Attached files

file filename
EX-31.1 - EXHIBIT 31.1 CEO CERTIFICATION - TESCO CORPexh311ceocert201610-k.htm
EX-32 - EXHIBIT 32 SEC 906 CERTIFICATION - TESCO CORPexh32sec906cert201610-k.htm
EX-31.2 - EXHIBIT 31.2 CFO CERTIFICATION - TESCO CORPexh312cfocert201610-k.htm
EX-23.1 - EXHIBIT 23.1 CONSENT OF AUDITORS, ERNST & YOUNG - TESCO CORPexh231consentofauditorerns.htm
EX-21 - EXHIBIT 21 SUBSIDIARIES - TESCO CORPexh21subsidiariesoftescoco.htm
EX-10.23 - EXHIBIT 10.23 STIP - TESCO CORPexh10232017shorttermincent.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Fiscal Year Ended December 31, 2016
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from                      to                     
Commission file number: 001-34090
tescologoa21a04.jpg
 Tesco Corporation
(Exact name of registrant as specified in its charter)
Alberta
76-0419312
(State or Other Jurisdiction
of Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
 
11330 Clay Road
Suite 350
Houston, Texas
77041
(Address of Principal Executive Offices)
(Zip Code)
713-359-7000
(Registrant’s telephone number, including area code)
Securities to be registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Shares, without par value
 
Nasdaq Stock Market
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   ¨    No   þ 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  þ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  ¨
Accelerated filer  þ
Non-accelerated filer  ¨ (Do not check if a smaller reporting company)
Smaller reporting company  ¨
 
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨    No  þ
The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant at the close of business on June 30, 2016 was $173,724,383 based upon the last sales price reported for such date on the NASDAQ Stock Market.  For purposes of this disclosure, shares of common stock held by persons who hold more than 10% of the outstanding shares of common stock and shares held by



officers and directors of the registrant as of June 30, 2016 have been excluded as such persons may be deemed to be affiliates. This determination is not necessarily conclusive.

Number of shares of Common Stock outstanding as of February 28, 2017: 46,718,884.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the registrant’s 2017 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report on Form 10-K.



TABLE OF CONTENTS
 
 
Page
 
PART I
 
 
 
 
 
PART II
 
 
 
 
 
PART III
 
 
 
 
 
PART IV
 
 

 






PART I

This Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (this "Report") contains "forward-looking statements" within the meaning of Canadian and United States securities laws, including within the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. From time to time, our public filings, press releases and other communications by our officers and representatives (such as conference calls and presentations) will contain forward-looking statements. Forward-looking information is often, but not always, identified by the use of words such as "anticipate", "believe", "expect", "plan", "goal", "seek", "strategy", "future", "intend", "forecast", "target", "project", "likely", "may", "will", "should", "could", "estimate", "predict" or similar words suggesting future outcomes or language suggesting an outlook. Forward-looking statements in this Report on Form 10-K include, but are not limited to, statements with respect to expectations of our prospects, future revenue, earnings, activities and technical results.

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events, trends, the economy and other future conditions. The forward-looking statements in this Report are made as of the date it was issued. We do not undertake any obligation to update publicly or to revise any of the included forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.

By their very nature, forward-looking statements involve inherent risks and uncertainties, both general and specific and risks that outcomes implied by forward-looking statements will not be achieved. We caution readers not to place undue reliance on these statements as a number of important factors could cause the actual results to differ materially from the beliefs, plans, objectives, expectations and anticipations, estimates and intentions expressed in such forward-looking statements.

Item 1. Business
 
General

In this Report the terms "Tesco Corporation," "we," "us," "our," or "the Company," refers to Tesco Corporation and all of its subsidiaries.

Tesco Corporation was organized under the laws of Alberta, Canada on December 1, 1993 through the amalgamation of Shelter Oil and Gas Ltd., Coexco Petroleum Inc., Forewest Industries Ltd. and Tesco Corporation. The Company’s principal executive offices are located at 11330 Clay Road, Suite 350, Houston, Texas 77041, its telephone number is 713-359-7000 and its internet web address is www.tescocorp.com. The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, are available free of charge through our website at www.tescocorp.com as soon as reasonably practicable after we electronically file those materials with, or furnish those materials to, the Securities and Exchange Commission (“SEC”). The public may read and copy these materials at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. For additional information on the operations of the SEC’s Public Reference Room, please call 1-800-SEC-0330. In addition, the SEC maintains an Internet site at www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically. The Company’s Code of Business Conduct and Ethics is also posted on our website. The company’s common stock is traded on the NASDAQ stock exchange under the symbol "TESO".

Tesco Corporation is a global leader and provider of highly engineered technology-based solutions for drilling, servicing, and completion of wells for the upstream energy industry. The Company seeks to improve the way wells are drilled by delivering safer and more efficient solutions that add value by reducing the costs of drilling for, and producing, oil and natural gas. Our operations consist of top drives and automated pipe handling equipment sales and rentals; aftermarket sales and services; and tubular services, including related products and accessories sales.

Our business segments are:

Products – top drives and automated pipe handling equipment sales, rentals and aftermarket sales and services;
Tubular Services – onshore and offshore tubular services and sales of related products and accessories;
Research and Engineering – internal research, engineering, and development activities related to our proprietary products and tubular services; and
Corporate and Other – including executive management and several global support and compliance functions.



1


Products segment

Our Products segment sells equipment and provides services to drilling contractors and exploration and production ("E&P") companies throughout the world. We provide equipment rental services on a day-rate basis for land and offshore drilling rigs and we also provide aftermarket sales and support services to our customers.

We assemble top drives, automated catwalks and other automated pipe handling equipment based upon our proprietary designs, which are used in drilling operations to either convey tubulars to and from the rig floor or rotate the drill string and/or casing while suspended from the derrick above the rig floor. Our equipment offers portability and flexibility; permitting drilling companies to utilize their assets in both permanent and temporary installations. We offer for sale a range of portable and permanently installed top drive products that includes both hydraulically and electrically powered machines capable of delivering 400 to 1,350 horsepower, with a rated lifting capacity of 150 to 750 tons while our automated catwalk systems are suitable for rig floor heights ranging from 4 feet through 35 feet. Our systems automate both the conveyance of tubulars and the drilling process, requiring fewer people as compared to conventional pipe conveyance methods and kelly drilling with a rotary table. With each system we sell, we offer installation and support services, including training.

We offer six distinct series of top drive systems, using either hydraulic, induction alternating current ("AC"), or permanent magnet AC technology and two models of automated catwalks. We believe that we are an industry leader in the development and provision of both portable and permanently installed top drive systems. Our designs and technology provide very high power density, allowing for a high power to weight ratio. We use AC induction technology and late generation power electronics throughout our entire line of electric top drives, allowing the end user to specify its preferred power electronics and motor combination and permitting us to select components from a larger vendor base. Our EMI top drive units are available with 150 to 250 ton load path configurations. We also developed our EXI system in response to market demands for a high performance compact electric top drive system, commonly required on modern fast moving rigs frequently used in pad drilling operations. The EXI system has a load path rating of 350 to 400 tons and generates 600 horsepower. In 2015, an 800 horsepower version of the EXI was released, available in both 350 and 400 ton load path configurations. The ESI is our latest model, which has a load path rating of 500 to 750 tons and generates 1,000 to 1,350 horsepower. The HXI is a new generation of our current hydraulic HMI system, incorporating a full suite of operational features and providing a significant gain in performance. The HXI system has a load path rating of 150 to 250 tons and is driven by a 700 horsepower self-contained diesel-driven hydraulic power unit. Our automated catwalk designs utilize a dual articulating design that seamlessly automates the conveyance of tubulars to and from the rig floor, allowing the catwalk to be remotely set and operated for any rig floor height ranging from 4 feet to 35feet.

