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Tesco Corporation (NASDAQ:TESO)

Q4 2013 Earnings Conference Call

February 28, 2014 11:00 a.m. ET

Executives

Julio M. Quintana – President & CEO

Chris L. Boone – SVP & CFO

Fernando R. Assing – EVP & COO

John M. Dodson – Corporate Controller

Analysts

Jess Patel – Clarkson Capital Markets

Joseph D. Gibney – Capital One Securities, Inc.

Marc Bianchi – Cowen and Company

Robert MacKenzie - Iberia Capital Partners

Pike Howard - Johnson Rice & Company

Thomas Curran – FBR Capital Markets & Co

Operator

Good day, ladies and gentlemen, and welcome to the TESCO Corporation Fourth Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I will now turn the call over to your host, Julio Quintana, President and Chief Executive Officer. Please go ahead.

Julio M. Quintana

Thank you, Stephanie. Good morning, ladies and gentlemen, and welcome to TESCO's Fourth Quarter and Year End 2013 Earnings Conference Call. I'm Julio Quintana, TESCO's President and CEO, and I'll be hosting the call today from Calgary. Chris Boone, our Chief Financial Officer is with me on the call. Fernando Assing, our Chief Operating Officer and John Dodson, our Controller are on the call from Houston.

I'll begin with some general comments on the quarter, then Chris will give you an overview of our financial results. Following Chris’s remarks, I'll return and provide some perspective on the year.

Before I begin, it is important to note that during the course of this call, we 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 refer you to that release for additional information.

Now on to our fourth quarter and year end results. We reported net income and EPS for Q4 of $5.5 million or $0.14 per share on $136.9 million of revenue compared to $11.7 million of net income or $0.29 per share in Q3 2013 on $132.2 million of revenue. Adjusted net income for the quarter ended December 31 2013 and was $8.7 million or $0.22 per diluted share.

Adjusted net income for the fourth quarter excludes the after tax impact foreign currency translation losses of $2.3 million or $0.06 per diluted share primarily from Latin American currency devaluations and certain severance charges of $900,000 or $0.02 per diluted share. But includes the after tax impact and of a sequential quarterly swing in allowance for doubtful accounts in Latin America and the Middle East of $1.3 million or $0.03 per diluted share.

Higher legal fees for patent defense of $400,000 or $0.01 per diluted share and $600,000 or $0.02 per diluted share, due to drilling delays from severe North-American weather and Iraqi disruptions, excluding all these items we would have a yielded a quarterly EPS of $0.28 per diluted share.

Operating income decreased during the quarter to $12.2 million down from operating income of $17.8 million from Q3. Our reported OI margin was 9% but adjusted for all the aforementioned items would have been 12%. For all of 2013, reported net income was $36.3 million or $0.91 per diluted share for the year ended December 31, 2013 compared to $49.8 million or a $1.27 per diluted share for 2012.

Adjusted net income for the year ended December 31, 2013 was $38.5 million or $0.97 per diluted share. Adjusted net income for the years ended December 31, 2013 and 2012 excluded $1 million and $8.7 million after tax gained on the sale of casing and drilling business respectively. Revenue was $525.3 million for the year ended December 31, 2013 compared to $553 million for 2012.

Operating income decreased for 2013 to $55.6 million down from operating income of $76.8 million for 2012. Effectively, almost all of this decrease in operating income can be attributed to the softening experience in North America both in services as well as product sales business. Given current drilling activity levels in North America, we experienced reasonable results due to improving international operations. Our Tubular Services business continue to set new records in the fourth quarter and for 2013 we enjoyed the highest annual revenue in the company’s history and exceeded 4,000 automated jobs for the first time.

Although our Top Drive business has continued to be negatively impacted by the decreased active rig count in North America, our Top Drives strategy the shift to international markets, especially to Russia and Latin America has partially offset the decline we experienced in North America. Over the last few months we have begun to experience a strengthening in our Top Drive business both in North America and international. Today our Top Drive backlog stands at 39 units which is a 50% increase to our third quarter backlog of 26 units.

Finally, we are particularly proud of improvement in our balance sheet or we grew cash year on year from $22 million to $97.3 million as a result of excellent free cash flow and great focus on optimizing working capital which is a key aspect of our Tesco 3.0 quality initiative.

With the increased focus on our base businesses and continuous improvement in our operational efficiency, we are well positioned to meet the challenges and opportunities for 2014 and beyond. I will get into this in more detail after Chris summarizes the financial result. Chris?

Chris L. Boone

Thank you, Julio. I will discuss our fourth quarter and year end operating results by business segments and give some comments on our corporate and other expenses. Starting with Top Drives, revenue totaled $81.9 million for the quarter, a increase from $78 million in Q3. The increase from Q3 is primarily a result of increased sales of higher tonnage Top Drives primarily in the Russian market.

