XNAS:TESO Tesco Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

XNAS:TESO (Tesco Corp): Fair Value Estimate
Premium
XNAS:TESO (Tesco Corp): Consider Buying
Premium
XNAS:TESO (Tesco Corp): Consider Selling
Premium
XNAS:TESO (Tesco Corp): Fair Value Uncertainty
Premium
XNAS:TESO (Tesco Corp): Economic Moat
Premium
XNAS:TESO (Tesco Corp): Stewardship
Premium
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2012
o 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to

Commission file number: 001-34090

Tesco Corporation
(Exact name of registrant as specified in its charter)

Alberta
76-0419312
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
3993 West Sam Houston Parkway North
Suite 100
Houston, Texas
77043-1221
(Address of Principal Executive Offices)
(Zip Code)
713-359-7000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes   x     No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   x   No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer   o
Accelerated Filer   x
Non-Accelerated Filer   o
Smaller Reporting Company   ¨
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ¨     No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.
Number of shares of Common Stock outstanding as of April 30, 2012:   38,611,383



TABLE OF CONTENTS
 
 




Below is a list of defined terms that are used throughout this document:

TESCO CASING DRILLING®
 
 = CASING DRILLING
TESCO’s Casing Drive System
 
 = CDS™ or CDS
TESCO’s Multiple Control Line Running System
 
 = MCLRS™ or MCLRS





A list of our trademarks and the countries in which they are registered is presented below:

Trademark
 
Country of Registration
TESCO®
 
United States, Canada
TESCO CASING DRILLING®
 
United States
CASING DRILLING®
 
Canada
CASING DRILLING™
 
United States
Casing Drive System™
 
United States, Canada
CDS™
 
United States, Canada
Multiple Control Line Running System™
 
United States, Canada
MCLRS™
 
United States, Canada

When we refer to “TESCO”, “we”, “us”, “our”, “ours”, or “the Company”, we are describing Tesco Corporation and our subsidiaries.
 



Caution Regarding Forward-Looking Information; Risk Factors
 
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Canadian and United States securities laws, including the United States Private Securities Litigation Reform Act of 1995.  From time to time, our public filings, press releases and other communications (such as conference calls and presentations) will contain forward-looking statements.  Forward-looking information is often, but not always identified by the use of words such as “anticipate,” “believe,” “expect,” “plan,” “intend,” “forecast,” “target,” “project,” “may,” “will,” “should,” “could,” “estimate,” “predict” or similar words suggesting future outcomes or language suggesting an outlook.  Forward-looking statements in this Quarterly Report on Form 10-Q include, but are not limited to, statements with respect to expectations of our prospects, future revenue, earnings, activities and technical results.
 
Forward-looking statements and information are based on current beliefs as well as assumptions made by, and information currently available to, us concerning anticipated financial performance, business prospects, strategies and regulatory developments.  Although management considers these assumptions to be reasonable based on information currently available to it, they may prove to be incorrect.  The forward-looking statements in this Quarterly Report on Form 10-Q are made as of the date it was issued and we do not undertake any obligation to update publicly or to revise any of the included forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.
 
By their very nature, forward-looking statements involve inherent risks and uncertainties, both general and specific, and risks that outcomes implied by forward-looking statements will not be achieved.  We caution readers not to place undue reliance on these forward-looking statements as a number of important factors could cause the actual results to differ materially from the beliefs, plans, objectives, expectations and anticipations, estimates and intentions expressed in such forward-looking statements.
 
These risks and uncertainties include, but are not limited to, the impact of changes in oil and natural gas prices and worldwide and domestic economic conditions on drilling activity and demand for and pricing of our products and services, other risks inherent in the drilling services industry (e.g. operational risks, potential delays or changes in customers’ exploration or development projects or capital expenditures, the uncertainty of estimates and projections relating to levels of rental activities, uncertainty of estimates and projections of costs and expenses, risks in conducting foreign operations, the consolidation of our customers, and intense competition in our industry), and risks associated with our intellectual property and with the performance of our technology.  These risks and uncertainties may cause our actual results, levels of activity, performance or achievements to be materially different from those expressed or implied by any forward-looking statements.  When relying on our forward-looking statements to make decisions, investors and others should carefully consider the foregoing factors and other uncertainties and potential events.
 
Copies of our Canadian public filings are available at www.tescocorp.com and on SEDAR at www.sedar.com.  Our U.S. public filings are available at www.tescocorp.com and on EDGAR at www.sec.gov.
 
Please see Part I, Item 1A—"Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2011 and Part II, Item 1A—"Risk Factors" of this Quarterly Report on Form 10-Q for further discussion regarding our exposure to risks.  Additionally, new risk factors emerge from time to time and it is not possible for us to predict all such factors, nor to assess the impact such factors might have on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward looking statements.  Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.





PART I—FINANCIAL INFORMATION

Item 1.     Financial Statements.

 TESCO CORPORATION
Condensed Consolidated Balance Sheets (Unaudited)
(in thousands)
 
 
March 31,
2012
 
December 31,
2011
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
17,891

 
$
23,069

Accounts receivable trade, net of allowance for doubtful accounts of $2,845 and $2,491 as of March 31, 2012 and December 31, 2011, respectively
132,891

 
117,711

Inventories, net
127,786

 
111,769

Income taxes recoverable
3,007

 
3,020

Deferred income taxes
5,866

 
4,909

Prepaid and other assets
30,531

 
33,326

Total current assets
317,972

 
293,804

Property, plant and equipment, net
207,546

 
203,068

Goodwill
32,732

 
32,732

Deferred income taxes
12,020

 
12,416

Intangible and other assets, net
6,727

 
7,195

Total assets
$
576,997

 
$
549,215

Liabilities and Shareholders’ Equity
 

 
 

Current liabilities
 

 
 

Current portion of long term debt
$
725

 
$
2,793

Accounts payable
53,779

 
57,443

Deferred revenue
23,392

 
25,924

Warranty reserves
7,472

 
3,103

Income taxes payable
2,057

 
2,336

Accrued and other current liabilities
25,570

 
34,069

Total current liabilities
112,995

 
125,668

Long term debt
25,575

 
3,832

Other liabilities
2,623

 
2,434

Deferred income taxes
7,694

 
4,474

Total liabilities
148,887

 
136,408

Commitments and contingencies (Note 10)


 


Shareholders’ equity
 

 
 

Common shares; no par value; unlimited shares authorized; 38,596 and 38,569 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively
207,457

 
206,573

Retained earnings
185,152

 
170,733

Accumulated comprehensive income
35,501

 
35,501

Total shareholders’ equity
428,110

 
412,807

Total liabilities and shareholders’ equity
$
576,997

 
$
549,215

 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 

1


TESCO CORPORATION
Condensed Consolidated Statements of Income (Unaudited)
(in thousands, except per share information)
 
 
Three Months Ended March 31,
 
2012
 
2011
Revenue
 
 
 
Products
$
68,941

 
$
37,193

Services
83,480

 
68,429

 
152,421

 
105,622

Operating expenses
 
 
 
Cost of sales and services
 
 
 
Products
52,310

 
25,059

Services
67,485

 
58,434

 
119,795

 
83,493

Selling, general and administrative
11,063

 
11,728

Research and engineering
2,542

 
2,885

Total operating expenses
133,400

 
98,106

Operating income
19,021

 
7,516

Other expense (income)
 
 
 
Interest expense
(358
)
 
286

Interest income
(31
)
 

Foreign exchange loss
280

 
186

Other expense (income)
(1,332
)
 
28

Total other expense
(1,441
)
 
500

Income before income taxes
20,462

 
7,016

Income tax provision
6,043

 
2,699

Net income
$
14,419

 
$
4,317

Earnings per share:
 
 
 
Basic
$
0.37

 
$
0.11

Diluted
$
0.37

 
$
0.11

Weighted average number of shares:
 
 
 
Basic
38,583

 
38,076

Diluted
39,066

 
38,753


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


2



TESCO CORPORATION
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
 
 
Three Months Ended March 31,
 
2012
 
2011
Operating Activities
 
 
 
Net income
$
14,419

 
$
4,317

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
10,780

 
9,267

Stock compensation expense
727

 
2,477

Bad debt expense
369

 
250

Deferred income taxes
2,659

 
497

Amortization of financial items
46

 
46

Gain on sale of operating assets
(5,310
)
 
(171
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable trade, net
(9,225
)
 
(13,971
)
Inventories
(16,017
)
 
(10,445
)
Prepaid and other current assets
2,722

 
(2,126
)
Accounts payable and accrued liabilities
(9,167
)
 
