Tesco Management Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 7.13 | About: Tesco Corporation (TESO)

Tesco (NASDAQ:TESO)

Q2 2013 Earnings Call

August 07, 2013 9:00 am ET

Executives

Julio Manuel Quintana - Chief Executive Officer, President and Executive Director

Robert L. Kayl - Chief Financial Officer and Principal Accounting Officer

Analysts

Ryan Fitzgibbon - Global Hunter Securities, LLC, Research Division

Josh C. Lingsch - Simmons & Company International, Research Division

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

Operator

Good day, ladies and gentlemen, and welcome to the Tesco Corporation Second Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.

I'd now like to turn the call over to your host for today, Mr. Julio Quintana, President and Chief Executive Officer. Sir, you may begin.

Julio Manuel Quintana

Thank you, Ben. Good morning, ladies and gentlemen, and welcome to TESCO's second quarter 2013 earnings conference call. I'm Julio Quintana, TESCO's President and CEO, and I will be hosting our call. Bob Kayl, our Chief Financial Officer, is with me on the call. I'll begin with some general comments on the quarter, then Bob will give you an overview of financial results. Following Bob's remarks, I'll return and provide an update on our business and plans for the future.

Before I begin, it is important to note that during the course of this call, Bob and I will make forward-looking statements within the meaning of the Private Securities Litigation Act of 1995 Canadian Securities Legislation. These statements are based on current expectations that involve risks and uncertainties, which could cause actual results to vary from those anticipated. These risks and uncertainties have been and are more fully described in our annual reports and quarterly reports filed with the SEC and with the Securities Regulatory Authorities in Canada. You should not place any undue reliance on these forward-looking statements made in the conference call nor do we intend to update these forward-looking statements. Also, we will use certain non-GAAP measures. The earnings release issued yesterday afternoon contains an explanation and a reconciliation of these measures to GAAP measures. And we refer you to that release for additional information.

Now, on to our second quarter results. We reported net income and EPS in Q2 of $10.2 million or $0.26 a share on $129 million of revenue compared to $8.8 million of net income or $0.22 per share in Q1 of 2013 on $127.1 million of revenue. Operating income increased during the quarter to $13.8 million, up from operating income of $11.7 million from Q1. Given our current drilling activity levels in North America, we are pleased with our results for the second quarter of 2013. With strengthening activity on international business unit, our Tubular Services business again enjoyed record revenue and operating income during the second quarter. With increased sales in international markets, our overall Top Drive sales activity continues at a steady space. Today, our Top Drive backlog stands at 30 units. Although our Top Drive rental business has continued to be negatively impacted by the slowdown in North America, our Top Drive rental strategies to ship to international markets, especially to Russia and Latin America, has partially offset the decline we experienced in North America. With the increased focus on our base businesses and continuous improvement in operational efficiency, we are well positioned to meet the challenges and opportunities for the rest of 2013 and beyond.

I'll give more into this in detail after Bob summarizes the results. Bob?

Robert L. Kayl

Thank you, Julio. I will discuss our second quarter 2013 operating results by business segment and then give some comments on our corporate and research and engineering expenses. Starting with Top Drive, revenue totaled $76.1 million for the quarter, a slight increase sequentially from Q1. The increase from Q1 is primarily a result of increased aftermarket sales and services. We sold 24 units, both in Q2 and in Q1 of this year, compared to 34 units in Q2 of 2012. Of the 24 units sold in Q2, there were 21 new units and 3 used units from our rental fleet. In Q1, the 24 units sold consisted of 22 new units and 2 used units from the fleet. With the 21 new units delivered to customers in Q2, we ended the quarter with a backlog off 10 Top Drive units with a potential value of $12.9 million, down from 20 units with a potential value of $28.9 million at the end of Q1. However, several orders that we were expecting to book in June were not booked until the first couple of weeks of July. Today our backlog stands at 30 units with several sales pending.

We do not include a sale in our backlog until the contract is signed and we have received a nonrefundable deposit if required by the contract. Top Drive rental revenue was $30.8 million in Q2, up from $29.7 million in Q1, but down from $33.9 million in Q2 2012. Our revenue increased from last quarter primarily due to an increase in operating days in Latin America. Currently, our fleet of rental Top Drive stands at 133 units, a decrease from the 136 units we had at the end of Q1. Aftermarket sales and service revenue was $16.1 million in Q2, up from $13.1 million in Q1 and down from $16.9 million in Q2 2012. The increase from Q1 is due to stronger aftermarket sales, part sales in Russia and North America. Our Top Drive operating margins were 23% in Q2, an increase from 20% in Q1 and a decrease from 25% in Q2 2012. The increase from Q1 is primarily due to the mix of new Top Drive models delivered in Q2 and increased aftermarket sales and service activity.

