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TESO > SEC Filings for TESO > Form 10-K on 4-Mar-2014All Recent SEC Filings

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Form 10-K for TESCO CORP


4-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Our Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with our consolidated financial statements and the accompanying footnotes included in Part II, Item 8, Financial Statements and Supplementary Data included in this Report on Form 10-K. Our MD&A includes forward-looking statements that are subject to risks and uncertainties that may result in actual results differing from the statements we make. These risks and uncertainties are discussed further in Part I, Item 1A, Risk Factors included in this Report on Form 10-K.

Overview

Listed below is a general outline of our MD&A:

         Our business - includes a summary of our business purposes, a
          description of the current business environment, a summary of our 2013
          performance and an outlook for 2014;


         Results of operations - includes a year-over-year analysis of the
          results of our business segments, our corporate activities, and other
          income statement items;


         Liquidity and capital resources - includes a general discussion of our
          sources and uses of cash, available liquidity, our liquidity outlook
          for 2014, an overview of cash flow activity during 2013, and additional
          factors that could impact our liquidity;


         Critical accounting estimates - includes a discussion of accounting
          estimates that involve the use of significant assumptions and/or
          judgments in the preparation of our consolidated financial statements;
          and


         Off balance sheet arrangements - includes a discussion of our (i) off
          balance sheet arrangements, including guarantees and letters of credit,
          if any, and (ii) other contractual obligations.


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Our Business

We are a global leader in the design, manufacturing of products, and service delivery of technology-based solutions for the upstream energy industry. We seek to change the way wells are drilled by delivering safer and more efficient solutions that add real value by reducing the costs of drilling for and producing oil and natural gas.

Prior to the sale of the Casing Drilling business during the second quarter of 2012, our four business segments were:

Top Drives - top drive sales, top drive rentals and after-market sales and services;

Tubular Services - automated and conventional tubular services;

Casing Drilling - proprietary Casing Drilling technology; and

         Research and Engineering - internal research and development activities
          related to our automated tubular services and top drive model
          development, as well as the Casing Drilling technology prior to the
          sale.

For a detailed description of these business segments, see Part I, Item 1, Business included in this Report on Form 10-K.

Business Environment

Along with the number of wells drilled, one of the key indicators of our business is the number of active drilling rigs. During 2013, North America continued to experience a downturn in rig activity. However, with the increase in drilling rig efficiencies, well count continues to hold up despite the drop in actual rig count. Additionally, certain countries in Latin America experienced a decline in rig activity due to various geopolitical and economic reasons. Current global macro economic conditions make any projections difficult. Below is a table that shows rig counts by region for the years ended December 31, 2013, 2012, and 2011.

                  Average Rig Count(1)              Increase (Decrease)
                 2013       2012     2011     2012 to 2013      2011 to 2012
U.S.           1,761       1,919    1,875     (158 )   (8)%      44       2%
Canada           355         365      423      (10 )   (3)%     (58 )    (14)%
Latin America    419         423      424       (4 )   (1)%      (1 )     -%
Asia Pacific     246         356      256     (110 )   (31)%    100       39%
Middle East      372         241      292      131      54%     (51 )    (17)%
Africa           125         119       78        6      5%       41       53%
Europe           135          96      118       39      41%     (22 )    (19)%
Worldwide      3,413       3,519    3,466     (106 )   (3)%      53       2%


__________________________________


(1) Source: Baker Hughes Incorporated worldwide rig count; averages are monthly. The Baker Hughes International Rotary Rig Count is a monthly census of active drilling rigs exploring for or developing oil or natural gas outside North America (U.S. and Canada). The Baker Hughes International Rotary Rig Count does not include rigs drilling in Russia, the Caspian region, Iran, Sudan, Cuba, North Korea or onshore China. Iraq was excluded from the International Rotary Rig Count for the period September 1990 to May 2012. Syria is currently excluded from the International Rotary Rig Count as of February 2012 due to difficulty obtaining data as a result of continued civil unrest. To be counted as active a rig must be on location and be drilling or 'turning to the right'. A rig is considered active from the moment the well is "spudded" until it reaches target depth or "TD". Rigs that are in transit from one location to another, rigging up or being used in non-drilling activities such as workovers, completions or production testing, are not counted as active.