We saw 26 units in Q4 this year compared to 26 units in Q3 and 30 units in Q4 of 2012. Of the 26 units sold in Q4 there were 24 new units and two used units from our rental fleet. In Q3, the 26 units sold consisted of 21 new units and 5 used units from our rental fleet. With the 24 new units delivered customers in Q4, we ended the quarter with a backlog of 32 Top Drive units with a potential value of $44.2 million, up from 26 units with a potential value of $37.6 million at the end of Q3.As Julio already mentioned today our backlog stands at a healthy 39 units. A portion of this backlog will be shift in the first quarter of 2014 more will be awaited in the second and third quarters.

Top Drive rental revenue was $32 million in Q4, down slightly from $32.6 million in Q3 and up from $28.7 million in Q4 2012. Our revenue decreased from last quarter primarily due to decreased operating days mostly in Latin America and Russia. Currently, our fleet of rental Top Drives stands at 129 units, a decrease from 130 units we had at the end of Q3 2013.

Aftermarket sales and service revenue was $15.3 million in Q4, up from $14.8 million in Q3 and slightly down from $15.4 million in Q4 2012. The increase from Q3 is primarily due to increased aftermarket part sales in North America.

Our Top Drive operating margins before adjustments were 19% in Q4 2013, a decrease from 25% of both Q3 in 2013 and Q4 2012. The decrease from Q3 2013 is primarily due to the higher number of used Top Drive models delivered in Q3 2013 and decreased Top Drive rental operating days.

Pre-tax severance charges for Top Drive were 400,000. The sequential quarterly swing from Q3 to Q4 2013 related to allowance for doubtful accounts for Top Drive was $900,000. Adjusting to these items the operating margins would have been 21%. Revenue from the Top Drive segment for all of 2013 was $311.6 million, a decrease of $357.8 million for 2012 primarily due to the decrease in the number of units sold during 2013, coupled with decreased in revenue from aftermarket sales and services mostly in North America. Top Drive sales for all of 2013 were 100 units made up of 88 new units and 12 used compared to 131 units made out of the 121 new and 10 used sold on 2012. Full year operating income margin before adjustment was 23% in 2013 down from the 25% operating margin in 2012. The decrease is primarily due to the lower number of Top Drives sold between the periods.

Now onto Tubular Services. Revenue was a record $55 million in Q4, up from $54.2 million in Q3 and up 15% from $50.3 million in Q4 2012. Automated casing running revenue was a record $45.3 million in Q4, up from $43.6 million in Q3, as a result of increased CDS equipment sales. Our Q4 2012 automated casing running revenue was $39 million.

The number of jobs utilizing our automated Casing Drive System was 1,014 in Q4, marking the second time we have exceeded 1,000 automated jobs in a quarter. This was slightly down from 1,063 jobs in Q3 and up from 947 jobs in Q4 2012. We recorded $6.6 million of revenue from CDS equipment sales in Q4, up from $3.6 million in Q3 and $2.9 million in Q4 2012.

Conventional casing running revenue decreased to $9.7 million in Q4 2013 compared to $10.6 million in Q3 2013, primarily due to a decrease in the number of conventional jobs in Canada. Our Q4 2012 conventional revenue was $11.3 million.

Overall, Tubular Services operating income before adjustments in Q4 2013 was $8.6 million compared to operating income of $9.6 million in Q3 2013 and $6.9 million in Q4 2012. The decrease from Q3 was primarily due to a $900,000 impact of drilling delays from North American weather and Iraqi disruptions.

The pretax impact of severance charges for tubular services was 200,000. The sequential quarterly swing from Q3 to Q4 2013 related to allowance for doubtful accounts for Tubular Services is $1 million. Adjusting for these items Q4 2013 would have yielded operating income of $10.7 million or 19%.

As Julio mentioned in his opening remarks, the number of jobs utilizing our automated Casing Drive System was a record 4,008 jobs in 2013, marking the first time we have exceeded 4,000 automated jobs in a year. This is up from 3,525 jobs in 2012. The higher automated job count from 2012 was primarily due to increased automated activity in most of our markets with our Latin American market seeing the most dramatic entries. 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 automated service offerings.

Our CDS fleet was 309 units at the end of 2013 compared to 306 units at the end of 2012.

Revenue for the Tubular Services segment for all of 2013 was $213.1 million, an increase of 17% when compared to $182.4 million for 2012. The Automated casing revenue included $16.1 million of CDS equipment sales for 2013, compared to $6.7 million in the prior year.

Operating income before adjustments from the Tubular Service segment for 2013 was $37 million, up from $21.7 million in 2012. The increase from the prior year is due to the improved margins for automated and conventional offerings in addition to increased sales of CDS equipment which required higher operating margins the most of our Tubular service offerings.

Full-year Tubular Services operating margins before adjustments improved 17% in 2013 up from 12% in 2012. We remain committed to drive profitability in this segment of above 20% operating margins.

Now onto corporate and other expenses, corporate costs were $10.4 million for Q4 2013 compared to $9.1 million for Q3 2013 and $8 million in Q4 2012. The increase from Q3 is primarily due to increased legal fees of $600,000 and severance expense of $700,000. For all of 2013, corporate costs increased to $42.4 million compared to $30.3 million for 2012, primarily due to increased legal fees, higher incentive compensation and increased cost associated with centralized operation and support personnel. These increased personnel costs were partially offset but decreased overhead cost at the field levels.