5,163

Income taxes payable (recoverable)
(266
)
 
(1,374
)
Other noncurrent assets and liabilities, net
260

 
36

Net cash used for operating activities
(8,003
)
 
(6,034
)
Investing Activities
 
 
 
Additions to property, plant and equipment
(17,866
)
 
(8,148
)
Proceeds on sale of operating assets
820

 
325

Other, net
73

 

Net cash used for investing activities
(16,973
)
 
(7,823
)
Financing Activities
 
 
 
Issuances of debt
26,000

 

Repayments of debt
(6,325
)
 

Proceeds from exercise of stock options
123

 
132

Other, net

 
(45
)
Net cash provided by financing activities
19,798

 
87

Change in cash and cash equivalents
(5,178
)
 
(13,770
)
Net cash and cash equivalents, beginning of period
23,069

 
60,603

Net cash and cash equivalents, end of period
$
17,891

 
$
46,833

Supplemental cash flow information
 
 
 
Cash payments for interest
$
88

 
$
71

Cash payments for income taxes
3,620

 
4,784

Cash received for income tax refunds
385

 
458

Property, plant and equipment accrued in accounts payable
967

 
811


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


3



TESCO CORPORATION
Condensed Consolidated Statements of Shareholders’ Equity and
Comprehensive Income (Unaudited)
(in thousands)


 
Common stock shares
 
Common shares
 
Retained earnings
 
Accumulated comprehensive income
 
Total
 
For the three months ended March 31, 2012
 
 
 
 
 
 
 
 
 
Balances at January 1, 2012
38,569

 
$
206,573

 
$
170,733

 
$
35,501

 
$
412,807

Net income

 

 
14,419

 

 
14,419

Stock compensation related activity
27

 
884

 

 

 
884

Balances at March 31, 2012
38,596

 
$
207,457

 
$
185,152

 
$
35,501

 
$
428,110

 
 
 
 
 
 
 
 
 
 
For the three months ended March 31, 2011
 
 
 
 
 
 
 
 
 
Balances at January 1, 2011
38,058

 
$
196,431

 
$
143,737

 
$
35,501

 
$
375,669

Net income

 

 
4,317

 

 
4,317

Stock compensation related activity
91

 
1,522

 

 

 
1,522

Balances at March 31, 2011
38,149

 
$
197,953

 
$
148,054

 
$
35,501

 
$
381,508

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


4


TESCO CORPORATION
 
Notes to Unaudited Condensed Consolidated Financial Statements

Note 1—Nature of Operations and Basis of Preparation
 
Nature of Operations

We are a global leader in the design, manufacture and service delivery of technology-based solutions for the upstream energy industry.  We seek to change the way wells are drilled by delivering safer and more efficient solutions that add real value by reducing the costs of drilling for and producing oil and natural gas.  Our product and service offerings consist mainly of equipment sales and services to drilling contractors and oil and natural gas operating companies throughout the world.

Basis of Presentation
 
We prepared this Quarterly Report on Form 10-Q pursuant to instructions for quarterly reporting required to be filed with the Securities and Exchange Commission (“SEC”).  Because this is an interim period filing presented using a condensed format, it does not include all information and footnotes normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”).  You should read this report along with our Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 Annual Report on Form 10-K”), which contains a summary of our significant accounting policies and other disclosures.  The condensed consolidated financial statements as of March 31, 2012 and for the quarters ended March 31, 2012 and 2011 are unaudited.  We derived the unaudited condensed consolidated balance sheet as of December 31, 2011 from the audited consolidated balance sheet filed in our 2011 Annual Report on Form 10-K.  In our opinion, we have made adjustments, all of which were normal recurring adjustments unless otherwise disclosed herein, that we believe are necessary for a fair statement of the balance sheets, results of operations and cash flows, as applicable.
 
These unaudited condensed consolidated financial statements include the accounts of all consolidated subsidiaries after the elimination of all significant intercompany accounts and transactions.

Fair Value of Financial Instruments
 
At March 31, 2012, the carrying amount of cash and cash equivalents, accounts receivable trade, restricted cash, non-trade receivables, accounts payable and accrued liabilities approximated their fair value due to their short maturities. At March 31, 2012, the carrying amount of our long term debt approximated its fair value.  The fair value of our long term debt is determined using observable inputs and is based on current market interest rates for debt issued with similar maturities by companies with risk profiles similar to ours (Level 2).

Revision to Previously Issued Financial Statement
 
The unaudited condensed consolidated statement of income for the quarter ended as of March 31, 2011 has been revised to reflect a one-time Colombian government enacted net worth tax for all Colombian entities, effective January 1, 2011.  Based on our Colombian operations' net equity, measured on a Colombian tax basis as of January 1, 2011, our total net-worth tax obligation was approximately $0.7 million, which is not deductible for tax purposes.  The unaudited condensed consolidated financial statements as of March 31, 2012 and for the quarters ended March 31, 2012 and 2011, included in this Quarterly Report on Form 10-Q, properly reflect the Colombian tax obligation. The following table summarizes the effect of recording the revision on the unaudited condensed consolidated statement of income for the quarter ended March 31, 2011 (in thousands, except per share information):

 

5


 
Three Months Ended March 31, 2011
 
As previously reported
 
Adjustments
 
As revised
Revenue
$
105,622

 
$

 
$
105,622

 
 
 
 
 
 
Total operating expenses
$
97,413

 
$
693

 
$
98,106

 
 
 
 
 
 
Income before income taxes
$
7,709

 
$
(693
)
 
$
7,016

 
 
 
 
 
 
Net income
$
5,010

 
$
(693
)
 
$
4,317

 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
Basic
$
0.13

 
$
(0.02
)
 
$
0.11

Diluted
$
0.13

 
$
(0.02
)
 
$
0.11


Subsequent Events

We conducted our subsequent events review through the date on which these unaudited condensed consolidated financial statements were filed with the SEC.

In April 2012, the Company entered into a definitive agreement to sell our CASING DRILLING™ business to Schlumberger for a total consideration of $45 million in cash, subject to customary purchase price adjustments. The sale is expected to close in the second quarter of 2012. As of March 31, 2012, our CASING DRILLINGTM long lived assets, inventory and accounts receivable had a net book value of approximately $11.0 million, $6.7 million and $4.9 million, respectively.
In April 2012, we amended our credit agreement (the "new credit facility") to provide a revolving line of credit of $125 million including up to $20 million of swing line loans (collectively, the “New Revolver”). The new credit facility has a term of five years and all outstanding borrowings on the New Revolver are due and payable on April 29, 2017.  Additionally, the new credit facility bears interest at a margin above LIBOR, federal funds rate, or the prime rate for U.S. dollar loans as determined by JPMorgan Chase Bank, N.A. in New York.  We are required to pay a commitment fee on available, but unused, amounts of the new credit facility of 0.375-0.500 percent per annum and a letter of credit fee of 1.00 percent per annum on outstanding face amounts of letters of credit issued under the new credit facility. Amounts available under the New Revolver are reduced by letters of credit issued under our credit facility, not to exceed $50 million in the aggregate.  Amounts available under the swing line loans may also be reduced by letters of credit or by means of a credit to a general deposit account of the applicable borrower.  The availability of future borrowings may also be limited in order to maintain certain financial ratios required under the covenants.  The new credit facility contains covenants that we consider usual and customary for an agreement of this type, including a leverage ratio, a minimum net worth, and limitations on allowable amounts for the disposal of obsolete assets and annual capital expenditures, and a fixed charge coverage ratio.  The new credit facility prohibits incurring any additional indebtedness outside the existing credit facility in excess of $50 million, paying cash dividends to shareholders and contains other restrictions, which are standard to the industry.  All of our direct and indirect material subsidiaries in the United States and Canada are guarantors of any borrowings under the new credit facility.  

In April 2012, we received a favorable determination on a legacy withholding tax issue in a foreign jurisdiction. We have reversed $1.9 million of accruals previously made for this issue ($1.3 million to other income and a $0.6 million reduction of interest expense). For a detailed discussion of this matter, see Note 10—Commitments and Contingencies.

Note 2—Summary of Significant Accounting Policies

Significant Accounting Policies

There have been no material changes to our accounting policies, as described in the notes to our audited consolidated financial statements included in our 2011 Annual Report on Form 10-K.




6


Recent Accounting Pronouncements

Each reporting period we consider all newly issued but not yet adopted accounting and reporting guidance applicable to our operations and the preparation of out consolidated financial statements. We do not believe that any issued accounting and reporting guidance not yet adopted by us will have a material impact on our unaudited condensed consolidated financial statements.