Summary of 2013 and Operational Performance

During 2013, our Tubular Services segment improved on its performance from 2012 and provided an incremental strong base of earnings. Our automated tubular services offering continues to gain market acceptance on a global basis, and we remain committed to growing this segment as we believe that every top drive rig will eventually convert to running casing with an automated system, such as the CDS that we offer. The downturn in North American rig activity negatively impacted our Top Drive segment, which was partially offset by improvement in most of our international Top Drive markets. We also invested in


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new and enhanced product and service offerings that are being developed in our Research and Engineering segment. We continue to grow operationally and fiscally stronger as demonstrated by the following factors:

         we increased our net cash position from $21.8 million at December 31,
          2012 to $96.9 million at December 31, 2013;


         we increased our cash provided by operating activities from $17.6
          million in 2012 to $94.0 million in 2013;


         we improved our inventory processes and, as a result, decreased net
          inventory by $27.1 million, or 22%, during 2013;


         we increased our Tubular Services operating income from $21.7 million
          in 2012 to a record $37.0 million in 2013;


         we surpassed 4,000 CDS automated casing running jobs by recording 4,008
          jobs in 2013, up from 3,525 in 2012; and


         although we had a particularly difficult Top Drive rental market in
          North America during 2013, we were able to partially offset this
          decline with a 23% increase in revenue and related rental activity in
          Latin America.

Outlook for 2014

The current outlook for the global economy varies widely, but market data
suggests and we believe that most indicators point towards a continued slow
recovery in 2014. Below is a table that shows projected drilling activity for
2014 by region and compares these projections to the number of wells drilled
during each of the years ended December 31, 2013, 2012 and 2011. In particular,
U.S. and Canadian activity is projected to increase by 5% and international
activity is projected to increase by 1% from average 2013 levels.

                                                         Wells drilled (1)
                                                     Years ended December 31,
                                          2014            2013          2012          2011
                                      (forecast)(1)
U.S.(2)                                     45,834        44,198        44,732        44,905
Canada                                      11,392        10,337        10,711        12,612
Latin America                                4,703         4,750         4,635         4,743
Europe, Africa, Middle East                 14,544        14,221        14,511        12,086
(including Russia)
Far East (including China)                  29,800        29,706        27,168        26,880
Worldwide                                  106,273       103,212       101,757       101,226


__________________________________


(1) Source: Report by World Oil magazine, February 2014.

(2) U.S. data for the wells drilled in 2013 is estimated by World Oil magazine, February 2014.

Current global macro-economic conditions make any projections difficult and uncertain; however, in each of our revenue generating segments, we anticipate moderately improved activity into 2014, as follows:

Top Drive - Based upon existing drilling and bidding levels and the size of our product sale backlog, we expect our top drive order rate and rental activity to remain steady in 2014. In our North America markets, we are experiencing a slight improvement in bidding and quoting activity. Our top drive sales backlog at December 31, 2013 was 32 units with a total potential revenue value of $44.2 million, compared to 28 units with a total potential revenue value of $42.2 million at December 31, 2012. Our customers have maintained their focus on lowering project costs, which continues to put downward pressure on our sales prices on select product offerings. We expect our international top drive sales, rental activity, and after-market sales and services to hold steady in 2014; and

Tubular Services - We expect our CDS automated and conventional Tubular Services business to strengthen in our international markets in 2014. We will continue to expand our automated and conventional Tubular Services offerings, particularly in the major unconventional shale regions in North America and select international locations.


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Results of Operations

Below is a summary of our revenue and operating results for the years ended December 31, 2013, 2012, and 2011 (in thousands, except percentages):

                        Year Ended December 31,                          Increase/Decrease
                   2013          2012          2011            2012 to 2013             2011 to 2012
Segment revenue
Top Drive       $ 311,632     $ 357,842     $ 344,698     $ (46,210 )    (13)%     $  13,144        4%
Tubular
Services          212,997       182,404       151,124        30,593       17%         31,280       21%
Casing Drilling       624        12,893        17,147       (12,269 )    (95)%        (4,254 )    (25)%
Consolidated
revenue         $ 525,253     $ 553,139     $ 512,969     $ (27,886 )     (5)%     $  40,170        8%

