Tesco Corporation Q1 2010 Earnings Call Transcript

| About: Tesco Corporation (TESO)

Tesco Corporation (NASDAQ:TESO)

Q1 2010 Earnings Call

May 7, 2010; 11:00 am ET

Executives

Julio Quintana - President & Chief Executive Officer

Bob Kayl - Chief Financial Officer

Analysts

Neal Dingmann - Wunderlich Securities

Chris Glasine - Simmons & Company

John Keller - Stephens Inc.

Terese Fabian - Sidoti & Co.

William Conroy - Pritchard Capital

Daniel Burke - Johnson Rice

David Griffiths - Unidentified Company

Doug Garber - FBR Capital Markets

Operator

Good day ladies and gentlemen, and welcome to the TESCO Corporation, first quarter 2010 earnings call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions)

I would now like to introduce your host for today’s conference, Mr. Julio Quintana, President and CEO.

Julio Quintana

Thank you Betty. Good morning ladies and gentlemen, and welcome to TESCO’s first quarter 2010 earnings conference call. I’m Julio Quintana, TESCO’s President and CEO and I’ll be hosting our call today. 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 our financial results. Following Bob’s remarks I’ll return and provide an update on our business 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 and 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 contains an explanation and/or reconciliation of these measures to GAAP measures, and we’ll refer you to that release for additional information. Now on to our first quarter results.

We reported net income and EPS in Q1 of $2.2 million or $0.06 per share, and $86 million of revenue, compared to $9 million of net loss or $0.24 share loss in Q4 of 2009, and $85 million of revenue. Operating income increased during the quarter to $2.9 million, up from an operating loss of $13.9 million for Q4.

Likewise, operating margins for Q1 increased to 3% from a negative 16% in Q4. The increase in both operating income and net income from Q4 was primarily due to several one-time items recorded during the fourth quarter of 2009. We continue to see increased activity in many of our business lines, but we are still cautiously optimistic for the remainder of 2010.

I’ll get into this in more detail after Bob summarizes the financial results. Bob.

Bob Kayl

Thank you, Julio. I will discuss our first quarter 2010 operating results by business segments, and then give some comments on our corporate, and research and engineering expenses.

Starting with Top Drives; revenue totaled $52.1 million for the quarter, 23% lower than the same period last year, and down 3% sequentially from Q4. The decrease from Q4 is primarily a result of lower Top Drive sales. We sold 14 Top Drives in Q1 compared to 17 last quarter, and 32 units sold in the first quarter of 2009.

Of the 14 units sold in Q1, 12 were new units, one was the used unit from our rental fleet and one was a consignment sale. With the 12 new units delivered to customers in Q1, we ended the quarter with a backlog of 18 Top Drive units, with the value of $25.9 million, up from 11 units with the value of $16.1 million at the end of Q4.

During Q1 we continued to see improved Top Drive sales activity, and today our Top Drive backlog stands at 24 units with several sales pending. As you know, we don’t include a sale in our backlog until the contract is signed and we’ve received a non-refundable deposit, if required by the contract.

Top Drive rental revenue was $24.1 million in Q1, up from $22.2 million in Q4, and $23.6 million in Q1, 2009. The increase from Q4 is due to increased rental revenues throughout our operating locations, but particularly in North America and Latin America.

Currently our rental fleet of Top Drives stands at 117 units, the same as of the end of Q4, but down from a 126 units at the end of Q1 2009. Day rates for Top Drive rentals improved during the quarter.

We relocated several of our US units into international markets in 2009 where demand has been stronger. With the increased utilization and demand for our rental units, we are beginning to see some opportunity for further increase in our day rates in certain markets.

After market sales and services revenue was $10.9 million in Q1, down slightly from $11.1 million in Q4, and $15.8 million during Q1 2009. As we sell more Top Drive units, we expect this business to become a larger portion of our Top Drive segment in coming years.

Both operating income and margins increased in our Top Drive segment from Q4. Top Drive operating margins were 24% in Q1, compared to 16% in Q4. This increase is primarily due to a $5.4 million inventory adjustment and a $2.6 million accrual for litigations reserves recorded during Q4, 2009. Top Drive operating income was $12.4 million in Q1, compared to $8.4 million in Q4 2009, and $17.3 million in Q1 2009.

Now on to Tubular Services. Revenue was $31.3 million in Q1, up from $29.1 million in Q4, but down from $37 million in Q1, 2009. Most of the increase from Q4 was in North America and Latin America. Proprietary revenue was $ 25.8 million in Q1, up from $24.4 million in Q4 as a result of more proprietary jobs completed during the quarter.

Our Q1 2009 proprietary revenue was $27.4 million, which included $4.6 million proprietary equipment sales. There were no proprietary equipment sales in the first quarter of 2010.

