XNAS:TESO Tesco Corporation Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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 June 30, 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 July 31, 2012:   38,674,083



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, 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; 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 (“2011 Annual Report on Form 10-K”) 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)
 
 
June 30,
2012
 
December 31,
2011
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
32,587

 
$
23,069

Accounts receivable trade, net of allowance for doubtful accounts of $2,602 and $2,491 as of June 30, 2012 and December 31, 2011, respectively
115,585

 
117,711

Inventories, net
114,737

 
111,769

Income taxes recoverable
4,333

 
3,020

Deferred income taxes
6,653

 
4,909

Prepaid and other assets
36,076

 
33,326

Total current assets
309,971

 
293,804

Property, plant and equipment, net
202,619

 
203,068

Goodwill
32,732

 
32,732

Deferred income taxes
9,665

 
12,416

Intangible and other assets, net
7,048

 
7,195

Total assets
$
562,035

 
$
549,215

Liabilities and Shareholders’ Equity
 

 
 

Current liabilities
 

 
 

Current portion of long term debt
$
794

 
$
2,793

Accounts payable
43,950

 
57,443

Deferred revenue
21,774

 
25,924

Warranty reserves
7,376

 
3,103

Income taxes payable
2,013

 
2,336

Accrued and other current liabilities
30,502

 
34,069

Total current liabilities
106,409

 
125,668

Long term debt
305

 
3,832

Other liabilities
2,546

 
2,434

Deferred income taxes
9,548

 
4,474

Total liabilities
118,808

 
136,408

Commitments and contingencies (Note 11)


 


Shareholders’ equity
 

 
 

Common shares; no par value; unlimited shares authorized; 38,673 and 38,569 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively
209,468

 
206,573

Retained earnings
198,258

 
170,733

Accumulated comprehensive income
35,501

 
35,501

Total shareholders’ equity
443,227

 
412,807

Total liabilities and shareholders’ equity
$
562,035

 
$
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 June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Revenue
 
 
 
 
 
 
 
Products
$
56,711

 
$
43,917

 
$
125,652

 
$
81,110

Services
79,962

 
73,361

 
163,442

 
141,790

 
136,673

 
117,278

 
289,094

 
222,900

Operating expenses
 
 
 
 
 
 
 
Cost of sales and services
 
 
 
 
 
 
 
Products
41,444

 
33,486

 
93,754

 
58,545

Services
67,590

 
60,945

 
135,075

 
119,379

 
109,034

 
94,431

 
228,829

 
177,924

Selling, general and administrative
12,890

 
11,589

 
23,953

 
23,317

Gain on sale of CASING DRILLINGTM
(13,289
)
 

 
(13,289
)
 

Research and engineering
3,414

 
2,403

 
5,956

 
5,288

Total operating expenses
112,049

 
108,423

 
245,449

 
206,529

Operating income
24,624

 
8,855

 
43,645

 
16,371

Other expense (income)
 
 
 
 
 
 
 
Interest expense
949

 
798

 
591

 
1,084

Interest income
(27
)
 
(2,482
)
 
(58
)
 
(2,482
)
Foreign exchange loss
2,943

 
697

 
3,223

 
883

Other expense (income)
743

 
(559
)
 
(589
)
 
(531
)
Total other expense
4,608

 
(1,546
)
 
3,167

 
(1,046
)
Income before income taxes
20,016

 
10,401

 
40,478

 
17,417

Income tax provision
6,910

 
3,012

 
12,953

 
5,711

Net income
$
13,106

 
$
7,389

 
$
27,525

 
$
11,706

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.34

 
$
0.19

 
$
0.71

 
$
0.31

Diluted
$
0.34

 
$
0.19

 
$
0.70

 
$
0.30

Weighted average number of shares:
 
 
 
 
 
 
 
Basic
38,639

 
38,164

 
38,611

 
38,120

Diluted
39,081

 
38,928

 
39,069

 
38,831


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)
 
 
Six Months Ended June 30,
 
2012
 
2011
Operating Activities
 
 
 
Net income
$
27,525

 
$
11,706

Adjustments to reconcile net income to net cash provided by (used for) operating activities:
 
 
 
Depreciation and amortization
20,585

 
18,501

Stock compensation expense
1,749

 
4,139

Bad debt expense
840

 
323

Deferred income taxes
6,081

 
(197
)
Amortization of financial items
118

 
91

Gain on sale of operating assets
(19,546
)
 
(1,170
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable trade, net
(7,021
)
 
(22,382
)
Inventories
(13,485
)
 
(27,806
)
Prepaid and other current assets
3,292

 
(332
)
Accounts payable and accrued liabilities
(15,415
)
 
18,697

Income taxes recoverable
(1,521
)
 
(2,930
)
Other noncurrent assets and liabilities, net
(744
)
 
