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KEG > SEC Filings for KEG > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for KEY ENERGY SERVICES INC

Form 10-Q for KEY ENERGY SERVICES INC


8-Nov-2012

Quarterly Report


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 full range of well services to major oil companies, foreign national oil companies and independent oil and natural gas production companies. Our services include rig-based and coiled tubing-based well maintenance and workover services, well completion and recompletion services, fluid management services, fishing and rental services, and other ancillary oilfield services. Additionally, certain rigs are capable of specialty drilling applications. We operate in most major oil and natural gas producing regions of the continental United States and have operations in Mexico, Colombia, the Middle East, and Russia. In addition, we have a technology development and control systems business based in Canada. Our operations in Argentina were sold during the third quarter of 2012. See "Note 3. Discontinued Operations" in "Item 1. Financial Statements" of Part I of this report for further discussion.
The following discussion and analysis should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes as of and for the three and nine months ended September 30, 2012 and 2011, included elsewhere herein, and the audited consolidated financial statements and notes thereto included in our 2011 Form 10-K. We operate in two business segments; U.S. and International. We also have a "Functional Support" segment associated with managing our U.S. and International operating segments. See "Note 15. Segment Information" in "Item 1. Financial Statements" of Part I of this report for a summary of our business segments. Recent Developments

On September 14, 2012, we completed the sale of our Argentina operations for approximately $12.5 million, net of transaction costs. The $12.5 million net proceeds from the sale of Argentina operations includes $2.0 million received in cash and the balance in notes receivable. In connection with the sale, we recognized a total loss of $85.7 million, which includes the noncash impairment charge of $41.5 million recorded in the first quarter of 2012, and a write-off of $51.9 million cumulative translation adjustment previously recorded in Accumulated other comprehensive loss.
PERFORMANCE MEASURES
We believe that the Baker Hughes U.S. land drilling rig count is the best barometer of overall oilfield capital spending and activity levels in our primary U.S. onshore market. 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. Generally, when oil and natural gas prices rise, capital spending by our customers tends to increase. Conversely, if oil and natural gas prices fall, capital spending by our customers tends to decrease. Accordingly, U.S. onshore oilfield activity, as represented by the Baker Hughes U.S. land drilling rig count, tends to increase and decrease with the increase and decrease in oil and natural gas prices.

                                         NYMEX Henry        Average Baker
                  WTI Cushing Oil      Hub Natural Gas     Hughes U.S. Land
                        (1)                  (1)          Drilling Rigs (2)
2012:
First Quarter    $          102.98    $           2.50                1,947
Second Quarter   $           93.06    $           2.35                1,924
Third Quarter    $           92.17    $           2.89                1,855
2011:
First Quarter    $           94.07    $           4.20                1,695
Second Quarter   $          102.02    $           4.38                1,803
Third Quarter    $           89.53    $           4.05                1,915
Fourth Quarter   $           93.96    $           3.48                1,972

(1) Represents the average of the monthly average prices for each of the periods presented. Source: EIA and Bloomberg

(2) Source: www.bakerhughes.com

Internally, we measure activity levels in our U.S. and International segments 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


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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.

In the U.S., our rig activity occurs primarily on weekdays during daylight hours. Accordingly, we track U.S. rig activity on a "per U.S. working day" basis. Key's U.S. working days per quarter, which exclude national holidays, are indicated in the table below. Our international rig activity and domestic trucking activity tend to occur on a 24/7 basis. Accordingly, we track our international rig activity and our domestic trucking activity on a "per calendar day" basis. The following table presents our quarterly rig and trucking hours from 2011 through the third quarter of 2012:

                                                                                              Key's U.S. Working
                                            Rig Hours                      Trucking Hours          Days (3)
                                                              Total
                                          International     Continuing
                                           Continuing       Operations
2012:                         U.S.       Operations (1)        (2)
First Quarter                435,280            84,469        519,749            722,718                     64
Second Quarter               428,864           104,656        533,520            685,587                     63
    Third Quarter            412,998           103,448        516,446            607,480                     63
Total 2012:                1,277,142           292,573      1,569,715          2,015,785                    190
2011:
First Quarter                415,691            52,965        468,656            711,701                     64
Second Quarter               426,278            59,384        485,662            776,382                     63
Third Quarter                428,236            66,375        494,611            757,550                     64
Fourth Quarter               413,052            69,528        482,580            721,411                     61
Total 2011:                1,683,257           248,252      1,931,509          2,967,044                    252