Segment operating income
Top Drive       $  67,462     $  87,716     $  88,799     $ (20,254 )    (23)%     $  (1,083 )     (1)%
Tubular
Services           37,004        21,708        16,680        15,296       70%          5,028       30%
Casing Drilling     2,124         8,191       (12,392 )      (6,067 )    (74)%        20,583       166%
Research and
engineering        (8,578 )     (10,457 )     (12,512 )       1,879       18%          2,055       16%
Corporate and
other             (42,396 )     (30,363 )     (38,058 )     (12,033 )    (40)%         7,695       20%
Consolidated
operating
income             55,616        76,795        42,517       (21,179 )    (28)%        34,278       81%
Other expense       3,952         2,200         1,245         1,752       80%            955       77%
Income before
income taxes       51,664        74,595        41,272       (22,931 )    (31)%        33,323       81%
Income tax
provision          15,404        24,781        14,276        (9,377 )    (38)%        10,505       74%
Net income      $  36,260     $  49,814     $  26,996     $ (13,554 )    (27)%     $  22,818       85%

Top Drive Segment

Our Top Drive business segment sells equipment and provides services to drilling contractors and oil and natural gas operating companies throughout the world. We primarily manufacture top drives that are used in drilling operations to rotate the drill string and/or casing while suspended from the derrick above the rig floor. We also provide top drive rental services on a day-rate basis for land and offshore drilling rigs, and we provide after-market sales and support for our customers. The following is a summary of our top drive operating results and metrics for the years ended December 31, 2013, 2012, and 2011 (revenue and operating income in thousands, except percentages):


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                        Year Ended December 31,                          Increase/Decrease
                   2013          2012          2011            2012 to 2013             2011 to 2012
Top Drive
revenue
Sales           $ 127,189     $ 166,722     $ 152,599       (39,533 )    (24)%        14,123        9%
Rental services   125,181       126,095       135,706          (914 )     (1)%        (9,611 )     (7)%
After-market
sales and
services           59,262        65,025        56,393        (5,763 )     (9)%         8,632       15%
                $ 311,632     $ 357,842     $ 344,698     $ (46,210 )    (13)%     $  13,144        4%
Top Drive
operating
income          $  67,462     $  87,716     $  88,799       (20,254 )    (23)%        (1,083 )     (1)%
Number of top
drive sales:
New                    88           121           106           (33 )    (27)%            15       14%
Used or
consigned              12            10             9             2       20%              1       11%
End of period
number of top
drives in
rental fleet:         129           135           132            (6 )     (4)%             3        2%
Rental
operating days
(a)                24,561        25,420        28,280          (859 )     (3)%        (2,860 )    (10)%
Average daily
operating rate  $   5,097     $   4,960     $   4,799           137        3%            161        3%


__________________________________


(a) Defined as a day that a unit in our rental fleet is under contract and operating; does not include stand-by days.

Top Drive sales revenue - The decrease in revenue from 2012 to 2013 and increase from 2011 to 2012 were due to the number of new top drive units sold as a result of demand caused by both domestic and international rig count for each respective period. Our selling price per unit varies significantly depending on the model, whether the unit was previously operated in our rental fleet and whether a power unit was included in the sale. Revenue related to the sale of used or consigned top drive units was $9.9 million, $13.5 million, and $9.0 million during 2013, 2012, and 2011, respectively.

Top Drive rental services revenue - The decrease in revenue from 2012 to 2013 was due to the decrease in rental operating days resulting from lower rig count in North America during 2013. The 2013 average rig count in the U.S. was 1,761 units as compared to an average of 1,919 units in 2012. The decrease in revenue from 2011 to 2012 was due to the decrease in rental operating days resulting from lower rig count in North America during the second half of 2012. The 2012 average rig count in the U.S. was over 2,000 units in January 2012 but had dropped below 1,800 units in December 2012. Our rental fleet increased by 3 units in 2012 and then decreased by 6 units during 2013 to react to the demand of our customers for rental services.

Top Drive after-market sales and services revenue - The decrease in revenue from 2012 to 2013 was primarily due to lower rig count in North America during 2013.
The increase in revenue from 2011 to 2012 was the result of higher market demand created by a larger installed base of Tesco top drives.

Top Drive operating income - The decrease in Top Drive operating results from 2012 to 2013 was due to a decrease in revenue from top drive sales and after-market sales and services due to the factors described above.