902

Net cash provided by (used for) operating activities
2,458

 
(458
)
Investing Activities
 
 
 
Additions to property, plant and equipment
(35,022
)
 
(19,470
)
Proceeds on sale of operating assets
8,853

 
1,616

Proceeds on sale of CASING DRILLINGTM, net of transaction costs
38,045

 

Other, net
(43
)
 
(1,415
)
Net cash provided by (used for) investing activities
11,833

 
(19,269
)
Financing Activities
 
 
 
Issuances of debt
35,400

 


Repayments of debt
(40,926
)
 

Proceeds from exercise of stock options
753

 
539

Other, net

 
(85
)
Net cash provided by (used for) financing activities
(4,773
)
 
454

Change in cash and cash equivalents
9,518

 
(19,273
)
Net cash and cash equivalents, beginning of period
23,069

 
60,603

Net cash and cash equivalents, end of period
$
32,587

 
$
41,330

Supplemental cash flow information
 
 
 
Cash payments for interest
$
199

 
$
119

Cash payments for income taxes
8,563

 
8,833

Cash received for income tax refunds
631

 
459

Property, plant and equipment accrued in accounts payable
1,004

 
1,275


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


3



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


 
Common stock shares
 
Common shares
 
Retained earnings
 
Accumulated comprehensive income
 
Total
 
For the six months ended June 30, 2012
 
 
 
 
 
 
 
 
 
Balances at January 1, 2012
38,569

 
$
206,573

 
$
170,733

 
$
35,501

 
$
412,807

Net income

 

 
27,525

 

 
27,525

Stock compensation related activity
104

 
2,895

 

 

 
2,895

Balances at June 30, 2012
38,673

 
$
209,468

 
$
198,258

 
$
35,501

 
$
443,227

 
 
 
 
 
 
 
 
 
 
 
For the six months ended June 30, 2011
 
 
 
 
 
 
 
 
 
Balances at January 1, 2011
38,058

 
$
196,431

 
$
143,737

 
$
35,501

 
$
375,669

Net income

 

 
11,706

 

 
11,706

Stock compensation related activity
128

 
4,263

 

 

 
4,263

Balances at June 30, 2011
38,186

 
$
200,694

 
$
155,443

 
$
35,501

 
$
391,638

 

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, which contains a summary of our significant accounting policies and other disclosures.  The condensed consolidated financial statements as of June 30, 2012 and for the quarters and six months ended June 30, 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 June 30, 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 June 30, 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).

Subsequent Events

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

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.

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 our 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.

5



Note 3—Sale of CASING DRILLING™

On June 4, 2012, the Company completed the sale of substantially all of the assets of the CASING DRILLING™ segment to Schlumberger Oilfield Holdings Ltd. and Schlumberger Technology Corporation (together, the "Schlumberger Group") for a total cash consideration of approximately $45.0 million, pending a working capital purchase price adjustment expected to occur in September 2012. In June 2012, the Company recognized a total pre-tax gain of approximately $13.3 million, net of transaction costs. The table below sets forth the details contributing to the gain on sale (in thousands):

Total cash consideration
$
45,000

Fixed assets, net
(11,932
)
Inventories, net
(10,517
)
Accounts receivable, net
(8,307
)
Transaction costs
(955
)
Gain on sale of CASING DRILLING™
$
13,289


At June 30, 2012, the Company had received $39.0 million of cash, with the remaining balance of $6.0 million to be released from escrow when certain terms and conditions are satisfied by the Company.

Note 4—Details of Certain Accounts

At June 30, 2012 and December 31, 2011, prepaid and other current assets consisted of the following (in thousands):

 
June 30,
2012
 
December 31,
2011
Prepaid taxes other than income
$
6,439

 
$
9,968

Deposits
8,567

 
7,995

Prepaid insurance
2,417

 
5,136

Other prepaid expenses
4,893

 
4,247

Restricted cash
8,652

 
2,609

Deferred job costs
3,196

 
2,251

Non-trade receivables
1,912

 
1,120

 
$
36,076

 
$
33,326

 
At June 30, 2012 and December 31, 2011, accrued and other current liabilities consisted of the following (in thousands):

 
June 30,
2012
 
December 31,
2011
Accrued payroll and benefits
$
16,197

 
$
15,545

Accrual for foreign withholding tax claim
2,782

 
5,125

Accrued taxes other than income taxes
6,097

 
9,809

Other current liabilities
5,426

 
3,590

 
$
30,502

 
$
34,069




6


Note 5—Inventories

At June 30, 2012 and December 31, 2011, inventories, net of reserves for excess and obsolete inventories of $1.3 million and $4.4 million, respectively, by major classification were as follows (in thousands):