In addition to our top drive sales, we maintain a fleet of 116 top drives and four catwalks deployed strategically throughout the world that we rent on a day-rate basis for land and offshore drilling rigs. Our rental fleet is highly transportable; offers a range of systems that can be installed in practically any mast configuration, including workover rigs; and are mobilized to meet the needs of our customers. Our rental fleet is composed principally of hydraulically powered top drive systems, with power ratings of 475 to 1,205 horsepower and load path ratings of 150 to 650 tons, each equipped with its own independent diesel engine driven hydraulic power unit. This unique combination permits a high level of portability and installation flexibility. We currently maintain top drive rental units in Argentina, Mexico, United States, Canada, Russia, Indonesia, and the U.A.E.

We also provide aftermarket sales and services to our installed customer base through our facilities around the globe. Our service offerings include initial rig up and training for our sold units, onsite supervision, and recertification and repair services. In 2014, we extended our aftermarket support beyond our own equipment to service competitor brand top drives and other automated pipe handling equipment. Entry into this market was primarily at the request of our current customer base with mixed fleets and represents an attractive growth opportunity for us. We maintain regional stocks of high-demand parts in order to expedite top quality, original replacement parts for top drive systems. Our highly experienced field personnel are responsible for the rig up and installation of most units, which includes both rental units and customer-owned units. In addition, our technicians are available to perform work under callout maintenance and fleet management arrangements.

Markets and Competition

Demand for our top drives and pipe handling products, rental services, and aftermarket sales and service depends primarily upon the level of drilling activity and capital spending of drilling contractors and "E&P" companies. Our customers for product sales and aftermarket sales and service primarily consist of drilling contractors, rig builders, and equipment brokers. Occasionally, we may also sell products and provide aftermarket sales and services to major and independent "E&P" companies and national oil companies ("NOCs") who wish to own and manage their own top drive and automated pipe handling systems. Our rental fleet customers include drilling contractors, major and independent "E&P" companies, and "NOCs".


2


We estimate that approximately 70% of land drilling rigs drilling deviated and horizontal wells are currently equipped with top drive systems, including Russia, China and India, where a lower number of rigs operate with top drives today. By contrast, we estimate that approximately 95% of offshore rigs are equipped with top drives. We were the first top drive manufacturer to provide portable top drives for land drilling rigs. We believe that land-based market potential still exists for our top drive drilling system technology, including both portable and permanently installed applications. Further, when many top drive systems approach the end of their useful lives and are inefficient or may not have legacy parts available, we see the development of a conversion market, which provides an important opportunity for us. In addition, the current technology demand associated with complex drilling is driving the demand for newer more capable Top Drives to replace older existing equipment.

Our primary competitors in the sale of top drive systems are National Oilwell Varco, Inc. ("NOV") and Canrig Drilling Technology Ltd., a subsidiary of Nabors Industries Ltd. In addition, low-cost manufacturers, notably from China, have entered the market in recent years. We believe that we have the second largest installed base and are the number two global provider of top drives, following NOV. Of the three major top drive system providers, we believe that we maintain the largest fleet of assets solely for rental purposes. Top drive sales competition in our industry takes place primarily on the basis of equipment features and capacities , the quality of the services and technical support offered, delivery lead time, and price.

Backlog

Historically we have reported product sales backlog as an indicator of our business trends. In the current environment, however, we are experiencing product sales that were not previously part of reported backlog as customers' willingness to commit to long lead time purchases diminishes. For that reason, we maintain a supply of finished goods top drives to rapidly satisfy top drive demand. We consider a product sales order as backlog when the customer has signed a purchase contract; submitted the purchase order; and, if required by the purchase agreement, paid a deposit. Revenue from services is recognized as the services are rendered, based upon agreed daily, hourly, or job rates. Accordingly, we have no backlog for services.

Our top drive sales backlog at December 31, 2016 was 10 units with a total potential revenue value of $9.3 million, compared to eight units with a total potential revenue value of $7.2 million at December 31, 2015. The backlog revenue varies depending on the product mix and the scope of the equipment supplied.

We have the ability to adjust our top drive assembly capacity to meet current and expected customer demand. In the past, we reduced our assembly operations substantially in response to market conditions and later, when conditions improved, we expanded them to meet demand.

Tubular Services segment

Our Tubular Services segment includes a suite of proprietary offerings, as well as conventional casing and tubing running services for both onshore and offshore markets. These services are typically contracted on a callout basis. Casing is steel pipe that is installed in oil, natural gas, or geothermal wells to maintain the pressure and structural integrity of the well bore, isolate water bearing surface sands, prevent communication between subsurface strata, and provide structural support of the wellhead and other casing and tubing strings in the well. Most operators and drilling contractors install casing and tubing using service companies like ours that use specialized equipment and personnel trained for this purpose. Wells can have from two to ten casing strings of various sizes installed. These jobs encompass wells from vertical holes to high angle extended reach wells and include both onshore and offshore applications. Our Tubular Services business segment also includes the sale of new and used Casing Drive System ("CDSTM") tools and accessories.

Our patented "CDS" is a tool which facilitates running, reaming and drilling casing into a well bore on most rigs equipped with a top drive. This tool offers improved safety and efficiency over traditional methods by eliminating operations that are associated with high risk of personal injury. It also increases the likelihood that the casing can be run to casing point on the first attempt, offers the ability to simultaneously rotate and reciprocate the casing string as required while circulating drilling fluid and requires fewer people on the rig for casing running operations than traditional methods.

We developed and employ a suite of complementary tools within our tubular services business. Our Side Entry Swivel Sub ("SESS") tool works in conjunction with the "CDS" tool to allow rotation and reciprocation of the casing string during cementing operations. Reciprocation and rotation is recognized by the industry as greatly improving uniformity and quality around the casing, in turn helping to reduce the potential of environmental incidents and future intervention costs. Our Multi-Plug Launching System ("MPLS"), expected to be launched in the market in Q1 2017, complements our "SESS" and "CDS" tools. Its stackable design allows for a compact, robust, and user friendly system for most rig types. It gives us the ability to launch the vast majority of our customers’ cement plugs and significantly reduces the transition time between casing running and cementing operations. In 2016,

3


we commercialized our Wireless Torque and Tension System ("TesTORK"), which ensures greater accuracy to the make-up of premium casing connections.

We offer a full range of offshore casing and tubing running services, in both deep water and shelf applications. Tesco believes it has the industry leading equipment and highly trained personnel available to run everything from the largest casing strings to the most complex completions. As part of our suite of equipment, we have the Multiple Control Line Running System ("MCLRSTM") which is a proprietary and patented technology for running DW completions, as well as ultra-high torque power tongs and handling equipment available to run casing strings of up to 1250 tons.