In addition, 2012 included $3.1 million credit to penalties and other income due to favorable tax judgment in 2012. We estimate for 2014 that corporate G&A cost will average about $9 and $10 million per quarter and product line SG&A cost will average around $4 million per quarter.

Research and engineering cost for Q4 2013 were $1.9 million compared to $2.1 million in Q3, 2013 and to $2.7 million in Q4 2012. For all of 2013, research and engineering costs were $8.6 million compared to $10.5 million for 2012, decrease of 18%. The decrease in the prior year is primarily due to the absence of casing drilling research and engineering costs after the sale of this business in June 2012. We anticipate 2014 R&D costs will remain between $9 million and $10 million annually.

Research and engineering continues to be a strategic investment for the company, and we plan to continue to invest in our proprietary technologies.

Foreign exchange losses for Q4 2013 were $2.3 million, compared to $500,000 in Q3 2013 and $800,000 in Q4 2012. The foreign exchange loss increase is primarily driven by Latin American currency devaluations during the fourth quarter of 2013, primarily Argentina.

Additionally, in January 2014, the Argentina Peso devalued from 6.4 to 8 and can potentially negatively impact Q12014 by $0.04 to $0.05 cents per diluted share. For all of 2013, foreign exchange losses were $4.8 million compared to $3.1 million in 2012. This was a negative impact for $0.12 per diluted share to EPS for the entire year. The Foreign Exchange loss increase was primary driven by Latin American currency devaluations during 2013. During 2014, we’ll be focused on reducing our net asset exposure of local currencies that are at higher risk of devaluation to the dollar. Our effective tax rate for Q4 2013 was 39% compare to 32% in Q32013 and 26% in Q42012. Our effective tax rate increase from Q3 given no tax benefits being derived from the foreign exchange losses which alone call us an 8 percentage point increase in our tax rate for Q4 2013. For all of 2013, our effective task rate was 30% compare to 33% in 2012. Foreign Exchange losses that are caused still an increase in 2013.

According to the balance sheet, at December 31, 2013, cash and cash equivalence were $7.3 million compared to $22 million at December 21, 2012. During 2013, we built up our cash balance through excellent free cash flow from operations and approved working capital balances especially inventory.

Inventory loss was reduced by over $27 million during 2013 this reduction is result of focused efforts to utilize slow moving inventory, better planning tools to reduce safety stock and global inventory of visibility through the new ERP System. For the fourth quarter, receivables increased by $9 million due to the timing of shipments in the quarter. TESO remained at 94 days compared to the prior quarter. Total capital expenditures were $12.8 million in Q42013 compare to $8.4 million in Q3 2013 and $13.6 million in Q4 2012. Total capital expenditures for 2013 were $37.5 million compared to $62.7 million in 2012. 2013 spending was primarily for additions to our top drive rental fleet and maintenance and expansion CapEx for two particular services. We project our total capital expenditures for 2014 to be between 25 and 45 million based on current marketing conditions. I now turn the discussion back to Julio.

Julio M. Quintana

Thanks Chris. We recognize that the yearend numbers have several moving parts. However, many extra numbers all took place in 2013. I will highlight a few. First, despite potential headwinds in North American rig building and service business, our international operations managed to replace almost all of the lost revenue. As a result, a revenue for 2013 dropped only 5% compared to the record year of 2012. With the ongoing apparent strengthening North American business and continued momentum internationally, this positions us well in 2014 for improved global results.

Secondly, we have proven to our investors and customers alike that our tubular service business has excellent momentum for growth and that we can substantially leverage the profitability as we now begin to capitalize on a global footprint. We won major contracts around the globe. We set new records for revenue and income and we exited the year with excellent momentum. With the award the Gulf of Mexico offshore contract, which we are now begun to execute. We’re on track for rapid expansion into the offshore markets.

Thirdly, what we needed to span substantial indirect dollars to implement many of our global quality systems this year, we experience in 2013 some of the benefit for this investments such as inventory. We are confident that 2014 and beyond will see substantial improvement in the quality for product excellence and the way we manage our inventory. This will convert to improved performance throughout the company. We are now also ready to control this indirect cost to better align with our revenue base.

Fourth, we move forward of the acquisition of our catwalk system. The first of several acquisitions we wish to make. As of today, we already have seven units in our sales backlog. As we continue to advance our products portfolio, our product backlog from catwalks is immense levels to CBS units will continue to play a larger role in our business.

Fifth, our balance sheet continues to strengthen as our global infrastructure continues to yield results. We are not finished. We recognize that a best in class global company needs to do a better job of managing exposure such as receivables and foreign exchange losses. We’re working diligently in this front to modify operation processes to minimize such exposures.

In summary, we’ll it can only be described as a year off-peak oil and gas activity for much of the industry. 2013 marks the TESO many excellent wins. It was a year in which we saw new record revenue. Again, record revenue in our tubular services business. Again, record operating income in tubular services with year and year margin improvement of over 5 percentage point. This marks four years in a row of continuous record revenue and operating income in this business line. Additionally, the reintroduction of our new top drive model, the ESI which today constitutes 48% of our backlog.