 
June 30,
2012
 
December 31,
2011
Raw materials
$
73,269

 
$
75,399

Work in progress
7,146

 
6,892

Finished goods
34,322

 
29,478

 
$
114,737

 
$
111,769


Note 6—Property, plant and equipment

At June 30, 2012 and December 31, 2011, property, plant, and equipment, at cost, by major category were as follows (in thousands):

 
June 30,
2012
 
December 31,
2011
Land, buildings and leaseholds
$
27,386

 
$
24,588

Drilling equipment
292,237

 
312,344

Manufacturing equipment
8,651

 
6,910

Office equipment and other
29,567

 
27,621

Capital work in progress
17,723

 
10,814

 
375,564

 
382,277

Less: Accumulated depreciation
(172,945
)
 
(179,209
)
 
$
202,619

 
$
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 $0.2 million and $1.9 million, respectively, for the three and six months ended June 30, 2012. One and five used top drives were sold from our rental fleet during the three and six months ended June 30, 2012, respectively.

Depreciation and amortization expense for the three and six months ended June 30, 2012 and 2011 are included on our unaudited condensed consolidated statements of income as follows (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Cost of sales and services
$
9,308

 
$
8,761

 
$
19,572

 
$
17,624

Selling, general and administrative expense 
497

 
473

 
1,013

 
877

 
$
9,805

 
$
9,234

 
$
20,585

 
$
18,501


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.



7


Note 7—Warranties

Changes in our warranty accrual for the six months ended June 30, 2012 were as follows (in thousands):
 
June 30, 2012
Balance as of January 1, 2012
$
3,103

Charged to expense, net
5,299

Deductions
(1,026
)
Balance as of June 30, 2012
$
7,376


During the six months ended June 30, 2012, we recorded warranty expenses of $4.4 million specifically associated with the gear box housing issue for our new ESI model. 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. We have completed the inspection for 12 units out of the first 18 ESI units produced. Based on the results of the completed inspections, we have increased the specific warranty provision by $0.5 million during the second quarter of 2012, in addition to $3.9 million of specific warranty provision recorded during the first quarter of 2012.


Note 8—Earnings per Share

Weighted average shares

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

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Basic weighted average number of shares outstanding 
38,639

 
38,164

 
38,611

 
38,120

Dilutive effect of stock-based compensation
442

 
764

 
458

 
711

Diluted weighted average number of shares outstanding
39,081

 
38,928

 
39,069

 
38,831

Anti-dilutive options excluded from calculation due to exercise prices
1,320

 
608

 
1,052

 
735


Note 9—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 and six months ended June 30, 2012 and 2011 was as follows (in thousands):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Current tax provision
$
3,488

 
$
3,706

 
$
6,872

 
$
5,908

Deferred tax provision (benefit)
3,422

 
(694
)
 
6,081

 
(197
)
Income tax provision
$
6,910

 
$
3,012

 
$
12,953

 
$
5,711

 
Our effective tax rate, which is income tax expense as a percentage of pre-tax earnings, was 35% and 32% for the three and six months ended June 30, 2012, respectively, compared to 29% and 33% for the same periods in 2011, respectively.  The 6% increase and 1% decrease in our effective tax rate for three and six months ended June 30, 2012 as compared to the same periods 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 June 30, 2012. The

8


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.

Note 10—Long term debt

Long term debt consists of the following (in thousands):
 
 
June 30, 2012
 
December 31, 2011
Capital leases
329

 
5,567

Other notes payable
770

 
1,058

Current portion of long term debt
(794
)
 
(2,793
)
Non-current portion of long term debt
$
305

 
$
3,832

 
As part of our acquisition of Premiere Casing Services - Egypt S.A.E ("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 six months ended June 30, 2012 we paid off a significant amount of the outstanding balances related to Premiere's capital leases. At June 30, 2012 the outstanding balance of Premiere's capital leases was $0.3 million.
 
At June 30, 2012, we had a credit agreement which was entered into on April 27, 2012, to provide a revolving line of credit of $125 million, including up to $20 million of swing line loans (collectively, the “Revolver”). The credit facility has a term of 5 years and all outstanding borrowings on the Revolver are due and payable on April 29, 2017.  The 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 credit facility of 0.375-0.500 percent per annum and a letter of credit fee of 1.00-2.00 percent per annum on outstanding face amounts of letters of credit issued under the credit facility. Amounts available under the 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 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 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 credit facility.  

Under the Revolver at June 30, 2012, we had no outstanding borrowings, $4.5 million in letters of credit outstanding and $120.5 million in available borrowing capacity. We were in compliance with our bank covenants at June 30, 2012.


