Key Energy Services, Inc.'s (KEG) CEO Richard J. Alario on Q1 2014 Earnings - Call Transcript

Key Energy Services, Inc. (KEG) Q1 2014 Earnings Call Corrected Transcript: 01-May-2014


PARTICIPANTS

Corporate Participants

West Gotcher - Director, Investor Relations & Corporate Development, Key Energy Services

Richard J. Alario - Chairman, President & Chief Executive Officer, Key Energy Services, Inc.

John Marshall Dodson - Senior Vice President and Chief Financial Officer, Key Energy Services, Inc.

Other Participants

Neal D. Dingmann - Analyst, SunTrust Robinson Humphrey

Trey A. Stolz - Analyst, IBERIA Capital Partners LLC

Blake A. Hutchinson - Analyst, Howard Weil, Inc.

Kurt Hallead - Analyst, RBC Capital Markets LLC

John M. Daniel - Analyst, Simmons & Co. International

J. Marshall Adkins - Analyst, Raymond James & Associates, Inc.

Scott J. Levine - Analyst, Imperial Capital LLC

Daniel J. Burke - Analyst, Johnson Rice & Co. LLC

Michael Urban - Analyst, Deutsche Bank Securities, Inc.

MANAGEMENT DISCUSSION SECTION

Operator: Good morning. My name is Jeremy, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Key Energy Services' Q1 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

I would now like to turn the call over to the Director of Investor Relations and Corporate Development, Mr. West Gotcher. You may begin your conference.

West Gotcher, Director, Investor Relations & Corporate Development

Thank you, Jeremy. And thank you, all, for joining Key Energy Services for our first quarter 2014 financial results conference call. This call includes forward-looking statements. A number of factors could cause actual results to differ materially from the expectations expressed in this call, including risks factors discussed in our 2013 Form 10-K and other reports most recently filed with the SEC, which are available on our website.

This call may also include references to non-GAAP financial measures. Please refer to our website for a reconciliation of any non-GAAP financial measures provided in this call to the comparable GAAP financial measures. For reference, our general investor presentation is available on Key's website at keyenergy.com under the Investor Relations tab.

I'm going to turn the call over Dick Alario, Key's Chairman, President, and CEO, who will provide some introductory comments regarding the first quarter and discuss current trends in our businesses. Then Marshall Dodson, our CFO, will review our results and provide some guidance commentary. Dick will return to conclude our prepared remarks and open the call to your questions. Dick?

Richard J. Alario, Chairman, President & Chief Executive Officer

Thank you, West. Good morning, everyone. Let me first point out that Trey Wilson, our COO, is unable to join us on the call this morning. He's currently traveling out of the country on a previously scheduled trip. As a result, our - as West said, our normal call format will change a bit as you heard. So with that I'll get started.

Key generated a consolidated GAAP net loss of $0.08 a share for the first quarter. These results include a $0.01 loss due to severance in Mexico that we had discussed on last quarter's call, yielding a normalized $0.07 loss for the quarter. In the U.S., revenue in the first quarter was essentially flat to the prior quarter. These results fell below our previously guided range of 3% to 5% improvement as what turned out to be the harshest winter in years took a toll on many of Key's principal operating regions and on top of that if you layer in the severe rain events that hit the West Coast which didn't have anything to do with winter, but which had significant impact on our California operations, it's clear that our larger operating regions, and in particular those where our revenues are mostly production service driven were not spared weather disruptions. In total, weather impacts accounted for approximately $0.01 of EPS loss in the first quarter.

On the other hand, our large diameter coiled tubing units, our large well service rigs, and premium drill pipe driven by increased horizontal completion activity performed well in the quarter, but didn't see a full seasonal recovery due to the weather disruptions that I mentioned earlier. Once those issues abated, however, these services experienced improved demand as increased well count and associated completion activity progressed above the pace of typical seasonality in many active unconventional resource plays.

Our two and three-eighths inch coiled tubing units for instance were completely sold out as we exited the first quarter, achieving effectively 100% utilization. Further during Q1, we saw utilization of our two-inch coiled tubing units improve over 1,000 basis points as we captured some additional work where the two inch units brought the same utility to our customers as the two and three-eighths units did. While this is certainly not a trend, it is an encouraging development given that as the number and service intensity of horizontal wells increases incremental coil demand will likely be felt in the resource plays. As such, Key's already in a position to leverage its underutilized asset base to take advantage of that impending market demand, which would yield meaningful top line and margin growth for that business.

To that point, we believe that since these completion-driven businesses have moved beyond the weather disruptions in the first quarter, they should continue to show improved financial results as we move through the year and as the ramp up in unconventional, horizontal completion activity continues.

Our production-driven businesses, including Rig Services and Fluid Management Services, performed slightly below expectations as the seasonally muted first quarter was further burdened by severe weather and changes in regional revenue mix. Demand for production-driven services remains good and should improve as the inventory of aging oil wells continues to grow at a healthy pace, and as legacy oil wells continue to provide excellent returns at $100 a barrel oil.

We have seen the volume of large-scale production-oriented tenders begin to rap in a meaningful way recently. However, we're also seeing that the larger operators approach these projects at a methodical pace in order to identify the right long-term partners. As an example, we were recently awarded a 100-well project in the Bakken for a large independent that is re-completing older, horizontal oil wells, the first project of its kind for this operator.

Not only are we encouraged by the fact that operators are beginning to perform significant work over and re-completion activities on older, horizontal oil shale wells, the Bakken's being the oldest, but we're also pleased that, once the startup efficiencies were addressed on this project, we were able to deliver results approximately 25% faster than what the operator had budgeted. It's these types of results that contribute to be mutually beneficial to long-term partnerships. And it's these types of long-term partnerships that we envision driving production services contracting for larger operators going forward.

