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TESCO Corporation (NASDAQ:TESO)

Q3 2012 Earnings Call

November 5, 2012 11:00 AM ET

Executives

Julio Quintana - President & CEO

Bob Kayl - CFO

Analysts

Jeff Spittel - Global Hunter Securities

Robert MacKenzie - FBR

Joe Gibney - Capital One

Josh Lingsch - Simmons & Company

Doug Garber - Dahlman Rose

Daniel Burke - Johnson Rice

John Keller - Stephens Inc.

Operator

Welcome to the TESCO Corporation third quarter 2012 Earnings Conference Call. (Operator Instructions). I would like to introduce our host for today Mr. Julio Quintana, President and CEO. Sir, please go ahead.

Julio Quintana

Thank you Karen. Good morning ladies and gentlemen and welcome to the TESCO’s third quarter 2012 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 Securities Regulation 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 this morning contains an explanation and a reconciliation of these measures to GAAP measures, and we refer you to that release for additional information.

Now on to our third quarter results, we reported net income and diluted EPS Q3 of $9 million or $0.23 per share on a 126.4 million of revenue compared to 13.1 million of net income of $0.34 per share in Q2, 2012 on 136.7 million of revenue. The second quarter included a $13.3 million of pretax gain on the sale of CASING DRILLING business. Operating income decreased during the quarter to 16.2 million down from operating income with 24.6 million primarily due to the aforementioned gain.

Operating margins decreased to 12.8% to Q3 compared to 18% in Q2. Excluding the gain on the sale of our patient growing business in the second quarter operating margins increased to around 8.3% to 12.8% sequentially. Increase in our profitability and return on capital employed have been a stated objective over the last several quarters. We are satisfied with our delivered performance in operating efficiency during this quarter I believe further improvement is possible.

We ended the quarter with a backlog of 30 units with a potential revenue value of 42.4 million. We continue to book an average of six units per month and are prepared for somewhat softer 2013. However we do not believe a dramatic decline of the top price sales market is likely.

We delivered better, normalized operating income during this third quarter and believe this trend should continue. Despite again to see some slowdown in North America we were able to grow our Tubular Services business revenue to record levels and maintain markets.

We are seeing some slowdown in our Top Drive order flow and our backlog stands to 27 units today. Our transformation post-CASING DRILLING is complete. With this increased focus on our base businesses and operational efficiencies we believe we are well positioned for the remainder of 2012 and then in 2013.

I will get into this in more detail after Bob summarizes the financial results. Bob?

Bob Kayl

Thank you Julio. I will discuss our third quarter 2012 operating results by business segment and then give some comments on our corporate and research and engineering expenses. Starting with Top Drives, revenue totaled 79.2 million for the quarter 5% lower than the same period last year and down 12% sequentially from last quarter. The decrease from last quarter is primarily a result of a lower number of Top Drive unit sales and the decrease in the number of operating base for our rental fleet. We sold 28 units for the quarter compared to 34 units in Q2 and 27 units in Q3, 2011.

Off the 28 units sold for the quarter there were 25 new units and 3 used units from our rental fleet. Off the 34 units sold in Q2 there were 33 new units and one used unit. With the 25 new units delivered to our customers in Q3 we ended the quarter with a backlog of 30 Top Drive units with the potential value of 42.4 million down from 41 units with a potential value of 57.3 million at the end of last quarter. During Q3, we saw a decrease in the Top Drive sales activity and today our Top Drive backlog stand at 27 units with several sales pending. We do not include a sale in our backlog until the contract is signed and we have received a non-refundable deposit if required by the contract.

Top Drive rental revenue was 28.8 million in Q3 down from 33.9 million in Q2 and 35.1 million in Q3, 2011. The decrease from Q2 was primarily due to an increase in operating days in Russia, Mexico and in North America consistent with the decrease in the number of active rates in the U.S. and Canada. Currently our rental fleet of Top Drive stands at a 135 units up from 130 units at the end of Q2 as we continue to invest in our global fleet.

