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Key Energy Services Inc. (NYSE:KEG)

Q4 2012 Results Earnings Call

February 15, 2013 11:00 AM ET

Executives

Gary Russell - Vice President, Investor Relations

Dick Alario - Chairman, President and CEO

Trey Whichard - Chief Financial Officer

Trey Wilson - Chief Operating Officer

Analysts

Blake Hutchinson - Howard Weil

John Daniel - Simmons & Company

Marshall Adkins - Raymond James

Trey Stolz - IBERIA Capital Partners

Kurt Hallead - RBC Capital Markets

Jeff Tillery - Tudor Pickering Holt

Rob Mackenzie - FBR Capital Markets

Neal Dingmann - SunTrust

Tom Curran - Wells Fargo Securities

Mike Urban - Deutsche Bank

John Keller - Stephens Inc.

Operator

Good morning. My name is Tracy, and I will be your conference operator today. At this time, I would like to welcome everyone to Key Energy’s Q4 2012 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. And I’ll now introduce and turn the call over to Mr. Gary Russell, Vice President of Investor Relations. You may begin your conference.

Gary Russell

Thank you, Tracy. And thank you everyone for joining Key Energy Services for our fourth quarter and full year 2012 financial results conference call. I’m Gary Russell, Vice President of Investor Relations.

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 risk factors discussed in our 2011 Form 10-K and other reports recently -- 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 any -- 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 to Dick Alario, Key’s Chairman, President and CEO. And he’ll provide some introductory comments, then Trey Whichard, our CFO will provide a financial summary including forward guidance, followed by Trey Wilson, our COO, who will provide an operation summary and finally, Dick will return to conclude our prepared remarks and open the call for your questions. Dick?

Dick Alario

Thank you, Gary. Good morning, everyone. So, fourth quarter, Key generated earnings from continuing operations of $0.09 per share, which is right at the midpoint of our expected range. Our U.S. contribution was slightly better than we expected and our International results were little more than we expected.

U.S. activity in the quarter was impacted by seasonal factors and year end customer budget exhaustion as we had anticipated. Notwithstanding, one large customer activity reduction was favorable oil fundamentals to other customers are increasing activity levels. Accordingly, we see opportunities to redeploy our idled assets into an improving demand environment as the year rolls up.

In Mexico, anticipated activity increases didn’t fully materialized as some incremental work assignments from our customer were delayed into 2013. The rest of our international regions performed essentially in line with expectations. Our activity growth in Mexico has since resumed and we believe we’ll have another strong year there in 2013.

2012 on the whole contrasted greatly between our Domestic and International segments. In the U.S., our business was challenged by activity relocation from gas markets to oil markets, which led to overall excess capacity and higher unabsorbed costs, while we managed moderate U.S. revenue growth of 6% for a year, our operating income was down 20% compared to 2011.

Looking at it by business line, U.S. rig services had good year with revenue growing about 8% and our legacy Fishing & Rental Services business had an outstanding growing 23% compared to 2011.

In contrast, revenue from fluids management, coiled tubing and Edge business declined in 2012, this was due primarily to their disproportionately larger exposure to gas markets particularly the Haynesville Shale where the average drilling rig count declined 58% year-on-year.

In U.S., we spent a better of first half of 2012 mobilizing people and assets from gas markets to oil markets which was costly yet necessary endeavor. We experienced a 32% decline in our gas market revenue in the face of 43% decline gas directed drilling activity.

As we grew our position in oil markets, overall activity softened in the back half of the year and competition increased. Beginning last year and continuing today we’ve taken steps to improve our U.S. cost structure, business line by business line and region by region.

Internationally we had great year, revenues up 67% compared to 2011, and operating income grew 62%. This was largely driven by activity expense in Mexico, also during the year we opened operations in Oman and we sold our Argentina business.

Our International segment represented 20% of consolidated revenues during the fourth quarter with higher margins and higher investment returns in the U.S. We expect our International segment to continue to grow as a percent of the total company.

As Gary said, I’ll have some additional comments at the end of our prepared, but now I’ll turn it over to Trey Whichard for his financial review.

Trey Whichard

Okay, Dick. Our fourth quarter consolidated results obviously in line with earlier expectations. Better than expected results in our Fishing & Rental Services and our Coiled Tubing businesses helped us offset a more pronounced sequential decline in rig services activity than we had anticipated going into the quarter.

The improved results in Fishing & Rental and Coiled businesses also have covered cost and efficiencies in Mexico where we were staffed to accommodate increase activity that ended up being postponed into this year’s first quarter.

The sequential increase in functional support cost and overall G&A expense is reflective of third quarter adjustment to bonus accruals that reduced what had been recorded in the first half of 2012. Most of the third quarter adjustment was captured in our functional support segment, which represents roughly 60% of our consolidated G&A expense.

For the full year 2012, G&A expenses were approximately 12% of revenue and our consolidated tax rate was just under 36%. For 2013, we project G&A to approximate 13% of consolidated revenue and believe our tax rate will come in around 36%.

Our quarterly interest expense run rate in 2013 should approximate fourth quarter’s expense of $13.9 million, which would result in a slight year-over-year increase.

Following 2012’s capital spend of $447 million, our 2013 depreciation expense is estimated to be in a range of $225 million to $230 million, and our approved capital spending budget for 2013 is $210 million.