9



Note 11—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 Company has historically provided information regarding certain legal proceedings that do not meet the definition of a material pending legal proceeding as such term is defined in Item 103 of Regulation S-K.  The Company will continue to provide information regarding such legal proceedings.  However, the Company will only provide information regarding any new legal proceedings in which it or its subsidiaries are involved if the Company assesses that such a proceeding is a material pending legal proceeding.  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 June 30, 2012.

Weatherford International, Inc. and Weatherford/Lamb Inc. (together, “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

10


customer of similar volume of purchases and/or services.

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 (“patent re-examinations”) we and Weatherford filed with the USPTO. However, the patent re-examinations already initiated continue with only the respective patent owner corresponding with the USPTO. Ongoing re-examination procedures include the patents owned by us and asserted in the Houston Suit. An oral hearing with the Board of Patent Appeals and Interferences (“BPAI”) at the USPTO was scheduled for August 1, 2012. The timing of a decision from the BPAI is not known, and, if adverse to us, will be subject to appeal to the Court of Appeals for the Federal Circuit.

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 June 30, 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 June 30, 2012 and December 31, 2011, our

11


total exposure under outstanding letters of credit was $7.7 million and $12.8 million, respectively.
 

Note 12—Segment Information
 
Business Segments
 
Prior to the sale of the CASING DRILLING™ business during the second quarter of 2012, our four business segments were: Top Drive, Tubular Services, CASING DRILLING™, and Research and Engineering. On June 4, 2012, the Company completed the sale of substantially all of the assets of the CASING DRILLING™ segment, which consisted of the proprietary CASING DRILLING™ technology. 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 Research and Engineering segment is comprised of our internal research and development activities related to our proprietary tubular services and top drive model development, as well as the CASING DRILLING™ technology prior to the sale.

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, corporate general and administrative expenses, and 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.  Prior to the sale of the CASING DRILLING™ business during the second quarter of 2012, we did not track or measure property, plant and equipment by business segment and, as such, this information is not presented for property, plant, and equipment balances at December 31, 2011.
 
Significant financial information relating to our business segments is presented below (in thousands):

 
Three Months Ended June 30, 2012
 
Top
Drive
 
Tubular
Services
 
CASING
DRILLING™
 
Research &
Engineering
 
Corporate and
Other
 
Total
Revenue
$
90,138

 
$
41,635

 
$
4,900

 
$

 
$

 
$
136,673

Depreciation and amortization
2,795

 
5,615

 
396

 
22

 
977

 
9,805

Operating income (loss)
22,924

 
4,608

 
8,886

(1)
(3,414
)
 
(8,380
)
 
24,624

Other expense (income)
 

 
 

 
 

 
 

 
 

 
4,608

Income before income taxes
 

 
 

 
 

 
 

 
 

 
$
20,016


(1) Includes gain on sale of assets of $13.3 million


 
Three Months Ended June 30, 2011
 
Top
Drive
 
Tubular
Services
 
CASING
DRILLING™
 
Research &
Engineering
 
Corporate and
Other
 
Total
Revenue
$
78,568

 
$
34,783

 
$
3,927

 
$

 
$

 
$
117,278

Depreciation and amortization
2,712

 
4,423

 
1,168

 
6

 
925

 
9,234

Operating income (loss)
21,657

 
2,496

 
(3,724
)
 
(2,403
)
 
(9,171
)
 
8,855

Other expense (income)
 

 
 

 
 

 
 

 
 

 
(1,546
)
Income before income taxes
 

 
 

 
 

 
 

 
 

 
$
10,401



12


 
Six Months Ended June 30, 2012
 
Top
Drive
 
Tubular
Services
 
CASING
DRILLING™
 
Research &
Engineering
 
Corporate and
Other
 
Total
Revenue
$
191,953

 
$
85,106

 
$
12,035

 
$

 
$

 
$
289,094

Depreciation and amortization
5,709

 
11,433

 
1,479

 
42

 
1,922

 
20,585

Operating income (loss)
47,818

 
9,550

 
8,032

(1)
(5,956
)
 
(15,799
)
 
43,645

Other expense (income)
 

 
 

 
 

 
 

 
 

 
3,167

Income before income taxes
 

 
 

 
 

 
 

 
 

 
$
40,478


(1) Includes gain on sale of assets of $13.3 million


 
Six Months Ended June 30, 2011
 
Top
Drive
 
Tubular
Services
 
CASING
DRILLING™
 
Research &
Engineering
 
Corporate and
Other
 
Total
Revenue
$
149,017

 
$
67,071

 
$
6,812

 
$

 
$

 
$
222,900

Depreciation and amortization
5,338

 
8,998

 
2,315

 
18

 
1,832

 
18,501

Operating income (loss)
42,816

 
4,109

 
(6,837
)
 
(5,289
)
 
(18,428
)
 
16,371

Other expense (income)
 

 
 

 
 

 
 

 
 

 
(1,046
)
Income before income taxes
 

 
 

