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Edited Transcript of KEG.N earnings conference call or presentation 9-Aug-18 3:00pm GMT

Q2 2018 Key Energy Services Inc Earnings Call

HOUSTON Aug 27, 2018 (Thomson StreetEvents) -- Edited Transcript of Key Energy Services Inc earnings conference call or presentation Thursday, August 9, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Brunnert

Key Energy Services, Inc. - Senior VP & COO

* J. Marshall Dodson

Key Energy Services, Inc. - Senior VP, CFO & Treasurer

* Katherine I. Hargis

Key Energy Services, Inc. - Senior VP, General Counsel & Corporate Secretary

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Conference Call Participants

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* Daniel Joseph Burke

Johnson Rice & Company, L.L.C., Research Division - Senior Analyst

* John Matthew Daniel

Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service

* Michael William Urban

Seaport Global Securities LLC, Research Division - MD & Senior Analyst

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Presentation

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Operator [1]

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Good morning, my name is Jennifer, and I will be your conference operator today. At this time, I would like to welcome everyone to the Key Energy Services Second Quarter 2018 Earnings Call. (Operator Instructions) And I would like to turn the conference over to Senior Vice President and General Counsel, Katherine Hargis. Please go ahead.

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Katherine I. Hargis, Key Energy Services, Inc. - Senior VP, General Counsel & Corporate Secretary [2]

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Thank you, Jennifer, and thank you all for joining Key Energy Services for our Second Quarter 2018 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 2017 Form 10-K, our first quarter 2018 10-Q, and other reports most recently filed with the SEC, which are available on our website at www.keyenergy.com.

This call may also include references to non-GAAP financial measures. Please refer to our previously posted earnings release, which can be found on 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.

With that, I'm going to turn the call over to Marshall Dodson, Key's CFO and interim CEO.

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [3]

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Thanks, Katherine, and good morning, everyone. Also joining me on this call this morning is David Brunnert, Key's Chief Operating Officer.

The second quarter of 2018 was a milestone quarter for Key, marking the first quarter in a couple of years where we generated free cash flow, organically built cash and improved liquidity.

We generated a 15% quarter-on-quarter increase in consolidated revenues, taking them to $144 million, resulting in an operating loss of $8.9 million with $12 million in adjusted EBITDA for the second quarter of 2018.

This represents an improvement of $11.3 million from the first quarter of 2018. I am pleased with the inflection in the positive adjusted EBITDA this quarter.

Everyone at Key has been driving hard to achieve this goal, and I would like to say thank you to the men and women of Key for the hard work they've put in every day, providing safe and efficient service to our customers, which allowed us to achieve this result.

I'm now going to run through each of the segments, then hand it over to Dave to cover a few points, then come back and wrap things up.

We grew revenue in all of our segments this quarter, and all segments also experienced margin expansion as we moved past the startup inefficiencies in cost of the prior 6 to 8 months, and also benefited from a full quarter of improved pricing.

In our Rig Services segment, we generated $80.5 million of revenues in the second quarter, an improvement of $10.2 million or 14.4% over the first quarter. This revenue increase was driven by 7% improvement in quarterly rig hours, and a 7% improvement in pricing. Pricing improved in all markets to various degrees, but did very regionally due to local supply-demand dynamics. Adjusted EBITDA margins in the second quarter was 20%, a 700- basis point improvement from the first quarter. Gross margin in this segment, which excludes G&A, also improved and was 24% for the second quarter of 2018. Looking ahead, we expect revenue growth in the low- to mid-single digit next quarter, driven mostly by activity with some price improvement. We don't expect to see much additional impact from price until the fourth quarter.

Our margins next quarter will be impacted by some transitory costs, largely due to large worker's compensation charges stemming from a vehicular incident last month, along with some customer transition. With those impacts, we might see margins fall around 100 basis points, when otherwise we'd expect an improvement of around 100 basis points. Those impacts will be behind us for the fourth quarter, at which time we should also see some price benefit.