(1) International continuing operations rig hours exclude rig hours generated in Argentina, since our Argentina operations were sold in the third quarter of 2012 and are reported as discontinued operations. Argentina rig hours were 54,625 and 55,972 for the first and second quarters of 2012, respectively, and Argentina rig hours were 56,804, 59,255, 59,532, and 50,876 for the first, second, third and fourth quarters of 2011, respectively.

(2) Total continuing operations rig hours include U.S. rig hours and international continuing operations rig hours, as described in footnote (1) above.

(3) Key's U.S. working days are the number of weekdays during the quarter minus national holidays.

MARKET CONDITIONS AND OUTLOOK
Market Conditions - Quarter Ended September 30, 2012 Demand for our services in the U.S. oil markets declined in the third quarter versus the second quarter of 2012 due to reduced customer spending resulting from lower customer cash flow and budget constraints and an oversupply of service capacity. Activity in natural gas markets also continued to decline in the third quarter as a result of low natural gas prices. Third quarter 2012 results for our Fluid Management Services and Fishing & Rental Services businesses continued to be negatively impacted by the decline in activity and pricing in the natural gas markets. Our Coiled Tubing Services results were adversely affected by less efficient equipment utilization on lower activity as well as lower pricing. Revenue in our Rig Services business also declined compared to the second quarter of 2012 due to reduced customer spending and activity project delays in some of our oil markets.
Internationally, our activity in the third quarter of 2012 grew sequentially quarter-over-quarter and year-over-year, driven in large part by the full deployment of our rigs in Mexico and improving operating efficiencies. Market Outlook
We anticipate customer demand in the U.S. to continue to decline through year end 2012. Additionally, typical seasonal declines in the U.S. will likely have a greater impact than in prior years as a result of additional service capacity in oil markets and our more expensive fixed cost structure. We continue to seek opportunities to reduce fixed and variable costs in markets where activity levels are not adequate to justify higher costs.
In our international markets, we expect activity to generally trend higher, leading to continued revenue growth and margin improvement, particularly in Mexico where recent asset deployments should further improve financial performance.


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RESULTS OF OPERATIONS
The following table shows our consolidated results of operations for the three
and nine months ended September 30, 2012 and 2011, respectively (in thousands):
                                                 Three Months Ended             Nine Months Ended
                                                    September 30,                 September 30,
                                                 2012          2011           2012            2011
REVENUES                                      $ 490,851     $ 468,542     $ 1,493,599     $ 1,247,493
COSTS AND EXPENSES:
Direct operating expenses                       335,799       285,804         991,292         795,053
Depreciation and amortization expense            52,947        41,708         156,588         120,047
General and administrative expenses              53,567        59,063         172,566         159,861
Operating income                                 48,538        81,967         173,153         172,532
Loss on early extinguishment of debt                  -             -               -          46,451
Interest expense, net of amounts capitalized     13,962        10,554          39,574          30,003
Other, net                                       (1,529 )         590          (3,938 )        (9,932 )
Income from continuing operations before tax     36,105        70,823         137,517         106,010
Income tax expense                              (12,915 )     (25,077 )       (49,147 )       (36,706 )
Income from continuing operations                23,190        45,746          88,370          69,304
Loss from discontinued operations, net of tax
(expense) benefit of $(13,551), $-, $4,304
and $-, respectively                            (60,209 )      (2,308 )       (93,568 )        (8,218 )
Net income (loss)                               (37,019 )      43,438          (5,198 )        61,086
Income (loss) attributable to noncontrolling
interest                                          1,075          (730 )           665          (1,027 )
INCOME (LOSS) ATTRIBUTABLE TO KEY             $ (38,094 )   $  44,168     $    (5,863 )   $    62,113