Our outstanding shares count is currently 152 million shares and looking at the first quarter of 2013, in addition to full quarter of operational inefficiencies expected in our U.S. rig services business, our result will reflect an increase in G&A expenses, as well as the annual unemployment tax obligation which burdens our first quarter. Compared to the fourth quarter, the increased G&A and unemployment tax burden will impact results by $0.04 to $0.05.

As stated in our press release, first quarter consolidated revenue is projected to decline approximately 5% sequentially and while much of this decline is expected to occur within our U.S. operations, we project International revenue will be down as much as 5% sequentially, and this is due to lower third-party revenue in Mexico.

As our activity has expanded in Mexico, so have third-party services we’re required to manage in association with our work, this work varies by project and very difficult to predict.

We do forecast our core well servicing revenue in Mexico to increase sequentially during the quarter, resulting in a better mix of higher margin revenue. We should support a sequential improvement in our international operating income margins.

And with that, I’ll turn the call over to Trey Wilson.

Trey Wilson

Thank you, Trey. We shared the consensus view that U.S. oilfield service market activity as whole or likely be roughly flat with 2012 level. So far this quarter U.S. pricing has been generally stable, with moderate pressure for certain in select markets.

We are anticipating moderate growth through 2013 for first quarter lows driven by activity in oil markets. We believe that will set the stage for overall healthier fundamentals especially in the back half of 2013 and into 2014, that improving backdrop should go a long way towards helping our fluids, coiled tubing and flowback businesses which support new well drilling and completion related activity.

Moreover, following our capital investments of 2011 and 2012, we have underutilized capacity in the U.S. which we believe should generate additional revenue growth potential without additional capital investment as customer demand returns.

Throughout 2012 our rig services business performed well, owing in part to its exposure to oil markets, strong operating performance of its management team, our crews and equipment.

We have seen some moderate pricing pressure but less than we initially anticipated given the level of activity decline. We generally believe we will be bidding new work into an improving market as one might expect in a $90 per barrel oil environment and with rapidly growing population of over 500,000 producing oil wells in the U.S. that require regular maintenance. We see opportunities to redeploy our recently idled assets and crews and we have made headway already.

Fluid services remained structurally challenge owing to overcapacity and increasing crowded oil markets, following the reduction of market activity in gas markets. Our business is particularly challenged in the Bakken market which became oversupply with equipment even as customer demand declined.

Accordingly, we are acutely focused on better alignment of this businesses resources with relatively more attractive opportunities and more aggressively reducing cost we wanted, despite these efforts this business might take another quarter to before results are realized.

Coiled Tubing Services revenue was up slightly in the fourth quarter and margins increased more than 300 basis points from improved operating efficiencies and a more favorable higher margin mix of work. The pricing declines we experienced in 2012 are mostly in the first half of the year and primarily concentrated in the gas markets.

Over the past couple quarters pricing has been and continues to be pretty stable, as a result of corrective actions that took place early in the year, we believe we are now situated in markets that offer more balanced and profitable mix of work, and are well-positioned to take advantage of any increases in market activity.

Our Fishing & Rental Services business includes our traditional oilfield equipment Fishing & Rental Services, as well as our flowback services that we brand as Edge. Our traditional rental business enjoyed strong demand and utilization through 2012, and we believe that we should have another good year in 2013.

Likewise, our expertise in downhole recovery remains in high demand by our customers. We also expect our flowback business to see improvements in its new markets as 2013 progresses. Overall, our Fishing & Rental Services segment had higher revenue and profitability in the fourth quarter as compared to third and we expect this trend to continue.

2012 was great year for our International segment, revenue growth was approximately 67% fueled primarily by Mexico where our operating and business development leadership teams did an outstanding job essentially doubling the size of our operation in the country.

In Mexico, we expect activity growth from higher utilization of equipment already in the country, which will be working not only for PEMEX but also potentially for several large U.S. service companies.

Our established asset base includes not just rigs but also electric wireline, mechanical wireline and coiled tubing equipment, and we expect to work not just in ATG and [Hydra] in the northern region, but also at Veracruz which is in the northern region and also we expect to work in the southern region.

Among our goals in Mexico for 2013 is goal to diversify the type of work we do, who we do it for and where we do it. The market for Key in Columbia has been good, as we have consistently worked our non-rigs in the country over the past several quarters. We have three additional rigs in the country which we believe will put into service in the first half of this year.

Our outlook for the Middle East market is positive. Today, all our activity in Bahrain and Oman is contract driven and we’ve been very selective about the Middle East contacts we chose to participate in. The Middle East has been the most prolific oil producing region in the world for decades.

Now, as many of these reservoirs face meaningful production decline, operators and state oil companies are growing more focused on brownfield production maintenance to help extend these declines.

We believe that this emerging trend should lead to more opportunities for Key and as we gain a larger critical mass of rigs in the region, we believe our success will beget success like in Mexico and Colombia, leading to more growth, better overall operating efficiencies, margins and returns.

Lastly, following our significant investments in 2011 and 2012, we have the opportunity to pare back capital investment this year and still have the potential for revenue growth from the equipment we bought in 2012.