Our conventional service offerings provide automated and manual equipment and personnel for the installation of tubing and casing, including power tongs, pick-up/lay-down units, torque monitoring services for new well construction and work-over and re-entry operations.

Markets and Competition

Our Tubular Services customers primarily consist of oil and natural gas operating companies, including major and independent "E&P" companies; "NOCs"; drilling contractors; and other service companies, particularly those providing integrated project management services to operating companies that under these projects have contractual obligations to provide tubular running and handling services. Demand for our tubular services strongly depends upon capital spending of oil and natural gas companies, the actual number of wells drilled by these companies, and the complexity of the wells drilled.

The tubular services market consists generally of very few large, global operators and a large number of small and medium-sized operators that typically operate in limited geographic areas where the market is highly fragmented. The largest global competitors in the service market are Weatherford International, Ltd., Franks International, Inc. and Baker Hughes Incorporated. The largest global competitors for the "CDS" equipment sales are Volant and "NOV". Competition in the service and "CDS" equipment sales market takes place primarily on the basis of price, safety, service quality, utility and quality of the equipment provided and the proximity of the service provider and equipment to the work site. We leverage our existing global infrastructure to maintain a competitive tubular service and "CDS" equipment sales business that is able to respond to customer needs in most regions of the world. We believe that the demand for our proprietary automated tubular services will increase as non-conventional drilling technologies such as directional and horizontal drilling are more frequently implemented in new wells being drilled.

While we are aware of competitive technology similar to our "CDS" tool, we believe that we continue to be a market leader in this technology. Our "CDS" system is easily and quickly installed on any top drive system, and we offer skilled and trained personnel at the field level who have specialized knowledge of top drive drilling system operations.

Research and Engineering segment

As a technology-driven company, we continue to invest significantly in research and development activities, primarily related to the further development and enhancement of our automated product offerings. We hold rights, through patents and patent license agreements, to patented and/or patent pending technologies for certain innovations that we believe will have application to our core businesses. We pursue patent protection in appropriate jurisdictions including, but not limited to, the United States, Canada and Europe, where we believe our innovations could have significant potential application to our core businesses. We generally retain all intellectual property rights to our technology through non-disclosure and technology ownership agreements with our employees, suppliers, consultants and other third parties with whom we do business.

For the year ended December 31, 2016, we invested 4.3% of our revenue in research and engineering activities. We expect to continue to invest in the development, commercialization, and enhancement of proprietary technologies.

Corporate and Other

The Corporate and Other segment consists of expense at the corporate level, which includes executive management, general and administrative costs, selling, marketing and other expenses that are not directly related to or allocated down to other segments in our internal reporting.


4


Financial Information About Geographic Areas

Our Products and Tubular Services segments are distributed globally. For information of our property, plant and equipment by business segment and geographic area at December 31, 2016, see Part II, Item 8, "Financial Statements and Supplementary Data, Note 12" included in this Report. The following table presents our revenue by segment and geographic areas for the years ended December 31, 2016, 2015 and 2014 (in thousands).

 
 
United States and Canada
 
International
 
Total
 
 
Revenue
 
%
 
Revenue
 
%
 
Products
 
 
 
 
 
 
 
 
 
 
2016
$
29,742

 
41%
 
$
43,144

 
59%
 
$
72,886

 
2015
45,791

 
31%
 
99,917

 
69%
 
145,708

 
2014
139,100

 
44%
 
179,686

 
56%
 
318,786

Tubular Services
 
 
 
 
 
 
 
 
 
 
2016
$
30,733

 
50%
 
$
31,118

 
50%
 
$
61,851

 
2015
54,723

 
41%
 
79,307

 
59%
 
134,030

 
2014
106,600

 
48%
 
117,542

 
52%
 
224,142

Casing Drilling(1)
 
 
 
 
 
 
 
 
 
 
2014
63

 
100%
 

 
—%
 
63

__________________________________
(1) On June 4, 2012, we completed the sale of substantially all of the assets of the Casing Drilling segment to the Schlumberger Group.

Procurement of Materials and Supplies

We believe that materials and components used in our servicing and assembly operations and purchased for sales are generally available from multiple sources. The prices paid by us for our raw materials may be affected by, among other things, energy, steel and other commodity prices; tariffs and duties on imported materials; foreign currency exchange rates and the general level of activity within our industry. For a discussion of the procurement of materials and supplies, see Part II, Item 8, "Financial Statements and Supplementary Data, Note 12" included in this Report.

Seasonality
 
Our business is subject to seasonal cycles associated with winter-only, summer-only, dry-season, or regulatory-based access to drilling locations. The most significant of these occur in Canada and Russia, where traditionally, the first and fourth calendar quarters of each year are the busiest, as certain drilling locations are only accessible when frozen. As of December 31, 2016, approximately 17% of our top drive rental fleet was located in Canada and Russia.

In certain regions in Asia Pacific, South America, and the Gulf of Mexico we are subject to a decline in activities due to seasonal rains and storms. Further, seasonal variations in the demand for hydrocarbons and accessibility of certain drilling locations in North America can affect our business as our activity generally follows the active drilling rig count. We seek to actively manage our asset base around the world to minimize the impact of geographically specific seasonality.

Customers
 
Our accounts receivable are principally with major independent "E&P" companies, other oil field services companies, and "NOCs" and are subject to normal industry credit risks. We perform ongoing credit evaluations of customers and grant credit based upon past payment history, financial condition and anticipated industry conditions. Customer payments are regularly monitored and a provision for doubtful accounts is established based upon specific situations and overall industry conditions. Many of our customers are located in international areas that are inherently subject to risks of economic, political and civil instabilities, including the effects of currency fluctuations and exchange controls, such as devaluation of foreign currencies and other economic problems, which may impact our ability to collect those accounts receivable. We monitor customers who are at risk for non-payment and will, if warranted by the set of circumstances, lower available credit extended to those customers or establish alternative arrangements, including increased deposit requirements or payment schedules.

No single customer accounted for 10% or more of our consolidated revenue in the years ended December 31, 2016, 2015 and 2014.

5


Employees

As of December 31, 2016, the total number of our employees worldwide was 1,215. We believe that we have a good relationship with our employees. We seek to maintain a high level of employee satisfaction and we believe our employee compensation systems are competitive. As required by local regulations in Argentina, our employees, representing approximately 10% of total employees, are subject to union contracts. As of February 28, 2017 the total number of our employees worldwide was approximately 1,184.

Trademarks

We own various trademarks that are important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained.

Item 1A. Risk Factors

Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995

We operate in an environment that involves a number of significant risks and uncertainties. We caution you to read the following risk factors, which have affected, and/or in the future could affect, our business, prospects, operating results and financial condition. The risks described below include forward-looking statements, and actual events and our actual results may differ materially from these forward-looking statements. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also impair our business, prospects, operating results and financial condition. Furthermore, additional risks and uncertainties are described under other captions in this Report and should also be considered by our investors.

Risks associated with the oil and natural gas industry

The price of oil and natural gas negatively impacted our business and continued depressed prices of oil and natural gas would continue to negatively impact our business.

Reduction in the prices of oil and natural gas impacts the willingness of "E&P" companies to invest, which in turn impacts the level of drilling activity by our customers and potential customers. Prices of oil and natural gas are primarily determined by supply, demand, government regulations relating to oil and natural gas production and processing, and international political events, none of which can be accurately predicted. In times of declining activity, not only is there less opportunity for us to sell our products and services, but there is increased competitive pressure that tends to reduce the prices we may charge to customers and, therefore, reduce our margins.

