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Key Energy Services (NYSE:KEG)

Q4 2013 Earnings Call

February 14, 2014 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

Blake Allen Hutchinson - Howard Weil Incorporated, Research Division

Jeff Tillery - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

Kurt Hallead - RBC Capital Markets, LLC, Research Division

James M. Rollyson - Raymond James & Associates, Inc., Research Division

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

John M. Daniel - Simmons & Company International, Research Division

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

Operator

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Key Energy Services Fourth Quarter 2013 Earnings Conference Call. [Operator Instructions] Thank you. Mr. West Gotcher, Director of Investor Relations and Corporate Development, you may begin your conference.

West Gotcher

Thank you, Rob. And thank you, all, for joining Key Energy Services for our Fourth Quarter 2013 Financial Results Conference Call. This call includes forward-looking statements. A number of factors could cause actual results to differ materially from the expectations expressed in this call, including 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, Key's Chairman, President and CEO, who will provide some introductory comments; then 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 to your questions. Dick?

Richard J. Alario

Thank you, West. Good morning, everyone. Key generated a consolidated GAAP net loss of $0.08 per share for the fourth quarter. This result includes a $0.02 loss due to severance payments to employees associated with reductions in force, mainly in Mexico.

In the U.S., revenue in the fourth quarter was down 6% sequentially, falling in the middle of our guidance range. On top of typical seasonality effects in the business, we experienced multiple severe weather events that impacted our operations across the country. This was chiefly in the Permian Basin and in the Mid-Continent regions.

Although we sustained more weather impact than what was built into our expectation for the quarter, traction in growing our customer base, particularly in Rig Services, as well as some customers working to make up lost time, helped mitigate the weather impacts.

As we look out to 2014 customer capital spending and market activity, we're already seeing positive demand signals from many of our customers and have seen the pace of inquiries for our services increase so far this year. Should this condition sustain, which we now believe is likely, it will help to address the oversupply of service capacity we see today in certain markets.

Outside the U.S., we were successful in getting additional rigs back to work in the fourth quarter, which partially offset a significant decline in Mexico. I'll cover Mexico in a minute, but before I do so, I wanted to touch on our International business as a whole. I've not been satisfied with our performance internationally, and we're taking steps to perform a workover on this segment to ensure that we're operating as leanly as possible. This includes reducing staff, moving assets to stronger markets and generally improving cost efficiencies in order to increase our cash flows from these businesses.

Now on Mexico. Looking back on our commentary over 2013, we believed activity in the North Region of Mexico would begin to normalize in 2014 as PEMEX moved beyond the budget hangover from excessive spending in 2012. We expected that, by today, workover tenders would have been let and contracts signed, with work plans either finalized or at least in process. This is what we understood from discussions with senior PEMEX officials.

What we, as well as, apparently, our contacts in PEMEX, didn't foresee was continued budget hangover from '12, coupled with the way the energy reform process would evolve and unfold and the impact that would have on PEMEX's operations.

As we sit today, the releasing of tenders for 2014 workover activity has not occurred, and the drilling and completions mega tenders for new well installation, awards for which were announced this week, are smaller in number and scope than what was discussed only a few months ago.

Overall, we believe that planning for work that would maintain and restore PEMEX's onshore production is being deferred as engineers and managers focus on the Round Zero process. Thus, we, as well as others in the service business in Mexico, are forced to deal after-the-fact with what may turn out to be a longer period of reduced demand from PEMEX's North Region.

As the near-term impacts of all this made itself known late in the fourth quarter, we began to further scale back our workforce, close facilities, and otherwise size our business for the current environment. In addition to the severance charge we took in the fourth quarter, we will incur similar charges this quarter, and we'll be moving rigs out of the country at a faster rate than we had planned. Our goal is to reduce cost such that we can generate positive cash flow, and our view is that the current uncertainties will turn to tailwinds for service providers once the country works through Round Zero and reform, allowing for capital to be deployed.

Before I turn the call over to Trey, I want to point out that, as measured by total recordable incidents per 200,000 man-hours, Key achieved the best safety performance in its history in 2013. And I want to thank and congratulate every employee at Key for their commitment to work safely and to thank our customers for working with us to drive unsafe action conditions out of our operations. This is a significant achievement, as working safely is a core value at Key. And as we talk about our drive to expand our customer base, this cultural commitment to safety is one of the factors that, I believe, differentiates our customer -- our company, sorry. Now I'll turn the call over to Trey.

Newton W. Wilson

In the U.S., winter arrived with a vengeance in the fourth quarter, disrupting our operations earlier and more than we had anticipated going into the quarter, but were somewhat offset as efforts to expand our customer base gained traction and some catch-up work for our customers at the end of the quarter helped offset the severe weather impacts.

