Key Energy Services Management Discusses Q3 2013 Results - Earnings Call Transcript

Oct.31.13 | About: Key Energy (KEG)

Key Energy Services (NYSE:KEG)

Q3 2013 Earnings Call

October 31, 2013 11:00 am ET

Executives

West Gotcher

Richard J. Alario - Chairman, Chief Executive Officer, President, Chairman of Equity Award Committee and Member of Executive Committee

Newton W. Wilson - Chief Operating Officer, Executive Vice President and Assistant Secretary

J. Marshall Dodson - Chief Financial Officer and Senior Vice President

Analysts

J. Marshall Adkins - Raymond James & Associates, Inc., Research Division

Blake Allen Hutchinson - Howard Weil Incorporated, Research Division

Neal Dingmann - SunTrust Robinson Humphrey, Inc., Research Division

Jason A. Wangler - Wunderlich Securities Inc., Research Division

Michael W. Urban - Deutsche Bank AG, Research Division

Daniel J. Burke - Johnson Rice & Company, L.L.C., Research Division

Operator

Good morning. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to the Key Energy Services Third Quarter 2013 Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the conference over to West Gotcher, Director of Investor Relations and Corporate Development. Please go ahead.

West Gotcher

Thank you, Steve, and thank you, all, for joining Key Energy Services for our Third Quarter 2013 Financial Results Conference Call.

This call includes forward-looking statements. A number of factors could cause the actual results to differ materially from the expectations expressed in this call, including risk factors discussed in our 2012 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 to Dick Alario, he's Chairman, President and CEO, who will provide some introductory comments. And Trey Wilson, our COO, will provide an operations summary, followed by Marshall Dodson, our CFO, who will review our results and provide some guidance commentary. And lastly, Dick will return to conclude our prepared remarks and open the call for your questions. Dick?

Richard J. Alario

Thank you, West. Good morning, everyone, and thank you for joining us today. Key generated a consolidated net loss of $0.03 per share for the third quarter. This included a $0.02 per share impact from the effective tax rate.

In the U.S., revenue in the third quarter was down 4.6% sequentially, slightly below our recent guidance. As we expected, broad market activity in the U.S. remains generally flat relative to the second quarter. Oversupply of capacity in certain markets negatively affected U.S. revenue, and changes in customer spending programs caused us to incur idle time as we redeployed these assets to new opportunities. This choppiness is symptomatic of our somewhat oversupplied flat market. And I want to emphasize it's more impactful in our well completion-related services in markets as compared to our legacy well repair and maintenance businesses.

Appreciating these dynamics, Key has been and will remain focused on operating as leanly as possible, while at the same time delivering the quality and safety in the field that our customers require. For example, year-to-date, we have reduced our overall G&A headcount by 10%. This is just one step that we've taken already toward aligning our cost structure to match current market conditions. We saw the benefits of this effort offset negative operating margins this quarter. And also, I'm encouraged that even in this environment, our operational leaders and field personnel have improved Key's total recordable safety incident rate over last year, which was our best ever.

Looking beyond the actions we've taken to manage costs, we continue to position Key to thrive in a flat U.S. market through balanced service offerings across the wells' life, giving Key exposure to unconventional horizontal well and legacy vertical well activities. In this stage of efficiency-driven customer decision-making, the value we deliver allows us to drive better returns off the investments we've already made. And we'll talk more about that later in our prepared remarks.

In the third quarter, approximately 60% of Key's U.S. revenue was derived from production-related services, and 40% was derived from completion-related services.

We're encouraged by early signals regarding U.S. E&P capital spending expectations for 2014 and the higher demand that would result from increased spending levels. We believe that we are well positioned to take advantage of increased demand with almost no incremental capital spending required, thereby affording Key the opportunity to generate excellent free cash flow and improve returns.