The slight decrease in Top Drive operating results from 2011 to 2012 was due primarily to a decrease in operating days for the rental fleet, partially offset by higher revenue from top drive sales and after-market sales and services. Additionally during 2012, we recorded warranty expenses of $4.4 million specifically associated with our new ESI top drive model.

Tubular Services Segment

Our Tubular Services business segment includes both automated and conventional services, which are typically offered as a "call out" service on a well-by-well basis. Our automated service offerings, in particular the CDS, provide a safer and more automated method for running casing and, if required, reaming the casing into the hole, as compared to traditional methods. Additionally, our automated Tubular Services business includes the installation services of deep water smart well completion equipment using our MCLRS, a proprietary and patented technology that improves the quality of the installation of high-end well completions. Our conventional Tubular Services business provides equipment and personnel for the installation of tubing and casing, including power tongs, pick-up/lay-down units, torque monitoring services, and connection testing services for new well construction and in work-over or re-entry operations. Below is a summary of our Tubular Services operating results


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and metrics for the years ended December 31, 2013, 2012, and 2011 (revenue and operating income in thousands, except percentages):

                        Year Ended December 31,                          Increase/Decrease
                   2013          2012          2011            2012 to 2013             2011 to 2012
Tubular
Services
revenue
Automated       $ 172,174     $ 141,191     $ 120,315     $  30,983       22%      $  20,876       17%
Conventional       40,823        41,213        30,809          (390 )     (1)%        10,404       34%
                $ 212,997     $ 182,404     $ 151,124     $  30,593       17%      $  31,280       21%
Tubular
Services
operating
income          $  37,004     $  21,708     $  16,680     $  15,296       70%      $   5,028       30%
Number of
automated jobs      4,008         3,525         3,557           483       14%            (32 )     (1)%

The increases in Tubular Services revenue from 2012 to 2013 and from 2011 to 2012 were due to increased demand for tubular services. A significant amount of current U.S. drilling activity is in shale formations that require directional and horizontal drilling techniques, which we believe are good applications for our automated service offerings. In addition, increased domestic and international demand for our tubular services, both automated and conventional, has resulted in new jobs at more favorable pricing terms. The Tubular Services automated revenue for 2013, 2012, and 2011 also included $16.1 million, $6.7 million, and $2.3 million, respectively, of revenue from CDS equipment sales. Additionally, during 2013 and 2012, Premiere Casing Services - Egypt SAE ("Premiere"), which we acquired in October 2011, recorded $13.3 million and $8.3 million of revenue, respectively, from conventional service offerings, compared to $0.7 million during 2011.

The increase in Tubular Services operating income from 2012 to 2013 was due primarily to higher revenue for our automated tubular services offerings mentioned above and increased CDS equipment sales, which provide higher operating margins. The improvement in our Tubular Services operating results from 2011 to 2012 was primarily a function of the revenue factors discussed above, which provided flow-through to our operating margin as benefits were derived from economies of scale. During 2010, our operating results included a $1.8 million decrease in operating income resulting from a customer dispute over contract term interpretations, which was resolved favorably in 2013.

 Casing Drilling Segment

On June 4, 2012, we completed the sale of substantially all of the assets of the
Casing Drilling segment to the Schlumberger Group. For detailed discussion of
this matter, see Part II, Item 8, Financial Statements and Supplementary Data,
Note 3 included in the Report on Form 10-K.

Below is a summary of our Casing Drilling operating results for the years ended
December 31, 2013, 2012, and 2011 (in thousands, except percentages):
                        Year Ended December 31,                          Increase/Decrease
                   2013          2012          2011            2012 to 2013             2011 to 2012
Casing Drilling
revenue         $     624     $  12,893     $  17,147     $ (12,269 )    (95)%     $  (4,254 )    (25)%
Casing Drilling
operating
income (loss)   $   2,124     $   8,191     $ (12,392 )   $  (6,067 )    (74)%     $  20,583       166%

Casing Drilling operating income for the years ended December 31, 2013 and 2012, includes a $1.4 million and $12.4 million gain from the sale of the business segment, respectively.

