Key Energy Services, Inc.INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006

INDEX

2FORWARD-LOOKING STATEMENTS

In addition to statements of historical fact, this report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Statements that are not historical in nature or that relate to future events and conditions are, or may be deemed to be, forward-looking statements.  These “forward-looking statements” are based on our current expectations, estimates and projections about current expectations, estimates and projections about the Company, our industry and management’s beliefs and assumptions concerning future events and financial trends affecting our financial condition and results of operations.  In some cases, you can identify these statements by terminology such as “may,” “will,” “predicts,” “projects,” “potential” or “continue” or the negative of such terms and other comparable terminology.  These statements are only predictions and are subject to substantial risks and uncertainties.  Actual performance or results may differ materially and adversely.

We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date of this report except as required by law.  All of our written and oral forward-looking statements are expressly qualified by these cautionary statements and any other cautionary statements that may accompany such forward-looking

statements.  The reasons for these differences include changes that occur in our business environment as well as differences stemming from the delay in our financial reports, such as the following factors:

·   Possible adverse consequences of failure to file past SEC reports;

·   Limitations on access to public capital markets;

·   Inability of common stock to trade on a recognized exchange and potential inability to re-list on a recognized exchange;

·   Impact of material weaknesses in internal control over financial reporting;

·   Potential changes in tax liabilities; and

·   Civil litigation.

PART I — FINANCIAL INFORMATION

NOTE REGARDING OUR FINANCIAL REPORTING PROCESS

This report has been delayed due to our restatement and financial reporting process for periods ending December 31, 2003, which began in March 2004.  That process was completed on October 19, 2006.  Our 2003 Financial and Informational Report on Form 8-K/A, filed with the Securities and Exchange Commission (“SEC”) on October 26, 2006, included an audited 2003 consolidated balance sheet which presented our financial condition as of December 31, 2003 in accordance with Generally Accepted Accounting Principles (“GAAP”).  We did not present other consolidated financial statements in accordance with GAAP as we were unable to determine with sufficient certainty the appropriate period(s) in 2003 or before in which to record certain write-offs and write-downs that were identified in our restatement process.  Our former registered public accounting firm expressed an unqualified opinion that the 2003 balance sheet fairly presented our financial condition on December 31, 2003.  The firm also audited the other financial statements presented in the 2003 Financial and Informational Report.  It opined that the financial statements other than the 2003 balance sheet did not fairly present our financial condition or results of operations or cash flows for the periods covered in accordance with GAAP.  Investors should refer to the 2003 Financial and Informational Report for a full description of the restatement and financial reporting process for periods prior to 2004.  Investors are strongly cautioned not to rely on any of the financial statements contained in the 2003 Financial and Informational Report, other than the 2003 balance sheet, as fairly presenting, for the periods covered, our financial condition or our results of operations or cash flows, in accordance with GAAP.  Any information set forth in the 2003 Financial and Informational Report that incorporates or discusses information contained in the financial statements is subject to the same caution.  You also should not rely on any of our previously-filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the periods that ended prior to and including September 30, 2003.

We have completed our financial statements for the years ended December 31, 2004, 2005 and 2006, and on August 13, 2007, we filed our Annual Report on Form 10-K for the year ended December 31, 2006.  Concurrently with the filing of this report, we are filing our Quarterly Reports on Form 10-Q for the first three quarters of 2005 and the remaining two quarters of 2006.  The 2005 Quarterly Reports on Form 10-Q also include 2004 quarterly information.  In light of our inability to provide financial statements in accordance with GAAP for periods prior to 2004, we will not be filing any other earlier reports, including annual reports for 2004 and 2005, or quarterly reports for the first three quarters of 2004.  Due to the delay in the filing of this Quarterly Report, certain information presented in this report relates to significant events that have occurred subsequent to March 31, 2006.

Item 1.

CONSOLIDATED FINANCIAL STATEMENTS

Key Energy Services, Inc.

Condensed Consolidated Balance Sheets

(In thousands)

(Unaudited)

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

3

Key Energy Services, Inc.

UnauditedCondensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

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

4

Key Energy Services, Inc.

UnauditedCondensed Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

(Unaudited)

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

5

Key Energy Services, Inc.

UnauditedCondensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

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

6

Key Energy Services, Inc.