$210 million, we’ll invest in 2013 will be spend on general equipment, maintenance and upgrades. Within our 2013 plan, some of our equipment upgrades will consists of new 550 horsepower class heavy workover rigs, which we consider to be our franchise rig and new smaller purpose-built rigs for our West Coast market. All this new rigs will replace older rigs, which will retire over time.

Now, I’ll turn the call back over to Dick for his concluding remarks.

Dick Alario

Thanks, Trey. As U.S. activity growth begins to materialize again this year, we believe Key is now well positioned to capitalize on the operating leverage inherent in our company.

Following the U.S. market changes of last year, we are approaching 2013 with caution and conservatism. That said, we do have cause for optimism against the backdrop of moderate oil market growth in the U.S. in 2013. We see some of the from last year’s subsiding. We see a rapidly growing inventory of horizontal wells that will largely require a regular maintenance, and we see several new emerging shale basins.

And in International, we see opportunities to build out our existing platform and possibly expand our footprint. To take advantage of these growth drivers, we believe we are building the well service rigs of the future. We are improving our U.S. footprint to take advantage of the shift to new marketplaces, and we are better positioning our business to support more assets outside the U.S., where as I said margins are returning higher and activity tends to be longer duration and less volatile.

Most specifically, Key’s service offerings today create a balance that enables the company to participate more fully, whether the cycle is in the new well insulation phase or the existing well maintenance phase.

And speaking of the balance of opportunities, before we close, I’m going to take a moment to highlight our business prospects in the Permian Basin. With almost 370 active drilling rigs in the Permian market, it’s the most active of any basin in U.S. and it represents nearly a quarter of total U.S. onshore drilling activity.

Likewise, with approximately 82,000 producing oil wells or 15% of U.S. onshore total, the Permian has the largest producing oil well inventory in the U.S. It’s already the source of Key’s largest discrete revenue base and it is home to our biggest workforce and don’t miss this point.

We are certainly enthused by trend we are seeing, as our customers there transition to horizontal completions. We believe that as this continues, Key’s opportunity to increase its surface intensity in these extended rich completions, coupled with the later life repair and maintenance needs of these wells will impact our financial results possibly across the cycle.

Taking all of this into consideration, our U.S. view is, while 2013 might be “flat” with 2012, flat does not mean the two years will look alike. As opposed to last year in the U.S., we see building demand into 2014. In International, our view is for continued strengthening and opportunity to grow with assets that are already in place.

Operator, those will conclude our prepared remarks this morning, so we can now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Blake Hutchinson with Howard Weil. Your line is now open.

Blake Hutchinson - Howard Weil

Good morning, guys.

Dick Alario

Hey, Blake.

Trey Whichard

Good morning.

Blake Hutchinson - Howard Weil

I just wanted to size the loss here as we go into first quarter of the major customer and the well service business. Through your guidance and given the improvement in some of the other side sub segments, are you more or less implying that most of the 5% loss in revenue will be relegated to the U.S. well service business?

Dick Alario

Yeah.

Blake Hutchinson - Howard Weil

Okay. So, if we take that and then assume some sort of decremental margin I guess we can make the assumption that -- how much was that already impacting you in 4Q I guess that’s one of the question? How much was that already hitting in 4Q or you just talking a couple weeks at the end of quarter?

Dick Alario

It work its way down, so the average of the fourth quarter is going to be higher than the average of the first quarter. We do expect it to start looking its way back up, but off of a lower base, Blake. You can see the revenue in our press release. Rig services was down 13% in the fourth quarter sequentially which is -- that 2X what we would typically expect the quarter to look like given normal seasonal activity decline.

Blake Hutchinson - Howard Weil

Okay. And then just -- finally, on that line of questioning, so your assumption in first quarter -- do you also again make the assumption that you getting -- there is no mitigation of the loss in first quarter?

Dick Alario

Well, no, not really. We expect the quarter as it progresses to continually improve. March is going to be better than February, and February should be better than January, particularly on the rig side of the business.

Blake Hutchinson - Howard Weil

Okay. So that’s in the guidance.

Dick Alario

Yeah. And let me make another point and I expect it will probably be your next question. As we think about the U.S., our first half 2013 revenue will be roughly equal to the second half 2012 revenue. Margins in the first half of 2013 in the U.S, we forecast it would be similar to the operating income margins in the second half of 2012. A different way to think about it is that our first half margins for the first half of the year in the U.S. should be 200 to 300 basis points better than our Q1 operating income margins.

Blake Hutchinson - Howard Weil

Great. That is exactly where I was going at. Thanks a lot. I will turn it back.

Dick Alario

Okay.

Operator

Your next comes from the line of John Daniel with Simmons & Company. Your line is open.

John Daniel - Simmons & Company

Hey, guys.

Dick Alario

Hey, John.

John Daniel - Simmons & Company

Dick, as you guys see the laterals continue to go farther out, have you seen at this point any transition from customers switching back from coiled to workover rigs?

Dick Alario

So far only in one market, in the Bakken.

John Daniel - Simmons & Company

Okay. Would you expect that to become a similar trend in other basins and if so or if not, why?

Dick Alario

It’s a little hard to say, John. However, you could make the argument that as you get out towards 10,000 feet that becomes a question. I will say that we have become much better. When I say we, I mean the industry, particularly with [2.375] inch coil and extending out that far in states where we are allowed to haul that kind of coil, stream up and down the highway. One of the reasons that we couldn’t do it effectively in the Bakken is because of the road restrictions in North Dakota.