Our Fluid Management services segment also saw a revenue improvement in the second quarter, increasing by $800,000 or 3.7%. That revenue improvement generated 150% incremental adjusted EBITDA margin, increasing adjusted EBITDA to $3.4 million.

Our truck activity fell 6,500 hours or 3% in the second quarter, as we repositioned assets and exited some markets to take advantage of better areas, and also generated more non-trucking revenues. Price improved 3% on the lower hours with the balance of the revenue increase coming from non-truck revenues.

Our margins also benefited by moving past some of the cost impacts in the prior quarter. Next quarter, we expect revenue to be up a couple of percent, but with similar dynamics as the second quarter, where we expect a reduction in truck hours offset by price in non-truck revenues. Those combined effects will translate to a revenue increase that improves margin by 100- to 200- basis points.

In the Fishing & Rental segment, revenues increased $2.7 million or 19% with a 70% incremental margin, improving our adjusted EBITDA to $3.6 million and yielded an adjusted EBITDA margin of 22%. We added a veteran leader to this segment last quarter, and are seeing the improvements in both sales and margins. As we increase the utilization of our assets and work margins back to a range we would expect for this business, next quarter, we expect to see 3% to 5% revenue growth and margin improvement of 100- to 200- basis points.

Coiled Tubing saw another solid quarter of revenue growth, with revenues increasing 29.6% or $5.5 million to $23.9 million. Adjusted EBITDA also improved increasing to $4.3 million for the quarter and a margin of 17.9%. While we had a good quarter and I'm pleased we continued our run of strong quarterly revenue growth and saw a recovery in margins, we did not achieve our revenue of margin expectations in this segment. Rain in South Texas and damage to a large diameter unit impacted our revenues in June. The temporary loss of that unit will have a couple of months impact. So for the third quarter, we expect to see revenues grow 5% to 10%, with margins improving into the high 20s.

Our G&A increased to $22.9 million in the second quarter of 2018 from $24.6 million in the first quarter of 2018. G&A in the second quarter of 2018 included $0.2 million of equity-based compensation as compared to $2 million in the first quarter, largely due to a gain on the cancellation awards from the resignation of our former CEO. Excluding the impact of stock-based compensation, G&A increased $0.2 million in the second quarter of 2018 from the first quarter. I'd expect G&A to be around $25 million in the third quarter, and include about $1 million of equity-based compensation expense pending the appointment of a permanent CEO.

With that, I'll turn it over to Dave.

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David Brunnert, Key Energy Services, Inc. - Senior VP & COO [4]

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Thanks, Marshall. As Marshall said, our rig hours increased 7% quarter-on-quarter, driven primarily by growth in the Permian, where we grew rig hours 15%. This compares to the 6% increase we saw in the average AESC rig count over the same period, and 9% increase in the Permian's average AESC rig count quarter-on-quarter.

In the second quarter, we saw increasing demand for both completions and maintenance rig work in the Permian, with our increase in activity there split evenly between the two.

We continue to field inquiries and requests for additional rigs. Late in the second quarter, we also added an established Permian veteran to lead our team there, and I am excited about the growth we see ahead of us in this important market under his leadership.

The Permian possesses the greatest growth opportunity in the U.S. It also presents the toughest market to operate in with a very competitive landscape for acquiring and retaining both customers and employees. The employee positions in greatest demand are truck drivers and mechanics. The shortage of qualified personnel for those positions has driven significant labor inflation. Thus far, we have offset this inflation with margin enhancing price increases. We're also starting to see increasing tightness in qualified rig crews. This is making it tougher to quickly meet our customers request for additional rigs.

We believe that as we move through the back half of the year, this tightness will again provide the backdrop for further price increases to supply our great crews to meet this increasing demand. Without price and wage increases, the market will face challenges meeting the growing demands.

A big topic of conversation is centered around take away capacity in the Permian. Every customer appears to be impacted differently. So far, we have not experienced any significant reductions in activity in the Permian due to take away constraints, but we are aware of some customers who are deferring increases in completion activity until 2019.