Weather interruptions accounted for approximately 35% of our sequential decline in revenue. Within U.S. Rig Services, we've seen the most success from our enhanced business development effort, and we experienced only a 3.6% decline in revenues sequentially. We view this as especially encouraging, given the weather issues that burdened the fourth quarter. Approximately 60% of the sequential revenue decline was due to severe weather in the Permian and Mid-Continent regions.

We averaged 399 rigs -- average rigs worked for the fourth quarter, with 400 and 384 average rigs working during November and December, respectively. Despite the weather in January, we averaged 408 rigs worked. Additionally, rig hours in the Permian Basin were up to just under 53,000 in January, 13% over September and about 20% better than December activity. Further, pricing in this business remains generally stable. We expect to continue to lever our competitive advantages in this business in 2014 and have challenged our leadership team to increase average rigs worked by 10% to 15% on a year-over-year basis.

Our Fluid Management Services continues to benefit from the restructuring effort we initiated last year, as revenue fell only 4.2% sequentially. Approximately half of this decline was due to severe weather shutdowns, mainly in the Permian Basin and the Mid-Continent Region.

Pricing declined slightly in the fourth quarter as compared to the third quarter, and this business remains the most competitive and oversupplied of all the services we offer. We reiterate our expectation for this business to generate low double-digit operating income margins as we progress through 2014.

Our overall utilization in Coiled Tubing Services was down approximately 200 basis points as compared to the third quarter. The severe weather and customer shutdowns in the back half of the quarter, especially, impacted our large-diameter units. Utilization of our large 2 3/8-inch pipe diameter units declined to approximately 70% in the fourth quarter. Previously, we had indicated these units were effectively sold out.

We've seen an improvement in utilization in January and expect utilization to return as our customers' programs resume. Utilization of our 2-inch diameter units, with utilization of approximately 25%, continued to be challenged during the quarter's competitive pressures, and this market remained fierce. Our units under 2 inches in diameter remain approximately 50% utilized.

From a regional perspective, I'd like to highlight that we continue to see success in the Permian Basin, which accounted for approximately 17% of total Coiled Tubing Services revenue in the fourth quarter, and this compares to approximately 13% of revenue during the first 9 months of 2013. We expect first quarter activity to be up more than seasonally as compared to the fourth quarter as operators return to work and our business benefits from the expected increase in horizontal completions in the oil shale markets.

Our Fishing and Rental Services business saw revenues decline approximately 8% sequentially, as this business was unable to overcome severe weather and activity slowdowns in the back half of the quarter in some of our markets. We see the traditional Fishing and Rental business improving as we enter the first quarter and expect to return to prior levels of revenue and profitability as we exit the seasonally slow period of the year and horizontal drilling activity picks up pace.

The frac stack and well testing business remains challenged, given significant competition in our operating regions and the lack of activity in the gassy regions.

As we look to 2014, we believe that the traditional Rentals business will be a top candidate for any growth capital we deploy, given the high-return nature of this business.

Turning to International. As Dick described in his opening remarks, in Mexico, we were working 8 fewer rigs at the end of the year as compared to the end of the third quarter. At the end of the year, we were working a total of 30 rigs internationally, compared to 34 at the end of the third quarter. Rigs deployed under contract and awards partially offset the 8-rig reduction in Mexico.

As it pertains to the cost inefficiencies in Mexico, we began taking a series of actions in the fourth quarter to align our cost structure with our activity of 5 rigs working. We've reduced our headcount in Mexico by 85% from where we were in the first quarter of 2013, when we were operating about 40 rigs.

Further, as we discussed in our press release earlier this year, we expect to move at least 12 rigs out of Mexico to the U.S. during the first half of 2014. And once we've completed this, we'll pursue the redeployment of a similar number of rigs, while remaining vigilant for any work opportunities in Mexico.

We've identified homes in the U.S. for the first 12 rigs and expect these rigs to begin working by the third quarter of 2014. We expect the all-in cost per rig to average approximately $250,000, which includes mobilization and repair and maintenance associated with preparing the rig to be in top condition when it enters the field.

In Colombia, we ended the fourth quarter with 15 rigs in the country, and we worked an average of 11 rigs during the quarter, an increase of 1 active rig as compared to the third quarter. We were not profitable in Colombia during the fourth quarter, as we were impacted by excess mobilization expenses.

We continue to be pleased with our progress in Ecuador. We expect that as we move through the start-up phase in this country, we should achieve operating margins in the mid- to high teens. We ended the quarter with 4 rigs in the country, 3 of which were working.