But in Texas, we don’t face the similar restrictions, so we can haul [2.375] inch coil up and down and we have been successful in getting farther out with [2.375] and we have the 2 inch. In fact, it’s the most demand -- it’s the type of coil that’s in most demand for us in the Eagle Ford.

So, at this point, we haven’t run into any resistance. But I just have to say that if that begins to happen, our expectation is the same effect that we saw in the North Dakota market is that for Key, if we can’t use the coil unit in certain operators we can certainly get the job done with a workover rig.

John Daniel - Simmons & Company

Right. Good balance. Okay. That’s all I had. Thanks, guys.

Dick Alario

Thank you.

Operator

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

Marshall Adkins - Raymond James

Good morning, guys. Quick one, couple for me. One of the things that struck me about the hours seasonally -- obviously, they are low but they were lower than normal. What was it? We were pushing a $100 oil world now and the hours a week. Is the main explanation for that kind of that one customer, and should we expect the margins in the rig servicing business to bottom Q1?

Dick Alario

Yeah. I think we said, Marshall, that the main single largest -- but look we have customers that change activity from time to time even in stronger markets. But we put that in the press release and highlighted it in the script because it was the single largest impact on our business and clearly we have called Q1 as the bottom and we expect that to improve as the year unfolds.

Marshall Adkins - Raymond James

Let’s just switch gears and go to CapEx and you are whacking it by more than half, and you said most of it’s have to go to few new rigs or place once you going to retire. Can you give us a little more color on that or is there any coiled tubing in there? Rental tools, obviously has done pretty well. Do you ramp that up, a little more color on the CapEx if you could?

Trey Whichard

Marshall, this is Trey. We’ve got spare capacity. Obviously as we wind up the year and we spend quite a bit of capital on building that capacity over the last couple of years and at this point the way that we are thinking about the U.S. market in particular is that we don’t have to invest in a lot of new capacity to capture a recovering activity from current levels.

Marshall Adkins - Raymond James

Right, so.

Dick Alario

Marshall, just a little more color. In that number that we gave you, $210 million, depending on a couple of factors you could anticipate that we would build about 40 of our franchise rigs and either replace most of all of that in the U.S. market or some of those are certainly likely to go outside the U.S. So, just a little more color on the capital, we could probably build 40 to 45 new rigs within that. And we call that upgrading, by the way because they are replacement rigs. That gives you a little more context.

Marshall Adkins - Raymond James

So behind the rigs, are we going to spend continued spend on fishing and rentals. I assume we are done built new coiled tubing in it, is that fair?

Dick Alario

Well, it’s fair to say that as -- the thing we’ve been concentrating on in our fishing and rental business is drill pipe, high end premium drill pipes and pressure control equipment, blowout preventers and things like that. We have a little money in there for some of that. But as the rig count -- drill rig count picks up -- depending on the market demand, we could certainly spend some capital in those areas the year unfolds. We are going to buy some production, some rental production tubing. We do have some money in there for that because there has been some pretty good demand in a couple of markets for production tubing, rental tubing.

Marshall Adkins - Raymond James

And the coiled tubing as we are pretty much done for a while, I assume?

Dick Alario

Yeah. Particularly on the coiled tubing side of the business, the fluids and the rig side of the business, Marshall, we’ve got 25%, 30% upside and activity with the equipment that we’ve got on the fence at this point.

Marshall Adkins - Raymond James

That’s what I was saying. I just want to make sure. Very helpful, guys. Thanks.

Dick Alario

Thank you.

Operator

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

Trey Stolz - IBERIA Capital Partners

Good morning, guys.

Dick Alario

Trey, good morning.

Trey Stolz - IBERIA Capital Partners

Just a question going back to the well service customer that impacted 4Q and 1Q. Looking at that, should we think of that with larger service rigs, smaller? How is that impacting your mix there? And then, does that translate into opportunities to potentially move rigs to Mexico as you tried to grow that region if Mexico is coming back?

Dick Alario

We don’t think about those particular rigs as being the ones that are available to go overseas. When we think about that, those will probably be built, be part of these 40 new builds that we will put in place. Most of the work that was idle -- most of the equipment that was idled by our large customer was shallow, low-pressure vertical oil well.

We are pulling units in the Permian and in California. So, not the kind of rigs that we would be sending overseas and very good work by the way, not low-end work by any means. But repair and maintenance work, not completion work, is what was idled.

Trey Stolz - IBERIA Capital Partners

Okay. Got it. And then on Edge, looking at Edge and the frac sector that was -- a lot of pressure pumping utilization seemingly up in 1Q. Are you seeing an impact there on the Edge business thus far?

Dick Alario

Well, as you saw we had a better quarter in Edge, part of that is due to getting our footprint well established in a couple of these new markets. And yeah, we probably benefitted somewhat from some increase in activity and I couldn’t resist. By the focus of that business right now is in the Eagle Ford and the Bakken and we couldn’t be happier about some of things that we are seeing going on in the Haynesville as in the last year as well.

In next call, I will expand on that. If you recall, when we acquired Edge, that’s where all of their business was. If that market came back that would be the single most impactful thing that could happened for the Edge business and to some degree for one or two of our other business, coiled tubing and trucking. So we like what we’ve seen in terms of some improvement in that market just in the last 24 hours, right.