Now, I'd like to discuss some regional trends, both in terms of the first quarter as well as our outlook for the second quarter and the remainder of the year. Clearly, the Permian Basin is the region experiencing the most significant increases in activity, as shown by the horizontal drilling rig count in this region, reaching approximately 60% of total operating rigs, as compared to approximately 35% a year ago.

Growth in the Permian horizontal completion market has already allowed Key to increase its relative revenue generation in the Permian by 200 basis points, as compared to the fourth quarter, to where we are now deriving 30% of our U.S. revenues from the Permian Basin. We expect Permian to contribute more relative revenue generation in our U.S. business as the shift to horizontal well development continues there and as we continue to penetrate new customers and expand our business with existing customers.

Looking to the Mid-Continent, including the Mississippian Lime, the SCOOP, Granite Wash, and to some extent, the Haynesville, we've been encouraged by demand there and activity levels over the last quarter or two. We've successfully been able to capture opportunities from multiple service lines in this region. In fact, to this point in April, our Rig Services business in this market has seen the highest hours per workday in more than a year, up 9% compared to our Q1 average.

In addition to unconventional oil shale activity, we've seen a tick-up in gas related activity in this region, both production and completion activities. On the completion side, as an example, we've had an East Texas-based coiled tubing unit that until recently was a nomad, picking up jobs in whatever market it was able. Now, this unit has enough sustainable work to remain home and stay sufficiently utilized, at least for the near term. And we haven't seen that in years.

In addition, on the production side, we've begun to see some operators turn on old gas wells to take advantage of the current commodity price. While we're seeing signs of gas activity, and certainly would be encouraged to see further activity increases, this is not yet a significant driver for our business, but it's worthwhile to note.

During the first quarter, as others recently noted, the California market experienced a number of challenges, including heavy rains, a slow ramp-up in early year activity and, to some degree, well permitting issues in certain areas. Both our top line results and margins were pressured and we're currently assessing opportunities to increase activity to prior levels.

So, to summarize my U.S. comments, I believe that as we move further into this quarter and then into the back half of the year, our completions-driven businesses should continue to see meaningful improvement and benefit from the unconventional horizontal completion activity in many of our principal operating regions. Further, I believe that underlying demand for our production-driven services remains strong and should likely improve at a measured pace as we move through the year and as operators execute on the larger-scale projects.

In terms of pricing, generally pricing was stable to slightly pressured across our U.S. businesses in the first quarter as a large number of tenders hit the market. Competitive pricing dynamics remain the most severe in our frac stack, well testing and water hauling services. We expect that as activity continues to ramp, both in completion and production-driven services, pricing should stabilize further, setting up the potential for improvement as the year unfolds.

Turning now to International, as we expected on the last call, we exited first quarter with a positive EBITDA run rate. While we're pleased that we met the goal that we had set, we're far from satisfied with this segment as it currently sits. We continue to take the requisite actions necessary to move this segment back to profitability. We've reached the point where we're willing to say that our International business has essentially reached bottom. Mexico has clearly been the drag on this segment, and at this point, we're only working three rigs in Mexico.

So, to put it in perspective, if Mexico rig activity was to go to zero, the run rate impact would be approximately $0.005 per quarter in earnings. Said differently, our Mexico business now represents an option on the recovery and growth of the Mexican oil and gas market. During the quarter, we relocated 12 rigs from Mexico to the U.S. Our current plan is to proceed with moving another dozen rigs to the U.S., leaving us with 17 rig packages in Mexico to take advantage of the impending demand that's being created as production there continues to fall. I'd remind you that all of these rigs returning to the U.S. are large, highly capable units that are well suited to work in the high demand U.S. shale markets.

The balance of our International segment performed roughly in line with our expectations, though we remain focused on improving all of these businesses. We expect all of our foreign businesses to achieve positive operating income in the second quarter, with the exception of Mexico.

I'll stop here and turn the call over to Marshall.

John Marshall Dodson, Senior Vice President and Chief Financial Officer

Thanks, Dick. To repeat the headlines, our consolidated revenues for the quarter were $356.1 million, down 2% from the fourth quarter. U.S. revenues were $324 million, essentially flat compared to the fourth quarter, while International revenues declined 16% to $32.1 million. Our consolidated bottom-line GAAP EPS was a loss of $0.08 for the quarter. These results include a $0.01 loss due to severance. Excluding the severance charges, the company recorded a $0.07 per share loss for the quarter. First quarter top line results came in under our previously guided range as severe weather disruptions impacted multiple service lines and multiple markets. These disruptions had a $0.01 impact to our first quarter earnings.

Looking at the U.S., our completions-driven businesses saw a meaningful improvement, as compared to the fourth quarter, though the recovery was somewhat muted due to the weather disruptions and to pressures in the most competitive services. Coiled Tubing Services revenue improved 8% sequentially, and our large, completion-style well service rigs helped offset a decline in California and weather elsewhere in our Rig Services business.

U.S. operating income margins came in at 11%, approximately 100 basis points below the high-end of our previous expectation of a 200 basis point to 250 basis point decline. Compared to the fourth quarter, Q1 margins fell 220 basis points, due to the both the unemployment tax impact and costs associated with rig mobilizations, including rigs from Mexico, as well as domestic rigs. This offset some of the benefit from lower than expected depreciation. While we were successful in getting 12 rigs out of Mexico in the first quarter, about half the estimated cost per rig remains, as we put the rigs through their maintenance and final inspection programs.

Weather in the first quarter caused an additional 50 basis points of the margin decline over the weather impacts we experienced in the fourth quarter. Outside of the U.S., we averaged 29 rigs working in the first quarter and experienced a 16% decline in revenues, just outside our previous guidance. Our consolidated international segment operating income margin came in at a negative 32.7% due to significant cost inefficiencies and lower activity, primarily in Mexico, as well as severance of $1.3 million. Although, Mexico was about three-quarters of our international operating loss for the quarter, our other international businesses also combined for a loss, albeit at a level much closer to cash flow breakeven.