Moving on to our business outside the U.S. While I'm frustrated with the extra time it's taken to finalize contracts and place idle rigs and crews into service, I'm encouraged by the fact that we now have 43 rigs currently working or under contract outside the U.S. and already have awards in hand for additional rigs. And all of this has occurred without seeing a return of meaningful PEMEX activity in the North region of Mexico. Now speaking of Mexico, one point I want to make strongly this morning is that Key does not need to see constitutional reform in Mexico to achieve growth. We are exposed to many layers of opportunities that we believe should translate into higher activity, and I want to walk you through those.

Our first opportunity is PEMEX returning to work in a meaningful way in the North region. We believe this will happen in early 2014 and expect to know more on this later in the fourth quarter. Second, existing incentive-based programs in both the North and South regions are an additional opportunity for Key, and we are already working for operators under these contracts. Third, as new integrated contracts, the so-called mega tenders, are executed in both the North and South regions, these will provide an opportunity for additional market activity for Key, as these contracts will require well-service rigs and other services that we will provide in their work scopes. Fourth, Key is currently working rigs and coil tubing units in the South region of Mexico, and we believe that we have additional growth potential there.

And then, finally, as I said, any contemplated constitutional reform that positively affects the Mexican market structure and allows for outside capital infusions further provides for incremental opportunities for Key in Mexico.

As we move beyond the disruptions that occurred in 2013, we're beginning to see a more diversified International business emerging. And there's going to be a lot more on that in our script this morning. So for now, I'll turn the call over to Trey Wilson.

Newton W. Wilson

Thanks, Dick. In the U.S., while we saw a decline in revenues, we were able to maintain operating income margins on a sequential basis as a result of our efforts begun earlier in the year to control costs.

In our Rig Services segment, the market for these services remains highly competitive with many players, but we believe this market is the closest to being in balance. We experienced a slight decline in sequential revenues due to sustained competition. Even though rigs working fell to a low of 392 rigs during the quarter, we averaged 405 rigs working for the third quarter as compared to an average of 408 rigs in the first quarter and 418 in the second quarter.

The business maintained strong operating income margins for the quarter with margins remain slightly off the year's peak due to sustained competitive pressures. Our enhanced business development effort, focused on selling Key's value proposition to a broader group of customers to leverage our investment in over 700 rigs in the U.S., has gained some traction.

So far, in October, we've averaged 413 rigs worked. Notwithstanding our improvement in utilization to this point, we still expect seasonal impact from weather, fewer daylight hours and holiday days off to push revenue lower in the fourth quarter than the third quarter.

Our Fluid Management Services business continues to be challenged, as all of our markets remain afflicted with intense competition and asset overcapacity. However, we've achieved improvement in the business' financial results through changes begun earlier this year. Although revenues were slightly down on a sequential basis, we achieved a high single-digit operating income margin in the third quarter as compared to a loss in the first quarter and a slight profit in the second quarter. Our Fluid Management business will also see seasonal impact from weather, fewer daylight hours and extended holiday days off in the fourth quarter. As we think about next year, our expectation is that a low double-digit operating income margin is possible for this business in today's market.

Our overall utilization in Coiled Tubing Services was down approximately 400 basis points as compared to the second quarter, as we saw disparities in utilization for different types of assets. We've seen the market for our Coiled Tubing Services business delineate into 3 separate submarkets. The first of which is characterized by smaller units that predominantly perform production-related services and where demand remains fairly steady. The second market is comprised of the largest units performing highly efficient completion work where our utilization remains the highest. The third market is comprised of midsized units such as our 2-inch pipe diameter units. And this market is characterized by intense competition and meaningful asset oversupply for current demand, which has yielded pricing pressure. This portion of our Coiled Tubing business currently has the lowest utilization, and pricing in this business is off low-double digits this year. Our Coiled Tubing Services business was adversely affected in the third quarter due to customer program changes. Maintaining margins in this choppy environment is especially challenging as it is critical that we retain our skilled labor force even as the assets experienced redeployment delays.

Our Fishing and Rental business saw lower revenues on customer changes in the third quarter. However, this business consistently delivers some of the highest margins to Key. The traditional Fishing and Rental business, both onshore and offshore, remains strong. The recent top line and margin pressure in the overall segment is mostly due to lower pricing on some rental items like tubulars and lower activity in the frac stack and well testing business. We are deploying underutilized assets to markets where we can leverage our existing footprint to effectively and profitably work these assets. And we will continue our efforts to keep our cost structure in line with market conditions.