Our first major deepwater conflict in the Gulf of Mexico and we now have to effectively execute. Several new products being field tested it as we speak with substantial promise with 2014 and beyond. One of the best inventory turn years in our history. The highest year for generating operating cash flows and finally, stock performance point back five years which speaks both the OSX and the S&P 500. We will now take some questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Jess Patel, with Clarkson Capital Markets. Your line is open.

Jess Patel – Clarkson Capital Markets

Thanks. Good morning guys.

Julio M. Quintana

Good morning Jess.

Jess Patel – Clarkson Capital Markets

Maybe if we can start here with you spoke a little bit about maybe seen some green shoots in North American business, can you speak to what the tip of the sphere line be there I guess for the Top Drives business wherever you starting to see a little bit of strength?

Julio M. Quintana

The main one is Top Drive backlog, certainly we starting to see an increase in sales there, it will be more enquiries and then we actually booked some additional Top Drives in [Indiscernible] additional Top Drives sales there. Also the first half of the last year was leaker in terms of rental activity for us in the second half and so if we can sustain the second half activities or the upward pricing pressure something up there and if we can keep the rental fleet operating at the higher level and we did all last year that would look better and finally made quality changes in the aftermarkets side, the customers of course came to clamp down on part sales, I assume the parts purchases and repairs and we reasonably that can gone forever and so we would expect that as a little stronger, so I think a combination of those three mostly the Top Drive sales side suggest that North America will look stronger on that unless same is going to be a better year for North America but I do think in industrial that can be a better year than last year.

Fernando, I don’t recall the number on the backlog any job the backlog coming from North America versus international, can you please put that forth.

Fernando R. Assing

Jeff, let me add to Julio’s comment that our backlog is again 39 units, 40% of this has based in North America and as you know, it’s difficult for us to quantify coming on those and in international markets, but very healthy, a poor connective we are seeing now. Also just to add more color what Julio was saying we do expect some recovery North America based on the significant increasing weight count and weight complexity, service intensity, the [indiscernible] help the 2014 there is consensus both from the analysis upon that. It is also to add that in this year we’ll be spending a lot more time and therefore my weighting will have secured pretty large contract with I have seen in Gulf of Mexico where we’ll start to see the contribution of that contract that’s hopefully to come within 2015.

Jess Patel – Clarkson Capital Markets

All good news and I guess following on with the Top Drive businesses we think about it if we were to 48% of the backlog now related to the ESI, I’m assuming it’s North America does improve and then with some more growth initiatives internationally we should expect to see that mix of ESIs within the backlog start to move up overtime and if that is the case I would have imagined this probably a favorable mixture from a unit price stand point of those fair assessments?

Julio M. Quintana

I think that’s fair Jess, I think it’s two parts of that story and one is great story that ESI really is getting very traction amongst the customers, the revenue per top drive and we saw ESI is defiantly higher and so if that percentage continues to grow and were on the 50% so carried away with it, but let’s say it does stay pretty strong then you would expect the other revenue per sale to go up. On the negative side we haven’t totally dug our way out of some of the ESI cost from last year in some of that actually was other reason for the profitability in Q4 and so that also tends to drain a little bit are operating margin on the business line, so good that the top line is up, bad is low, we do expect that kind of continually improve within next two or three quarters as we kind of continue to get, I will sum up here, and Calgary is going through the planed yesterday and there are several good ideas on how to lower the cost of different items but it just doesn’t happen overnight , it does take us quarters.

So great news overall on the ESI, but do expected to take a couple of quarters to reconcile out of the system in terms of cost.

Jess Patel – Clarkson Capital Markets

All right. Thanks guys. Appreciate the color.

Julio M. Quintana

Thanks.

Operator

Our next question comes from Jo Gibney with Capital One, your line is open.

Joseph D. Gibney – Capital One Securities, Inc.

Thanks. Good morning. Just a couple of quick one’s from me. I was just curious, the dollar amount of the used Top Drives Sales in the quarter, if you have that Chris?

Chris L. Boone

I will let John Dodson grab that answer for me.

John M. Dodson

I’m sorry, can you repeat the question?

Joseph D. Gibney – Capital One Securities, Inc.

Sure. What is the dollar amount of the used Top Drive sales in the quarter?

John M. Dodson

Oh, yes. That number is…

Chris L. Boone

May be Jo, while John is looking at that one why don’t you ahead us with the second one and will come back.

Joseph D. Gibney – Capital One Securities, Inc.

Yes. Sure.

John M. Dodson

It’s $1.4 million.

Joseph D. Gibney – Capital One Securities, Inc.

$1.4 million, I appreciate it. The other was just trying, I apologize, the MCLRS revenues in the quarter?

John M. Dodson

MCLRS revenues was about 2.5.

Joseph D. Gibney – Capital One Securities, Inc.