Note 3—Details of Certain Accounts

At March 31, 2012 and December 31, 2011, prepaid and other current assets consisted of the following (in thousands):

 
March 31,
2012
 
December 31,
2011
Prepaid taxes other than income
$
7,889

 
$
9,968

Deposits
8,843

 
7,995

Prepaid insurance
3,261

 
5,136

Other prepaid expenses
4,533

 
4,247

Restricted cash
2,536

 
2,609

Deferred job costs
2,474

 
2,251

Non-trade receivables
995

 
1,120

 
$
30,531

 
$
33,326

 
At March 31, 2012 and December 31, 2011, accrued and other current liabilities consisted of the following (in thousands):

 
March 31,
2012
 
December 31,
2011
Accrued payroll and benefits
$
11,037

 
$
15,545

Accrual for foreign withholding tax claim
2,782

 
5,125

Accrued taxes other than income taxes
7,652

 
9,809

Other current liabilities
4,099

 
3,590

 
$
25,570

 
$
34,069


Note 4—Inventories

At March 31, 2012 and December 31, 2011, inventories, net of reserves of $4.4 million for excess and obsolete inventories, by major classification were as follows (in thousands):

 
March 31,
2012
 
December 31,
2011
Raw materials
$
86,306

 
$
75,399

Work in progress
6,364

 
6,892

Finished goods
35,116

 
29,478

 
$
127,786

 
$
111,769


7



Note 5—Property, plant and equipment

At March 31, 2012 and December 31, 2011, property, plant and equipment, at cost, by major category were as follows (in thousands):

 
March 31,
2012
 
December 31,
2011
Land, buildings and leaseholds
$
25,006

 
$
24,588

Drilling equipment
314,921

 
312,344

Manufacturing equipment
7,927

 
6,910

Office equipment and other
29,311

 
27,621

Capital work in progress
18,120

 
10,814

 
395,285

 
382,277

Less: Accumulated depreciation
(187,739
)
 
(179,209
)
 
$
207,546

 
$
203,068


The net book value of used top drive rental equipment sold included in cost of sales and services on our unaudited condensed consolidated statements of income was $1.7 million for the three months ended March 31, 2012. Four used top drives were sold from our rental fleet during the three months ended March 31, 2012. There were no sales of used units in the three months ended March 31, 2011.

Depreciation and amortization expense for the three months ended March 31, 2012 and 2011 are included on our unaudited condensed consolidated statements of income as follows (in thousands):
 
 
Three Months Ended March 31,
 
2012
 
2011
Cost of sales and services
$
10,265

 
$
8,863

Selling, general and administrative expense 
515

 
404

 
$
10,780

 
$
9,267


Sale of Operating Assets

When top drive units from our rental fleet are sold, the sales proceeds are included in revenue and the net book value of the equipment sold is included in cost of sales and services.  Proceeds from the sale of used top drives are included in proceeds from the sale of operating assets and the difference between revenue and the cost of sales and services is included in gain on sale of operating assets in the accompanying unaudited condensed consolidated statement of cash flows.

Note 6—Warranties

Changes in our warranty accrual for the three months ended March 31, 2012 were as follows (in thousands):
 
March 31, 2012
Balance as of January 1, 2012
$
3,103

Charged to expense, net
4,429

Deductions
(60
)
Balance as of March 31, 2012
$
7,472


During the three months ended March 31, 2012, we recorded warranty expenses of $3.9 million specifically associated with the gear box housing issue for our new ESI model.

8



Note 7—Earnings per Share

Weighted average shares

The following table reconciles basic and diluted weighted average shares (in thousands):

 
Three Months Ended March 31,
 
2012
 
2011
Basic weighted average number of shares outstanding 
38,583

 
38,076

Dilutive effect of stock-based compensation
483

 
677

Diluted weighted average number of shares outstanding
39,066

 
38,753

Anti-dilutive options excluded from calculation due to exercise prices
654

 
1,047


Note 8—Income Taxes
 
Tesco Corporation is an Alberta, Canada corporation.  We conduct business and are taxed on profits earned in a number of jurisdictions around the world.  Income taxes have been recorded based on the laws and rates in effect in the countries in which operations are conducted or in which we are considered a resident for income tax purposes.

Our income tax provision for the three months ended March 31, 2012 and 2011 was as follows (in thousands):

 
Three Months Ended March 31,
 
2012
 
2011
Current tax provision
$
3,384

 
$
2,202

Deferred tax provision
2,659

 
497

Income tax provision
$
6,043

 
$
2,699

 
Our effective tax rate, which is income tax expense as a percentage of pre-tax earnings, was 30% for the three months ended March 31, 2012 compared to 38% for the same period in 2011.  The 8% decrease in our effective tax rate for the three months ended March 31, 2012 as compared to the same period in 2011 is due to the fluctuating mix of pre-tax earnings in the various tax jurisdictions in which we operate around the world.
 
At December 31, 2011, we had an accrual for uncertain tax positions of $1.3 million.  During the first quarter of 2012, we reversed $0.1 million due to legal settlements occurring during the period, leaving a balance of $1.2 million at March 31, 2012. The accrual for uncertain tax positions is included in other liabilities in our consolidated balance sheet as we anticipate that these uncertainties will not be resolved within the next 12 months.  The resolution of these uncertainties should not have a material impact on our effective tax rate.
 
Certain state and foreign tax filings remain open to examination.  We believe that any assessment on these filings will not have a material impact on our financial position, results of operations or cash flows.  We believe that appropriate provisions for all outstanding issues have been made for all jurisdictions and all open years.  However, audit outcomes and the timing of audit settlements are subject to significant uncertainty.  Therefore, additional provisions on tax-related matters could be recorded in the future as revised estimates are made or the underlying matters are settled or otherwise resolved.

9



Note 9—Long term debt

Long term debt consists of the following (in thousands):
 
 
March 31, 2012
 
December 31, 2011
Credit revolver
$
25,000

 
$

Capital leases
379

 
5,567

Other notes payable
921

 
1,058

Current portion of long term debt
(725
)
 
(2,793
)
Non-current portion of long term debt
$
25,575

 
$
3,832

 
As part of our acquisition of Premiere in 2011, we assumed $7.4 million of outstanding debt at the acquisition date of October 16, 2011. At December 31, 2011 the balance of this debt was $5.6 million related to capital leases and $1.1 million related to notes payable. These balances represented all of our outstanding debt at December 31, 2011. During the three months ended March 31, 2012 we paid off a significant amount of the outstanding balances related to Premiere's capital leases. At March 31, 2012 the outstanding balance of Premiere's capital leases was $0.4 million.

At March 31, 2012, we had a credit agreement which was entered into in 2007 and has since been amended several times, most recently in October 2010 (the credit agreement, as so amended, being referred to as the “credit facility”).  Our credit facility originally had a term loan, which was paid in full in 2009, and a revolving line of credit of $100 million including up to $15 million of swingline loans (collectively, the “Revolver”), which was amended to $145 million in December 2007.  Our credit facility had a term of five years and all outstanding borrowings on the Revolver were due and payable on June 5, 2012.  Additionally, our credit facility bore interest at a margin above LIBOR, federal funds rate, or the prime rate for U.S. dollar loans as determined by JPMorgan Chase Bank, N.A. in New York.  We were required to pay a commitment fee on available, but unused, amounts of the credit facility of 0.20 percent per annum and a letter of credit fee of 1.00 percent per annum on outstanding face amounts of letters of credit issued under the credit facility.

Amounts available under the Revolver were reduced by letters of credit issued under our credit facility, not to exceed $20 million in the aggregate of all undrawn amounts and amounts that had yet to be disbursed under all existing letters of credit.  Amounts available under the swingline loans might also be reduced by letters of credit or by means of a credit to a general deposit account of the applicable borrower.  The availability of future borrowings might also be limited in order to maintain certain financial ratios required under the covenants.  

Our credit facility contained covenants that we considered usual and customary for an agreement of this type, including a leverage ratio, a minimum net worth, limitations on allowable amounts for the disposal of obsolete assets and annual capital expenditures, and a fixed charge coverage ratio.  The credit facility prohibited incurring any additional indebtedness outside the existing credit facility in excess of $15 million, paying cash dividends to shareholders and contains other restrictions, that were standard to the industry.  In addition, the credit facility was secured by substantially all our assets. All of our direct and indirect material subsidiaries in the United States and Canada were guarantors of any borrowings under the credit facility.

Under the Revolver at March 31, 2012, we had $25.0 million in borrowings, $0.5 million in letters of credit outstanding, and $119.5 million in available borrowing capacity.

