ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW Key Energy Services, Inc., its wholly-owned subsidiaries and its controlled subsidiaries (collectively, "Key," the "Company," "we," "us," "its," and "our") provide a complete range of services to major oil companies, foreign national oil companies and independent oil and natural gas production companies, including rig-based services, fluid management services, pressure pumping services, fishing services, rental services, and cased-hole electric wireline services. We operate in most major oil and natural gas producing regions of the United States as well as internationally in Argentina and Mexico. We also own a technology development company based in Canada and have equity interests in oilfield service companies in Canada and the Russian Federation.
The following discussion and analysis should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes as of March 31, 2009 and for the three months ended March 31, 2009 and 2008, included elsewhere herein, and the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.
During the quarter ended March 31, 2009, we operated in two business segments, Well Servicing and Production Services. We also have a "Functional Support" segment associated with managing all of our reportable operating segments. A description of our Well Servicing and Production Services business segments is outlined below:
Well Servicing
Rig Services
This segment includes the maintenance of existing wells, workover of existing wells, completion of newly drilled wells, drilling of horizontal wells, recompletion of existing wells (re-entering a well to complete the well in a new geologic zone or formation) and plugging and abandonment of wells at the end of their useful lives.
Workover services are performed to enhance the production of existing wells. Such services include extensions of existing wells to drain new formations either by deepening wellbores to new zones or by drilling horizontal or lateral wellbores to improve reservoir drainage. In less extensive workovers, our rigs are used to seal off depleted zones in existing wellbores and access previously bypassed productive zones.
Our completion services prepare a newly drilled oil or natural gas well for production. We typically provide a well service rig and may also provide other equipment such as a workover package to assist in the completion process.
Fluid Management Services
This segment also provides fluid management services, including oilfield transportation and produced-water disposal services. Our oilfield transportation and produced-water disposal services include vacuum truck services, fluid transportation services and disposal services for operators whose oil or natural gas wells produce saltwater and other fluids. In addition, we are a supplier of frac tanks which are used for temporary storage of fluids in conjunction with the fluid hauling operations. Our fluid management services will collect, transport and dispose of the saltwater. These fluids are removed from the well site and transported for disposal in a saltwater disposal ("SWD") well. Production Services
This segment provides multiple services as described below:
Pressure Pumping Services
We provide well stimulation and cementing services to oil and natural gas producers. Well stimulation services include fracturing, nitrogen, coiled tubing and acidizing services. These services (which may be completion or workover services) are provided to oil and natural gas producers and are used to enhance the production of oil and natural gas wells from formations which exhibit restricted flow of oil and natural gas. In the fracturing process, we typically pump fluid and sized sand, or proppants, into a well at high pressure in order to fracture the formation and thereby increase the flow of oil and natural gas. With our cementing services, we pump cement into a well between the casing and the wellbore.

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Fishing Services
We provide fishing services to major and independent oil and natural gas production companies in the Gulf Coast, Central and Permian Basin marketplaces, as well as in California. We also provided limited services offshore in the Gulf of Mexico. Fishing services involve recovering lost or stuck equipment in the wellbore utilizing a "fishing tool."
Rental Services
We provide rental services to major and independent oil and natural gas production companies in the Gulf Coast, Central and Permian Basin marketplaces, as well as in California. We offer a full line of services and rental equipment designed for use both onshore and offshore for drilling and workover services. Our rental tool inventory consists of drill pipe, tubulars, handling tools (including our patented
Hydra-WalkŪ pipe-handling units and services), pressure-control equipment, power swivels and foam air units.
Cased-hole Electric Wireline Services We perform activities at various times throughout the life of the well including perforating, completion logging, production logging and casing integrity services. After the wellbore is cased and cemented, we can provide a number of services. Perforating creates the flow path between the reservoir 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.
PERFORMANCE MEASURES In determining the overall health of the oilfield service industry, we believe 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 correlated well with 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 fallen dramatically since the fourth quarter of 2008 and prices for both oil and natural gas have also declined.

Average Baker NYMEX Henry Hughes U.S. WTI Cushing Oil Hub Natural Gas Land Drilling (1) (1) Rigs (2) 2009: First Quarter $ 43.18 $ 4.56 1,287 2008: First Quarter $ 97.94 $ 8.74 1,712 Second Quarter $ 123.95 $ 11.47 1,797 Third Quarter $ 118.05 $ 8.99 1,910 Fourth Quarter $ 59.06 $ 6.42 1,836

(1) Represents the average price for the periods presented. Source:
EIA / Bloomberg

(2) Source:
www.bakerhughes.com

Internally, we measure activity levels in our Well Servicing segment primarily through our rig and trucking hours. As capital spending by our customer base increases, demand for our services generally rises, resulting in increased rig and trucking services and more hours worked. Conversely, when activity levels decline due to lower spending by our customer base, we generally provide fewer services, which results in lower hours worked. The number of rig and trucking hours, as well as pricing, may also be affected by increases in industry capacity. We publicly release our monthly rig and trucking

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hours. The following table presents our quarterly rig and trucking hours from the first quarter of 2008 through the first quarter of 2009:

Rig Hours Trucking Hours 2009: First Quarter 489,819 499,247 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

MARKET CONDITIONS AND OUTLOOK Market Conditions - Quarter Ended March 31, 2009 Market conditions during the first quarter of 2009 continued the downward trend that began in the latter part of 2008. Overall demand for our services has continued to decline in response to the rapid decline in commodity prices for oil and natural gas since the third quarter of 2008, which has caused many of our customers' projects to become economically unviable. The global financial crisis, which has reduced the availability of credit financing to many of our customers, has also affected demand. Our activity levels during the first quarter of 2009 declined significantly relative to prior periods, even when taking into account the expansion of our operations over the prior twelve months. As industry-wide activity levels have fallen, pricing pressures have increased, resulting in lower pricing for our services over the same time period. The average Baker Hughes U.S. land drilling rig count for the first quarter of 2009 was 1,287, a decline of 29.9% from December 31, 2008 and a decline of 24.8% since the end of the first quarter of 2008. The activity decline portrayed by the Baker Hughes U.S. land drilling rig count over the past three months represents the steepest decline in a three month period since that data began to be captured and reported. Commodity prices have seen a similar decline; spot prices for West Texas Intermediate at Cushing, Oklahoma have declined approximately 51.1% since the end of the first quarter of 2008, and natural gas at the Henry Hub has declined approximately 63.5% over the same period. All of our operating units have seen reductions in activity and pricing pressure as the remaining service providers attempt to retain their market share; those that have been hardest hit are those that are more closely tied to natural gas drilling activity, including our pressure pumping, fishing, rental and cased-hole electric wireline operations.
In anticipation of the slowdown in activity, we implemented several cost reduction strategies during the late third and early fourth quarters of 2008, and those efforts continued and expanded during the first quarter of 2009. These strategies included pay rate and benefits reductions for our personnel, aggressive management of our supply chain in an effort to reduce our operating costs, and certain targeted workforce reductions. All of these efforts have helped to preserve some of our operating margins, but the decline in activity and pricing levels has been so rapid that our margins have suffered.
In early 2009 we reorganized our internal operating structure around six major lines of business - Rig Services, Fluid Management Services, Pressure Pumping Services, Fishing Services, Rental Services, and Electric Wireline Services - and organized our operations in the continental United States around six major geographical regions. We believe that this shift in organizational makeup will help us become more competitive in all of the markets in which we operate and allow us to better capture synergies associated with our size and implement more rapid and consistent decision making. We also believe that our new organizational structure will position us well, when the business cycle turns, to more effectively capture the incremental margins resulting from an increase in activity.
Market Outlook for the Remainder of 2009 We believe that the remainder of 2009 will continue to be difficult for our industry. Because commodity prices continue to be depressed and our customers' access to credit remains restricted, we believe it is probable that activity levels and pricing will not see much improvement for the remainder of 2009. In certain markets and lines of business, we have

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begun to see the rates of decline in activity and pricing decrease, but we are not yet able to predict where or when the bottom of the market will occur. This is supported by the April 30, 2009 U.S. land rig count, which stood at 889, which is approximately 30.9% lower than the March 31, 2009 rig count. At current commodity price levels, many of our customers are still reluctant to spend funds, given the uncertainty over the near- and mid-term outlook for prices as a result of economic conditions, and we cannot be certain that the recent volatility in commodity prices has abated.
For the remainder of 2009, we expect that our lines of business will continue to see low levels of activity and pricing relative to prior years. If commodity prices begin to stabilize, we anticipate that our Well Servicing businesses will be the first to level out, as our customers will first spend to maintain or increase their existing production. Less uncertainty over near- and mid-term oil and natural gas pricing, coupled with price reductions for our services, should encourage our customers to pursue maintenance activity on existing production. If commodity prices begin to recover, we feel that our Well Servicing segment will be the first to see the benefits in activity as our customers require workovers and other maintenance to bring wells that had previously been shut in back into production.
Internationally, we are experiencing significant labor-related issues related to our operations in Argentina, primarily related to not being able to terminate the employment of field and office personnel due to the significant pressure and influence of employees and labor organizations. During the first quarter of 2009, we took appropriate legal actions to seek relief from the Argentine government to enable us to downsize our workforce and, in the near future, we may choose to terminate a significant portion of our Argentine employee base. We are also considering other alternatives for administrative relief with respect to our business and operations in Argentina. The ultimate outcome of our actions is impossible to determine at this time, but we are prepared to downsize our local operations or exit the region entirely. For the year ended December 31, 2008, our operations in Argentina represented less than 6% of our consolidated revenues.
Because of our size, geographical diversity, and new organizational structure, we believe that we are well equipped to weather the downturn until commodity prices recover, leading our customers to spend more capital for production enhancement or maintenance needs and thereby increasing broader demand for our services. Until that time, management will continue to aggressively monitor and manage the Company's cost structure, and we will continue to focus on maintaining a strong balance sheet with acceptable leverage ratios and good liquidity. Management will also continue to explore opportunities for expanding our service footprint into new markets or new lines of business as those opportunities present themselves in the current market.

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