Consolidated Results of Operations - Three Months Ended September 30, 2012 and 2011
Revenues
Our revenues for the three months ended September 30, 2012 increased $22.3 million, or 4.8%, to $490.9 million from $468.5 million for the three months ended September 30, 2011 mostly due to continued strong demand for our rig-based services in oil markets, improved pricing and overall economic conditions as well as both domestic and international expansion. See "Segment Operating Results - Three Months Ended September 30, 2012 and 2011" below for a more detailed discussion of the change in our revenues. Direct Operating Expenses
Our direct operating expenses increased $50.0 million, to $335.8 million (68.4% of revenues), for the three months ended September 30, 2012, compared to $285.8 million (61.0% of revenues) for the three months ended September 30, 2011. The increase was a direct result of activity increases in our business and rising labor costs. Equipment and travel costs have also increased compared to the third quarter of 2011 due to increased activity and relocation of equipment. Depreciation and Amortization Expense
Depreciation and amortization expense increased $11.2 million, or 26.9%, to $52.9 million during the third quarter of 2012, compared to $41.7 million for the third quarter of 2011. The increase is primarily attributable to the increase in our fixed asset base through our acquisitions during 2011, as well as increased capital expenditures during 2011 and the first nine months of 2012. General and Administrative Expenses
General and administrative expenses decreased $5.5 million, to $53.6 million (10.9% of revenues), for the three months ended September 30, 2012, compared to $59.1 million (12.6% of revenues) for the three months ended September 30, 2011. The decrease relates to the partial reversal of 2012 incentive compensation accrual and a reduction in stock based compensation due to the lower stock price.


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Interest Expense, Net of Amounts Capitalized Interest expense increased $3.4 million, or 32.3%, to $14.0 million for the three months ended September 30, 2012, compared to $10.6 million for the same period in 2011. Interest expense for the three months ended September 30, 2012 increased due to the issuance of the Additional 2021 Notes and a higher outstanding balance under our 2011 Credit Facility. Other, Net
The following table summarizes the components of other, net for the periods indicated:

                                 Three Months Ended September 30,
                                      2012                  2011
                                          (in thousands)
Interest income              $              (12 )       $        (1 )
Foreign exchange (gain) loss             (1,341 )               641
Other (income) expense, net                (176 )               (50 )
Total                        $           (1,529 )       $       590

Income Tax Expense
We recorded income tax expense of $12.9 million on pre-tax income from continuing operations of $36.1 million in the third quarter of 2012, compared to income tax expense of $25.1 million on pre-tax income from continuing operations of $70.8 million in the third quarter of 2011. Our effective tax rate on continuing operations was 35.8% for the three months ended September 30, 2012, compared to 35.4% for the three months ended September 30, 2011. Our effective tax rates for such periods differ from the U.S. statutory rate of 35% due to a number of factors, including the mix of profit and loss between various taxing jurisdictions and the impact of permanent items that affect book income but do not affect taxable income.
Discontinued Operations
Our discontinued operations relate to the sale of Argentina completed during the third quarter of 2012. Our net loss from discontinued operations for the three months ended September 30, 2012, was $60.2 million, which includes a write off of $51.9 million cumulative translation adjustment previously recorded in Accumulated other comprehensive loss. This compares to a net loss from discontinued operations of $2.3 million for the three months ended September 30, 2011
Noncontrolling Interest
For the three months ended September 30, 2012, we allocated $1.1 million associated with the income incurred by our joint ventures to the noncontrolling interest holders of these ventures compared to a loss of $0.7 million for the three months ended September 30, 2011.