In April 2012, we amended the credit agreement. For a detailed discussion of the amended credit agreement, see Note 1—Nature of Operations and Basis of Preparation, Subsequent Events.

10



Note 10—Commitments and Contingencies
 
Legal contingencies

In the normal course of our business, we are subject to legal proceedings brought by or against us and our subsidiaries.  None of these proceedings involves a claim for damages exceeding ten percent of our current assets on a consolidated basis.

The estimates below represent our best estimates based on consultation with internal and external legal counsel.  There can be no assurance as to the eventual outcome or the amount of loss we may suffer as a result of these proceedings.

Varco I/P, Inc. (“Varco”) filed suit against us in April 2005 in the U.S. District Court for the Western District of Louisiana, alleging that our CDS infringes certain of Varco’s U.S. patents.  Varco seeks monetary damages and an injunction against further infringement.  We filed a countersuit against Varco in June 2005 in the U.S. District Court for the Southern District of Texas, Houston Division seeking invalidation of the Varco patents in question.  In July 2006, the Louisiana case was transferred to the federal district court in Houston, and as a result, the issues raised by Varco have been consolidated into a single proceeding in which we are the plaintiff.  We also filed a request with the U.S. Patent and Trademark Office (“USPTO”) for reexamination of the patents on which Varco’s claim of infringement is based.  The USPTO accepted the Varco patents for reexamination, and the district court stayed the patent litigation pending the outcome of the USPTO reexamination.  In May 2009, the USPTO issued a final action rejecting all of the Varco patent claims that we had contested.  Varco has appealed this decision with the USPTO and that reexamination appeal is pending. The outcome and amount of any future financial impacts from this litigation are not determinable at this time.

In December 2009, we received an administrative subpoena from the Department of the Treasury, Office of Foreign Assets Control (OFAC) regarding a past shipment of oilfield equipment made from our Canadian manufacturing facility in 2006 to Sudan.  We reviewed this matter and have provided a timely response to the subpoena.  Our internal investigation revealed that in 2006 and 2007, a total of four top drive units were shipped to Sudan from our Canadian manufacturing facility.  Technicians were also dispatched from one of our regional offices outside of the United States to install the top drive units.  The total revenue from these activities with respect to the periods involved was approximately 0.5% and 0.7% of total revenue in 2006 and 2007, respectively.  Our policy is not to conduct any business in or sell any products to Sudan and we have implemented strengthened controls and procedures designed to ensure compliance with this policy.  We disclosed the results of our internal investigation to, and are fully cooperating with, OFAC.  We continue to evaluate the potential outcome of this matter.  The effect on our consolidated financial position, results of operations or cash flows is not reasonably determinable at this time.  Accordingly, we have not accrued a reserve for this matter as of March 31, 2012.  An agreement tolling any applicable statute of limitations governing this investigation expired in January 2011 without a request for an extension.

Weatherford International, Inc. and Weatherford/Lamb Inc. (“Weatherford”) filed suit against us in the U.S. District Court for the Eastern District of Texas, Marshall Division in December 2007 (the “Marshall Suit”), alleging that various of our technologies infringe 11 different patents held by Weatherford.  Weatherford sought monetary damages and an injunction against further infringement.  Our technologies referred to in the claim included the CDS, the CASING DRILLING system and method, a float valve, and the locking mechanism for the controls of the tubular handling system.  We filed a general denial seeking a judicial determination that we did not infringe the patents in question and/or that the patents are invalid.

In August 2008, we filed suit against several competitors in the U.S. District Court for the Southern District of Texas – Houston Division, including Weatherford (the “Houston Suit”).  The Houston Suit claims infringement of two of our patents related to our CDS.  On October 26, 2010, we entered into a settlement with Weatherford (the “Settlement”) dismissing both the Marshall Suit and the Houston Suit (as it relates to Weatherford) with prejudice.  Among other provisions, the Settlement contains the following terms:

Non-exclusive irrevocable worldwide and royalty free cross licenses with respect to all the patents asserted by Weatherford in the Marshall Case and by us in the Houston Case, as well as certain other U.S. and foreign equivalents and counterparts; and
Weatherford has agreed to purchase for five years 67% of its worldwide top drive requirements from us, as long as we can meet production requirements, and to designate us as a preferred provider of after-market sales and service for top drives.  The prices we charge Weatherford will be equal to or lower than the prices we charge to any other customer of similar volume of purchases and/or services.



11


We entered into a Final Settlement and License Agreement (the "Settlement Agreement") with Weatherford on January 11, 2011, effective as of October 26, 2010.  As an additional condition of the Settlement Agreement, neither we nor Weatherford will pursue any cause of action that might adversely affect the validity or enforceability of each other's patents as listed in the exhibits to the Settlement Agreement, including any causes of action that may arise from the requests for review we filed with the U.S. Patent and Trademark Office in November 2008.

On November 11, 2010 we won a jury verdict against National Oilwell Varco, L.P. ("NOV"), Frank's Casing Crew and Rental Tools, Inc. ("Frank's") and Offshore Energy Services, Inc. ("OES") for infringing our U.S. Patent Nos. 7,140,443 and 7,377,324.  In that verdict, the jury found that NOV's accused product, the CRT 350, infringes all valid patent claims in the asserted patents, and that NOV contributorily infringed all valid patent claims in the asserted patents.  The jury also found that Frank's accused products, the (i) SuperTAWG, (ii) FA-1, and (iii) CRT 350, and OES's accused products, the CRT 350, infringe all valid patent claims in the asserted patents.  Damages were stipulated by the parties and the verdict is subject to entry of judgment and appeal.

We have been previously advised by the Mexican tax authorities that they believe significant expenses incurred by our Mexican operations from 1996 through 2002 are not deductible for Mexican tax purposes.  Between 2002 and 2008, formal reassessments disallowing these deductions were issued for each of these years, all of which we appealed to the Mexican court system.  We have obtained final court rulings deciding all years in dispute in our favor, except for 1996 as discussed below, and 2001 and 2002, both of which are currently before the Mexican Tax Court.  The outcomes of such appeals are uncertain.  We continue to believe that the basis for these reassessments was incorrect, and that the ultimate resolution of those outstanding matters will likely not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

In May 2002, we paid a deposit of $3.3 million to the Mexican tax authorities in order to appeal the reassessment for 1996.  In 2007, we requested and received a refund of approximately $3.7 million (the original deposit amount of $3.3 million plus $0.4 million in interest).  With the return of the $3.3 million deposit, the Mexican tax authorities issued a resolution indicating that we were owed an additional $3.4 million in interest and inflation adjustments but this amount had been retained by the tax authorities to satisfy a second reassessment for 1996.  We believed the second reassessment was invalid, and appealed it to the Mexican Tax Court.  In 2009, the Mexican Tax Court issued a decision accepting our arguments in part, which was subject to further appeal.

In May 2011, we received a refund of approximately $3.8 million (the remaining $3.4 million noted above, plus $0.4 million of additional interest and inflation adjustments) and recorded $2.4 million in interest income, $0.6 million in other income, partially offset by $0.4 million of related interest expense.  The remaining $1.2 million is included in other liabilities pending the ultimate resolution of this issue.

In August 2008, we received a claim in Mexico for $1.1 million in fines and penalties related to the exportation of certain temporarily imported equipment that remained in Mexico beyond the authorized time limit for its return.  We disagree with this claim and are currently litigating the matter.  In December 2009, we received a decision from the Mexican Tax Court in our favor, which is subject to further appeal.  The outcome of this litigation is uncertain. No accrual has been recorded for this claim.

In July 2006, we received a claim for withholding tax, penalties and interest related to payments over the periods from 2000 to 2004 in a foreign jurisdiction.  We disagree with this claim and are currently litigating this matter.  During 2006, we accrued an estimated pre-tax exposure of $3.8 million and continue to accrue interest for this matter. In April 2012, we received final determination for the 2000 and 2002 tax years and have reversed $1.9 million of the accrual ($1.3 million to other income and a $0.6 million reduction of interest expense). At March 31, 2012, we have $2.8 million accrued for the remaining years.

In October 2011, we received a $1.0 million tax assessment from the Norwegian tax authorities. In January 2012, we submitted to the authorities our position that no tax liability is due. Our submission was not accepted by the authorities and we are currently appealing this decision in the Norwegian legal system. We believe the assessment has no merit and no accrual has been made for this assessment.
 
