro-rata share ofIROC'sIROC’s earnings or losses to which we are entitled result in a temporary difference between book and taxable income. Under the provisions of SFAS 109, we record a deferred tax asset or liability, as appropriate, to account for these temporary differences.An impairment review of our equity method investment in IROC is performed on a quarterly basis to determine if there has been a decline in fair value that is other than temporary. The fair value of the asset is measured using quoted market prices or, in the absence of quoted market prices, fair value is based on an estimate of discounted cash flows. In determining whether the decline is other than temporary, we consider the cyclicality of the industry in which the investment operates, its historical performance, its performance in relation to its peers and the current economic environment. Future conditions in the industry, operating performance and performance in relation to peers and the future economic environment may vary from our current assessment of recoverability.Such future conditions could therefore result in a determination that a decline inWhile the carrying value of the investment approximated the fair valueis other than temporary. IROC'sduring the second quarter of 2008, IROC’s stock price is currentlydepressed. If we later determinedepressed and has historically been volatile. During the fourth quarter of 2008 the Company’s management determined that the declineisin the value of the investment in IROC was other than temporarywe would recordand as such recorded awrite-downpretax charge of $5.4 million in order to reduce the carrying value of the investment to fair value. Fair value was determined by using the quoted market prices for the IROC shares as of December 31, 2008.Geostream Services GroupOn October 31, 2008, we acquired a 26% interest in OOO Geostream Services Group (“Geostream”) for $17.4 million. We incurred direct transaction costs of approximately $1.9 million associated with the transaction. Geostream is located in the Russian Federation and provides drilling and workover services andsub-surface engineering and modeling in the Russian Federation. In connection with ourassetinitial investment, three officers of the Company became board members of Geostream, representing 50% of the board membership. We can exert significant influence over the operations of Geostream, but do not control it; therefore we account for it using the equity method.The fair value of the amounts we have invested in Geostream is in excess of the underlying book value of our investment. We are currently performing a valuation to determine the components of the difference in basis and have preliminarily allocated substantially all of the difference to goodwill. Our pro-rata share of Geostream’s net income for the two months ended December 31, 2008 was not material.We are contractually required to purchase an additional 24% of Geostream no later than March 31, 2009 for approximately €11.3 million (which at December 31, 2008 was equivalent to $15.9 million). For a period not to exceed six years subsequent to October 31, 2008, we have the option to increase our ownership percentage of Geostream to 100%; however, if we have not acquired 100% of Geostream on or before the end of the six-year period, we will be required to arrange an initial public offering for those shares.
93Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Advanced Flow Technologies, Inc.In September 2007 we completed the acquisition of AMI, a privately-held Canadian company focused on oilfield technology. Prior to thethen current fair market value.8. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTSacquisition, AMI owned a portion of another Canadian company, AFTI. As part of the acquisition, AMI increased its ownership percentage of AFTI to 51.46%. At December 31, 2007 we consolidated the assets, liabilities, results of operations and cash flows of AFTI into our consolidated financial statements, with the portion of AFTI remaining outside of our control forming a minority interest in our consolidated financial statements.
Our ownership of AFTI declined to 48.73% as of December 31, 2008 due to the issuance of additional shares by AFTI. As a result, we deconsolidated AFTI results from our consolidated financial statements at December 31, 2008 and now account for that interest under the equity method.NOTE 9. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS The following is a summary of the carrying amounts and estimated fair values of our financial instruments as of December 31,20072008 and2006.2007. SFAS No. 107,"DisclosuresDisclosures about Fair Value of FinancialInstruments" ("Instruments(“SFAS107"107”) defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)8. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)Cash, cash equivalents, short-term investments, accounts payable and accrued liabilities. These carrying amounts approximate fair value because of the short maturity of the instruments or because the carrying value is equal to the fair value of those instruments on the balance sheet date.December 31, 2007 December 31, 2006 Carrying Value Fair Value Carrying Value Fair Value (in thousands) Financial assets: Notes receivable—related parties $ 173 $ 173 $ 287 $ 287 Cash flow hedges — — 185 185
Financial liabilities:
8.375% Senior Notes due 2014 $ 425,000 $ 434,563 $ — $ — 2007 Senior Secured Credit Facility Revolving Loans 50,000 50,000 — — 2005 Senior Secured Credit Facility Term Loans — — 396,000 396,000 Notes payable—related parties 22,178 22,178 — — December 31, 2008 December 31, 2007 Carrying Value Fair Value Carrying Value Fair Value (In thousands) Financial assets:Notes receivable — related parties $ 336 $ 336 $ 173 $ 173 Financial liabilities:8.375% Senior Notes due 2014 $ 425,000 $ 282,115 $ 425,000 $ 434,563 Senior Secured Credit Facility revolving loans 187,813 187,813 50,000 50,000 Notes payable — related parties 20,318 20,318 22,178 22,178 Notes receivable-related parties. The amounts reported relate to notes receivable from certain employees of the Company related to relocation and retention agreements. The carrying values of these notes approximate their fair values as of the applicable balance sheet dates.Cash flow hedges.The carrying value of our cash flow hedges is equal to the fair value of those instruments on December 31, 2006. We had no cash flow hedges on December 31, 2007.8.375% Senior Notes due 2014. The fair value of our long-term debt is based upon the quoted market prices and face value for the various debt securities at December 31,
2007.2008. The carrying value of these notes as of December 31,20072008 was $425.0 million and the fair value was$434.6$282.1 million.2007Senior Secured Credit FacilityRevolving Loans.revolving loans. Because of their variable interest rates, the fair values of the revolving loans borrowed under our2007Senior Secured Credit Facility approximate their carrying values as of December 31,2007.2008. The carrying and fair values of these loans as of December 31,20072008 were approximately$50.0$187.8 million.2005 Senior Secured Credit Facility Term Loans.Because of their variable interest rates, the fair values of the term loans borrowed under our 2005 Senior Secured Credit Facility approximate their carrying values as of December 31, 2006. The carrying and fair values of these loans as of December 31, 2006 were $396.0 million. The loans were repaid in November 2007 with the proceeds from our 8.375% SeniorNotesdue 2014.Notes payable—payable — related parties. The amounts reported relate to the seller financing arrangement entered into in connection with our acquisition of Moncla (see“Note2—"Acquisitions"2. Acquisitions”). The carrying value of these notes approximate their fair values as of December 31,2007.2008.
949. DERIVATIVEKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIALINSTRUMENTSSTATEMENTS — (Continued)NOTE 10. DERIVATIVE FINANCIAL INSTRUMENTS Interest Rate Swaps.Under the term loan portion of our 2005 Senior Secured Credit Facility, we were exposed to risks related to variable interest rates.On March 10, 2006 we entered into twoKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)9. DERIVATIVE FINANCIAL INSTRUMENTS (Continued)$100.0$100.0 million notional amount interest rate swaps toeffectivelyfix the interest rate on a portion ofthis debt.the borrowings under our prior senior credit agreement, dated July 29, 2005 (the “Prior Credit Facility”). These swaps met the criteria of derivative instruments.The Company uses a historic simulation based on regression analysis to assess the effectiveness of the swaps as a hedge of the future cash flows of the forecasted transaction, both on a historical and prospective basis. The simulation regresses the monthly changes in the cash flows associated with the hedging instrument and the hedged item. The results of the regression indicated the swaps were highly effective in offsetting the future cash flows of the items being hedged and could be reasonably assumed to be highly effective on an ongoing basis. Based on the results of this analysis and the Company's intent to use the instruments to reduce exposure to changes in future cash flows attributable to interest payments, the Company elected to account for the swaps as cash flow hedges.The measurement of hedge ineffectiveness is based on a comparison of the cumulative change in the fair value of the actual swap designated as the hedging instrument and the cumulative change in fair value of a perfectly effective hypothetical derivative ("Perfect Hypothetical Derivative") (as defined in Derivatives Implementation Group ("DIG") Issue G7). The perfectly effective hypothetical swap mimics the terms of the debt with a fixed interest rate assumed to be the same as the hedge instrument. This method of measuring ineffectiveness is known as the "Hypothetical Derivative Method." Under this method, the actual swap is recorded at fair value on the Company's consolidated balance sheets and accumulated other comprehensive income is adjusted to a balance that reflects the lesser of either the cumulative change in the fair value of the actual swap or the cumulative change in the fair value of the Perfect Hypothetical Derivative. The amount of ineffectiveness, if any, is equal to the excess of the cumulative change in the fair value of the actual swap over the cumulative change in the fair value of the Perfect Hypothetical Derivative, and is recorded currently in earnings as a component of other income and expense on the Company's consolidated statements of operations.In connection with the termination ofthe 2005 Senior Securedour Prior Credit Facility in November 2007,(see Note 11—"Long-Term Debt"),we settled all outstanding interest rate swap arrangements. We recognized a loss of approximately $2.3 million related to the settlement of our interest rate swaps, which is recorded in our consolidated statements of operations as a component of interest expense.Call Options on 8.375% Senior Notes due 2014. The indenture related to our $425.0 million in 8.375% Senior Notes due 2014 (see“Note11—"12. Long-TermDebt"Debt”) contains provisions by which, at our option, we may redeem the notes at varying prices before their stated maturity date. Certain of these provisions are based on contingent events, such as a future equity offering by us or a change in control of the Company. Other provisions are not contingent in nature. In one of the non-contingent scenarios, the price at which we could retire the notes is based, in part, on a variable interest rate. We have analyzed all the provisions of the indenture that allow us to repaythe notesthis debt early in order to determine if any of these call options constitute an embedded derivative instrument under SFAS 133 and require bifurcation and separate measurement from the host contract. We followed the guidance provided in paragraphs 6, 12, 13 and 61 of SFAS 133 andDIGDerivatives Implementation Group (“DIG”) Issues B-16 and B-39 in determining whether or not the call options required bifurcation and separate measurement. Based on our analysis, we do not believe these options require bifurcation and separate measurement.Foreign Currency Instruments.In connection with our acquisition of AMI in September 2007 (see Note 2—"Acquisitions"), we became party to four swap arrangements that exchanged Singaporean Dollars for Canadian Dollars. These arrangements meet the definition of a derivative under SFAS 133.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)9. DERIVATIVE FINANCIAL INSTRUMENTS (Continued)We have not elected to treat these derivatives as cash flow hedges and as a result, any gains or losses arising out of changes in the fair value of these contracts are recorded as unrealized gains or losses in our consolidated statements of operations as a component of other income and expense. As of December 31, 2007, the aggregate notional amount of these contracts was approximately $0.4 million USD and the aggregate fair value of these contracts was less than $0.1 million USD. The last of these contracts settled in January 2008. For the year ended December 31, 2007, the unrealized holding loss associated with these contracts was not material.10. INCOME TAXESNOTE 11. INCOME TAXES The components of our income tax expense are as follows:Year Ended December 31, 2007 2006 2005 (in thousands) Current income tax (expense) benefit: Federal and state $ (81,384 ) $ (92,213 ) $ (18,022 ) Foreign (771 ) (4,242 ) (3,610 ) Year Ended December 31, 2008 2007 2006 (82,155 ) (96,455 ) (21,632 ) (In thousands) Deferred income tax (expense) benefit: Current income tax expense: Federal and state $ (55,190 ) $ (81,384 ) $ (92,213 ) Foreign (5,306 ) (771 ) (4,242 ) Federal and state (24,281 ) (7,906 ) (13,952 ) Foreign (332 ) 914 264 (60,496 ) (82,155 ) (96,455 ) Deferred income tax (expense) benefit: Federal and state (30,363 ) (24,281 ) (7,906 ) Foreign 616 (332 ) 914 (24,613 ) (6,992 ) (13,688 ) (29,747 ) (24,613 ) (6,992 ) Total income tax expense Total income tax expense $ (106,768 ) $ (103,447 ) $ (35,320 ) $ (90,243 ) $ (106,768 ) $ (103,447 ) We made net federal income tax payments of approximately $33.5 million, $85.5 million$87.6 millionand$10.8$87.6 million for the years ended December 31, 2008, 20072006and2005,2006, respectively. We made net state income tax payments of approximately $6.6 million,$8.4$6.6 million and$1.0$8.4 million for the years ended December 31, 2008, 20072006and2005,2006, respectively. We made net foreign tax payments of approximately $3.4 million, $4.2 million$3.0 millionand$5.4$3.0 million for the years ended December 31, 2008, 20072006and2005,2006, respectively. For the years ended December 31, 2008, 2007 and 2006, tax benefits allocated tostockholders'stockholders’ equity for compensation expense for income tax purposes in excess of amounts recognized for financial reporting purposes were $1.7 million, $3.4 million and less than $0.1 million, respectively.For the year ended December 31, 2005, no tax expense was allocated to stockholders' equity for compensation expense for income tax purposes less than amounts recognized for financial reporting purposes.The Company had allocated tax benefits tostockholders'stockholders’ equity in prior years for compensation expense for income tax purposes in excess of amounts recognized for financial reporting purposes.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)10. INCOME TAXES (Continued)Income tax expense differs from amounts computed by applying the statutory federal rate as follows:Year Ended December 31, Year Ended December 31, 2008 2007 2006 2007 2006 2005 Income tax computed at Federal statutory rate 35.0 % 35.0 % 35.0 % 35.0 % 35.0 % 35.0 % State taxes 3.2 1.7 2.4 3.1 3.2 1.7 Meals and entertainment 0.9 0.8 2.1 Executive and share-based compensation 0.6 1.1 0.6 Foreign rate differential 0.2 — 1.3 Non deductible goodwill 12.8 — — Change in valuation allowance 0.2 (0.5 ) — (0.3 ) 0.2 (0.5 ) Other (1.4 ) (0.4 ) 0.4 1.2 0.3 1.5 Effective income tax rate 38.7 % 37.7 % 41.8 % 51.8 % 38.7 % 37.7 % As of December 31,20072008 and2006,2007, our deferred tax assets and liabilities were comprised of the following:December 31, 2007 2006 (in thousands) Deferred tax assets: Net operating loss and tax credit carryforwards $ 6,000 $ 5,375 Self-insurance reserves 21,484 21,593 December 31, Allowance for doubtful accounts 4,731 4,793 2008 2007 Accrued liabilities 15,600 24,287 (In thousands) Equity-based compensation 3,876 2,736 Other 488 18 Deferred tax assets: Net operating loss and tax credit carryforwards $ 4,664 $ 6,000 Self-insurance reserves 20,944 21,484 Allowance for doubtful accounts 4,023 4,731 Accrued liabilities 14,681 15,600 Equity-based compensation 10,116 3,876 Other 3,085 488 Total deferred tax assets Total deferred tax assets 52,179 58,802 57,513 52,179 Valuation allowance for deferred tax assets Valuation allowance for deferred tax assets (1,458 ) (841 ) (844 ) (1,458 ) Net deferred tax assets Net deferred tax assets 50,721 57,961 56,669 50,721 Deferred tax liabilities: Deferred tax liabilities: Property and equipment (150,802 ) (121,314 ) Intangible assets (31,993 ) (16,196 ) Other (318 ) (309 ) Property and equipment (190,675 ) (150,802 ) Intangible assets (27,952 ) (31,993 ) Other — (318 ) Total deferred tax liabilities Total deferred tax liabilities (183,113 ) (137,819 ) (218,627 ) (183,113 ) Net deferred tax liability, net of valuation allowance Net deferred tax liability, net of valuation allowance $ (132,392 ) $ (79,858 ) $ (161,958 ) $ (132,392 ) In 2008, deferred tax liabilities decreased by $1.0 million for adjustments to accumulated other comprehensive loss. In 2007, deferred tax liabilities decreased by $0.2 million for adjustments to accumulated other comprehensive loss.In 2006, deferred tax liabilities increased by $0.2 million for adjustments to accumulated other comprehensive loss.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. INCOME TAXES (Continued)In recording deferred income tax assets, we consider whether it is more likely than not that some portion or all of the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those deferred income tax assets would be deductible. We consider the scheduled reversal of deferred income tax liabilities and projected future taxable income for this determination. To fully realize the deferred income tax assets related to our federal net operating loss carryforwards that do not have a valuation allowance due to Section 382 limitations, we would need to generate future federal taxable income of approximately$5.9$4.8 million over the next ten years. With certain exceptions noted below, we believe that after considering all the available
96Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)objective evidence, both positive and negative, historical and prospective, with greater weight given to the historical evidence, it is more likely than not that these assets will be realized.We estimate that as of December 31, 2008, 20072006and20052006 we have available $7.1 million, $8.2 million$9.3 millionand$14.0$9.3 million, respectively, of federal net operating loss carryforwards. Approximately$5.8$4.7 million of our net operating losses as of December 31,20072008 are subject to a $1.1 million annual Section 382 limitation and expire in 2018. Approximately $2.4 million of our net operating losses as of December 31,20072008 are subject to a $5,000 annual Section 382 limitation and expire in 2016 through 2018. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Due to annual limitations under Sections 382 and 383, management believes that we will not be able to utilize all available carryforwards prior to their ultimate expiration. The deferred tax asset associated with our remaining federal net operating loss carryforwards that will expire before utilization due to Section 382 limitations of $2.3 million includes a valuation allowance of $0.8 million as a result of the Section 382 limitations at December 31, 2008 and 2007,and 2006,respectively.We estimate that as of December 31, 2008, 20072006and20052006 we have available $16 million, $19 million,$31 million,and$43$31 million, respectively, of state net operating loss carryforwards that will expire from20082009 to 2025. To fully realize the deferred income tax assets related to our state net operating loss carryforwards, we would need to generate future West Virginia taxable income of$14.2$12.9 million over the next1817 years and future Pennsylvania taxable income of$3.5$2.0 million over the next1817 years. Management believes that it is not more likely than not that we will be able to utilize all available carryforwards prior to their ultimate expiration. The deferred tax asset associated with our remaining state net operating loss carryforwards at December 31,20072008 of$1.7$1.4 million includes a valuation allowance of less than $0.1 million as a result.In the second quarter of 2006, the Texas Margins Tax (see below) was enacted. At that point in time, a deferred tax asset of approximately $0.2 million related to Texas net operating losses that had a complete valuation allowance was effectively converted to a Texas Margins Tax credit that no longer requires a valuation allowance. A tax benefit net of federal tax effect was recorded in the second quarter of 2006 relating to the release of this valuation allowance. In the fourth quarter of 2006, we implemented plans for an internal reorganization of our legal entity structure to occur at year end. After the reorganization, state net operating losses previously subject to valuation allowances of $2.3 million no longer require valuation allowances. A tax benefit net of federal tax effect was recorded in the fourth quarter 2006 relating to the release of this valuation allowance.In 2007, the Company began operations in Mexico that resulted in a net operating loss of$2.0$2 million and a deferred tax asset related to the net operating loss carryforward of $0.6 million. Mexico enacted a new flat tax rate effective January 1, 2008. The flat taxwill functionfunctions in addition toKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. INCOME TAXES (Continued)the regular corporate tax rate of 28%. Tax expense
will beis calculated under both methods and if the flat tax is greater than the regular tax, the additional tax expense above the regular taxwill beis assessed in addition to the regular tax calculation.We haveIn 2007, we recorded a full valuation allowance related to our Mexico net operating loss carryforwards of $0.6 million,at December 31, 2007,as managementbelievesbelieved that,because ofdue to the enactment of the Mexico flat tax, all of our net operating loss carryforwards related to the Mexico operationsarewere not more likely than not to be fully realized in thefuture based onfuture. It was determined thefuture reversalCompany would not be in a flat tax position in 2008 and all ofdeferred tax liabilities. Thethe 2007 regular net operating lossexpireswill be utilized against 2008 regular Mexico income. Accordingly, the valuation allowance of $0.6 million set up in2017.2007 was released in 2008.
In 2007, the Company made a stock acquisition of AMI, a Canadian company. At December 31, 2008 and 2007, theCompany'sCompany’s Canadian operations hadanet operatinglosslosses of $3.8 million and $3.2 million, respectively. At December 31, 2008 anda2007 the deferred tax asset related to the net operating loss carryforwardofwas $1.1 million and $1.0million. The net operating loss is comprised of approximately $2.0millionnet operating loss as of the acquisition date and an additional $1.2 million net operating loss from operations for the four months ended December 31, 2007.respectively. We have recorded no valuation allowance related to our Canadian net operating loss carryforwards at December 31, 2008 and 2007, as management believes that all of our net operating loss carryforwards related to the Canadian operations are more likely than not to be fully realized in the future. To fully realize the deferred income tax assets related to our Canadian net operating loss carryforwards, we would need to generate $0.2 million of future Canadian taxable income over the nexteightseven years and$3.1$3.6 million of future Canadian taxable income over the next nineteen years. The net operating losses expire from 2015 to2027.2028.We did not provide for U.S. income taxes or withholding taxes on the 2008 unremitted earnings of our Mexico subsidiaries as these earnings are considered permanently reinvested. Unremitted earnings of our Mexico subsidiaries, representing tax basis accumulated earnings and profits, totaled approximately $6.3 million as of December 31, 2008. We did not provide for U.S. income taxes on 2007 and 2006 unremitted earnings of our
97Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)foreign subsidiaries as our tax basis in each foreign subsidiary was in excess of the book basis as of December 31, 2007 and 2006.In December 2006, the FASB issued FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in anenterprise'senterprise’s financial statements in accordance with SFAS 109. FIN 48 prescribes a recognition threshold and measurement attributes for the financial statement recognition and measurement of an income tax position taken or expected to be taken in an income tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.In May 2007, the FASB issued FSPFIN 48-1. FSPFIN 48-1 provides guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. In determining whether a tax position has been effectively settled, entities must evaluate (i) whether taxing authorities have completed their examination procedures; (ii) whether the entity intends to appeal or litigate any aspect of a tax position included in a completed evaluation; and (iii) whether it is remote that a taxing authority would examine or re-examine any aspect of a taxing position. FSPFIN 48-1 is to be applied upon the initial adoption of FIN 48.We adopted the provisionsAs ofFIN 48 and FSP FIN 48-1 on January 1,December 31, 2008, December 31, 2007 andrecorded a $1.3 million decrease to the balance of our retained earnings to reflect the cumulative effect of adopting these standards.As part of the acquisitions we made during 2007, the Company acquired or assumed unrecognized tax benefits, as defined by FIN 48. The cumulative effect of the acquisition of the unrecognized tax benefits was $3.2 million, which consisted primarily of rig refurbishment and meals and entertainment expense.As ofJanuary 1,2007 and December 31,2007 we had approximately$3.8$5.6 million, $6.8 million and$6.8$3.4 million, respectively, of unrecognized tax benefits net of federalbenefitbenefits which, if recognized, would impact our effective tax rate. We have accrued approximately $2.1 million, $2.3 million and $1.0 million for the payment ofKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. INCOME TAXES (Continued)interest and penalties as of December 31, 2008, December 31, 2007 and January 1, 2007, respectively.
While itWe believe that is reasonably possiblefor changes to occur due to settlementthat approximately $2.8 million ofexaminations orour currently remaining unrecognized tax positions, each of which are individually insignificant, may be recognized by theexpirationend of 2008 as a result of a lapse of the statute oflimitations, we do not anticipate significant changes in our unrecognized tax benefit liability in the next 12 months.limitations.
We file income tax returns in the United States federal jurisdiction and various states and foreign jurisdictions.In January 2005, the Internal Revenue Service concluded its examination of the Company'sWe are not under a current federal taxreturnsexamination. Federal tax years ending December 31, 2005 and forward are open for taxyears June 30, 1997 through December 31, 2002. These examinations have substantially concluded all U.S. federal income tax matters through the year ended December 31, 2002. However, due to the use of net operating losses in subsequent years, these audited tax years as well as the subsequent un-audited 2003-2007 tax years remain openaudits as of December 31,2007.2008. Our other significant filings areinArgentina which has been examined through 2006, Mexico which is in the initial stages of a 2007 tax audit of our initial year of operations and in the State of Texas, where tax filings remain open for 2003 to 2006 for certain subsidiaries of the Company.There were noWe recognized tax benefits in 2008 of $1.7 million for expirations of statutes oflimitations in 2007 that would require the releaselimitations. We recorded an income tax benefit ofa FIN 48 reserve. However, a change in the circumstances surrounding the audit$0.7 million, increase to deferred tax liabilities ofour Egyptian operations has resulted in the$0.5 million and decrease to goodwill ofthe FIN 48 reserve$0.5 million related tothat audit by approximately $0.7 million. The current reserve related to the Egyptian audit is $0.4 million.these statute expirations.