We face risks due to the cyclical nature of the oil and natural gas industry and the corresponding credit risk of our customers.

Political or economic circumstances throughout the energy-producing regions of the world can impact the market price of oil and natural gas for extended periods of time. As substantially all of our backlog and accounts receivable are with customers involved in the oil and natural gas industry, any significant downturn in industry performance could result in financial exposure for us due to orders in our backlog being cancelled or payments becoming more difficult to collect or uncollectible.

Our revenue and earnings are subject to fluctuations period over period and are difficult to forecast.
 
Our revenue and earnings may vary significantly from quarter to quarter depending upon:
 
the level of drilling activity worldwide, as well as the particular locations where we have operations;
the variability of customer orders or a reduction in customer orders, which are particularly unpredictable in international markets and which may leave us with excess or obsolete inventories;
the levels of inventories of our products held by end users and distributors;
the mix of our products sold or leased and the margins on those products;
new products offered and sold or leased by us or our competitors;
weather conditions or other natural disasters that can affect our operations or our customers’ operations;

6


changes in oil and natural gas prices and currency exchange rates, which may affect the costs and prices for our products;
the level of capital equipment orders, which may vary with the level of new rig construction and refurbishment activity in the industry;
changes in drilling and exploration plans, which can be particularly volatile in international markets;
the ability of our vendors to timely supply necessary component parts used for the manufacturing of our products; and
the ability to manufacture and timely deliver customer orders, particularly in the Products segment due to the increasing size and complexity of our models.

In addition, our fixed costs cause our margins to significantly decrease when activity is low and service capacity is underutilized.

We could be subject to substantial liability claims, which would adversely affect our financial condition, results of operations and cash flows.
 
Certain equipment and processes are used by us and other companies in the oil and natural gas industry during the delivery of oilfield services in hostile environments, such as exploration, development and production applications. An accident or a failure of a product or process could cause personal injury, loss of life, damage to property, equipment, or the environment and suspension of operations. Our insurance may not protect us against liability for some kinds of events, including events involving pollution, or against losses resulting from business interruption. Moreover, in the future we may not be able to maintain insurance at levels of risk coverage or policy limits that we deem adequate. Substantial claims made under our policies could cause our premiums to increase. Any future damages caused by our products that are not covered by insurance, or are in excess of policy limits or are subject to substantial deductibles, could adversely affect our financial condition, results of operations and cash flows.

Possible legislation and regulations related to global warming and climate change could have an adverse effect on our operations and the demand for oil and natural gas.

International, federal, state and local authorities and agencies are currently evaluating and promulgating climate-related legislation and regulations that are focused on restricting greenhouse gas ("GHG") emissions. In addition, climate change legislation is periodically considered in the United States Congress, and international jurisdictions are also considering the need to address climate changes by legislation or regulation. Several regional GHG initiatives have formed which may require reporting or development of cap and trade programs. These developments may curtail production and demand for fossil fuels such as oil and natural gas in areas of the world where our customers operate and thus adversely affect future demand for our services, which may in turn adversely affect our future results of operations. Additionally, federal and/or state legislation to reduce the effects of GHG may potentially have a direct or indirect adverse effect on our operations, including the possible imposition on us and/or our customers of additional operational costs due to carbon emissions generated by oil and natural gas related activities. Finally, our business could be negatively affected by climate change-related physical changes or changes in weather patterns, which could result in damages to or loss of our physical assets, impacts on our ability to conduct operations and/or disruption of our customers’ operations.

Oil and natural gas operations could be adversely impacted by changes in, and compliance with, restrictions or regulations on onshore and offshore drilling in the United States and abroad, which may adversely affect our business and operating results.

New federal and state legislation may result in increased costs to drill, complete and operate wells, as well as delays in obtaining permits to drill wells all of which could negatively impact our customers and thereby our business and operating results. If legislation is passed to ban hydraulic fracturing, the number of wells drilled in the future could drop dramatically and the economic performance of those drilled would be negatively affected. Local authorities have also instituted restrictions to hydraulic fracturing operations which could result in negative impacts to our business.

Any significant consolidation or loss of end user customers could have an impact on our business.

"E&P" companies and drilling contractors have undergone substantial consolidation in recent years and additional consolidation is likely. Consolidation activity affects oil and natural gas activities as consolidated companies attempt to increase efficiency and reduce cost. Generally, only the more promising exploration and development projects from each merged entity are likely to be pursued, which may result in overall lower post-merger exploration and development activities. Consequently, consolidation could result in fewer end users of our products or in the combined company standardizing its equipment preference in favor of a competitor’s products.


7


We operate in an intensively competitive industry, and if we fail to compete effectively, our business will suffer.

The drilling industry is driven primarily by cost minimization. Our strategy is aimed at reducing drilling costs through the application of new technologies. Our competitors, many of whom have a more diverse product line and access to greater amounts of capital than we do, have the ability to compete against the cost savings generated by our technology by reducing prices and by introducing competing technologies. Our competitors may also have the ability to offer bundles of products and services to customers that we do not offer. We have limited resources to sustain prolonged price competition and maintain the level of investment required to continue the commercialization and development of our new technologies.

To compete in our industry, we must continue to develop new technologies and products.

The markets for our products and services are characterized by continual technological developments and we have identified our products as providing technological advantages over other competitive products. As a result, substantial improvements in the scope and quality of product function and performance can occur over a short period of time. If we are not able to develop commercially competitive products in a timely manner in response to changes in technology, our business may be adversely affected. Our future ability to develop new products depends on our ability to:

design and commercially produce products that meet the needs of our customers;
successfully market new products; and
obtain and maintain patent protection.

We may encounter resource constraints, cash and credit constraints, technical barriers, or other difficulties that would delay introduction of new products and services in the future. Our competitors may introduce new products or obtain patents before we do and achieve a competitive advantage. Additionally, the time and expense invested in product development may not result in commercial applications.

For example, from time to time, we have incurred significant losses in the development of new technologies which were not successful for various commercial or technical reasons. If we are unable to successfully implement technological or research and engineering type activities, our growth prospects may be reduced and our future revenue may be materially and adversely affected. In addition, we may experience operating losses after new products are introduced and commercialized because of high start-up costs, unexpected manufacturing costs or problems, or lack of demand.  

Risks associated with the global economy

The current global economic and political environment may negatively impact industry fundamentals, and the related decrease in demand for drilling could cause a downturn in the oil and natural gas industry. Such a condition could have a material adverse impact on our business.  

An extended deterioration in the global economic environment may impact fundamentals that are critical to our industry, such as the global demand for, and consumption of, oil and natural gas. Reduced demand for oil and natural gas generally results in lower oil and natural gas prices and prolonged weakness in the economy could impact the economics of planned drilling projects, resulting in curtailment, reduction, delay or postponement for an indeterminate period of time. Furthermore, an extended deterioration in the political environment in countries where we operate or that produce significant supply of the world’s demand for oil may also impact fundamentals that are critical to our industry, such as the global supply of oil and natural gas. Constraints in the global supply of oil caused by political turmoil in any of the large oil-producing countries of the world could significantly increase oil and natural gas prices while the removal of such constraints could significantly decrease oil and natural gas prices for an indeterminate period of time. Such volatility in oil and natural gas prices could negatively impact the world economy and our industry. Any long-term reduction in oil and natural gas prices will reduce oil and natural gas drilling and production activity and result in a corresponding decline in the demand for our products and services, which could adversely affect the demand for sales, rentals or services of our top drive units and for our tubular services. These reductions could adversely affect the future net realizability of assets, including inventory, fixed assets and other intangible assets.