In addition to the operating loss, the International segment incurred a $1.5 million forex charge during the quarter, primarily due to the decline in the Russian ruble and the Colombian peso. We believe that with our current activity stacking levels in Mexico, the cost reduction steps we've taken across our international operations, and with most mobilization startup inefficiencies behind us, we've effectively bottomed in this segment.

We expect all our markets except Mexico to post positive operating income in the second quarter and expect our Mexican operation to be only a slight drag on a cash flow basis until such time as activity in Mexico picks up.

We ended the first quarter with $39 million of accounts receivable outstanding with PEMEX and the contract finalization process with them is nearly complete. Under the terms of our contracts, we would then expect for the remaining balances to be paid to us late this quarter or early next quarter.

G&A expense for the fourth quarter was $53 million, or 14.8% of revenues. Substantially the entire sequential increase in G&A was due to changes in the fair value of existing stock-based compensation and unemployment taxes. The unemployment tax burden will not recur in second quarter.

Depreciation and amortization expense was $51 million for the quarter due to the timing and levels of capital spend as well as lower amortization of intangible assets. Interest expense was $14 million. Cash flow from operations was $46 million and cash flow expenditures for the quarter were $29 million.

We redeemed the remaining $3.6 million of our outstanding 8.375% Senior Notes this quarter and did not reduce our outstanding revolver balance. We ended the first quarter with cash on hand of $40.9 million and a net debt to capitalization ratio of 36.2% as compared to cash of $28.3 million last quarter and a net debt to capitalization ratio of 36.6%. We currently expect to continue to reduce leverage during 2014.

During the first quarter, we realized a greater than expected tax benefit of $7.7 million based on our pre-tax loss of $19.6 million and this implies an effective quarterly tax rate of 39.3%. For the remainder and the full year of 2014, we expect our effective tax rate to average approximately 35% to 37%.

Looking forward, we expect completion activity in the U.S. to achieve meaningful improvement. However, due to more methodical large scale planning by our customers, we believe production-driven services may continue to trail the rate of activity increase as compared to our completion services. As such, we expect U.S. revenue to increase 4% to 6% in the second quarter with a further increase in the third quarter.

We expect U.S. operating income margins to improve 250 basis point to 350 basis points as we move past the weather and seasonal impacts of the past two quarters, but our margins will remain burdened by the cost of rig redeployments from Mexico to the U.S. as we complete work on the first dozen rigs and begin our redeployment of the second dozen.

In our International segment, we expect our second quarter revenue to decline 5% to 10% sequentially as we averaged 27 rigs. We expect operating income margins to improve to approximately 2,000 basis points if we realize a full quarter of a normalized cost structure in Mexico and a return to profitability in our other markets.

For the second quarter of 2014, we expect G&A expense to be between $55 million and $57 million, and expect depreciation and amortization expense to be between $52 million and $55 million. We reiterate our 2014 capital plan of $198 million. The current plan contemplates building 50 new well service rigs. However, to the extent the rigs coming back from Mexico are replacement rather than incremental, we will bring our capital spending on new build rigs down accordingly.

While the 2014 plan contemplated limited growth capital given our focus on leveraging the investments made over the past three years, with our KVA implementation where challenging our team to identify and reallocate capital for incremental growth opportunities. To that end, we've already moved on some of those opportunities, primarily in our rentals business, and we're also adding saltwater disposal capacity.

Now, I'll turn the call back over to Dick.

Richard J. Alario, Chairman, President & Chief Executive Officer

Thank you, Marshall. In closing, I'd like to briefly recap several themes that we focused on in our comments this morning.

First, completion-driven activity in unconventional resource plays will be a significant driver of North American land activity in the near term and we have sufficient excess equipment from our recent heavy capital spend cycle to take advantage of the first tranche of that with minimal new capital outlay.

Second, large-scale production enhancement projects will begin to materialize at a measured pace as operators identify long-term partners and we believe Key is well positioned to be a recipient of those. Third, the aging of the horizontal oil shale well inventory has begun to require recompletion solutions and we believe this trend provides an added dimension to U.S. service demand that we've not seen before. And finally, we believe that we've reached bottom in Mexico and we believe that when activity resumes, Key will be a primary beneficiary.

As a result of these themes, it's our view that as our customers continue to execute on their plans for the year, additional capacity from our service lines will be consumed, setting up a more constructive environment for pricing.

Operator, these conclude our prepared remarks this morning. We'll now open the call up for questions.


QUESTION AND ANSWER SECTION

Operator: [Operator Instructions] Your first question comes from the line of Neal Dingmann from SunTrust. Your line is open.

<Q - Neal Dingmann - SunTrust Robinson Humphrey>: Morning, Guys. Dick, I'm trying to get a handle here now after the change in the movement of the rigs around. Number one, I'm just wondering of the higher horsepower rigs in the 450 or higher running and how many of those you have available in the U.S. or I guess another way to tackle that, what the utilization rate of these rigs, I'm just wondering if you still have a lot of availability of these.

<A - Dick Alario - Key Energy Services, Inc.>: Neal, we've said that about 15% of our fleet, 15% to 20% of our fleet that's actually out there working falls into that category. It puts it somewhat over 100. That's what we're building primarily this year. These are the ones that we've talked about in our capital discussion. It's mostly what we're building of the large rigs that you've described. So depending, as we said, on the rig of how much of those become incremental versus how much of those wind up being replacement, we'll be adding - I feel sure we'll be adding a pretty significant number of the large rigs to our U.S. fleet in terms of our building program.