Based on signals we've seen from operators and the scale associated with integrated projects in the country, we believe this market could offer some growth opportunities for Key. This was the first quarter that both our Russia and Middle East businesses were fully under our control. We saw a slight profit in Russia during the quarter, and our performance in the Middle East was impacted negatively in the fourth quarter by customer activity disruptions.

Now I'll turn the call over to Marshall.

J. Marshall Dodson

Thanks, Trey. To repeat the headlines, our consolidated revenues for the quarter were $362.2 million, down 7% from the third quarter. U.S. revenues were $324.1 million, down 6% compared to the third quarter, while International revenues declined 15% to $38.1 million. Our consolidated bottom line GAAP EPS was a loss of $0.08 for the fourth quarter. These results include a $0.02 loss due to severance. Excluding the severance charges, the company recorded a $0.06 per share loss for the fourth quarter.

Looking at the U.S., all of our businesses saw sequential declines in revenue due to fewer daylight hours, holidays, as well as multiple severe weather events, though our Rig Services and Fluid Management Services exhibited less-than-seasonal declines. This helped to offset more-than-expected severe weather and contributed to an overall decline of 6%, consistent with the midrange of our prior guidance.

Further, improvements in these businesses and tight cost control helped to maintain our U.S. operating income margin, which fell only 60 basis points as compared to our previously guided range of 200 to 350 basis points. Approximately 50 basis points of the operating income margin decline was attributable to severe weather. Our operating income margins were benefited about 100 basis points by our continually improving safety performance, which resulted in lower workers' compensation costs.

While we expect continued improvement in safety performance, we do not expect this benefit to repeat in the first quarter of 2014. Outside of the U.S., we averaged 32 rigs working in the fourth quarter and experienced a 15% decline in revenues on the lower rig count. Our consolidated International segment operating income margin came in at a negative 53.1%, outside of our expectations. This was due to significant cost inefficiencies and lower activity, primarily in Mexico; severance of $2.6 million associated with headcount reductions, again, largely in Mexico; a $3.2 million charge associated with the audit by PEMEX we previously disclosed; and $2 million of expense associated with the excess mobilization cost in Colombia.

At the end of the fourth quarter, we had $67 million of accounts receivable outstanding with PEMEX. Thus far, in 2014, we've collected an additional $20 million of receivables from PEMEX, bringing our total balance down to $47 million today. We expect to continue to reduce our outstanding PEMEX receivable as we progress through the first quarter.

G&A expense for the fourth quarter was $48 million, or 13.3% of revenues, and was benefited by a true-up of incentive compensation expense of approximately $2 million that we do not expect to repeat in the first quarter of 2014. Depreciation and amortization expense was $56 million for the quarter, and interest expense was $14 million. Cash flow from operations was $77 million. Capital expenditures for the quarter were $53 million, and for the full year 2013, it was $164 million, approximately $16 million below our previously guided levels.

We reduced our borrowings by $65 million during the fourth quarter and ended with a net debt-to-capitalization ratio of 36.5%, consistent with our stated goal of bringing down our leverage to the mid-30s. We currently expect to continue to reduce leverage during 2014.

During the fourth quarter, we realized a greater-than-expected tax benefit of $2.9 million based on our pretax loss of $15.4 million, which implies an effective quarterly tax rate of 18.9%. As we look to 2014, we expect our effective tax rate to average approximately 35% to 37%.

Looking forward, we expect U.S. revenues in the first quarter to increase 3% to 5% over fourth quarter 2013 levels. However, we expect our U.S. margins to be pressured in the first quarter of 2014, primarily by payroll taxes and costs associated with moving rigs from Mexico to the U.S. and, as a result, expect margins to decline approximately 200 to 250 basis points.

In our International segment, we expect our first quarter revenue to decline 10% to 15% sequentially as we average around 29 rigs internationally. Additionally, we expect to incur a severance expense of $1 million to $2 million. Excluding this severance expense, we expect to be approximately at cash flow breakeven by the end of the first quarter as we adjust our cost structure.

Until the rigs are redeployed or operating, our International operating income margin will be burdened by depreciation expense on idle rigs, which averages around $100,000 per international rig per quarter.

For full year 2014, we are planning a capital expenditure budget of approximately $198 million consisting mostly of maintenance capital. This includes the addition of about 50 rigs, which we are not planning as incremental to our fleet. In the event the rigs brought back from Mexico are not additive to our average working rig count, we may reduce our capital budget accordingly.

At this contemplated level of capital spending and with expected market conditions, coupled with improvements in working capital through the collection of our outstanding PEMEX receivable, we would expect to be able to exceed a net debt-to-capitalization ratio of 35%.