The takeaway problem does not seem to be impacting our production related work today. And at this time, we don't expect to see much of an impact over the back half of the year. If we do, we will shift assets to stronger markets as we do routinely. This is one of the benefits of our strong national footprint.

Nationally, in the second quarter, we generated about 14% of our rig hours from completions work and averaged 19, 24-hour rig packages. This is up about 12% from our first quarter average. Our AESC Class 4 and 5 well service rigs continue to be in strong demand.

Our crude Class 4 and 5 rigs ran at near full utilization in the second quarter, and we are deploying more rigs as the market conditions and crew availability allow. This is true for both completions or production work where we are seeing greater demand for work on horizontal wells across most basins.

Our Coiled Tubing business continued to grow and we deployed all of the large diameter units as planned. We averaged 6 large diameter units working in the second quarter as compared to 5 during the first quarter. Our expectation was to average about 7 units working this past quarter, but as Marshall said, weather in South Texas and the temporary loss of a unit in June slowed our progress.

The resulting lost revenue and the uncovered cost weighed on our margins. Market demand for our large coil units remain strong with good economics. As our customers continue to refine their well designs in lateral lengths, we often see their need shift from coiled tubing to stick pipe using well service rig.

Whatever technique our customers prefer, we are well-positioned to meet their demands with our well completion solutions, including our large diameter coiled tubing, Class 4 and 5 well service rigs and a full complement of rental equipment.

During the second quarter, the bottom line of our Fluids Management segments benefited from moves me make to reposition trucks to the most economically attractive markets. For some time now, we've been moving assets to areas of strength and exiting marginal or unprofitable markets where we expect to continue to do this. Our results also benefited from higher disposed water volumes with those volumes increasing 17% over the first quarter. Frac tank rental activity and pricing has also improved, particularly, in the Permian where revenues from those assets increased over 30% quarter-on-quarter.

That said, our growth continues to be constrained by lack of drivers and mechanics. I believe we will continue to see improving demand for all of our services and are well-positioned with a broad range of solutions to meet our customers' production needs and help them unlock the potential of their wells. Completion activity is driving demand for large diameter coiled tubing units and our industry-leading fleet of Class 4 and 5 well service rigs as well as our suite of rental offerings.

We can offer our customers a comprehensive solution package to meet their needs where many of our competitors cannot. We also see steady improvement in demand for production maintenance services as operators turn to the high return workovers and maintenance work, and expect it to continue through 2018 and into 2019.

With that, I'll turn it back over to Marshall.

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [5]

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Thanks, Dave. A few remaining financial points before wrapping up.

In the second quarter of 2018, depreciation expense was $20.7 million, and interest expense was $8.5 million. We expect both of these costs to be consistent with second quarter levels over the back half of the year.

Cash flow from operations was $8.2 million in the second quarter and use of cash over the first 6 months of 2018 was $15.2 million. Our capital expenditures were $7.7 million for the second quarter of 2018, and $17.2 million over the first 6 months of 2018.

We have also had $8.9 million of proceeds from asset or other sales over the first half of 2018, resulting in a net spend of $8.3 million.

With the demand we're experiencing for 24-hour packages and certain rental real items, we are slightly increasing our CapEx to be between $35 million and $40 million in 2018, still with about $15 million of assets or other sale proceeds, and we still expect our total liquidity at the end of 2018 to be fairly flat to where we exited 2017.

Turning to our balance sheet, cash stood at $52.3 million at the end of the second quarter of 2018. And we had $38.3 million available under our ABL credit facility, which is undrawn. This combines for a total liquidity of $90.6 million at the end of the second quarter of 2018, and is an improvement of $12.4 million over the first quarter of '18. The asset coverage ratio under our term loan stood at 1.9x at the end of the second quarter as compared to the minimum required of 1.35x.

In closing, I'm very honored and proud to be serving as interim CEO at this particular moment in Key's history. We marked our first positive cash flows in some time and there's a great future ahead of Key. I believe Key will continue to benefit from the structural changes made over the past several years as we move to take advantage of increasing activity both from the recovery in oil prices and the growing opportunity ahead of us with horizontal oil wells while also prudently managing our balance sheet to maximize the value for our shareholders.