2.5. Okay, great. And Julio just conceptually, just talk a little bit about Gulf of Mexico deepwater, I know you’re beginning to execute this first major in these nascent stages as you move into this market, but obviously you have a lot of opportunity, but just, you know, do you anticipate, is it your hope to secure the additional booking this year, do you think it is sort of either little bit of improving ground scenario in all of ’14, sort of what are your expectations for how much growth from Mexico can move the needle for you near term?

Julio M. Quintana

As we – as I tried explaining it out last quarter, I think, you know, it is an essential contract for us in that it is multiple rigs over multiple years and so as you said, do everything on the rigs once we get to the peak, it could be worth tens of millions of dollars a year of revenue. We just literally started the first job a couple of weeks ago. We are limited by our own capability, so it is not that there is not activity out there that we’re trying to get people up and running, and get equipment up and running, and so it is going to be the steady progression from now until probably this time next year, a steady progression of increased activity as we grow.

And so, I do expect substantial ramp up to take place that could be worth a lot of money to us to continue to perform. Obviously, beyond that, yes, we want to get additional work, but one of the things that I have told our guys is we don’t want to stumble and so our instinct is going to be to make sure we deliver effectively here, build a good name for ourselves before we jump into another contract of this size.

So, it is – if we can get a contract here up and running that is already worth tens of millions of dollars in revenue, get it up and running, that is a pretty good jump for 2014, obviously when another customer comes along and really wants our help, we will look at that, but I will be just happy to get this one up and running in 2014.

Joseph D. Gibney – Capital One Securities, Inc.

Okay. Fair enough. I appreciate it. Thanks.

Julio M. Quintana

Thanks.

Operator

Our next question comes from Robert MacKenzie with Iberia Capital. Your line is open.

Robert MacKenzie - Iberia Capital Partners

Hi, thanks. Julio, if I may, I wanted to try and dig in a little further, try and get some more granularity on top drive margins here, and these moving pieces within those, I think you mentioned in your comments that excluding all the charges you realized this quarter that was closer to 21% in the fourth quarter versus just shy of 25% in 3Q, and just short of 23% in 2Q. You also did say ESI hurt us some, but can you give us some more granularity on the moving parts from one quarter to the next a little bit.

Julio M. Quintana

Sure. I think there is several items there. So the first one is, even if you at it year-on-year, maybe it is a little easier, 22% versus 25%, the main drain throughout the year was number one, is the ESI profitability, so we talked about that one already that is just going to take a deal away out of that. The second one is North American aftermarket business was soft all year and in fact, even in Q4 was a little softer. We were implementing quite a few changes, so softer for me, cost perspective being a little bit too high.

The third one was, moving parts for rentals in Latin America primarily in Mexico where they had some budgetary problems and so they didn’t ramp up all the Top Drives offshore like they -- like we would expected and then a little bit slow down in Russia, that’s kind of get partially offset by Argentina. And so the combination of those three is what’s--oh, sorry, sorry, good point Chris, thank you. And of course, year, quarter on quarter, we delivered 5 used units in Q3 compared to only 2 in Q4. So, the combination of all that is what led to the decreased profitability.

So then if we say, “What does it look like for 2014?”, certainly in the Top Drive sales side, it’s feeling like volume. We’re certainly starting off better in 2014 than we were in 2013, so we can extrapolate that to suggest maybe 2014’s better on the Top Drive side. If we have the ESI cost behind us, so we’re going forward, that’s better than 2013. The aftermarket business, we worked pretty hard in North America to get that moving again, so we really should see a pretty good improvement there in 2014.

And then, Top Drive rentals Argentina is looking stronger, we won the contract for the land work in Mexico, we are still negotiating, we technically have lost the offer of contract but we’re still negotiating our way through that one for PanaMex, but Argentina is increasing, Russia’s getting stronger. So kind of overall it feels like, like the rental business internationally will be equal to maybe 2013. So when you put it all together, we should have a stronger 2014, in terms of profitability than we did in 2013.

Robert MacKenzie - Iberia Capital Partners

And that’s across the entire segment, correct?

Julio M. Quintana

That’s across the entire segment, yes. With a wild card, one wild card always being, you know, how many used units which we sell, which tend to swing the numbers quite a bit.

Robert MacKenzie - Iberia Capital Partners

Right, okay. Thank you then. And I have to be questioned that I must have missed it, how many rental space units do you have the rental space unit in a quarter?

Julio M. Quintana

129, I think was the number. I think we were down one. But yes, we reported in that, I think it was 129.

Robert MacKenzie - Iberia Capital Partners

Okay. Thanks very much.

Julio M. Quintana

Okay, thanks.

Operator

Our next question comes from Marc Bianchi with Cowen, your line is open.

Marc Bianchi – Cowen and Company

Good morning guys.

Julio M. Quintana

Good morning Marc.

Marc Bianchi – Cowen and Company

Just to follow on with Tubular Services, kind of in the same line of questioning that Rob was offering, as we think about the roadmap for margins in 2014. I think you said the adjusted number in fourth quarter was 19.5, how quickly or what kind of a margin benefit can we expect as we roll through the year from Gulf of Mexico and other initiatives that you have there?