For the first quarter of 2014, we expect G&A expense to be between $53 million and $55 million, as we will be burdened by the accrual of full target incentive compensation. We expect depreciation and amortization expense to be between $54 million and $56 million and expect this run rate for 2014.

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

Richard J. Alario

Thank you, Marshall. Since we're starting a new year, I'd like to briefly recap a few of the themes that will drive Key's success this year.

First, we believe the actions that we took to lower our cost structure and increase revenue in the U.S. over the course of 2013 will improve Key's financial performance. Second, we believe we're taking the necessary actions to insulate ourselves from further losses in our International segment and allow us to operate profitably as we await increased activity in Mexico. Third, as you can tell by our maintenance- and upgrade-only capital spending plan, we believe we'll be able to leverage our existing asset base as the U.S. market benefits from increased capital spending plans of our customers, which will drive superior returns for our shareholders.

To that point, this quarter, we're instituting a more robust financial performance metric based on an economic value-added approach that we're calling Key value-added, or KVA. This new financial metric is consistent with our return-focused culture and will be used to evaluate our investments and will be the compensation metric used to incentivize our employees. I'm sure that we'll have much more to say about this in the future as we implement it and as it improves returns.

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

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Blake Hutchinson from Howard Weil.

Blake Allen Hutchinson - Howard Weil Incorporated, Research Division

First of all, I just want to make sure that we're taking your commentary and kind of calibrating our thoughts correctly. When you talk about -- realizing this is a bit of a moving target as assets leave the country, when you talk about cash flow breakeven and maybe looking out to the second quarter run rate, given that your goals are towards the end of the first quarter, are we talking about somewhere in the loss of -- a high single-digit loss that is equated to cash flow breakeven for the International segment?

J. Marshall Dodson

Yes, it would -- we'll be burdened by -- even if we get the operation cash flow positive in -- specifically in Mexico, as we work through our initiatives, we're going to be burdened by depreciation on the rigs that are there until we move them back. And that's about $100,000 per rig per quarter.

Blake Allen Hutchinson - Howard Weil Incorporated, Research Division

Okay. So just use that metric to kind of fashion what the loss position might be? And then, at that point, that's kind of the level that, for lack of a better term, is acceptable until we get some motion from PEMEX?

J. Marshall Dodson

I wouldn't use acceptable. But that's what we'll be capable of generating at that level. And we'll be moving rigs out and adjusting the cost structure accordingly. Our other businesses we'll be working on, too, to get our overall margins internationally to a level that we get -- or we would view as acceptable and consistent with where those businesses have been historically and we believe we're able to generate -- or we should be able to generate.

Blake Allen Hutchinson - Howard Weil Incorporated, Research Division

And then, just kind of following up on your kind of margin progression projection from 4Q to 1Q. First of all, does that contemplate charging, basically, all the rig moves into first quarter? And then, secondly, it sounds like there's some good momentum around the other businesses. Are you kind of just assuming flat margins for those, or is there also an improvement assumed in the underlying -- in the remainder of the underlying business?

J. Marshall Dodson

I think -- 2 points. One, I mentioned that, in the fourth quarter, we did see -- our margins were benefited about 100 basis points by lower worker compensation costs. While we believe we'll continue to improve our safety performance, we're not assuming that, that repeats. It's based on actual -- actuarial calculation, so that's not going to be there in the first quarter. And then, as you think about the rig moves, we talked about 12 rigs over the first half at about $250,000 each. So spreading that half-and-half, I think, will kind of help bridge that.

Blake Allen Hutchinson - Howard Weil Incorporated, Research Division

Okay. And then there is or is not a lot of baked in, in terms of -- or contemplated in terms of just progression, margin progression for the underlying businesses as is it sounds like activity momentum is picking up here?

J. Marshall Dodson

Yes. And I think as we move out of kind of a seasonally constrained first quarter and start to generate more revenue with activity, that will impact the margins with the incrementals.

Operator

Your next question comes from the line of Jeff Tillery from Tudor, Pickering, Holt.

Jeff Tillery - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

As I think about the U.S. business progression through the course of the year, Marshall, you just talked about some of the margin headwinds for the first quarter at some of your transitories. As we go into the second quarter, is it fair to think about the seasonal increase as being kind of, top line, high single digits as the way you guys see it today?