Aftermarket sales and service was 16 million in Q3 down from 16.9 million in Q2 and up from 13.2 million in Q3, 2011. The increase from the same period in 2011 is due to higher market demand and a larger install base of TESCO Top Drives. Our Top Drive operating margins were 23.5% in Q3 a decrease from 25.4% in Q2 and 24.6% in Q3, 2011. The decrease from Q2 and Q3, 2011 is primarily due to lower Top Drive rental revenue as a result of and decline in the number of operating days of our Top Drive rental fleet primarily in North America, Mexico and then Russia.

This quarter also included approximately 600,000 higher bad debt expense than in Q2 in the Top Drive segment. Now on to Tubular Services, revenue was 47 million in Q3, up from 41.7 million in Q2 and up from 38.1 million in Q3, 2011. This is the highest quarterly revenue Tubular Services in our history. Proprietary revenue was a record 36.5 million in Q3 up from 33.1 million in Q2 due to increase proprietary casing running jobs and increased sales of CDS equipment. Our Q3, 2011 proprietary revenue was 30.9 million.

We have performed 902 proprietary casing running jobs in Q3 compared to 817 in Q2 and 958 in Q3, 2011. We remain focused on converting the market to running casing with our CDS technology. Our CDS fleet was 369 at the end of Q3 the same was at the end of Q2.

Conventional revenue increased to 10.5 million in Q3 versus 8.6 million in Q2 primarily due an increased number of jobs particularly in the middle-east. Our Q3, 2011 conventional revenue was 7.2 million. Overall Tubular Services offering income in Q3 was 5.3 million with an operating margin of 11% compared to operating income of 4.6 million in Q2 and 4.3 million in Q3, 2011.

The increase from Q2 is primarily due to improved performance in the middl-east and increased sales CDS equipment. Now on to corporate expenses which were 6.5 million compared to 8.4 million for Q2 and 9.6 million in Q3, 2011. The decrease from prior periods is primarily a result of lower compensation expense for quarter during the quarter.

Research and engineering cost for Q3 were 1.8 million compared to 3.4 million in Q2 and 4 million in Q3, 2011. The decrease from prior periods was primarily due to the absence of CASING DRILLING research and engineering after the sale of this business in the second quarter. Our effective tax rate for Q3 was 45% compared to the 35% in Q2 and 41% in Q3, 2011. The increase for this quarter is primarily due to a $1.5 million tax audit assessment in a foreign jurisdiction.

Our effective tax rate which is income tax expense as a percentage of pretax earnings also increased from prior periods due to the fluctuating mix of pretax earnings in the various tax jurisdictions in which we operate around the world.

Turning to the balance sheet, at September 30, cash and cash equivalents were 36.1 million compared to 23.1 million at December 31, 2011. During the nine months ended September 30, we have used cash primarily to purchase and build capital equipment for rental fleet and to expand our Tubular Services businesses. Capital expenditures were 15.8 million in Q3 compared to 17.3 million in Q2 and 14.6 million in Q3, 2011.

We project our total expenditures for 2012 to be between 55 million and 65 million based on current market conditions. I will now turn the discussion back to Julio.

Julio Quintana

Thanks Bob. The sale of CASING DRILLING business line, our transformation is effectively complete. We are much improved company 12 months ago and ready for our next phase. Our current stock price seems to be inconsistent with today’s TESCO. As such I want to spend a few minutes discussing the current perception of TESCO and our future.

First I believe the market place too much emphasis on changes in our backlog. The backlog is only a representation of our product sales business. Top Drive sales revenue for the trailing 12 months constitutes only 32% of our total revenue that is to say 68% of TESCO’s revenue something other than Top Drive sales.

Now as I have stated in prior calls, we have anticipated a slowdown in the Top Drive sales business. We will manage the slowdown, if you want to know how well we will manage this issue, realize that the end of 2009 our backlog stood at 11 units and the rest of our business was severally depressed. An analysis of 2009 and 2010 shows that we build cash and strengthened our balance sheet to the market we covered and the business returned. Our backlog at the end of Q3 stood at 30 units and continue to book units at a rate of about six per month. We are not in a situation similar to the end of 2009 nor do we expect the next year to be a severe than 2009.