Now onto Tubular Services. Revenue was a record $52.7 million in Q2, up 3% from $51.1 million in Q1 and up 27% from $41.6 million in Q2 2012. Automated casing running revenue was a record $43.1 million in Q2, up 7% from $40.2 million in Q1, as a result of increased demand in the Asia Pacific, Latin America and European regions for automated offerings. Our Q2 2012 automated casing running revenue was $33.1 million, reflecting a 30% increase over the last 12 months. The number of jobs utilizing our automated Casing Drive System was a record 975 jobs in Q2, up from 956 jobs in Q1 and 817 jobs in Q2 2012. The higher automated job counts from Q1 were primarily due to increased activity in Latin America. Additionally, a significant amount of current U.S. drilling activity in shale formations requires directional and horizontal drilling techniques, which we believe are good applications for our automated service offering.

Our CDS fleet was 298 units at the end of Q2 compared to 305 units at the end of Q1. We recorded $3.1 million of revenue from CDS equipment sales in Q2, up from $2.8 million in Q1 and $500,000 in Q2 2012. Also, we recorded $600,000 of revenue from our MCLRS offerings in Q2, down from $1.7 million in Q1 and $4 million in Q2 2012.

Conventional casing running revenue decreased to $9.6 million in Q2 compared to $10.9 million in Q1, primarily due to a decrease in the number of conventional jobs in North America. Our Q2 2012 conventional revenue was $8.6 million. Overall, Tubular Services operating income in Q2 was $11.3 million with an operating margin of 22% compared to operating income of $7.4 million in Q1 and $4.6 million in Q2 2012. The increase from Q1 is primarily due to higher revenue discussed above, including higher CDS equipment sales, which generally provide higher operating margin. Additionally, we recorded $1.9 million benefit to operating expenses due to a favorable determination of a legacy contract dispute from 2010. Without this favorable onetime benefit, our operating margin would have been 18%.

Now onto corporate expenses, which were $12.5 million for Q2 compared to $10.5 million for Q1 and $8.4 million in Q2 2012. The increase from prior periods was due primarily to increased legal fees, incentive compensation and centralized operations support personnel. Research and engineering costs for Q2 were $2.5 million compared to $2 million in Q1 and $3.4 million in Q2 2012. Research and engineering continues to be a strategic investment for the company, and we plan to continue to invest in our proprietary technologies. Our effective tax rate for Q2 was 20% compared to 30% in Q1 and 35% in Q2 2012. Our effective tax rate, which is income tax expense as a percentage of pre-tax earning, fluctuates depending on the mix of pre-tax earning in the various tax jurisdictions in which we operate around the world. In addition, our effective tax rate was impacted by a $1.4 million decrease to tax expense for the favorable determination and settlements of legacy tax cases in 2 foreign jurisdictions.

Turning to the balance sheet. At June 30, 2013, cash and cash equivalents were $46.1 million compared to $22 million at the end of last year. During the 6 months ended June 30, 2013, net cash provided by operating activities of $28.9 million was partially offset by cash used for capital expenditures. Total capital expenditures were $7.6 million in Q2 compared to $8.7 million in Q1 and $17.3 million in Q2 2012. We project our total capital expenditures for 2013 to be between $30 million and $40 million based on current market conditions.

I'll now turn the discussion back to Julio.

Julio Manuel Quintana

Thanks, Bob. Let me recap where we are. We're happy with the results for the quarter. North America drilling activity has stabilized as expected and our Tubular Services business has been an excellent means for steadying our North American business. In addition, with strengthening activity in nearly all our international business units, our Tubular Services businesses is continuing to grow quarter-over-quarter, and we anticipate this trend to continue for the remainder of 2013. This business segment delivered record quarterly revenue and operating income during Q2, topping the previous record established in the first quarter of 2013. We are particularly pleased with our continued improvement in our international operations.