Outside of the U.S., we made further progress this quarter diversifying our regional and customer mix. We expect to have 40 rigs located in Mexico at end of the year, with approximately 20 to 25 idle rigs at that time. We began the year with 51 rigs in Mexico.

In Ecuador, we currently have 3 rigs in the country and expect to have a fourth by the end of the year. While the pace of our ramp-up has been slower than expected, 3 of these rigs will be operating under a recently signed multi-year contract with work beginning sometime during the fourth quarter.

And in Colombia, while the timing of incremental activity has, again, been slower than expected, we continue to find additional quality opportunities for our rigs, some of which we'll be working under multi-year contracts. Delays in equipment mobilizations and contract negotiations weighed on third quarter results. We ended the quarter with 15 rigs in the country, and we expect to have 16 by year end.

We recently signed an agreement to buy out our partner in the Middle East, now giving us full control of both our Russia and Middle East businesses, where we have 14 rigs. We believe that we can more effectively grow in the Middle East and Russia operating the businesses ourselves.

More broadly, we remain committed to taking advantage of opportunities in these regions as we expand and diversify our customer base outside of the U.S. and continue to pursue opportunities for profitable expansion and redeployment of idle rig equipment.

Now I'll turn the call over to Marshall.

J. Marshall Dodson

Thanks, Trey. Our consolidated revenues for the quarter were $389.7 million, down 5% from the second quarter.

U.S. revenues were $345.1 million, down 5% compared to the second quarter. Our International revenues declined 10% to $44.6 million.

Our consolidated bottom line EPS was a loss of $0.03, which was adversely affected by an additional $0.02 of loss due to an effective tax rate of 137.2%, primarily driven by permanent book-tax differences.

Looking at the U.S., all of our businesses saw sequential declines in revenue, with improvements in FMS and cost control by our operations personnel holding our U.S. segment decremental margin to 19%.

Outside the U.S., we averaged 35 rigs working in the third quarter and experienced a 10% decline in revenues on the lower rig count and over $1 million in lost revenue due to weather in Mexico.

Our consolidated International segment operating margin came in at a negative 16.4%, outside of our expectations due to weather impacts, higher-than-expected start-up costs in Ecuador and cost inefficiencies associated with delayed rig redeployments primarily in Mexico.

In Mexico, costs were not reduced commensurate with activity, as the cost to do so would have been greater than carrying the expenses until those idle rigs with crews were redeployed, which is expected in Q4. As a result, these activity delays had a high-margin impact as our cost structure remained relatively fixed and too high for the activity levels.

At the end of the third quarter, we had $90 million of accounts receivable outstanding with PEMEX. We expect to collect substantially all of our old outstanding accounts receivable from PEMEX by year end, which should generate approximately $40 million to $50 million of free cash flow from working capital in the fourth quarter.

G&A expense was $53 million, or 13.5% of revenues, for the third quarter. As we have said, we remain focused on removing costs from our operations and support groups, and this has provided a 14% reduction in G&A expense from first quarter levels. As our revenues recover, we should see a reduction in our G&A as a percentage of revenue.

Depreciation and amortization expense was $57 million for the quarter, and interest expense was $14 million. Cash flow from operations was $113 million. During the quarter, we received a $20 million refund from the IRS associated with the prior year taxes.

Capital expenditures for the quarter were $38 million and $111 million for the 9 months ending in the third quarter. We currently expect to spend approximately $70 million during the fourth quarter for a total of approximately $180 million for full year 2013 as compared to our previously guided number of $210 million.

It's too early for us to give 2014 CapEx guidance, though we reiterate what we believe to be healthy maintenance capital spend of $175 million to $210 million at current activity levels.

We reduced our borrowings by $35 million during the third quarter and ended with a net debt-to-capitalization ratio of 36.7%, consistent with our stated goal of bringing down our leverage to the mid-30s. We currently expect to continue to reduce leverage in the fourth quarter.