But also, don't forget, the 24 rigs that we are bringing back from Mexico, half of them which are already here, all fit into that category. So we'll be beefing up our large rig capability in the U.S. market pretty handily this year and, as I said, now that we've begun to see the advent of the significant workover demand in the horizontal oil wells, what I mean is significant type of work on a per well basis, these are the kind of rigs that are required to do that. So it adds a dimension of demand that is new and that we haven't seen before. Therefore, we feel like all those rigs coming back from Mexico have good homes and the demand out there is real strong to put them to work.

<Q - Neal Dingmann - SunTrust Robinson Humphrey>: Great. And then I know last quarter you talked about and you - I guess even in the prior quarters, you've talked a lot about the operational efficiencies continuing to be seen. Maybe could you talk a little bit about that? Again, is that incorporated in some of this new guidance? Your thoughts about whether we're talking in the coiled tubing or in the workovers, some of the operating efficiency that you all think to be seen here going forward.

<A - Dick Alario - Key Energy Services, Inc.>: Yeah. Listen, as we've said, as the market moves more and more towards pad drilling, that's one of the things that causes the greatest amount of efficiency in our field operations. And the good news is that it is a positive for the service sector and Key as much as it is for the customers. When our customers go to pads, the planning cycle is much more efficient. And we can manage our labor forces and our delivery of goods, inventory, and various things to the locations a lot more effectively. So we benefit from that and that's included in our thoughts as we think about the year going forward.

Obviously, the other side of that is it helps our customers to free up more cash to do more legacy type work. So that's a sort of backside benefit for Key as well. But no doubt, we continue to see opportunities to deliver efficiency and it is part of what we're thinking about going forward. I'm not sure we have it all baked in as we think about the rest of the year and we haven't been that descriptive on it yet, but we've got to keep a little bit in our pocket, right?

<Q - Neal Dingmann - SunTrust Robinson Humphrey>: Sure. And then lastly, just on the pricing you talked about seeing some of these - pricing should start to stabilize, I guess, or maybe even improve beyond that. Is that based on the tenders, Dick, that you're already seeing? Or do you assume that the tenders will continue and you'll even potentially see more pricing beyond this?

<A - Dick Alario - Key Energy Services, Inc.>: It is based on our expectation that these large tenders that we've seen come in recently will consume capacity in the market. Whether it's Key capacity or someone else's capacity at first, the fact that it's going to tighten things up will, as we've said, provide a more constructive environment in the back half of the year. It's also based on the levels of activity that we're hearing others talk about and experiencing ourselves in certain service lines. I go back to some of our commentary on large diameter coiled tubing.

When you hear us say that we were 100% utilized coming out of Q1, obviously there's not a whole lot of that being delivered to the market in terms of new capacity. So we believe it'll be one of the first ones where there'll be some pricing inflection in the back half of the year. It's just an example. I'm not saying that that's the complete list but that's the example. As you get to 100% utilization then you have the expectation that it's firm enough to be able to possibly get some pricing as the year unfolds.

<Q - Neal Dingmann - SunTrust Robinson Humphrey>: It sounds like a lot of activity. Thanks, Dick.

<A - Dick Alario - Key Energy Services, Inc.>: You're welcome.

Operator: Your next question comes from the line of Trey Stolz of IBERIA Capital Partners. Your line is open.

<Q - Trey Stolz - IBERIA Capital Partners LLC>: Good morning, guys. Just kind of go back to the margin guidance, Marshall, you talked about 250 basis point to 350 basis point improvement quarter-over-quarter, but if we look back, I think you said it was 220 basis points for payroll taxes, and another 50 basis point or so for weather. Is there any operating leverage we should expect because, I guess, the guidance range doesn't account or allow for much?

<A - Marshall Dodson - Key Energy Services, Inc.>: No. As Dick said, we hope to gain some efficiencies as we move through and recall that we had weather in the fourth quarter. We're kind of moving out of the down two quarters where we have weather and seasonal impacts. So that ought to be a benefit to us as we move into the second quarter and beyond. And we also will have the pressure, again, on our margins in the second quarter of the rig moves from Mexico. So we've got 12 rigs here in the States right now that we're working on as fast and as hard as we can to get out into the field and get working, and that's kind of the second part of the process. And we've got another 12 rig that are about to get on trucks and are starting to move in to the U.S. so that we can go through that same process again.

<Q - Trey Stolz - IBERIA Capital Partners LLC>: And the rig moves and maintenance work there, any way you can quantify the impact maybe on the cost line for the quarter?

<A - Marshall Dodson - Key Energy Services, Inc.>: Yeah. So we had before talked about it at $250,000 per rig and spread over the first half of the year, that's, what, a $1.5 million a quarter. And so I think that's a pretty good average to use on the next dozen. We also mentioned that we had costs, not only in the first quarter associated with the U.S. in getting the rigs into the U.S. but also with our domestic fleet in terms of getting some other rigs ready to go to work and moving them into position. That shouldn't weigh on us as much next quarter.

<Q - Trey Stolz - IBERIA Capital Partners LLC>: All right. And moving on to the International segment, you mentioned Mexico being a slight drag on a cash flow basis. I assume the $7.5 million G&A figure probably still in effect. So are we looking at operating income or operating loss of something just over $7.5 million from that guidance?

<A - Marshall Dodson - Key Energy Services, Inc.>: For?

<Q - Trey Stolz - IBERIA Capital Partners LLC>: For the International segment.

<A - Marshall Dodson - Key Energy Services, Inc.>: There's a lot of different moving pieces in there but it's going to be - we're calling for about a 2,000 basis point improvement in our operating income margins internationally. We're going to have a little bit less DD&A as we move rigs out so depending on how many get out, that'll impact the number some. But we would expect around a 2,000 basis point improvement in the margins and a slight decrease in the revenues.

<Q - Trey Stolz - IBERIA Capital Partners LLC>: All right. Great. I'll re-queue if I have anything else. Thanks.

Operator: Your next question comes from the line of Blake Hutchinson from Howard Weil. Your line is open.

<Q - Blake Hutchinson - Howard Weil, Inc.>: Good morning, guys.