First on Top Drives. As Bob mentioned, we delivered 21 units, new units and 3 used units to third parties during the quarter. We had anticipated the booking of several Top Drives in Q2, which rolled over to early July. As a result, we ended the quarter with a backlog of 10 units, down from 20 units at the end of Q1. However, current backlog of 30 units and sustained order activity provide a level of confidence that our product sales business will remain steady in the near and medium term. Aftermarket revenue increased 23% from the first quarter. We're keenly focused on this business and believe that it will be a key as rigs with top regimen working in our installed base continues to grow. Today our installed base stands at over 1,200 Top Drives units around the world. This installed base increased by over 12% in 2012 and more than 20% over the last 2 years. This base will prove to be an annuity and provide organic growth for TESCO in future years, as should continue to grow based on current sales level and backlog.

On the rental front, we increased revenue and operating base compared to the first quarter of this year. This increase was driven by our international locations, and we expect this trend will continue. In Q2 2013, 82% of our Top Drive rental revenue was sourced from our international operations.

Switching to Tubular Services, we are proud of our accomplishments. Switching to Tubular Services. We are proud of our accomplishment in Tubular Services which generated a quarterly record of $52.7 million in revenue and $11.3 million in operating income in Q2, a 22% margin. Normalized for the onetime recovery of the 2010 contract dispute, a benefit of a $1.9 million, our normalized operating margin was 18%. A couple of years ago when losing money in Tubular Services, we told our investors that we could run our Tubular Services business at an operating margin in excess of 20%. We're on track with that plan, and we have accomplished this with substantially softening in North American market. This is a tribute to our differentiated automated pipe running business. We're systematically achieving critical mass in all our business units and are expanding in several key international markets. This will help drive profitable growth in this segment going forward. We are committed to making this business a major contributor to TESCO, both in revenue and to the bottom line. The improved performance of this quarter, coupled with our TESCO 3.0 strategy, should continue to position TESCO for growth for years to come.

Ben, we'll now take the questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Ryan Fitzgibbon Global Hunter Securities.

Ryan Fitzgibbon - Global Hunter Securities, LLC, Research Division

Start with the Top Drive business. Congrats on the backlog back up to 30 units. Can you talk a little bit about the mix? What percent of that is international versus U.S., and I know Julio you mentioned a couple of big orders since in the quarter ended. Can you give us some insight as to how many customers actually came in about those incremental 20 units?

Robert L. Kayl

Yes. Let me take that one, Ryan. This is Bob. The mix between domestic and international, the majority is in international locations, about 20% of that backlog is in North America. And then the mix of customers who came in with the orders in July. That was really just a couple of customers. There were some pretty significant fleet deals that we booked early in the month.

Ryan Fitzgibbon - Global Hunter Securities, LLC, Research Division

Okay. And then do you think you're still -- in the past, you had mentioned kind of rightsizing the business to be able to produce, call it, 8 to 10 units per month. Do you think you can maintain the cadence you've had for the first half of the year and still have a target of maybe 100 units sold in 2013?

Julio Manuel Quintana

Certainly our capacity is there to do that, Ryan. That's not a problem, our Top Drive building capacity. I think we see basically staying on plan for the year on Top Drive sales. Whether it's going to be 80, 90 or 100, it's hard to tell, but certainly, pretty much on plan. I think the way I described it in the script, which is steady, the business feels steady. And I think that continues for the remainder of the year.

Ryan Fitzgibbon - Global Hunter Securities, LLC, Research Division

Okay, good to hear. Second question is on Tubular Services. Julio, can you talk a little bit about what you've done internally to give margins to where they are now? And I know you mentioned previously the goal still north of 20%, is that something we can expect potentially in the back half of this year as your international uptick continues to improve?