The second point to understand is that TESCO is not a North America centric business. Nearly 60% of our revenue comes from either services which we render internationally or Top Drive sales that we recognize in Canada but are driven by international demand. This international percentage continues to expand. In fact we anticipate excellent activity internationally next year, we believe we will grow our international business in 2013 in Top Drive rents, aftermarket and Tubular Services.

Yes, North America may slow some but we are ready for that slowdown and we believe that our international presence and business should offset some if not all of the impact in weaker North American business next year.

The third point to understand is that TESCO’s business is not a capital intensive business. Our trailing 12 month CapEx is 64 million, however only a couple of million dollars will be considered recurring maintenance CapEx all other CapEx is spent on either equipment for expansion of our Tubular Services business mostly tied to secured contracts or replacement CapEx for used Top Drive that we occasionally sell our Top Drive rental fleet. Both these categories of CapEx are discretionary. TESCO continues to generate significant cash flow across all of our businesses.

Finally though we are experiencing a record revenue and near record income, our EBITDA multiple is effectively the lowest in our 12 year history. Our stock is currently trading below book value, we believe that TESCO shares are significantly undervalued today.

As I mentioned our future is cleared, we have moved the burden of CASING DRILLING and our strategy focus is on three key building blocks. First we will build on our excellent Top Drive service reputation and expand from maintaining our own Top Drives to maintaining third party Top Drives which we do today and ultimately to full rig maintenance. Our trailing 12 month revenue in this business is only 67 million in a market which is well over 3 billion in size.

Secondly, we will transform our Tubular Services business from our call-off CDS focus business into a broad base technologically differentiated offering. Again our penetration into this market is less than 10% today. As Bob mentioned earlier this quarter was a record for this business line momentum continues to build and finally we will convert our Top Drive business into full mechanization offering with world class manufacturing and supply chain skills.

We will accomplish this strategy with an intense focus on innovative mechanization products and an absolute obsession with quality in all that we that. In a word, we are very positive on TESCO’s future. Karen, we will now take some questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Jeff Spittel from Global Hunter Securities.

Jeff Spittel - Global Hunter Securities

Maybe if we could start off with rental fleet and maybe if you could give us some color in terms of what a reasonable expectation will be for the (inaudible) as we get closer to the end of the year and I’m assuming you’re going to add before as we march through the end of 2012 here?

Bob Kayl

Yes Jeff we ended the quarter with a 135 units in the rental fleet, several of those units came into the fleet towards the end of the quarter so they didn’t have the benefit of the whole quarter of operating days. What we said historically is that our rental fleet, the ideal size was anywhere from 125 to 145. So I think the current size we are very comfortable with and we are comfortable with the mix of that fleet the way it's spread out around the world.

Jeff Spittel - Global Hunter Securities

And then maybe can you provide a little color around how many CDS units you sold during the third quarter?

Bob Kayl

We haven’t disclosed the number of units but the sales was 1.5 million of sales but we don’t give an account on CDS sales.

Jeff Spittel - Global Hunter Securities

And then maybe a question as we look forward to 2013 here some of these plans were the activity were shifted in North America, as such the Permian maybe not as much penetration there horizontally. As that starts to shift over the next several quarters, what you think the impact is going to be on the CDS business there.

Julio Quintana

Yes clearly we have done a nice job I think Jeff on moving our equipment and our people from the gas rich place like East Texas and North Louisiana, Arkansas and North East and to places like the Rocky and South Texas and Permian so that I’m pretty satisfied. I do see more and more our customers talking about horizontally in places like the Permian and absolutely whenever that happens that’s music to our ears for all of our businesses, not just CDS usage but the unlimited pipe running and the Top Drive rental and sales as well. So it's a very good signal.