Segment Operating Results - Three Months Ended September 30, 2012 and 2011 The following table shows operating results for each of our segments for the three-month periods ended September 30, 2012 and 2011 (in thousands):

For the three months ended
September 30, 2012
                                                                             Functional
                                          U.S.         International          Support            Total
Revenues from external customers      $  397,814     $        93,037     $           -        $  490,851
Operating expenses                       337,678              73,678            30,957           442,313
Operating income (loss)                   60,136              19,359           (30,957 )          48,538


For the three months ended
September 30, 2011
                                                                             Functional
                                          U.S.         International          Support            Total
Revenues from external customers      $  411,789     $        56,753     $           -        $  468,542
Operating expenses                       305,582              44,416            36,577           386,575
Operating income (loss)                  106,207              12,337           (36,577 )          81,967


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U.S.
Revenues for our U.S. segment decreased $14.0 million, or 3.4%, to $397.8 million for the three months ended September 30, 2012, compared to $411.8 million for the three months ended September 30, 2011. The decrease for this segment was due to less customer spending and lower activity in natural gas markets as well as increased competition.
Operating expenses for our U.S. segment were $337.7 million during the three months ended September 30, 2012, which represented an increase of $32.1 million, or 10.5%, compared to $305.6 million for the same period in 2011. The increase was directly attributable to increased activity in oil markets during the period combined with the impact of inflationary pressure on fuel, wages and benefit related expenses.
International
Revenues for our International segment increased $36.3 million, or 63.9%, to $93.0 million for the three months ended September 30, 2012, compared to $56.8 million for the three months ended September 30, 2011. The increase was primarily attributable to increased activity in Mexico. Operating expenses for our International segment increased $29.3 million, or 65.9%, to $73.7 million for the three months ended September 30, 2012, compared to $44.4 million for the three months ended September 30, 2011. These expenses increased as a direct result of additional activity during the period. We also incurred additional costs to mobilize assets to Oman and Mexico. Functional Support
Operating expenses for Functional Support, which represent expenses associated with managing our U.S. and International operating segments, decreased $5.6 million, or 15.4%, to $31.0 million (6.3% of consolidated revenues) for the three months ended September 30, 2012 compared to $36.6 million (7.8% of consolidated revenues) for the same period in 2011. The decrease in costs primarily related to lower incentive bonus accrual and stock based compensation. Consolidated Results of Operations - Nine Months Ended September 30, 2012 and 2011
Revenues
Our revenues for the nine months ended September 30, 2012 increased $246.1 million, or 19.7%, to $1,493.6 million from $1,247.5 million for the nine months ended September 30, 2011, mostly due to continued strong demand for our rig-based services in oil markets, improved pricing and overall economic conditions as well as both domestic and international expansion of our business. See "Segment Operating Results - Nine Months Ended September 30, 2012 and 2011" below for a more detailed discussion of the change in our revenues. Direct Operating Expenses
Our direct operating expenses increased $196.2 million, to $991.3 million (66.4% of revenues), for the nine months ended September 30, 2012, compared to $795.1 million (63.7% of revenues) for the nine months ended September 30, 2011. We incurred additional costs during the period to relocate assets and personnel from declining natural gas markets to oil markets. As a result, we experienced activity increases in the oil markets we serve as well as rising labor costs. Depreciation and Amortization Expense
Depreciation and amortization expense increased $36.5 million, or 30.4%, to $156.6 million for the nine months ended September 30, 2012, compared to $120.0 million for the nine months ended September 30, 2011. The increase was primarily attributable to the increase in our fixed asset base through our acquisitions during 2011, as well as increased capital expenditures during 2011 and the first nine months of 2012.
General and Administrative Expenses
General and administrative expenses increased $12.7 million, to $172.6 million (11.6% of revenues), for the nine months ended September 30, 2012, compared to $159.9 million (12.8% of revenues) for the nine months ended September 30, 2011. The increase was primarily due to higher employee compensation, benefit costs and professional fees. In addition, prior year expenses were offset by a favorable legal settlement of $5.5 million in which Key Energy Services, Inc was the plantiff.
Loss on Extinguishment of Debt