The following table presents the activity during20072008 related to our FIN 48 reserve (in thousands):Balance at January 1, 2007 $ 4,123 Additions based on tax positions related to the current year — Additions based on tax positions related to prior years 104 Increases in unrecognized tax benefits acquired or assumed in business combinations 2,403 Reductions for tax positions from prior years — Settlements (908 ) Balance at December 31, 2007 $ 5,722 Balance at January 1, 2008 $ 5,722 Additions based on tax positions related to the current year 551 Additions based on tax positions related to prior years 104 Decreases in unrecognized tax benefits acquired or assumed in business combinations (707 ) Reductions for tax positions from prior years (612 ) Settlements — Balance at December 31, 2008 $ 5,058 Tax Legislative ChangesAmerican Jobs CreationThe Economic Stimulus Act of2004.2008. TheAmerican Jobs CreationEconomic Stimulus Act of2004 added2008 permits a bonus first-year depreciation deduction of 50% of theSection 199 deduction to the Internal Revenue Code. This allows for tax deduction on qualifying domestic production activities, as definedadjusted basis of qualified property (most personal property andlimitedsoftware) acquired and placed inthe Internal Revenue Code. We concluded we will receive benefits of $2.0 million, $1.6 million and $0.6 million from this deduction for the years endedservice after December 31, 20072006and2005, respectively.before January 1, 2009. We have
98Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)estimated $123 million of qualifying additions in 2008 resulting in additional 2008 tax depreciation of $49 million.The American Recovery and Reinvestment Act of 2009. The American Recovery and Reinvestment Act of 2009 extends the bonus first-year depreciation deduction of 50% of the adjusted basis of qualified property acquired and placed in service to after December 31, 2008 and before January 1, 2010.Revised TexasMargins Tax.Franchise tax. In May 2006, the state of Texas enacted a new law, effective January 1, 2007, that substantially changes the tax system in Texas. The law replaces the taxable capital and earned surplus components of its franchise tax with a new tax that is based on modified gross revenue. This law imposes a tax on a unitary group of affiliatedentities'entities’ net receipts rather than on the earned surplus of each separate entity.The Company recognized a tax benefit of $0.4 million in the second quarter of 2006 related to the enactment of the new law. In 2007, the Company incurred $5.5 million of state income tax expense related to the Texas Margins Tax.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)11. LONG-TERM DEBTNOTE 12. LONG-TERM DEBT The components of our long-term debt are as follows:December 31, 2007 2006 (in thousands) 8.375% Senior Notes due 2014 $ 425,000 $ — 2007 Senior Secured Credit Facility revolving loans due 2012 50,000 — Notes payable—related party, net of fair value discount 22,178 — 2005 Senior Secured Credit Facility term loans — 396,000 Capital lease obligations 26,815 25,794 523,993 421,794 Less: current portion (12,379 ) (15,714 ) Total long-term debt and capital lease obligations, net of fair value discount $ 511,614 $ 406,080 December 31, 2008 2007 (In thousands) 8.375% Senior Notes due 2014 $ 425,000 $ 425,000 Senior Secured Credit Facility revolving loans due 2012 187,813 50,000 Other long-term indebtedness 3,015 — Notes payable — related party, net of discount of $182 and $322 20,318 22,178 Capital lease obligations 23,149 26,815 659,295 523,993 Less current portion (25,704 ) (12,379 ) Total long-term debt and capital lease obligations, net of fair value discount $ 633,591 $ 511,614 8.375% Senior Notes due 2014On November 29, 2007, the Company issued $425.0 million aggregate principal amount ofits8.375% Senior Notes due 2014 (the"Notes"“Senior Notes”), under an Indenture, dated as of November 29, 2007 (the"Indenture"“Indenture”), among us, the guarantors party thereto (the"Guarantors"“Guarantors”) and The Bank of New York Trust Company, N.A., as trustee. The Senior Notes were priced at 100% of their face value to yield 8.375%. Net proceeds, after deducting initialpurchasers' discountspurchasers’ fees and estimated offering expenses, were approximately $416.1 million. We used approximately $394.9 million of the net proceeds to retireourthen existing term loans, including accrued and unpaid interest,under the 2005 Senior Secured Credit Facility,with the balance used for general corporate purposes.The2005SeniorSecured Credit Facility was terminated in connection with our entry into the 2007 Senior Secured Credit Facility described below.TheNotes are general unsecured senior obligations of Key. Accordingly, they will rank effectively subordinate to all of our existing and future secured indebtedness. The Senior Notes are or will be jointly and severally guaranteed on a senior unsecured basis by certain of our existing and future domestic subsidiaries.Interest on the Senior Notes is payable on June 1 and December 1 of each year beginning June 1, 2008. The Senior Notes mature on December 1, 2014.On or after December 1, 2011, the Senior Notes will be subject to redemption at any time and from time to time at our option, in whole or in part, upon not less than 30 nor more than 60days'days’ notice, at the redemption prices (expressed as percentages of the principal amount redeemed) set forth below, plus accrued
99Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)and unpaid interest thereon to the applicable redemption date, if redeemed during the twelve-month period beginning on December 1 of the years indicated below:Year Percentage Percentage 2011 104.188 % 104.19 % 2012 102.094 % 102.09 % 2013 100.000 % 100.00 % Notwithstanding the foregoing, at any time and from time to time before December 1, 2010,the Companywe may, on any one or more occasions, redeem up to 35% of the aggregate principal amount ofKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)11. LONG-TERM DEBT (Continued)the outstanding Senior Notes at a redemption price of 108.375% of the principal amount thereof, plus accrued and unpaid interest thereon to the redemption date, with the net cash proceeds of any one or more equity offerings; provided that at least 65% of the aggregate principal amount of the Senior Notes issued under the Indenture remains outstanding immediately after each such redemption; and provided, further, that each such redemption shall occur within 180 days of the date of the closing of such equity offering.
In addition, at any time and from time to time prior to December 1, 2011, the Company may, at our option, redeem all or a portion of the Senior Notes at a redemption price equal to 100% of the principal amount thereof plus the applicable premium (as defined in the Indenture) with respect to the Senior Notes and plus accrued and unpaid interest thereon to the redemption date. If the Company experiences a change of control, subject to certain exceptions, it must give holders of the Senior Notes the opportunity to sell to the Company their Senior Notes, in whole or in part, at a purchase price equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest thereon to the date of purchase.The Company and its restricted subsidiaries are subject to certain negative covenants under the indenture governing the Senior Notes. The indenture limits the ability of the Company and each of its restricted subsidiaries to, among other things, (i) sell assets, (ii) pay dividends or make other distributions on capital stock or subordinated indebtedness, (iii) make investments, (iv) incur additional indebtedness or issue preferred stock, (v) create certain liens, (vi) enter into agreements that restrict dividends or other payments from its subsidiaries to itself, (vii) consolidate, merge or transfer all or substantially all of its assets, (viii) engage in transactions with affiliates and (ix) create unrestricted subsidiaries.These covenants are subject to certain exceptions and qualifications. In addition, substantially all of the covenants will terminate before the Notes mature if one of two specified ratings agencies assigns the Notes an investment grade rating in the future and no events of default exist under the Indenture. Any covenants that cease to apply to us as a result of achieving an investment grade rating will not be restored, even if the credit rating assigned to the Notes later falls below an investment grade rating.In connection with the sale of the Senior Notes, the Company entered into a registration rights agreement with the initial purchasers, pursuant to which ithasagreed to file an exchange offer registration statement with the SEC with respect to an offer to exchange the Senior Notes for substantially identical notes thatarewould be registered under the Securities Act, and to use reasonable best efforts to cause such registration statement become effective on or prior to November 29, 2008.Additionally,In accordance with the agreement, the Companyhas agreed to commence the registered exchange offer and to use its reasonable best efforts to issue, on or prior to the date that is 60 days after the date on which thefiled an exchange offer registration statement with the SEC on August 19, 2008, which became effective August 22, 2008, and offered to exchange an aggregate principal amount of $425.0 million of registered 8.375% Senior Notes due 2014, which the Company refers to as the exchange notes, for any and all of our original unregistered 8.375% Senior Notes due 2014 that were issued in a private offering on November 29, 2007. The terms of the exchangefor all Notes tendered prior theretonotes were substantially identical to those terms of the original notes, except that the transfer restrictions, registration rights and additional interest provisions relating to the originally issued notes did not apply to the exchange notes. References to the “Senior Notes” herein includes exchange notes issued in theregisteredexchange offer.Under some circumstances, in lieu of a registered exchange offer, the Company has agreed to file a shelf registration statement to cover resales of the Notes by certain holders thereof and to use reasonable best efforts to keep the shelf registration statement effective for a period of at least two years or such shorter period ending on the earlier of when all of the Notes available for sale thereunder (i) have been sold pursuant thereto and (ii) are no longer restricted securities (as defined in Rule 144 under the Securities Act, or any successor rule thereof). The Company and the Guarantors are required to pay additional interest if they fail to comply with their obligations to register the Notes within the specified time periods.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)11. LONG-TERM DEBT (Continued)As of December 31,2007,2008, the Company is in compliance with all the covenants required under the Senior Notes.
1002007Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Senior Secured Credit FacilitySimultaneously with the closing of the offering of the Senior Notes, the Company entered into a new credit agreement (the"Credit Agreement"“Credit Agreement”) with several lenders. The Credit Agreement provides for a senior secured credit facility (the"2007 Senior“Senior Secured CreditFacility"Facility”) consisting of a revolving credit facility, letter of credit sub-facility and swing line facility of up to an aggregate principal amount of $400.0 million, all of which will mature no later than November 29, 2012.The 2007All obligations under the Senior Secured Credit Facility are guaranteed by most of our subsidiaries andthe obligations thereunderare secured bysubstantially allmost oftheour assets,of the Companyincluding our accounts receivable, inventory andare or will be guaranteed by certain of the Company's existing and future domestic subsidiaries.equipment.
The2007Senior Secured Credit Facility replaced theCompany's 2005 Senior SecuredCompany’s Prior Credit Facility, which wasterminated in connectionrepaid with theclosing ofproceeds from theoffering of theSenior Notes.The interest rate per annum applicable to amounts borrowed under the2007Senior Secured Credit Facility are, at theCompany'sCompany’s option, (i) LIBOR plus the applicable margin or (ii) the higher of (x) Bank ofAmerica'sAmerica’s prime rate and (y) the Federal Funds rate plus 0.5%, plus the applicable margin. The applicable margin for LIBOR loans ranges from 150 to 200 basis points, and the applicable margin for all other loans ranges from 50 to 100 basis points, both of which depend upon theCompany'sCompany’s consolidated leverage ratio.The2007Senior Secured Credit Facility contains certain financial covenants, which, among other things, require the maintenance of a consolidated leverage ratio not to exceed 3.50 to 1.00 and a consolidated interest coverage ratio of not less than 3.00 to 1.00, and limit theCompany'sCompany’s capital expenditures to $250.0 million per fiscal year, up to 50% of which amount may be carried over for expenditure in the following fiscal year. Each of the ratios referred to above will be calculated quarterly on a consolidated basis for each trailing four fiscal quarter period. In addition, the2007Senior Secured Credit Facility contains certain affirmative and negative covenants, including, without limitation, restrictions on (i) liens; (ii) debt, guarantees and other contingent obligations; (iii) mergers and consolidations; (iv) sales, transfers and other dispositions of property or assets; (v) loans, acquisitions, joint ventures and other investments (with acquisitions permitted so long as, after giving pro forma effect thereto, no default or event of default exists under the2007Senior Secured Credit Facility, the consolidated leverage ratio does not exceed 2.75 to 1.00, the Company is in compliance with the consolidated interest coverage ratio and the Company has at least $25 million of availability under the2007Senior Secured Credit Facility); (vi) dividends and other distributions to, and redemptions and repurchases from, equity holders; (vii) prepaying, redeeming or repurchasing subordinated (contractually or structurally) debt; (viii) granting negative pledges other than to the lenders; (ix) changes in the nature of theCompany'sCompany’s business; (x) amending organizational documents, or amending or otherwise modifying any debt, any related document or any other material agreement if such amendment or modification would have a material adverse effect; and (xi) changes in accounting policies or reporting practices; in each of the foregoing cases, with certain exceptions. Further, the2007Senior Secured Credit Facility permits share repurchases up to $200.0 million and provides that share repurchases in excess of $200.0 million can be made only if our debt to capitalization ratio is below 50%.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)11. LONG-TERM DEBT (Continued)As of December 31,2007,2008, the Company is in compliance with all the covenants required under the2007Senior Secured Credit Facility.The Company may prepay the2007Senior Secured Credit Facility in whole or in part at any time without premium or penalty, subject to certain reimbursements to the lenders for breakage and redeployment costs.On September 15, 2008, Lehman Brothers Holdings (“Lehman”) filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code. Lehman Commercial Paper, Inc. (“LCPI”), a subsidiary of Lehman, was a member of the syndicate of banks participating in our Senior Secured Credit Facility. LCPI’s commitment was approximately 11% of the Company’s total facility. As of December 31,2007,2008, the Company had approximately$50.0$139.3 millionoutstanding in borrowingsavailable underthe revolving portion of the 2007its Senior Secured Credit Facility. This availability reflects the reduction of approximately $19.3 million of unfunded commitments by LCPI. The Company also had$61.1
101Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)$53.6 million in committed letters of creditunder the facility, and $288.9 million available to borrowunder the facility. Under the terms of the agreement, committed letters of credit count against our borrowing capacity under the revolving credit facility.In addition to interest, we also pay a quarterly commitment fee of 0.3% of our available balance under the revolver, and an annual fee for our committed letters of credit equal to 1.5% of the balance of our committed letters of credit.Seller Financing Arrangement in Moncla PurchaseIn connection with the acquisition of Moncla (see“Note2—"Acquisitions"2. Acquisitions”), the Company entered into two promissory notes with the sellers. The first is an unsecured note in the amount of $12.5 million, which is due and payable in a lump-sum, together with accrued interest, on October 25, 2009. Interest on this note is due on each anniversary of the closing of the acquisition of Moncla, which was October 25, 2007. The second unsecured note in the amount of $10.0 million is payable in annual installments of $2.0 million, plus accrued interest, beginning October 25, 2008 through 2012. Each of the notes bears interest at the Federal Funds rate, adjusted annually on the anniversarydateof the closing date. As of December 31,2007,2008, the interest rate on these notes was4.75%1.5%.Interest expense for the years ended December 31, 2008 and 2007 was $1.2 million and $0.2 million, respectively, on the two notes in aggregate.
The Federal Funds rate does not represent a rate that would have resulted if an independent borrower and an independent lender had negotiated a similar transaction under comparable terms and conditions and is not equal to our incremental borrowing rate. In accordance withAPBAccounting Principles Board (“APB”) No. 21,"InterestInterest on Receivables andPayables" ("Payables(“APB21"21”) and SFAS No. 141, Business Combinations(“SFAS 141”), we recorded the promissory notes at fair value which resulted in a discount being recorded. The discount will be recognized as interest expense over the life of the promissory notes using the effective interest method.2005 Senior Secured Credit FacilityOn July 29, 2005, we entered into a Credit Agreement (the "2005 Senior Secured Credit Facility").The2005 Senior Secured Credit Facility consisted of (i) a revolving credit facility of up to an aggregate principalamount of$65.0 million, which wasdiscount remaining tomature on July 29, 2010; (ii) a senior term loan facility in the original aggregate principal amount of $400.0 million, which was to mature on June 30, 2012; and (iii) a prefunded letter of credit facility in the aggregate amount of $82.3 million, which was to mature on July 29, 2010. The revolving credit facility included a $25.0 million sub-facility for additional letters of credit. The proceeds from the term loan facility, along with cash on hand, were used to redeem or repay our Previous Senior Notes (defined below).Borrowings under the 2005 Senior Secured Credit Facility through December 31, 2005 bore interest upon the outstanding principal balance, at the Company's option, at the prime rate plus a margin of 1.75% or a Eurodollar rate plus a margin of 2.75%. These margins were increased on December 31, 2005 by 0.50% and again on June 30, 2006 by 0.50% because the Company did not meetKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)11. LONG-TERM DEBT (Continued)certain filing targets for our 2003 Annual Report on Form 10-K. We were also required to pay certain fees in connection with the credit facilities, including a commitment fee as a percentage of aggregate commitments.Between November 1, 2005 and July 27, 2007, we amended the 2005 Senior Secured Credit Facility three times in order to, among other things, (i) extend the filing deadlines for our 2006 Annual Report on Form 10-K and quarterly reports for 2005, 2006, and the first two quarters of 2007, (ii) reduce the Eurodollar spreads and commitment fees associated with the term loans under the facility, (iii) increase the limitations on our capital expenditures, (iv) increase the permitted stock repurchase basket under the agreement, (v) increase and subsequently eliminate the permitted acquisitions basket under the agreement, and (vi) eliminate provisions requiring the Company to prepay term loans under the facility with excess cash flow. We paid a total of approximately $1.7 million in fees for these amendments.On November 29, 2007, the Company issued the Notes, and used the proceeds to retire the term loan amounts then outstanding under the 2005 Senior Secured Credit Facility. We recognized a loss of approximately $9.6 million upon the extinguishment of the 2005 Senior Secured Credit Facility.2003 Senior Secured Credit FacilityOn November 10, 2003, we entered into a Fourth Amended and Restated Credit Agreement (the "2003 Senior Secured Credit Facility"). The 2003 Senior Secured Credit Facility consisted of a $175.0 million revolving loan facility with the entire amount being available for letters of credit. We previously had the right, subject to certain terms and conditions, to increase the total commitment under the facility to $225.0 million if we were unable to obtain additional lending commitments.Our failure to file our 2003 Annual Report on Form 10-K on a timely basis violated the covenants of the 2003 Senior Secured Credit Facility. Between March 31, 2004 and July 20, 2005, we amended the terms of the 2003 Senior Secured Credit facility six times to waive the covenants and extend the due date for our 2003 Annual Report on Form 10-K and other filings. During 2005 we paid a total of $1.1 million in fees related to the various amendments to the 2003 Senior Secured Credit Facility. On July 29, 2005, we entered into the 2005 Senior Secured Credit Facility, which replaced the 2003 Senior Secured Credit Facility.Previous Senior NotesOn May 14, 2003, we completed a public offering of $150.0 million of 6.375% Senior Notes due May 1, 2013 (the "6.375% Senior Notes"). The proceeds from the public offering, net of fees and expenses, were used to repay the balance of the revolving loan facility then outstanding under our then-existing credit facility, with the remainder being used for general corporate purposes. The 6.375% Senior Notes required semi-annual interest payments on May 1 and November 1 of each year. Interest of $8.9 million was paid on these notes during 2005.On March 6, 2001, we completed a private placement of $175.0 million of 8.375% Senior Notes due March 1, 2008 (the "8.375% Senior Notes"; together with the 6.375% Senior Notes, the "Previous Senior Notes"). The net cash proceeds from the private placement were used to repay all of the remaining balance of prior term loans and a portion of the revolving credit facility then outstanding under our then-existing credit facility. On March 1, 2002, we completed the public offering of an additional $100.0 million of 8.375% Senior Notes. The net cash proceeds were used to repay theKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)11. LONG-TERM DEBT (Continued)outstanding balance of the revolving loan facility under our then-existing credit facility. The 8.375% Senior Notes required semi-annual interest payments on March 1 and September 1 of each year. Interest of $27.3 million was paid on these notes during 2005.Defaults Under Previous Senior Note Indentures and Repayment of Previous Senior NotesOur failure to file our 2003 Annual Report on Form 10-K with the SEC and deliver it to the trustee under the indentures for the Previous Senior Notes before March 30, 2004 constituted a default under those indentures. During 2004 and 2005 we amended the terms of each of the indentures three times to waive the covenant non-compliance and extend the due date for our 2003 Annual Report on Form 10-K and other filings. In order to obtain these amendments and consents we incurred costs totaling $9.0 million during 2005. The final amendment to the indentures established due dates of May 31, 2005 for filing our 2003 Annual Report on Form 10-K and of July 31, 2005 for filing our 2004 Annual Report on Form 10-K and 2004 quarterly reports on Form 10-Q. The consents also provided a due date of October 31, 2005 for filing our quarterly reports on Form 10-Q for the first and second quarters of 2005. We failed to meet these deadlines, and on June 6, 2005 the trustee for the Previous Senior Notes sent us notice of the financial reporting violation, which the triggered a 60-day cure period. Due to our failure to cure this default, on September 28, 2005 we received a valid acceleration notice from the trustee for the 6.375% Senior Notes.The 6.375% Senior Notes were repaid on October 5, 2005, at a price of 100% of the outstanding principal amount plus accrued and unpaid interest to the repayment date, resulting in a net cash outlay of $154.1 million. We redeemed all $275.0 million outstanding principal amount of the 8.375% Senior Notes on November 8, 2005. The 8.375% Senior Notes were redeemed at a price of 104.188% of the principal amount plus accrued and unpaid interest to the redemption date, for a net cash outlay of $290.9 million. resulting in a loss of $14.1 million. We recognized losses totaling $16.4 million related to these transactions. Proceeds from the 2005 Senior Secured Credit Facility and cash on hand were used to repay the Previous Senior Notes.Default Under Lease AgreementsAs discussed in Note 6—"Sale-Leaseback Transactions," we lease certain equipment such as tractors, trailers, frac tanks and forklifts from financial institutions under master lease agreements. Under certain of these master lease agreements, we were required to provide current annual and quarterly financial reports. For certain of these leases, we obtained a series of waivers from the financial institutions regarding the filing of these reports, the last of which allowed us until September 30, 2006 to file an Annual Report on Form 10-K for 2003. Due to our inability to provide audited financial statements for the year ended December 31, 2003 that comply with SEC rules, we are not in compliance with the terms of these equipment leases. We do not intend to seek additional waivers from the financial institutions, and as a result the equipment lessors may demand that the leasesberepaid. As of December 31, 2007, no formal demands for repayment had been made by the lessors. As of December 31, 2007, the total amount outstanding under such lease agreements was approximately $2.7 million. We have recorded a current liability of $1.7 million in our consolidated balance sheetsamortized as of December 31, 2008 and 2007which represents our obligation under these lease agreements that are accountedwas $0.2 million and $0.3 million, respectively, foras capital leases.both notes in the aggregate. Theremaining $1.0total amount of discount amortization included in interest expense related to the notes for the years ended December 31, 2008 and 2007 was approximately $0.1 millionrepresents the remaining payments under leases with those lessors that we account for as operating leases.Key Energy Services, Inc.andSubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)11. LONG-TERM DEBT (Continued)less than $0.1 million, respectively.