Operator

Thank you. And our next question comes from the line of Robert MacKenzie from FBR.

Robert MacKenzie - FBR

Question for you I guess Julio and Bob, can you give us an update, apologize if I miss this earlier on the CFO search.

Julio Quintana

Bob has agreed to stay through the signing of the K in March. We have started to search and we have interviewed candidates and our plans to proper transition, hopefully the firm is going to roll that between the new candidate involved.

Robert MacKenzie - FBR

Okay so you’re narrowing down to a short-list would that be fair?

Julio Quintana

I wouldn’t say it yet. It's still early.

Robert MacKenzie - FBR

Okay. Thank you. Back to operations, can you give us a number on how revenue you generated from sales of used Top Drives this quarter?

Julio Quintana

Yes there was three unit sold and sale was 3.1 million operating units.

Robert MacKenzie - FBR

And did you mention earlier how many Top Drives you have in the rental fleet at the end of the quarter and today?

Julio Quintana

There were 135 units in the rental fleet in the quarter.

Robert MacKenzie - FBR

How do you think about that going forward through this downturn? I know in the last downturn, if I recall correctly I don’t have my model in front of me, you built the rental fleet inside somewhat keeping your manufacturing operations fairly steady is that something we should expect this time around as well.

Julio Quintana

Yes I think the difference job the more we were a couple of years ago to where we are today, at the time our rental fleet was about a 110 units and it was predominantly in North America. We did use some of our manufacturing capacity during the last downturn to build out some units for the rental fleet given that our fleets are higher today. I don’t envision us to add a bunch of units going forward, you can see that some of that production capacity. Now like I said earlier you may, that fleet does fluctuate kind between this 125 and 140 level.

So we tipping a little bit.

Bob Kayl

Yes again if you look at the last downturn Rob, we sold a quite few units on our fleet and so if you anticipate everybody is kind of modeling varying views on North American downturn, I think the general consensus is kind of flat year-over-year, kind of rig activity. I actually think we got little bit further deeper than a lot deeper.

But anyway if you look at the last round we sold quite a few used units during that period as people tried to insure CapEx and we will do that again and if that’s case and let’s say we wedel to one 122-125 because we sell, it doesn’t show you and then of course we will use our production capacity to build that backup. We do think that the particularly international the rental business continues to be very strong next year and we will be able to increase that activity.

Robert MacKenzie - FBR

And then I guess my final question is this, transitioning for the international rental business, the international sale business, how would you help us think about what kind of orders we might see internationally for new Top Drives next year.

Julio Quintana

I think the international business as a whole stays very strong and I think as long as that's the case, then the rig building or rig retrofitting experience that we've had, I think continues. As I think we mentioned in the last few years, about half our top drive sales tend to go internationally except during these uptick years, like we had a couple of years where you get a little bit more North American centric. So my bet Rob, is that, the top drive sales business internationally which again constitutes approximately half of the sales really, stays pretty strong the next couple of years. Realize that, one of the things that has hurt us has been our ESI quality problem that kept us from selling the 500 ton class which is the best and most popular tonnage class sold out there in international market and so that thing resolves itself which effectively we’re done with and gets back going again, that will also help us expand that international backlog.

Operator

Thank you. And our next question comes from the line of Joe Gibney from Capital One.

Joe Gibney - Capital One

Just a question on rental, just trying to understand the decrease in operating days in Russia and Mexico and nature of that. Was this more transitory in nature? You’ve turned down on activity. Just curious if you could provide a little bit color there.

Julio Quintana

Sure, a couple of issues there. As I mentioned, a combination of three things, North America, Russia and Mexico. In North America it is activity based and so we have seen some drop off in North America. In Mexico it’s should be a contractual issue. Basically our customer has a capital budgeting restriction, when they basically use up all their CapEx and just organizationally and bureaucratically just takes a while to get some new chunk of money put in place. And so the resultant have the CapEx available to invest and so they tend to put down whole. And then in Russia, as a combination of some sales of our rental fee that needs to be replenished and it’s a place where the ESI quality problem hit the hardest. A lot of the ESIs were going into Russia and so we were forced to have to provide some relief for our customers in the form of bringing them tough drive rentals on a discounted basis or in some cases, minimal charge basis to get them through their various (inaudible). But all those are both Mexico and Russia are short term issues that worked themselves out between now and the end of the year and then of course what happens in North America is still to be seen.