Our income tax provision for the third quarter was $2.7 million or 137% of the pretax loss of $2 million for the quarter. Several moving parts impact this. As full year results narrow, the impact of nondeductible expenses or permanent book-tax differences are magnified in our tax provision. That, coupled with generating income in the U.S., which is the highest corporate taxes in the world, and losses in countries with lower tax rates combined for the unusual tax rate impact this quarter. This will result in a full year effective tax rate for 2013 of around 10%. As we look to 2014, we expect our effective tax rate to return to approximately 35% to 37%.

During the third quarter, we signed an agreement to buy out our partner in the Middle East for $5 million, plus a working capital reimbursement and expect to complete this transaction late in the fourth quarter. With this, the financial results of this operation are fully reflected in the consolidated financial results, and Key will no longer employ a minority interest accounting for this business.

Looking forward, we expect our U.S. revenue in the fourth quarter to experience a more-than-seasonal decline of 5% to 7%. This is largely due to seasonal factors, but also includes the impact of some operators having an extended slowdown in the second half of the quarter, particularly impacting completion-related services. Given our need to maintain our skilled employees for activity in 2014, we would anticipate margin erosion in the fourth quarter of around 350 basis points at the high end of our revenue decline and around 200 basis points at the low end.

Outside the U.S., we are currently working 34 rigs, which we expect to maintain during the fourth quarter, and have an additional 9 rigs under contract, which we expect to begin generating revenues by the end of 2013. For modeling purposes, you should assume that these rigs benefit 2014, but only have a limited impact on the fourth quarter.

We've been awarded work for 5 additional rigs and expect this to most likely benefit us only in the first quarter. The work for these 48 rigs is not dependent upon our ramp-up of PEMEX activity in the North region.

In the fourth quarter, we expect G&A expense to be between $50 million and $52 million and depreciation and amortization expense to be $57 million to $58 million.

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

Richard J. Alario

Thank you, Marshall. And in closing this morning, I'd like to very briefly recap several themes that drive Key's success next year. First, we're encouraged, as we said, by announcements that we've already seen around 2014 U.S. E&P capital spending. Second, in Mexico, we believe that we will see demand for our services increase beginning in the first quarter. Third, we believe there's a significant backlog of horizontal oil wells that have been drilled over the past 4 or 5 years that are nearing the point where they will begin to require regular maintenance and workover services. And fourth, we believe the strong asset base that we've built in the last 3 years provides us with the opportunity to deliver meaningful growth and significant earnings upside.

So wrapping all this up, we expect to utilize a variety of methods to enhance shareholder value, including debt reduction, returning capital to shareholders and opportunistic growth if there's sufficient return potential. We believe our capital flexibility and existing asset base provides Key a differentiated platform from which we can drive superior returns.

Operator, those conclude our prepared remarks this morning. And we'll now open our call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Marshall Adkins from Raymond James.

J. Marshall Adkins - Raymond James & Associates, Inc., Research Division

Let's go ahead and hone in on the International side. Obviously, that was the, I think, big disappointment versus what most of us were expecting. You gave a little bit of color there, I think, weather, the Mexico situation, I guess some startup costs. But can you give us a little bit more detail on exactly what's gone on there? It appears things will begin to ramp back up in Q4 and get better next year. So I'd like to get some color really more on '14, as well in terms of where you think the International business will go.

Richard J. Alario

Marshall, this is Dick. I'll make a couple of sort of broader comments, some of which will reiterate some things we've already said. But I'll try to give you a little more, and then possibly both Trey and Marshall -- and/or Marshall would have some additional comments. I mean, I think the first thing to recognize is the statement that we said. We see a broader base of International business for Key next year. And that's very important because it deconcentrates our dependency on PEMEX's North Region budget. Now let me say one thing about that before we move on. Let's make sure that we all recognize that the thing that happened with the PEMEX 2013 North Region budget was isolated. It was a hangover or an overhang from some overspending that they had in 2014. They've been public about this, and they've been very willing to work with us to make sure that we, as a contractor, a serious contractor for PEMEX, understand what happened. And they kept their promises about paying us. So we view that as an isolated situation. And we believe that as is the case more typically than not, activity will begin to occur in the first quarter for the normalized PEMEX North Region planning. Their production is down as a result of this activity slowdown that they had. And they have the desire to get the production back up. So before we leave the North Region, I just want to make sure that we have that framed. So...