 
 

 
 

 
 

 
$
17,417



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 and six months ended June 30, 2012 and 2011 was as follows (in thousands):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Canada
44,208

 
35,550

 
100,742

 
69,289

United States
41,926

 
34,725

 
80,349

 
66,590

South America
13,688

 
13,366

 
28,769

 
25,671

Mexico
13,431

 
10,053

 
25,547

 
17,764

Asia Pacific
11,604

 
9,458

 
22,741

 
17,819

Europe, Africa and Middle East
7,396

 
7,629

 
15,170

 
14,314

Russia
4,420

 
6,497

 
15,776

 
11,453

Total
136,673

 
117,278

 
289,094

 
222,900



13


The physical location of our net property, plant and equipment by geographic area as of June 30, 2012 and December 31, 2011 was as follows (in thousands):

 
Top Drive
 
Tubular Services
 
Overhead, Corporate and Other
 
June 30,
2012
United States
$
17,630

 
$
16,107

 
$
16,304

 
$
50,041

Mexico
36,365

 
6,776

 
593

 
43,734

South America
4,868

 
12,611

 
379

 
17,858

Asia Pacific
8,282

 
13,431

 
167

 
21,880

Russia
17,094

 
1,359

 
71

 
18,524

Europe, Africa and Middle East
1,730

 
25,539

 
6,166

 
33,435

Canada
13,020

 
2,928

 
1,199

 
17,147

Total
$
98,989

 
$
78,751

 
$
24,879

 
$
202,619


 
 
December 31,
2011
United States
 
$
56,758

Mexico
 
35,473

South America
 
22,943

Asia Pacific
 
22,414

Russia
 
20,236

Europe, Africa and Middle East
 
30,544

Canada
 
14,700

Total
 
$
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.
 
Prior to the sale of the CASING DRILLING™ business during the second quarter of 2012, our business segments were:

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 and top drive model development, as well as the CASING DRILLING™ technology prior to the sale.

On June 4, 2012, the Company completed the sale of substantially all of the assets of the CASING DRILLING™ segment to the Schlumberger Group. For a detailed discussion of this matter, see Part I, Item 1—"Financial Statements", Note 3—Sale of CASING DRILLING™ in this Quarterly Report on Form 10-Q.

Business Environment

In 2011 and during the first six months of 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 has continued to improve in most geographic regions 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 and six months ended June 30, 2012 and 2011.
 
 
Three Months Average Rig Count(1)
 
Increase / (Decrease)
 
Six Months Average Rig Count(1)
 
Increase / (Decrease)
 
June 30,
 
 
June 30,
 
 
2012
 
2011
 
2011 to 2012
 
2012
 
2011
 
2011 to 2012
U.S.
1,970

 
1,830

 
140

8
 %
 
1,981

 
1,773

 
208

12
 %
Canada
173

 
188

 
(15
)
(8
)%
 
382

 
387

 
(5
)
(1
)%
Latin America (includes Mexico)
438

 
417

 
21

5
 %
 
435

 
413

 
22

5
 %
Middle East (excludes Iran, Iraq and Sudan)
343

 
291

 
52

18
 %
 
327

 
287

 
40

14
 %
Asia Pacific (excludes China onshore)
241

 
251

 
(10
)
(4
)%
 
246

 
262

 
(16
)
(6
)%
Europe (excludes Russia)
117

 
112

 
5

4
 %
 
115

 
115

 

 %
Africa
90

 
76

 
14

18
 %
 
86

 
79

 
7

9
 %
Worldwide
3,372

 
3,165

 
207

7
 %
 
3,572

 
3,316

 
256

8
 %

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

Summary of the Second Quarter Ended June 30, 2012 and Operational Performance

During the second 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 also improved significantly in the second quarter of 2012 as compared to the second 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

15


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:

Increased revenue from $117.3 million in the second quarter of 2011 to $136.7 million in the second quarter of 2012;

Completed the sale of substantially all of the assets of the CASING DRILLING™ segment to the Schlumberger Group for a total purchase price of approximately $45.0 million, recognizing a total pre-tax gain of approximately $13.3 million, net of transaction costs;

Increased operating income from $8.9 million in the second quarter of 2011 to $11.3 million (excluding a pre-tax gain of approximately $13.3 million, net of transaction costs, on the sale of CASING DRILLING™) in the second quarter of 2012;

Renewed our credit agreement to provide a revolving line of credit of $125 million, including up to $20 million of swing line loans; and

Increased cash and cash equivalents from operating activities during the six months ended June 30, 2012 as compared to the same period in 2011.

 Outlook for 2012

Volatility in the global economy has continued over the past few quarters as a result of European debt crisis, reduced consumer demand, slower GDP growth rates in the United States and internationally, and declining oil and 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, any significant elimination of tax incentives 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 sustained activity levels 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 41 units at June 30, 2012, compared to 57 units at March 31, 2012 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 throughout the second half of 2012 and 2013, which should increase demand for our MCLRS proprietary services.