The number of jobs had in our proprietary casing drive system or CDS was a record 797 in Q1 versus 767 jobs in the fourth quarter, and 562 jobs in Q1 of last year. We continue to see increased demand and acceptance of our CDS tool in the market, and we expect this trend to continue. Our CDS fleet was 255 units at the end of the quarter, the same as at the end of Q4.

Conventional revenue rose to $5.5 million in Q1, versus $4.7 million in Q4, primarily due to the increase in rig count in North America during Q1. Pricing for this business continues to be depressed due to the significant complication for available work.

Overall Tubular Services operating income in Q1 was $3.5 million compared to an operating loss of $2 million in Q4, which was driven by a $2 million inventory charge. With the increase in activity and the focus on cost reduction over the past year, we’re pleased to report that this segment returned to profitability in the first quarter.

Moving on to casing drilling. Casing drilling revenue increased to $2.6 million in Q1 from $2.4 million during the fourth quarter, and down from $5.1 million in Q1 of 2009. Operating loss for the quarter was $2.9 million compared to $11.7 million in Q4, and $1.4 million in Q1 of 2009. Casing drilling results for Q4 included a $7 million one-time inventory charge.

Now on to our corporate expenses, which were $8.5 million in the first quarter, compared to $7.7 million in Q4. The increase from Q4 was primarily due to higher bonus accruals, due to our positive operating result in the first quarter. Total selling, general and administrative costs were $10.8 million in Q1 compared to $9.8 million in Q4.

Research and Engineering costs were $1.6 million for the first quarter, up from $900,000 in Q4. Research and engineering continues to be a strategic development for the company, and we plan to continue to invest in our proprietary technologies.

Our effective tax rate for Q1 was 32%, down from 38% recorded in the fourth quarter. We expect our effective tax rate to remain between 30% and 35% for 2010, depending on the level of income earned in various jurisdictions in which we operate.

Turing to the balance sheet; at March 31 2010, our cash and cash equivalents were $36.6 million with zero debt. During the first quarter we paid the remaining $8.6 million of debt outstanding as of December 31 and we are debt free today.

We continue to generate free cash flow during the quarter, which we intend to use to reinvest into our various business lines. Our capital expenditures in the first quarter were $2.5 million, down from $3.6 million in Q4. Based on current market conditions, we expect our 2010 CapEx to be between $20 million and $30 million.

I’ll now turn the discussion back to Julio.

Julio Quintana

Thanks Bob. We’re beginning to see increased activity across many of our business lines. Our Q1 revenue increased slightly over Q4, primarily due to increased Top Drive rental activity and increased Tubular Services revenue.

The product sales business has clearly gained momentum in recent months, and our proprietary technologies continue to differentiate themselves. However, we are still taking a cautiously optimistic approach to this market.

The cost cutting and efficiency initiatives implemented last year are beginning to demonstrate results. Still we must continue to manage our business to ensure that our costs do not get ahead of our market recovery.

Looking at Q1, it is important to note that we returned to profitability in our tubular services segment, added to our third party Top Drive backlog, grew and improved our Top Drive rental business, continued the expansion of our proprietary tubular services business, and generated free cash flow which allowed us to fully pay off our remaining debt during the quarter.

Digging a little deeper into each of our business lines let me first address the Top Drive business. As Bob mentioned, we delivered 12 new Top Drives and two used Top Drives for third parties during the quarter, and we ended the quarter with a backlog of 18 units.

The increase on backlog net of units delivered was a result of 19 new Top Drive orders received during the quarter. The current backlog and new order activity provide an increasing level of confidence that the product sales business will continue to strengthen in the near and medium term.

Long term, we still believe another new built rig cycle is likely. This belief is mainly due to the competitive advantage and the efficiencies gain by newer faster moving rigs when drilling out a full development program. Each day saved whether in drilling or moving, multiplied over an entire development program, adds value to the operation.

As activity continues to recover, TESCO is in good shape to handle increased demand. Capacity at our manufacturing facility currently stands at about four to six units per month. We believe this represents a reasonable capacity to meet current and expected demand.

As we discussed last quarter, activity beyond this capacity would require us to hire additional personal to meet the production needs; something we could do so with relative ease. A further constrain on manufacturing over the current capacity could be in a supply of long lead items for our Top Drives. We continue to work diligently on sales and operational planning to ensure effective procurement of these long need items.

After market revenue was down slightly from Q4. The decrease was mainly in our international locations due to decreased demand for parts and services. We believe that business should recover, as Top Drive rigs remain working.

Today our installed base stands at over 800 Top Drives around the world and continues to grow. This installed base should give us a solid foundation of which to grow this business, and it should contribute reasonable probability to our Top Drive segment in future years.