Long-Term Debt Principal Repayment and Interest ExpensePresented below is a schedule of the repayment requirements of long-term debt for each of the next five years and thereafter as of December 31,2007:2008:Principal Amount of
Long-Term Debt(in thousands) Principal Amount of Long-Term Debt 2008 $ 2,000 (In thousands) 2009 2009 14,500 $ 16,500 2010 2010 2,000 3,015 2011 2011 2,000 2,000 2012 2012 52,000 189,813 2013 — Thereafter Thereafter 425,000 425,000 Total principal payments 497,500 Total principal payments 636,328 Less: fair value discount Less: fair value discount (322 ) 182 Total long-term debt Total long-term debt $ 497,178 $ 636,146
102Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Presented below is a schedule of our estimated minimum lease payments on our capital lease obligations for the next five years and thereafter as of December 31,2007:Capital Lease
Obligation Minimum
Lease Payments(in thousands) 2008 $ 13,142 2009 9,251 2010 6,066 2011 2,950 2012 244 Thereafter — Total minimum lease payments 31,653 Less: executory costs (2,696 ) Net minimum lease payments 28,957 Less: amounts representing interest (2,142 ) Present value of minimum lease payments $ 26,815 Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)11. LONG-TERM DEBT (Continued)Capital Lease Obligation Minimum Lease Payments (In thousands) 2009 $ 10,635 2010 7,913 2011 4,832 2012 1,969 2013 378 Thereafter — Total minimum lease payments 25,727 Less: executory costs (729 ) Net minimum lease payments 24,998 Less: amounts representing interest (1,849 ) Present value of minimum lease payments $ 23,149 Interest expense for the years ended December 31, 2008, 20072006and20052006 consisted of the following:Year Ended December 31, Year Ended December 31, 2008 2007 2006 2007 2006 2005 (In thousands) (in thousands) Cash payments $ 33,964 $ 40,290 $ 39,098 $ 45,211 $ 33,964 $ 40,290 Commitment and agency fees paid 2,232 4,244 14,909 102 2,232 4,244 Amortization of discount and premium, net — — (212 ) Amortization of debt issuance costs 1,680 1,620 1,351 Amortization of discount, net 140 — — Amortization of deferred financing costs 1,975 1,680 1,620 Settlement of interest rate swaps 2,261 — — — 2,261 — Net change in accrued interest 1,366 (3,869 ) (3,581 ) 333 1,366 (3,869 ) Capitalized interest (5,296 ) (3,358 ) (1,266 ) (6,514 ) (5,296 ) (3,358 ) Total interest expense $ 36,207 $ 38,927 $ 50,299 $ 41,247 $ 36,207 $ 38,927 As of December 31, 2008 and 2007, the weighted average interest rate of our variable rate debt was5.9787%.4.17% and 5.98%, respectively.Deferred Financing CostsIn connection with our long-term debt, we capitalized costs and expenses of approximately $0.3 million, $13.4 million and $0.5 million for the years ended December 31, 2008, 2007 and 2006, respectively. Amortization of deferred financing costs totaled $2.0 million, $1.7 million and $1.6 million for the years ended December 31, 2008, 2007 and 2006, respectively. Unamortized debt issuance costs written off and included in the determination of the gain or loss on the extinguishment of debt were zero, $9.6 million and
10312. COMMITMENTS AND CONTINGENCIESKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)zero for the years ended December 31, 2008, 2007 and 2006, respectively. Net carrying values for the years presented appear in the table below:December 31, 2008 2007 (In thousands) Deferred financing costs:Gross carrying value $ 12,609 $ 12,262 Accumulated amortization (2,120 ) (145 ) Net carrying value $ 10,489 $ 12,117 NOTE 13. COMMITMENTS AND CONTINGENCIES Operating LeaseArrangements.ArrangementsKey leases certain property and equipment under non-cancelable operating leases thatgenerallyexpire at various dates through2020,2019, with varying payment dates throughout each month.As of December 31,2007,2008, the future minimum lease payments under non-cancelable operating leases are as follows (in thousands):Lease Payments 2008 $ 7,428 Lease Payments 2009 5,569 $ 6,312 2010 3,823 5,664 2011 1,719 4,578 2012 1,540 4,000 2013 2,996 Thereafter 4,145 4,679 $ 24,224 $ 28,229 The Company also is party to a significant number of month-to-month leases that are cancelable at any time. Operating lease expense was $22.4 million, $16.4 million$17.0 millionand$19.5$17.0 million for the years ended December 31, 2008, 2007 and 2006,and 2005,respectively.Litigationin the Normal Course of Business.Various suits and claims arising in the ordinary course of business are pending against us. Due in part to the locations where we conduct business in the continental United States, we are often subject to jury verdicts and arbitration hearings that result in outcomes in favor of the plaintiffs. We continually assess our contingent liabilities, including potential litigation liabilities, as well as the adequacy of our accruals and our need for the disclosure of these items. In accordance with SFAS 5, we establish a provision for a contingent liability when it is probable that a liability has been incurred and the amount is estimable. As of December 31, 2008, the aggregate amount of our provisions for losses related to litigation that are deemed probable and estimable is approximately $4.5 million. We do not believe that the disposition of any of theseitemsmatters will result in an additional loss materially in excess of amounts that have been recorded. In the year ended December 31, 2008, we recorded amaterial adverse impact on our financial position, resultsbenefit ofoperations or cash flows.approximately $2.2 million related to settlement of ongoing legal matters and continued refinement of liabilities recognized for litigation deemed probable and estimable. Provisions related to litigation matters that were deemed probable and estimable were $6.8 million in 2007 and $28.8 million in 2006.
104Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)GonzalesMatter.MatterIn September 2005, a class action lawsuit,Gonzales v. Key Energy Services, Inc., was filed in Ventura County, California Superior Court, alleging that Key did not pay its hourlyKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)12. COMMITMENTS AND CONTINGENCIES (Continued)employees for travel time between the yard and the wellhead and that certain employees were denied meal and rest
periods between shifts. We haveperiods. On September 17, 2008, we reached an agreement in principle, subject to court approval, to settle all claims related to this matter for $1.2 million. In 2005 we recorded a liability for thismatterlawsuit, anddo not expect thattheconclusionsubsequent settlement of this matterwillin 2008 did not have a material impact on our financial position, results of operations or cash flows.Litigation with Former Officers andEmployees.EmployeesWe were named in a lawsuit by our former general counsel, Jack D. Loftis, Jr., filed in the U.S. District Court, District of New Jersey on April 21, 2006, in which he alleges a"whistle-blower"“whistle-blower” claim under the Sarbanes-Oxley Act, breach of contract, breach of duties of good faith and fair dealing, breach of fiduciary duty and wrongful termination.Mr. Loftis previously filed his "whistle-blower" claim with the Department of Labor ("DOL"), which found that there was no reasonable cause to believe that we violated the Sarbanes-Oxley Act when we terminated Mr. Loftis and dismissed the complaint. On June 28, 2007, the New Jersey District Court transferred the case to the U.S. District Court for the Eastern District of Pennsylvania, where it is pending.On July 6, 2007, we delivered a notice to Mr. Loftis, through his counsel, of our intention to treat his termination of employment effective July 8, 2004 as "for cause" under his employment agreement.On August 17, 2007, the Company filed counterclaims against Mr. Loftis alleging attorney malpractice, breach of contract and breach of fiduciary duties. In its counterclaims, the Company seeks repayment of all severance paid to Mr. Loftis to date (approximately $0.8 million) plus benefits paid during the period July 8, 2004 to September 21, 2004,as well asand damages relating to the allegations of malpractice and breach of fiduciary duties. The case was transferred to and is now pending in the U.S. District Court for the Eastern District of Pennsylvania and is currently set for trial in the fourth quarter of 2009. We recorded for the fourth quarter of 2008 a liability for this matter and do not believe that the conclusion of this matter will have a material impact on our financial position, results of operations or cash flows.OnSeptember 21, 2007,October 17, 2006, Jane John, theCompany's Boardex-wife ofDirectors determinedour former chief executive officer, Francis John, filed a complaint in Bucks County, Pennsylvania against her ex-husband and the Company. Ms. John alleges breach of marital agreement, breach of options agreements, civil conspiracy and fraud. She alleges that Mr.Loftis should be terminated "for cause" effective July 8, 2004,John andfurther found that his vested and unvestedthe Company defrauded her with regard to Mr. John’s compensation, as well as in the disclosures of marital property. By virtue of assignments, Ms. John holds 375,000 stock optionsshouldwhich expired unexercised during the period before the Company became current in its financial statements, when such options could not bedeemed expired.exercised. In resolving a separate lawsuit between the Company and Mr. John, Mr. John agreed to indemnify the Company with respect to damages attributable to any and all of Ms. John’s claims, other than damages attributable to any alleged breach of Ms. John’s stock option agreements, for which the Company agreed to indemnify Mr. John. Discovery in the case remains ongoing, and there is currently not a trial setting. We recorded a liability for this matter for the third quarter of 2008 and do not believe that the conclusion of this matter will have a material impact on our financial position, results of operations or cash flows.
On September 3, 2006, our former controller and former assistant controller filed a joint complaint against the Companyonin133rdthe 133rd District Court, Harris County, Texas, alleging constructive termination and breach of contract.Discovery is now ongoing in this case.Additionally, on January 11, 2008, our formerChief Operating Officer,chief operating officer, James Byerlotzer, filed a lawsuit in the 55th District Court, Harris County, Texas, alleging breach of contract based on his inability to exercise his stock options during the period thatKey waswe were not current initsour SEC filings, and based onKey'sour failure to provide him shares of restricted stock.We are
vigorously defending againstcurrently set for trial in both of theseclaims; however, we cannot predictmatters in theoutcomesecond quarter of 2009. We have not recorded a liability for these matters and do not believe that thelawsuits.conclusion of these matters will have a material impact on our financial position, results of operations or cash flows.
On August 21, 2006, our former chief financial officer, Royce W. Mitchell, filed a suit against the Company in385th385th District Court, Midland County, Texas alleging breach of contract with regard to alleged bonuses, benefits, expense reimbursements, conditional stock grants and stock options, as well as relief under theories of quantum meruit, promissory estoppel and specific performance. On February 15, 2008, the parties
105Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)settled the matter for $0.5 million, which included reimbursement of expenses and attorneys fees of approximately $0.4 million.ShareholderStockholder Class Action Suits and DerivativeActions.ActionsSince June 2004, we and certain of our officers and directors were named asa defendantdefendants in six class action complaints brought on behalf of a putative class of purchasers of our securities for alleged violations of federal securities laws, which were filed in federal district court in Texas. These six actions were consolidated into one action.On November 1, 2005, the plaintiffs filed a consolidated amended class action complaint. The complaint was brought on behalf of a class of putative class of purchasers of our securities between April 29, 2003 and June 4, 2004. The complaint generally alleges that we made falseKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)12. COMMITMENTS AND CONTINGENCIES (Continued)and misleading statements and omitted material information from our public statements and SEC reports during the class period, in violation of the Securities Exchange Act of 1934, including alleged: (i) overstatement of revenues, net income, and earnings per share, (ii) failure to take write-downs of assets, consisting of primarily idle equipment, (iii) failure to amortize the Company's goodwill, (iv) failure to disclose that the Company lacked adequate internal controls and therefore was unable to ascertain the true financial condition of the Company, (v) material inflation of the Company's financial results at all relevant times, (vi) misrepresentation of the value of acquired businesses, and (vii) failure to disclose misappropriation of funds by employees.Four
shareholderstockholder derivative actions were also filed,by certain of our shareholders, purporting to actpurportedly on our behalf,asserting various claims against the named officer and director defendants. The derivative actionsgenerallyallegealleging the same facts as those in theshareholderconsolidated stockholder classaction suits. Those suits also allege breach of fiduciary duty, abuse of control, waste of corporate assets, and unjust enrichment by these defendants.action. On September 7, 2007, we reached agreements in principle to settle all
pending securitiesof these stockholder class action and derivative lawsuits in consideration of payments totaling $16.6 million in exchange for full and complete releases for all defendants, of whichKey will be required to paythe Company paid approximately $1.1 million.FinalWe received final approval of the settlement of theshareholder andstockholder class action claims by the courtis anticipated to occuron March 6, 2008, and final court approval on the derivative settlement was received on August 8, 2008. All litigation in thefirst quarter of 2008. We have recorded an appropriate liability for this matter.stockholder class action and derivative matters has been concluded.
Expired OptionHolders.HoldersOnIn September24,2007, Belinda Taylor filed a lawsuit in the 11th Judicial District of Harris County, Texas, on behalf of herself and all similarly situatedresidents of Texas, filed a lawsuit in the 11thJudicial District of Harris County, Texas, alleging that the Company breached its contracts withcurrent and former employees who held vested options that expired between April 28, 2004 and the date that the Company became current in its financial statements (the"Expired“Expired OptionHolders"Holders”). The suit,also allegesas amended, alleged that the Company breached its contracts with the Expired Option Holders, and breached its fiduciary duties and duties of good faith and fair dealing in the pricing of stock options it granted to those Expired OptionHolders, based uponHolders. On March 6, 2008, thealleged overstatement of assets priorparties agreed tothe Company's restatement. Ms. Taylor amended her lawsuit on September 25, 2007, to includesettle all pending claims with all Expired Option Holders,regardlessexcluding those terminated for cause and those who have previously filed suits against us, for approximately $1.0 million, which includes all taxes and legal fees. The court entered a final order approving the settlement on August 25, 2008 and dismissed the case. In December 2008, the payments to the class, pursuant to the terms ofresidence.the settlement, were completed.The lawsuits in which we are involved with Jane John and our former controller and former assistant controller, described above under“Litigation with Former Officers and Employees,”also involve claims relating to expired stock options.Automobile Accident LitigationOn August 22, 2007, one of our employees was involved in an automobile accident that resulted in a third party fatality and during the first quarter of 2008 we recorded an appropriate liability for this matter. The lawsuit arising from this accident was settled during the third quarter of 2008 and the Companyhas deniedrecognized incremental expense of less than $0.5 million related to theallegations, and does not expectsettlement during theresolutionthird quarter ofthis matter to have a material impact on its financial position, results of operations or cash flows.2008.
TaxAudits.AuditsWe are routinely the subject of audits by tax authorities, and in the past have receivedsomematerial assessments from tax auditors. As of December 31, 2008 and 2007, we have recorded reserves that management feels are appropriate for future potential liabilities as a result of these audits. While we believe we have fully reserved for these assessments, the ultimate amount ofsettlementsettlements can vary fromthis estimate.our estimates.In connection with an ongoing sales tax audit, the Company recorded a liability of approximately $3.2 million during the third quarter of 2008 relating to state sales taxes not collected from the Company’s customers from 2003 through September 30, 2008 and therefore not remitted to the appropriate state agency.
106Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The provision was recorded as general and administrative expense. We do not expect that the ultimate resolution of the matter will result in a loss materially in excess of the amount already accrued.In connection with our former Egyptian operations, which terminated in 2005, we are undergoing income tax audits for all periods in which we had operations. As of December 31,20062008, the Companyhadhas recorded a liability of approximately$1.1$0.4 million relating to open Egyptian income tax audits. In the fourth quarter of 2007, the Company reached a preliminary settlement with the Egyptian tax authorities on the 2003 and 2004 tax years, recording a tax benefit of $0.7 million and reducing the tax liability accrued at December 31, 2007 to approximately $0.4 million.We do not expect that the ultimate resolution of the matter will result in a loss materially in excess of the amount already accrued.
Self-InsuranceReserves.ReservesWe maintain reserves forworkers'workers’ compensation and vehicle liability on our balance sheet based on our judgment and estimates using an actuarial method based on claimsKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)12. COMMITMENTS AND CONTINGENCIES (Continued)incurred. We estimate general liability claims on acase-by-case basis. We maintain insurance policies for
workers'workers’ compensation, vehicle liability and general liability claims. These insurance policies carry self-insured retention limits or deductibles on a per occurrence basis. The retention limits or deductibles are accounted for in our accrual process for allworkers'workers’ compensation, vehicular liability and general liability claims. As of December 31,20072008 andDecember 31, 2006,2007, we have recorded$69.0$68.9 million and $69.0 million, respectively, of self-insurance reserves related toworkers'workers’ compensation, vehicular liabilities and general liability claims. Partially offsetting these liabilities, we had approximately$8.1$10.8 million and$5.7$8.1 million of insurance receivables as of December 31, 2008 and 2007, respectively. We feel that the liabilities we have recorded are appropriate based on the known facts and2006, respectively.circumstances and do not expect further losses materially in excess of the amounts already accrued for existing claims.
Environmental RemediationLiabilities.LiabilitiesFor environmental reserve matters, including remediation efforts for current locations and those relating to previously-disposed properties, we record liabilities when our remediation efforts are probable and the costs to conduct such remediation effortsarecan be reasonably estimated.EnvironmentalWhile our litigation reserves reflect the application of our insurance coverage, our environmental reserves do not reflectmanagement'smanagement’s assessment of the insurance coverage that may apply tothesethe matters atissue, if such coverage is available, whereas our litigation reserves do reflect the application of our insurance coverage.issue. As of December 31,20072008 andDecember 31, 2006,2007, we have recorded$3.1$3.0 million and$4.6$3.1 million, respectively, for our environmental remediation liabilities.We feel that the liabilities we have recorded are appropriate based on the known facts and circumstances and do not expect further losses materially in excess of the amounts already accrued.
We provide performance bonds to provide financial surety assurances for the remediation and maintenance of our SWD properties to comply with environmental protection standards. Costs for SWD properties may be mandatory (to comply with applicable laws and regulations), in the future (required to divest or cease operations), or for optimization (to improve operations, but not for safety or regulatory compliance).Registration Payment ArrangementIn January 1999, we issued 150,000 warrants (the “Warrants”) in connection with a debt offering that were exercisable for an aggregate of approximately 2.2 million shares of the Company’s stock at an exercise price of $4.88125 per share. As of December 31, 2008, 83,800 Warrants had been exercised, leaving 66,200 outstanding, which were exercisable for approximately 1.0 million shares of our common stock. Termination notice was provided to the holders of the outstanding Warrants that the Warrants expired on February 2, 2009.Under the terms of the Warrants, the Company was required to maintain an effective registration statement covering the shares potentially issuable upon exercise of the Warrants. If the Company did not have
107Argentina Payroll Matters.Our Argentinean subsidiary,Key Energy Services,S.A., had previously underpaid social security contributionsInc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)an effective registration statement covering the shares, the Company was required to make liquidated damages payments to theAdministración Federal de Ingressos Públicos ("AFIP") as a resultholders ofapplying an incorrect rate inthecalculationWarrants. During the twelve months ended December 31, 2008, 2007 and 2006, the Company made liquidated damages payments totaling $0.8 million, $0.9 million and $0.9 million, respectively. On August 21, 2008, the requisite registration statement required by the terms of the Warrants became effective. From and after August 22, 2008, no additional liquidated damage payments were required to be made by the Company.NOTE 14. ACCUMULATED OTHER COMPREHENSIVE LOSS The components of ourobligations. Additionally, we also underpaid AFIPaccumulated other comprehensive loss are asa result of our incorrect use of food stamp equivalents provided to employees as compensation. The correct amounts have been reflected in these financial statements. On May 31, 2007 we paid AFIP $3.5 million, representing the cumulative amount of underpayment and interest. As a result of our underpayment, AFIP has imposed fines and penalties against us and has begun an audit of our filings made to them in prior years. We have recorded an appropriate liability for this matter and do not expect the ultimate resolution of this matter to have a material impact to our financial position, results of operations or cash flows.13. FOREIGN CURRENCY TRANSLATIONfollows:
December 31, 2008 2007 (In thousands) Foreign currency translation loss $ (46,520 ) $ (37,959 ) Deferred loss from available for sale investments (30 ) (22 ) Accumulated other comprehensive loss $ (46,550 ) $ (37,981 ) The local currency is the functional currency for our operations in Argentina, Mexico andCanada.Canada, and for our equity investments in Canada and the Russian Federation. The cumulative translation gains and losses resulting from translating each foreignsubsidiary'ssubsidiary’s financial statements from the functional currency to U.S. dollars are included in other comprehensive income and accumulated instockholders'stockholders’ equity until a partial or complete sale or liquidation of our net investment in the foreign entity. The table below summarizes the conversion ratios used to translate theKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)13. FOREIGN CURRENCY TRANSLATION (Continued)financial statements and the cumulative currency translation gains and losses, net of tax, for each
of our foreign subsidiaries:Argentina Mexico Canada(1) Total (in thousands, except for conversion ratios) As of December 31, 2007:
Conversion ratio
3.15 : 1
10.92 : 1
0.98 : 1
n/a
Cumulative translation adjustment $ (38,181 ) $(143 ) $365 $ (37,959 )
As of December 31, 2006:
Conversion ratio
3.1 : 1
n/a
1.17 : 1
n/a
Cumulative translation adjustment $ (36,896 ) $— $218 $ (36,678 ) (1)Foreign currency translation gains for Canada include translation gains related to the acquisition of AMI and the Company's equity-method investment in IROC Systems Corp.
14. EMPLOYEE BENEFIT PLANScurrency:
Argentine Peso Mexican Peso Canadian Dollar Euro Russian Rouble Total (In thousands, except for conversion ratios) As of December 31, 2008:Conversion ratio 3.46:1 13.78:1 1.22:1 0.71:1 29.48:1 n/a Cumulative translation adjustment $ (43,654 ) $ (1,663 ) $ (917 ) $ (286 ) $ — $ (46,520 ) As of December 31, 2007:Conversion ratio 3.15:1 10.92:1 0.98:1 0.68:1 24.51:1 n/a Cumulative translation adjustment $ (38,181 ) $ (143 ) $ 365 $ — $ — $ (37,959 ) NOTE 15. EMPLOYEE BENEFIT PLANS We maintain a 401(k) plan as part of our employee benefits package. We match 100% of employee contributions up to 4% of theemployee'semployee’s salary into our 401(k) plan, subject to maximums of $9,200, $9,000$8,800and$8,400$8,800 for the years ended December 31, 2008, 20072006and2005,2006, respectively. Our matching contributions were $11.9 million, $10.2 million$7.4 millionand$5.8$7.4 million for the years ended December 31, 2008, 2007 and 2006,and 2005,respectively.Employees are fully vested in the matching contributions when they are made by the Company.
Effective January 1, 2006, we no longer offered participants the option to purchase units of company stock through a 401(k) plan fund. We discontinued this option for participants and transferred all units of Key stock into another 401(k) plan fund, which did not affect the ability of plan participants to manage these contributions.
10815. STOCKHOLDERS' EQUITYKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)NOTE 16. STOCKHOLDERS’ EQUITY Common StockOn December 31, 2008, we had 200,000,000 shares of common stock authorized with a $0.10 par value, of which 121,305,289 shares were issued and outstanding, and during 2008 no dividends were paid. On December 31, 2007, we had 200,000,000 shares of common stock authorized with a $0.10 parvalue;value, of which 131,142,905of thesesharesof common stockwere issued and outstanding, and during 2007 no dividendshad been issued. On December 31, 2006, we had 200,000,000 shares of common stock authorized with a $0.10 par value; 131,624,038 of these shares of common stockwereissued and outstanding, and no dividends had been issued.paid. Under the terms of the Senior Notes and2007Senior Secured Credit Facility, we must meet certain financial covenants before we may pay dividends. We currently do not intend to pay dividends.Share RepurchaseProgram.ProgramOnIn October26,2007,the Company'sour Board of Directors authorized a share repurchase programin which the Company may spendof up to $300.0 millionto repurchasewhich is effective through March 31, 2009. From the inception of the program in November 2007 through December 31, 2008, we have repurchased approximately 13.4 million shares ofitsour common stockon thethrough openmarket. The program expires at the end of the first quarter of 2009. In 2007, the Company repurchasedmarket transactions for an aggregateof 2,341,400 shares at a total costprice of approximately$32.2$167.3 million. Share repurchases during 2008 were approximately 11.1 millionwhich represents the fair market value of thesharesbased on thefor an aggregate price of approximately $135.2 million. Our repurchase program, as well as theCompany'samount and timing of future repurchases, is subject to market conditions, our financial condition, and our liquidity. Our Senior Secured Credit Facility permits us to make stockon the datesrepurchases in excess ofpurchase.$200.0 million only if our consolidated debt to capitalization ratio (as defined) is below 50%; as of December 31, 2008, that ratio was below 50%.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)15. STOCKHOLDERS' EQUITY (Continued)Tax
Withholding.WithholdingIn June 2006, the Company began purchasing shares of restricted common stock that had been previously granted to certain of theCompany's executiveCompany’s officers, pursuant to an agreement under which those individuals were permitted to sell shares back to the Company in order to satisfy the minimum income tax withholding requirements related to vesting of these grants. We repurchased a total of72,84797,443 and80,83572,847 shares for an aggregate cost of $1.2 million and $1.3 million during 2008 and$1.2 million during2007,and 2006,respectively, which represented the fair market value of the shares based on the price of theCompany'sCompany’s stock on the dates of purchase.Through December 31,2007,2008, under the share repurchase program, tax withholdings and share acquisitions in prior years, we have repurchased approximately2.913.7 million shares of our common stock, at an aggregate cost of$44.3$171.0 million.Common Stock WarrantsIn January 1999, we issued 150,000Warrantswarrants (the “Warrants”) in connection with a debt offering that were exercisable for an aggregate of approximately 2.2 million shares of theCompany's commonCompany’s stock at an exercise price of $4.88125 perunderlyingshare.The Warrants were recorded at their fair value on the dateAs ofissuance as a component of stockholders' equity. During the fourth quarter of 2007, 2,500 Warrants were exercised for 23,226 shares of our common stock. These exercises were made under the "cashless" exercise provisions of the Warrants. AtDecember 31,2007, 85,000 warrants remained2008, 83,800 Warrants had been exercised, leaving 66,200 outstanding,andwhich were exercisable for approximately1.21.0 million shares of our common stock.TheTermination notice was provided to the holders of the outstanding Warrantsexpireand the Warrants expired onJanuary 15,February 2, 2009.Under the terms of the Warrants,we arethe Company was required to maintain an effective registration statement covering the sharesof common stockpotentially issuable uponexercise.exercise of the Warrants. Ifwe are unable to maintainthe Company did not have an effective registration statementwe arecovering the shares, the Company was required topaymake liquidated damagesfor periods in whichpayments to the holders of the Warrants. Because of the Company’s past failure to timely file its Annual and Quarterly Reports with the SEC, it did not have an effective registration statement,is not maintained. We were unable to maintain an effective registration statement due to our past inability to timely file our required periodic reports withand during theSEC and we have not filed a new registration statement. As a result, we paid liquidated damages of $0.9 million, $0.9 million and $0.7 million for the yearstwelve months ended December 31, 2008, 2007 and 2006, the Company made liquidated damages payments totaling $0.8, $0.9 and2005,$0.9 million, respectively. On August 21, 2008, the requisite registration statement required by the terms of the Warrants became effective. From and after August 22, 2008, no additional liquidated damage payments were required to be made by the Company related to the Warrants.