16



Operating Results

Below is a summary of our operating results for the three and six months ended June 30, 2012 and 2011 (in thousands, except percentages):

 
Three Months Ended June 30,
 
Increase / (Decrease)
 
Six Months Ended June 30,
 
Increase/(Decrease)
 
2012
 
2011
 
2011 to 2012
 
2012
 
2011
 
2011 to 2012
Segment revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
Top Drive
$
90,138

 
$
78,568

 
$
11,570

15%
 
191,953

 
149,017

 
42,936

29%
Tubular Services
41,635

 
34,783

 
6,852

20%
 
85,106

 
67,071

 
18,035

27%
CASING DRILLING™
4,900

 
3,927

 
973

25%
 
12,035

 
6,812

 
5,223

77%
Consolidated revenue
$
136,673

 
$
117,278

 
$
19,395

17%
 
289,094

 
222,900

 
66,194

30%
Segment operating income (loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
Top Drive
$
22,924

 
$
21,657

 
$
1,267

6%
 
47,818

 
42,816

 
5,002

12%
Tubular Services
4,608

 
2,496

 
2,112

85%
 
9,550

 
4,109

 
5,441

132%
CASING DRILLING™
8,886

 
(3,724
)
 
12,610

339%
 
8,032

 
(6,837
)
 
14,869

217%
Research & engineering
(3,414
)
 
(2,403
)
 
(1,011
)
(42)%
 
(5,956
)
 
(5,289
)
 
(667
)
(13)%
Corporate and other
(8,380
)
 
(9,171
)
 
791

9%
 
(15,799
)
 
(18,428
)
 
2,629

14%
Consolidated operating income
24,624

 
8,855

 
15,769

178%
 
43,645

 
16,371

 
27,274

167%
Other expense (income)
4,608

 
(1,546
)
 
6,154

398%
 
3,167

 
(1,046
)
 
4,213

403%
Income tax provision
6,910

 
3,012

 
3,898

129%
 
12,953

 
5,711

 
7,242

127%
Net income
$
13,106

 
$
7,389

 
$
5,717

77%
 
27,525

 
11,706

 
15,819

135%
 
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 and six months ended June 30, 2012 and 2011 (in thousands, except percentages, units, days, and rate):
 

17


 
Three Months Ended June 30,
 
Increase / (Decrease)
 
Six Months Ended June 30,
 
Increase/(Decrease)
 
2012
 
2011
 
2011 to 2012
 
2012
 
2011
 
2011 to 2012
Top Drive revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales
$
39,314

 
$
30,953

 
$
8,361

27%
 
$
89,713

 
$
55,915

 
$
33,798

60%
Rental services
33,893

 
34,652

 
(759
)
(2)%
 
68,540

 
67,908

 
632

1%
After-market sales and services
16,931

 
12,963

 
3,968

31%
 
33,701

 
25,194

 
8,507

34%
 
90,138

 
78,568

 
11,570

15%
 
$
191,954

 
$
149,017

 
$
42,937

29%
Top Drive operating income
$
22,924

 
$
21,657

 
$
1,267

6%
 
$
47,818

 
$
42,816

 
$
5,002

12%
Number of top drive sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
New
33

 
21

 
12

57%
 
68

 
38

 
30

79%
Used or consignment
1

 
3

 
(2
)
(67)%
 
5

 
4

 
1

25%
 
34

 
24

 
10

42%
 
73

 
42

 
31

74%
End of period number of top drives in rental fleet:
130

 
128

 
2

2%
 
130

 
128

 
2

2%
Rental operating days(a)
6,658

 
7,039

 
(381
)
(5)%
 
13,645

 
13,909

 
(264
)
(2)%
Average daily operating rate
$
5,091

 
$
4,923

 
$
168

3%
 
$
5,023

 
$
4,882

 
$
141

3%

 (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 second quarter of 2012 and year-to-date by 7% and 8%, respectively, from the same periods 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. We have completed the inspection for 12 units out of the first 18 ESI units produced. Based on the results of the completed inspections, we have increased the specific warranty provision by $0.5 million during the second quarter of 2012, in addition to $3.9 million of specific warranty provision recorded during the first quarter of 2012.

Top Drive sales revenue — The increase in revenue for the three and six months ended June 30, 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 $1.1 million and $1.9 million for the three months ended June 30, 2012 and 2011, respectively, and $8.1 million and $2.6 million for the six months ended June 30, 2012 and 2011, respectively.