J. Marshall Adkins - Raymond James & Associates, Inc., Research Division

As it sits now, that business looks better next year?

Richard J. Alario

I'm sorry?

J. Marshall Adkins - Raymond James & Associates, Inc., Research Division

As it sits now, that area looks meaningfully better in'14?

Richard J. Alario

It does. If -- I think we can agree that -- or should be able to agree that if PEMEX planning and spending is typical, then 2014 should look probably more like 2011 or '12. Maybe not an all-time record year, but a good year. So yes, I think your statement is accurate. Now I think the more important thing is that the places that we're finding to put some of the idled rigs from Mexico -- by the way, don't miss the words that we used "under contract" -- have taken longer than we expected and anticipated to get contract signed and get equipment mobilized in place, crews hired and trained blah, blah, blah, rigs inspected, all that kind of stuff. However, it is happening. We are not looking for much impact of the additional rigs in the fourth quarter. But next year, they're going to have impact, they're going to be profitable, we believe. And thus, we have begun to seriously deconcentrate our dependence on PEMEX's North Region budget. Now to go back, as I talked about all these other layers of opportunity in Mexico, but we've kind of been through that, I will tell you that we also have, as Marshall mentioned, a handful of awards. They're not contracted yet, but they are various forms of commitment from customers outside of PEMEX's North Region to -- that add some of the additional rigs that aren't accounted in the 43 or whatever that number was that we talked about earlier. So we believe that there has been a longer-than-anticipated period to get the idle equipment to work. But we now have pretty good visibility, contracted arrangements and formal awards that will begin to impact the International side. I'm glad that we held on to the people. It was painful, but it is more expensive to let some of those folks go than -- and then have to rehire. And the severance in some of these places is high. So it was a business decision, it did affect our margins in the fourth quarter, along with some weather and some of those things you mentioned. But at the end of the day, we're going to come out with a better diversification, more reliable, built-to-last footprint, and that's going to help us avoid the kind of issues that we had in 2013. I think that's what people should expect of us, and that's what we're going to get taken care of.

J. Marshall Adkins - Raymond James & Associates, Inc., Research Division

That's helpful. One kind of unrelated follow-up here. The Oxy has announced kind of a restructuring. How do you see that impacting you? Is that a good thing for you all?

Richard J. Alario

Based on the announcements that we've seen earlier this week and the announced capital budgets for the 2 primary areas, meaning West Texas and California, where we primarily do business with Oxy -- and when you hear us use the word encouraged, obviously, this is one of the reasons we're encouraged. Those are huge increases in planning for next year. And if you assume that Key still delivers the kind of quality service that companies like Oxy, let's just say it that way, expect, we should get our share. And it sure is nice to have a view from the customer of a significant ramp-up in spending in those areas. Those are fairway -- middle of the fairway places. Key is extremely strong in those 2 areas. We should be able to take advantage of our cost structure and our presence and don't see any downside from any of that at all.

J. Marshall Adkins - Raymond James & Associates, Inc., Research Division

Either way, it soaks up excess capacity, so...

Richard J. Alario

That's a great point. That's a great point.

Operator

Your next question comes from the line of Blake Hutchinson from Howard Weil.

Blake Allen Hutchinson - Howard Weil Incorporated, Research Division

Just -- first, just around the margin guidance for 4Q of 200 to 350 basis points of erosion. Curious whether that is simply reflective of you that Rig Services may be more impacted, therefore higher-margin business is going away, or you're bearing a burden in Coiled and Edge that -- it's just the result of having some assets that were stuck between utilized and underutilized going from 3Q to 4Q. And what -- maybe having a disproportionate effect there, or if this is just kind erring to the conservative side here?