On the rental front, operating days decreased slightly to 5373 days in Q1, down from 5422 days in Q4. Nevertheless, the revenue was the highest it has been since Q4 2008, with nine pre-owned units in our Top Drive fleet. This is a reflection of our strategic redeployment of units outside North America, before and during the downturn of 2009.

Today we are seeing continued demand in nearly all of our operating locations, but particularly in Russia and Latin America. We expect to continue this trend over the coming quarters.

Switching to Tubular Services. One of the high points of the quarter was our record number of proprietary jobs. We completed a record 797 jobs in Q1, versus 767 jobs in the fourth quarter, and 562 jobs in Q1 of last year. This is the third consecutive quarter of record job count, and this business continues to gain momentum.

We are convinced that every Top Drive rig will eventually run casing with an automated system such as our CDS. The two offers superior safety, and got more advantages, which we believe has proved a revolution in casing running.

As we discussed last quarter, we continue to work on our cost structure in North America. This has begun to pay off. Our Tubular Services segment generated operating income of $3.5 million in Q1 compared to a loss last quarter. We are committed to making this business a major contributor to TESCO both in revenue and to the bottom line.

Finally let’s review casing drilling. Casing drilling revenue increased to $2.6 million in Q1 from $2.4 million during the fourth quarter, and down from $5.1 million in Q1 2009. As we discussed last quarter, current revenue and activity are clearly below our desired levels. However, the prospect list is encouraging.

Today, most of our work is international, with Latin America being our strongest region. Strategically we plan to continue to drive this technology into the offshore market, which is a higher cost environment to the operators, and with a value, casing drilling can more easily be demonstrated.

As I mentioned last quarter, we do not anticipate a return of sale revenue run rate until near end of the year. We are committed to moving this technology in to a high volume, high cost, multi rig opportunities mostly offshore, which will continue to be drilled despite temporary fluctuations in commodity prices. Such focus requires a longer-term business development cycle. However, we believe this is the right thing to do in the long term, and we are committed to seeing through on this strategy.

We will now take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Neal Dingmann - Wunderlich Securities.

Neal Dingmann – Wunderlich Securities

I just wondered, on the Top Drive there’s 18 units; a couple of questions on the Top Drives. First, those 18 units, how quick do you’ll anticipate getting those out the door, and then, what are you seeing on bidding activity or kind of what do you think the landscape looks like maybe just for the remainder of this year?

Julio Quintana

If you look at the backlog Neal, the majority of the units that we are selling or delivering into the North American market but in fact are going international, so most of the demand I think still is coming from the international market for us. I think that continues to stay relatively healthy, if not increasing for the remainder of the year, as the oil prices remain strong.

So my overall feeling is that, we’ve seen an up-tick during the last three or four months, and there is nothing to tell us that that up-tick is going to slowdown for the remainder of the year.

Neal Dingmann – Wunderlich Securities

Then looking over to tubular services, obviously its pretty incredible, the direct to proprietary casing jobs. I’m wondering, on those, are you continuing to develop those in additional areas? Is it with newer customers? I’m just wondering if you continue to get these records as it -- I guess what I’m asking is it more organically or are you expending markets?

Julio Quintana

No, the growth is all organic, and its kind of all everywhere, but have the business is in North America, and in fact probably 80% of that North American business is in the resource plays, that’s where we really differentiate ourselves.

Obviously we have a high angle type of drilling operations, but as far as the growth Neal, it’s been pretty much across the board everywhere in the geographies where we are, and I actually think we are under investing in that business part of our strategy, but it does kind of get more aggressive in that growth.

Neal Dingmann – Wunderlich Securities

Does that include offshore. I’m just wondering, you briefly had mentioned that, but I’m wondering what you think the prospects there are offshore?

Julio Quintana

Certainly we do both offshore and onshore work. In many ways we are more differentiated arguably with this technology offshore than onshore, but still probably 80% of our business is land. We don’t have quite the infrastructure in place to compete with some of the big guys in certain markets. We are in the process of changing that and we will get much more aggressive with offshore.

We recognize that the revenue put out there is a lot better, and in fact this technology should differentiate itself quiet nicely there. So it only more of an infrastructure issue for us, rather than whether or not the market is better for offshore versus land.

Neal Dingmann – Wunderlich Securities

Then just last question if I could; just on both Tubular Services and casing drilling, it looks like obviously we’re profitable again on that casing drilling side. Are you able to, going forward starting to run a pricing through there, or is it just your able to trim cost or I guess as we sort of model this in for the remainder of the year, what should we expect on margins and is that going to come? I guess what side is that coming from more; the cost side or more on the pricing side?

Julio Quintana

Yes, you’re right. The Tubular Services for casing drilling component went positive, not the casing drilling component.

Neal Dingmann – Wunderlich Securities

You’re correct. I’m sorry correct.