Joe Gibney - Capital One

And just could you elaborate a little bit further on the ESI, you referenced its effectively done. Now I assume then all inspections are complete. I know last quarter you had indicated you lost out on a few sales. So just provide a little bit color on hoping that trend related to that particular regime.

Julio Quintana

Sure, when I say done, Joe I apologize, what I meant was that we don't expect to take any more charges other than what we’re already taken in Q2, Q1. In terms of done I meant, that the new deal boxes that need to get put on location and replace the deal boxes are in the process of the final stage. It should be done at December-January timeframe. In terms of orders, no we are taking orders already for 2013. And so we’d expect that to start ramping back up over the coming quarters. Also, I think we mentioned last quarter that we’re introducing a 150 ton class unit in to the sales mix and in fact, I think we’re scheduling to deliver that first one now in December and also taking orders for that, so we’ll have some pretty key new products coming into the market, the last couple of quarters, I think before the help are across.

Joe Gibney - Capital One

Just Bob’s model related question, I was just curious on R&D run rate going forward and also if there is any meaningful contribution at all from MCLR’s revenues in the quarter. Didn’t sound like, it like sound more CDS sales and a ramp up boost but any color there on the tubular revenue contribution in the quarter would be helpful.

Bob Kayl

Yes, the (inaudible) business was a little bit lower than what it was in Q2. But still pretty decent quarter for us. On the R&D run rate, now with the absence of the case in drilling, research and engineering, I think we told you on the last call was that number should come down and in fact it did. I think we’re comfortable with this 2-2.5 million per quarter run rate which puts us between 8 and 10 million on an annualized basis. Of course that's another area that spending is somewhat discretionary. So if the downturn or if the pullback next year continues to be a little stronger than what we currently expect, that's an area that we could make some adjustments as well.

Operator

Thank you. And our next question comes from the line of Josh Lingsch from Simmons & Company.

Josh Lingsch - Simmons & Company

As we look at international growth in ’13, do you see that evenly distributed through the year? Is it more weighted to the back half of ’13?

Julio Quintana

No, I don't anticipate the back half loading. I think it would probably be pretty well evenly loaded. The more likely scenario is that, international saves evenly loaded, North America takes a bit and I think there is a general (inaudible) that it could start coming back as early as the second half of next year, but no, internationally I think it stays pretty flat.

Josh Lingsch - Simmons & Company

And then turning to the balance sheet, with respect for your plans for cash and your next cash position in balance sheet and likely free cash flow generation next year. Could you walk us through what do you find you think would best position TESCO going forward?

Julio Quintana

Yes, I think Josh when you see us do with a cash of course it is bundle any CapEx that the company is going to desire next year and need next year. we always look at opportunities that may present themselves in the form of acquisitions, whether those are new technology that might be add-on acquisitions to our existing product lines or even small regional geographic acquisitions like we did with Egypt last fall that would give us presence in a market where strategically we want to be long term and then the question is do you buy it or build it and a lot of times we could find nice little tuck in acquisitions to help position us well in those markets. So I think the use of cash next year is going to be reinvesting back into the business.

Bob Kayl

Yes, if I could add to a little bit Josh, as I mentioned in my comments, I just got three overarching aspects to our strategy. So the first one is its move from being a top drive repair maintenance shop to being a full breakthrough repair maintenance shop and that really expands our ability to go after some potential companies from rig monitoring equipment kind of companies to aftermarket competitors that have maybe specific skill set in certain equipment. So you can see us looking at positions there. If you look at the tubular services side, certainly we will continue to acquire small companies that are regional footprint for example, we did the acquisition last year in Egypt, a premier we then took that business, moved it in to Saudi and we’re doing great in Saudi and then into Iraq, helped in Iraq and in fact we think this quarter was the first they actually the quarter into profitability and did nice job of growth there. So that's a good example of excess taste on that mode. We will do more of those. And also more technologies that are out there around the whole concept of running and cementing, chasing, we think we have a lot of ideas on how to improve that whole process to get better quality cement jobs. And you’ll see us do more of that.