Julio M. Quintana

Yes, no problem Marc. So let me just kind of remind everybody, going back the last couple of years, you know, the strategy behind driving the profitability, so it was several things. One is, we had too much cost and chasing the wrong businesses in North America, so we focused very much on getting that, heading in the right direction.

The second one, the biggest driver was the international footprint, getting that filled in. We’ve done a great job of that particularly in Latin America in our 4th quarter, you know, actually third quarter and fourth quarter, we’ve had some difficulties as you know, both with the Egyptian instability and with the Iraqi instability. So if we assume that that kind of settles down, then that will drive, obviously the profitability there which is kind of consistent with that chunk of a strategy of filling in more of the infrastructure.

The third leg of that stool was, the product sales side. So, continuing to sell CDS has made a very nice quarter in Q4 on product sales, we expect that--I don’t know that--I don’t know if they expect Q4 times 4 to continue, that would be pretty aggressive, but certainly expect year on year, CDS product sales to be pretty healthy.

The fourth one, we had mentioned was the MCLRS business which was soft throughout 2013 and we are now converting more and more that MCLRS business really into a deep water, total Tubular Services business. So for example, the contract we talked about for deep water includes MCLRS. And so, if you look at that business, as I think I mentioned last quarter, our total offshore business worldwide is about 15% of the total revenue for Tubular Services, our stated objective is to drive that to 30% of our business. Obviously this contract is a big chunk of trying to make that happen. If we were to go from 15 to 30% mark, we would be very healthily in the 20’s with operating margins in. So, the offshore portion is a key part of making that happen.

Marc Bianchi – Cowen and Company

Okay. As you roll from fourth quarter to first quarter, should you be able to recover all of that impact that was beyond the severance and the doubtful account adjustment?

Chris L. Boone

Certainly, you know, on doubtful account again, our reserved methodology is really focuses on linked something is age, not necessarily 100% on its future collectability. So, first we would like to be able to get those older receivables collected and be able to claw back some of this additional reserved we booked in Q4. You know, that will certainly be a goal we will have in Q1 through Q2. You know, really, some of those obviously, jobs you lose due to weather and that don’t immediately pop back certainly the demand would still be there for those as those weather improved and obviously, Iraq is back and running again by our customers.

Julio M. Quintana

Yes, I think Marc, I was thinking about your question kind of geography by geography as Chris was answering, so certainly momentum looks good in Asia, momentum looks good in Latin America with the wild card being Venezuela, we don’t have a huge business in Venezuela but we have some business there, so and what’s going to happen there politically but certainly Latin America has had great momentum I think continues into 2014. I think Middle East has good momentum. Saudi continues to be healthy and if we can get, like I said, stability in the other countries then no reason to believe that Middle East wouldn’t come back stronger than in Q4.

And then, North America, it feels like bottom, you know, it feels like we’ve been kind of fighting this, not so much activity level but just fighting its downward pricing pressure for a while now and so, it’s just kind of feels like this steady movement that we’ve been under and certainly, I can’t see it getting any worse. I would expect it to be getting a little better and then if you add to that, the offshore business strengthening then yes it feels pretty reasonably ready to go to the next level. I don’t know Fernando if you want to add any additional color to that?

Fernando R. Assing

I think Julio you showed most of the clients and certainly it feels that we are bouncing at the bottom, shouldn’t get worse. For sure the 2014, we’re expecting to be stronger, how much of that spent will be materialized in Q1 then of course till a matter of judgment, a few weeks to go, we believe we’re stopping the riot in the right path. We also combined with the--what you mentioned Julio on the pricing pressure which is a never-ending game here in North America. We also, we spent a lot of 2013 working on our cost structure which we think we have revamped in line with market conditions right now. We should get some of those benefits from Q1.

Marc Bianchi – Cowen and Company

Okay, thanks guys, I’ll turn it back.

Julio M. Quintana

Thanks Marc.

Operator

Our next question comes from Pike Howard with Johnson Rice, your line is open.

Pike Howard - Johnson Rice & Company

Hey good morning guys. Thanks for taking my question. I just wanted to get a, I guess a little more detailed question in regards to your comment about the timing sort of law on the Top Drive deliveries in Q1 and more weighted towards the second and third quarters, could you just comment on what’s driving that? I know that hasn’t really been the case in the past?

Julio M. Quintana

Sure, no. It’s just as you saw, we had a pretty nice ramp up in order flow here in the beginning of the year.

Pike Howard - Johnson Rice & Company

Okay.

Julio M. Quintana

So it’s not just going to, you know, we don’t have the--as you saw in inventory, we don’t have all the finished goods up and running like we did last year, all that was reported, pretty nice the second half of the year and so we just got to get the momentum going again. So, it may just take us a month or two to kind of get it going, so some of them may slip into April or something like that instead of Q1.

Pike Howard - Johnson Rice & Company

Understood. And then just one more quick one, nice job obviously in turning that inventory into cash here in the quarter. On the working capital side, do you think that that’s fairly sustainable as we look for 2014, just trying to get a feel for the working capital outlook in 2014?