Julio Quintana

Yes, so I think casing running, I think it’s been a combination of both, but prices are not there; let me say differently. We have been really steadfast in making sure that we keep our costs inline when we go after projects that we know are profitable, so that’s been a big contributor. But the other contributor is utilization. We’ve been getting more volume. As you look, really we haven’t increased tool count now for over a year, and our job kind of continues to rise. So as we get better and better utilization of the equipment, then you start driving to profitability.

So our key is to get the write down and to make sure that we are driving profitability an optimum utilization of tools, while still growing the top line; and so those two are the main drivers of profitability more so than pricing percent.

Operator

Your next question comes from Chris Glasine - Simmons & Company.

Chris Glasine – Simmons & Company

Just quickly, did I hear correctly that the majority of the 19 units that you booked in Q1 went domestically or internationally?

Bob Kayl

Yes Chris, this is Bob. The majority of your books are for North America deliveries, but looking ultimately at the customers, we believe that many of those units will ultimately go international. The deliveries for us will be in North America.

So we’ll recognize the revenue as U.S. and Canada, but we know that those rigs are heading to the international locations. So the market pool is coming from international more that from North America.

Chris Glasine – Simmons & Company

Second line of questioning; can you give us an update now with regard to the location of your rental units. More specifically, how many you have left in North America and also how many you have in Russia now?

Julio Quintana

Specifically Chris, there are 117 units in the round fleet. There’s about 13 out of 40 in North America, and in Russia were about 10 to 12. The most of the rent is coming from international, even though the fact I can tell you is that the North American market has strengthened really nicely.

Operator

Your next question comes from John Keller - Stephen.

John Keller – Stephens Inc.

I want to look at the Top Drive for a second. I’m just curious, is there a situation where with the orders picking up, and it seems like more and more particularly on the land side rig upgrades or adding Top Drives. Is that in anyway going to impact the potential for the rental market going forward, basically the sales will cannibalize any rental?

Julio Quintana

We’ve been having this debate is this industry now for 13 years or whatever it is, 14 years. In theory I guess the answer is yes, in practicality the answer is no. For example, the rental business right now is actually very strong in the U.S. market.

As people look to try to compete against the higher end products, invariably they end up having to put Top Drives on the rigs. The Top Drive may not be available, or more likely that customer may not want to spend the CapEx, or maybe if it’s a wealth into small rig contractor, then they don’t want to maintain a rig fleet or a top rig fleet of three for example, and so you are going to have some level of need for rentals.

My feeling and we’ve kind of run the business this way John, is that if we look at the fact that there’s 6,000 or 7,000 rigs around the world, there will always be a need for 100 to 200 rental units around the world to provide for rental for one off kind of projects, or to provide for remote operations where we can keep the Top Drive running may be easier than a contractor can.

I think as I mentioned before to you guys, one of the big drivers for us is the big international operators do not want to own Top Drives. The downtime associated with Top Drive is a big problem for them, and rather than only Top Drivers maintaining it themselves and paying through downtime with the rig, they’d come to us and say “hey you guys can maintain your own top drives better than anybody and run them. Why don’t you run them for us?”

Our rental fleet is the best performing fleet of Top Drivers in the world since the minimization of downtime, and that’s how we differentiate ourselves. So I think the combination of service need, and lack of infrastructure, and lack of knowledge of keeping these thing running around the world, will always maintain what we believe is the demand for this 100 to 150 maybe 200 top drive type of market on the global scale. So we are not very worried about cannibalizing it now.

John Keller – Stephens Inc.

Then clearly you’re seeing good traction with the proprietary casing and running business, but the growth maybe hasn’t kept pace with that of the rig count, particularly domestically. So if the rig count had to flatten out in the back half of the year, do you think you could still continue to grow your job count?

Julio Quintana

Yes. Our growth has been limited not by market, but by all lack of capital. What ended up happening was you know back from here, in 2008 we felt we needed to add more CapEx; not just the tools, but also shops and commencement tools so forth, and so we made the decision, but that was pulling up to a year, because we wanted to invest heavily in the top drive rental fleet.

If you recall, we were 103 units in 2008, and we ramped it all the way to 126, and that really paid up most of our available capital for the year. We said “Well, that’s okay, we’ll do it 2009.” 2009 came along and of course nobody spent any money last year. So we kind of got into two years of under investing in this key technology.

So our objective here is to invest a lot more aggressively in the growth of this business for the next three years. We think the dominant players today or certainly the leader in the proprietary technology today, and so we want to drive that business harder and steal more market share. So no, I don’t think that barring will collapse the North American rig market. I don’t think the flattening on the rig market in the U.S. will have any impact on our growth.

John Keller – Stephens Inc.