10916. EQUITY-BASED COMPENSATIONKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)NOTE 17. SHARE-BASED COMPENSATION 2007 Incentive PlanOn December 6, 2007, the Company’s shareholders approved the 2007 Equity and Cash Incentive Plan (the “2007 Incentive Plan”). The 2007 Incentive Plan is administered by the Board or a committee designated by the Board (the “Committee”). The Board or the Committee (the “Administrator”) will have the power and authority to select Participants (as defined below) in the 2007 Incentive Plan and to grant Awards (as defined below) to such Participants pursuant to the terms of the 2007 Incentive Plan.Subject to adjustment, the total number of shares of the Company’s common stock, par value $0.10 per share, that will be available for the grant of Awards under the 2007 Incentive Plan may not exceed 4,000,000 shares; however, for purposes of this limitation, any stock subject to an award that is canceled, forfeited or expires prior to exercise or realization will again become available for issuance under the 2007 Incentive Plan. Subject to adjustment, no Participant will be granted, during any one year period, options to purchase common stockand/or stock appreciation rights with respect to more than 500,000 shares of common stock. Stock available for distribution under the 2007 Incentive Plan will come from authorized and unissued shares or shares reacquired by the Company in any manner. All awards under the 2007 Incentive Plan are granted at fair market value on the date of issuance.Awards may be in the form of options (incentive stock options and nonstatutory stock options), restricted stock, restricted stock units, performance compensation awards and stock appreciation rights (collectively, “Awards”). Awards may be granted to employees, directors and, in some cases, consultants and those individuals whom the Administrator determines are reasonably expected to become employees, directors or consultants following the grant date of the Award (“Participants”). However, incentive stock options may be granted only to employees. Vesting periods may be set at the Board’s discretion, and Awards have ten-year contractual lives.The Board at any time, and from time to time, may amend or terminate the 2007 Incentive Plan. However, except as provided otherwise in the 2007 Incentive Plan, no amendment will be effective unless approved by the shareholders of the Company to the extent shareholder approval is necessary to satisfy any applicable law or securities exchange listing requirements. As of December 31, 2008, there have been 1,806,556 awards granted with 2,250,144 remaining grants available under the 2007 Incentive Plan.1997 IncentivePlan.PlanOn January 13, 1998,Key'sKey’s shareholders approved the Key Energy Group, Inc. 1997 Incentive Plan, as amended (the"1997“1997 IncentivePlan"Plan”, and together with the 2007 Incentive Plan, the “Plans”). The 1997 Incentive Plan is an amendment and restatement of the plans formerly known as the Key Energy Group, Inc. 1995 Stock Option Plan and the Key Energy Group, Inc. 1995 Outside Directors Stock Option Plan. On November 17, 2007, the 1997 Incentive Plan terminated pursuant to its terms.Under the 1997 Incentive Plan, Key was allowed to grant the following awards to certain key employees, directors who are not employees ("Outside Directors") and consultants of Key, our controlled subsidiaries, and our 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 restricted stock, (v) performance shares and performance units, (vi) other stock-based awards and (vii) supplemental tax bonuses. The number and kind of securities that were issued under the 1997 Incentive Plan and pursuant to then-outstanding incentive awards are subject to adjustments to preventKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)16. EQUITY-BASED COMPENSATION (Continued)enlargement or dilution of rights resulting from stock dividends, stock splits, recapitalizations, reorganization or similar transactions.The exercise price of options granted under the 1997 Incentive Plan is at or above the fair market value per share on the date the options are granted. Under the 1997 Incentive Plan, while the shares of common stock are listed on a securities exchange, fair market value was determined using the closing sales price on the immediate preceding business day as reported on such securities exchange.When the shares were not listed on an exchange, which includes the period from April 2005 through October 2007, the fair market value was determined by using the published closing price of the common stock on the Pink Sheets on the business day immediately preceding the date of grant.The exercise of NSOs results in a U.S. tax deduction to us equal to the difference between the exercise price and the market price at the exercise date.
110Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)During the period2000-2001, the Board of Directors granted 3.7 million stock options that were outside the 1997 Incentive Plan, of which180,000120,000 remained outstanding as of December 31,2007.2008 The 3.7 million non-plan options were in addition to and do not include other options which were granted under the 1997 Incentive Plan, but not in conformity with certain of the terms of the 1997 Incentive Plan.2007 Incentive Plan.Accelerated Vesting of Option and SAR AwardsOn December 6, 2007,Because of declines in theCompany's shareholders approved its 2007 Equity and Cash Incentive Plan (the "2007 Incentive Plan"). The 2007 Incentive Plan will be administered byCompany’s stock price, the Company’s Boardor a committee designated byof Directors resolved during theBoard (the "Committee"). Whilefourth quarter of 2008 to accelerate theCompany is a publicly traded company, the Committee may consist solely of two or more membersvesting period on certain of theBoard who qualify as "outside directors" within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"), and as "non-employee directors" under Rule 16b-3 as promulgated under Section 16 of the Securities Exchange Act of 1934. The Board or the Committee (the "Administrator") will have the power and authority to select Participants (as defined below) in the 2007 Incentive Plan and to grant Awards (as defined below) to such Participants pursuant to the terms of the 2007 Incentive Plan.Subject to adjustment, the total number of shares of the Company's commonCompany’s outstanding unvested stockpar value $0.10 per share, that will be available for the grant of Awards under the 2007 Incentive Plan may not exceed 4,000,000 shares; however, for purposes of this limitation, any stock subject to an Award that is canceled, forfeited or expires prior to exercise or realization will again become available for issuance under the 2007 Incentive Plan. Subject to adjustment, no Participant will be granted, during any one year period, options to purchase common stock and/or stock appreciation rights with respect to more than 500,000 shares of common stock. Stock available for distribution under the 2007 Incentive Plan will come from authorized and unissued shares or shares reacquired by the Company in any manner.Awards may be in the form of options (incentive stock options and nonstatutory stock options), restricted stock, restricted stock units, performance compensationoption awards and stock appreciation rights,(collectively, "Awards"). Awards may be granted to employees, directors and, in some cases, consultants and those individuals whom the Administrator determines are reasonably expected to become employees, directors or consultants following the grant date of the Award ("Participants"). However, incentive stock options may be granted only towhich affected approximately 280 employees.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)16. EQUITY-BASED COMPENSATION (Continued)The 2007 Incentive Plan provides that in the event of certain corporate events or changes in the Company's common stock, Awards and the maximum number of shares subject to all Awards under the 2007 Incentive Plan and the maximum number of shares that can be awarded to any one person will be adjusted to reflect such event. Any such adjustment made to an incentive stock option will be made in accordance with Section 424(a) of the Code and any such adjustment made to a nonstatutory option will be made so as not to violate Section 409A of the Code.In the event of a Change in Control (as defined in the 2007 Incentive Plan), unless otherwise provided in an Award agreement, all options and stock appreciation rights will become immediately exercisable with respect to 100% of the shares subject to such option or stock appreciation rights, and the restrictions will expire immediately with respect to 100% of shares of restricted stock or restricted stock units subject to such Award (including a waiver of any applicable performance goals). In addition, unless otherwise provided in an Award agreement, all incomplete performance periods in respect of a performance compensation award will end upon the Change in Control, and the Administrator will (a) determine the extent to which performance goals with respect to each such performance period have been met, (b) cause to be paid to the applicable participant partial or full performance compensation awards with respect to performance goals for each such performance period based upon the Administrator's determination of the degree of attainment of performance goals and (c) cause the Award, if previously deferred, to be settled in full as soon as possible. Further, in the event of a Change in Control, the Administrator may in its discretion and upon advance notice to the affected persons, cancel any outstanding Awards and pay to the holders thereof, in cash or stock, or any combination thereof, the value of such Awards based upon the price per share of the Company's common stock received or to be received by other shareholders of the Company in the event.Upon exercise, payment or delivery pursuant to an Award, the participant will be required to certify that the participant has not engaged in any Detrimental Activity (as defined in the 2007 Incentive Plan). Subject to the terms of the applicable Award agreement, the Administrator may cancel, rescind, suspend, withhold or otherwise limit or restrict any unexpired, unpaid or deferred Awards at any time if the participant engages in any Detrimental Activity. If a participant engages in Detrimental Activity after any exercise, payment or delivery pursuant to an Award, during any period for which any restrictive covenant prohibiting such activity is applicable to the participant, such exercise, payment or delivery may be rescinded within one year thereafter. In the event of any such rescission, the participant will pay to the Company the amount of any gain realized or payment received asAs a result of theexercise, payment or delivery,acceleration, the Company recorded a pre-tax charge of approximately $10.9 million insuch mannergeneral andon such terms and conditions as may be required by the Company.
operations.The Board at any time, and from time to time, may amend or terminate the 2007 Incentive Plan. However, except as provided otherwiseadministrative expense in the2007 Incentive Plan, no amendment will be effective unless approved by the stockholdersaccompanying consolidated statement ofthe Company to the extent stockholder approval is necessary to satisfy any applicable law or securities exchange listing requirements. As of December 31, 2007, no Awards had been granted under the 2007 Incentive Plan.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)16. EQUITY-BASED COMPENSATION (Continued)Stock Option AwardsStock option awards granted under the1997 Incentive PlanPlans have a maximum contractual term of ten years from the date of grant. Shares issuable upon exercise of a stock option are issued from authorized but unissued shares of theCompany'sCompany’s common stock. The following table summarizes the stock option activity related to the1997 Incentive PlanPlans andthecertain options granted in prior years that were outside the 1997 IncentivePlan, of which 180,000Plan. 5.0 million options were outstanding as of December 31, 2008, and 2.3 million shares remained available for issuance under the 2007 Incentive Plan as of December 31, 2008 (shares in thousands):Year Ended December 31, 2008 Weighted Average Weighted Average Options Exercise Price Fair Value Outstanding at beginning of period 4,594 $ 11.01 $ 5.32 Granted 1,379 $ 14.76 $ 5.43 Exercised (757 ) $ 8.81 $ 4.81 Cancelled or expired (255 ) $ 14.53 $ 6.15 Outstanding at end of period 4,961 $ 12.21 $ 5.38 Exercisable at end of period 4,911 $ 12.30 $ 5.42 Year Ended December 31, 2007 Weighted Average Weighted Average Options Exercise Price Fair Value Outstanding at beginning of period 5,829 $ 9.46 $ 4.94 Granted 1,195 $ 14.41 $ 5.98 Exercised (1,592 ) $ 8.45 $ 4.58 Cancelled or expired (838 ) $ 10.36 $ 5.03 Outstanding at end of period 4,594 $ 11.01 $ 5.32 Exercisable at end of period 2,615 $ 8.34 $ 4.47
111Year Ended December 31, 2007 Options Weighted Average
Exercise PriceWeighted Average
Fair ValueOutstanding at beginning of period 5,829 $ 9.46 $ 4.94 Granted 1,195 $ 14.41 $ 5.98 Exercised (1,592 ) $ 8.45 $ 4.58 Cancelled or expired (838 ) $ 10.36 $ 5.03 Outstanding at end of period 4,594 $ 11.01 $ 5.32
Exercisable at end of period
2,615
$
8.34
$
4.47Year Ended December 31, 2006 Options Weighted Average
Exercise PriceWeighted Average
Fair ValueOutstanding at beginning of period 9,275 $ 8.68 $ 4.79 Granted 833 $ 15.03 $ 7.21 Exercised — $ — $ — Cancelled or expired(1) (4,279 ) $ 8.86 $ 5.06 Outstanding at end of period 5,829 $ 9.46 $ 4.94
Exercisable at end of period
4,791
$
8.42
$
4.51Year Ended December 31, 2005 Options Weighted Average
Exercise PriceWeighted Average
Fair ValueOutstanding at beginning of period 10,408 $ 8.47 $ 4.77 Granted 385 $ 12.20 $ 6.09 Exercised — $ — $ — Cancelled or expired (1,518 ) $ 8.16 $ 4.97 Outstanding at end of period 9,275 $ 8.68 $ 4.79
Exercisable at end of period
8,628
$
8.49
$
4.75(1)Cancelled/expired options in 2006 include approximately 3.9 million options previously held by our former chief executive officer, which were cancelled in connection with his termination.
Key Energy Services, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)16. EQUITY-BASED COMPENSATION (Continued)Year Ended December 31, 2006 Weighted Average Weighted Average Options Exercise Price Fair Value Outstanding at beginning of period 9,275 $ 8.68 $ 4.79 Granted 833 $ 15.03 $ 7.21 Exercised — $ — $ — Cancelled or expired(1) (4,279 ) $ 8.86 $ 5.06 Outstanding at end of period 5,829 $ 9.46 $ 4.94 Exercisable at end of period 4,791 $ 8.42 $ 4.51 (1) Cancelled/expired options in 2006 include approximately 3.9 million options previously held by our former chief executive officer, which were cancelled in connection with his termination. The following table summarizes information about the stock options outstanding at December 31,20072008 (shares in thousands):Options Outstanding Weighted Average
Remaining
Contractual Life
(Years)Number of
Options
OutstandingWeighted Average
Exercise PriceWeighted Average
Fair ValueRange of Exercise Prices: $ 3.00 - $ 7.44 1.46 749 $ 4.80 $ 3.42 $ 7.45 - $ 9.37 3.45 980 $ 8.34 $ 4.82 $ 9.38 - $13.10 6.40 933 $ 11.27 $ 4.98 $13.11 - $14.70 9.56 1,196 $ 14.31 $ 5.98 $14.71 - $18.90 8.26 736 $ 15.20 $ 7.26 4,594 $ 11.01 $ 5.32
Aggregate intrinsic value (in thousands)
$
16,153
Options Exercisable Number of
Options
OutstandingWeighted Average
Exercise PriceWeighted Average
Fair ValueRange of Exercise Prices: $ 3.00 - $ 7.44 749 $ 4.80 $ 3.42 $ 7.45 - $ 9.37 958 $ 8.35 $ 4.84 $ 9.38 - $13.10 882 $ 9.49 $ 4.88 $13.11 - $14.51 26 $ 14.29 $ 7.07 2,615 $ 8.34 $ 4.47
Aggregate intrinsic value (in thousands)
$
15,992
Options Outstanding Weighted Average Remaining Number of Contractual Life Options Weighted Average Weighted Average (Years) Outstanding Exercise Price Fair Value Range of exercise prices: $ 3.00 - $ 7.44 1.42 549 $ 3.85 $ 2.62 $ 7.45 - $ 9.37 2.28 660 $ 8.31 $ 4.89 $ 9.38 - $13.10 5.63 813 $ 11.32 $ 5.28 $13.11 -$14.70 8.55 1,066 $ 14.31 $ 5.99 $14.71 -$19.42 8.63 1,873 $ 15.22 $ 6.14 4,961 $ 12.21 $ 5.38 Aggregate intrinsic value (in thousands) $ 578 Options Exercisable Number of Options Weighted Average Weighted Average Exercisable Exercise Price Fair Value Range of exercise prices: $ 3.00 - $ 7.44 499 $ 3.83 $ 2.71 $ 7.45 - $ 9.37 653 $ 8.33 $ 4.89 $ 9.38 - $13.10 821 $ 11.30 $ 5.11 $13.11 -$14.70 1,066 $ 14.31 $ 5.99 $14.71 -$19.42 1,872 $ 15.22 $ 6.14 4,911 $ 12.30 $ 5.42 Aggregate intrinsic value (in thousands) $ 556 The total fair value of stock options granted during the years ended December 31, 2008, 2007 and 2006and 2005was $7.5 million, $7.1 million and $6.0 million,and $2.3 million,respectively.ForThe total fair value of stock options vested during the year ended December 31, 2008 was $19.4 million, including $14.8 million resulting from the112
Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)acceleration of the vesting of certain of the Company’s equity awards. For the years ended December 31, 2008, 2007 and 2006, the Company recognized approximately $15.1 million, $3.5 million and $2.6 million in pre-tax expense related to stockoptions.options, respectively. For unvested stock option awards outstanding as of December 31,2007, we expect2008, the Company expects to recognize approximately$7.3less than $0.1 million of compensation expense over a weighted average remaining vesting period of approximately0.582.4 years.Tax benefitsThe weighted average remaining contractual term for stock option awards exercisable as of$0.7December 31, 2008 is 6.5 years. The intrinsic value of the options exercised for the years ended December 31, 2008 and 2007 was $5.8 million and $10.2 million, respectively. No options wererecognizedexercised in 2006. Cash received from the exercise of options for the year ended December 31,2007 related to stock options.2008 was $6.7 million with recognition of associated tax benefits in the amount of $5.2 million.
Common Stock AwardsIn June 2005 we began granting shares of common stock to our outside directors and certain employees. Common stock awards granted to our outside directors vest immediately, while those granted to our employees vest ratably over a three-year period and are subject to forfeiture. The total fair market value of all common stock awards granted during the years ended December 31, 2008, 2007 and 2006and 2005was $6.5 million, $4.7 million and $5.9 million,and $6.5 million,respectively.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)16. EQUITY-BASED COMPENSATION (Continued)Pursuant to the agreement under which they are issued common stock awards, recipients of those awards may have shares withheld in order to satisfy thoseindividuals'individuals’ income tax obligations associated with the vesting of the awards granted to them. Shares withheld for tax withholding purposes totaled72,84797,443 and80,83572,847 for the years ended December 31,20072008 and2006,2007, respectively, with aggregate repurchase values of$1.3$1.2 million and$1.2$1.3 million, respectively. In connection with a vesting in June of 2006, one of the recipients was permitted to have an amount withheld that was in excess of the required minimum withholding under current tax law. Under SFAS 123(R),we arethe Company is required to account for this grant as a liability award. Compensation expense for this award during the years ended December 31, 2008, 2007 and 2006and 2005was less than $0.1 million, $0.1 million and $0.2 million,and $0.1 million,respectively.The last tranche of shares associated with this award vested during 2008.
The following table summarizes information for the years ended December 31, 2008, 20072006and20052006 about the common share awards that have been issued by the Company (shares in thousands):Year Ended December 31, 2008 Weighted Average Weighted Average Outstanding Issuance Price Vested Issuance Price Shares at beginning of year 1,078 $ 14.01 478 $ 13.48 Shares issued during year(1) 428 $ 15.10 47 $ 18.01 Previously issued shares vesting during year — $ — 320 $ 13.97 Shares repurchased during year (97 ) $ 12.86 (97 ) $ 12.86 Shares at end of year 1,409 $ 14.42 748 $ 14.05
113Year Ended December 31, 2007 Outstanding Weighted Average
Issuance PriceVested Weighted Average
Issuance PriceShares at beginning of year 833 $ 13.69 258 $ 12.44 Shares issued during year(1) 318 $ 14.87 54 $ 17.48 Previously issued shares vesting during year — $ — 239 $ 13.87 Shares repurchased during year (73 ) $ 14.05 (73 ) $ 14.05 Shares at end of year 1,078 $ 14.01 478 $ 13.48 Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Year Ended December 31, 2007 Weighted Average Weighted Average Outstanding Issuance Price Vested Issuance Price Shares at beginning of year 833 $ 13.69 258 $ 12.44 Shares issued during year(1) 318 $ 14.87 54 $ 17.48 Previously issued shares vesting during year — $ — 239 $ 13.87 Shares repurchased during year (73 ) $ 14.05 (73 ) $ 14.05 Shares at end of year 1,078 $ 14.01 478 $ 13.48 Year Ended December 31, 2006 Weighted Average Weighted Average Outstanding Issuance Price Vested Issuance Price Shares at beginning of year 543 $ 11.90 43 $ 11.90 Shares issued during year(1) 371 $ 15.92 46 $ 14.95 Previously issued shares vesting during year — $ — 250 $ 11.90 Shares repurchased during year (81 ) $ 11.90 (81 ) $ 11.90 Shares at end of year 833 $ 13.69 258 $ 12.44 (1) Shares of common stock issued to our non-employee directors vest immediately upon issuance. Year Ended December 31, 2006 Outstanding Weighted Average
Issuance PriceVested Weighted Average
Issuance PriceShares at beginning of year 543 $ 11.90 43 $ 11.90 Shares issued during year(1) 371 $ 15.92 46 $ 14.95 Previously issued shares vesting during year — $ — 250 $ 11.90 Shares repurchased during year (81 ) $ 11.90 (81 ) $ 11.90 Shares at end of year 833 $ 13.69 258 $ 12.44 Year Ended December 31, 2005 Outstanding Weighted Average
Issuance PriceVested Weighted Average
Issuance PriceShares at beginning of year — $ — — $ — Shares issued during year(1) 543 $ 11.90 43 $ 11.90 Previously issued shares vesting during year — $ — — $ — Shares repurchased during year — $ — — $ — Shares at end of year 543 $ 11.90 43 $ 11.90 (1)Shares of common stock issued to our non-employee directors vest immediately upon issuance.
For common stock grants that vest immediately upon issuance,we recordthe Company records expense equal to the fair market value of the shares on the date of grant. For common stock awards that do not immediatelyKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)16. EQUITY-BASED COMPENSATION (Continued)vest,
we recognizethe Company recognizes compensation expense ratably over the vesting period of the grant, net of estimated and actual forfeitures. For the years ended December 31, 2008, 2007 and 2006,and 2005, wethe Company recognized $6.1 million, $5.6 million$3.6 millionand$2.5$3.6 million, respectively, of pre-tax expense associated with common stock awards, including common stock grants to our outside directors, net of estimated and actual forfeitures. In connection with the expense related to common stock awards recognized during the year ended December 31,2007, we2008, the Company recognized tax benefits of approximately$1.2$1.5 million. For the unvested common stock awards outstanding as of December 31,2007,2008, the Company anticipates that it will recognize approximately$5.2$5.5 million of pre-tax expense over the next0.651.5 years.Phantom Share PlanIn December 2006,wethe Company announced the implementation of a"Phantom“Phantom Share Plan,"” in which certain of our employees were granted"Phantom“Phantom Shares."” The Phantom Shares vest ratably over a four-year period and convey the right to the grantee to receive a cash payment on the anniversary date of the grant equal to the fair market value of the Phantom Shares vesting on that date. Grantees are not permitted to defer this payment to a later date. The Phantom Shares are a"liability"“liability” type award under SFAS 123(R), and we account for these awards at fair value. We recognize compensation expense related to the Phantom Shares based on the change in the fair value of the awards during the period and the percentage of the service requirement that has been performed, net of estimated and actual forfeitures, with an offsetting liability recorded on our consolidated balance sheets.During 2007, weWe recognized less than $0.1 million of pre-tax benefit and approximately $3.3 million of pre-tax compensation expense associated with the PhantomShares.Shares for the years ended December 31, 2008 and 2007, respectively. As of December 31,2007,2008, we recorded current and non-current liabilities of$2.4$0.9 million and$0.9$0.5 million, respectively, which represented the aggregate fair value of the114
Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Phantom Shares on that date. As of December 31, 2006, the amount of compensation expense and liabilities recorded related to the Phantom Share Plan in our consolidated financial statements were not material.We recognized income tax benefits associated with the Phantom Shares of less than $0.1 million and $1.3 million in2007.2008 and 2007, respectively. For unvested Phantom Share awards outstanding as of December 31,2007,2008, we expect to recognize approximately$3.4$1.3 million of compensation expense over a weighted average remaining vesting period of approximately1.51.7 years. The first payout under the Phantom Share Plan was made in January 2008, at which time we paid approximately $1.6 million in cash to the holders of Phantom Shares that vested in December 2007.Stock Appreciation RightsIn August 2007, the Company issued approximately 587,000stock appreciation rights ("SARs")SARs to its executive officers. Each SAR has a ten-year term from the date of grant and vests in equal annual installments on the first, second and third anniversaries of the date of grant. Upon the exercise of a SAR, the recipient will receive an amount equal to the difference between the exercise price and the fair market value of a share of theCompany'sCompany’s common stock on the date of exercise, multiplied by the number of shares of common stock for which the SAR was exercised. All payments will be made in shares of theCompany'sCompany’s common stock. Prior to exercise, the SAR does not entitle the recipient to receive any shares of theCompany'sCompany’s common stock and does not provide the recipient with any voting or otherstockholders'stockholders’ rights. The Company accounts for these SARs as equity awards under SFAS 123(R) and recognizes compensation expense ratably over the vesting period of the SAR based on their fair value on the date of issuance, net of estimated and actual forfeitures.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)16. EQUITY-BASED COMPENSATION (Continued)Compensation expense recognized in 2008 and 2007 in connection with the SARs was approximately $3.1 million and $0.6million.million, respectively. Income tax benefits of approximately $1.1 million and $0.2 million in 2008 and 2007, respectively, were recognized by the Company in connection with this expense.ForThe vesting of all of the Company’s outstanding SAR awards was accelerated during the fourth quarter of 2008 and therefore there were no outstanding unvestedSARs outstandingSAR awards as of December 31,2007,2008. As such, the Companyanticipates that itwill not recognizeapproximately $2.8 million ofexpenseover the next 1.6 years.in future periods associated with these awards.