Julio Manuel Quintana

Yes. As you guys have heard me say several times, there are several things that have to come together to consistently operate north of 20%. So we start with the fact that most of our business is still in North America. And so getting the operational efficiencies in going there was a key part, so that's one. The second one is the critical mass international. It's been an absolute requirement. So start filling in that infrastructure and certainly that continues. And I think that's got still quite a bit of running room. In fact, today we're making money in all our business units with that business, and we continue that to strengthen. The next item is the injection of the MCLRS business, which as we know, it's a very high-margin business for us. Unfortunately, that's kind of a choppy business. As you see this quarter, the numbers were down compared to first quarter. But I think it's going be up and down for the next several quarters. The fourth thing that has to happen is the injection of additional technologies like cementing, which is going nicely but still a very small number in the overall mix, but continues to add to the bottom line. And the biggest swing will be on our product sales, CDS product sales which this quarter over $3 million of CDS sales. But we see that being choppy but still being steady going forward. So and then to that, you add the wildcard of what could happen in North America in terms of natural gas activity. If you believe that you're bullish on natural gas, then that's very bullish on the Tubular Services business. If you believe that's going to go down, then obviously the opposite. We think North America will stay pretty much like it is now in terms of activity, and we will continue to take market share in that market. So when you put all that together, and I have a bit of a long-winded answer your question, Ryan, I am confident on the 20%. All these things have to kind of come together to get to that 20%. Is it going to happen Q3 versus Q4 versus Q2 of next year? I don't know if there's enough moving parts there that it's kind of hard to say. But certainly, I'm pretty confident that the high-teens kind of number that we're operating at is sustainable with the one caveat being that the MCLRS business and the CDS products business is choppy. And so I wouldn't get too bullish in any one given quarter, but overall, I think we have shifted the business from single-digit, low-teens to a high-teens business, and we believe we can keep it there and grow from here over the next several quarters.

Ryan Fitzgibbon - Global Hunter Securities, LLC, Research Division

That's good to hear. Last one for me. With the, call it, cash balance of $50 million, we've got you generating quite a bit of cash in the back half of the year. Any updates to your capital allocation strategy? And is there anything in particular you're seeing in the market in terms of deal flow that's more exciting now than it was previously?

Julio Manuel Quintana

I don't know if deal flow has changed too much the last few quarters. We have and continue to talk to several companies that are a good fit for us and are consistent with the TESCO 3.0 strategy that we've laid out, and we're going to be patient with that, Ryan. But if and when those things come to fruition, we will execute on them. So for now, our plan would be to hang onto that cash, wait for the right deal to come along and then execute. We certainly have the capacity to deal with our balance sheet with no debt and the $46 million of cash-on-hand to do those deals when they do present themselves.

Ryan Fitzgibbon - Global Hunter Securities, LLC, Research Division

Okay. And still no real interest in a buyback at this point?

Julio Manuel Quintana

No, not at this point.

Operator

Our next question comes from the line of Josh Lingsch of Simmons & Company.

Josh C. Lingsch - Simmons & Company International, Research Division

A little bit of a follow-up on the last question, but higher level, Julio. I was wondering if you could give us maybe an update on the TESCO 3.0 strategic initiative that you previously outlined? How are you thinking about this now? What progress has been made, and what should we expect in the near future?

Julio Manuel Quintana

So just to refresh everybody's mind, there's kind of 3 components of the strategy. The first one is a rig maintenance strategy. The second one is a rig mechanization strategy. So the rig maintenance is about moving from aftermarket of Top Drives only to ultimately several key components on the rig. The rig mechanization is about bringing additional products to the market so that we can sell more than just Top Drive. And then the final one is the Tubular Services expansion, broaden the Tubular Services expansion. So let me start with the Tubular Services first. There are a handful of companies that would be a good fit for us that we are working on the M&A front, and certainly getting some of those in would be a nice way to, again, get critical mass, particularly international. We are working those, all those being private parties. It's hard to say the timing on any of those at this point. But meanwhile, we're not standing still. As you can see, the numbers keep going up. We can grow that business organically quite nicely. We think we can really turbo charge it if we can do some acquisition work there, but I think that one continues very nicely. And in addition to that, we are introducing products like cementing that seems to be catching on quite nicely beyond North America. Now originally, we were doing just North America testing. We're now taking it to other markets, and it's starting to get some traction. So we're pretty happy with the Tubular Services projection. On the rig maintenance side, there were just kind of 2 key steps that we are taking, both very active. One is, gearing ourselves up to be able to do third-party aftermarket repair and maintenance of Top Drives. We are very actively doing that. We are working on third-party Top Drives as we speak, and I think that continues to drive that business nicely. And then the second part, the second model, is more of a broader rig analysis and complete kind of rig refurbishing and maintenance approach, maintenance offering, and we have a couple of contracts that we are working there. I'd like to believe we can close on those contracts between now and the end of the year. So I'd say that one is going pretty well. On the rig maintenance -- excuse me, on the rig mechanization front, we have a major product launch on one of those products that we're developing probably between now and, call it, end of the year that we're quite excited about that we can start adding to our offering from the R&D front. So we'll see how that develops, but we're quite excited about it. And then beyond that, there is a handful of acquisitions there that are being debated. I would say those are probably not going to be a 2013 event. So more of an R&D kind of focus. So overall, I'd say it's moving at a decent pace for the remainder of the year.