Then finally I just want to circle back on the margin question for that segment a little bit. It was a little bit unclear; I mean from a sustainability standpoint, do you think that you can keep margins where they are or drive some margin expansion as the year progresses?

Julio Quintana

Yes, I think what you are seeing in the margin is -- obviously 2009 was a very difficult year for the company, and we made a lot of hard choices with reducing headcount, but along side of that we made a lot of efficiency stride in our business, particularly our chief resources business, and given the dynamic of last year’s market, we are more selective on the job that we do.

So a year ago we may have been chasing jobs that were say breakeven, and today we are saying no to maybe conventional jobs where we would be loosing money. So the answer of your question is, we believe that those markets are sustainable, and given if we see an increase in revenues, we expect those margins to at least hold steady if not a group cycle.

Bob Kayl

Yes, I think that’s it. To me this Tubular Service business should be perfectly capable of using operating income, at least in the 20s and my feeling is we are trying to do that. We are going to do that through high utilization, more efficient utilization or equipment of people and controlling costs, and we are going to do that.

Operator

Your next question comes from Terese Fabian - Sidoti & Company.

Terese Fabian – Sidoti & Co.

I have a question on your delivery schedule for the Top Drive units in your backlog; and considering what the run rate might be for our new unit deliveries. During the year, you said you’re comfortable with sort of four to six per month capacity that you now have. Does that mean that you would max out at say 18 top drive deliveries per quarter?

Julio Quintana

No, the width of this band here depends very much on the top drive models. So small units we can fill them up pretty quickly, large units obviously take longer to build, so that’s one variable, and the other one is just our own willingness to take risks on the inventory side.

We can hire people pretty quickly. So four to six we’re saying is our current capacity. If we say we can go to eight to 10 frankly, within a month or two week and ramp that capacity up simply. So the big walk for it is more of “Are we prepared to go by 10 caterpillar engines on spec, betting that we’re going to be able to sell the top drives six to eight months from now.

So its more of managing our own working capital to what we think the projection is, than in fact our own capacity. We can build Top Drives and ramp up pretty fast, if indeed the market starts to move in that direction. So we are just managing that very, very tightly.

Terese Fabian – Sidoti & Co.

And what type of models do you have in your backlog now?

Bob Kayl

Yes, it varies for us. There is several of our EMI units, several EXIs, but it’s basically across the board.

Julio Quintana

Yes but as a whole I would say that, most of the units are looking here at the list, most of the units fall into the medium sized type of unit that would be built up sooner or faster than say an HCI which is a slower build.

Terese Fabian - Sidoti & Co.

Then I have a question on your Tubular Services revenue. I think in the last quarter you had an amount from the multiple control line running with system sales, and I think you do not have it is this quarter. What is the outlook on that?

Julio Quintana

So we did have decent revenues for MCLRS this Q1. If I look at the next six to eight quarters Terese, I see that growing really nicely. We actually have a fare amount of captured contracting work already.

I do think that for the next quarter or two it’s going to be soft. In fact, we are acutely impacted by the well control situation in the Gulf of Mexico. We were not on that rig but three of that rig, but three of the rigs that we were doing MCLRS work on were pulled off the operation to go support that effort. So certainly we’ll be impacted by in Q2.

Then generally because its deepwater work in the gulf, Q3 tends to slow because of the hurricane season, and so my guess is that Q2 and Q3 will be somewhat soft compared to Q1, but if I look at Q4 and beyond, we have a terrific backlog building for that business.

Terese Fabian - Sidoti & Co.

Okay, and is that often associated with the propitiatory casing running operations?

Julio Quintana

Yes, we put our last proprietary casing, that’s correct.

Operator

Your next question comes from William Conroy - Pritchard Capital.

William Conroy - Pritchard Capital

Maybe just to tie on a little but more to the previous question Julio. Are you seeing any discernable trend, not so much I guess in backlog which you’ve addressed, but more in your customer inquiries on what your budding; a change in the mix of the drives.

Julio Quintana

In terms of the models?

William Conroy - Pritchard Capital

Well really kind of large small or more new build insulations versus upgrades; anything that’s standing out to you.

Julio Quintana

I don’t think it’s much different. I think it just kind of varies. One quarter will go in one directions and the next quarter will go the other direction. As a general rule, about half of the Top Drives that we sell are for retrofitting existing rigs, and about half are for new builds. This is kind of the last five years.

Obviously today there is best new builds being put out than there was two years ago. Also today its more retrofit, but my feeling is if I kind of look at the next couple of three years, we’re in the best at the -- proportions will stay about the same, about a 50/50 slip.

Then in terms of size, not really, we’ll go for a quarter or two when we sell a bunch of big ECI and HCI, and then new we’ll sell ten EXI’s which are smaller. So I don’t see any trend there, any different in the past. The trend is that certainly there is a lot more activity, a lot more biding activity, a lot more request for Top Drives today, than there was a couple of quarters ago for sure.