Trey Stolz - IBERIA Capital Partners

Could you quantify or qualify that? What you have seen in the last 24 hours?

Dick Alario

We saw a big announcement about activity in the Haynesville by our customer.

Trey Stolz - IBERIA Capital Partners

All right.

Dick Alario

I hate to. I don’t want to mention any names but it fits out there.

Trey Stolz - IBERIA Capital Partners

Got you. Okay. All right. That will do it for me.

Dick Alario

Thank you.

Operator

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

Kurt Hallead - RBC Capital Markets

Morning.

Dick Alario

Morning.

Kurt Hallead - RBC Capital Markets

I just had a couple of questions here on the international front. You identified Mexico, Columbia and Middle East. Unless I missed it, I don’t think you mentioned anything about Russia. So maybe you can give us some color on what you think the prospects might be there. And then maybe kind of wrap it up and put a nice bow on it. What kind of range of international revenue growth do you guys think you might be able to see in 2013?

Dick Alario

Yeah. Okay. Kurt, listen, Russia is a small market for Key. Our strategy there was to get our toe in the water. It’s in there. We have a building business. It’s been improving. We have a little bit different business model in what most people in the region have and it is the second largest oil well inventory market in the world.

So there is a great reason for Key to be in that market. And we would be very, very patient as we learn about it and as we get better at convincing small select group of customers that this highly reliable equipment that we have over there, better way to go. You should expect -- Trey can give you some brackets around little more context around our international guidance.

Trey Whichard

As we in the second half of the year, Kurt, we had equipment deliveries going into these -- into our growth countries led by Mexico. Trey referred to the equipment that was basically ideal in the fourth quarter that will be going back to work and we’ve been talking about it for the last quarter or two, the capacity that we have in those markets, on the ground today on a fully utilized basis would be able to generate 20% plus type revenue growth year-over-year.

Kurt Hallead - RBC Capital Markets

Okay. Great. And then I did have a follow-up on the comment there about, I believe, what Encana indicated, they’re going to pick up activity in the Haynesville. You guys thinks that’s a one-off situation or do you think that’s indicative of some additional E&P companies becoming a bit more active for getting their cost structure in line to pull it to make sense for them to get more active?

Dick Alario

Well, there is no question. There is more than one company that has a model and has a core acreage in the Haynesville that would yield returns at high 3s and $4 gas. We think we know what those are. We follow that very closely. As I said, it was a very important market to us. So we don’t think its one-off. And again we’re approaching this whole thing with caution and conservatism as we said.

But we certainly have to comment that we like the announcement that we saw and we don’t believe its one company thing. I’m not going to call it a trend at this point but it’s not one company.

Kurt Hallead - RBC Capital Markets

Okay. And then I just might wrap it up with this. I know, you guys indicated and then Trey, you just indicated in today’s call that 20% to 30% revenue upside if you put some idle capacity back into work. Seen that in your prior presentation as well, I guess, the question I would have for you, where do you think the primary markets are going to be to put those idle assets to work within the course of the next -- let’s call it six to nine months?

Trey Whichard

Well, yeah, and to be clear, Kurt that’s capacity that we have it could go to work, if the activity came back. And where is that likely to come back and you probably have as good a feel for that as we do. And the core areas that we’ve been seeing growth in obviously are the liquids dominant markets.

Kurt Hallead - RBC Capital Markets

Sorry. It won’t be, for example, (inaudible) heavily loaded to say the Permian, is there now a shift going out of the Eagle Ford because the NGL differentials aren’t all that favorable? That’s a kind of -- if you’ve got any additional color on that, that would be great.

Trey Whichard

Dick commented specifically on the Permian. And because of the overall base level activity there is so much higher than the other areas, the growth there is going to be a lot more meaningful to us.

Dick Alario

I would add for every one of those possible complicated trends that we see this year, as you mentioned with Eagle Ford, there is at least one that benefits us on the other side. You look at the Eastern Permian that was known today as the Cline Shale, I mean, if it turns out to be anything like its being talked about then here comes another leg up in terms of potential activity and that will -- that’s a shale.

I mean, that will be a horizontal high intensity service market. So, there is at least one upside for every potential bottleneck that’s out there. And that’s why we talk about 2013 being somewhat different than 2012.

Kurt Hallead - RBC Capital Markets

Great. Hey, it’s very helpful. I appreciate it.

Dick Alario

Thank you.

Operator

Your next question comes from the line of Jeff Tillery with Tudor Pickering Holt. Your line is open.

Jeff Tillery - Tudor Pickering Holt

Hi. Good morning guys.

Dick Alario

Hey, Jeff.

Jeff Tillery - Tudor Pickering Holt

If I think about U.S. business lines in 2013, should I think about year-over-year basis coiled tubing and the fishing and rental business faring the best kind of year-over-year comps and rig service and fluid handling the softest. Is that the correct way to think about? Thanks.

Dick Alario

I think it’s a little to early to make that call. You’ve already seen some good traction in rentals and coiled in the fourth quarter. And as Trey said in his prepared remarks, we expect that trend to continue. One of the areas that we’re being cautious in is to -- is in the rig and our fluid management business because it’s just too early to make that statement I think.