Richard J. Alario

Jeff, this is Dick. That's a little high for typical seasonality. If you're saying that we could -- excuse me. What -- let me be clear on what we're saying here. Typical seasonality, it changes from year-to-year, but 35% is what we typically see in the U.S. Based on what our customers are telling us, we believe that will be exceeded. It's hard to say, at this point, how much because it's early, and we're just in the phase now of being able to plan out work and get assets in the right places and things, but the -- I think the thing we're trying to convey is we've seen enough increased demand, inquiries, discussions to lead us to believe we'll top that this year, and so it will be better than seasonally. I hesitate to put a range on top of typical seasonality, but you could start with what we see as 3% to 5%, again, in Q2 and add -- and you could add something to that. I just -- it's so early, I hesitate to just try to frame that. But you can tell by our, hopefully, our comment, that we're pretty positive on the things that have taken shape already this year.

Jeff Tillery - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

That's perfect. That was very helpful. As we think about in Mexico, obviously, your cost structure is coming significantly down. I may have missed it in the commentary, but total rigs in Mexico, after these planned moves, is that high 20s, is that where you are? I guess that's question one. And the second question, with kind of all the moving parts on cost structure, what sort of activity levels do you think you need to get that business of Mexico alone to either cash flow or profit breakeven? How are you guys thinking about it?

Richard J. Alario

I'll address the rig count question first. We expect, now, with the increased number that we target moving out of the country, to be in the high teens or possibly around 20 after that's done.

Jeff Tillery - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

And so the current utilization would be kind of roughly 1/4 of that number. Where do we need to see activity increase to turn the tides in terms of going from red to green on profitability?

Richard J. Alario

In Mexico?

Jeff Tillery - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

Yes.

Richard J. Alario

Marshall has given some color on where we were in the past at breakeven.

J. Marshall Dodson

Yes -- no -- well, I think what I'd said around that is we'll be generating positive cash flows. Our goal is to get to where we're generating positive cash flows at the 5 rigs we have today. Obviously, that's going to be weighed down by the depreciation expense until such time as those rigs start to generate margins or we get them back to the U.S. working, generating cash. So as I think about the margin progressions in Mexico, as we move through beyond the 5, each rig is going to add a little bit more to where we can get more in line with where we've been historically there.

Operator

And your next question comes from the line of Kurt Hallead from RBC.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

So I'm just curious, again, as you work through 2014 and kind of focus more on the International segment than the U.S. segment, you guys gave some indications that the second quarter in the U.S., for example, would come back, I think, greater than seasonally adjusted with the first quarter, second quarter. That's kind of question number one. I just wanted clarity on the U.S. And then on the International, can you just give us some general sense on a year-on-year basis on what you may expect to get from an international revenue standpoint? What kind of percentage change are you looking at, to be explicit?

Richard J. Alario

Sure. Kurt, it's Dick. To be clear, we were talking about the second quarter when we referred to a view that we'll see better than typical seasonality. So it's the second quarter, not first. And at this point, we're not ready to talk about what our full year view is in International. There are lots of moving parts, and as you heard, we've got some internal initiatives that are based on rightsizing the cost to be cash breakeven or better. Look, I will say this. We continue to chase opportunities. I think the business that we recently opened up in Ecuador and the fact that we've got 3 rigs running steadily down there, possibly 4 soon, is a good indication that there are still markets out there where we could put rigs to work. And if you take Mexico's problems out last quarter, we did a pretty good job of putting rigs to work outside the U.S. other than in Mexico. So a little too early for us to give you more clarity on that. But directionally, we believe that there's opportunity to increase our active rig count in the international marketplace. We have great assets that will still be in Mexico, able to take advantage of that market when it strengthens. But we'll be putting more rigs to work as the year unfolds outside the U.S. and outside of Mexico.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Well, great. And you guys gave some great color, as well, around the dynamics of the market kind of heading out of 2013. There's been a lot of buzz recently about the pickup in activity in the Permian and how that's going to be the panacea for the U.S. marketplace and is going to drive pricing power for a number of different products and services. You're involved in a lot of different products and services with pretty good breadth of coverage from a client standpoint. What's your take on what's going on? And do you think that we're truly at a positive inflection from a pricing standpoint for a number of products and services this year?