J. Marshall Dodson

It's as much -- this is Marshall, Blake. It's as much a function of our desire to retain all of our quality people during the time period when they may not have billable work. So your decrementals are going to be a little bit higher than what you would normally expect. So we have...

Blake Allen Hutchinson - Howard Weil Incorporated, Research Division

So that's just strategically rather than any underdeployment on any one segment or something like that?

J. Marshall Dodson

Right. It's an expectation that we need to hold on to our folks.

Richard J. Alario

Yes, Blake, it's Dick. Let me add to what Marshall's saying. I hope that people appreciate that given the kind of cost traction -- cost reduction traction at the G&A component and in field that we've exhibited over the last, actually, 2 quarters, I hope people appreciate that Key's done its part to make sure that we are sizing our cost structure for a flat market. But we also have to keep focused on what we believe will be a better year next year and the difficulty of replacing these people if we were to lay them off just to try to keep our quarter-to-quarter margins intact. At some point, it becomes more of -- as you said, more of a strategic decision, and we believe that's where we are. We think things begin to happen more positively in the U.S. early next year and it's going to be a benefit. Looking back in the second and third quarter, it will have become clear that it will be a benefit for us to hold on to those people that we work so hard to recruit and train.

Blake Allen Hutchinson - Howard Weil Incorporated, Research Division

Good, that's helpful. And then I just wanted to kind of maybe put some numbers behind Marshall's line of questioning on the International market. Marshall, you outlined, I guess, quite a bit of burden with regard to carrying the rigs that are more or less ready for work, but not earning or not on the payroll for the quarter, as well as some excess burden in Mexico. I mean, if I think about that, if we get these rigs deployed and we're at a rig count north of 40, by my math, you swing pretty sharply and maybe -- certainly not 4Q, but in the first quarter back into the black. And I mean, would it be getting way ahead of ourselves to think that you could get double-digit margins in International early in the year?

J. Marshall Dodson

Yes. It's -- the biggest swing factor and driver on our results last quarter was our cost structure in Mexico. And we need -- with the way it's sized right now, we needed about 18 -- or need about 18 rigs to breakeven. We were well south of that during the quarter. We're closer to that now, and some of the rigs we talked about are slated to go to work there. So as we think about the fourth quarter, it's -- the margin performance is going to depend really on the timing of getting some of these contracted rigs generating revenues. And as we move forward into 2014 and the 48 will kind of cross over into the 50s, double-digit margins, as you move beyond that, are definitely possible.

Operator

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

Neal Dingmann - SunTrust Robinson Humphrey, Inc., Research Division

Say, Dick, just a kind of question on the well servicing kind of backlog and then your thoughts as far as pricing ability. I still think that this conversation before would think because of what peers and others show as far is just the total well count continue to expand from a large base that I got to think that -- I guess my question is, how quick would you think we would burn through the current inventory? And are there others right now out there that are adding to capacity? Or how do you see sort of supply right now?

Richard J. Alario

And you're speaking specifically about the rig business. Right, Neal?

Neal Dingmann - SunTrust Robinson Humphrey, Inc., Research Division

Yes, sir.