Notes to Consolidated Financial StatementsNOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

(Unaudited)

1.             ORGANIZATION AND SUMMARY OF SIGNFICANTSIGNIFICANT ACCOUNTING POLICIES

The Company

Key Energy Services, Inc. is a Maryland corporation that was organized in April 1977 and commenced operations in July 1978 under the name National Environmental Group, Inc. We emerged from a prepackaged bankruptcy plan in December 1992 as Key Energy Group, Inc. On December 9, 1998, we changed our name to Key Energy Services, Inc. (“Key” or the “Company”). We believe that we are now the leading onshore, rig-based well servicing contractor in the United States. From 1994 through 2002, we grew rapidly through a series of over 100 acquisitions, and today we provide a complete range of well services to major oil companies and independent oil and natural gas production companies, including rig-based well maintenance, workover, well completion and recompletion services, oilfield transportation services, cased-hole electric wireline services and ancillary oilfield services, fishing and rental services and pressure pumping services. During 2006, Key conducted well servicing operations onshore in the continental United States in the following regions: Gulf Coast (including South Texas, Central Gulf Coast of Texas and South Louisiana), Permian Basin of West Texas and Eastern New Mexico, Mid-Continent (including the Anadarko, Hugoton and Arkoma Basins and the ArkLaTex and North Texas regions), Four Corners (including the San Juan, Piceance, Uinta, and Paradox Basins), the Appalachian Basin, Rocky Mountains (including the Denver-Julesberg, Powder River, Wind River, Green River and Williston Basins), and California (the San Joaquin Basin), and internationally in Argentina. We also provide limited onshore drilling services in the Rocky Mountains, the Appalachian Basin and in Argentina. During 2006, we conducted pressure pumping and cementing operations in a number of major domestic producing basins 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 Basin regions of Texas, as well as in California and the Mid-Continent region.

Basis of Presentation

The consolidated financial statementsfiling of Key Energy Services, Inc. (the “Company”, or “Key”) and its wholly-owned subsidiaries as of September 30, 2003 and for the three and nine month periods ended September 30, 2003 and 2002 are unaudited.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in this Quarterly Report on Form 10-Q pursuantwas delayed due to the rulesour restatement and regulations offinancial reporting process for periods ending December 31, 2003, which began in March 2004. That process was completed on October 19, 2006. Our 2003 Financial and Informational Report on Form 8 K/A, filed with the Securities and Exchange Commission (the “SEC”(“SEC”) on October 26, 2006, included an audited 2003 consolidated balance sheet which presented our financial condition as of December 31, 2003 in accordance with Generally Accepted Accounting Principles (“GAAP”). However,We did not present our other consolidated financial statements in accordance with GAAP as we were unable to determine with sufficient certainty the appropriate period(s) in 2003 or before in which to record certain write offs and write downs that were identified in our restatement process. Our former registered public accounting firm expressed an unqualified opinion that the 2003 balance sheet fairly presented our financial condition on December 31, 2003 in accordance with GAAP. The firm also audited the other financial statements presented in the 2003 Financial and Informational Report. It opined that the financial statements other than the 2003 balance sheet did not fairly present our financial condition or results of operations or cash flows for the periods covered in accordance with GAAP. Investors should refer to the 2003 Financial and Informational Report for a full description of the restatement and financial reporting process for periods prior to 2004.

The accompanying unaudited condensed consolidated financial statements in this report have been prepared in accordance with the instructions for interim financial reporting prescribed by the SEC.  The December 31, 2005 year-end condensed consolidated balance sheet data was derived from audited financial statements but does not include all the disclosures required by GAAP.  These interim financial statements should be read together with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2006.

The unaudited condensed consolidated financial statements contained in this report include all material adjustments that, in the opinion of management, these interim financial statements include all theare necessary adjustments to fairly presentfor a fair statement of the results of operations for the interim periods presented.  These unauditedpresented herein.  The results of operations for the interim periods presented in this report are not

necessarily indicative of the results to be expected for the full year or any other interim period due to fluctuations in demand for our services, timing of maintenance and other expenditures, and other factors.

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 (1) analyze assets for possible impairment, (2) determine depreciable lives for our assets, (3) assess future tax exposure and realization of deferred tax assets, (4) determine amounts to accrue for contingencies, (5) value tangible and intangible assets, and (6) assess workers’ compensation, vehicular liability, self-insured risk accruals and other insurance reserves. Our actual results may differ materially from these estimates. We believe that our estimates are reasonable.

Due to the delay in the filing of this report as discussed above, additional information regarding certain liabilities and uncertainties that existed as of the date of this report has become available, either through additional facts about, or the ultimate settlement or resolution of, the liability or uncertainty.  We have taken any additional information that has come to light into account in our estimates and disclosure of any potential liabilities or other contingencies as of the date of this report, in accordance with FASB Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (“SFAS 5”).  The discussion of our commitments and contingencies (see Note 7) should be read in conjunction with the audited financial statements includedcorresponding disclosures made in the Company’s Transitionour Annual Report on Form 10-K for the six monthsyear ended December 31, 2002.  The results of operations for the three and nine month periods ended September 30, 2003 are not necessarily indicative of the results of operations for the full fiscal year ending December 31, 2003.