<A - Dick Alario - Key Energy Services, Inc.>: Morning, Blake.

<Q - Blake Hutchinson - Howard Weil, Inc.>: Dick, you've talked a lot about the tendering process here from a qualitative basis. Can you help us understand a bit better? Because I think historically we might have looked at your combination of businesses and thought of it as close to all spot all the time as any group of businesses out there. In terms of quantitatively, what portion of either your overall or maybe Rig Services asset base could be subject or attached to tender-based activity versus spot? And just to clarify, Marshall's talked a lot about getting rigs ready, getting rigs ready to work. Are we consciously holding assets out of the spot market to have availability for some of these tenders?

<A - Dick Alario - Key Energy Services, Inc.>: Well, Blake, on the first question, I'm not sure that we'll see a material increase in the amount of our rig capacity that's going to be bound by contracted arrangements. That's the not the difference that we're citing here. What we're citing is that these are projects that we've anticipated coming to the market for a long time and the two aspects that we're commenting on is that they're pretty sizeable in that they're horizontal oil well workovers so they have service intensity far beyond what we see in our legacy shallow oil fields.

And then the fact that they are large in terms of well number, when you get awarded a 100-well project to do these rig completions, I mean this takes a long time to get this done and you're able to put a lot of focus on the efficiency of your operation and managing our own costs and things like that, delivering, as we said in the prepared remarks, a really good outcome for the customer in terms of being able to afford to save him some money. So we couldn't be happier about the advent of that sort of thing because the big question has been asked of us many, many times.

The answer to your second question is no, we're not holding back anything. But you should read into the fact that, as you heard Marshall say, we're spending more than a normal amount of money on getting rigs that are in stack yards ready to go to work than we normally do because we see the sort of impending demand increasing and we will take advantage of that. Again, not necessarily on a spot or contracted basis as far as we can predict right now. Just on a general demand and we expect that these larger customers who have these more pronounced projects that they want to be pretty methodical about, that's the kind of work that Key is well set up for. So I'm not sure that we're calling a difference in the level of contracting commitment, but we are seeing a difference in the level of demand, and we're seeing these projects which are much more complex and use 24-hour operations, large rigs, and a lot more ancillary equipment, that's sort of the positive upside of this.

<Q - Blake Hutchinson - Howard Weil, Inc.>: Okay. And then just within the Rig Services business, the flat revenue trajectory here sequentially, it kind of highlights the fact that California must have been a huge headwind. Can you help us understand how that might proceed going forward? Are we still in a quarter of recovery and flat into June before improving in the back half? Or what does that hold as such a large contributor to that Rig Services business?

<A - Dick Alario - Key Energy Services, Inc.>: Yeah. It did affect us materially, so you read that right. As I said, we have some other opportunities out there to reverse that and we're looking at those as we speak. But a part of the issue out there, a big part of the issue was weather. That's abated. And a big part of the issue was some permitting delays in various counties in California. That hasn't gotten a lot better but it's improved as our customers learn to deal with some of the new permitting regulations that have been put in place out there. So can I tell you that it'll all be behind us at the end of this quarter? Hard to say at this point, it'll certainly be improved as we go into Q3.

<Q - Blake Hutchinson - Howard Weil, Inc.>: And then just a quick follow-on. You talked a lot about some improvement in some of the business lines exiting the quarter. Your broad guidance for 2Q in the U.S., is that more premised on kind of what you see is what you get from March and April type results? Or do we need some of the back half of second quarter spending to kick in to kind of fill out those numbers?

<A - Dick Alario - Key Energy Services, Inc.>: Blake, we're playing that kind of right down the fairway. We fully expect that we'll see some back half improvement in the quarter but essentially, we're basing that off the run rates that we're currently seeing in the business.

<Q - Blake Hutchinson - Howard Weil, Inc.>: Great. I'll turn it back. Thanks a lot.

Operator: Your next question comes from the line of Kurt Hallead from RBC Capital Markets. Your line is open.

<Q - Kurt Hallead - RBC Capital Markets LLC>: Great. Thanks. Good morning.

<A - Dick Alario - Key Energy Services, Inc.>: Good morning.

<Q - Kurt Hallead - RBC Capital Markets LLC>: I appreciate the color you guys provided this morning. I understand the comments pretty clearly coming across that the international market generally has bottomed and most of that alluding to Mexico. With the reduced loss on the international front going into the second quarter, what's your anticipation of when you can then get back into the black? You think that's something that could transpire in 2014? Is it something that we might have to wait until 2015 for?

<A - Dick Alario - Key Energy Services, Inc.>: Kurt, it's Dick. I think what we're saying is that it's not going to take - especially once we get to next tranche of rigs out of Mexico and the DD&A drops as it will. I mean it doesn't take a whole lot for us to turn that corner, and based on commentary that we've seen from Mexico from government budget planning, commentary that's just recently come out based on the view of some other large multi-faceted services companies who own some of these incentive contracts, and integrated contracts. We are more encouraged about the back half of the year than we have been over the past couple of quarters. So the new good is, is that's why we say that we now have this option in our business model on the Mexican comeback because it doesn't take a whole lot for us to turn that corner, particularly after we get our DD&A down here over the next few months.

<Q - Kurt Hallead - RBC Capital Markets LLC>: But in the...

<A - Dick Alario - Key Energy Services, Inc.>: It very well could happen in the back half of the year. This is what I'm saying. But we are being cautious because there is still a lot of things that have to snap together. I will make one more comment that we didn't have in our scripted notes. Much as we talked about in the U.S. where some large production driven tenders that come to the market recently. In Mexico, we've also recently seen a number of opportunities from integrated service companies under these incentive contracts, and some of those are under negotiation now. And hopefully, those will, as you indicate, will get started sooner rather than later. I'm not ready to make any announcements at this point.