We are exposed to risks associated with the financial markets.

 
While we intend to finance our operations primarily with existing cash and cash flow from operations, we may require additional financing to support our operations and fund our growth. If any of the insurance companies or other financial institutions are unable to perform their obligations insurance policies or other contracts, and we are unable to find suitable replacements on

8


acceptable terms as a result of recent market conditions, credit disruptions, or otherwise, our results of operations, liquidity, and cash flows could be adversely affected.

Many of our customers access the credit markets to finance their oil and natural gas drilling and production activity. The inability of these parties to obtain financing on acceptable terms, due to credit disruptions or otherwise, could impair their ability to perform under their agreements with us and lead to various negative effects on us, including business disruption, decreased revenue and increases in bad debt write-offs. A sustained decline in the financial stability of our customers would have a material adverse impact on our business and results of operations.

The occurrence or threat of terrorist attacks could materially impact our business.

The occurrence or threat of terrorist attacks could adversely affect the economies of countries where we operate. A lower level of economic activity could result in a decline in energy consumption, which could cause a decrease in spending by oil and natural gas companies for exploration and development. In addition, these risks could trigger increased volatility in prices for crude oil and natural gas which could also adversely affect spending by oil and natural gas companies. A decrease in spending for any reason could adversely affect the markets for our products and thereby adversely affect our revenue and margins and limit our future growth prospects. Moreover, these risks could cause increased instability in the financial and insurance markets and adversely affect our ability to access capital and to obtain insurance coverage that we consider adequate or are required to obtain by our contracts with third parties.

We face risks related to natural disasters and pandemic diseases, which could materially and adversely disrupt our operations and affect travel required for our worldwide operations.

A portion of our business involves the movement of people, parts and supplies to or from international locations. Any restrictions on travel or shipments to and from international locations, due to the occurrence of natural disasters such as earthquakes, floods, or hurricanes; or an epidemic or outbreak of diseases, in these locations, could significantly disrupt our operations and decrease our ability to provide services to our customers. In addition, our local workforce could be affected by such an occurrence or outbreak which could also significantly disrupt our operations and decrease our ability to provide services to our customers.

Our operations are subject to political and economic instability and risk of government action that could have a material adverse effect on our business, consolidated results of operations, and consolidated financial condition.

We are exposed to risks inherent in doing business in each of the countries in which we operate. In places like Russia, Latin America, the Middle East and Asia Pacific, we may have difficulty or extra expense in navigating the local bureaucracies and legal systems. We may face challenges in enforcing contracts in local courts or be at a disadvantage when we have a dispute with a customer that is an agency of the state. We may be at a disadvantage to competitors that are not subject to the same international trade and business practice restrictions that U.S. and Canadian laws impose on us.

While diversification is desirable, it exposes us to risks related to cultural, political and economic factors of various jurisdictions which are beyond our control. As a general rule, we have elected not to carry political risk insurance against these risks, which include

loss of revenue, property and equipment as a result of hazards such as wars, insurrection and other instances of political and economic instability;
the effects of currency fluctuations and exchange controls, such as devaluation of foreign currencies and other economic problems;
changes or interpretations in laws, regulations and policies of international governments, including those associated with changes in the governing parties, nationalization and expropriation;
protracted delays in securing government consents, permits, licenses, or other regulatory approvals necessary to conduct our operations; and
protracted delays in the collection of accounts receivable due to economic, political and civil instabilities.

We are subject to foreign governmental regulations in some jurisdictions in which we operate that favor or require awarding contracts to local contractors or require foreign contractors to employ citizens of, or purchase supplies from, a certain jurisdiction. Such regulations may adversely affect our ability to compete in that jurisdiction. Our operations in some jurisdictions may be significantly affected by union activity and general labor unrest. In Argentina and Mexico, where we have operations, labor

9


organizations have substantial support and have considerable political influence. In Argentina, the demands of labor organizations have increased in recent years and seem likely to continue as a result of the general labor unrest and dissatisfaction resulting from the disparity between the cost of living and salaries in Argentina exacerbated by the devaluation of the Argentine Peso. Consequently, our operations in Argentina or Mexico may face labor disruptions in the future, and any such disruptions may have a material adverse effect on our financial condition or results of operations. Further, unionization efforts have been made from time to time in other jurisdictions in which we operate with varying degrees of success. Any such unionization could increase our costs or limit the flexibility in that market.

Due to unsettled political conditions in many oil-producing countries, our operations, revenue and profits are subject to adverse consequences of war, the effects of terrorism, civil unrest, strikes, currency controls and governmental actions. These and other risks described above could result in the loss of our personnel or assets, cause us to evacuate our personnel from certain countries, cause us to increase spending on security worldwide, disrupt financial and commercial markets, including the supply of and pricing for oil and natural gas and generate greater political and economic instability in some of the geographic areas in which we operate. Areas where we operate that have significant risk include, but are not limited to, Argentina, Egypt, Indonesia, Mexico, and Russia. In addition, any possible reprisals as a consequence of military or other action, such as acts of terrorism in the United States or elsewhere, could have a material adverse effect on our business, consolidated results of operations and consolidated financial condition. The continuance of our sales to customers, and our operations, in Russia and the region are uncertain if existing sanctions are amended or otherwise expanded. Continued political instability, deteriorating macroeconomic conditions, the implementation of additional economic sanctions that restrict our ability to do business and actual or threatened military action in the region could have a material adverse effect on our operations in the region and on the result of operations of our Products segment.

Cybersecurity incidents could have a material adverse effect on our business, consolidated results of operations and consolidated financial condition.

Our operations are also subject to the risk of information technology disruptions. Cybersecurity incidents, in particular, are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and the corruption of data. We believe that we have implemented appropriate measures to mitigate potential risks to our technology and our operations from these information technology disruptions. However, given the unpredictability of the timing, nature and scope of information technology disruptions, we could potentially be subject to production downtimes, operational delays, the compromising of confidential or otherwise protected information, destruction or corruption of data, security breaches, other manipulation or improper use of our systems and networks or financial losses from remedial actions, any of which could have a material adverse effect on our cash flows, competitive position, financial condition or results of operations.

Risks associated with our business

We have been party to patent infringement claims and we may not be able to protect or enforce our intellectual property rights.

Some of our products and the processes used to produce our products have been granted U.S. and international patent protection, or have patent applications pending. Nevertheless, patents may not be granted for our applications and, if patents are issued, the claims allowed may not be sufficient to protect our technology. Changes in U.S. patent law may have the effect of making certain of our patents more likely to be the subject of claims for invalidation.

Our competitors may be able to independently develop technology that is similar to ours without infringing our patents. This is especially true internationally where the protection of intellectual property rights may not be as effective. In addition, obtaining and maintaining intellectual property protection internationally may be significantly more expensive than doing so domestically. We may have to spend substantial time and money defending our patents. After our patents expire, our competitors will not be legally constrained from marketing products substantially similar to ours.