Now, we’ve given you our thoughts on the first quarter but I think it’s too early to put those businesses in those boxes just quite yet. If we should have the kind of back half of the year that it would take to get to flat activity then those businesses are going to do well also.

Jeff Tillery - Tudor Pickering Holt

And then in the fourth quarter…

Trey Whichard

Let me add just a function of math, Jeff, because of the problems in coiled that we talked about that are well behind us, happened early last year that won’t repeat and because of the tremendous activity disruption that we experienced in the Edge-related businesses in the Haynesville market issue that won’t repeat it. From an operational performance -- perspective, 2013 is going to be a lot better than 2012 will be for those businesses.

Jeff Tillery - Tudor Pickering Holt

That makes sense. That’s kind of the line of question I was going. In the fourth quarter, with the step-up in fishing and rental revenues, was that -- is that evidence of Edge gaining traction in the new areas or was it more broad based?

Dick Alario

Both. We saw -- we did see improvement in Edge and we did see improvement in our legacy business in Q4.

Jeff Tillery - Tudor Pickering Holt

Okay. Thank you, guys. That’s all I had.

Dick Alario

Thank you.

Operator

Your next question comes from the line of Rob Mackenzie with FBR Capital Markets. Your line is open.

Rob Mackenzie - FBR Capital Markets

Good morning guys.

Dick Alario

Hi Rob.

Trey Whichard

Hi, Rob.

Rob Mackenzie - FBR Capital Markets

Dick, I wanted to get you to expand on a comment from the earlier script about your customers going to hold on the completions in the Permian. I want you get a better feel for what you think that can mean for your domestic well service businesses as well as the other business that’s around there. And in terms of the magnitude, the timing, how material is that and how do you see that flying out over the next two, three, four, fiver quarters?

Dick Alario

Yeah. Great question. Three things and you’re talking about well service, right, just to be clear.

Rob Mackenzie - FBR Capital Markets

Yeah.

Dick Alario

Three, four things actually. First of all, a shift to completion work some degree. So if feeds these large rigs that we’ve been building, not very -- many of those large rigs thus far have been doing completion work in the Permian, switch to horizontals would drive that which will drive more 24 hour work because completion work is typically 24 hour. And then finally the water volumes associated with those long laterals are obviously going to increase.

So that covers the landscape on well service and then we’ve opened up in the Permian in our coiled tubing business to get ready for this. And that obviously as we use coil for drill outs in the completion process, that now we have a better opportunity. If you look at the Permian over the last two and the half years as the rig count has built up, there is a tremendous gap between the drilling rig count overall and the horizontal drilling rig count in the Permian.

You don’t see that as you look historically back at the Eagle Ford and the Bakken and the Marcellus as those rig counts have increased in those markets, it’s been all horizontal. If you look at rest of the U.S., the two markets that clearly have seen rig count improvements but not as much tracking horizontal drill rig count, it’s been California and Permian and so our deduction mathematically from that is, as that trend takes hold in the Permian, that’s the biggest upside out there and as I say that’s where we have and Key has got more signs hanging on the highway in the Permian Basin than anywhere else in the world. So it obviously be a beneficiary of that trend.

Rob Mackenzie - FBR Capital Markets

Okay. And as part of my earlier question, if you could expand on how you see the trajectory of that growth playing out?

Dick Alario

Bob, it’s a little -- it’s hard to try to really put a guess to it but if you just add up anecdotally some of the things you’ve seen by a few operators there recently these 1300, 1400 barrel a day wells in the northern Midland part of the play and those kinds of things. And if you read what has been said so far in the earning season by the rig companies who are putting more high efficiency rigs designed for horizontals in the market and the impact to some of those. We don’t have those kinds of rigs.

I think you’ve certainly cut away appreciating the trend, it’s hard to say how fast it is but we’re doing horizontal completions in the Permian today. It’s not like it hasn’t started and we just see that strengthening as ‘13 rolls out and then getting even strong as ‘14 rolls out. That is, Bob, best I could do for you. We have some internal loose brackets around that but I don’t think they are sound enough at this point to be talking about projection in that market.

Rob Mackenzie - FBR Capital Markets

Fair enough. Thanks. I’ll turn it back.

Dick Alario

Thank you.

Operator

Your next question comes from the line of Neal Dingmann with SunTrust. Your line is open.

Neal Dingmann - SunTrust

Good morning, gentlemen. Dick, just one question I have or I guess, two actually. First just on the press release where you mentioned just when you were guiding and Trey were guiding to the first quarter being done a bit that $0.02 to $0.04 and you referred to the cost efficiency, inefficiencies associated with the U.S. rig services.

I’m just wondering again you’re talking about the Permian lot of things coming up, I guess, that’s -- is it safe to say that’s just more of a, kind of, generally going to be just first time issue because of those inefficiencies and then as activity comes, you will become more fully utilized. So I’m just trying to get a handle on that.

Trey Whichard

Neal, this is Trey Whichard. It’s largely that the result of the labor force and we -- as we expect to put these assets back to work, in fact, are putting them to work. We’re going to have to bear the cost of the labor force about the corresponding revenue. And that’s where the inefficiency comes in. And obviously it results in a pretty large deferment.

Neal Dingmann - SunTrust

Okay. So I mean, Trey, just in general, on just I guess if you look at personnel cost not only for the work over rigs but just for across the board. I mean, are you generally seeing those down versus the second half of last year. And it will continue to trend down or they’re a holding a bit flat.