Valuation Assumptions on Stock Options and Stock Appreciation RightsThe fair value of each stock option grant or SAR was estimated on the date of grant using the Black-Scholes option-pricing model, based on the following weighted-average assumptions:Year Ended December 31, 2007 2006 2005 Risk-free interest rate 4.41 % 4.70 % 3.80 % Expected life of options, years 6 6 6 Expected volatility of the Company's stock price 39.49 % 48.80 % 53.85 % Expected dividends none none none 17. TRANSACTIONS WITH RELATED PARTIESYear Ended December 31, 2008 2007 2006 Risk-free interest rate 2.86 % 4.41 % 4.70 % Expected life of options, years 6 6 6 Expected volatility of the Company’s stock price 36.86 % 39.49 % 48.80 % Expected dividends none none none NOTE 18. TRANSACTIONS WITH RELATED PARTIES Employee Loans and AdvancesFrom time to time and continuing in the comparative periods contained in this report, we have made certain retention loans and relocation loans to employees other than executive officers. The retention loans are forgiven over various time periods so long as the employee continues employment at the Company. The relocation loans are repaid upon the employee selling his prior residence. As of December 31, 2008 and 2007, these loans, in the aggregate,totaltotaled approximately $0.2million.million and $0.2 million, respectively. Of this
115Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)amount, less than $0.1 million were made to former officers of the Company, with the remainder being made to current employees of the Company.Seller Financing Arrangement Associated with Moncla AcquisitionIn connection with the acquisition of Moncla (see “Note2—"Acquisitions"2. Acquisitions”), the Company entered into two promissory notes payable agreement with the seller, who, subsequent to the acquisition, became an officer of the Company. The first is an unsecured note in the amount of $12.5 million, which is due and payable in a lump-sum, together with accrued interest, on October 25, 2009. Interest on this note is payable on each anniversary of the closing of the acquisition of Moncla, which was October 25, 2007. The second unsecured note in the amount of $10.0 million is payable in annual installments of $2.0 million, plus accrued interest, beginning October 25, 2008 through 2012. Each of the notes bears interest at the Federal Funds rate adjusted annually on the anniversarydateof the closing date.The Federal Funds rate does not represent a rate that would have resulted if an independent borrower and an independent lender had negotiated a similar transaction under comparable terms and conditions and is not equal to our incremental borrowing rate. In accordance with APB 21 and SFAS 141, we recorded the promissory notes at fair value which resulted in a discount being recorded.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)17. TRANSACTIONS WITH RELATED PARTIES (Continued)The discount will be recognized as interest expense over the life of the promissory notes using the effective interest method.
Transactions with EmployeesIn connection with our acquisition of Western, the former owner of Western, Fred Holmes, became an employee of the Company. Mr. Holmes owned at the time of the acquisition, and continues to own, an exploration and production company, Holmes Western Oil Corporation (“HWOC”), which was a customer of Western. Subsequent to the acquisition, the Company continued to provide services to HWOC. The prices charged for these services are at rates that are an average of the prices charged to our other customers in the California market. As of December 31, 2008, our receivables with HWOC totaled approximately $0.2 million, and for the year ended December 31, 2008, revenues from HWOC totaled approximately $4.3 million.Board of Director Relationship with CustomerIn October 2007, we added a member to theCompany'sCompany’s Board of Directors who is the Senior Vice President, General Counsel and Chief Administrative Officer of Anadarko Petroleum Corporation("Anadarko"(“Anadarko”), which is one of our customers. Sales to Anadarko comprised less than 2% of our total revenues for theyearyears ended December 31,2007.2008 and 2007, respectively. Transactions with Anadarko for our services are made at market prices.18. SEGMENT INFORMATIONNOTE 19. SEGMENT INFORMATION For2007,2008, our reportable operating business segments are well servicing, pressure pumping and fishing and rental. We aggregate services which create our reportable segments in accordance with SFAS 131. The accounting policies of the reportable segments are the same as those described in “Note 1. Organization and Summary of Significant Accounting Policies.” We evaluate the performance of our operating segments based on revenue and EBITDA, which is a non-GAAP measure and not disclosed below.All inter-segment sales pricing is based on current market conditions.
WellServicing.servicing. These operations provide a full range of well services, including rig-based services, oilfield transportation services, cased-hole wireline services and other ancillary oilfield services necessary to complete, maintain and workover oil and natural gas producing wells. Our Argentina and Mexico operations are included in our well servicing segment. We aggregate our operating divisions engaged in well servicing activities into our well servicing reportable segment.
116Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)PressurePumping.pumping. These operations provide well stimulation and cementing services. Stimulation includes fracturing, nitrogen services and acidizing services and is used to enhance the production of oil and natural gas wells from formations which exhibit a restricted flow of oil and / or natural gas. Cementing services include pumping cement into a well between the casing and the wellbore.Fishing andRental.rental. These operations provide services that include"fishing"“fishing” to recover lost or stuck equipment in a wellbore through the use of"fishing“fishing tools."” In addition, this segment offers a full line of services and rental equipment designed for use both onshore and offshore for drilling and workover services and includes an inventory consisting of tubulars, handling tools, pressure-control equipment and power swivels.Corporate / Other. We apply the provisions ofEITF 04-10 for our segment reporting. Under the provisions ofEITF 04-10, operating segments that do not individually meet the aggregation criteria described in SFAS 131 may be combined with other operating segments that do not individually meet the aggregation criteria to form a separate reportable segment. We have combined all of our operating segments that do not individually meet the aggregation criteria established in SFAS 131 to form the"Corporate“Corporate andOther"Other” segment for our segment reporting. Corporate expenses include general expenses associated with managing all reportable operating segments. Corporate assets consist principally of cash and cash equivalents, short-term investments, deferred financing costs, investments inKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)18. SEGMENT INFORMATION (Continued)subsidiaries, accounts and notes receivable from subsidiaries, the
Company'sCompany’s investment in IROC Services Corp., and deferred income tax assets.Well Pressure Fishing Corporate/ Servicing Pumping and Rental Other Eliminations Total (In thousands) As of and for the year ended December 31, 2008:Operating revenues $ 1,509,823 $ 344,993 $ 117,272 $ — $ — $ 1,972,088 Inter-segment revenue 4,153 1,221 (5,374 ) — Direct operating expenses 942,886 239,870 70,706 — (3,135 ) 1,250,327 Depreciation and amortization expense 125,008 22,237 11,809 11,720 — 170,774 Interest expense, net of amounts capitalized (1,880 ) (1,402 ) (512 ) 44,793 248 41,247 Net income (loss) 347,007 23,834 3,991 (289,329 ) (1,445 ) 84,058 Property and equipment, net 762,849 191,563 62,429 34,842 — 1,051,683 Total assets 1,688,732 277,693 103,521 2,035,206 (2,088,229 ) 2,016,923 Capital expenditures, excluding acquisitions 147,963 42,860 19,970 8,201 — 218,994
117�� Well
ServicingPressure
PumpingFishing
and RentalCorporate /
OtherDiscontinued
OperationsEliminations Total (in thousands) As of and for the year ended December 31, 2007: Operating revenues $ 1,264,797 $ 299,348 $ 97,867 $ — $ — $ — $ 1,662,012 Gross margin 526,103 109,703 40,592 — — — 676,398 Depreciation and amortization 90,274 16,854 8,742 13,753 — — 129,623 Interest expense (712 ) (1,048 ) (493 ) 38,708 — (248 ) 36,207 Net income (loss) 360,617 83,785 22,028 (297,141 ) — — 169,289 Property and equipment, net 693,804 133,903 48,703 34,798 — — 911,208 Total assets 1,500,913 247,018 89,802 402,513 — (381,169 ) 1,859,077 Capital expenditures, excluding acquisitions (135,336 ) (51,115 ) (19,811 ) (6,298 ) — — (212,560 ) Well
ServicingPressure
PumpingFishing
and RentalCorporate /
OtherDiscontinued
OperationsEliminations Total (in thousands) As of and for the year ended December 31, 2006: Operating revenues $ 1,201,228 $ 247,489 $ 97,460 $ — $ — $ — $ 1,546,177 Gross margin 476,220 109,112 40,243 — — — 625,575 Depreciation and amortization 95,673 12,416 6,787 11,135 — — 126,011 Interest expense (615 ) (600 ) (98 ) 40,240 — — 38,927 Net income (loss) 311,339 88,070 22,860 (251,236 ) — — 171,033 Property and equipment, net 531,685 97,372 35,971 29,263 — — 694,291 Total assets 1,022,898 190,704 79,364 206,622 — 41,810 1,541,398 Capital expenditures, excluding acquisitions (143,080 ) (35,513 ) (12,953 ) (4,284 ) — — (195,830 ) Well
ServicingPressure
PumpingFishing
and RentalCorporate /
OtherDiscontinued
OperationsEliminations Total (in thousands) As of and for the year ended December 31, 2005: Operating revenues $ 956,457 $ 152,320 $ 81,667 $ — $ — $ — $ 1,190,444 Gross margin 322,414 60,019 27,768 — — — 410,201 Depreciation and amortization 85,772 8,785 6,024 11,307 — — 111,888 Interest expense 86 (328 ) 35 50,506 — — 50,299 Net income (loss) 175,576 51,661 14,926 (193,085 ) (3,361 ) — 45,717 Property and equipment, net 479,972 71,688 27,214 31,467 — — 610,341 Total assets 919,887 151,683 67,082 450,709 658 (260,775 ) 1,329,244 Capital expenditures, excluding acquisitions (79,410 ) (27,258 ) (4,070 ) (7,408 ) — — (118,146 ) Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Well Pressure Fishing Corporate/ Servicing Pumping and Rental Other Eliminations Total (In thousands) As of and for the year ended December 31, 2007:Operating revenues, net $ 1,264,797 $ 299,348 $ 97,867 $ — $ — $ 1,662,012 Direct operating expenses 738,694 189,645 57,275 — — 985,614 Depreciation and amortization expense 90,274 16,854 8,742 13,753 — 129,623 Interest expense, net of amounts capitalized (712 ) (1,048 ) (493 ) 38,708 (248 ) 36,207 Net income (loss) 360,617 83,785 22,028 (297,141 ) — 169,289 Property and equipment, net 693,804 133,903 48,703 34,798 — 911,208 Total assets 1,500,913 247,018 89,802 402,513 (381,169 ) 1,859,077 Capital expenditures, excluding acquisitions 135,336 51,115 19,811 6,298 — 212,560 Well Pressure Fishing Corporate/ Servicing Pumping and Rental Other Eliminations Total (In thousands) As of and for the year ended December 31, 2006:Operating revenues, net $ 1,201,228 $ 247,489 $ 97,460 $ — $ — $ 1,546,177 Direct operating expenses 725,008 138,377 57,217 — — 920,602 Depreciation and amortization expense 95,673 12,416 6,787 11,135 — 126,011 Interest expense, net of amounts capitalized (615 ) (600 ) (98 ) 40,240 — 38,927 Net income (loss) 311,339 88,070 22,860 (251,236 ) — 171,033 Property and equipment, net 531,685 97,372 35,971 29,263 — 694,291 Total assets 1,022,898 190,704 79,364 206,622 41,810 1,541,398 Capital expenditures, excluding acquisitions 143,080 35,513 12,953 4,284 — 195,830 118
18. SEGMENT INFORMATIONKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following table presents information related to our foreign operations (in thousands of U.S. Dollars):Argentina Mexico Canada Total Foreign As of and for the year ended December 31, 2007:
Operating revenues
$
93,925
$
8,956
$
2,938
$
105,819Total assets 82,550 12,870 8,876 104,296
As of and for the year ended December 31, 2006:
Operating revenues
$
78,321
$
—
$
—
$
78,321Total assets 77,878 — — 77,878
As of and for the year ended December 31, 2005:
Operating revenues
$
68,183
$
—
$
—
$
68,183Total assets 58,816 — — 58,816 U.S. Argentina Mexico Canada Eliminations Total (In thousands) As of and for the year ended December 31, 2008:Revenue from external customers $ 1,800,199 $ 118,841 $ 47,200 $ 5,848 $ — $ 1,972,088 Long-lived assets 1,434,578 25,419 45,547 7,482 (55,225 ) 1,457,801 Capital expenditures, excluding acquisitions 181,525 2,677 34,792 — — 218,994 As of and for the year ended December 31, 2007:Revenue from external customers 1,556,108 $ 93,925 $ 9,041 $ 2,938 $ — $ 1,662,012 Long-lived assets 1,368,735 29,762 11,089 10,782 (49,156 ) 1,371,212 Capital expenditures, excluding acquisitions 197,120 3,997 11,348 95 — 212,560 As of and for the year ended December 31, 2006:Revenue from external customers $ 1,467,856 $ 78,321 $ — $ — $ — $ 1,546,177 Long-lived assets 1,064,031 30,623 — — (41,862 ) 1,052,792 Capital expenditures, excluding acquisitions 186,348 9,482 — — — 195,830 NOTE 20. SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION Year Ended December 31, 2008 2007 2006 (In thousands) Noncash investing and financing activities:Property and equipment acquired under captial lease obligations $ 7,654 $ 12,003 $ 15,349 Asset retirement obligations 397 12 155 Unrealized (loss) gain on short-term investments (8 ) — 328 Unrealized gain on cash flow hedges — — 185 Accrued repurchases of common stock — 2,949 — Debt assumed and issued in acquisitions — 40,149 — Software acquired under financing arrangement 3,985 — — Supplemental cash flow information:Cash paid for interest $ 45,313 $ 38,457 $ 44,534 Cash paid for taxes $ 43,494 $ 96,327 $ 99,048 Cash paid for interest includes cash payments for interest on our long-term debt and capital lease obligations, commitment and agency fees paid, and cash paid to settle the interest rate swaps associated with the termination of our Prior Credit Facility.Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)19. UNAUDITED SUPPLEMENTARY INFORMATION—QUARTERLY RESULTS OF OPERATIONSNOTE 21. UNAUDITED SUPPLEMENTARY INFORMATION — QUARTERLY RESULTS OF OPERATIONS Set forth below is unaudited summarized quarterly information for the two most recent years covered by these consolidated financial statements (in thousands, except for per share data):First Quarter Second Quarter Third Quarter Fourth Quarter(2) Year Ended December 31, 2007: Revenues $ 408,919 $ 410,511 $ 413,967 $ 428,615 Gross margin 173,406 172,288 156,485 174,219 Income before income taxes 84,694 78,471 59,832 52,943 Net income 52,190 48,136 35,896 33,067
Earnings per share(1):
Basic $ 0.40 $ 0.37 $ 0.27 $ 0.25 Diluted $ 0.39 $ 0.36 $ 0.27 $ 0.25 First Quarter Second Quarter Third Quarter Fourth Quarter Year Ended December 31, 2008:Revenues $ 456,399 $ 502,003 $ 535,620 $ 478,066 Direct operating expenses 281,641 322,488 342,195 304,003 Impairment of goodwill and equity method investment — — — 75,137 Income (loss) before income taxes 56,907 71,247 77,541 (31,639 ) Net income (loss) 34,484 44,012 48,462 (42,900 ) Earnings per share(1): Basic $ 0.27 $ 0.35 $ 0.39 $ (0.35 ) Diluted $ 0.27 $ 0.35 $ 0.39 $ (0.35 ) First Quarter Second Quarter Third Quarter Fourth Quarter(2) Year Ended December 31, 2007:Revenues $ 408,919 $ 410,511 $ 413,967 $ 428,615 Direct operating expenses 235,513 238,223 257,482 254,396 Income before income taxes 84,694 78,471 59,832 52,943 Net income 52,190 48,136 35,896 33,067 Earnings per share(1): Basic $ 0.40 $ 0.37 $ 0.27 $ 0.25 Diluted $ 0.39 $ 0.36 $ 0.27 $ 0.25 (1) Quarterly earnings per common share are based on the weighted average number of shares outstanding during the quarter, and the sum of the quarters may not equal annual earnings per common share. (2) Revenues, gross margins, income before income taxes, net income and earnings per share were impacted in the fourth quarter of 2007 due to the acquisitions of Moncla, Kings and AMI. See “Note 2. Acquisitions.” First Quarter Second Quarter Third Quarter Fourth Quarter Year Ended December 31, 2006: Revenues $ 347,958 $ 372,036 $ 417,600 $ 408,583 Gross margin 129,336 151,975 180,199 164,065 Income before income taxes 48,430 63,920 98,822 63,308 Net income 30,063 39,582 60,885 40,503
Earnings per share(1):
Basic $ 0.23 $ 0.30 $ 0.46 $ 0.31 Diluted $ 0.22 $ 0.29 $ 0.45 $ 0.31 (1)Quarterly earnings per common share are based on the weighted average number of shares outstanding during the quarter, and the sum of the quarters may not equal annual earnings per common share.(2)Revenues, gross margins, income before income taxes, net income and earnings per share were impacted in the fourth quarter of 2007 due to the acquisitions of Moncla, Kings and AMI. See Note 2—"Acquisitions."
20. CONDENSED CONSOLIDATING FINANCIAL STATEMENTSNOTE 22. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS The Notes are guaranteed by virtually all of our domestic subsidiaries, all of which are wholly-owned. The guarantees were joint and several, full, complete and unconditional. There were no restrictions on the ability of subsidiary guarantors to transfer funds to the parent company.As a result of these guarantee arrangements, we are required to present the following condensed consolidating financial information pursuant to SECRegulationS-X RuleS-XRule 3-10,"Financial“Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered."”
120Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)December 31, 2008 Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated (In thousands) Assets:Current assets $ 29,673 $ 440,758 $ 88,534 $ 157 $ 559,122 Property and equipment, net — 1,025,007 26,676 — 1,051,683 Goodwill — 316,669 4,323 — 320,992 Deferred financing costs, net 10,489 — — — 10,489 Intercompany notes and accounts receivable and investment in subsidiaries 1,917,522 419,554 1,775 (2,338,851 ) — Other assets 22,597 48,237 3,803 — 74,637 TOTAL ASSETS$ 1,980,281 $ 2,250,225 $ 125,111 $ (2,338,694 ) $ 2,016,923 Liabilities and equity:Current liabilities $ 13,792 $ 231,528 $ 28,054 $ (1 ) $ 273,373 Capital lease obligations, less current portion — 13,714 49 — 13,763 Notes payable — related parties, less current portion — 6,000 — — 6,000 Long-term debt, less current portion 612,813 1,015 — — 613,828 Intercompany notes and accounts payable 305,348 1,624,932 69,204 (1,999,484 ) — Deferred tax liabilities 187,596 — 985 — 188,581 Other long-term liabilities — 60,386 260 — 60,646 Stockholders’ equity 860,732 312,650 26,559 (339,209 ) 860,732 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY$ 1,980,281 $ 2,250,225 $ 125,111 $ (2,338,694 ) $ 2,016,923
121December 31, 2007 Parent
CompanyGuarantor
SubsidiariesNon-Guarantor
SubsidiariesEliminations Consolidated (in thousands) Assets: Current assets $ 39,501 $ 378,865 $ 69,499 $ — $ 487,865 Net property and equipment — 880,907 30,301 — 911,208 Goodwill — 373,283 5,267 — 378,550 Deferred costs, net 12,117 — — — 12,117 Intercompany receivables and investments in subsidiaries 1,557,993 175,461 — (1,733,454 ) — Other assets 11,217 52,074 6,046 — 69,337 TOTAL ASSETS $ 1,620,828 $ 1,860,590 $ 111,113 $ (1,733,454 ) $ 1,859,077
Liabilities and equity:
Current liabilities $ 17,278 $ 192,222 $ 25,297 $ — $ 234,797 Long-term debt 475,000 — — — 475,000 Capital lease obligations — 15,998 116 — 16,114 Long-term notes payable— related party — 20,500 — — 20,500 Intercompany payables 78,660 1,489,377 24,408 (1,592,445 ) — Deferred tax liabilities 157,759 (79 ) 2,388 — 160,068 Other long-term liabilities 3,133 60,216 251 — 63,600 Stockholders' equity 888,998 82,356 58,653 (141,009 ) 888,998 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,620,828 $ 1,860,590 $ 111,113 $ (1,733,454 ) $ 1,859,077 Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)December 31, 2007 Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated (In thousands) Assets:Current assets$ 39,501 $ 378,865 $ 69,499 $ — $ 487,865 Property and equipment, net — 880,907 30,301 — 911,208 Goodwill — 373,283 5,267 — 378,550 Deferred financing costs, net 12,117 — — — 12,117 Intercompany notes and accounts receivable and investment in subsidiaries 1,557,993 175,461 — (1,733,454 ) — Other assets 11,217 52,074 6,046 — 69,337 TOTAL ASSETS$ 1,620,828 $ 1,860,590 $ 111,113 $ (1,733,454 ) $ 1,859,077 Liabilities and equity:Current liabilities $ 17,278 $ 192,222 $ 25,297 $ — $ 234,797 Capital lease obligations, less current portion — 15,998 116 — 16,114 Notes payable — related parties, less current portion — 20,500 — — 20,500 Long-term debt, less current portion 475,000 — — — 475,000 Intercompany notes and accounts payable 78,660 1,489,377 24,408 (1,592,445 ) — Deferred tax liabilities 157,759 (79 ) 2,388 — 160,068 Other long-term liabilities 3,133 60,216 251 — 63,600 Stockholders’ equity 888,998 82,356 58,653 (141,009 ) 888,998 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY$ 1,620,828 $ 1,860,590 $ 111,113 $ (1,733,454 ) $ 1,859,077 122
20. CONDENSED CONSOLIDATINGKey Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Year Ended December 31, 2008 Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated (In thousands) Revenues$ — $ 1,818,736 $ 175,845 $ (22,493 ) $ 1,972,088 Costs and expenses:Direct operating expenses — 1,139,006 127,374 (16,053 ) 1,250,327 Depreciation and amortization expense — 163,257 7,517 — 170,774 Impairment of goodwill and equity-method investment — 75,137 — — 75,137 General and administrative expenses 1,616 237,635 19,251 (795 ) 257,707 Interest expense, net of amounts capitalized 44,842 (4,320 ) 477 248 41,247 Other, net 5,219 (7,073 ) 9,143 (4,449 ) 2,840 Total costs and expenses, net51,677 1,603,642 163,762 (21,049 ) 1,798,032 (Loss) income before income taxes and minority interest (51,677 ) 215,094 12,083 (1,444 ) 174,056 Income tax expense (81,233 ) (4,320 ) (4,690 ) — (90,243 ) Minority interest — — 245 — 245 NET (LOSS) INCOME$ (132,910 ) $ 210,774 $ 7,638 $ (1,444 ) $ 84,058
123Year Ended December 31, 2007 Parent
CompanyGuarantor
SubsidiariesNon-guarantor
SubsidiariesEliminations Consolidated (in thousands) Revenues $ — $ 1,561,059 $ 105,819 $ (4,866 ) 1,662,012 Costs and expenses: Direct expenses — 906,254 82,980 (3,620 ) 985,614 Depreciation and amortization — 123,821 5,802 — 129,623 General and administrative 1,693 216,959 11,935 (191 ) 230,396 Interest expense, net of amounts capitalized 38,866 (3,134 ) 723 (248 ) 36,207 Loss on early extinguishment of debt 9,557 — — — 9,557 Other, net (449 ) (5,850 ) 1,781 (807 ) (5,325 ) Total costs and expenses, net 49,667 1,238,050 103,221 (4,866 ) 1,386,072 (Loss) income before income taxes (49,667 ) 323,009 2,598 — 275,940 Income tax (expense) benefit (105,928 ) 934 (1,774 ) — (106,768 ) Minority interest — — 117 — 117 NET (LOSS) INCOME $ (155,595 ) $ 323,943 $ 941 $ — $ 169,289 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Year Ended December 31, 2007 Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated (In thousands) Revenues$ — $ 1,561,059 $ 105,819 $ (4,866 ) $ 1,662,012 Costs and expenses:— Direct operating expenses — 906,254 82,980 (3,620 ) 985,614 Depreciation and amortization expense — 123,821 5,802 — 129,623 General and administrative expenses 1,693 216,959 11,935 (191 ) 230,396 Interest expense, net of amounts capitalized 38,866 (3,134 ) 723 (248 ) 36,207 Loss on early extinguishment of debt 9,557 — — — 9,557 Other, net (449 ) (5,850 ) 1,781 (807 ) (5,325 ) Total costs and expenses, net49,667 1,238,050 103,221 (4,866 ) 1,386,072 (Loss) income before income taxes and minority interest (49,667 ) 323,009 2,598 — 275,940 Income tax expense (105,928 ) 934 (1,774 ) — (106,768 ) Minority interest — — 117 — 117 NET (LOSS) INCOME$ (155,595 ) $ 323,943 $ 941 $ — $ 169,289 124
Key Energy Services, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSYear Ended December 31, 2007 Parent
CompanyGuarantor
SubsidiariesNon-guarantor
SubsidiariesEliminations Consolidated (in thousands) Net cash provided by operating activities $ (3,401 ) $ 264,275 $ (10,955 ) $ — $ 249,919 Net cash used in investing activities (473,412 ) (732,359 ) (5,160 ) 908,084 (302,847 ) Net cash provided by financing activities 476,813 429,809 24,702 (908,084 ) 23,240 Effect of exchange rates on cash — — (184 ) — (184 ) Net (decrease) increase in cash — (38,275 ) 8,403 — (29,872 ) Cash at beginning of period — 84,633 3,742 — 88,375 Cash at end of period $ — $ 46,358 $ 12,145 $ — $ 58,503 Year Ended December 31, 2008 Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated (In thousands) Net cash provided by operating activities$ 17,573 $ 364,840 $ (15,249 ) $ — $ 367,164 Cash flows from investing activities:Capital expenditures — (214,659 ) (4,335 ) — (218,994 ) Acquisitions, net of cash acquired — (63,457 ) — — (63,457 ) Acquisition of fixed assets from asset purchases — (34,468 ) — — (34,468 ) Investment in Geostream Services Group (19,306 ) — — — (19,306 ) Intercompany notes and accounts (179,501 ) (199,428 ) (1,515 ) 380,444 — Other investing activities, net — 7,151 — — 7,151 Net cash (used in) provided by investing activities(198,807 ) (504,861 ) (5,850 ) 380,444 (329,074 ) Cash flows from financing activities:Borrowings on revolving credit facility 172,813 — — — 172,813 Repayments on revolving credit facility (38,026 ) — — — (38,026 ) Repurchases of common stock (139,358 ) — — — (139,358 ) Intercompany notes and accounts 177,698 181,016 21,730 (380,444 ) — Other financing activities, net 8,107 (11,506 ) — — (3,399 ) Net cash provided by (used in) financing activities181,234 169,510 21,730 (380,444 ) (7,970 ) Effect of changes in exchange rates on cash— — 4,068 — 4,068 Net increase in cash— 29,489 4,699 — 34,188 Cash and cash equivalents at beginning of period— 46,358 12,145 — 58,503 Cash and cash equivalents at end of period$ — $ 75,847 $ 16,844 $ — $ 92,691 ITEM 9.Changes inKey Energy Services, Inc. andDisagreements with Accountants on Accounting and Financial DisclosureSubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Year Ended December 31, 2007 Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated (In thousands) Net cash (used in) provided by operating activities $ (3,401 ) $ 264,275 $ (10,955 ) $ — $ 249,919 Cash flows from investing activities:Capital expenditures — (207,400 ) (5,160 ) — (212,560 ) Acquisitions, net of cash acquired — (157,955 ) — — (157,955 ) Investment in available for sale securities — (121,613 ) — — (121,613 ) Proceeds from the sale of available of sale securities — 183,177 — — 183,177 Intercompany notes and accounts (473,412 ) (434,672 ) — 908,084 — Other investing activities, net — 6,104 — — 6,104 Net cash (used in) provided by investing activities(473,412 ) (732,359 ) (5,160 ) 908,084 (302,847 ) Cash flows from financing activities:Repayment of long-term debt (396,000 ) — — — (396,000 ) Proceeds from long-term debt 425,000 — — — 425,000 Borrowings on revolving credit facility 50,000 — — — 50,000 Common stock acquired by purchase (30,454 ) — — — (30,454 ) Intercompany notes and accounts 424,822 458,560 24,702 (908,084 ) — Other financing activities, net 3,445 (28,751 ) — — (25,306 ) Net cash provided by (used in) financing activities476,813 429,809 24,702 (908,084 ) 23,240 Effect of changes in exchange rates on cash— — (184 ) — (184 ) Net (decrease) increase in cash— (38,275 ) 8,403 — (29,872 ) Cash and cash equivalents at beginning of period— 84,633 3,742 — 88,375 Cash and cash equivalents at end of period$ — $ 46,358 $ 12,145 $ — $ 58,503 126
None.ITEM 9A.Controls and ProceduresITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls andProcedures.ProceduresWe maintain a set of disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934("the Exchange Act"(the “Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified in theSEC'sSEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to theCompany'sCompany’s management, including theCompany's ChairmanCompany’s principal executive officer andChief Executive Officer and Chief Financial Officer,principal financial officer, as appropriate to allow timely decisions regarding required disclosure.TheCompany'sCompany’s management, with the participation of theCompany's ChairmanCompany’s principal executive officer andChief Executive Officer and Chief Financial Officer,principal financial officer, has evaluated the effectiveness of theCompany'sCompany’s disclosure controls and procedures (as such term is defined inRules 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, theCompany's ChairmanCompany’s principal executive andChief Executive Officer and Chief Financial Officerfinancial officers have concluded that, because of the material weakness described below for our payroll process, our disclosure controls and procedures were ineffective as of the end of suchperiod, due to the material weaknesses in our internal control over financial reporting described below, our disclosure controls and procedures were not effective.period.
Changes in Internal Control Over Financial Reporting.We believe that there have been changes in our internal control over financial reporting during the period from January 1, 2007 to December 31, 2007 that have significantly improved our internal control over financial reporting. In August 2007 we filed our Annual Report on Form 10-K for the year ended December 31, 2006 ("2006 Report") and, as described in Item 9A. "Controls and Procedures" in that report, we identified multiple material weaknesses as of December 31, 2006. During 2007 and since filing the 2006 Report, we have made numerous changes to address those weaknesses. Based on these actions, we concluded that the following material weaknesses previously identified had been remediated as of December 31, 2007:•Recognition of expenditures•Account reconciliations•Accounting for income taxes
Improvements in 2007 for our internal control over financial reporting that remediated the 2006 weaknesses included adding a process for and controls over the accrual and recording of expenditures with appropriate reconciliations and review, an overall program of account reconciliations and review and a process, including controls and appropriate review, for our accounting for income taxes.In other instances, the controls that were implemented during 2007 were not sufficient to effectively remediate the material weakness, or there were not sufficient instances of the controls in operation to make a determination that these controls were operating effectively. The actions taken with respect to the material weaknesses identified as of December 31, 2006 but not remediated at December 31, 2007 are discussed below in "Management'sManagement’s Report on Internal Control Over FinancialReporting."Management's Report on Internal Control Over FinancialReportingManagement is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
Company'sCompany’s assets that could have a material effect on the financial statements.Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting can also be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.A material weakness (as defined in SECRule 12b-2) is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.Management conducted an assessment of the effectiveness of theCompany'sCompany’s internal control over financial reporting as of December 31,2007.2008. In making this assessment, management used the criteria
127described inInternalControl—Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management concluded thatourthe Company’s internal control over financial reporting was not effective as of December 31,2007. Management has identified the following material weaknesses of internal control over financial reporting as of December 31, 2007:Financial Close and Reporting:In our 2006 Report, we identified2008 due to a material weaknessat December 31, 2006 in our financial close and reportingdescribed below.Payroll process.In third quarter of 2007 we filed our 2006 Report, our Quarterly Reports on Form 10-Q for the years 2005 and 2006 and our Quarterly Reports on Form 10-Q for the first and second quarters of 2007, and, in November 2007, we filed our Quarterly Report on Form 10-Q for the third quarter of 2007. In response to the material weaknesses in financial close and reporting disclosed in the 2006 Report, management instituted substantial changes in 2007 to our internal control structure. These changes included additional personnel, adding analytical procedures and reviews, methodologies for the preparation of our financial statements, reconciliations of our accounts and reconciliations between our general ledger and subledger systems as well as increasing the availability of evidence for those controls. However, as a result of our delayed reporting and the devotion of resources to completing our required 2006 and 2007 filings under the Exchange Act, many of these improvements were not in place and evidenced as operating effectively until the financial close and reporting activities for the fourth quarter of 2007. Due to the timing of these improvements, sufficient instances of these controls in operation had not occurred for the controls to be assessed as effective at December 31, 2007. As a result, we could not conclude that this material weakness had been remediated.Management believes that the control activities put in place in 2007 are sufficient to remediate previously identified deficiencies and that with the passage of sufficient close and reporting cycles to evidence effective operation of these controls the material weakness will be remediated.Authorizations of Expenditures:In our 2006 Report, we determined that at December 31, 2006 multiple control deficiencies existed regarding our ability to appropriately ensure and evidence that expenditures, covering substantially all aspects of spending, were approved by the appropriate level of management in accordance with our established policies and, as a result, we identified this as a material weakness. Deficiencies related to authorizations for payroll were among the deficiencies identified in 2006; for 2007, those are discussed separately below. During 2007, changes were made that included the establishment of approval authorities and automated controls in our procurement system. Notwithstanding these changes, certain deficiencies remained at December 31, 2007. The remaining deficiencies resulting in our material weakness are our inability to ensure and evidence that (i) timely approvals occurred for expenditures made through our procurement system or (ii) that expenditures not made through our procurement system were appropriately approved in accordance with our policies. In addition to the changes previously discussed, we also instituted compensating controls in 2007, such as analytical procedures; however, these compensating controls were not all in place and evidenced as operating effectively until the financial close and reporting for the fourth quarter of 2007. As a result, sufficient instances of these controls in operation had not occurred for the controls to be assessed as effective at December 31, 2007.We are continuing to make enhancements to our procurement processes and controls and believe that these changes, coupled with the passage of sufficient close and reporting cycles for compensating controls put in place in 2007 to be evidenced as operating effectively, will remediate this weakness.Recording of Revenues:In our 2006 Report, we determined that a material weakness existed at December 31, 2006 regarding the recording of revenues, as our revenue process is heavily dependent on manual reviews and approvals of credit terms, amounts to be billed and recorded and adjustments for bad debts. At December 31, 2007, we determined that a material weakness remained in our revenue process, as manual approvals at the field level necessary to evidence the recognition of revenues and sufficient evidence of those approvals could not be adequately substantiated. We put compensating controls in place in 2007, such as analytical reviews of accrued revenues, analysis of aged receivables and account reconciliations of our revenue systems and general ledger. Sufficient instances had not occurred for all of these compensating controls to be assessed as effective at December 31, 2007. As a result, we have concluded that a material weakness identified in our 2006 Report remained in 2007.Management believes that the compensating controls put in place in 2007 should be sufficient to compensate for the identified deficiencies in approvals and that with the passage of sufficient close and reporting cycles to evidence operation of these controls the material weakness will be remediated.Property, Plant & Equipment (PP&E):In our 2006 Report, we determined that a material weakness existed at December 31, 2006 regarding the recording of PP&E. In 2007, substantial changes were made to our processes and controls; however, for two areas of our accounting for PP&E—the timing of assets being placed in service and the timing of recognition of gains and losses and approval for asset dispositions—a material weakness remained at December 31, 2007. Due to the design and utilization of our procurement system and practices, certain final costs for an asset may not be captured in a timely manner. As a result of this, the asset may be physically placed in service prior to all cost information being received. This delay in accumulating necessary cost information may delay the beginning of depreciation expense. Additionally, while we have implemented controls, including counts and observations, to ensure that information regarding asset dispositions is captured and recorded, obtaining evidence of appropriate approval for the disposition as well as the timing of the receipt of that information may result in delays in the recording of the disposition which could cross reporting periods.Management is making enhancements to our procurement processes and practices and believes that these changes, coupled with compensating controls for the identified deficiencies, including reconciliations and analytical reviews of balances and depreciation expense will remediate this weakness.User Developed Applications:In the course of preparing our consolidated financial statements, numerous spreadsheets and database programs ("User Developed Applications") are employed. The User Developed Applications are utilized by us in calculating estimates, reconciling payroll hours, tracking inventory costs and making cost allocations, among other things. At December 31, 2006, we identified a material weakness as most User Developed Applications were not secured as to access, logical security, changes or data integrity. To mitigate the associated risk for situations where the above controls could not be implemented, compensating controls were put in place; however, for many of these compensating controls, sufficient instances had not occurred for these controls to be assessed as effective at December 31, 2007. As a result, we have concluded that this material weakness identified in our 2006 Report remained in 2007.In 2007, management began an effort to identify all of its User Developed Applications and remediate the weakness through controls in the User Developed Applications themselves or compensating controls. These efforts, along with elimination of User Developed Applications from critical processes, continue into 2008. Management believes that with the passage of sufficient close and reporting cycles to evidence operation of these compensating controls the material weakness will be remediated.Application Access and Segregation of Duties:In our 2006 Report, we determined that material weaknesses existed at December 31, 2006 in four aspects of information technology general controls over security and segregation of duties of our primary financial systems. These include security administration procedures, administrator access privileges, database and file access and password controls. The weaknesses in these information technology general control areas were further evidenced by or related to deficiencies in our various access controls at the financial system level, causing inappropriate access and segregation of duties issues in significant processes. In 2007 we implemented management reports for business owner review as well as administrative controls and procedures. These controls were not fully effective in remediating the identified weakness. We put compensating controls in place in 2007, such as analytical reviews. Sufficient instances had not occurred for these controls to be assessed as effective at December 31, 2007. As a result, we have concluded that this material weakness identified in our 2006 Report remained in 2007.Management believes that the compensating controls put in place are sufficient to compensate for the identified deficiencies in access and segregation of duties and that with the passage of sufficient close and reporting cycles to evidence operation of these controls the risk associated with the material weakness will be remediated. Management will also be implementing additional activities around business owner review of access and segregation of duties across the systems we utilize.Payroll:We determined thatat December 31, 2007ineffective control activities surrounding our payroll process constituted a material weakness in our system of internal control as of December 31, 2008. In particular,personnel involved in the process,these control activities pertained to documentation and approvals of employee master file data, properdocumentationevidence concerning approval of hours worked or rate changescoupled withand deficiencies with reconciliations where payroll data was a majorcomponent, constituted acomponent. The actions taken and the controls that were in place and operating during 2008 with respect to this material weakness,in our system of internal controls. These deficiencies had been previouslywhich was identified inour 2006 Reportprevious years, were not sufficient to effectively remediate this material weakness aspartofAccount ReconciliationsandAuthorization for Expenditures.December 31, 2008. In
2007,2008, we continued our process to improve our data quality and controls surrounding our payroll processbeginningthat began in 2007. During the middle of 2008, we began to relocate the payroll function from a shared services location in Midland, Texas to our corporate offices in Houston, Texas. During this transition, the payroll department lost a significant percentage of its staff which required their replacement withsystem enhancements and organizational changes. In late 2007,new personnel. We also increased the overall size of the payroll department upon its relocation to Houston. With this change, weinitiated another phase of this process, which will encompass changes toalso added new payroll practicesfurther organizational changesand procedures. Additionally, throughout 2008, we worked on the replacement of ourcurrentexisting payrollsystem.system with a new human resource information system, which included a payroll system, that was initiated in late 2007. However, due to the nature and functionality of the payroll system that was in place during 2008, our conversion to a new system was delayed until January 2009. The implementation of a new human resource information system allows for automated workflow and approval of information, including, among other things, employee master file data, hours worked and rate changes. We believe thatthesechanges, whichas the new payroll department employees receive the proper training and with the implementation of the new human resource and payroll system that was completed in January 2009, we will further strengthen our control structure,andincrease our efficiencyas well asin processing payroll and provide transparencyintoof payroll related data,will remediateallowing for the remediation of thisdeficiency. We anticipate that this process will be completed in the third quarter of 2008.material weakness.
Our internal control over financial reporting has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report included herein.Remediation of Material Weaknesses in Internal Control Over Financial ReportingIn October 2006, we filed our 2003 Financial and Informational Report onForm 8-K/A with the SEC, which described numerous material weaknesses in internal control over financial reporting that we identified during our restatement and delayed financial reporting process. In the third quarter of 2007, we filed our Annual Report onForm 10-K for the year ended December 31, 2006 and reported that nine of the material weaknesses that we had previously identified remained as of December 31, 2006. Our Annual Report onForm 10-K for the year ended December 31, 2007, filed in February 2008, reported that some of these material weaknesses had been remediated and that seven existed at December 31, 2007.Beginning in the fourth quarter of 2007 and continuing in 2008, the Company implemented numerous remediation efforts to address the material weaknesses in existence at December 31, 2007 as described in“Item 9A. Controls and Procedures”in the 2007 Report. As a result of these efforts, the Company’s management determined that as of December 31, 2008, six of the seven material weaknesses identified in the 2007 Report had been remediated, but as discussed above, the material weakness relating to the controls surrounding the payroll process had not been remediated. While many of the changes in internal control over financial reporting were made during the fourth quarter of 2007, they were not in place and operating long enough during 2007 to be assessed as effective. In addition, we made changes in internal control over financial reporting during 2008 to further address the material weaknesses identified in the 2007 Report. The material weaknesses identified in the 2007 Report that have been remediated are:Financial Close and Reporting. Management instituted substantial changes in the fourth quarter of 2007 to our internal control structure related to our financial reporting and close process. These changes included additional personnel, additional analytical procedures and reviews, revised methodologies for the preparation
128of our financial statements, more reconciliations of our accounts and additional reconciliations between our general ledger and subledger systems as well as increased evidence validating those controls. Based upon these changes in internal control and the testing and evaluation of the effectiveness of these controls, the Company’s management has concluded that remediation of the material weakness for financial close and reporting had been achieved as of December 31, 2008.Authorizations of Expenditures. During 2007, changes concerning authorization of expenditures were made that included the establishment of approval authorities, automated controls in our procurement system and analytical procedures around expenditures. Additionally, in 2008, we implemented an application that allows for automated and paperless invoicing and an automated workflow for approvals of expenditures. Based upon these changes in internal control and the testing and evaluation of the effectiveness of these controls, the Company’s management has concluded that remediation of the material weakness for authorizations of expenditures had been achieved as of December 31, 2008.Recording of Revenues. During 2007, we added controls surrounding our recognition of revenues, such as analytical reviews of accrued revenues, analysis of aged receivables and account reconciliations between our revenue systems and general ledger. Based upon these changes in internal control and the testing and evaluation of the effectiveness of these controls, the Company’s management has concluded that remediation of the material weakness for recording of revenues had been achieved as of December 31, 2008.Property, Plant & Equipment (PP&E). In 2007, changes related to accounting for PP&E were made that included the preparation of roll forwards, reconciliations of balances and analytical reviews of balances and depreciation expense. Additionally, in 2008, we implemented analytical procedures and reviews to evaluate the status of assets recorded aswork-in-progress to ensure that depreciation expense for assets transferred out ofwork-in-progress was correct in all material respects as well as to ensure that gains and losses associated with disposals are reflected in the appropriate periods. Based upon these changes in internal control and the testing and evaluation of the effectiveness of these controls, the Company’s management has concluded that remediation of the material weakness for PP&E had been achieved as of December 31, 2008.User Developed Applications. In 2008, we implemented a formal financial spreadsheet controls policy to govern the development, use and control of critical financial spreadsheets, which the users of these applications are following. Based upon this change in internal control and the testing and evaluation of the effectiveness of these controls within the financial spreadsheet controls policy, the Company’s management has concluded that remediation of the material weakness for user developed applications had been achieved as of December 31, 2008.Application Access and Segregation of Duties. In 2007, to address application access and segregation of duties, we implemented management reports for business owner review as well as administrative controls and procedures. In 2008, we made improvements to our business owner review of application access and segregation of duties to allow for a more thorough review of access rights and duties. Based upon these changes in internal control and the testing and evaluation of the effectiveness of these controls, the Company’s management has concluded that remediation of the material weakness for application access and segregation of duties had been achieved as of December 31, 2008.Changes in Internal Control Over Financial ReportingThere were no changes in our internal control over financial reporting during our last fiscal quarter of 2008, other than those described above, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.ITEM 9B. OTHER INFORMATION Not applicable.
129ITEM 9B.ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Item 10 is incorporated by reference pursuant to Regulation 14A under theSecuritiesExchangeAct of 1934.Act. We expect to file a definitive proxy statement with the SEC within 120 days after the close of the year ended December 31,2007.ITEM 11.Executive Compensation2008.
ITEM 11. EXECUTIVE COMPENSATION Item 11 is incorporated by reference pursuant to Regulation 14A under theSecuritiesExchangeAct of 1934.Act. We expect to file a definitive proxy statement with the SEC within 120 days after the close of the year ended December 31,2007.ITEM 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters2008.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Item 12 is incorporated by reference pursuant to Regulation 14A under theSecuritiesExchangeAct of 1934.Act. We expect to file a definitive proxy statement with the SEC within 120 days after the close of the year ended December 31,2007.ITEM 13.Certain Relationships and Related Transactions, and Director Independence2008.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE Item 13 is incorporated by reference pursuant to Regulation 14A under theSecuritiesExchangeAct of 1934.Act. We expect to file a definitive proxy statement with the SEC within 120 days after the close of the year ended December 31,2007.ITEM 14.Principal Accountant Fees and Services2008.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES Item 14 is incorporated by reference pursuant to Regulation 14A under theSecuritiesExchangeAct of 1934.Act. We expect to file a definitive proxy statement with the SEC within 120 days after the close of the year ended December 31,2007.2008.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES The following financial statements, schedules and exhibits are filed as part of thisReport:- report:
1.- Financial
Statements—Statements — See"Index“Index to Consolidated FinancialStatements"Statements”at Page61.- 64.
2.- Financial Statement Schedules filed in Part IV of this
Annual Reportreport are listed below:•Schedule II—Valuation and other Qualifying Accounts
• Schedule II — Valuation and other Qualifying Accounts We have omitted all other financial statement schedules because they are not required or are not applicable, or the required information is shown in the financial statements in notes to the financial statements.3. ExhibitsExhibit No.Description3 .1 Articles of Restatement of Key Energy Services, Inc. (Incorporated by reference to Exhibit 3.1 of the Company’s Annual Report onForm 10-K for the fiscal year ended December 31, 2006, FileNo. 001-08038.) 3 .2 Unanimous consent of the Board of Directors of Key Energy Services, Inc., dated January 11, 2000, limiting the designation of the additional authorized shares to common stock. (Incorporated by reference to Exhibit 3.2 of the Company’s Quarterly Report onForm 10-Q for the quarter ended March 31, 2000, FileNo. 001-08038.)