Stock Based Compensation

The Company accounts for stock option grants to employees using the recognition and measurement principles of APB Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and related interpretations.  Under the Company’s stock incentive plan, the price of the stock on the grant date is the same as the amount an employee must pay to exercise the option to acquire the stock.  Accordingly, the options have no intrinsic value at grant date, and in accordance with the provisions of APB 25, no compensation cost is recognized in the consolidated statement of operations.

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

7

Reclassifications

2006.

Certain reclassifications have been made to prior period amounts to conform to current period financial statement classifications. These reclassifications primarily relate to the change in our reportable segments. Prior to 2004, our Pressure Pumping and Fishing and Rental segments were reported as part of our Well Servicing segment; Pressure Pumping and Fishing and Rental are now presented as independent reportable segments. Additionally, as further discussed in Note 2—“Discontinued Operations,” we sold the majority of our contract drilling assets to Patterson-UTI Energy on January 15, 2005. These assets had previously been reported as part of our Contract Drilling reportable segment. The assets, cash flows, and results of operations of these activities are presented as discontinued operations in our condensed consolidated unaudited financial statements for all periods presented in this Report.

Our remaining contract drilling operations are now reported as part of our Well Servicing segment. We apply the provisions of EITF Issue 04-10, “Determining Whether to Aggregate Operating Segments That Do Not Meet Quantitative Thresholds” (“EITF 04-10”) in our segment reporting in Note 9—“Segment Information.” Our remaining contract drilling operations do not meet the quantitative thresholds as described in Statement of Financial Accounting Standards No. 131, “Disclosures About Segments of an Enterprise and Related Information” (“SFAS 131”), and, under the provisions of EITF 4-10, since the operating segments meet the aggregation criteria we are permitted to combine information about this segment with other similar segments that individually do not meet the quantitative thresholds to produce a reportable segment.

Principles of Consolidation

Within 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 our interest in entities for which we do not have significant control or influence under the threecost method. When we have an interest in an entity and nine months ended September 30, 2002 to conform tocan exert significant influence but not control, we account for that interest using the presentation forequity method. See Note 5—“Investment in IROC Systems Corp.”

In January 2003, the threeFinancial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities—an Interpretation of ARB No. 51” (“FIN 46”). In December 2003 the FASB issued the updated and nine months ended September 30, 2003.  Certain propertyfinal interpretation of ARB No. 51 (“FIN 46R”). FIN 46R requires that an equity investor in a variable interest entity have significant equity at risk (generally a minimum of 10%, which is an increase from the 3% required under previous guidance) and equipment of the Company, which may be used in either well servicing or drilling that had been previously classified as drilling has now been reclassified as well servicing along with related operating results.  The reclassification was made because thehold a controlling interest, evidenced by voting rights, and absorb a majority of the entity’s expected losses, receive a majority of the entity’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 variable interest entities created or obtained after March 15, 2004. The adoption of FIN 46R did not materially impact our consolidated financial statements.

Revenue Recognition

Well Servicing Rigs.  Well servicing revenue consists primarily of maintenance services, workover services, completion services and plugging and abandonment services. We recognize revenue when services are performed, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the price is fixed or determinable. These criteria are typically met at the time we complete a job for a customer. Primarily, we price well servicing rig services by the hour of service performed. Depending on the type of job, we may charge by the project or by the day.

Oilfield Transportation.  Oilfield transportation revenue consists primarily of fluid and equipment transportation services and frac tanks which are used in nature.conjunction with fluid hauling services. We recognize revenue when services are performed, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the price is fixed or determinable. These criteria are typically met at the time we complete a job for a customer. Primarily, we price oilfield trucking services by the hour or by the quantities hauled.

Pressure Pumping and Fishing and Rental Services.  Pressure pumping and fishing and rental services include well stimulation and cementing services, and recovering lost or stuck equipment in the wellbore.  We recognize revenue when services are performed, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the price is fixed or determinable. These criteria are typically met at the time we complete a job for a customer. Generally, we price fishing and rental tool services by the day and pressure pumping services by the job.

8

  Ancillary oilfield services include services such as wireline operations, wellsite construction, roustabout services, foam units and air drilling services. We recognize revenue when services are performed, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the price is fixed or determinable. These criteria are typically met at the time we complete a job for a customer. We price ancillary oilfield services by the hour, day or project depending on the type of services performed.

2.ASSET RETIREMENT OBLIGATIONS – SFAS 143Cash and Cash Equivalents

We 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 balance arrangements. However, at March 31, 2006, all of our obligations under the 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.