Operator, this concludes our prepared remarks. We'll now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of John Daniel with Simmons and Company.

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John Matthew Daniel, Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service [2]

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First question is a housekeeping one. If you could -- and if you said this in the prepared remarks, I missed it -- but just your average working counts in terms of rigs and coil units for the quarter?

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [3]

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We didn't give the average rigs, looks like the second coil was 6 units.

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John Matthew Daniel, Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service [4]

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Okay, got it. A lot of us had been hoping that we'd see consequential industry consolidation play out. And as you guys well know that hasn't materialized. I'm curious, given the improvement you're seeing in the rig business, and knowing that there's no shortage of 10 to 20 rig type companies out there, many of whom are high-quality local operations, what's your appetite for looking at those type of tuck-in deals and could you do -- is there any appetite of using equity or other types of transactions as a means to help delever the balance sheet? Just your thoughts on that.

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [5]

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Yes, so -- the -- we've said -- and we believe for a long time that consolidation would be good for the industry, and we'll benefit whether we participate or not. As to smaller tuck-ins, the risk with those is that we would end up buying assets and retaining the people. But to the extent that there's an opportunity out there with good quality people who'd want to work for a company like Key, then that's an opportunity that we'd definitely look at and consider. As to using equity, that's obviously something that we definitely think about as well, for the right acquisition.

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John Matthew Daniel, Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service [6]

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Fair enough. Last one I'll turn it back over to others. The coil business with 6 units running now. Obviously, there's a lot of -- it's not just you -- -- of the 2-inch unit market in smaller seems to be pretty terrible. What's your outlook for that? And what do we do with those units going forward?

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [7]

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So there's not much demand out there for 2-inch units. You see it occasionally where operators will use a 2-inch in some cases, a really long 2-inch string can be used and is used rather than a 2 3/8. There may be some remedial application for those units at some point in the future, we're not seeing a lot of that right now. But most operators want to use 2 5/8s or 2 3/8s or a well service rig if they can't get out to the end with one of those two options.

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Operator [8]

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Your next question comes from the line of Mike Urban with Seaport Global.

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Michael William Urban, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [9]

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So you guys talked about the shift that you're seeing as wellbores get -- laterals get a bit longer using well service rigs and stick pipe, that's something your competitors have talked about as well. Do you see that as incremental demand? Or, I mean, I know you are somewhat agnostic but are you -- is it incremental demand to the large-diameter coiled units or is it taking share to some extent?

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [10]

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You know, I don't necessarily think it's taking share. As Dave mentioned, we have seen some operators start off with coil and then move to using stick pipe or start off with stick pipe and then try coil. Every engineer has a preference. Every well is different and each technique is suited for a different well. I will say that we have seen some customers have bad experiences with coil, where they've had very expensive fishing jobs, some of which we've benefited from. And then they kind of switch back to stick pipe for a while. So I think as the overall completion trends grows, it's going to be specific into each market relative to the well design and the availability of each asset.

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Michael William Urban, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [11]

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Got you. And it looks like you've gotten into the cementing business a little bit or at least highlighting it a little more. How material is that for you? And is that something you would hope to grow or build out? Or is it more of an opportunistic kind of thing?

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [12]

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We've been adding to our presence. We've been doing cementing for quite some time with our PNA business but we started adding a few more assets to that. Dave you want to touch on that for a minute?

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David Brunnert, Key Energy Services, Inc. - Senior VP & COO [13]

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Yes, our additions are really focused on niche smaller cementing jobs, and we have no intention of entering the large cementing stream business so we're not going to compete with our majors that do big strings. But we plan to be in the niche cementing business and we're having some success as you pointed out.

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [14]

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It's not material at this point, but we do see an underserved market that we're going to go serve.