130Exhibit No.Description3 .3 Second Amended and Restated By-laws of Key Energy Services, Inc., adopted September 21, 2006. (Incorporated by reference to Exhibit 3.1 of the Company’s Current Report onForm 8-K filed on September 22, 2006, FileNo. 001-08038.) 3 .4 Amendment to Second Amended and Restated By-laws of Key Energy Services, Inc., adopted November 2, 2007. (Incorporated by reference to Exhibit 3.1 of the Company’s Current Report onForm 8-K filed on November 2, 2007, FileNo. 001-08038.) 3 .5 Amendments to Second Amended and Restated By-laws of Key Energy Services, Inc., adopted April 4, 2008. (Incorporated by reference to Exhibit 3.1 of the Company’s Current Report onForm 8-K filed on April 9, 2008, FileNo. 001-08038.) 4 .1 Warrant Agreement, dated as of January 22, 1999, between Key Energy Services, Inc. and the Bank of New York, a New York banking corporation as warrant agent. (Incorporated by reference to Exhibit 99(b) of the Company’s Current Report onForm 8-K filed on February 3, 1999, FileNo. 001-08038.) 4 .2 Warrant Registration Rights Agreement dated January 22, 1999, by and among Key Energy Services, Inc., the Guarantors named therein, Lehman Brothers Inc., Bear, Stearns & Co., Inc., F.A.C. / Equities, a division of First Albany Corporation, and Dain Rauscher Wessels, a division of Dain Rauscher Incorporated. (Incorporated by reference to Exhibit 99(e) of the Company’s Current Report onForm 8-K filed on February 3, 1999, FileNo. 001-08038.) 4 .3 Indenture, dated as of November 29, 2007, among Key Energy Services, Inc., the guarantors party thereto and The Bank of New York Trust Company, N.A., as trustee. (Incorporated by reference to Exhibit 4.1 of the Company’s Current Report onForm 8-K filed on November 30, 2007, FileNo. 001-08038.) 4 .4 Registration Rights Agreement dated as of November 29, 2007, among Key Energy Services, Inc., the subsidiary guarantors of the Company party thereto, and Lehman Brothers Inc., Banc of America Securities LLC and Morgan Stanley & Co. Incorporated, as representatives of the several initial purchasers named therein. (Incorporated by reference to Exhibit 4.2 of the Company’s Current Report onForm 8-K filed on November 30, 2007, FileNo. 001-08038.) 4 .5 First Supplemental Indenture, dated as of January 22, 2008, among Key Marine Services, LLC, the existing Guarantors and The Bank of New York Trust Company, N.A., as trustee. (Incorporated by reference to Exhibit 4.5 of the Company’s Quarterly Report onForm 10-Q for the quarter ended March 31, 2008, FileNo. 001-08038.) 4 .6* Second Supplemental Indenture, dated as of January 13, 2009, among Key Energy Mexico, LLC, the existing Guarantors and The Bank of New York Trust Company, N.A., as trustee. 10 .1† Key Energy Group, Inc. 1997 Incentive Plan, as an amendment and restatement effective November 17, 1997 of the Key Energy Group, Inc. 1995 Outside Directors Stock Option Plan. (Incorporated by reference to Exhibit B of the Company’s Schedule 14A Proxy Statement filed November 26, 1997, FileNo. 001-08038.) 10 .2† Form of Restricted Stock Award Agreement under Key Energy Group, Inc. 1997 Incentive Plan. (Incorporated by reference to Exhibit 10.15 of the Company’s Annual Report onForm 10-K for the year ended December 31, 2006, FileNo. 001-08038.) 10 .3† The 2006 Phantom Share Plan of Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K dated October 19, 2006, FileNo. 001-08038.) 10 .4† Form of Award Agreement under the 2006 Phantom Share Plan of Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report onForm 8-K dated October 19, 2006, FileNo. 001-08038.) 10 .5† Form of Stock Appreciation Rights Agreement under Key Energy Group, Inc. 1997 Incentive Plan. (Incorporated by reference to Exhibit 99.1 of the Company’s Current Report onForm 8-K filed on August 24, 2007, FileNo. 001-08038.) 10 .6† Form of Non-Plan Option Agreement under Key Energy Group, Inc. 1997 Incentive Plan. (Incorporated by reference to Exhibit 4.1 of the Company’s Registration Statement onForm S-8 filed on September 25, 2007, FileNo. 333-146294.) 131
Exhibit No.Description3.1Articles of Restatement of the Company. (Incorporated by Reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2006, File No. 1-8038.)3.2Exhibit No.
Unanimous consent of the Board of Directors of the Company dated January 11, 2000, limiting the designation of the additional authorized shares to common stock. (Incorporated by reference to Exhibit 3.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2000, File No. 1-8038.)Description3.3Second Amended and Restated By-laws of Key Energy Services, Inc. (Incorporated by reference to Exhibit 3.1 of the Company's Form 8-K filed on September 22, 2006, File No. 1-8038.)3.4
10Amendment to Second Amended and Restated By-laws of Key Energy Services, Inc. (Incorporated by Reference to Exhibit 3.1 of the Company's Form 8-K filed on November 2, 2007, File No. 1-8038.)4.1.7†
Warrant Agreement dated as of January 22, 1999 between the Company and the Bank of New York, a New York banking corporation as warrant agent. (Incorporated by reference to Exhibit 99(b) of the Company's Form 8-K filed on February 3, 1999, File No. 1-8038.)4.2Warrant Registration Rights Agreement dated January 22, 1999, by and among the Company and Lehman Brothers Inc., Bear, Stearns & Co., Inc., F.A.C. / Equities, a division of First Albany Corporation, and Dain Rauscher Wessels, a division of Dain Rauscher Incorporated. (Incorporated by reference to Exhibit 99(e) of the Company's Form 8-K filed on February 3, 1999, File No. 1-8038.)4.3Indenture, dated as of November 29, 2007, among Key Energy Services, Inc., the guarantors party thereto and The Bank of New York Trust Company, N.A., as trustee. (Incorporated by Reference to Exhibit 4.1 of the Company's Form 8-K filed on November 30, 2007, File No. 1-8038.)4.4Registration Rights Agreement dated as of November 29, 2007, among Key Energy Services, Inc., the subsidiary guarantors of the Company party thereto, and Lehman Brothers Inc., Banc of America Securities LLC and Morgan Stanley & Co. Incorporated, as representatives of the several initial purchasers named therein. (Incorporated by Reference to Exhibit 4.2 of the Company's Form 8-K filed on November 30, 2007, File No. 1-8038.)10.1†Key Energy Group, Inc. 1997 Incentive Plan, as an amendment and restatement effective November 17, 1997 of the Key Energy Group, Inc. 1995 Outside Directors Stock Option Plan. (Incorporated by reference to Exhibit B of the Company's Schedule 14A Proxy Statement filed November 26, 1997, File No. 000-22665.)10.2†Form of Restricted Stock Agreement under Key Energy Group, Inc. 1997 Incentive Plan.10.3†The 2006 Phantom Share Plan of Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated October 19, 2006, File No. 1-8038.)10.4†Form of Award Agreement under the 2006 Phantom Share Plan of Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.2 of the Company's Current Report on Form 8-K dated October 19, 2006, File No. 1-8038.)10.5†Form of Stock Appreciation Rights Agreement. (Incorporated by Reference to Exhibit 99.1 of the Company's Form 8-K filed on August 24, 2007, File No. 1-8038.)10.6†Form of Non-Plan Option Agreement. (Incorporated by Reference to Exhibit 4.1 of the Company's Registration Statement on Form S-8 filed on September 25, 2007, File No. 333-146294.)10.7†
Key Energy Services, Inc. 2007 Equity and Cash Incentive Plan. (Incorporated by Reference to Appendix A of theCompany'sCompany’s Schedule 14A Proxy Statement filed on November 1, 2007, FileNo.1-8038.001-08038.)10.8†*
10
.8†Form of Nonstatutory Stock Option Agreement under 2007 Equity and Cash Incentive Plan. (Incorporated by reference to Exhibit 10.8 of the Company’s Annual Report onForm 10-K for the year ended December 31, 2007 filed on February 28, 2008, FileNo. 001-08038.) 10.9†
10
.9†Restated Employment Agreement, dated effective as of December 31, 2007, among Richard J. Alario, Key Energy Services, Inc. and Key Energy Shared Services, LLCLLC. (Incorporated byReferencereference to Exhibit 10.1 of theCompany'sCompany’s Current Report onForm 8-K filed on January 7, 2008, FileNo.1-8038.001-08038.)10.10†
10
.10†Acknowledgment and Waiver by Richard J. Alario, dated March 25, 2005, regarding rescinded option grant. (Incorporated by reference to Exhibit 10.1 of the Company'sCompany’s Current Report onForm 8-K dated March 29,2005.2005, FileNo. 001-08038.)10.11†
10
.11†Restated Employment Agreement, dated effective as of December 31, 2007, among William M. Austin, Key Energy Services, Inc. and Key Energy Shared Services, LLCLLC. (Incorporated byReferencereference to Exhibit 10.2 of theCompany'sCompany’s Current Report onForm 8-K filed on January 7, 2008, FileNo.1-8038.001-08038.)10.12†
10
.12†Restated Employment Agreement, dated effective as of December 31, 2007, among Newton W. Wilson III, Key Energy Services, Inc. and Key Energy Shared Services, LLCLLC. (Incorporated byReferencereference to Exhibit 10.3 of theCompany'sCompany’s Current Report onForm 8-K filed on January 7, 2008, FileNo.1-8038.001-08038.)10.13†
10
.13†Acknowledgment and Waiver by Newton W. Wilson III, dated March 25, 2005, regarding rescinded option grantgrant. (Incorporated by reference to Exhibit 10.2 of theCompany'sCompany’s Current Report onForm 8-K dated March 29,2005.2005, FileNo. 001-08038.)10.14†
10
.14†*Amended and Restated Employment Agreement, dated October 22, 2008, between Kimberly R. Frye, Key Energy Services, Inc. and Key Energy Shared Services, LLC. 10 .15† Restated Employment Agreement dated effective as of December 31, 2007, among Kim B. Clarke, Key Energy Services, Inc. and Key Energy Shared Services, LLC (Incorporated by Referencereference to Exhibit 10.4 of theCompany'sCompany’s Current Report onForm 8-K filed on January 7, 2008, FileNo.1-8038.001-08038.)10.15†
10
.16†Employment Agreement, dated as of January 1, 2004, between Key Energy Services, Inc. and Jim D. Flynt dated as of January 1, 2004.Flynt. (Incorporated by reference to Exhibit 10.6 of theCompany'sCompany’s Current Report onForm 8-K dated October 19, 2006, FileNo.1-8038.001-08038.)10.16†
10
.17†First Amendment to Employment Agreement, dated November 26, 2007, between Key Energy Services, Inc. and Jim D. Flynt. (Incorporated by Referencereference to Exhibit 10.2 of theCompany'sCompany’s Current Report onForm 8-K filed on November 30, 2007, FileNo.1-8038.001-08038.)10.17†
10
.18†Employment Agreement, dated November 17, 2004, between Key Energy Services, Inc. and Phil Coyne dated November 17, 2004.Coyne. (Incorporated by reference to Exhibit 10.8 of theCompany'sCompany’s Current Report onForm 8-K dated October 19, 2006, FileNo.1-8038.001-08038.)10.18†
10
.19†First Amendment to Employment Agreement, between the Company and Phil Coyneeffective as of January 24,2005.2005, between Key Energy Services, Inc. and Phil Coyne. (Incorporated by reference to Exhibit 10.9 of theCompany'sCompany’s Current Report onForm 8-K dated October 19, 2006, FileNo.1-8038.001-08038.)10.19†*
10
.20†Amended and Restated Employment Agreement, dated December 31, 2007, between Key Energy Services, Inc. and Don D. Weinheimer datedWeinheimer. (Incorporated by reference to Exhibit 10.19 of the Company’s Annual Report onForm 10-K for the year ended December 31,2007.2007 filed on February 28, 2008, FileNo. 001-08038.)10.20†
10
.21†Employment Agreement, dated August 14, 2007, between the CompanyKey Energy Shared Services, LLC and J. Marshall Dodson. (Incorporated byReferencereference to Exhibit 10.1 of theCompany'sCompany’s Quarterly Report onForm 10-Q for the quarter ended September 30, 2007, FileNo.1-8038.001-08038.)10.21†
10
.22†Employment Agreement, dated August 14, 2007, between the CompanyKey Energy Shared Services, LLC and D. Bryan Norwood. (Incorporated byReferencereference to Exhibit 10.2 of theCompany'sCompany’s Quarterly Report onForm 10-Q for the quarter ended September 30, 2007, FileNo.1-8038.001-08038.)132
Exhibit No.Description10 .23†* Restated Employment Agreement, effective August 1, 2007, between Key Energy Shared Services, LLC and Tommy Pipes. 10 .24†* Employment Agreement, effective August 1, 2007, between Key Energy Services, Inc. and John Carnett. 10 .25 Office Lease, effective as of January 20, 2005, between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K dated January 26, 2005, FileNo. 001-08038.) 10 .26 First Amendment to Office Lease, dated as of March 15, 2005, between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K dated June 30, 2005, FileNo. 001-08038.) 10 .27 Second Amendment to Office Lease, dated as of July 24, 2005, between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report onForm 8-K dated June 30, 2005, FileNo. 001-08038.) 10 .28 Credit Agreement, dated as of November 29, 2007, among Key Energy Services, Inc., each lender from time to time party thereto, Bank of America, N.A., as Paying Agent, Co-Administrative Agent, Swing Line Lender and L/C Issuer, and Wells Fargo Bank, National Association, as Co-Administrative Agent, Swing Line Lender and L/C Issuer. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on November 30, 2007, FileNo. 001-08038.) 10 .29 Stock and Membership Interest Purchase Agreement, dated as of September 19, 2007, between and among Key Energy Services, LLC, the Sellers named therein, and Moncla Well Service, Inc. and certain other affiliated companies named therein. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on September 20, 2007, FileNo. 001-08038.) 10 .30 First Amendment to Stock and Membership Interest Purchase Agreement, dated as of October 25, 2007, among Key Energy Services, LLC, the Sellers named therein, and Moncla Well Service, Inc. and certain other affiliated companies named therein. (Incorporated by reference to Exhibit 10.3 of the Company’s Quarterly Report onForm 10-Q for the quarter ended September 30, 2007, FileNo. 001-08038.) 10 .31* Second Amendment to Stock and Membership Interest Purchase Agreement, dated as of September 30, 2008, among Key Energy Services, LLC, the Sellers named therein, and Moncla Well Service, Inc. and certain other affiliated companies named therein. 10 .32 Purchase Agreement, dated November 14, 2007, by and among the Company, certain of its domestic subsidiaries, and Lehman Brothers, Inc., Banc of America Securities LLC and Morgan Stanley & Co. Incorporated, as representatives of the initial purchasers. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report onForm 8-K filed on November 15, 2007, FileNo. 001-08038.) 10 .33 Asset Purchase Agreement, dated December 7, 2007, among Key Energy Services, LLC, Kings Oil Tools, Inc. and Thomas Fowler. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on December 13, 2007, FileNo. 001-08038.) 10 .34 Purchase Agreement, dated April 3, 2008, among Key Energy Services, LLC, Western Drilling Holdings, Inc., and Fred S. Holmes and Barbara J. Holmes. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on April 9, 2008, FileNo. 001-08038.) 10 .35 Stock Purchase Agreement, dated May 30, 2008, by and among Key Energy Services, LLC, and E. Kent Tolman, Nita Tolman, Ronald D. Jones and Melinda Jones. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on June 5, 2008, FileNo. 001-08038.) 10 .36 Asset Purchase Agreement, dated July 22, 2008, by and among Key Energy Pressure Pumping Services, LLC, Leader Energy Services Ltd., Leader Energy Services USA Ltd., and CementRite, Inc. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on July 24, 2008, FileNo. 001-08038.) 133
Exhibit No.Description10 .37 Master Agreement, dated August 26, 2008, by and among Key Energy Services, Inc., Key Energy Services Cyprus Ltd., OOO Geostream Assets Management and L-Group. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on September 2, 2008, FileNo. 001-08038.) 21 * Significant Subsidiaries of the Company. 23 * Consent of Independent Registered Public Accounting Firm. 31 .1* Certification of CEO pursuant to Securities Exchange ActRules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. of 2002. 31 .2* Certification of Principal Financial Officer pursuant to Securities Exchange ActRules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32 * Certification of CEO and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 10.22†Office Lease effective as of January 20, 2005 between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated January 26, 2005, File No. 1-8038.)Indicates a management contract or compensatory plan, contract or arrangement in which any Director or any Executive Officer participates.10.23First Amendment to Office Lease dated as of March 15, 2005 between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated June 30, 2005, File No. 1-3038.)10.24*Second Amendment to Office Lease dated as of July 24, 2005 between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.2 of the Company's Current Report on Form 8-K dated June 30, 2005, File No. 1-8038.)10.25Credit Agreement, dated as of June 29, 2005, among the Company, as Borrower, the several lenders from time to time party thereto, Lehman Brothers Inc., as sole lead arranger and sole book runner, Lehman Commercial Paper Inc., as syndication agent, administrative agent and as collateral agent, and Wells Fargo Foothill, Inc., as revolving administrative agent. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated August 4, 2005, File No. 1-8038.)10.26First Amendment to Credit Agreement and First Amendment to Guaranty and Collateral Agreement dated as of November 1, 2005, among the Company, as Borrower, the Guarantors, the Lenders, and Lehman Commercial Paper Inc., as administrative agent for the Lenders and as Collateral Agent for the Lenders and other Secured Parties. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated November 7, 2005, File No. 1-8038.)10.27Second Amendment to Credit Agreement dated as of November 21, 2006, among the Company, as Borrower, the Guarantors, the Lenders, and Lehman Commercial Paper Inc., as administrative agent for the Lenders and as Collateral Agent for the Lenders and other secured Parties. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated October 19, 2006, File No. 1-8038.)10.28Third Amendment to Credit Agreement dated as of July 27, 2007, among the Company, as Borrower, the Guarantors, the Lenders and Lehman Commercial Paper, Inc., as administrative agent for the Lenders and as Collateral Agent for the Lenders and other Secured Parties. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated July 31, 2007, File No. 1-8038.)Filed herewith.134
10.29Fourth Amendment to Credit Agreement dated as of November 12, 2007, among Key Energy Services, Inc., as Borrower, the guarantors signatory thereto, the Lenders, and Lehman Commercial Paper Inc., as administrative agent for the Lenders and as Collateral Agent for the Lenders and other Secured Parties. (Incorporated by Reference to Exhibit 10.1 of the Company's Form 8-K filed on November 15, 2007, File No. 1-8038.)10.30Credit Agreement dated as of November 29, 2007, among Key Energy Services, Inc., each lender from time to time party thereto, Bank of America, N.A., as Paying Agent, Co-Administrative Agent, Swing Line Lender and L/C Issuer, and Wells Fargo Bank, National Association, as Co-Administrative Agent, Swing Line Lender and L/C Issuer. (Incorporated by Reference to Exhibit 10.1 of the Company's Form 8-K filed on November 30, 2007, File No. 1-8038.)10.31Stock and Membership Interest Purchase Agreement dated as of September 19, 2007. (Incorporated by Reference to Exhibit 10.1 of the Company's Form 8-K filed on September 20, 2007, File No. 1-8038.)10.32First Amendment to Stock and Membership Interest Purchase Agreement dated October 25, 2007, among Key Energy Services, LLC and the Sellers (as defined therein). (Incorporated by Reference to Exhibit 10.3 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, File No. 1-8038.)10.33Asset Purchase Agreement dated December 7, 2007 among Key Energy Services, LLC, Kings Oil Tools, Inc. and Thomas Fowler. (Incorporated by Reference to Exhibit 10.1 of the Company's Form 8-K filed on December 13, 2007, File No. 1-8038.)10.33Purchase Agreement, dated November 14, 2007, by and among the Company, certain of its domestic subsidiaries, and Lehman Brothers, Inc., Banc of America Securities LLC and Morgan Stanley & Co. Incorporated, as representatives of the initial purchasers. (Incorporated by Reference to Exhibit 10.2 of the Company's Form 8-K filed on November 15, 2007, File No. 1-8038.)21*Significant Subsidiaries of the Company.23*Consent of Independent Registered Public Accounting Firm.31.1*Certification of CEO pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. of 2002.31.2*Certification of CFO pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32*Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.†Indicates a management contract or compensatory plan, contract or arrangement in which any Director or any Executive Officer participates.*Filed herewith.
Pursuant to the requirements of Section 13ofor 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.KEY ENERGY SERVICES, INC.Date: February 29, 2008KEY ENERGY SERVICES, INC.