Other Contingencies
 
We are contingently liable under letters of credit and similar instruments that we enter in connection with the importation of equipment to foreign countries and to secure our performance on certain contracts.  At March 31, 2012 and December 31, 2011, our total exposure under outstanding letters of credit was $8.4 million and $12.8 million, respectively.
 

12



Note 11—Segment Information
 
Business Segments
 
Our four business segments are: Top Drive, Tubular Services, CASING DRILLING™ and Research and Engineering. Our Top Drive segment is comprised of top drive sales, top drive rentals and after-market sales and service.  Our Tubular Services segment includes both our proprietary and conventional tubular services.  Our CASING DRILLING™ segment consists of our proprietary CASING DRILLING™ technology.  Our Research and Engineering segment is comprised of our internal research and development activities related to our proprietary tubular services, CASING DRILLING™ technology, and top drive model development.

We measure the results of our business segments using, among other measures, each segment’s operating income, which includes certain corporate overhead allocations.  Overhead costs include field administration and operations support.  At a business segment level, we incur costs directly and indirectly associated with revenue.  Direct costs include expenditures specifically incurred for the generation of revenue, such as personnel costs on location or transportation, maintenance and repair, and depreciation of our revenue-generating equipment.


Certain sales and marketing activities, financing activities and corporate general and administrative expenses as well as other (income) expense and income taxes are not allocated to our business segments.

Goodwill is allocated to the business segment to which it specifically relates.  Our goodwill has been allocated to the Tubular Services segment.  We do not track or measure property, plant and equipment by business segment and, as such, this information is not presented.
 
Significant financial information relating to our business segments is presented below (in thousands):

 
Three Months Ended March 31, 2012
 
Top
Drive
 
Tubular
Services
 
CASING
DRILLING™
 
Research &
Engineering
 
Corporate and
Other
 
Total
Revenue
$
101,816

 
$
43,471

 
$
7,134

 
––

 
––

 
$
152,421

Depreciation and amortization
2,913

 
5,818

 
1,083

 
20

 
946

 
10,780

Operating income (loss)
24,893

 
4,942

 
(853
)
 
(2,542
)
 
(7,419
)
 
19,021

Other expense (income)
 

 
 

 
 

 
 

 
 

 
(1,441
)
Income before income taxes
 

 
 

 
 

 
 

 
 

 
$
20,462


 
Three Months Ended March 31, 2011
 
Top
Drive
 
Tubular
Services
 
CASING
DRILLING™
 
Research &
Engineering
 
Corporate and
Other
 
Total
Revenue
$
70,449

 
$
32,288

 
$
2,885

 
––

 
––

 
$
105,622

Depreciation and amortization
2,625

 
4,575

 
1,147

 
11

 
909

 
9,267

Operating income (loss)
21,158

 
1,613

 
(3,113
)
 
(2,885
)
 
(9,257
)
 
7,516

Other expense (income)
 

 
 

 
 

 
 

 
 

 
500

Income before income taxes
 

 
 

 
 

 
 

 
 

 
$
7,016


13



Geographic Areas
 
We attribute revenue to geographic regions based on the location of the customer.  Generally, for service activities, this will be the region in which the service activity occurs.  For equipment sales, this will be the region in which the sale transaction is complete and title transfers.  Our revenue by geographic area for the three months ended March 31, 2012 and 2011 was as follows (in thousands):

 
Three Months Ended March 31,
 
2012
 
2011
United States
38,423

 
31,865

South America
15,081

 
12,305

Canada
56,534

 
33,739

Russia
11,356

 
4,956

Asia Pacific
11,138

 
8,361

Mexico
12,116

 
7,711

Europe, Africa and Middle East
7,773

 
6,685

Total
152,421

 
105,622


The physical location of our net property, plant and equipment by geographic area as of March 31, 2012 and 2011 was as follows (in thousands):

 
March 31,
2012
 
December 31,
2011
United States
$
56,804

 
$
56,758

Mexico
36,586

 
35,473

South America
21,209

 
22,943

Asia Pacific
22,592

 
22,414

Russia
19,089

 
20,236

Europe, Africa and Middle East
35,498

 
30,544

Canada
15,768

 
14,700

Total
$
207,546

 
$
203,068



14


Item 2.                      Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q.  This discussion contains forward-looking statements.  Please see “Caution Regarding Forward-Looking Information; Risk Factors” above and “Risk Factors” in Part II, Item IA below and in our 2011 Annual Report on Form 10-K, for a discussion of the uncertainties, risks and assumptions associated with these statements.

Overview and Outlook

We are a global leader in the design, manufacture and service delivery of technology based solutions for the upstream energy industry.  We seek to change the way wells are drilled by delivering safer and more efficient solutions that add real value by reducing the costs of drilling for and producing oil and natural gas.
 
Our four business segments are:
Top Drives – top drive sales, top drive rentals and after-market sales and services;
Tubular Services – proprietary and conventional tubular services;
CASING DRILLING™ – proprietary CASING DRILLING™ technology; and
Research and Engineering – internal research and development activities related to our proprietary tubular services, CASING DRILLING™ technology, and top drive model development.

Business Environment

In 2011 and into 2012, oil and natural gas drilling activity increased significantly from the low level of activity beginning with the severe global economic downturn in 2008.  During 2011, international rig count increased from 2010 levels and continues to improve in 2012.  One of the key indicators of our business is the number of active drilling rigs.  Below is a table that shows average rig count by region for the three months ended March 31, 2012 and 2011.
 
 
Three Months Average Rig Count(1)
 
 
 
March 31,
 
Increase / (Decrease)
 
2012
 
2011
 
2011 to 2012
U.S.
1,991

 
1,716

 
275

16
 %
Canada
592

 
587

 
5

1
 %
Latin America (includes Mexico)
432

 
410

 
22

5
 %
Middle East (excludes Iran, Iraq and Sudan)
311

 
283

 
28

10
 %
Asia Pacific (excludes China onshore)
250

 
273

 
(23
)
(8
)%
Europe (excludes Russia)
112

 
118

 
(6
)
(5
)%
Africa
83

 
82

 
1

1
 %
Worldwide
3,771

 
3,469

 
302

9
 %

(1)  Source: Baker Hughes Incorporated worldwide rig count; averages are monthly.

Summary of the First Quarter Ended March 31, 2012 and Operational Performance

During the first quarter of 2012, our Top Drive segment had a significant increase in the number of top drive units sold compared to the same period in 2011.  Our Tubular Services segment revenue and operating income has also improved significantly in the first quarter of 2012 as compared to the first quarter of 2011. This segment is continuing to recover from lower activity levels in the Gulf of Mexico caused by the drilling moratorium imposed in 2010 and extreme winter weather conditions that slowed North American operations in the first quarter of 2011. Our proprietary tubular services offering continues to gain market acceptance and we remain committed to growing this segment as we believe that every rig with a top drive will eventually convert to running casing with an automated system, such as our CDS™ system.  We also invested in new and enhanced product and service offerings in our Research and Engineering segment.  We believe that our financial condition has improved significantly over the past year, as demonstrated by the following:



15


Increased revenue from $105.6 million in the first quarter of 2011 to $152.4 million in the first quarter of 2012;

Increased operating income from $7.5 million in the first quarter of 2011 to $19.0 million in the first quarter of 2012;

Growth in our top drive backlog from 43 units with potential revenue value of $57.4 million at March 31, 2011 to 57 units with potential revenue value of $74.0 million at March 31, 2012; and

Although we used more cash and cash equivalents to fund operating activities during the three months ended March 31, 2012 as compared to the same period in 2011, we also increased our inventory levels in order to meet anticipated customer demand.

 Outlook for 2012

Volatility in the global economy has continued over the past few quarters as a result of the United States debt downgrade, European debt crisis, reduced consumer demand, slower GDP growth rates in the United States and internationally, and declining natural gas prices. Furthermore, in order to address negative fiscal situations and initiate deficit reduction measures, many governments are seeking additional revenue sources, including eliminating key federal income tax incentives currently available to oil and natural gas exploration and production companies. Current global macro-economic conditions make any projections difficult and uncertain; however, they could result in oil and gas operators curtailing drilling activity, which would negatively affect our business.

Thus far, clear signs of weakening demand have had a limited impact on oil and natural gas market fundamentals and we continue to anticipate moderately improved activity for the remainder of 2012 in each of our revenue generating segments, as follows:

Top Drive - Based upon existing drilling and bidding levels and the size of our product sale backlog, we expect our top drive order rate and rental activity to remain steady for the remainder of 2012. In North America, we are experiencing some downward pressure in bidding activity.  Our outstanding new unit sales backlog was 57 units at March 31, 2012, compared to 43 units at March 31, 2011 and 74 units at December 31, 2011.  Our customers have maintained their focus on lowering project costs, which continues to put downward pressure on our sales prices on select product offerings. 
 