Josh C. Lingsch - Simmons & Company International, Research Division

That's great color. And then as a follow-up, Bob, maybe this one is best for you, the growth of the CapEx, your CapEx budget, the growth CapEx portion of that, what percentage is directed towards the Top Drive business versus the Tubular Services business?

Robert L. Kayl

It's a little heavier weighted towards Top Drives, particularly with our Tubular Services business, where we've invested quite a bit of CapEx over the last couple of years than Tubular Services, specifically in the Middle East and the Asia Pac region. Where we're spending money on Tubular Services today for CapEx is usually when it's tied to specifically to a contract or to increase our -- the number of rates that we're on. So not the majority, but a greater portion is going to the Top Drive business.

Operator

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

Julio Manuel Quintana

Sorry. I apologize, guys. I'm having a really hard time hearing. I don't know what's happening here with the call.

[Technical Difficulty]

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

Julio, I had a question for you on the Top Drive rentals business. I think in your commentary, you had suggested you expected activity in your international markets the trend to continue. I think, namely trend towards higher activity. Can you talk about the markets where you're seeing that opportunity?

Julio Manuel Quintana

Sure. Just a little bit of -- just made an overall color. North America has strengthened from the low that we were at in terms of the number of units utilization that's come up. We think the utilization will stay more or less where it's at now in North America. And so we'll continue to sell for -- a few more units out of that market, either into the cross-sell side or to the international side. We have moving couple of units internationally. The 2 biggest areas, of course, that we have are Latin America, which continues to strengthen. So that would be one. We have some contracts there that can expand even further than they are today. So I think Latin America will continue to look very good for the rest of the year. And then if you recall, Russia got hit last year 2 ways. One was the ESI quality problem needed to be backfilled with rentals. And so we took a little hit there. And then we had several units that we're renting that we ended up selling to the customer. And so a combination of all that made for a weaker second half last year and first half of this year in Russia. And we expect that market to strengthen for the remainder of the year. So it's primarily going to come from Latin America and the Russian market.

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

Okay, great. So stable North America and or stable U.S. market...

Julio Manuel Quintana

Dan?

[Technical Difficulty]

Julio Manuel Quintana

Daniel, I don't know which part of this you heard or didn't hear.

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

Julio, I think I did get the whole -- the entirety of the answer on Top Drive rentals. Hopefully you can hear me. I guess, my second question would be then to shift gears and to address Tubular Services. Over the last year, my impression has been the bulk of the advance in margin has been driven by improved absorption in your international markets. But I guess my question is more on where the majority of the revenue is generated in terms of the North America market. Can you just summarize for us what the margin progression in the North America market, again, specific to Tubular Services, not necessarily addressing the CDS and MCLRS impacts. Have you got -- has that margin actually improved over the last year for you all or has it held flat?

Julio Manuel Quintana

Yes. I'd say flat, slight improvement, and what I mean by that is, remember what happened, right? We had very strong operations in East Texas, the Northeast, the gas-rich region. And then we shifted to primarily West Texas and South Texas. And so we took a short-term hit from doing that and now that we started filling in those markets, then that's driven the profitability up again. So if you look kind of peak to peak, we're kind of about where we were prior to all that, maybe a little bit better. But overall, not a big shift. The majority of the improvement has come from the international expansion, the increase in critical mass and then MCLRS and CDS product sales. Those 3 tend to be what drives the business the most. But the biggest profitability drain we've had over the last couple of years has been that global infrastructure that we've put in place that wasn't making money in lots of places. So the fact that we're finally getting some good traction there is really what's driving the profitability quite a bit.

Operator

As I'm showing no additional questions in queue, I'd like to turn the conference back over to management for any closing remarks.

Julio Manuel Quintana

Okay. Thank you, Ben. In closing, I'd like to thank you for participating in the call today and your interest in TESCO. Our commitment to executing on our strategy continues to prove itself. We look forward to talking next quarter. Take care.

Robert L. Kayl

Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect. Have a great rest of the day.

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