Chris L. Boone

Right, we’ve done a lot of work on trying more to have, you know, the right inventory to really improve our turns. I think there’s still work to go on reducing against some of the slower moving and stock inventory we have. We may see some increasing back in the amount of finished Top Drives we have in inventory for quick sale. We’re pretty successful of 2013 having units on the ground ready to sell when demand came. And so, we’re probably a little lower on that a year end, so you can probably see us build a little bit of that back up, again hopefully offset some of that by, again reducing some of the other parts of inventory to offset. Receivables we continue to work, you know, the biggest challenge is some DSO certainly always remain in Latin America, the Middle East, again we’re making concerted efforts to at least eliminate as many issues that involve slower payment that we can to work that DSO.

Pike Howard - Johnson Rice & Company

Okay, great. That was it for me. I’ll turn it back. I appreciate it.

Julio M. Quintana

Thanks.

Operator

Our next question comes from [Indiscernible] your line is open.

Unidentified Analyst

Thank you. A lot of my questions have asked, but I have two questions. Why it’s just in Tubular Services, I wonder if there is a cage in contracts that you’re winning. Now that this is becoming your bigger business and yes, historically I think added 20% margins and I wonder if there’s a sort of more determined sense of timing in terms when we might get there given the growth in that division.

Julio M. Quintana

Yes, I apologize James, you were literally broken up when you spoke but I think that the question was basically the timing of getting and staying in the 20% margin and as I had mentioned, I think it was Marc that asked the question a minute ago, I think all of these things that I mentioned from cost structure in North America to filling in the international infrastructure to offshore, kind of all have to run together to be able to drive that profitability like we have done and my feeling is that the offshore contract that we have will probably put us over that hump on a more permanent basis once and for all. So, I guess the question of how fast we could ramp up that, assuming all else stays equal right. It’s a matter of how fast we can ramp that up. In practical terms, if we look at the way that we’ve been growing a business on an international scale, if we said 2014 continues to grow like 2012, we probably could get above the 20% consistently without needing the offshore ramp up. So, it feels like it’s a matter of a quarter or two, not a year or two to sustain a 20% number.

Unidentified Analyst

And does the--are the contracts changing in nature and size. Are the kinds of clients that you’re approaching or the kinds of contracts that you’re posing changing. I’m not under that impression but I do want to ask.

Julio M. Quintana

No, no. It’s -- the only, what you would call, fundamental change is that we are, as a company taking on, bidding on larger and larger offshore contracts with large multinationals. So historically, we had been more of a land-centric company, shorter-terms, smaller contracts, so we have built enough confidence now as the number 3Tubular Services company in the world and say, hey, we can go up to these big contracts and execute. So I guess the one strategic shift, if you want to call it, that’s taken place is that we are chasing these much larger offshore contracts.

Unidentified Analyst

Okay, thank you. And the second question that I have is, look, we really thank you for your letter on February 20th around returning ex-capital, which I must admit is larger than I would have thought at this point in time, in terms of your net cash back to investors and looking at strategic options available to the company and the questions that our advisors would have on your reply is, why will it take 4 months from today or 3-4 months to come up with a strategic, sort of, full review of the company given that this is a process that, you know, it seems you’re engaging with some frequency. So, you know, we have no problems with it but want to understand the sense of timing a little bit better?

Julio M. Quintana

Sure, no, not a problem at all. We, James, every year, year and a half, we do a very thorough analysis or a business from a strategic perspective, both from an operational point of view and from a financial point of view and we build pretty extensive models and we look at things like, you know, what’s really going to happen in the Middle East? You know, do we want to really stay there? If we don’t stay there, where do we take the capital, etcetera. And so, that was really the response that we gave you guys, which is I don’t think any investor would want us to make a major capital structure decision without really, kind of, working through the operational strategy of the company.

And so we just happen to be in the middle of that process when we received the letter and we said we will build your suggestions into an overall analysis of the company and literally our schedule. We have a company to run so, it’s not if we shut the company down and go strategize. If we have a company to run and along the way we do this process, then it’s usually a 3-month process that we go through every year or two to make sure that we are understanding every strategic implication. So, we’re well on the way to do that as we said in the response, you should expect to hear back from us, you the investors, some time in Q2 in a very specific way what we think the right thing to do and we will definitely do that.

Unidentified Analyst

Thank you.

Julio M. Quintana

Thanks James.

Operator

[Operator Instructions] Our next question comes from Thomas Curran with FBR Capital, your line is open.

Thomas Curran – FBR Capital Markets & Co

Good morning guys.

Julio M. Quintana

Good morning Tom.

Thomas Curran – FBR Capital Markets & Co

When it comes to the most recent momentum you’ve seen for new Top Drive sales, excuse me, could you share some more color on the international side, where you’re seeing the strongest growth and then as you look into 2014, which markets you’re currently the most excited about.