On July 1, 2002,Property and Equipment

Asset Retirement Obligations.  In connection with our well servicing activities, we operate a number of Salt Water Disposal (“SWD”) facilities. Our operations involve the Company adoptedtransportation, handling and disposal of fluids in our SWD facilities that 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 Statement of Financial Accounting Standards No. 143, Accounting“Accounting for Asset Retirement ObligationsObligations” (“SFAS 143”).  The new standard requires the Company to, we recognize a liability for the presentfair value of all legal obligations associated with the retirement of tangible long-lived assets and capitalize anand equal amount as a cost of the asset depreciatingasset. We depreciate the additional cost over the estimated useful life of the asset.  At September 30, 2003 and December 31, 2002,assets. 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.

Adoption of SFAS 143 was required for all companies with fiscal years beginning after June 15, 2002. Amortization of the assets associated with the asset retirement obligationobligations was approximately $3,570,000$0.1 million and $9,231,000, respectively, related$0.1 million for the quarters ended March 31, 2006, and 2005, respectively.

Asset and Investment Impairments.  We apply Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) in reviewing our long-lived assets and investments 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 applying this statement, we group our long-lived assets on a division-by-division basis and compare the estimated future cash flows of each division to expected abandonment coststhe 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 market conditions, such as adverse changes in the prices of its oil and natural gas, producing propertieswhich could reduce the fair value of certain of our property and salt water disposal wells.equipment. The decrease indevelopment of future cash flows and the balance fromdetermination of fair value for a division involves significant judgment and estimates. As of March 31, 2006 and December 31, 20022005, no trigger events had been identified by management.

Goodwill and Other Intangible Assets

Goodwill results from business acquisitions and represents the excess of approximately $5,661,000 is primarily due toacquisition costs over the salefair value of the Company’s oilnet assets acquired. We account for goodwill and natural gas properties (see Note 12) and, to a lesser extent, the plugging and abandonment of saltwater disposal wells, partially offset by the acquisition of saltwater disposals wells and the accretion of the discounted liability.

3.GOODWILL AND OTHER INTANGIBLE ASSETS – SFAS 142

The Company followsother intangible assets under the provisions of Statement of Financial Accounting Standards No. 142, Goodwill“Goodwill and Other Intangible AssetsAssets” (“SFAS 142”). SFAS 142 eliminates the amortization for goodwill and other intangible assets with indefinite lives. Intangible assets with lives restricted by contractual, legal, or other means will continue to be amortized over their expected useful lives. Goodwill and other intangible assets no longernot subject to amortization are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impairedimpaired. SFAS 142 requires a two-step process for testing impairment. First, the fair value of each reporting unit is compared to its carrying value to determine whether an indication of impairment exists. If impairment is indicated, then the fair value of the reporting unit’s goodwill is determined by allocating the unit’s fair value to its assets and liabilities (including any unrecognized intangible assets) as set forthif the reporting unit had been acquired in SFAS 142.a business combination. The Company completedamount of impairment for goodwill is measured as the excess of its carrying value over its fair value. We conduct annual impairment assessments, the most recent assessment of goodwill impairment for each of its reporting unitsaffecting this report as of June 30, 2003.December 31, 2005. The assessmentassessments did not result in an indication of goodwill impairment and as of September 30, 2003 management believes no additional assessment is necessary.

impairment.

Intangible assets subject to amortization under SFAS 142 consist of noncompete agreements and patents.patents and trademarks. Amortization expense for the noncompete agreements is calculated using the straight-line method over the period of the agreement, ranging from three to seven years. The cost and accumulated amortization are retired when the noncompete agreement is fully amortized and no longer enforceable. Amortization expense for patents and trademarks is calculated using the straight-line method over the useful life of the patent or trademark, ranging from five to seven years.

The gross carrying amount  Amortization of noncompete agreements subject to amortization totaled approximately $14,332,000for the quarters ended March 31, 2006 and $18,669,000 at September 30, 20032005 was $0.6 million and December 31, 2002, respectively.  Accumulated amortization related to these intangible assets totaled approximately $5,068,000 and $7,511,000 at September 30, 2003 and December 31, 2002,$0.7 million, respectively.  Amortization expenseof patents and trademarks for the quarters ended March 31, 2006 and 2005 was $0.1 million and $0.1 million, respectively.  During the three months ended September 30, 2003March 31, 2006, the Company capitalized approximately $0.1 million of costs associated with patents and 2002 was approximately $982,000trademarks.  No costs associated with noncompete agreements were capitalized during the first quarter of 2006.

Derivative Instruments and $1,260,000, respectively.  Amortization expense for the nine months ended September 30, 2003 and 2002 was approximately $3,114,000 and $2,404,000, respectively.  Amortization expense for the next five succeeding years is estimated to be approximately $3,329,000, $2,613,000, $2,026,000, $1,180,000 and $104,000.

9