We are subject to legal proceedings and may, in the future, be subject to additional legal proceedings.

In the normal course of our business, we are subject to legal proceedings brought by or against us and our subsidiaries. We are also subject to complaints or allegations from former, current, or prospective employees alleging violations of employment-related laws. We are currently involved in legal proceedings described in Part II, Item 8, "Financial Statements and Supplementary Data, Note 11" included in this Report. From time to time, we may become subject to additional legal proceedings which may include contract, tort, intellectual property, tax, regulatory compliance and other claims. Lawsuits or claims could result in decisions against us which could have a material adverse effect on our financial condition, results of operations, or cash flows.


10


Our products and services are used in hazardous conditions and we are subject to risks relating to potential liability claims.

Most of our products are used in hazardous drilling and production applications where an accident or a failure of a product can have catastrophic consequences. While we attempt to limit our exposure to such risks through contracts with our customers, these measures may not protect us against liability for certain kinds of events, including blowouts, cratering, explosions, fires, loss of well control, loss of hole, damaged or lost drilling equipment, damage or loss from inclement weather or natural disasters, and losses resulting from business interruption. Our insurance coverage generally provides that we assume a portion of the risk in the form of a self-insured retention, and may not be adequate in risk coverage or policy limits to cover all losses or liabilities that we may incur. The occurrence of an event not fully insured or indemnified against, or the failure of a customer or insurer to meet its indemnification or insurance obligations, could result in substantial losses. Moreover, we may not be able in the future to maintain insurance at levels of risk coverage or policy limits that we deem adequate. Any significant claims made under our policies will likely cause our premiums to increase. Any future damages caused by our products or services that are not covered by insurance, are in excess of policy limits or are subject to substantial deductibles, could materially reduce our earnings and cash available for operations.

Environmental compliance and remediation costs and the costs of environmental liabilities could exceed our estimates.

The energy industry is affected by changes in public policy, federal, state, local and international laws and regulations. The adoption of laws and regulations curtailing exploration and development drilling for oil and natural gas for economic, environmental and other policy reasons may adversely affect our operations due to our customers having limited drilling and other opportunities in the oil and natural gas "E&P" industry. The operations of our customers, as well as our properties, are subject to increasingly stringent laws and regulations relating to environmental protection, including laws and regulations governing air emissions, water discharges, waste management and workplace safety.

We provide warranties on our products and if our products fail to operate properly our business will suffer.

We provide warranties as to the proper operation and conformance to specifications of the equipment we manufacture. Our products are often deployed in harsh environments including subsea applications. The failure of these products to operate properly or to meet specifications may increase our costs by requiring additional engineering resources and services, replacement of parts and equipment or monetary reimbursement to a customer. In the past, we have experienced quality problems with raw material vendors, which required us to recall and replace certain equipment and components. We have also received warranty claims and we expect to continue to receive them in the future. Such claims may exceed the reserve we have set aside for them. To the extent that we incur substantial warranty claims in any period because of quality issues with our products, our reputation, ability to obtain future business and earnings could be materially and adversely affected.

Our profitability is driven to a large extent by our ability to deliver the products we manufacture in a timely manner.

Disruptions to our production schedule or supply chain may adversely impact our ability to meet delivery commitments. If we fail to deliver products according to contract terms, we may suffer material financial penalties and a diminution of our commercial reputation and future product orders.

We rely on the availability of raw materials, component parts and finished products to produce our products.

We buy raw materials, components and precision machining or subassembly services from many different vendors located primarily in Canada, U.S., Europe, South East Asia, and the Middle East. The price and lead times for some products have fluctuated along with the general changes of steel prices around the world. We also source a substantial amount of electrical components, including permanent magnet motors and drives as well as a substantial amount of hydraulic components, including hydraulic motors, from suppliers located in the U.S. and abroad. The inability of suppliers to meet performance, quality specifications and delivery schedules could cause delays in manufacturing and make it difficult or impossible for us to meet outstanding orders or accept new orders for the manufacture of the affected equipment. In addition, the lack of an efficient supply chain could cause us to hold higher levels of inventory.

The design of some of our equipment is based on components provided by specific sole source manufacturers.

Some of our products have been designed around components which are only available from one source of supply. In some cases, a manufacturer has developed or modified the design of a component at our request, and consequently we are the only purchaser of such items. If the manufacturer of such an item should go out of business or cease or refuse to manufacture the component in question, or raise the price of such components unduly, we may have to identify alternative components and redesign portions of

11


our equipment. This could cause delays in manufacturing and make it difficult or impossible for us to meet outstanding orders or accept new orders for the manufacture of the affected equipment.

Our business requires the retention and recruitment of a skilled workforce and key employees, and the loss of such employees could result in the failure to implement our business plans.

As a technology-based company, we depend upon skilled engineering and other professionals in order to engage in product innovation and ensure the effective implementation of our innovative technology. We compete for these professionals, not only with other companies in the same industry, but with oil and natural gas service companies generally and other industries. In periods of high energy and industrial manufacturing activity, demand for the skills and expertise of these professionals increases, which can make the hiring and retention of these individuals more difficult and expensive. Failure to recruit and retain such individuals may result in our inability to maintain a competitive advantage and reduce customer satisfaction. The loss or incapacity of certain key employees for any reason, including our President and Chief Executive Officer, Fernando R. Assing; Senior Vice President and Chief Financial Officer, Christopher L. Boone; and Senior Vice President and Chief Operating Officer, John T. Gatlin; could have a negative impact on our ability to implement our business plan due to the specialized knowledge these individuals possess. We do not maintain key man insurance on any of our personnel.

Our business relies on the skills and availability of trained and experienced trades and technicians to provide efficient and necessary services to us and our customers. Hiring and retaining such individuals are critical to the success of our business plan. Retention of staff and the prevention of injury to staff are essential in order to provide a high level of service.

We may be unable to identify or complete any business combinations.

Business combinations have been and may continue to be an element of our business strategy. We may not be able to identify, close, or successfully integrate the assets and operations of an acquired businesses with our own business. Any inability on our part to integrate and manage the growth of acquired businesses may have a material adverse effect on our results of operations and financial condition. We also may not be able to identify and acquire additional businesses in the future on terms favorable to us.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.
 
The following table details our principal facilities that we own or lease.
Location
 
Owned or Leased
 
Description
Houston, Texas
 
Leased
 
Corporate and regional headquarters for North American operations in Products and Tubular Services segments.
Kilgore, Texas
 
Owned
 
Regional operations base for the Tubular Services segment in east Texas and northern Louisiana.
Lafayette, Louisiana
 
Owned
 
Regional operations base for the Tubular Services segment in southern Louisiana and the Gulf of Mexico.
Calgary, Alberta, Canada
 
Owned
 
Assembly of top drives and other equipment.
Moscow, Russia
 
Leased
 
Regional headquarters for Russia.
Dubai, United Arab Emirates
 
Leased
 
Regional headquarters for the Middle East and North Africa.
Cairo, Egypt
 
Owned
 
Regional operations base for Egypt.
Kuala Lumpur, Malaysia
 
Leased
 
Regional headquarters for the Asia Pacific region.

We believe our existing equipment and facilities to be adequate to support our operations.