By:By:/s/ J. Marshall DodsonWILLIAM M. AUSTINWilliam M. Austin,Senior VicePresident and Chief Financial OfficerJ. Marshall Dodson,Vice President and Chief Accounting Officer(Principal Financial Officer)Date: February 27, 2009Each person whose signature appears below hereby constitutes and appoints Richard J. Alario andWilliam M. Austin,J. Marshall Dodson, and each of them, his true and lawful attorney-in-fact and agent, with full powers of substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report onForm 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission granting to said attorneys-in-fact, and each of them, full power and authority to perform any other act on behalf of the undersigned required to be done in connection therewith.Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.SignatureTitleDate
SignatureTitleDate/s/RICHARD J. ALARIO
Richard J. Alario
Richard J. AlarioChairman of the Board of Directors,
President and Chief Executive Officer(Principal(Principal Executive Officer)February 29, 200827, 2009/s/WILLIAM M. AUSTINWilliam M. Austin
Senior Vice President and ChiefFinancial Officer(Principal Financial Officer)
February 29, 2008/s/J. MARSHALL DODSON
J. Marshall Dodson
J. Marshall Dodson
Vice President and Chief Accounting
Officer(Principal Accounting(Principal Financial Officer)
February29, 200827, 2009/s/DAVID J. BREAZZANO
David J. Breazzano
David J. Breazzano
Director
February29, 200827, 2009/s/ Lynn R. Coleman
Lynn R. Coleman
Director
February29, 200827, 2009/s/KEVIN P. COLLINS
Kevin P. Collins
Kevin P. Collins
Director
February29, 200827, 2009/s/WILLIAM D. FERTIG
William D. Fertig
William D. Fertig
Director
February29, 200827, 2009/s/W. PHILLIP MARCUM
W. Phillip Marcum
W. Phillip Marcum
Director
February29, 200827, 2009SignatureTitleDate/s/RALPHRalph S.MICHAEL, III
Michael,
Ralph S. Michael, III
Director
February29, 200827, 2009/s/WILLIAM F. OWENS
William F. Owens
William F. Owens
Director
February29, 200827, 2009/s/ARLENE M. YOCUM
Arlene M. Yocum
Arlene M. Yocum
Director
February29, 200827, 2009/s/ROBERT K. REEVES
Robert K. Reeves
Robert K. Reeves
Director
February29, 200827, 2009/s/J. ROBINSON WEST
J. Robinson WestDirectorFebruary 29, 2008Exhibit No.Description3.1J. Robinson WestArticles of Restatement of the Company. (Incorporated by Reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2006, File No. 1-8038.)3.2Director
Unanimous consent of the Board of Directors of the Company dated January 11, 2000, limiting the designation of the additional authorized shares to common stock. (Incorporated by reference to Exhibit 3.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2000, File No. 1-8038.)3.3Second Amended and Restated By-laws of Key Energy Services, Inc. (Incorporated by reference to Exhibit 3.1 of the Company's Form 8-K filed on September 22, 2006, File No. 1-8038.)3.4Amendment to Second Amended and Restated By-laws of Key Energy Services, Inc. (Incorporated by Reference to Exhibit 3.1 of the Company's Form 8-K filed on November 2, 2007, File No. 1-8038.)4.1Warrant Agreement dated as of January 22, 1999 between the Company and the Bank of New York, a New York banking corporation as warrant agent. (Incorporated by reference to Exhibit 99(b) of the Company's Form 8-K filed onFebruary3, 1999, File No. 1-8038.)4.2Warrant Registration Rights Agreement dated January 22, 1999, by and among the Company and Lehman Brothers Inc., Bear, Stearns & Co., Inc., F.A.C. / Equities, a division of First Albany Corporation, and Dain Rauscher Wessels, a division of Dain Rauscher Incorporated. (Incorporated by reference to Exhibit 99(e) of the Company's Form 8-K filed on February 3, 1999, File No. 1-8038.)4.3Indenture, dated as of November 29, 2007, among Key Energy Services, Inc., the guarantors party thereto and The Bank of New York Trust Company, N.A., as trustee. (Incorporated by Reference to Exhibit 4.1 of the Company's Form 8-K filed on November 30, 2007, File No. 1-8038.)4.4Registration Rights Agreement dated as of November 29, 2007, among Key Energy Services, Inc., the subsidiary guarantors of the Company party thereto, and Lehman Brothers Inc., Banc of America Securities LLC and Morgan Stanley & Co. Incorporated, as representatives of the several initial purchasers named therein. (Incorporated by Reference to Exhibit 4.2 of the Company's Form 8-K filed on November 30, 2007, File No. 1-8038.)10.1†Key Energy Group, Inc. 1997 Incentive Plan, as an amendment and restatement effective November 17, 1997 of the Key Energy Group, Inc. 1995 Outside Directors Stock Option Plan. (Incorporated by reference to Exhibit B of the Company's Schedule 14A Proxy Statement filed November 26, 1997, File No. 000-22665.)10.2†Form of Restricted Stock Agreement under Key Energy Group, Inc. 1997 Incentive Plan.10.3†The 2006 Phantom Share Plan of Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated October 19, 2006, File No. 1-8038.)10.4†Form of Award Agreement under the 2006 Phantom Share Plan of Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.2 of the Company's Current Report on Form 8-K dated October 19, 2006, File No. 1-8038.)10.5†Form of Stock Appreciation Rights Agreement. (Incorporated by Reference to Exhibit 99.1 of the Company's Form 8-K filed on August 24, 2007, File No. 1-8038.)27, 200910.6†Form of Non-Plan Option Agreement. (Incorporated by Reference to Exhibit 4.1 of the Company's Registration Statement on Form S-8 filed on September 25, 2007, File No. 333-146294.)10.7†Key Energy Services, Inc. 2007 Equity and Cash Incentive Plan. (Incorporated by Reference to Appendix A of the Company's Schedule 14A Proxy Statement filed on November 1, 2007, File No. 1-8038.)10.8†*Form of Nonstatutory Stock Option Agreement under 2007 Equity and Cash Incentive Plan.10.9†Restated Employment Agreement dated effective as of December 31, 2007, among Richard J. Alario, Key Energy Services, Inc. and Key Energy Shared Services, LLC (Incorporated by Reference to Exhibit 10.1 of the Company's Form 8-K filed on January 7, 2008, File No. 1-8038.)10.10†Acknowledgment and Waiver by Richard J. Alario dated March 25, 2005 regarding rescinded option grant. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated March 29, 2005.)10.11†Restated Employment Agreement dated effective as of December 31, 2007, among William M. Austin, Key Energy Services, Inc. and Key Energy Shared Services, LLC (Incorporated by Reference to Exhibit 10.2 of the Company's Form 8-K filed on January 7, 2008, File No. 1-8038.)10.12†Restated Employment Agreement dated effective as of December 31, 2007, among Newton W. Wilson III, Key Energy Services, Inc. and Key Energy Shared Services, LLC (Incorporated by Reference to Exhibit 10.3 of the Company's Form 8-K filed on January 7, 2008, File No. 1-8038.)10.13†Acknowledgment and Waiver by Newton W. Wilson III dated March 25, 2005 regarding rescinded option grant (Incorporated by reference to Exhibit 10.2 of the Company's Current Report on Form 8-K dated March 29, 2005.)10.14†Restated Employment Agreement dated effective as of December 31, 2007, among Kim B. Clarke, Key Energy Services, Inc. and Key Energy Shared Services, LLC (Incorporated by Reference to Exhibit 10.4 of the Company's Form 8-K filed on January 7, 2008, File No. 1-8038.)10.15†Employment Agreement between Key Energy Services, Inc. and Jim D. Flynt dated as of January 1, 2004. (Incorporated by reference to Exhibit 10.6 of the Company's Current Report on Form 8-K dated October 19, 2006, File No. 1-8038.)10.16†First Amendment to Employment Agreement dated November 26, 2007, between Key Energy Services, Inc. and Jim D. Flynt. (Incorporated by Reference to Exhibit 10.2 of the Company's Form 8-K filed on November 30, 2007, File No. 1-8038.)10.17†Employment Agreement between Key Energy Services, Inc. and Phil Coyne dated November 17, 2004. (Incorporated by reference to Exhibit 10.8 of the Company's Current Report on Form 8-K dated October 19, 2006, File No. 1-8038.)10.18†First Amendment to Employment Agreement between the Company and Phil Coyne effective as of January 24, 2005. (Incorporated by reference to Exhibit 10.9 of the Company's Current Report on Form 8-K dated October 19, 2006, File No. 1-8038.)10.19†*Amended and Restated Employment Agreement between Key Energy Services, Inc. and Don D. Weinheimer dated December 31, 2007.10.20†Employment Agreement dated August 14, 2007 between the Company and J. Marshall Dodson. (Incorporated by Reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, File No. 1-8038.)10.21†Employment Agreement dated August 14, 2007 between the Company and D. Bryan Norwood. (Incorporated by Reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, File No. 1-8038.)10.22Office Lease effective as of January 20, 2005 between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated January 26, 2005, File No. 1-8038.)10.23First Amendment to Office Lease dated as of March 15, 2005 between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated June 30, 2005, File No. 1-3038.)10.24Second Amendment to Office Lease dated as of July 24, 2005 between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.2 of the Company's Current Report on Form 8-K dated June 30, 2005, File No. 1-8038.)10.25Credit Agreement, dated as of June 29, 2005, among the Company, as Borrower, the several lenders from time to time party thereto, Lehman Brothers Inc., as sole lead arranger and sole book runner, Lehman Commercial Paper Inc., as syndication agent, administrative agent and as collateral agent, and Wells Fargo Foothill, Inc., as revolving administrative agent. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated August 4, 2005, File No. 1-8038.)10.26First Amendment to Credit Agreement and First Amendment to Guaranty and Collateral Agreement dated as of November 1, 2005, among the Company, as Borrower, the Guarantors, the Lenders, and Lehman Commercial Paper Inc., as administrative agent for the Lenders and as Collateral Agent for the Lenders and other Secured Parties. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated November 7, 2005, File No. 1-8038.)10.27Second Amendment to Credit Agreement dated as of November 21, 2006, among the Company, as Borrower, the Guarantors, the Lenders, and Lehman Commercial Paper Inc., as administrative agent for the Lenders and as Collateral Agent for the Lenders and other secured Parties. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated October 19, 2006, File No. 1-8038.)10.28Third Amendment to Credit Agreement dated as of July 27, 2007, among the Company, as Borrower, the Guarantors, the Lenders and Lehman Commercial Paper, Inc., as administrative agent for the Lenders and as Collateral Agent for the Lenders and other Secured Parties. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K dated July 31, 2007, File No. 1-8038.)10.29Fourth Amendment to Credit Agreement dated as of November 12, 2007, among Key Energy Services, Inc., as Borrower, the guarantors signatory thereto, the Lenders, and Lehman Commercial Paper Inc., as administrative agent for the Lenders and as Collateral Agent for the Lenders and other Secured Parties. (Incorporated by Reference to Exhibit 10.1 of the Company's Form 8-K filed on November 15, 2007, File No. 1-8038.)10.30Credit Agreement dated as of November 29, 2007, among Key Energy Services, Inc., each lender from time to time party thereto, Bank of America, N.A., as Paying Agent, Co-Administrative Agent, Swing Line Lender and L/C Issuer, and Wells Fargo Bank, National Association, as Co-Administrative Agent, Swing Line Lender and L/C Issuer. (Incorporated by Reference to Exhibit 10.1 of the Company's Form 8-K filed on November 30, 2007, File No. 1-8038.)10.31Stock and Membership Interest Purchase Agreement dated as of September 19, 2007. (Incorporated by Reference to Exhibit 10.1 of the Company's Form 8-K filed on September 20, 2007, File No. 1-8038.)10.32First Amendment to Stock and Membership Interest Purchase Agreement dated October 25, 2007, among Key Energy Services, LLC and the Sellers (as defined therein). (Incorporated by Reference to Exhibit 10.3 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, File No. 1-8038.)10.33Asset Purchase Agreement dated December 7, 2007 among Key Energy Services, LLC, Kings Oil Tools, Inc. and Thomas Fowler. (Incorporated by Reference to Exhibit 10.1 of the Company's Form 8-K filed on December 13, 2007, File No. 1-8038.)10.33Purchase Agreement, dated November 14, 2007, by and among the Company, certain of its domestic subsidiaries, and Lehman Brothers, Inc., Banc of America Securities LLC and Morgan Stanley & Co. Incorporated, as representatives of the initial purchasers. (Incorporated by Reference to Exhibit 10.2 of the Company's Form 8-K filed on November 15, 2007, File No. 1-8038.)21*Significant Subsidiaries of the Company.23*Consent of Independent Registered Public Accounting Firm.31.1*Certification of CEO pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. of 2002.31.2*Certification of CFO pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32*Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.†Indicates a management contract or compensatory plan, contract or arrangement in which any Director or any Executive Officer participates.*Filed herewith.
Board of Directors and Shareholders ofKey Energy Services, Inc.We have audited in accordance with the standards of the Public Company Accounting Oversight Board (United States) the consolidated financial statements of Key Energy Services, Inc. and Subsidiaries referred to in our report dated February26, 2008,24, 2009, which is included in the annual report to security holders and incorporated by reference in Part II of this form. Our report on the consolidated financial statements includes explanatory paragraphs, which discuss the adoption ofStatement of Financial Accounting Standards No. 123 (revised 2004),Share Based Payments,Financial Accounting Standards Interpretation No. 48,Accounting for Uncertainty in Income Taxes, and FSPEITF 00-19-2,Accounting for Registration Payment Arrangements. Our audits of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15, which is the responsibility of theCompany'sCompany’s management. In our opinion, this financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein./s/ GRANT THORNTON LLPHouston, TexasScheduleII—II — Valuation and Qualifying AccountsAdditions Balance at Charged to Beginning of Charged to Other Balance at Period Expense Accounts Acquisitions Deductions End of Period (In thousands) Allowance for doubtful accounts: As of December 31, 2008 $ 13,501 $ 37 $ (38 ) $ 15 $ (2,047 ) $ 11,468 As of December 31, 2007 12,998 3,675 — 1,251 (4,423 ) 13,501 As of December 31, 2006 10,843 1,854 301 — — 12,998 (in thousands)
S-2EXHIBIT INDEXExhibit No.Description3 .1 Articles of Restatement of Key Energy Services, Inc. (Incorporated by reference to Exhibit 3.1 of the Company’s Annual Report onForm 10-K for the fiscal year ended December 31, 2006, FileNo. 001-08038.) 3 .2 Unanimous consent of the Board of Directors of Key Energy Services, Inc., dated January 11, 2000, limiting the designation of the additional authorized shares to common stock. (Incorporated by reference to Exhibit 3.2 of the Company’s Quarterly Report onForm 10-Q for the quarter ended March 31, 2000, FileNo. 001-08038.) 3 .3 Second Amended and Restated By-laws of Key Energy Services, Inc., adopted September 21, 2006. (Incorporated by reference to Exhibit 3.1 of the Company’sForm 8-K filed on September 22, 2006, FileNo. 001-08038.) 3 .4 Amendment to Second Amended and Restated By-laws of Key Energy Services, Inc., adopted November 2, 2007. (Incorporated by reference to Exhibit 3.1 of the Company’sForm 8-K filed on November 2, 2007, FileNo. 001-08038.) 3 .5 Amendments to Second Amended and Restated By-laws of Key Energy Services, Inc., adopted April 4, 2008. (Incorporated by reference to Exhibit 3.1 of the Company’sForm 8-K filed on April 9, 2008, FileNo. 001-08038.) 4 .1 Warrant Agreement, dated as of January 22, 1999, between Key Energy Services, Inc. and the Bank of New York, a New York banking corporation as warrant agent. (Incorporated by reference to Exhibit 99(b) of the Company’s Current Report onForm 8-K filed on February 3, 1999, FileNo. 001-08038.) 4 .2 Warrant Registration Rights Agreement dated January 22, 1999, by and among Key Energy Services, Inc., the Guarantors named therein, Lehman Brothers Inc., Bear, Stearns & Co., Inc., F.A.C. / Equities, a division of First Albany Corporation, and Dain Rauscher Wessels, a division of Dain Rauscher Incorporated. (Incorporated by reference to Exhibit 99(e) of the Company’s Current Report onForm 8-K filed on February 3, 1999, FileNo. 001-08038.) 4 .3 Indenture, dated as of November 29, 2007, among Key Energy Services, Inc., the guarantors party thereto and The Bank of New York Trust Company, N.A., as trustee. (Incorporated by reference to Exhibit 4.1 of the Company’s Current Report onForm 8-K filed on November 30, 2007, FileNo. 001-08038.) 4 .4 Registration Rights Agreement dated as of November 29, 2007, among Key Energy Services, Inc., the subsidiary guarantors of the Company party thereto, and Lehman Brothers Inc., Banc of America Securities LLC and Morgan Stanley & Co. Incorporated, as representatives of the several initial purchasers named therein. (Incorporated by reference to Exhibit 4.2 of the Company’s Current Report onForm 8-K filed on November 30, 2007, FileNo. 001-08038.) 4 .5 First Supplemental Indenture, dated as of January 22, 2008, among Key Marine Services, LLC, the existing Guarantors and The Bank of New York Trust Company, N.A., as trustee. (Incorporated by reference to Exhibit 4.5 of the Company’s Quarterly Report onForm 10-Q for the quarter ended March 31, 2008, FileNo. 001-08038.) 4 .6* Second Supplemental Indenture, dated as of January 13, 2009, among Key Energy Mexico, LLC, the existing Guarantors and The Bank of New York Trust Company, N.A., as trustee. 10 .1† Key Energy Group, Inc. 1997 Incentive Plan, as an amendment and restatement effective November 17, 1997 of the Key Energy Group, Inc. 1995 Outside Directors Stock Option Plan. (Incorporated by reference to Exhibit B of the Company’s Schedule 14A Proxy Statement filed November 26, 1997, FileNo. 001-08038.) 10 .2† Form of Restricted Stock Award Agreement under Key Energy Group, Inc. 1997 Incentive Plan. (Incorporated by reference to Exhibit 10.15 of the Company’s Annual Report onForm 10-K for the year ended December 31, 2006, FileNo. 001-08038.) 10 .3† The 2006 Phantom Share Plan of Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K dated October 19, 2006, FileNo. 001-08038.) 10 .4† Form of Award Agreement under the 2006 Phantom Share Plan of Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report onForm 8-K dated October 19, 2006, FileNo. 001-08038.) Additions Balance at
Beginning of
PeriodCharged to
ExpenseCharged to
Other
AccountsAcquisitions Deductions Balance at
End of PeriodAllowance for doubtful accounts: As of December 31, 2007 $ 12,998 $ 3,675 $ — $ 1,251 $ (4,423 ) $ 13,501 As of December 31, 2006 10,843 1,854 301 — — 12,998 As of December 31, 2005 8,990 1,853 — — — 10,843 Exhibit No.Description10 .5† Form of Stock Appreciation Rights Agreement under Key Energy Group, Inc. 1997 Incentive Plan. (Incorporated by reference to Exhibit 99.1 of the Company’s Current Report onForm 8-K filed on August 24, 2007, FileNo. 001-08038.) 10 .6† Form of Non-Plan Option Agreement under Key Energy Group, Inc. 1997 Incentive Plan. (Incorporated by reference to Exhibit 4.1 of the Company’s Registration Statement onForm S-8 filed on September 25, 2007, FileNo. 333-146294.) 10 .7† Key Energy Services, Inc. 2007 Equity and Cash Incentive Plan. (Incorporated by Reference to Appendix A of the Company’s Schedule 14A Proxy Statement filed on November 1, 2007, FileNo. 001-08038.) 10 .8† Form of Nonstatutory Stock Option Agreement under 2007 Equity and Cash Incentive Plan. (Incorporated by reference to Exhibit 10.8 of the Company’s Annual Report onForm 10-K for the year ended December 31, 2007 filed on February 28, 2008, FileNo. 001-08038.) 10 .9† Restated Employment Agreement, dated effective as of December 31, 2007, among Richard J. Alario, Key Energy Services, Inc. and Key Energy Shared Services, LLC. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on January 7, 2008, FileNo. 001-08038.) 10 .10† Acknowledgment and Waiver by Richard J. Alario, dated March 25, 2005, regarding rescinded option grant. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K dated March 29, 2005, FileNo. 001-08038.) 10 .11† Restated Employment Agreement, dated effective as of December 31, 2007, among William M. Austin, Key Energy Services, Inc. and Key Energy Shared Services, LLC. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report onForm 8-K filed on January 7, 2008, FileNo. 001-08038.) 10 .12† Restated Employment Agreement, dated effective as of December 31, 2007, among Newton W. Wilson III, Key Energy Services, Inc. and Key Energy Shared Services, LLC. (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report onForm 8-K filed on January 7, 2008, FileNo. 001-08038.) 10 .13† Acknowledgment and Waiver by Newton W. Wilson III, dated March 25, 2005, regarding rescinded option grant. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report onForm 8-K dated March 29, 2005, FileNo. 001-08038.) 10 .14†* Amended and Restated Employment Agreement, dated October 22, 2008, between Kimberly R. Frye, Key Energy Services, Inc. and Key Energy Shared Services, LLC. 10 .15† Restated Employment Agreement dated effective as of December 31, 2007, among Kim B. Clarke, Key Energy Services, Inc. and Key Energy Shared Services, LLC (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report onForm 8-K filed on January 7, 2008, FileNo. 001-08038.) 10 .16† Employment Agreement, dated as of January 1, 2004, between Key Energy Services, Inc. and Jim D. Flynt. (Incorporated by reference to Exhibit 10.6 of the Company’s Current Report onForm 8-K dated October 19, 2006, FileNo. 001-08038.) 10 .17† First Amendment to Employment Agreement, dated November 26, 2007, between Key Energy Services, Inc. and Jim D. Flynt. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report onForm 8-K filed on November 30, 2007, FileNo. 001-08038.) 10 .18† Employment Agreement, dated November 17, 2004, between Key Energy Services, Inc. and Phil Coyne. (Incorporated by reference to Exhibit 10.8 of the Company’s Current Report onForm 8-K dated October 19, 2006, FileNo. 001-08038.) 10 .19† First Amendment to Employment Agreement, effective as of January 24, 2005, between Key Energy Services, Inc. and Phil Coyne. (Incorporated by reference to Exhibit 10.9 of the Company’s Current Report onForm 8-K dated October 19, 2006, FileNo. 001-08038.) 10 .20† Amended and Restated Employment Agreement, dated December 31, 2007, between Key Energy Services, Inc. and Don D. Weinheimer. (Incorporated by reference to Exhibit 10.19 of the Company’s Annual Report onForm 10-K for the year ended December 31, 2007 filed on February 28, 2008, FileNo. 001-08038.) Exhibit No.Description10 .21† Employment Agreement, dated August 14, 2007, between Key Energy Shared Services, LLC and J. Marshall Dodson. (Incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report onForm 10-Q for the quarter ended September 30, 2007, FileNo. 001-08038.) 10 .22† Employment Agreement, dated August 14, 2007, between Key Energy Shared Services, LLC and D. Bryan Norwood. (Incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report onForm 10-Q for the quarter ended September 30, 2007, FileNo. 001-08038.) 10 .23†* Restated Employment Agreement, effective August 1, 2007, between Key Energy Shared Services, LLC and Tommy Pipes. 10 .24†* Employment Agreement, effective August 1, 2007, between Key Energy Services, Inc. and John Carnett. 10 .25 Office Lease, effective as of January 20, 2005, between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K dated January 26, 2005, FileNo. 001-08038.) 10 .26 First Amendment to Office Lease, dated as of March 15, 2005, between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K dated June 30, 2005, FileNo. 001-08038.) 10 .27 Second Amendment to Office Lease, dated as of July 24, 2005, between Crescent 1301 McKinney, L.P. and Key Energy Services, Inc. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report onForm 8-K dated June 30, 2005, FileNo. 001-08038.) 10 .28 Credit Agreement, dated as of November 29, 2007, among Key Energy Services, Inc., each lender from time to time party thereto, Bank of America, N.A., as Paying Agent, Co-Administrative Agent, Swing Line Lender and L/C Issuer, and Wells Fargo Bank, National Association, as Co-Administrative Agent, Swing Line Lender and L/C Issuer. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on November 30, 2007, FileNo. 001-08038.) 10 .29 Stock and Membership Interest Purchase Agreement, dated as of September 19, 2007, between and among Key Energy Services, LLC, the Sellers named therein, and Moncla Well Service, Inc. and certain other affiliated companies named therein. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on September 20, 2007, FileNo. 001-08038.) 10 .30 First Amendment to Stock and Membership Interest Purchase Agreement, dated as of October 25, 2007, among Key Energy Services, LLC, the Sellers named therein, and Moncla Well Service, Inc. and certain other affiliated companies named therein. (Incorporated by reference to Exhibit 10.3 of the Company’s Quarterly Report onForm 10-Q for the quarter ended September 30, 2007, FileNo. 001-08038.) 10 .31* Second Amendment to Stock and Membership Interest Purchase Agreement, dated as of September 30, 2008, among Key Energy Services, LLC, the Sellers named therein, and Moncla Well Service, Inc. and certain other affiliated companies named therein. 10 .32 Purchase Agreement, dated November 14, 2007, by and among the Company, certain of its domestic subsidiaries, and Lehman Brothers, Inc., Banc of America Securities LLC and Morgan Stanley & Co. Incorporated, as representatives of the initial purchasers. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report onForm 8-K filed on November 15, 2007, FileNo. 001-08038.) 10 .33 Asset Purchase Agreement, dated December 7, 2007, among Key Energy Services, LLC, Kings Oil Tools, Inc. and Thomas Fowler. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on December 13, 2007, FileNo. 001-08038.) 10 .34 Purchase Agreement, dated April 3, 2008, among Key Energy Services, LLC, Western Drilling Holdings, Inc., and Fred S. Holmes and Barbara J. Holmes. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on April 9, 2008, FileNo. 001-08038.) 10 .35 Stock Purchase Agreement, dated May 30, 2008, by and among Key Energy Services, LLC, and E. Kent Tolman, Nita Tolman, Ronald D. Jones and Melinda Jones. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on June 5, 2008, FileNo. 001-08038.) Exhibit No.Description10 .36 Asset Purchase Agreement, dated July 22, 2008, by and among Key Energy Pressure Pumping Services, LLC, Leader Energy Services Ltd., Leader Energy Services USA Ltd., and CementRite, Inc. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on July 24, 2008, FileNo. 001-08038.) 10 .37 Master Agreement, dated August 26, 2008, by and among Key Energy Services, Inc., Key Energy Services Cyprus Ltd., OOO Geostream Assets Management and L-Group. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report onForm 8-K filed on September 2, 2008, FileNo. 001-08038.) 21 * Significant Subsidiaries of the Company. 23 * Consent of Independent Registered Public Accounting Firm. 31 .1* Certification of CEO pursuant to Securities Exchange ActRules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. of 2002. 31 .2* Certification of Principal Financial Officer pursuant to Securities Exchange ActRules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32 * Certification of CEO and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. † Indicates a management contract or compensatory plan, contract or arrangement in which any Director or any Executive Officer participates. * Filed herewith.
of spending, were approved by the appropriate level of management in accordance with their established policies. This is a result of a lack of appropriate approvals for expenditure transactions either made through the procurement system or made outside of the system.