And finally, as I mentioned, the third leg of that school is the move from certainly more than just a top drive actually selling a complete mechanization product for the rig and on that basis, there is a whole slew of companies that you can look at buying. Again, most of them tend to be kind of niche relative small, $10 to $30 million kind of (inaudible) that would certainly be a nice package to a top drive, one of the top drivers in Saudi so the guys just with it. So there is plenty of opportunities to spend that money wisely. Just in terms of the strategy we have we’re creating much more of this.

Operator

Thank you. And our next question comes from the line of Doug Garber with Dahlman Rose.

Doug Garber - Dahlman Rose

With your healthy balance sheet and your good free cash flow generation, what are your thoughts on returning cash to shareholders in the form of either dividends or more likely in the share repurchases, especially at these levels.

Julio Quintana

Yes Doug, look it’s something that every good board always discusses the virtues of one versus another and discussions we have basically look at to talk about share buyback. We talk about some kind of dividend program. But I think at the end of the day, we really do believe that the best use of this money is to expand our business and so that's more than likely we’re going to focus. We’re not closing the door to other possibilities. But at this point we believe that it replace that.

Doug Garber - Dahlman Rose

Also want to ask you about the top drive margin. It was a little lighter than I expected and I understand that was mostly a mix issue, I guess as rental as a higher margin business, but going slower, how do you think about that margin? Is this a good run rate to use now that your manufacturing facility, I mean you work out the kinks today on the supply chain. How do you just think about that margin going forward?

Julio Quintana

Yes, I think that also what you had in the quarter Doug was a little bit worse bad debt expense in Q3 than we had in Q2, it’s about 600,000 more top drive bad debt in the quarter than we had last quarter. So the margins are a little depressed because of that and the bigger impact which you pointed out was the mix in because with the drop in top down rental revenue and rental property, that makes the margins look lower than they had historically over the last few quarters. I think going forward, as the rental business holds up probably pretty well internationally next year, I wouldn’t expect those margins to drop below these levels.

Bob Kayl

I would agree with that, that we should be thinking in terms of improving top drive rentals relative to top price sales and so that will help and show up in margin.

Doug Garber - Dahlman Rose

And also on the CDS sales, could you talk about what kind of visibility or backlog you have in to sell in those units? I know that's been a strategic initiative to ramp up those sales. Could you give us some background and overview on how you see that going forward?

Bob Kayl

Sure, I would say at this point it feels like the momentum is accelerating rather than decelerating. The biggest change in that the biggest probably we expect to see will be from the rig builders and rig owners and rig builders the state of the art rentals. So we’re still pretty bullish and we’ll continue to expand this business for the foreseeable future. But at this point, and I would say it’s probably gone a quarter or two slower than we had liked, but that's a little more on resourcing and focus on getting things done, especially in light of the tough (inaudible) of the case in going to sale, that's kind on a focus of, but anyway we’re pretty confident this thing will continue to expand. But that's clear, we won’t be reporting backlog on this thing and generally it tend to remain comparatively spotty I think for the next few quarters.

Operator

Thank you. And our next question comes from the line of Daniel Burke from Johnson Rice.

Daniel Burke - Johnson Rice

The tubular services business and topline there, fair to say that excluding MCLRS and CDS, I assume your US tubular services revenues would have declined sequentially, right?

Julio Quintana

No Daniel, I think it was fairly flat with what we've aimed since Q2.

Daniel Burke - Johnson Rice

And could you talk about then, maybe elaborate on the domestic side of the tubular services business and what level of margin pressure or pricing pressure maybe you see in there?