12


Item 3. Legal Proceedings.

In the normal course of our business, we are subject to legal proceedings brought by or against us and our subsidiaries. None of these proceedings involves a claim for damages exceeding ten percent of our current assets on a consolidated basis. See Part II, Item 8, "Financial Statements and Supplementary Data, Note 11" included in this Report for a summary of certain closed and ongoing legal proceedings. Such information is incorporated into this Part I, Item 3, "Legal Proceedings" in this Report by reference.

Item 4. Mine Safety Disclosures.

None.

13


PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our outstanding shares of common stock are traded on the Nasdaq Stock Market ("NASDAQ") under the symbol "TESO." The following table outlines the share price trading range by quarter for 2016 and 2015.
 
Share Price Trading Range
 
High
 
Low
2016
($ per share)
4th Quarter
$
9.65

 
$
6.50

3rd Quarter
8.22

 
6.21

2nd Quarter
9.77

 
5.72

1st Quarter
9.10

 
5.13

2015
 

 
 

4th Quarter
$
9.00

 
$
6.63

3rd Quarter
10.96

 
7.01

2nd Quarter
13.28

 
10.86

1st Quarter
13.12

 
9.53

 
As of February 28, 2017, the closing sales price of our common stock as reported by the NASDAQ was $8.35 per share, and there were approximately 216 holders of record, including brokers and other nominees.

Dividend Policy

On May 5, 2014 the Company's Board of Directors (the "Board") approved the initiation of a quarterly cash dividend. Cash dividends aggregated $7.8 million and $6.0 million for the years ended December 31, 2015 and 2014, respectively. In February 2016, the Board suspended payment of the Company’s quarterly dividend as part of a broader plan of reducing costs, working capital, and capital expenditures in order to preserve liquidity. The Board formally terminated the Company’s dividend program in November 2016 and currently has no intention to declare or pay any dividends in the foreseeable future.
 
Stock Repurchase Program

On May 2, 2014, the Board authorized a common stock repurchase program (the "Program"), which permitted us to repurchase up to $100,000,000 of our current shares outstanding. The repurchase of the common shares was conducted as a normal course issuer bid ("NCIB"). The program expired on June 30, 2016. We did not repurchase any shares during the years ended December 31, 2016 and 2015, respectively.


14


Performance Graph

The following performance graph and table compares the yearly percentage change in the cumulative shareholder return for the five year period commencing on December 31, 2011 and ending on December 31, 2016 on our common shares (assuming a $100 investment was made on December 31, 2011) with the total cumulative return of the Russell 2000 Index and the Philadelphia Oil Service Sector Index ("OSX"), assuming reinvestment of dividends.
teso-123120_chartx49828.jpg
 
 
Dec 31, 2011
 
Dec 31, 2012
 
Dec 31, 2013
 
Dec 31, 2014
 
Dec 31, 2015
 
Dec 31, 2016
Tesco Corp.
 
$
100

 
$
90

 
$
156

 
$
103

 
$
59

 
$
69

OSX
 
$
100

 
$
102

 
$
130

 
$
97

 
$
68

 
$
85

Russell 2000
 
$
100

 
$
115

 
$
157

 
$
163

 
$
153

 
$
183



15


Item 6. Selected Financial Data.

The following selected financial data should be read in conjunction with "Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8, Financial Statements and Supplementary Data" of this report.
 
 
Years Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(in millions, except per share data)
Summary of operations
 
 
 
 
 
 
 
 
 
Operating revenues
$
134.7

 
$
279.7

 
$
543.0

 
$
524.9

 
$
553.2

Net income (loss)
(117.9
)
 
(133.8
)
 
21.4

 
35.3

 
50.2

 
 
 
 
 
 
 
 
 
 
Per share data
 
 
 
 
 
 
 
 
 
Basic earnings (loss)
$
(2.73
)
 
$
(3.43
)
 
$
0.54

 
$
0.90

 
$
1.30

Diluted earnings (loss)
(2.73
)
 
(3.43
)
 
0.53

 
0.89

 
1.28

Dividends declared

 
0.20

 
0.15

 

 

 
 
 
 
 
 
 
 
 
 
Balance sheet data
 
 
 
 
 
 
 
 
 
Total assets
$
344.3

 
$
421.7

 
$
619.3

 
$
634.7

 
$
585.6

Long term obligations (including capital leases)

 

 

 
0.5

 
0.3


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

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand our operations and our present business environment. MD&A is provided as a supplement to, and 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. 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.

Overview

Tesco Corporation is a global leader and provider of highly engineered technology-based solutions for drilling, servicing, and completion of wells for the upstream energy industry. The Company seeks to improve the way wells are drilled by delivering safer and more efficient solutions that add value by reducing the costs of drilling for, and producing, oil and natural gas. Our operations consist of top drives and automated pipe handling equipment sales and rentals, aftermarket sales and services, and tubular services, including related products and accessories sales.

Our revenues and operating results are directly related to the level of worldwide oil and gas drilling and production activities and the profitability and cash flows of "E&P" companies and drilling contractors, which are affected by current and anticipated oil and gas prices.

Unless indicated otherwise, results of operations data are presented in accordance with generally accepted accounting principles in the United States ("GAAP").

Our Segments

Our operating structure is the basis for our internal and external financial reporting. As of December 31, 2016, our operating structure included the following business segments: (i) Products – top drives and automated pipe handling equipment sales, rentals and aftermarket sales and services, (ii) Tubular Services – onshore and offshore tubular services and sales of related products and accessories, (iii) Research & Engineering – internal research and development activities related to our proprietary tubular services and products development, and (iv) Corporate and Other – including executive management and several global support and compliance functions.


16


Business Environment

Our revenue is heavily dependent on the level of drilling activity of "E&P" companies. The willingness of "E&P" companies to spend capital on drilling activities is primarily affected by the current and anticipated prices of crude oil and natural gas, which is driven by such factors as the level of worldwide oil and gas reserves inventory, civil unrest and conflicts in oil producing countries, oil sanctions, and global economics, among other things. When drilling rigs are active they consume products and services produced by the oilfield services companies like ours. Accordingly, rig count and well count are important business barometers for the drilling industry and its suppliers, as they may reflect the relative strength and stability of energy prices and overall market activity. However, these counts should not be solely relied on as an indicator of the economic condition of our industry, as other specific and pervasive conditions may exist that affect overall energy prices and market activity.

Below is a table that shows the average rig count by region for the years ended December 31, 2016, 2015 and 2014.
 
Average Rig Count(1)
 
Increase (Decrease)
 
2016
 
2015
 
2014
 
2015 to 2016
 
2014 to 2015
United States
510

 
977

 
1,862

 
(467
)
 
(48)%
 
(885
)
 
(48)%
Canada
128

 
193

 
380

 
(65
)
 
(34)%
 
(187
)
 
(49)%
Latin America (includes Mexico)
198

 
319

 
397

 
(121
)
 
(38)%
 
(78
)
 
(20)%
Asia Pacific (excludes China onshore)
187

 
220

 
254

 
(33
)
 
(15)%
 
(34
)
 
(13)%
Middle East (excludes Iran, Iraq and Syria)
390

 
406

 
406

 
(16
)
 
(4)%
 

 
—%
Africa (excludes Sudan)
85

 
106

 
134

 
(21
)
 
(20)%
 
(28
)
 
(21)%
Europe (excludes Russia)
96

 
117

 
145

 
(21
)
 
(18)%
 
(28
)
 
(19)%
Total
1,594

 
2,338

 
3,578

 
(744
)
 
(32)%
 
(1,240
)
 
(35)%

Below is a table that shows well count by region for the years ended December 31, 2016, 2015 and 2014.
 