<Q - Kurt Hallead - RBC Capital Markets LLC>: Okay. And when you look at the U.S. market, it gave some earlier indications as to what product lines are doing well for you, and what may still going to be challenge. But what do you think from a growth standpoint? Let me phrase it differently. What are some of the product lines that you think in the second half of the year could show the greatest improvement, so second half versus first half.

<A - Dick Alario - Key Energy Services, Inc.>: Well. We think that our rig business could see some very, very large upside as some of these things we've talked about come to fruition. The second thing I would call out, is in our rental business, I don't want you to miss the comment that Marshall had at the end of his script. We have already found some opportunities to shift some capital under our KVA assessment program that we have just now installed and the company haven't really completely embraced it yet. We've already found some opportunities to move some of the 2014 capital which was almost totally maintenance based.

We now found a way to free up some of that and have some demand on the premium drill pipe side and on some saltwater disposal wells in some premium locations in the shale plays that we can now get after here over the next quarter or two. Some of that's already been ordered and we are in final negotiations on a couple of SWDs. So we have in fact found some growth opportunity. And so I would say those would be the first ones that will react.

The other one I think that bears some mention is, what we put a little bit of color on in the script, which was our mid-size coiled tubing fleet. Every day that goes by, we get better at finding ways to use two-inch coil almost as effectively in certain types of well architecture as two-and-three-eighths. And two-inch is where we have the most oversupply and that's not just true for us but for everybody. So if we can continue to get some traction there, that's a real nice growth opportunity because it really throws some nice margin off because those - that's already sitting there and if we can find some more work for it, it becomes pretty effective.

<Q - Kurt Hallead - RBC Capital Markets LLC>: Okay. And your comments on natural gas activity did get my attention because to this point, quite frankly, I haven't heard much in the way of movement on the natural gas front so I just - could you maybe expand on that a little bit more for us?

<A - Dick Alario - Key Energy Services, Inc.>: Well, to start with exactly what we said, we don't - we're not calling this an inflection point, but we're calling out some things that we haven't seen in several years that are now being seen and we felt it was or we feel it's important that the market understand that Key is well positioned. We haven't abandoned the gas markets, we still have facilities and people and relationships there, mostly over the last few - several - couple years, actually, doing work in particularly areas where you have a good oil and gas production mix.

Now what we've seen are the early signs of a handful of customers who have taken advantage of the short-term commodity price inflection to go turn on some old gas wells that have good return metrics associated with these prices and the cost to do this. And at the time as you well know there has been some pick-up in some of the core acreage areas of particularly places like the Haynesville, where we're finding better opportunities but again, don't read this into Key making - putting a stake in the sand at this point, but read this as Key saying that we've begun to see some encouraging signs and we would be much more encouraged if we continue to see those signs.

We cited a couple of examples of things with the coiled tubing unit that's now returned to East Texas and has a good level of work lined up for it, and we haven't seen that in eight to ten quarters so it doesn't take a whole lot to encourage us and that's what I'm telling you that our mindset is, it's a much more positive enhancement.

<Q - Kurt Hallead - RBC Capital Markets LLC>: That's great. Appreciate it Dick.

Operator: Your next question comes from the line of John Daniel from Simmons & Company. Your line is open.

<Q - John Daniel - Simmons & Co. International>: Hi, guys. Some are just some housekeeping. Marshall, I think you mentioned Q1 international rig count was 29 rigs, can you remind us what Q4 was and an expectation for Q2?

<A - Marshall Dodson - Key Energy Services, Inc.>: Q2, I think we talked about 27 rigs.

<Q - John Daniel - Simmons & Co. International>: Okay.

<A - Marshall Dodson - Key Energy Services, Inc.>: I'll have to get back to you on the fourth quarter, I can't remember the stuff on my head right now.

<Q - John Daniel - Simmons & Co. International>: Okay. And then -

<A - Marshall Dodson - Key Energy Services, Inc.>: It was around 30 rigs I think.

<Q - John Daniel - Simmons & Co. International>: 30 rigs, okay.

<A - Marshall Dodson - Key Energy Services, Inc.>: 30 rigs, 31rigs.

<Q - John Daniel - Simmons & Co. International>: And if I could get you guys to expand on the success in the Bakken? I think Dick, I was trying to write quickly, but a customer in the Bakken where you expect to do, where you're working about 25% faster than their expectations. Was that, were those rigs employing the KeyView system? And can you just expand on what drove that efficiency?

<A - Dick Alario - Key Energy Services, Inc.>: Those rigs do, the equipment we have up there does support the KeyView system, and it is part of the reason that we've been able to drive that efficiency. These are, I'll give you a little more color, these are some of the first wells that this operator installed in the market in that oil shale, these are open hole, these were originally open hole completions where we're now going in and doing a complete redo with a re-frac and all the associated, we're not doing the fracking obviously but all of the associated services that go along with that.

By the way, we've also seen some production results and not only is it going well in the field, but the customer seems to have every reason to continue on because the production results are pretty good, they don't - these wells are not getting back to their original IPs but they're getting pretty darn close. So without commenting on their economics, it looks like they should be happy with the funds they're spending to get these wells redone.

Again, the point I want to make is a) we know how to do this stuff, b) we can do it even better than the customer - this particular customer had cited it, at least in terms of how much time it takes and we think it's the beginning of a level of activity that really hasn't been present in the business before. Again, this is what we've been saying about why we build big rigs and big coiled tubing units and invested in some of the other services that are required to do this kind of work. As you know, oil wells require maintenance. Horizontal oil wells require maintenance as well, and it's encouraging to begin to see some early signs of some reaction to that by our customers.

<Q - John Daniel - Simmons & Co. International>: Okay. Just two more for me. And on that last question, given the success with that case study, is it too early or have you been able to take that case study to other customers in the area to try to encourage them to do similar thing?