William Conroy - Pritchard Capital

On the after market side, other than just the increase in your installed based, what gets that revenue ticking-up or ticking-up more quickly. Seemingly you’ve had a pretty good rebound in fleet utilization, just installed fleet utilization, which one would think might be bringing that up. Is there just a lag effect, are some of your customers internalizing some of the activity that you might have done earlier. Anything going on there, or what will get that number to start to move up.

Julio Quintana

Yes I think it’s a combination of several things. Obviously the increased instable base drives things upward, but its much more driven I think by are ability to diver quality service.

I would say, as a whole if you look at the last 12 to 18 months, we’ve struggled to balance our inventory properly to meet the needs of the growing installed base, and so I think we’ve been less in response to the customer, so the customers are searching for alternatives, so we are fixing that. So certainly our ability to deliver parts and service on a timely bases is a key part of our future growth.

Yes, some customers do break things internally, particulate the bigger ones. They can justify the infrastructure, but as a whole, every drill contractor recognizes the Top Drive downtime for everybody as a big deal, and so to the extend that you can go to the customer, and convince him that you can keep the Top Drive running better that anybody else. They are predisposed to give you the work.

To us, the after market growth is a key part of the strategy, and step one of that is get the service quality to the highest level possible. I would say we are working our way towards that, we are not there yet, but it is a key part of where we are taking the business, and I do believe we’ll gain traction in that business as we prove to the customer that we can keep the Drive running better than anybody else, may be including themselves.

William Conroy - Pritchard Capital

is your biggest part of it qualified technicians?

Julio Quintana

Yes, that’s probably a fair statement. Its getting the level of quality initiatives in place. By the way, I think those thing you are seeing in terms of the downturn -- now lets be practical here, that we have a severe down turn in the last four or five quarters, the rig contractors will drop parts from there own fleet, which is what anybody would expect to do.

So if you have half your fleet down, and you need parts, instead of calling and buying it from TESCO or anybody, you can go rob parts from your own fleet and then use your own people to maintain it. So lot of what you have seen has been that drop in activity, not withstanding the fast that we need to push harder on the service part of the front.

Operator

Your next question comes from Daniel Burke- Johnson Rice.

Daniel Burke - Johnson Rice

I had a question on the margin in the Top Drive segment. It looks like based on our model, if you add back some on the charges in Q4, that Top Drive margin was flat to maybe down a bit sequentially. Is that just explained by some of the used units last quarter, or I guess with the up-tick in the rental fleet day rate we saw in Q1. I was wondering if you could address maybe some of the drivers there.

Julio Quintana

I think what you are seeing there Daniel is certainly the used unites do play a significant factor in driving our margins, and we spend more used units and that was pushing-up some of the margins.

Also as we came out of the downturn in 2009, we were much more aggressive with our pricing on our new units, and we are willing to accept a lower margin for some of those new sales, to move the inventory and to get the sales. So it’s the combination both the drop in the used sales and then also the acceptance in some lower margins on some new sales.

Within the rental business, again we don’t speak specifically about margins, but certainly that we did see our average day rate tick-up in Q1 versus Q4, so that actually drove a little bit better margins within our rental business.

Daniel Burke - Johnson Rice

Okay, that makes sense. Then just to follow-up to that then; pricing on new sales. As that backlog has continued to grow, I’d assume you’d gotten a bit more confident there.

Julio Quintana

Well, we’re being competitive at the market, so we’re still, we saw them at the same prices they were two years ago. The answer to that is no, but at the same time, we were building for fun or free either. We expect a reasonable margin within each of those sales and we have been a little more aggressive on pricing and we continue to be competitive in the market.

Bob Kayl

Yes, if I can add to that a little bit there Daniel, I think the competition is pretty strong for Top Drive sales. Frankly, following-up on Williams question on before and after market, I think a company can differentiate itself and want to be the number two player and have the global infrastructure to be able to support the customer. So the customer, one thing is the cost of the Top Drive and the other thing is the cost of the downtime.

So to the extent that we can convince a customer that if they buy from us, we will help minimize their downtime, then you can differentiate yourselves there and even charge a little bit more for the Top Drive. So to me that’s a key part of the entire effort of making sure that we can differentiae ourselves through our service, and we believe we can do that, but it is competitive lastly.

Daniel Burke - Johnson Rice

The other question I had was actually a far more high level Julio, but I was just curious, when you look at an event like this, this well controlled event, this high profile; I mean is this something that has the potential to change sort of customer receptivity towards some of the new technologies you guys look to introduce?