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During the nine months ended September 30, 2012, we did not incur a loss on extinguishment of debt. For the nine months ended September 30, 2011, our loss on extinguishment of debt was $46.5 million due to our tender offer for the 2014 Notes and the termination of the 2007 Credit Facility. Interest Expense, Net of Amounts Capitalized Interest expense increased $9.6 million, or 31.9%, to $39.6 million for the nine months ended September 30, 2012, compared to $30.0 million for the same period in 2011. Overall, interest rates on our debt have declined compared to the first nine months of 2011 due to our repurchase of the 8.375% 2014 Notes and the issuance of the 6.75% 2021 Notes during the first quarter of 2011. However, interest expense for the nine months ended September 30, 2012 increased due to the issuance of the Additional 2021 Notes and a higher outstanding balance under our 2011 Credit Facility.
Other, Net
The following table summarizes the components of other, net for the periods indicated:

                                            Nine Months Ended September 30,
                                               2012                 2011
                                                    (in thousands)
Interest income                          $          (26 )     $          (23 )
Foreign exchange gain                            (3,047 )             (3,869 )
Gain on sale of equity method investment              -               (4,783 )
Other income, net                                  (865 )             (1,257 )
Total                                    $       (3,938 )     $       (9,932 )

Income Tax Expense
We recorded income tax expense of $49.1 million on pre-tax income from continuing operations of $137.5 million for the nine months ended September 30, 2012, compared to income tax expense of $36.7 million on pre-tax income from continuing operations of $106.0 million for the nine months ended September 30, 2011. Our effective tax rate on continuing operations was 35.7% for the nine months ended September 30, 2012, compared to 34.6% for the nine months ended September 30, 2011. Our effective tax rates for the periods differ from the U.S. statutory rate of 35% due to a number of factors, including the mix of profit and loss between various taxing jurisdictions and the impact of permanent items that affect book income but do not affect taxable income. Discontinued Operations
Our net loss from discontinued operations was $93.6 million for the nine months ended September 30, 2012, compared to $8.2 million for the nine months ended September 30, 2011. Our discontinued operations relate to the sale of our business in Argentina completed during the third quarter of 2012. Included in the loss from discontinued operations for the nine months ended September 30, 2012 is a pre-tax loss of $85.7 million, which includes the noncash impairment charge of $41.5 million recorded in the first quarter of 2012, and a write-off of $51.9 million cumulative translation adjustment previously recorded in Accumulated other comprehensive loss.

Noncontrolling Interest
For the nine months ended September 30, 2012, we allocated $0.7 million associated with the income incurred by our joint ventures to the noncontrolling interest holders of these ventures compared to a net loss of $1.0 million for the nine months ended September 30, 2011.


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Segment Operating Results - Nine Months Ended September 30, 2012 and 2011 The following table shows operating results for each of our segments for the nine-month periods ended September 30, 2012 and 2011 (in thousands):

For the nine months ended September
30, 2012
                                                                              Functional
                                          U.S.          International          Support             Total
Revenues from external customers      $ 1,254,433     $       239,166     $           -        $ 1,493,599
Operating expenses                      1,020,342             193,323           106,781          1,320,446
Operating income (loss)                   234,091              45,843          (106,781 )          173,153


For the nine months ended September
30, 2011
                                                                              Functional
                                          U.S.          International          Support             Total
Revenues from external customers      $ 1,109,148     $       138,345     $           -        $ 1,247,493
Operating expenses                        858,092             113,874           102,995          1,074,961
Operating income (loss)                   251,056              24,471          (102,995 )          172,532

U.S.
Revenues for our U.S. segment increased $145.3 million, or 13.1%, to $1,254.4 million for the nine months ended September 30, 2012, compared to $1,109.1 million for the nine months ended September 30, 2011. The increase was due to an increase in activity for our rig-based services and fishing and rental services along with improved pricing.
Operating expenses for our U.S. segment were $1,020.3 million during the nine months ended September 30, 2012, which represented an increase of $162.3 million, or 18.9%, compared to $858.1 million for the same period in 2011. We incurred additional costs during the period to relocate assets and personnel from declining natural gas markets to oil markets. As a result, we experienced increased activity in oil markets during the period combined with the impact of inflationary pressure on fuel, wages and benefit-related expenses. International
Revenues for our International segment increased $100.8 million, or 72.9%, to $239.2 million for the nine months ended September 30, 2012, compared to $138.3 . . .

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