Top Drive rental revenue — The decrease in revenue for the three months ended June 30, 2012 compared to the same period in 2011 is due to a decrease in the number of operating days during the respective periods. The increase in revenue for the six months ended June 30, 2012 compared to the same period in 2011 is due to improved rental daily operating rates and a larger rental fleet during the respective periods. 

Top Drive after-market sales and services revenue — Revenue for the three and six months ended June 30, 2012 improved significantly compared to the same periods 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 and six months ended June 30, 2012 as compared to the same period in 2011 is due to higher revenue from Top Drive sales, and after-market sales and services discussed above. This increase for the six months ended June 30, 2012, was significantly offset due to an increase in warranty expense of $4.4 million specifically associated with the gearbox housing issue for our new ESI model.




18


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 Running Service 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 and six months ended June 30, 2012 and 2011 (in thousands, except percentages and number of jobs):
 
 
Three Months Ended June 30,
 
Increase/ (Decrease)
 
Six Months Ended June 30,
 
Increase/(Decrease)
 
2012
 
2011
 
2011 to 2012
 
2012
 
2011
 
2011 to 2012
Tubular Services revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
Proprietary
$
33,067

 
$
29,230

 
$
3,837

13%
 
$
65,655

 
$
53,758

 
$
11,897

22%
Conventional
8,568

 
5,553

 
3,015

54%
 
19,451

 
13,313

 
6,138

46%
 
$
41,635

 
$
34,783

 
$
6,852

20%
 
$
85,106

 
$
67,071

 
$
18,035

27%
Tubular Services operating income
$
4,608

 
$
2,496

 
$
2,112

85%
 
$
9,550

 
$
4,109

 
$
5,441

132%
Number of proprietary jobs
817

 
914

 
(97
)
(11)%
 
1,676

 
1,734

 
(58
)
(3)%
 
The increase in Tubular Services revenue for the three and six months ended June 30, 2012 compared to the same periods 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 and six months ended June 30, 2012, revenue related to our MCLRS proprietary tubular services increased $3.5 million and $4.3 million, respectively, compared to the same periods in 2011, due to the market conditions in the first half of 2011 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 and six months ended June 30, 2012 included $0.5 million and $2.2 million, respectively, of revenue for CDS equipment sales while no CDS equipment sales were made during the same periods in 2011.

The increase in Tubular Services operating income for the three and six months ended June 30, 2012 as compared to the same periods in 2011 is due to higher revenue for our MCLRS proprietary tubular services and CDS equipment sales, which provide higher operating margins, higher revenue for proprietary and conventional jobs as discussed above, and improved margins as oil and natural gas drilling activity continues to recover from the severe downturn experienced in prior years. 

CASING DRILLING™ Segment

On June 4, 2012, the Company completed the sale of substantially all of the assets of the CASING DRILLING™ segment to the Schlumberger Group. The CASING DRILLING™ business was based on the proprietary CASING DRILLING™ technology, which used patented equipment and processes to allow an oil or gas well to be drilled using standard well casing pipe.  

The following is a summary of the operating results of the segment prior to the sale for the three and six months ended June 30, 2012 and 2011 (in thousands, except percentages):
 
 
Three Months Ended June 30,
 
Increase / (Decrease)
 
Six Months Ended June 30,
 
Increase/(Decrease)
 
2012
 
2011
 
2011 to 2012
 
2012
 
2011
 
2011 to 2012
CASING DRILLING™ revenue
$
4,900

 
$
3,927

 
$
973

25%
 
$
12,035

 
$
6,812

 
$
5,223

77%
CASING DRILLING™ operating income (loss)
$
8,886

 
$
(3,724
)
 
$
12,610

339%
 
$
8,032

 
$
(6,837
)
 
$
14,869

217%

19


  
CASING DRILLING™ revenue for the three and six months ended June 30, 2012 improved significantly over the same periods 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 income for the three and six months ended June 30, 2012 includes approximately $13.3 million gain from the sale. For a detailed discussion of this matter, see Part I, Item 1—"Financial Statements", Note 3—Sale of CASING DRILLING™ in this Quarterly Report on Form 10-Q. Absent the gain, CASING DRILLING™ operating loss decreased for the three and six months ended June 30, 2012 compared to the same period in 2011 due primarily to increased revenue, the focus on cost management and related job activity.
 