Tubular Services - We expect our CDS™ proprietary and conventional casing running business to continue to grow moderately for the remainder of 2012. We will continue to expand our proprietary casing service offerings, particularly in the major unconventional shale regions in North America and select international locations. In addition, we expect drilling activity in the U.S. Gulf of Mexico to gradually increase into 2012, which should increase demand for our MCLRS proprietary services.

CASING DRILLING™ – In April 2012, the Company entered into a definitive agreement to sell our CASING DRILLING™ business to Schlumberger for a total consideration of $45 million in cash, subject to customary purchase price adjustments. The sale is expected to close in the second quarter of 2012.

16



Operating Results

Below is a summary of our operating results for the three months ended March 31, 2012 and 2011 (in thousands, except percentages):

 
Three Months Ended March 31,
 
Increase / (Decrease)
 
2012
 
2011
 
2011 to 2012
(in thousands, except percentages)
 
 
 
 
 
Segment revenue
 
 
 
 
 
 
Top Drive
$
101,816

 
$
70,449

 
$
31,367

45%
Tubular Services
43,471

 
32,288

 
11,183

35%
CASING DRILLING™
7,134

 
2,885

 
4,249

147%
Consolidated revenue
$
152,421

 
$
105,622

 
$
46,799

44%
Segment operating income (loss)
 
 
 
 
 
 
Top Drive
$
24,893

 
$
21,158

 
$
3,735

18%
Tubular Services
4,942

 
1,613

 
3,329

206%
CASING DRILLING™
(853
)
 
(3,113
)
 
2,260

(73)%
Research & engineering
(2,542
)
 
(2,885
)
 
343

(12)%
Corporate and other
(7,419
)
 
(9,257
)
 
1,838

(20)%
Consolidated operating income
19,021

 
7,516

 
11,505

153%
Other expense (income)
(1,441
)
 
500

 
(1,941
)
(388)%
Income tax provision
6,043

 
2,699

 
3,344

124%
Net income
$
14,419

 
$
4,317

 
$
10,102

234%
 
Top Drive Segment

Our Top Drive business segment sells equipment and provides services to drilling contractors and oil and natural gas operating companies throughout the world.  We primarily manufacture top drives that are used in drilling operations to rotate the drill string while suspended from the derrick above the rig floor.  We also provide top drive rental services on a day-rate basis for land and offshore drilling rigs, and we provide after-market sales and support for our customers.  The following is a summary of our operating results and metrics for the three months ended March 31, 2012 and 2011 (in thousands, except percentages, units, days and rate):
 

17


 
Three Months Ended March 31,
 
Increase / (Decrease)
 
2012
 
2011
 
2011 to 2012
Top Drive revenue
 
 
 
 
 
 
Sales
$
50,400

 
$
24,962

 
$
25,438

102%
Rental services
34,646

 
33,257

 
1,389

4%
After-market sales and services
16,770

 
12,230

 
4,540

37%
 
101,816

 
70,449

 
31,367

45%
Top Drive operating income
$
24,893

 
$
21,158

 
$
3,735

18%
Number of top drive sales:
 
 
 
 
 
 
New
35

 
17

 
18

106%
Used or consignment
4

 
1

 
3

300%
 
39

 
18

 
21

117%
End of period number of top drives in rental fleet:
130

 
125

 
5

4%
Rental operating days(a)
6,987

 
6,870

 
117

2%
Average daily operating rate
$
4,959

 
$
4,841

 
$
118

2%

 (a)  Defined as a day that a unit in our rental fleet is under contract and operating; does not include stand-by days.

Top Drive operating results were largely driven by increased oil and natural gas drilling activity and new rig build activity undertaken to meet anticipated global drilling demand. The average active rig count increased for the first quarter of 2012 by 9% from the same period in 2011.

In March 2012, our quality control processes found casting anomalies in the gearbox housing of our new ESI top drive model and subsequently determined that the casting of the gearbox housing did not meet TESCO's standards.  Because this quality issue may affect up to the first 18 ESI units produced, management has informed our customers to arrange for inspection in order to determine if their ESI top drive is impacted by this issue.  None of these top drive units have been placed into service by our customers. We have provided for a specific warranty accrual of $3.9 million at March 31, 2012.

Top Drive sales revenue — The increase in revenue for the three months ended March 31, 2012 compared to the same period in 2011 is due to an increase in the number of new units sold.

The selling price per unit varies significantly depending on the model, whether the unit was previously operated in our rental fleet and whether a power unit was included in the sale.  Revenue related to the sale of used or consignment top drive units was $7.0 million during the three months ended March 31, 2012 and $0.7 million for the three months ended March 31, 2011.

Top Drive rental revenue — The increase in revenue for the three months ended March 31, 2012 compared to the same period in 2011 is due to improved operating days, utilization rates and a larger rental fleet during the respective periods. 

Top Drive after-market sales and services revenue — Revenue for the three months ended March 31, 2012 improved significantly compared to the same period in 2011 as we began to recover lost business experienced in prior years due to the industry downturn and as a result of a larger installed base of top drives.

Top Drive operating income — The increase in Top Drive operating income for the three months ended March 31, 2012 as compared to the same period in 2011 is due to higher revenue for Top Drive sales, rental services, and after-market sales and services discussed above. This increase was significantly offset due to an increase in warranty expense of $3.9 million specifically associated with the gearbox housing issue for our new ESI model.

Tubular Services Segment

Our Tubular Services business segment includes both proprietary and conventional casing running services, which are mostly offered as a “call out” service on a well-by-well basis.  Our proprietary Tubular Service business is based on our Proprietary Casing

18


Running Service technology, which uses certain components of our CASING DRILLING™ technology, in particular the CDS™, and provides an efficient method for running casing and, if required, reaming the casing into the hole.  In addition, our proprietary Tubular Service business includes the installation services of deep water smart well completion equipment using our MCLRS, a proprietary and patented technology that improves the quality of the installation of high-end well completions.  Our conventional Tubular Service business provides equipment and personnel for the installation of tubing and casing, including power tongs, pick-up/lay-down units, torque monitoring services, connection testing services and power swivels for new well construction and in work-over and re-entry operations.  Below is a summary of our operating results and metrics for the three months ended March 31, 2012 and 2011 (in thousands, except percentages and number of jobs):
 
 
Three Months Ended March 31,
 
Increase/ (Decrease)
 
2012
 
2011
 
2011 to 2012
Tubular Services revenue
 
 
 
 
 
 
Proprietary
$
32,588

 
$
24,529

 
$
8,059

33%
Conventional
10,883

 
7,759

 
3,124

40%
 
$
43,471

 
$
32,288

 
$
11,183

35%
Tubular Services operating income
$
4,942

 
$
1,613

 
$
3,329

206%
Number of proprietary jobs
859

 
820

 
39

5%
 
The increase in Tubular Services revenue for the three months ended March 31, 2012 compared to the same period in 2011 is due to increased demand for tubular services.  A significant amount of current U.S. drilling activity is in shale formations that require directional and horizontal drilling techniques, which we believe are good applications for our proprietary service offerings. In addition, increased domestic and international demand for our tubular services, both proprietary and conventional, has resulted in new jobs at more favorable pricing terms. For the three months ended March 31, 2012 revenue related to our MCLRS proprietary tubular services increased $0.8 million compared to the same period in 2011, as revenue for the three months ended March 31, 2011 was minimal due to the market conditions resulting from the Deepwater Horizon explosion, the temporary Gulf of Mexico drilling moratorium and the resulting negative impact on the deepwater drilling permitting process. Tubular Services revenue for the three months ended March 31, 2012 included $1.8 million of revenue for CDS equipment sales while no CDS equipment sales were made during the same period in 2011.

The increase in Tubular Services operating income for the three months ended March 31, 2012 as compared to the same period in 2011 is due to higher revenue for proprietary and conventional jobs discussed above, as well as improved margins as oil and natural gas drilling activity continues to recover from the severe downturn experienced in prior years. 

CASING DRILLING™ Segment

Our CASING DRILLING™ business is based on our proprietary CASING DRILLING™ technology, which uses patented equipment and processes to allow an oil or gas well to be drilled using standard well casing pipe.  In contrast, conventional or straight practice rotary drilling requires the use of drill pipe and drill string components.  The demonstrated benefits of using well casing to drill the well compared with conventional drilling include a reduction in the risk of unscheduled downhole events that typically result in non-productive time and additional cost and operational risk to the drilling contractor and well operator.  