Trey Whichard

A lot of the increase we saw was earlier last year and it’s been fairly stable.

Neal Dingmann - SunTrust

Okay. And then lastly just on capacity -- not just for yield but just for you or Dick, just kind of your thoughts on particularly in two of your large areas like rigs services and fluid management. Just wondering what do you see in the way of sort of capacity coming this year. It seems everybody is sort of minding their business pretty well but just wanted to hear your take?

Dick Alario

I agree with your overall comment but as you dig into that, I would tell you that the capacity issues are greater on market-by-market basis in the fluid business than they are in the rig business. We don’t see much of a capacity at all in the rig business especially on the high-end large capacity rigs.

But there is no question that part of the reason that our fluid business is being impacted is pretty abundant, over capacity in some markets that two years ago that wasn’t the case. So just to split, while I generally agree, I think it’s important that we say that the rig business is in much better shape capacity wise.

Neal Dingmann - SunTrust

Dick, just to follow that up in last question just on, on that fluids, would you find yourself trying to get more -- dispose the wells and things that might have a little bit more limited capacity versus just on the trucking side?

Dick Alario

We have done that but it’s more about moving into the markets where opportunity is better and obviously can move a disposal well and the disposal well does have to be part of the overall service that you offer. So wouldn’t -- shouldn’t surprise you that we may decide to install some SWDs or by some at some point in some of these emerging markets but we can move the trucks and tanks there fairly quickly.

So it’s more about market opportunity than it is trying to be more selective about which parts of the service we’d have to go spend capital on.

Neal Dingmann - SunTrust

Perfect. Thank you all.

Operator

Your next question comes from the line of Tom Curran with Wells Fargo Securities. Your line is open.

Tom Curran - Wells Fargo Securities

Thank you. Good morning guys.

Dick Alario

Good morning, Tom.

Trey Whichard

Good morning.

Tom Curran - Wells Fargo Securities

Zeroing on Edge, what percentage of the rental assets as of today still have specs and configurations that relegate them to the Haynesville. And then based on the percentage of the CapEx budget Edge will be getting over the balance of 2013. Where would you expect that percentage should be upon exiting the year?

Dick Alario

I’ll take that, a little bit of a guess at the first part of your question. As you recall, when we acquired Edge the company had just begun to buy the equipment that was fit for purpose for the Eagle Ford which is not the same as the Haynesville. So if you go back and look at the revenue they were generating in the Haynesville, which was all of revenue essentially.

You’d sit here today thinking that something around half of the total assets in that grouped still be Haynesville style of assets. No, we still have some business there. I don’t want to make you think that we don’t have any work there. Some of that’s out and being utilized but if your question is do we have spare capacity, there is no doubt we have spare capacity for Edge-type assets in the Haynesville as I said that be biggest single impact

Going forward, we are not -- don’t misread what we’re saying. We are certainly not buying or preparing to buy or thinking about buying additional Haynesville style asset for Edge business. We would add a few handful of assets, Eagle Ford and Bakken style which are lower pressure, more volume assets as the year unfolds but we don’t need much of that either. We have spare capacity in that category of assets as well.

Tom Curran - Wells Fargo Securities

I guess, thank you for that. I guess, a different way of approaching the question would be what quarterly level of revenues and here are expanded to include all the fishing and rental and then also coiled tubing. So those two segment, what level of quarterly revenues, would you have to be closing in on for each of them to consider increasing CapEx budget and resuming investing in expansion of the asset fleet?

Dick Alario

Listen, I will give it to you this way. It’s a brilliant question by the way. We’ve said that we’ve got between 20% and 30% under utilized assets in our fishing and rental business and more like 40% in our coiled tubing business. So I’ll let you take it from there. Now, only one caution I would give you is that you can’t calculate that all of that spare capacity would be applicable to that sort of threshold when we would pulled the trigger and might buy more. You never wait until you fully utilize.

Tom Curran - Wells Fargo Securities

Of course. Right. And that’s why I said closing in on right where you cross that thresholding?

Dick Alario

Right, the main message though is we’ve got room to grow before we get there and that’s the point of where our CapEx for 2013 is. We don’t have to spend very much. By the way just a little more color. It’s not zero, you always have to spend a little money to get packages of equipments set up properly for different market.

So there is some capital in our budget to add some auxiliary equipment for rigs or whatever, its small fashion. But it’s no question, one of the catalysts is we think about it going forward is based on all the capital we spent in ‘11, ‘12, we have spare capacity that could be deployed as the market strengthens in the next couple of years.

Tom Curran - Wells Fargo Securities

That all makes…

Dick Alario

Operating leverage that I referred to in my prepared remarks.

Tom Curran - Wells Fargo Security

Right. And just looking to dig a little deeper into it but that all makes sense and thanks for being willing to go there. I just got two more here. The first would be just what percentage of Q4 revenues were derived from completion-related activities. And then the second would be for Trey Whichard, the expectations for SG&A as a percentage of revenues in 2013 and then maybe some color around working capital?

Dick Alario

Well, I’ll talk about the split. I’m not relegating this only to Q4. You look back over to the whole year, U.S. was about 65% completion driven, 35% is revenue. Product driven international was almost oil production. So when you add them both together, we would probably be sitting here today at 55% completion driven revenue and 45% production driven revenue.