Research and Engineering Segment

Our Research and Engineering segment is comprised of our internal research and development activities related to our automated tubular services and top drive model development, as well as the Casing Drilling technology prior to the sale on June 4, 2012. The following is a summary of our research and engineering expense for the years ended December 31, 2013, 2012, and 2011 (in thousands, except percentages):


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Year Ended December 31, Increase/Decrease
2013 2012 2011 2012 to 2013 2011 to 2012
Research and
engineering
expense $ 8,578 $ 10,457 $ 12,512 $ (1,879 ) (18)% $ (2,055 ) (16)%

Research and engineering expenses decreased from 2012 to 2013 and 2011 to 2012 due to the absence of Casing Drilling research and engineering after the sale of this business segment on June 4, 2012. We continue our investment in the development, commercialization and enhancements of our proprietary technologies.

Corporate and Other Segment

Corporate and other expenses primarily consist of the corporate level overhead,
general and administrative expenses, and certain selling and marketing
expenses. Below is a summary of our corporate and other expense for the years
ended December 31, 2013, 2012, and 2011 (in thousands, except percentages):

                        Year Ended December 31,                          Increase/Decrease
                   2013          2012          2011            2012 to 2013             2011 to 2012
Corporate and
other expenses  $  42,396     $  30,363     $  38,058     $  12,033       40%      $  (7,695 )    (20)%
Corporate and
other expenses
as a % of
revenue         8%            5%            7%                           3 pts                   (2) pts

Corporate and other expenses were higher in 2013 than in 2012 due primarily to increased general and administrative long-term and short-term incentive compensation of $3.8 million, increased legal fees of $2.9 million, and increased costs associated with centralized operations support personnel and other related increases of $5.3 million. Corporate and other expenses were lower in 2012 than in 2011 primarily due to decreased short term and long term incentive compensation.

Corporate and other expenses as a percentage of revenue increased in 2013 as compared to 2012 and 2011 due to lower revenues during 2013 primarily due to decreased top drive sales and increased corporate and other expenses due to the factors mentioned above.

Other Expense

Below is a summary of our other expense for the years ended December 31, 2013,
2011, and 2010 (in thousands, except percentages):

                             Year Ended December 31,                  Increase/Decrease
                          2013        2012        2011        2012 to 2013         2011 to 2012
Other expense
Interest expense        $   713     $ 1,204     $ 1,504     $  (491 )   (41)%   $  (300 )   (20)%
Interest income             (49 )      (104 )    (2,596 )        55      53%      2,492      96%
Foreign exchange losses   4,835       3,083       2,523       1,752      57%        560      22%
Other income             (1,547 )    (1,983 )      (186 )       436      22%     (1,797 )   (966)%
Total other expense     $ 3,952     $ 2,200     $ 1,245     $ 1,752      80%    $   955      77%

Interest expense - Interest expense decreased from 2012 to 2013 due primarily to interest expenses accrued during 2012 for tax assessments in foreign jurisdictions. Interest expense decreased from 2011 to 2012 due primarily to a reduction of $1.6 million to interest expense previously accrued for a legacy withholding tax issue in a foreign jurisdiction based on favorable determinations received in April 2012 and January 2013. This reduction was partially off-set by interest expenses accrued during 2012 for tax assessments in foreign jurisdictions. For detailed discussion of these tax matters, see Part II, Item 8, Financial Statements and Supplementary Data, Note 14 included in the Report on Form 10-K. During the fourth quarter of 2012, we drew


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down and repaid $10.0 million on our credit facility to fund working capital needs. In addition, 2012 results include interest expense on the debt assumed from our acquisition of Premiere in October 2011.

Interest income - Interest income decreased from 2011 in both 2012 and 2013 due to a refund received from the Mexican tax authorities during the second quarter of 2011 as described in Part II, Item 8. Financial Statements and Supplementary Data, Note 14 of this Report on Form 10-K. We recorded $2.4 million in interest income and $0.6 million in other income, partially offset by $0.4 million of interest expense during 2011 related to this refund.

Foreign exchange losses - Foreign exchange losses increased from 2012 to 2013 and from 2011 to 2012 due to fluctuations in the valuation of the U.S. dollar compared to other currencies in which we transact around the world, including the Venezuelan bolivar fuerte, Canadian dollars, Argentine pesos, Mexican pesos, Russian rubles, Euros, and Singapore dollars, among others. During 2013 we were . . .

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