In April 2012, the Company entered into a definitive agreement to sell our CASING DRILLING™ business to Schlumberger for a total consideration of $45 million in cash, subject to customary purchase price adjustments. The sale is expected to close in the second quarter of 2012.
The following is a summary of our operating results for the three months ended March 31, 2012 and 2011 (in thousands, except percentages):
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
2012
 
2011
 
2011 to 2012
CASING DRILLING™ revenue
$
7,134

 
$
2,885

 
$
4,249

147%
CASING DRILLING™ operating loss
$
(853
)
 
$
(3,113
)
 
$
2,260

73%

19


  
CASING DRILLING™ revenue for the three months ended March 31, 2012 improved significantly over the same period in 2011 due to improved demand for our services from multi-well contracts and an increase in the number of higher-margin jobs performed.

CASING DRILLING™ operating loss decreased for the three months ended March 31, 2012 compared to the same period in 2011 due primarily to increased revenue, our focus on cost management and related job activity. We believe that demand for CASING DRILLING™ services will continue to improve for the remainder of 2012 and into 2013 based on signed contracts and current bidding activity.
 
Research and Engineering Segment

Our Research and Engineering segment is comprised of our internal research and development activities related to Tubular Services technology, CASING DRILLING™ technology and top drive model development.  Below is a summary of our research and engineering expense for the three months ended March 31, 2012 and 2011 (in thousands, except percentages):

 
Three Months Ended March 31,
 
Increase / (Decrease)
 
2012
 
2011
 
2011 to 2012
Research and engineering expense
$
2,542

 
$
2,885

 
$
(343
)
(12)%
 
Research and engineering expenses decreased during the three months ended March 31, 2012 as compared to the same period in 2011. We continue to invest in the development, commercialization and enhancements of our proprietary technologies.

Corporate and Other Segment

Corporate and other expenses primarily consist of the corporate level general and administrative expenses and certain selling and marketing expenses.  Below is a summary of our corporate and other expenses for the three months ended March 31, 2012 and 2011 (in thousands, except percentages):
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
2012
 
2011
 
2011 to 2012
Corporate and other expenses
$
7,419

 
$
9,257

 
$
(1,838
)
(20)%
Corporate and other expenses as a % of revenue
5
%
 
9
%
 
(4) pts

Corporate and other expenses decreased $1.8 million during the three months ended March 31, 2012 as compared to the same period in 2011. Stock compensation decreased by $1.1 million and other compensation costs decreased by $0.7 million for the three months ended March 31, 2012, as compared to the same period in 2011.

Other Expense (Income)

The following is a summary of our other expense (income) for the three months ended March 31, 2012 and 2011 (in thousands, except percentages):
 

20


 
Three Months Ended March 31,
 
Increase / (Decrease)
 
2012
 
2011
 
2011 to 2012
Other expense (income)
 
 
 
 
 
 
Interest expense
$
(358
)
 
$
286

 
$
(644
)
(225)%
Interest income
(31
)
 

 
(31
)
Foreign exchange losses
280

 
186

 
94

51%
Other expense (income)
(1,332
)
 
28

 
(1,360
)
(4,857)%
Total other expense (income)
$
(1,441
)
 
$
500

 
$
(1,941
)
(388)%

In April 2012, we received a favorable determination on a legacy withholding tax issue in a foreign jurisdiction. We have reversed $1.9 million of accruals previously made for this issue ($1.3 million to other income and a $0.6 million reduction of interest expense). For a detailed discussion of this matter, see Part I, Item 2. Financial Statements, Note 10—Commitments and Contingencies.
 
  Income Tax Provision
 
 
Three Months Ended March 31,
 
Increase / (Decrease)
 
2012
 
2011
 
2011 to 2012
Effective income tax rate
30%
 
38%
 
(8) pts
 
We are an Alberta, Canada corporation.  We conduct business and are taxed on profits earned in a number of jurisdictions around the world. Our income tax rate is based on the laws and rates in effect in the countries in which our operations are conducted or in which we are considered a resident for income tax purposes.  Our effective tax rate, which is income tax expense as a percentage of pre-tax earnings, decreased for the three months ended March 31, 2012 compared to the same period in 2011 due to the fluctuating mix of pre-tax earnings in the various tax jurisdictions in which we operate around the world.

 Liquidity and Capital Resources

We rely on our cash and access to credit to fund our operations, growth initiatives and acquisitions.  Our primary sources of liquidity are cash flows generated from our operations, available cash and cash equivalents, and availability under our revolving credit facility.  We use these sources of liquidity to fund our working capital requirements, capital expenditures, strategic investments and acquisitions.  For 2012, we forecast capital expenditures to be between $50 million to $60 million based on increased demand for our products and services. We expect to be able to fund our activities for 2012 with cash flows generated from our operations, available cash and cash equivalents, and available borrowings under our revolving credit facility.
 
Our net cash position at March 31, 2012 and December 31, 2011 was as follows (in thousands):
 
March 31,
2012
 
December 31,
2011
Cash
$
17,891

 
$
23,069

Current portion of long term debt
(725
)
 
(2,793
)
Long term debt
(25,575
)
 
(3,832
)
Net cash / (debt)
$
(8,409
)
 
$
16,444


We report our net cash position because we regularly review it as a measure of our performance. However, the measure presented in this document may not always be comparable to similarly titled measures reported by other companies due to differences in the components of the measurement we use.

At March 31, 2012, we had a credit agreement which was entered into in 2007 and has since been amended several times, most recently in October 2010 (the credit agreement, as so amended, being referred to as the “credit facility”).  Our credit facility originally had a term loan, which was paid in full in 2009, and a revolving line of credit of $100 million including up to $15 million

21


of swingline loans (collectively, the “Revolver”), which was amended to $145 million in December 2007.  Our credit facility had a term of five years and all outstanding borrowings on the Revolver were due and payable on June 5, 2012.  Additionally, our credit facility bore interest at a margin above LIBOR, federal funds rate, or the prime rate for U.S. dollar loans as determined by JPMorgan Chase Bank, N.A. in New York.  We were required to pay a commitment fee on available, but unused, amounts of the credit facility of 0.20 percent per annum and a letter of credit fee of 1.00 percent per annum on outstanding face amounts of letters of credit issued under the credit facility.

Amounts available under the Revolver were reduced by letters of credit issued under our credit facility, not to exceed $20 million in the aggregate of all undrawn amounts and amounts that had yet to be disbursed under all existing letters of credit.  Amounts available under the swingline loans might also be reduced by letters of credit or by means of a credit to a general deposit account of the applicable borrower.  The availability of future borrowings might also be limited in order to maintain certain financial ratios required under the covenants.  

Our credit facility contained covenants that we considered usual and customary for an agreement of this type, including a leverage ratio, a minimum net worth, limitations on allowable amounts for the disposal of obsolete assets and annual capital expenditures, and a fixed charge coverage ratio.  The credit facility prohibited incurring any additional indebtedness outside the existing credit facility in excess of $15 million, paying cash dividends to shareholders and contains other restrictions, that were standard to the industry.  In addition, the credit facility was secured by substantially all our assets. All of our direct and indirect material subsidiaries in the United States and Canada were guarantors of any borrowings under the credit facility.

Under the Revolver at March 31, 2012, we had $25.0 million in borrowings, $0.5 million in letters of credit outstanding, and $119.5 million in available borrowing capacity.

In April 2012, we amended the credit agreement. For a detailed discussion of the amended credit agreement, see Part I, Item 2. Financial Statements, Note 1 included in this Quarterly Report on Form 10-Q.

Cash Flows

Our cash flows fluctuate with the level of spending by oil and natural gas companies for drilling activities.  Certain sources and uses of cash, such as the level of discretionary capital expenditures and the issuance and repayment of debt, are within our control and are adjusted as necessary based on market conditions.  The following is a discussion of our cash flows for the three months ended March 31, 2012 and 2011.

Operating Activities – Net cash provided by operating activities is our primary source of capital and liquidity.  Net cash used for operating activities was $8.0 million for the three months ended March 31, 2012 compared to $6.0 million during the same period in 2011.  The increase in net cash used for operating activities is primarily due to increased cash outlays for inventory purchases and increasing accounts receivable, as a result of our increased activity levels from the continued recovery in the economy and the oil and natural gas drilling activities in general. Inventory increased from $111.8 million at December 31, 2011 to $127.8 million at March 31, 2012 to support our top drive backlog, forecasted demand for top drive rental fleet additions, and forecasted customer demand for new CDS™ tools and AMSS parts.