<A - Dick Alario - Key Energy Services, Inc.>: We are doing work around that right now. Haven't gotten to the point yet where we can but we - that's one of the things that we have some people looking at.

<Q - John Daniel - Simmons & Co. International>: And then the last one for me. If you build the 15 new rigs that are coming out this year, do those automatically get the KeyView system? Or is that based off of a customer request?

<A - Dick Alario - Key Energy Services, Inc.>: All of our new rigs get the KeyView system. Everything we build now receives KeyView.

<Q - John Daniel - Simmons & Co. International>: Okay. Thanks, guys.

<A - Dick Alario - Key Energy Services, Inc.>: You're welcome.

Operator: Your next question comes from the line of Marshall Adkins from Raymond James. Your line is open.

<Q - Marshall Adkins - Raymond James & Associates, Inc.>: Morning, Dick. You're pretty clear on the whole U.S. margin front and it sounds like a lot of that, the margin improvement not being better is associated with moving rigs back from Mexico, but 4% to 6% sequential growth just seems like given the weather impact that you have more Mexico rigs, you have more daylight hours. Are you just being a little conservative there in the guidance for revenues?

<A - Dick Alario - Key Energy Services, Inc.>: We're not getting out over our skis, Marshall. But listen, as I said, a lot of tendering activity took place. Some of it is yet to be decided and while a good bit of it could put some rigs in trucks and various things to work this quarter, we sort of want to see that begin to happen before we stretch anymore. So read that like you will, but that's still above typical seasonality.

<Q - Marshall Adkins - Raymond James & Associates, Inc.>: Right. Okay. The whole KVA thing, I actually think that's a big deal and I think it's great to push for better returns. Give us more detail on what you're doing there in terms of timing and can you quantify any of the improvements you expect to see or is it just too early?

<A - Dick Alario - Key Energy Services, Inc.>: We'll make some comments about that. First of all, in terms of where we are, we began to install the training or began to do the training around value-added approach in January. And we've probably covered two levels of the organization thoroughly and are at the point now where we're getting to reach down to the regional/district level explaining to our people what this financial metric means and how they should think about it. The next step will be to, and we've already started this, go back and look at what our plans are for this year. And so my first point is we have begun to do that and it has begun to have some effect. We were able to free up, I don't want to get into numbers yet, but we were already able to free up some capital out of our 2014 budget, which was formerly put aside for maintenance type work and it's now been driven more toward the growth side. So that's what you should expect. You should expect a more efficient capital organization, one that pays much more attention to the cost of capital. And the behavior is not fully heeled at this point, but certainly by the end of the year, this is going to be embedded into our company, it's going to be a very [ph] soft (47:30) part of our culture.

<A - Marshall Dodson - Key Energy Services, Inc.>: And, Marshall, this is Marshall. I just to add one thing to point to what Dick said. Under this methodology the replacement asset costs as much as the new asset. And so the replacement asset with no growth carries a penalty, but if you can get the new asset, it also covers your KVA and yields growth, that's kind of the capital allocation distinction that's going on.

<Q - Marshall Adkins - Raymond James & Associates, Inc.>: Well, it sounds like you're pushing us all the way down to the district level, and when we look at the impact, really, you're starting to see some but it's a more 2015 event than it is 2014.

<A - Dick Alario - Key Energy Services, Inc.>: I think that's very fair. You'll see some results in 2014 but the more dramatic effect will happen next year.

<Q - Marshall Adkins - Raymond James & Associates, Inc.>: Perfect. Thanks, Dick.

<A - Dick Alario - Key Energy Services, Inc.>: You're welcome.

Operator: Your next question comes from the line of Scott Levine from Imperial Capital. Your line is open.

<Q - Scott Levine - Imperial Capital LLC>: Hey. Good morning, guys.

<A - Marshall Dodson - Key Energy Services, Inc.>: Morning.

<A - Dick Alario - Key Energy Services, Inc.>: Morning.

<Q - Scott Levine - Imperial Capital LLC>: So I wanted to ask about the Fluids business. It's seemingly you guys obviously have been pretty cautious about that business or downbeat with regard to fundamentals. I'm wondering whether you've seen any improvement there and I think I heard some mention of interest in saltwater disposal wells. Maybe a little bit more color and your thoughts on that business in general.

<A - Dick Alario - Key Energy Services, Inc.>: Well, one of the things that we certainly recognize is that one of the keys to be successful in the water - Fluids Management business is to have disposal wells in the right places. And to be frank, we've been less than aggressive in that area over the last couple years as we've focused most of our, almost all of our new capital went into that business, went into the Bakken, where we did buy some disposal wells and have a good network of disposal capabilities. However, we didn't do that as much in places like the Eagle Ford and other resource plays.

We're now turning our attention to those, and so following on to some of the discussion you just heard about KVA and what makes sense and what doesn't and sort of the new way we're thinking about things, certainly putting saltwater disposal capabilities in markets which have a long fairway of solid water management growth ahead of them like the Eagle - obviously to use Eagle Ford as an example, is a place where we're now going to allocate some of our capital. And it's going to enhance that business, it's going to allow us to save some costs in places where we're using public disposals, it's going to allow us to better service our customers and be more competitive on a pricing basis, so kind of all around, sort of good things and a little bit of a rejuvenated view of the Fluids business on our part.

<Q - Scott Levine - Imperial Capital LLC>: Got it. One follow-up if I may. I think you mentioned at the start of the year, you guys were looking to pay down a little bit more debt. Maybe some additional thoughts with regard to that, and maybe at what level would you guys start looking at maybe some more growth investment or maybe a little bit more color or your thoughts on the balance sheet.

<A - Marshall Dodson - Key Energy Services, Inc.>: Well, so, we're sitting at net debt to capital of around 36%. That's what we've targeted, a net debt to capital mid-30%s for quite a while. We have $85 million, I think, pre-payable under our credit facility. And as we look out through the year, we'll be going through and applying the KVA lens to our cash flow and our capital, and we'll allocate it from there.