Richard J. Alario

Well, let's start with this. Last quarter, about 30% of our revenue in the U.S. came from the Permian. So Key's a large, significant player in that market. The other thing is, is now, we do everything we do as a company in the Permian as supposed to about a couple of years ago, for example, we weren't in the Coiled Tubing business out there. Everything that Key does, including our frac stack business and coil, we now offer to our customers in the Permian. There's no question that we have a great deal of focus on that market. We love the fact that it's converting to a horizontal market. And as the well count inventory continues to increase in the horizontal part of the market, it does 2 things for us. Obviously, it increases our service intensity for completion work, which -- I will make this comment. If you notice, the things that we've been doing as a company, investing in big workover rigs that are excellent completion rigs, large coiled tubing units that are fit to purpose to do completions in a market like this, these are the services that are going to come in higher demand as that market converts from a vertical market to a horizontal market, as supposed to some of our services that are more designed for production-related activities in vertical or nonhorizontal wells. So it's the best of both worlds, right? You have a strong view by customers of the market. Their returns are fantastic. In pricing, I hesitate to get out over our skis on it, but you can see that, as I said in our comments, if you just simply take the fact that our customers intend to spend 6% to 9% more money in the U.S. this year than over last, more of that will go into horizontal new completions than last year. More wells will be horizontal, in terms of active well count, and all of that is going to be accentuated in the Permian because it's fairly young in its conversion from the vertical to the horizontal paradigm. I mean, you can tell that, if there's a place in the U.S. where capacity is going to get constrained to the point where there will be pricing power available, that's probably where it will happen first. And we have a big footprint there, so we should be a beneficiary of it whenever it begins to happen. Again, we're not making a call on that. I want to be very clear. It's early in the year. These plans of our customers are just beginning to take effect. But the bottom line is, Key is going to be a huge beneficiary of all these good things that are happening in that marketplace.

Operator

Your next question comes from the line of Jim Rollyson from Raymond James.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Dick, you -- obviously, Mexico has been -- the information you get out of there has been off from what they've told you. And so your crystal ball isn't any better than everybody else's, but curious, based on the latest round of information you have, with things being late and bids bring a little bit light of what you originally thought, what's the prognosis right now for your ability to pick up rigs working for PEMEX during the balance of the year? I mean, are we -- do you think you can get 6 rigs to work, or do you want to get that marriage to work? Just kind of what's your thought on how that progresses maybe throughout the year with what you know today?

Richard J. Alario

Well, Jim, I would say, firstly, we believe now that the pickup that is available to us in Mexico this year will come indirectly from PEMEX. It will be from the mega tenders, the incentivized contracts that are now being awarded and in fact, in terms of incentivized contracts, have been in place since last summer. So those are the first opportunities to be able to increase our rig count. The other thing is, in the South Region, which hasn't been as -- nearly as affected budget-wise as the North, we're active there. That's where our 2 coiled tubing units are. We have a couple of rigs running down there. So that market is now available to Key because we have people and a footprint and facilities. And so -- but some of that will, by the way, in that market, will come from incentivized contracts and mega tenders as well. But PEMEX is actually spending some money in the South Region. But listen, so here's what you really want to know. You want to know what I think about the rig count. Look, there's certainly opportunity this year for us to put -- if we keep -- if we wound up between 16 and 20 rigs left down there after the midyear, there's no question in my mind that we will have or could have the opportunity to put most, if not all, of those to work this year. Now a lot of things have to go right for that to happen, including, we'll have to get some opportunities directly from PEMEX. We don't have any tenders in hand at this point. So the timing is very, very difficult to predict. And frankly, we were wrong last quarter. So I'm loathe to go out and put my neck on the railroad tracks again, but the point is, that country is watching its production fall precipitously. It's going to need the kind of work that we do in order to recover it. At some point, as I said in the prepared remarks, that's going to turn into a tailwind. I'm sorry I can't give you more specifics around that, but again, it's important to know what the generalities are so that people can make a judgment about this, at some point, becoming a market that's got some heft to it.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

No, that's perfect color. I -- obviously, you've had a challenge even believing anything that comes out of there at this point. So a follow-up question, just when you think about the 12 rigs you've got coming out of Mexico coming into the U.S., which I think you said -- Trey said you've had -- got homes for already, maybe a little color on where they're going. But more specifically, how do the margins compare on the U.S. contracts for that -- those rigs today versus, maybe, what they were doing in Mexico a year ago when things were actually working?

Richard J. Alario

Sure. You should think of those rigs going into shale markets. They're really applicable for anything from the Bakken, Eagle Ford and Permian, I would say, are the 3 most likely places where we could incrementally put those rigs to work. Margin-wise, the Mexico business was a very, very strong margin business. So I wouldn't think of those assets being able to generate quite as good a margin in the U.S., unless things really heat up in the back side of the year and we get some pricing ability in places like the Permian.

Operator

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

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

Say, Dick, a question on California. I'm just wondering, not just on rigs, but wondering kind of on coil -- the coiled tubing. Again, how much can that demand really continue to pick up? It seems like some of the larger guys there have kind of indicated they're starting to spend a little bit more money, but I just don't have a good sense of what your thoughts are in the next several months.