Julio Quintana

Sure, well I think because we have been to shift over into the oil place pretty nicely, we really have not seen a lot of pricing pressure in North America. The interesting question will be based on what any one of you projects is going to be the decrease in rig count between and bottom, where you think bottom is two months away or six months ago. My sense is, if there is a 10% drop in rig count, Daniel, I don't think is going to make a very big dent on pricing. I am talking about 10% from now. We’re right down 6 to 10% year-over-year. if it starts to get much more than that, then I would expect to see some pricing pressure, but really today, we have not seen very much of that. I think part of that is, I think we’re still pretty differentiated in the market.

Daniel Burke - Johnson Rice

And then to flex it to the international side of tubular services then, I think you talked about crossing to profitability. I think it was specifically to Iraq or maybe you meant somewhere in the Middle East in general but maybe clarify that and then secondly, in Q3 are you at full run rate in Saudi? Are you still ramping there?

Julio Quintana

So my comment about Middle East was in general basically, we have three businesses over there each of Saudi and Iraq. I think the biggest contributor of those three was Saudi, but I think Iraq is going to help here and Egypt is going to holding. I would Egypt, assuming things stabilize there, politically, I would expect Egypt to improve. Saudi I think still has some room to expand further and Iraq has lots of room to expand future. So I think that Middle East, we should look to a pretty good year until ’13 for Middle East. As a whole, I think we've prudently said this before, Daniel that, critical mass internationally is an issue for us. And so we’re getting more and more focus on getting the critical mass volumes. I would say Asia Pacific is doing a nice job primarily in the Malaysia and Indonesia of really yielding some great results. I think the next target for us is Latin America in general. I think we are valued there by our customers but we’re too spread out and so we need to start getting this more focused or a lot more revenue in places like Mexico and Venezuela and Columbia if we’re going to get that profitability out there. And we’ll do that, so that's kind of a key focus. So as long as the, probably as we look at tubular services, as long as tubular services in North America stays flat, I'll be very happy and then our focus is continue to ramp up Middle East and get critical mass and in Latin America and the business is cut substantially different business. Of course in addition to the CDS sales and so forth I'm talking about.

Daniel Burke - Johnson Rice

And then to sum up, on your recount forecast in the US, not expecting to see intensive pricing pressures come through. So, your 11% margins Julio, still improving absorption in international markets. I assume you think its not like margins are going to fall down a single digits here in the next quarter or two. Double digits remains reasonable, flow double digits remains a reasonable place.

Julio Quintana

I think you tell me what North American rig counts (inaudible) are going to do. But if you assume that the North American activity stays flat. Then I'm confident that we’ll continue to improve in profitability.

Bob Kayl

A lot of that Daniel, will depend on mix too as we have quarters with more NCRS activity and more CDS sales, both of those businesses tend to be higher margin businesses. So the mix they impact the margins on focus loan.

Operator

Thank you and our next question comes from the line of John Keller of Stephens Inc.

John Keller - Stephens Inc.

Just a quick question on how you’re thinking about your top drive manufacturing capacity? I mean it sounds like order flow is going to come and remain at a level, it’s about half of your capacity and how do you approach scaling that down or maintaining kind of your 12 to I think its 14 per month run rate. I would just like to get your thoughts on that Julio.

Julio Quintana

Yes, you remember John, the last score around, again, give you guys a flavor here on how much this is going to fluctuate and how nimble we have to be. I think 2008 we built a 158 top drives, 137 or 138 were third party sales. That was 2008. By August 1st of 2009, we had orders for seven units. And again just to give you a sense of how much we have to adjust. And we did. We adjusted quite nicely and came out of that deep, deep hole. Again, we’re not seeing anything like that based on today’s run rate, you’ve got six, a month, if we thought it was hole, we saw some 70 to 90 units next year. So it’s still a pretty healthy year on that basis. But in terms of how we manage that John, remember we’re a design testing, assembly company. We’re really a General Motors or a Ford. We don't have much machine chops and everything else. So the way we manage that is by inventory flow. So how much order of parts we have coming in versus a projected sales schedule and then of course production and inventory personnel in manufacturing. I think you’ve heard me say before that I felt we cut a little bit too deeply last go around, in our manufacturing facilities. So I think we’ll be a little bit more cautious because we don't see this massive collapse in the business but we will manage our costs some of which are pretty variable based on that. So we did it once, we can do it again. I'm pretty confident that we can manage to do that process just fine.