Julio Quintana

No, I would certainly argue that as a whole, casing drilling is a better way to drill to minimize more controlled events. I don’t know a lot about exactly the place and it’s till being investigated, based on what in know, I don’t think that casing drilling would have made any difference in this particular situation.

But as a whole, I believe casing drilling is a tool that can make a big difference in terms of work and incidents. Having said that, do I think its going to make any substantial impact, positive or negative to TESCO? No, I don’t think so.

Operator

Your next question comes from David Griffiths – Unidentified Company.

David Griffiths – Unidentified Company

I just had a couple of questions for you. Can you talk about opportunities to potentially expand the rental fleet internationally? You kind of talked about the other capacity to build four to six Top Drives in-house, but if you wanted to expand the rental fleet internationally maybe later this year or next year, how would you chose to add manufacturing capacity to do that?

Julio Quintana

Manufacturing will not be the bottleneck. If we felt that the rental fleet needed to go to 130, 140, 150, which we are investigating, and we do recognize that there is a pretty good demand for it, then basically we will lay our schedule. We’ll basically make TESCO internal needs to just meet one more customer in the overall scheme of product manufacturing.

So if we say “Hey will I have to build a run rate of 60 Top Drives a year for a third part,” and then we can get another 30 Top Drives into our fleet for a total of 90, then we have to basically build out roughly 80 to 90 a month, then we just ramp up accordingly. So to us we don’t really differentiate.

The real question we’re going to roll the rental fleet over the next couple of three quarters, will be all driven by our view of the market, not by our capacity to build these units. We can get them out within a couple of quarters pretty quickly if we need to.

David Griffiths – Unidentified Company

If you had to hazard a guess, do you think you will be building some more Top Drives for rental fleets that are in the course of this year.

Julio Quintana

Its still early David. I can tell the demand is substantially better today than it was two quarters ago. Weather or not we want to grow from 117 to 125 or 150, we’re just still in the analysis stage putting it together, but the demand certainly doesn’t appear to have strengthened.

Bob Kayl

David, we thought that we said our ideal fleet is about 120 unites, but we said that in the context before we got into some of these newer markets where we recently penetrated. So I think the jury is still out on whether we would increase the fleet as we mentioned, but its certainly something that we are open to and looking at.

David Griffiths – Unidentified Company

Can you talk about as well, I think Julio your [Inaudible] were up a few weeks to ago, and you talked about a new technology that you are working and developing with the line of drilling. Can you talk a little bit about that, and how it is different in Casing Drilling and maybe how it help address your customer needs.

Julio Quintana

Sure. Our Casing Drilling offering, where we’ve now drilled 500 something wells over thousand straights of height, is mine is commercial and we are moving that along, but there’s two markets that we have struggled to get into.

One is, when you are start talking about really hard rock drilling, generally speaking our downhaul tools tend to not be able to outlast conventional drilling, and so we could still drill the well, but you’d take longer than you expect, and then at the end you don’t make much money for the customer, so that’s one area that we are tackling.

The other market that we have never accessed has been the deepwater market, because in any deepwater well, the casing as we ends at the ocean bottom. So from the ocean bottom to the rig there is no casing, its just the raising and in drill piping in on the whole. So what we’ve come up with, is a way to drill with casing in a liner environment where the casing stops at the ocean bottom, so that means you have to engage and disengage from the liner to do Casing Drilling.

In fact, all the tools are effectively the same as what we used not in our retrievable casing drilling system, with one exception, which is the new liner hanger system that we put together. We are in the process of testing our first tool this month. We’ll make probably two or three tests throughout the year. With the object, they were trying to take that commercial in early 2011.

Then obviously, if it works like we think it works, we would defiantly cancel test and yes, that’s a big deal to us, but its still in the R&D stage.

David Griffiths – Unidentified Company

Is that market potential -- overall is it a smaller or larger market in Casing Drilling?

Julio Quintana

The deepwater drilling environment which is around the world is the toughest drilling that we are consistently doing as an industry. Though in terms of tight hole pressure windows, through salt, high pressures, getting stuck, etc., We know that our Casing Drilling system is a perfect fit to that from our experience in drilling now, like I said it will cost us strength of pipe.

So we are very comfortable that from a downhaul perspective it’s a great application. The question is we are mechanically week in succeeding what we are trying to accomplish. If we succeed in one kind of accomplice, it’s a big deal for the industry right, because for example, it’s not common at all in the Casing Drill today, that because of Casing Drilling the operator can eliminate a string of casing.

A sting of bad casing in a deepwater environment can easily be worth $10 million or $20 million. So it does change the frame work of economies in deep water in a big way. So we are pretty excited, and we are working of course with all the big guys to try to help them understand that, and we are getting some good reception.

Operator

Your next question comes from Doug Garber - FBR Capital Markets.