Richard J. Alario

The short term, that market will behave very well and is one of the places that we think about when we say that, out past Q1, we'll see better than seasonally upside adjustment, Neal. And as you alluded to, there are operators out there doing things with their companies and their capital that are, clearly, very, very strong. And you've seen some of that just in the last 24 hours. So we like what's going on. It's a favorite market of ours. And we will -- I will tell you, just to give you -- this is the way I would try to help you with the answer. When Trey talked about our capital plan, and he talked -- he mentions rig replacement and refurbishment upgrades, one of the markets that we have targeted for some of that this year is California. So even though that's not the rig that is the one we typically use as a workover or completion rig in a big, bad shale market, it is a rig that, in the California market, is highly utilized, very, very profitable and among our best-performing assets in the company. So some of the capital that we talked about this morning will go to that. And therefore, you could see our rig count in California increase this year. It just depends on how we roll those rigs out and how fast things happen. I would think about maybe the back half of the year getting some impact in California from the increased asset footprint.

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

Okay. And then what's you all's -- either for you or Trey, I was just wondering your thoughts as far as expanding markets, the Utica, TMS, some of these markets. I know for a while, I've heard, obviously, some chatter about you being a bit more active in some of these newer plays. Your thoughts, number one, if that's going to be the case, and two, what kind of potential you see there? Is that more of a '15, '16 event, or is that something we could even potentially add to this year?

Richard J. Alario

Well, we're already seeing some things. We're active in both those markets that you mentioned. Let's use the TMS as an example. As you know, the rig count there is not -- the drilling rig count there is not a big number. But Key is well positioned. We have facilities in North Louisiana, we have facilities in South Louisiana to support basically all of our businesses. Now we aren't located in the heartland of the TMS, but we are able to service customers from where we currently have footprint. And as the markets develop, we may find ourselves in need of expanding into those areas because, clearly, those wells, as you saw with the big gas well that was announced yesterday and some of the liquids wells that have been announced up in the Utica and some of the wells that have been announced in the Tuscaloosa, are places where our customers are very excited about throwing a lot of capital. We're being cautious, by the way, with respect to moving into those areas, but we work for those customers every day. So these are places where Key has been taking in and given opportunities. Let me make this point. I want to hearken back to the comments I made about our conversion over to Key value-added. This is a classic example of a decision that will be made under the metrics posed by a value-added concept. Our people will come to us for capital from time to time for these, let's call, fringe markets today, and we will be very diligent as we go about the assessment of whether it's better to put capital in places like that as supposed to some of the core markets that Key's sort of strong in already. So I think this sets up perfectly for us to be able to put that robust evaluation out there and drive some benefit for our shareholders. That's the bottom line on these kinds of markets is, if we can service them with existing capacity and crews, that's upside for us. And, at the same time, in order to -- in order for us to be more highly committed, the thresholds under our KVA program will have to be met, and, again, that's what I think the -- that's why we're excited about instituting this business metric into our company because we surely admire the other companies that have begun to use this and the success that they've had with their stock price.

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

Okay. And then last one, just moving over to Fish and Rent. I was wondering, a couple of your peers had mentioned some -- a bit of increases they've had in rental equipment. I'm just wondering your thoughts as far as -- I guess I don't hear too much about that market. I mean, how much can that market expand? I know you've got a great footprint there in the Eagle Ford and the Perm. So I'm just wondering, again, just overall as a percentage of your business, is that something that, because of the demand right now you're seeing for that, could -- is that going to be a pretty -- is it going to be a large driver this year?

Richard J. Alario

It very well could be. In fact, what we've said is that, it -- because of the returns, it's the business that will likely get the first slug of growth capital as we find opportunities. And by the way, there are opportunities even in markets where there's a little bit of overcapacity. We have customers today asking us for things, so we may deploy some capital out that way. We just don't have it in our plan at this point. But clearly, the Fishing and Rental business for Key is a high return. And, again, on the KVA, it's going to be a winner, and you should expect that we'll be able to grow the business. I'm hesitant to give you a range at this point, but you should think positively about the opportunity and about our view that we would add capital to that business, given the -- as the opportunities unfold.

Operator

Your next question comes from the line of John Daniel from Simmons & Company.

John M. Daniel - Simmons & Company International, Research Division

Dick, I don't want to see you put your neck on the train tracks, but do want to ask about the Mexico question. I understand the desire to move the rigs out, and -- but given the cost to do so, does it make sense to move them out if you think that activity could eventually rebound once tenders are coming? It seems like you'd incur that cost again to put rigs back again in-country.