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Michael William Urban, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [15]

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And then last one from me is on the fluids business. As you cited, you're moving some assets around to try and improve the profitability. I mean, that's been a struggle in that business for a long, long time. It seems like a chronic issue for you guys. What's kind of the long-term outlook for that business. You don't really do much in terms of running, I think, in terms of pipes to volumes, and it seems like that's a trend going on there. How do you see your fluids business position long-term?

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [16]

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So we do have pipe volumes and we have been adding pipe volumes to our wells. I mentioned the growth in non-trucking  revenues, a lot of that is disposal volume. So we're -- where we have wells, they are well situated to meet the operator's needs. We definitely are pursuing those opportunities. I think in general, the water management side of the business is going to be shifting and changing over time and we will be as we move through time, shifting and changing our business to align with the needs of our customers. I think there's always going to be a demand for trucks. It's not -- you can't pipe everything so that's an aspect of business that'll be here for a long time, but there are many other opportunities that we are evaluating as we think about where we put capital over the next 12 to 18 months. There's a number of great opportunities. So to your point, there are markets in parts of the U.S. that just haven't seen much uptick in activity at all. And I think a lot of that has to do with the lack of oil production from a lot of the wells in those markets, right? So if you think about an old stripper well, it's going to make a lot more water than it does oil, and as that production is tapered off, the water volumes will fall. Those are also in areas where people are not going to go back in and put in water gathering systems. So I think as the economics come back to work-over, maintain, get production out of the conventional wells in East Texas and Louisiana and South Texas that the water volumes are going to go up. And we'll probably find ourselves sometime in the next year to 2 years very short of trucks and drivers in markets that we and our peers have all left. So it'll be an interesting dynamic to see that play out.

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Michael William Urban, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [17]

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Got you. And how much of your volumes were transported by pipe in the quarter? If you have a...

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [18]

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It's going to be less than 10%.

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Operator [19]

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Your next question comes from the line of Daniel Burke with Johnson Rice.

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Daniel Joseph Burke, Johnson Rice & Company, L.L.C., Research Division - Senior Analyst [20]

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So a little positive advance in the well service top line in Q2 and the guide points to some deceleration in Q3, and putting together your comments, it sounds like maybe you guys are constrained a little bit by crew availability, and then maybe there's a lag to some pricing gains. But I was wondering if you could kind of flush out maybe some of the factors that are in play in that Q3 revenue guide for rigs?

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [21]

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So we have customers asking for rigs every day. And it's -- the people just aren't there to go put the rigs out, and we're looking to bring on employees who are trained, who are qualified to do the work safely and efficiently. The last thing we want to do is put a rig out for a customer with a crew and leave a bad impression with that customer. So it takes time to find the right folks to do the work. So the growth is going to be a little more measured. The labor market is just really tight and when you look at the available pool, it's tight and it takes a while, but we've got some great recruiters in place. We've got training programs in place. We are actively adding people and we're meeting the demand. It's just not instantaneous. The rigs, we could put out tomorrow if we had the people. And we will get those rigs out, but it won't be tomorrow. It may be over the next week or month.

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Daniel Joseph Burke, Johnson Rice & Company, L.L.C., Research Division - Senior Analyst [22]

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And then maybe just one other again just to stay with well service that's a healthy advance really underpinning that Q2 result in Permian hours. Can you talk about on the flip-side what you saw in the Rockies market? Or what you're seeing there in kind of the summer months this year?

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [23]

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So the Rockies in general, is a bunch of different markets. You've got gas markets, you've got the D-J, and you've got the Bakken. And you know we -- the Bakken is a market that we love, and we have a great presence and great franchise, some great people in that market and the demand continues to grow. When you think about the oil markets in the U.S., it's the Bakken, the Permian and the Eagle Ford and -- all of which are doing really well.

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Operator [24]

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And we have no other questions in queue at this time.

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Katherine I. Hargis, Key Energy Services, Inc. - Senior VP, General Counsel & Corporate Secretary [25]

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Thank you, Jennifer. 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.

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [26]

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Thank you.

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Operator [27]

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Thank you for your participation. This does conclude today's conference call, and you may now disconnect.