Tom Curran - Wells Fargo Securities

Okay.

Trey Whichard

Okay. And on the SG&A front, our projections are for SG&A to approximate 13% of our revenue in 2013.

Tom Curran - Wells Fargo Security

Okay. And then what are you targeting for working capital Trey?

Trey Whichard

I’m targeting improvement in our working capital. Just -- we were at end of the year, we had some unbuild revenue for example with the few customers that are getting cleaned up and those types of things.

But it -- working capital and its fair question, it always you see going to intense focus here and obviously, we want to be efficient and keeping excess working capital to a minimum.

Tom Curran - Wells Fargo Security

But would you expect that to be a source of cash flow on whole for 2013?

Trey Whichard

Yeah.

Tom Curran - Wells Fargo Security

Okay. I guess I’ll stop here. I’ll pass along the conch shell. Thanks guys.

Operator

Your next question comes from the line of Mike Urban with Deutsche Bank. Your line is now open.

Mike Urban - Deutsche Bank

Thanks guys. Good morning.

Dick Alario

Good morning.

Mike Urban - Deutsche Bank

I wanted to follow up on the Edge commentary and especially vis-à-vis the Haynesville. And so you did see a big customer as you noted, say, they are going to add rigs in that activity and it sounds like you had some expectation there that could be some more? But just wanted to clarify one of the comments that you made, it sound like you did not have much of any excess capacity there? Is that correct because I hear that wrong?

Dick Alario

No. Just the opposite. We have excess capacity in our flowback business in Haynesville, that’s where all of Edge’s revenue came from when we required the company. And as the market dropped so significantly over the last year that equipment was mothballed and it’s sitting there and its -- that most of that and I’m really focus by the way on frac stack portion of it. Edge provides essentially two services frac stack and well testing.

We did move some of our well testing equipment out there but 15,000 pounds 7.5 inch valves that are used in frac stacks are only used, almost only used exclusively in the Haynesville so those are still sitting there.

Mike Urban - Deutsche Bank

Okay. So you did see that pick up in activity, you’d be able to respond pretty quickly without having to add any capacity with equipment?

Trey Wilson

Well, as I said, Mike, we always have to spend a little capital when you mothballed equipment get back up to see ready and maybe configuration exchange a little bit, so you spend a little bit it’s not very much particularly in this case.

Mike Urban - Deutsche Bank

Right. But you are not, having to move stuff around again and not -- and add new equipment and not to come in dislocation that you saw going the other way?

Dick Alario

No. You have too, and by the way, the cost dislocation, the Edge business is not as big as it is in some of our others. Now we would have to hire people, because we’ve going to cost significantly in Edge though and great deal that came from being able to have fewer focus, we would have to grow up higher but as you probably suspect that market is less available labor there, so if we wouldn’t be getting into super competitive market.

Mike Urban - Deutsche Bank

Okay. Got you. That’s all from me. Thank you.

Dick Alario

Thank you. Operator, we will take one more question.

Operator

Your next question comes from the line of John Keller with Stephens Inc. Your line is now open.

John Keller - Stephens Inc.

Hey, guys. Thanks for taking me here at the end and I apologize in advance for the random nature of these questions, but how many coiled units are you marketing right now?

Dick Alario

Trey you have that, what’s the coil.

Trey Wilson

46.

John Keller - Stephens Inc.

46. Okay. Perfect. And then, Trey, this question for you, so how you think about or what’s the target for kind of your incremental margin on the International side?

Trey Whichard

Well, haven’t disclosed it quite that way, the -- as I mentioned in my prepared remarks, we expect margins to improve sequentially internationally and what the better mix of work and we’d expect that trend to continue throughout the year.

John Keller - Stephens Inc.

Okay. Fair enough. And then, I was just hoping, I could get you to walk me through a little bit on the guidance here, make sure I understand this correctly from your commentary that, you expect first half ‘13 revenues and margins to look similar to second half of ‘12, correct?

Trey Whichard

Right. In the U.S.

John Keller - Stephens Inc.

In the U.S., okay. And then, I guess, that implies a pretty big ramp in Q2, if you are going to be down sequentially roughly 5%, that would be 15% to 20% kind of revenue growth in Q2? Does that, I mean, am I thinking about that correctly?

Trey Whichard

Yeah.

John Keller - Stephens Inc.

Okay. And so, beyond, is that just improvement in rig services helping drive that kind of that snap back there or maybe walk me through how that -- how you just at a high level how that, where you see that coming from?

Trey Whichard

Certainly, the rigs service group is the one that’s most significantly depressed and as that recover, they obviously going to be the once driving the recovery, but we expect improvement from really throughout all of our lines of businesses.

John Keller - Stephens Inc.

Okay. Fair enough.

Trey Whichard

I guess, it will be from rigs, John.

John Keller - Stephens Inc.

Okay. Perfect. Well, I appreciate it guys.

Dick Alario

Thank you.

Gary Russell

Thank you, Operator. This concludes our call. A replay of this can be access on our website at keyenergy.com under the Investor Relations tab. Also under the Investor Relations tab we have posted a schedule of our quarterly rigs and truck hours. Thank you everyone for joining us today. That’s concludes our call.

Operator

Thank you for joining. This concludes today’s conference call. You may now disconnect.

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