Operator

Thank you and our next question comes from Robert MacKenzie from FBR.

Robert MacKenzie - FBR

Quick follow up for you Julio, if I may, so is it your view that orders will be strong enough from combination of domestic international that you can keep manufacturing top drives in the 30 to 35 per quarter range you’ve been running at here recently?

Julio Quintana

No sir, that wasn’t. My apologies if that's the way it was written. No, that's what I'm saying. If you actually just do the math, what I said was, six a month times 12, 72. Obviously you would not keep production at that rate. We will for some period, we have an inventory, what happens is, you end up having to anticipate three, six, nine months out Rob, what kind of potential sales you have and so invariably you end up with a bunch of parts coming in, in a given cycle where you see, you know what you’re better off building this thing out and aiming up with a bunch of finished top drives because you know you can sell those on short order. Last call I think I remember we had that 25 to 26 top drives that were completely finished and in fact within 12 months we had them all sold. So my bet is that let us say that the six months holds, if the six a month holds, then then the product be some short term excess finish goods that will have, that we’ll give them or the subsequent six to 12 months and then we would do some adjustment of production accordingly to be able to manage that. But no, under no conditions are we saying that we’re going to keep at a 35 raising at this point now.

Robert MacKenzie - FBR

Okay, so how should we think about, how that affects your cost structure going forward? What do you think shifts in your plant in Calgary there, how are you going to accomplish that?

Julio Quintana

Yes, so it’s a combination, certainly for example, what happens when you’re running a run rate of 30 plus, you end up paying for over time for example and so what you end up doing is (inaudible) I am not going to go on any more over time (inaudible) partial time. Then you get into talking about contract also that we have for supply chain operations and so you probably decrease some of that contract help to make some of that happen. But at the end of the day, obviously it will depend on what the actual volume is. If the volume is in pick a number, 70 to 100 range, then I feel relatively comfortable that we can do a fair amount of adjustments to keep the margins in top drive business from being really effective, if you talk about 50 to 60 type of number, it’s obviously it don't get tougher things to do. But as long as it’s in that range, I feel relatively comfortable that we can go through that.

Bob Kayl

Rob, another thing to keep in mind is, sales within our top right segment, new sales tend to be the low margins business within that segment, so as top right sales decreases, our margin should pull up reasonably well just from the mix discussion we had earlier as well.

Julio Quintana

And again, it’s one of the things that I mentioned in my written comment about the fact that we put so much emphasis on the backlog and manufacturing. If you’re talking about having a year this year, whatever 120, 130 units and next year, a number of 70 to 100 units and again, we’re not suggesting that's a number guys, we’re telling you right now, we have an activity of about six a month, we don't know where that's going to go but if you say that, then basically you’re talking about a 50% drop in a $160 to $180 million business. You’re talking about impact to test something like $60-$70 million of revenue on a revenue base of 500 to 600 million, so 10-15% drop in top drive sales revenue when everything else internally is expanding. So the point of that is recognizing that the top drive sales, product sales fluctuation are a reasonably simple thing for us to manage it. And certainly that whole perspective is priced into our stock.

Operator

Thank you and we have no further questions at this time.

Bob Kayl

So thank you Sharon. So in closing, I would like thank you for participating in the call today and your interest in TESCO. In 2013, TESCOenters its third decade. With a renewed focus we have achieved in 2012, our solid balance and the holiday of our 2000 employees are ready for a very successful 2013 and beyond. Thank you and look forward to our discussion next quarter.

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