Julio M. Quintana

Sure. So, you know, first, let me remind everybody that our, you know, we sold approximately 100 top risers, so the 100 top risers in the year including the used units but that in general, most of our Top Drive sales are one here, two there you know, customers tend to buy in that fashion. We did have a couple of large Russian sales last year. As I think about the international--sorry, so first of all, so expect 2014 to be similar. Know, one, two here and there and then you get a occasional 10, 12, 15 Top Drives order from one customer. And I think about 2014, I think Russia will remain a very good market for us. I think China, Chinese manufacturers that are sending rigs outside of China, which has been a market for us but we think we’re getting better and better track scenario, I think we’re very excited about and those tend to be large orders, more lumpy. So, certainly at the market, but it looks pretty good.

And then, the last one is, a lot of the North American, you know, we call this roughly, 40, 50% of our business coming from North America, but we don’t really know exactly where the rigs are going to necessarily end up. So, you have a lot of the North American rig contractors that we worked with over the years that buy Top Drives and I don’t know Tom if it’s 20% or 50% but it’s a substantial portion of those end up in these different markets around the world so you know, arguably, three-fourth of our business may be really is, Top Drive sales ultimately distant for international markets. But I would say the--out of anything that we have going on, all the geographies that we worked, I think will look very healthy. One potential upside beyond our traditional upside would be a stronger China penetration for us in 2014.

Thomas Curran – FBR Capital Markets & Co

Thank you for that. Next, turning to the margin side for Top Drive sales, adjusted for the ESI costs fully normalized, what would you expect to be your incremental new unit margins truly on a volume basis, so assuming no help from pricing?

Julio M. Quintana

I’m not sure I understood the last part where you said, “truly on a volume basis” meaning if we do a hundred again or if we do--

Thomas Curran – FBR Capital Markets & Co

Well, no, just on incremental volume, however you’d want to define it but with no help from pricing is what I’m trying to drive at.

Julio M. Quintana

We are certainly, we’re building our business on the assumption that we get no help from pricing. I think the best way to maybe explain that is if you look at 2012 versus 2013 right? So 2013, we’re moving some of the one-offs 22% margins, 2012 25% margins, but that was selling 130 plus units versus a hundred units. So, if you basically said if we go back to 130 units, then I think we can comfortably say we can head right back towards that 25% margin. Remember last year, one of the other things that we did in 2013 is we actually kept some additional cost at our plant in anticipation of the business kind of strengthening again in 2014. So we did dampen a little bit of profitability on purpose in 2013 for the long-term benefit. So, I would feel very comfortable that if we go back to the 130 kind of volumes of 2012 that we would pretty easily head back into that 25% margin number as we particularly, as we get into ESI costs out of the system. So that would be my instinct pretty comfortably.

Thomas Curran – FBR Capital Markets & Co

Great and just so I’m clear, how much is left on the ESI costing currents front?

Julio M. Quintana

Well on the reserves, there’s no additional reserves at all to be taken, that was all 2013. The comment is more on the fact that we are now, we’ve been in [Vargna] for a couple of quarters on things like driving cost auto like the gearboxes for example, you know, one point last year the gearbox cost jumped from $70,000 to over $200,000 and now we’re heading back towards the $70,000 number but, you know, we needed to order 10 gearboxes to keep everybody happy so you’ve got a bunch of excess high-cost items in the inventory and so it’s just working our way through those that just takes another quarter or two, so. The best way I can explain it is think in terms of probably Q1, Q2, and Q3 to see, have a steady improvement in profitability from the ESI.

Thomas Curran – FBR Capital Markets & Co

Okay and then last one for me and thank you for that Julio, maybe an update on the M&A pipeline?

Julio M. Quintana

Well, we did the catwalk as you know, at the end of the year. Pretty small acquisition yet, as I mentioned on the script, we’ve got 7 of those things on order already and some very good activity for substantially more. So the acquisitions to me, we’re not talking about chasing hundred million dollar acquisitions right? We’re talking about chasing 5, 10, 20, 30 million dollar kind of acquisitions that are great tuck-ins to what we do and so there is probably 5 or 6 of those that we’re working pretty actively. Some of them are near the final stages, others are a quarter or two away or maybe never because they’re private and we’re trying to get them onboard. But we do have, I will say, half a dozen plus or minus that are very active in that order of scale that we would like to get on board and all of them are very specific, either additional products to bring into the fold or Tubular Services kind of companies.

I think I’ve been calling investors now for a quarter or two, that you know in 2014, you know if we don’t spend you know, 50 million or better kind of numbers, I’d be disappointed. I think we have opportunities for those at excellent multiples and we would certainly like to make that happen.

Thomas Curran – FBR Capital Markets & Co

Thanks, I’ll turn it back.

Julio M. Quintana

Thanks Tom.

Operator

I’m currently showing no further questions. At this time, I will now turn the call back over to management for closing remarks.

Julio M. Quintana

Thank you Stephanie. So in closing, I’d like to thank you for participating in the call today and your interest in TESCO. 2013 marked a major shift for TESCO, our ability to deliver and leverage our future growth is stronger than ever, the result of our investments and tough decisions we have made over the last couple of years. Thank you and look forward to our discussions next quarter.

Operator

Thank you ladies and gentlemen that does conclude today’s conference. You may all disconnect and everyone have a great day.

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