Richard J. Alario

Yes, thanks. Well, as we've said, and I want to emphasize, the rig business is the one that has been more stable with regard to pricing in our service mix certainly. The U.S. rig business has been one that has performed the best and that we feel continues to have the greatest amount of support under the pricing. I think part of that has to do with mix, the fact that we've got a strong large rig asset base capable of solving customers' issues in the horizontals with completion-type work, and as we've said, soon moving into that, plus some remedial work, which requires that kind of equipment. And so, I believe that's the biggest reason for that stability, their outbreaks of hostility in certain markets more along the lines -- more embedded in the sort of vertical legacy-type rig work. But again, I have to say, I think it has a lot to do with the continued difficulty recruiting and keeping good work for us in that business. It continues to force companies like ourselves to keep pricing stable at a minimum. As to how long it'll take to work through the excess capacity -- some of it -- there's not that much new capacity. Don't think of the rig business as -- in the same vein as you might have thought the pressure pumping a couple of years ago. There's not nearly that much capacity available in terms of manufacturing nor in terms of already built, sitting on the sidelines, waiting to go to work. We do have a pretty large fleet of rigs, north of 50, probably south of 150, that are capable of being fairly quickly outfitted to go back to work. Obviously, the challenge there is going to be crew availability. But we have recently done more in the area of broadening our customer base and broadening the base for the type of work that we are chasing with regard to some of the legacy assets, in other words, these non-large -- not the large rigs that I talked about earlier. And we expect that Key is going to be able to get, and has been able to get, as you heard Trey's numbers, improving in the fourth quarter. Think about it, you don't hear many companies talk about their actual utilization count going up from September to October. That's not typically what happens. Typically, the fourth quarter drives utilization count down. So it already tells you, we're already out there getting more traction with -- and this is with a kind of a new band of customers, something that we'd strategically targeted several months ago. It's beginning to happen. And while I don't think it's going to eat up a whole lot of excess capacity in the fourth quarter, we're going to continue doing that out in Q1 and Q2, and that will allow Key to put some more rigs out into the market and increase our utilization. I don't think we reach an inflection point -- and this is really, I think, what you probably wanted to hear. I don't think we reach an inflection point, a formal inflection point, with pricing in the first half of 2014. And I hesitate to comment beyond that. If the year turns out to be one where the expanded budgets that we're hearing about really impact operations in a significant way, then maybe the back half of the year we could see something, but we don't see anything as a major inflection point. Are there opportunities to get some pricing in discrete markets from time to time? There are, but we don't see a major inflection point in the first half of 2014.

Neal Dingmann - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And then last, just one follow-up, Dick, then I'll let you go. As far as just on opportunities, I mean, are there still -- sticking with the workover rigs, some people, maybe the private entities [ph] or what have you, are getting out of the business, or put it another way, are there other opportunities for you to add some without having to do any new builds? And if so, would you look for this maybe not just in workovers, but obviously in some of the other segments as well like Fluids or Coiled Tubing or et cetera?

Richard J. Alario

The way I would answer that at this point, Neal, is that the longer the industry deals with a flat U.S. market that has some overcapacity, as we discussed, the more opportune the idea of consolidation becomes in terms of the value it can create. We will continue to watch that. There very well could be opportunities in the future to take advantage of it. I don't feel like the appetites are quite there yet. But again, it shouldn't be a surprise to anybody. The longer companies have to deal -- and by the way, we've already seen, and you've seen some announcements of various business units being shut down and written off and those kinds of things. The longer that the flat market syndrome is in place, the more likely consolidation opportunities will present themselves. And we're -- I have to tell you, we're extremely focused on returns at Key. And we are extremely pleased that we have an asset base that we can grow our business on without having to spend any capital or acquire any companies or do anything like that. But the longer the flat market goes on, the more opportunities are going to come back. And we're always going to be open to take a look at them.

Operator

Your next question comes from the line of Jason Wangler from Wunderlich.

Jason A. Wangler - Wunderlich Securities Inc., Research Division

Just curious on the Coiled Tubing. You talked about kind of splitting it into 3 markets. Historically, you kind of talked about the great -- the bigger and smaller than 2-inch diameter on your fleet. Is there any way to kind of break the fleet down into those 3 segments?

Newton W. Wilson

This is Trey. The big equipment is almost 100% utilized. There's very high utilization in the equipment. The very small equipment, I talked about 3 segments, is around 50% -- a little over 50%. And the area where we're focused on in terms of our business development efforts is around the 2-inch category where there's a definite equipment oversupply in the market. And that utilization's around 35%. But we'll be very focused on trying to put more 2-inch to work as we go forward.

Jason A. Wangler - Wunderlich Securities Inc., Research Division

Okay. And then just on the CapEx side, just obviously, the $70 million for fourth quarter, can you maybe just give a little bit color on that, just given it's a pretty big slug to get to the $180 million by the end of the year?