Richard J. Alario

That may very well happen, John. And if it does, it will be serendipitous because, at this point, with the uncertainty that exists out there on timing, given the fact that we have opportunities in the U.S. market to put those rigs to work, we think it's a no-brainer. The cost to getting back down there is $150,000 to $200,000. And the contracts that exist, that typically have existed in Mexico, have enough foundation under them in terms of commitment levels to warrant sending rigs back down there if the terms are right and the prices are right. But since we don't know that, we're not going to take that risk. We're being very clear about that, and that's the readthrough that you should take. Key is going to put those rigs to work whether Mexico comes back or not.

John M. Daniel - Simmons & Company International, Research Division

Okay. A big picture question, but assuming we see U.S. drilling activity up mid-single digits, and I think you alluded to your sort of a house view that you think E&P spending will be up high single digits, as you kind of step back and think, again, big picture of the U.S. well service industry, what do you think is a reasonable framework for well service rig-hour growth in '14 versus '13? And I'm not asking for a Key-specific call, but just your view of the industry.

Richard J. Alario

Yes, I think it should -- thank you for that question, John. We think it should be bigger than the spending range. And the reason why is because the Permian, the biggest workover remedial market in the U.S., is the one getting the most increase in capital. The horizontal -- the U.S. horizontal well count has grown and is now well positioned in terms of the age of some of those wells to begin to require fairly significant remedial work. The U.S. drilling rig count is shifting more toward horizontal every month and, therefore, the service intensity for the workover rig used as a completion rig continues to grow. I mean, I can go on and on. So we should see, again, without -- and thank you for not holding me to a number, but we -- you add all those things up, and assuming a stable commodity environment, you should see more growth in demand in this line of work than in, say, drilling.

John M. Daniel - Simmons & Company International, Research Division

Fair enough. And just 2 more quick ones for me. The first is housekeeping. The rig move cost, Marshall, is that -- I just want to confirm, that's included in the 200 basis point margin reduction guidance for U.S.?

J. Marshall Dodson

Yes, yes.

John M. Daniel - Simmons & Company International, Research Division

Okay. And then, one -- I don't know if you want to take this one or not, but as you move forward with the KVA initiative, you mentioned earlier that you're -- that's going to be a good way of allocating capital to the performers. But what do you do with the underperformers?

Richard J. Alario

Well, that's the whole idea of economic value-added analysis, right? You look at your businesses and your investments with a view toward staying very focused on the ones that cover the cost of capital plus a return, and you stay less focused on the ones that don't. And as you've seen, and as I've said, we admire those companies that have had the courage to take those hard looks. And that KVA -- the institution of KVA at Key will require us to do the same thing, and we will do it.

Operator

[Operator Instructions] Your next question comes from the line of Daniel Burke from Johnson Rice.

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

Just really one question left. I wanted to explore a little bit more non-Mexico international, in particular, Colombia. Could you talk about the outlook for Colombia this year? I guess, the mobilization costs that burdened Q4 won't continue. But how healthy and how stable is that market for you all? What ability do the non-Mexico markets have to contribute to stabilizing the overall international result as we look out to the second half of '14 and presume Mexico remains at a depressed level?

Richard J. Alario

Yes, Daniel. It's Dick. Well, particularly with Colombia, I mean, generally speaking, the country is -- the business down there is -- the country's trying to grow it. They have some fairly significant production forecasts out there. And in order to get there, I can assure you they're going to need more drilling rigs, more completion rigs and many more workovers. So we like the way it sets up. And that country's just like every other one. It's going to depend on what kind of pricing and terms we can continue to get under our contract opportunities. But we've moved some rigs there recently, and we did so, presumably, because we see more opportunities down there. The other thing I'll tell you is our Ecuador business runs sort of as a satellite to our Colombian operation. And so Colombia has got value for Key, whether or not we see growth in that -- in those -- within those borders or not, because it supports a -- what appears to be a really nice opportunity in Ecuador. And then, of course, the rest of the world, as you know, we're adjusting to the acquisition of our 2 JVs in Russia and in the Middle East. So there's some transitional work being done there to improve our business. We're already seeing results of that in Russia. And so the question becomes, will we add capacity in those markets? That's going to be a KVA decision. We'll begin to take a hard look at that here shortly. We haven't gotten to that point yet. But there may be opportunities that we decide to take up, and there may be some that don't make any sense for us. But, I mean, generally speaking, as I said earlier, we should be able to put more rigs to work outside of Mexico and outside of our U.S. business as the year unfolds. So it's a -- we have a positive view that we can accomplish sort of what you alluded to. It's just a matter of how quickly that's going to happen, and it's so early that we sort of hesitate to give you a view on that.

Operator

And we have no further questions. I will turn the call back to our presenters.

West Gotcher

Thank you, Rob. 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, thank you for your participation. This concludes today's conference call, and you may now disconnect.

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