<Q - Scott Levine - Imperial Capital LLC>: Got it. Thank you.

<A - Marshall Dodson - Key Energy Services, Inc.>: So it has the best benefit.

<Q - Scott Levine - Imperial Capital LLC>: Understood. Thanks.

<A - Dick Alario - Key Energy Services, Inc.>: Thank you.

Operator: Your next question comes from the line of Daniel Burke from Johnson Rice. Your line is open.

<Q - Daniel Burke - Johnson Rice & Co. LLC>: Good morning, guys. Actually, one other question on the Fluids business, I apologize if I missed this earlier, but you all talked about regional revenue mix in the press release also affecting Fluids. And I guess it's - did you mean to say that Fluids had a negative impact due to regional revenue shifts, and can you help me better understand that?

<A - Dick Alario - Key Energy Services, Inc.>: Well, I don't think we cited Fluids particularly. But as I think back, we - one of the things we were sort of highlighting there was the California situation. We don't have a big Fluids business in California, so it wasn't as prevalent in that business as it was in Rigs.

<Q - Daniel Burke - Johnson Rice & Co. LLC>: Okay. Great. That's helpful. And then in terms of the commentary saying that production services growth will trail the rate of growth that you see coming in the completion services business, if - again, this has been gone over a couple times, Dick, and you just alluded to it. But if we look at your Rig Services business ex-California, would you assume that business could match the rate of revenue growth you anticipate on the completion side?

<A - Dick Alario - Key Energy Services, Inc.>: More so than with California for sure, although again, given our customer profile, even in some other areas, there's - we think there's going to be a little bit of difference between the uplift, and don't misread what we're saying. We see traction there, just not as fast as on the completion side.

One of the things that's been, to some degree surprising and more encouraging this year has been the speed with which operators have been attacking new well construction in these shale plays and in the Permian. And it's sort of the same syndrome we saw back in the early days of horizontal well installation, where more capital was being shifted into those areas than what had traditionally been done; and it's been a little bit surprising that how much new well construction focus the customer base has had. Now again, as the cash flow of those companies continues to improve based on that increased production, that's going to free up more cash to go take care of the existing wells, both in horizontal shale markets and in legacy markets that they - those companies own. So we think production services business is just lagging a quarter or two. There ought to be some catch-up there in the back half of the year.

<Q - Daniel Burke - Johnson Rice & Co. LLC>: That's helpful. And then to cram one last one in, the international rig count sequentially moving flat to down just a tick, given the rig count's flat, what drives the improvement sequentially in your other international markets?

<A - Dick Alario - Key Energy Services, Inc.>: A better mix of rigs working on contracts that are a little bit more profitable.

<A - Marshall Dodson - Key Energy Services, Inc.>: We're also getting past some of the start-up phase we had. We started up in Ecuador last year, that's kind of now all up and going. So it's moving with - remember we moved - our first move with the rig in Mexico was out of Mexico into other international markets. And so as all that gets up and moving, that allows us to kind of move up the curve and into more stable operating margins.

<Q - Daniel Burke - Johnson Rice & Co. LLC>: Okay. Well, great. Thank you, guys, for the time.

<A - Dick Alario - Key Energy Services, Inc.>: You're welcome. Thank you.

Operator: And your last question comes from the line of Mike Urban from Deutsche Bank. Your line is open.

<Q - Mike Urban - Deutsche Bank Securities, Inc.>: Thanks. Good morning. Just a clarification on Mexico, I think you said you had 17 rigs still in country; does that include that next slug that still needs to come back to the U.S.?

<A - Dick Alario - Key Energy Services, Inc.>: What we're saying, Mike, is we will be left with 17 rigs after we move the next dozen out that we've - haven't really started that yet, we'll start that next. [indiscernible] (55:06).

<Q - Mike Urban - Deutsche Bank Securities, Inc.>: Okay. So that's all that will be left. Okay. So that does [indiscernible] (55:08)

<A - Dick Alario - Key Energy Services, Inc.>: Yeah. After everything, that'll be left.

<Q - Mike Urban - Deutsche Bank Securities, Inc.>: Okay. So that does leave you with a good bit of potential leverage there if things get better.

<A - Dick Alario - Key Energy Services, Inc.>: That's right.

<Q - Mike Urban - Deutsche Bank Securities, Inc.>: Okay. Okay. And then on the rigs that you have moved back and will continue to move back, you highlighted the impact of the unit cost to mobilize those and do the maintenance there. Clearly that's going to impact the second quarter. As you bring that next group back, does that also move into an impact to Q3 a little bit as well?

<A - Marshall Dodson - Key Energy Services, Inc.>: Yeah. So if we kind of take the same it takes two quarters to move them all here and move them through the process to get them out and ready, there's going to be a little bit bleed over into Q3 for the second group of rigs.

<Q - Mike Urban - Deutsche Bank Securities, Inc.>: Okay. And then last thing for me is, you gave us some color on a couple different categories of utilization for coiled tubing. What's your overall fleet utilization right now?

<A - Marshall Dodson - Key Energy Services, Inc.>: I think it's in the mid 50s.

<Q - Mike Urban - Deutsche Bank Securities, Inc.>: Mid 50s? Okay. That is all from me. Thank you.

<A - Dick Alario - Key Energy Services, Inc.>: Thanks a lot.

Operator: And we have no further questions at this time. I would like to turn the call back over to our presenters.

West Gotcher, Director, Investor Relations & Corporate Development

Thank you, Jeremy. This concludes our call. The replay of this call can be accessed on our website, at keyenergy.com, under the Investor Relations tab. Also under the Investor Relations tab, we will post a schedule of our quarterly rig and truck hours after this call. Thank you for joining us today.

Operator: And this concludes today's conference call. You may now disconnect.

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