Doug Garber - FBR Capital Markets

I want to dig into your CapEx and understand what are your priorities between your business lines, specifically between maybe CDS unit grow or rental fleet growth. Also what are the constrains -- between the $20 million and $30 minion, with the health balance sheet, what would cause you to go kind of above that $30 million for CapEx this year.

Julio Quintana

Well the world is changing pretty past here. We put that plan together six months ago. The world was different than it is today; and today the world is different than it was yesterday, so it’s a bit of a moving target Dough.

From an overall perspective we wanted to take a relatively concretive CapEx and cash position when we built the plan last year, based on what we believe is a tenuous economic, world economic situation that can turn in a dime for us. So now we are saying “Hey, we still want to be responsible in how we manage cash though 2010, because of that much more that because of anything with TESCO, so put that as the back drop.

Then if you kind of go beyond that and look at the business lines, what we are seeing is, we are seeing increased demand in Top Drive rentals, which you are right, six months ago we didn’t see, and so now its feeling stronger and stronger, and so that will take on quite a bit of CapEx.

We know that we want to grow aggressively our Tubular Services business, and in fact we’re putting together some pretty large business, some of those [Inaudible] and that’s an interesting situation. So all of a sudden we could very quickly kind ourselves, because of the lower earnings from last year, all of a sudden we can find ourselves bucking up against some the covenants that we have in out debt facility that we have to watch our for.

Having said that, its not a problem, the banks are more than happy. We have a great debt facility and I think the banks are more that happy to support our growth if we chose to receptacles take advantage of the opportunity. So we have plenty of cash, we have no debt, have banks that want to support our growth. If we need to exceed that guidance that we have given you guys on CapEx, we will do it based on market conditions.

We are not saying right now that we are going to do it, we are analyzing all this, and as I said it’s pretty fluid per dynamic, but we are prepared to exceed that substantially if the right deal comes along, and we think we have plenty of avenues to make that happen.

Doug Garber - FBR Capital Markets

All right great Julio. Then my other question is’ previously you guys have done this small tuck in acquisition for conventional case and then converted it. Is that something you guys will still consider doing?

Julio Quintana

Yes, acquisitions as a whole. Not just there Dough, but as a whole its certainly another target for us. I think we made it pretty clear to the investors that we are going to be pretty true to who we are, drilling performance, drilling innovation type of acquisitions around what we do.

So we are not looking at going into the pumping business or something way out of the realm of what we do, but in the context of being the entity elimination company and the drilling innovation company, we are seeing fiscal get some opportunities, particularly in the international locations.

So we are looking at opportunities throughout the world, inclusive of casing running acquisitions to augment our growth. If any of those things hold, I am essentially going to look out, but if they mix us for it we’ll do it. I’m not going to buy things at a crazy price that doesn’t make sense.

We’ve been pretty diligent about making sure that we buy things that are a good fit at a reasonably price, and with the companies over sellers, I should say that I want to jump on board with TESCO and ride what we believe is the growth of TESCO. If that happens we’ll do it, if not then we’ll continue to grow radically.

Operator

(Operator Instructions) Your final question comes from Terese Fabian - Sidoti & Company.

Terese Fabian - Sidoti & Co.

Just a follow-up on the last questions; if you were, when you are to increase your position on the automate casing running segment. What would you be doing inters of investment; would you be looking at more locations or can you just talk about that little bit?

Julio Quintana

Yes, in the casing running I could assure you it’s a little bit of all the above. We have to spend more CapEx to grow our fleet. We have to spend CapEx to grow conventional equipment, so if we go into a new market for example. Actually our own [Inaudible] is a good example where we went in, and bid aggressively on an offshore about eight rig program and won it here a couple of years ago, and you bring new technology but you also have to out and buy some conventional equipment.

If you are not in that operation of course you have to set up shop and so forth, and so what you going to find is, its a little bit of all that, and then in certain markets if it made sense, then we can acquire a company to help accelerate that, and we are open to all that. So at the end if the day Terese, I think the CapEx would come from all sources, just depending on which market happens to hit as we capture work and win bids.

Terese Fabian - Sidoti & Co.

Okay, and would you be looking primarily at the domestic market for the off show work or are you looking at Brazil or other areas also?

Julio Quintana

No the primary target is outside North America. We see developments for outside North America.

Operator

I’m not showing any further questions. Would you like to continue with any further remarks?

Julio Quintana

Thank you Betty, I would, thank you. So in closing, I’d like to thank you for participating in the call today and your interest in TESCO. We remain committed to our strategic vision and the delivery to our shareholders.

We have continued to pursue growth while remaining storage or balance sheet. I believe that if we stay focused on our business development strategies, and here to our cost controls, we will succeed in our efforts. So thank you again for participating and we’ll talk to you next quarter.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may all disconnect. Everyone have a great day.

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