Investing Activities – Net cash used for investing activities was $17.0 million during the three months ended March 31, 2012 compared to $7.8 million during the same period of 2011.  During the three months ended March 31, 2012 and 2011, we used $17.9 million and $8.1 million of cash, respectively, for capital expenditures, and sales from operating assets provided $0.8 million and $0.3 million of cash, respectively. Our capital expenditures increased by $9.7 million or 119% during the three months ended March 31, 2012 as compared to same period of 2011 to meet projected demand for our products and services. 

Financing Activities – Net cash provided by financing activities was $19.8 million during the three months ended March 31, 2012 compared to $0.1 million for the same period in 2011.  During the first quarter of 2012, we borrowed $26.0 million from our revolving credit facility and used $6.3 million of cash to repay our debt.  

Manufacturing Purchase Commitments

Our manufacturing purchase commitments, which represent executed purchase orders that have been submitted to the respective vendors, have decreased from $82.7 million as of December 31, 2011 to $65.4 million as of March 31, 2012.  This decrease of $17.3 million, or 21%, is driven by a decrease in our backlog from 74 units as of December 31, 2011 to 57 units as of March 31, 2012.



22


Off-Balance Sheet Arrangements

As of March 31, 2012, we have no off-balance sheet arrangements other than the manufacturing purchase commitments and letters of credit described above, and future interest payments on the aggregate unused commitments under our revolving credit facility and lease commitments as described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2011 Annual Report on Form 10-K.

Critical Accounting Estimates and Policies
 
Our accounting policies are described in the notes to our audited consolidated financial statements included in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2011 Annual Report on Form 10−K.  We prepare our unaudited condensed consolidated financial statements in conformity with U.S. GAAP.  Our results of operations and financial condition, as reflected in our unaudited condensed consolidated financial statements and related notes, are subject to management’s evaluation and interpretation of business conditions, changing capital market conditions and other factors that could affect the ongoing viability of our business and customers.  We believe that the most critical accounting policies in this regard are those described in our 2011 Annual Report on Form 10−K.  While these issues require us to make judgments that are subjective, they are generally based on a significant amount of historical data and current market data.  There have been no material changes or developments in authoritative accounting pronouncements or in our evaluation of the accounting estimates and the underlying assumptions or methodologies that we believe to be critical accounting policies and estimates as disclosed in our 2011 Annual Report on Form 10−K.

Item 3.    Quantitative and Qualitative Disclosures About Market Risk.
 
The carrying value of cash, investments in short-term commercial paper and other money market instruments, accounts receivable, accounts payable and accrued liabilities approximate their fair value due to the relatively short-term period to maturity of the instruments.
 
The fair value of our long term debt depends primarily on current market interest rates for debt issued with similar maturities by companies with risk profiles similar to us.  We had $25.0 million outstanding debt under our credit facility at March 31, 2012.
 
Our accounts receivable are principally with oil and natural gas service and exploration and production companies and are subject to normal industry credit risks.  Please see Part I, Item 1A—“Risk Factors” in our 2011 Annual Report on Form 10-K for a detailed discussion of the risk factors affecting us.

There have been no material changes in the market risk factors since December 31, 2011.

Item 4.    Controls and Procedures.
 
Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in the SEC reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time period specified by the SEC’s rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. As of March 31, 2012, our Chief Executive Officer and Chief Financial Officer participated with management in evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2012, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended March 31, 2012, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 


23


PART II—OTHER INFORMATION

Item 1.    Legal Proceedings.

In the normal course of our business, we are subject to legal proceedings brought by or against us and our subsidiaries.  None of these proceedings involves a claim for damages exceeding ten percent of our current assets on a consolidated basis.  See Part I, Item 1—“Financial Statements and Supplementary Data”, Note 10 of this Quarterly Report on Form 10-Q for a summary of our ongoing legal proceedings. Such information is incorporated into this Part II, Item 1, "Legal Proceedings" by reference.

Item 1A. Risk Factors.

See Part I, Item 1A—"Risk Factors" in our 2011 Annual Report on Form 10-K for a detailed discussion of the risk factors affecting us.  There have been no material changes in the risk factors described in Part I, Item 1A—"Risk" Factors disclosed in our 2011 Annual Report on Form 10-K.
 
 Item 6.    Exhibits.
 
The Exhibit Index set forth below is incorporated herein by reference.

24



SIGNATURE
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 


 
TESCO CORPORATION
 
 
 
 
 
By:
/s/    JULIO M. QUINTANA        
 
 
Julio M. Quintana,
President and Chief Executive Officer
Date:
May 4, 2012
 
 
 
 
 
TESCO CORPORATION
 
 
 
 
 
By:
/s/    ROBERT L. KAYL        
 
 
Robert L. Kayl,
Senior Vice President and Chief Financial Officer
Date:
May 4, 2012
 


25



EXHIBIT INDEX

 
 
 
Exhibit No.
 
Description
3.1*
 
Articles of Amalgamation of Tesco Corporation, dated December 1, 1993 (incorporated by reference to Exhibit 4.1 to Tesco Corporation's Registration Statement on Form S-8 (File No. 333-139610) filed with the SEC on December 22, 2006)
 
 
 
3.2*
 
Amended and Restated By-laws of Tesco Corporation (incorporated by reference to Exhibit 3.1 to Tesco Corporation's Current Report on Form 8-K filed with the SEC on May 22, 2007)
 
 
 
10.1*
 
Asset Purchase Agreement dated April 29, 2012 (incorporated by reference to Exhibit 10.1 to Tesco Corporation's Current Report on Form 8-K filed with the SEC on May 1, 2012)
 
 
 
10.2*
 
Second Amended and Restated Credit Agreement dated April 27, 2012 (incorporated by reference to Exhibit 10.2 to Tesco Corporation's Current Report on Form 8-K filed with the SEC on May 1, 2012)
 
 
 
31.1
 
Rule 13a-14(a)/15d-14(a) Certification, executed by Julio M. Quintana, President and Chief Executive Officer of Tesco Corporation
 
 
 
31.2
 
Rule 13a-14(a)/15d-14(a) Certification, executed by Robert L. Kayl, Senior Vice President and Chief Financial Officer of Tesco Corporation
 
 
 
32
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Julio M. Quintana, President and Chief Executive Officer of Tesco Corporation and Robert L. Kayl, Senior Vice President and Chief Financial Officer of Tesco Corporation
 
 
 
101.INS**
 
XBRL Instance Document
 
 
 
101.SCH**
 
XBRL Taxonomy Extension Schema
 
 
 
101.CAL**
 
XBRL Taxonomy Extension Calculation Linkbase
 
 
 
101.DEF**
 
XBRL Taxonomy Extension Definition Linkbase
 
 
 
101.LAB**
 
XBRL Taxonomy Extension Label Linkbase
 
 
 
101.PRE**
 
XBRL Taxonomy Extension Presentation Linkbase


*
Incorporated by reference to the indicated filing
**
As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.



26

XNAS:TESO Tesco Corp Quarterly Report 10-Q Filling

Tesco Corp XNAS:TESO Stock - Get Quarterly Report SEC Filing of Tesco Corp XNAS:TESO stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

Content Partners
XNAS:TESO Tesco Corp Quarterly Report 10-Q Filing - 3/31/2012
Name |  Ticker |  Star Rating |  Market Cap |  Stock Type |  Sector |  Industry Star Rating |  Investment Style |  Total Assets |  Category |  Top Holdings |  Top Sectors |  Symbol |  Title Star Rating |  Category |  Total Assets |  Top Holdings |  Top Sectors |  Symbol |  Name Title |  Date |  Author |  Collection |  Interest |  Popularity Topic |  Sector |  Key Indicators |  User Interest |  Market Cap |  Industry Name |  Ticker |  Star Rating |  Market Cap |  Stock Type |  Sector |  Industry Star Rating |  Investment Style |  Total Assets |  Category |  Top Holdings |  Top Sectors |  Symbol / Ticker |  Title Star Rating |  Category |  Total Assets |  Symbol / Ticker |  Name Title |  Date |  Author |  Collection |  Popularity |  Interest Title |  Date |  Company |  Symbol |  Interest |  Popularity Topic |  Sector |  Key Indicators |  User Interest |  Market Cap |  Industry Name |  Ticker |  Popularity |  Our Choices Title |  Date |  Company |  Symbol |  Interest |  Popularity

Previous: XNAS:TESO Tesco Corp Insider Activity 4 Filing - 9/18/2012  |  Next: XNAS:TESO Tesco Corp Quarterly Report 10-Q Filing - 6/30/2012