Research and Engineering Segment

Our Research and Engineering segment is comprised of our internal research and development activities related to Tubular Services technology and top drive model development, as well as the CASING DRILLING™ technology prior to the sale.  Below is a summary of our research and engineering expense for the three and six months ended June 30, 2012 and 2011 (in thousands, except percentages):

 
Three Months Ended June 30,
 
Increase / (Decrease)
 
Six Months Ended June 30,
 
Increase/(Decrease)
 
2012
 
2011
 
2011 to 2012
 
2012
 
2011
 
2011 to 2012
Research and engineering expense
$
3,414

 
$
2,403

 
$
1,011

42%
 
$
5,956

 
$
5,288

 
$
668

13%
 
Research and engineering expenses increased during the three and six months ended June 30, 2012 as compared to the same periods in 2011 due to increased spending on our top drive technology. 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 and six months ended June 30, 2012 and 2011 (in thousands, except percentages):
 
 
Three Months Ended June 30,
 
Increase / (Decrease)
 
Six Months Ended June 30,
 
Increase/(Decrease)
 
2012
 
2011
 
2011 to 2012
 
2012
 
2011
 
2011 to 2012
Corporate and other expenses
$
8,380

 
$
9,171

 
$
(791
)
(9)%
 
$
15,799

 
$
18,428

 
$
(2,629
)
(14)%
Corporate and other expenses as a % of revenue
6%
 
8%
 
(2) pts
 
5%
 
8%
 
(3) pts

Corporate and other expenses decreased $0.8 million and $2.6 million during the three and six months ended June 30, 2012, respectively, as compared to the same periods in 2011. Stock compensation decreased by $0.5 million and $2.0 million, respectively, and other compensation costs decreased by $0.5 million and $1.0 million, respectively, for the three and six months ended June 30, 2012, as compared to the same periods in 2011.

Other Expense (Income)

The following is a summary of our other expense (income) for the three and six months ended June 30, 2012 and 2011 (in thousands, except percentages):
 

20


 
Three Months Ended June 30,
 
Increase / (Decrease)
 
Six Months Ended June 30,
 
Increase/(Decrease)
 
2012
 
2011
 
2011 to 2012
 
2012
 
2011
 
2011 to 2012
Other expense (income)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense
$
949

 
$
798

 
$
151

19%
 
$
591

 
$
1,084

 
$
(493
)
(45)%
Interest income
(27
)
 
(2,482
)
 
2,455

99%
 
(58
)
 
(2,482
)
 
2,424

98%
Foreign exchange losses
2,943

 
697

 
2,246

322%
 
3,223

 
883

 
2,340

265%
Other expense (income)
743

 
(559
)
 
1,302

233%
 
(589
)
 
(531
)
 
(58
)
(11)%
Total other expense (income)
$
4,608

 
$
(1,546
)
 
$
6,154

398%
 
$
3,167

 
$
(1,046
)
 
$
4,213

403%

In April 2012, we received a favorable determination on a legacy withholding tax issue in a foreign jurisdiction. The impact of this was recognized in the first quarter of 2012, when we 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 11—Commitments and Contingencies in this Quarterly Report on Form 10-Q.

Foreign exchange losses increased during the three and six months ended June 30, 2012 as compared to the same periods in 2011 due to fluctuations in the valuation of the U.S. dollar compared to other currencies we transact in around the world, including the Argentine peso, Mexican peso, and Russian ruble, among others.
 
  Income Tax Provision
 
 
Three Months Ended June 30,
 
Increase / (Decrease)
 
Six Months Ended June 30,
 
Increase / (Decrease)
 
2012
 
2011
 
 
2012
 
2011
 
Effective income tax rate
35%
 
29%
 
6 pts
 
32%
 
33%
 
(1) 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, increased for the three months ended June 30, 2012 and decreased for the six months ended June 30, 2012 compared to the same periods 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 available borrowings 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 and $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 June 30, 2012 and December 31, 2011 was as follows (in thousands):
 
June 30,
2012
 
December 31,
2011
Cash
$
32,587

 
$
23,069

Current portion of long term debt
(794
)
 
(2,793
)
Long term debt
(305
)
 
(3,832
)
Net cash
$
31,488

 
$
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 Quarterly Report on Form 10-Q may not always be comparable to similarly titled measures reported by other

21


companies due to differences in the components of the measurement we use.

At June 30, 2012, we had a credit agreement which was entered into on April 27, 2012, to provide a revolving line of credit of $125 million, including up to $20 million of swing line loans (collectively, the “Revolver”). The credit facility has a term of 5 years and all outstanding borrowings on the Revolver are due and payable on April 29, 2017.  The 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 credit facility of 0.375-0.500 percent per annum and a letter of credit fee of 1.00-2.00 percent per annum on outstanding face amounts of letters of credit issued under the credit facility. Amounts available under the Revolver are reduced by letters of credit issued under the 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 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 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 credit facility.  

Under the Revolver at June 30, 2012, we had no outstanding borrowings, $4.5 million in letters of credit outstanding and $120.5 million in available borrowing capacity. We were in compliance with our bank covenants at June 30, 2012.

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 six months ended June 30, 2012 and 2011.

Operating Activities – Net cash provided by operating activities is our primary source of capital and liquidity.  Net cash provided from operating activities was $2.5 million for the six months ended