Newton W. Wilson

Well, a big slug of that capital is related to our Rig Services business. Our West Coast market has continued to remain strong. We've been building rigs. We'll be building some rigs in the fourth quarter to go out and support that -- support that market, again, which has been a very good market. So a good bit of the capital is associated with Rig Services and just continuing to finish up some of the maintenance work that we've been doing during the year. We're just basically try to get the fleet really positioned to serve what we believe to be a better market next year.

Operator

Your next question comes from the line of Mike Urban from Deutsche Bank.

Michael W. Urban - Deutsche Bank AG, Research Division

My question have been answered.

Operator

I'm showing there are no further questions at this time.

Richard J. Alario

Okay, operator, we'll then -- we'll wrap up the call. West will have 1 or 2 more comments, and we thank everyone for participating. Well, we just had someone join. It shows on our chart that we have a caller now -- a question now, operator.

Operator

It comes from the line of Daniel Burke from Johnson Rice.

Daniel J. Burke - Johnson Rice & Company, L.L.C., Research Division

A question on the Fluids business. I thought I heard you all offer a margin forecast extending into 2014, expectation of double digits. A couple of good quarters in that business. Was just curious what gives you all the conviction that given the challenges in that business, you can build on the success you've had over the last couple of quarters in repairing the margin profile there?

Richard J. Alario

Well, this is Dick. Let me just say we've hit those kinds of margin numbers in the past. That's one thing that gives us some confidence and just broadly, the steps that we're taking and the trajectory that the improvement has already been on as we look out over the course of the next few quarters. I mean, it's not smoke and mirrors. It's a very -- in this case, very distinctive and precise thinking on our part based on other kinds of cost management opportunities, ability to put additional equipment into better markets and things like that. Trey will have some more specifics I just wanted to get those...

Newton W. Wilson

Well, just look at -- when we look at the business as a whole, we're in a number of markets. But in our biggest market, we make good margins in that market, high -- high teens, low 20% margins. And some of our other markets, we're not doing as well. So as we think about how we could get to low-double digits, it's the reparation that we're doing and expect to be able to do in the poorest performing markets, either in further cost reductions or a mix of cost reduction and revenue enhancements. So I think we believe that we can improve the margins in our weakest markets. And then with the strength of our best market, we can get to that low double-digit kind of margin.

Daniel J. Burke - Johnson Rice & Company, L.L.C., Research Division

Okay, that's helpful. And then I guess just one other one. We've counted International rigs a lot of different ways. But is 15 still the right total in terms of the number of rigs moved out of North Mexico? And then can you true me up for exactly where those rigs did go?

Richard J. Alario

Yes. Let us grab something, Daniel. It's not 15. I believe as we sit here today, it's 11, right, moved out of Mexico already.

J. Marshall Dodson

Out of the Northern region of Mexico. So that includes moving rigs to the Southern region of Mexico. And as you think about Mexico, we should have, I believe, around 40 rigs there at the end of the year. A few of those went to the U.S. And then we had rigs moved into Colombia and Ecuador.

Daniel J. Burke - Johnson Rice & Company, L.L.C., Research Division

Okay. And then maybe last one. Eastern Hemisphere, was there any change in the performance of the Eastern Hemisphere International business from Q2 to Q3?

Newton W. Wilson

Well, our Russia business is profitable. We've had some activity disruption in the Middle East portion of the business, and we had some rigs come off contract. Those rigs are now under a new contract and they're going back to work. So it's one of these temporary interruptions that we experienced and talked about in our prepared remarks. But as I said, we're going to be signing a new contract. We'll be putting some rigs back to work.

Richard J. Alario

And I think, broadly, the quarter-on-quarter performance of that area wasn't a major -- a material reason for the change in performance of the entire International business.

J. Marshall Dodson

It wasn't a big driver until our third quarter International performance.

West Gotcher

This concludes our call. A 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 have posted a schedule of our quarterly rig and truck hours. Thank you for joining us today.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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Key Energy (KEG): Q3 EPS of -$0.03 misses by $0.04. Revenue of $389.7M misses by $19.4M. (PR)