Well Counts (2)
For Years Ended December 31,
 
2016
 
2015
 
2014
 
(estimate)(2)
 
 
 
 
United States
14,632

 
28,692

 
47,402

Canada
3,463

 
5,309

 
10,513

Latin America
2,372

 
3,690

 
4,116

Europe, Africa, Middle East (including Russia)
13,719

 
13,684

 
14,072

Asia-Pacific (including China)
17,900

 
24,594

 
28,024

Total
52,086

 
75,969

 
104,127








__________________________________

(1) 
Source: Baker Hughes Incorporated worldwide rig count. The Baker Hughes North American Rotary Rig Count is a weekly census of the number of drilling rigs actively exploring for or developing oil or natural gas in the United States and Canada. 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). 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. 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.

(2) 
World Oil Forecast and Data Executive Summary 2017

17


Outlook

After nine consecutive quarters of activity decline in our industry, the business environment appears to have stabilized during the fourth quarter of 2016. Our response to the recent unprecedented market conditions resulted in aggressive cost rationalization and global reorganization to rightsize the company. During the year ended December 31, 2016, the global workforce was reduced by an additional 24%, as compared to December 31, 2015, resulting in a charge of $4.4 million. Facility closures during the same period resulted in a charge of $1.6 million. In addition, certain austerity measures and efforts to streamline our overhead and support structure initiated in the previous year continued. During the year ended December 31, 2015, the global workforce was reduced by 30%, resulting in a related aggregate charge of $10.9 million.

While North America rig count is expected to continue to increase during 2017, weakness in international and offshore markets is expected to continue. We see some opportunities to start to increase pricing in North America, however prevalent overcapacity will likely limit pricing power throughout 2017. We are also facing risks that cost inflation will exceed price increases in the short term.

Results of Operations

The discussions below relating to significant line items from our consolidated statements of income are based on our analysis of significant changes or events that impact the comparability of reported amounts. Where appropriate, we have identified specific events and changes that affect comparability or trends and, where reasonably practicable, have quantified the impact of such items. This discussion should be read in conjunction with Part II, Item 8, Financial Statements and Supplementary Data included in this Report.

Operating results by business segments

Below is a summary of the operating results of our business segments for the years ended December 31, 2016, 2015 and 2014 (in thousands, except percentages):
 
Year Ended December 31,
 
Increase/Decrease
 
2016
 
2015
 
2014
 
2015 to 2016
 
2014 to 2015
Segment revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
Products revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales
$
21,776

 
$
45,045

 
$
142,589

 
$
(23,269
)
 
(52)%
 
$
(97,544
)
 
(68)%
Rental services
26,238

 
61,621

 
103,718

 
(35,383
)
 
(57)%
 
(42,097
)
 
(41)%
Aftermarket sales and services
24,872

 
39,042

 
72,479

 
(14,170
)
 
(36)%
 
(33,437
)
 
(46)%
 
72,886

 
145,708

 
318,786

 
(72,822
)
 
(50)%
 
(173,078
)
 
(54)%
Tubular Services revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
Land
$
35,981

 
$
94,043

 
$
156,972

 
(58,062
)
 
(62)%
 
(62,929
)
 
(40)%
Offshore
20,697

 
32,582

 
39,855

 
(11,885
)
 
(36)%
 
(7,273
)
 
(18)%
CDSTM, Parts & Accessories
5,173

 
7,405

 
27,315

 
(2,232
)
 
(30)%
 
(19,910
)
 
(73)%
 
61,851

 
134,030

 
224,142

 
(72,179
)
 
(54)%
 
(90,112
)
 
(40)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Casing Drilling

 

 
63

 

 
—%
 
(63
)
 
(100)%
Revenue
$
134,737

 
$
279,738

 
$
542,991

 
$
(145,001
)
 
(52)%
 
$
(263,253
)
 
(48)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Segment operating income (loss)
 
 

 
 

 
 

 
 
 
 

 
 
Products
$
(54,628
)
 
$
(18,857
)
 
$
58,628

 
$
(35,771
)
 
190%
 
$
(77,485
)
 
(132)%
Tubular Services
(30,190
)
 
(46,124
)
 
35,514

 
15,934

 
(35)%
 
(81,638
)
 
(230)%
Casing Drilling

 

 
(632
)
 

 
—%
 
632

 
(100)%
Research and engineering
(5,750
)
 
(9,198
)
 
(9,574
)
 
3,448

 
(37)%
 
376

 
4%
Corporate and other
(24,215
)
 
(28,222
)
 
(37,393
)
 
4,007

 
(14)%
 
9,171

 
25%
 Operating income (loss)
$
(114,783
)
 
$
(102,401
)
 
$
46,543

 
$
(12,382
)
 
12%
 
$
(148,944
)
 
(320)%


18


Products segment

Demand for our top drives and pipe handling products, rental services, and aftermarket sales and service depends primarily upon the level of drilling activity and capital spending of drilling contractors and "E&P" companies. Revenues from our Products segment are generated through top drive and automated pipe handling new and used equipment sales, rentals, and field and in-house aftermarket sales and service. Our rental fleet of top drive and pipe handling equipment is highly mobile, where we install the units on the customers' rig sites and charge a daily rate for rental operating days. Rental operating days are defined as a day that a unit in our rental fleet is under contract and operating. When we sell proprietary used equipment from our rental fleet we record revenue and cost of sales. Aftermarket sales and service consists of part sales and in-house shop and callout field services. We provide these services for top drives and automated pipe handling equipment we manufacture and for selected models of our competitors.

2016 as compared with 2015

Sales
Revenues decreased by $23.3 million, or 52%, in 2016 as compared to 2015 primarily due to a decrease in the number of units sold globally as a result of the decrease in demand, rig count, and crude oil prices compared to the prior year. In 2016, we sold a total of 23 top drives, of which 15 were new and eight were used and from our rental fleet, as compared to the previous year, where we sold 40 top drives, of which 35 were new and five were used and from our rental fleet. In addition, we sold two used catwalks, during the year ended December 31, 2016. In 2016 we recognized revenue of $3.8 million related to the sale of eight used top drive units and two used catwalks from our rental fleet as compared to revenue of $2.3 million from the sale of five used top drive units from our rental fleet in 2015.

Rental Services
Revenues decreased by $35.4 million, or 57%, in 2016 as compared to 2015 primarily due to the depressed market demand within the industry causing a 41% decrease in our utilization as compared to 2015. In 2016, utilization declined to 17% due to fewer operating days and fewer contracted units. The global decrease in activity, particularly in Latin America, compounded with price compression, primarily impacted our revenues.

The rental fleet size decreased to 116 units, compared to 124 units in 2015. The decrease was primarily due to used top drive sales to various customers in 2016.

Aftermarket Sales and Services
Revenues decreased by $14.2 million, or 36%, in 2016 as compared to 2015 primarily due to a decline in demand for parts and services in North America and Asia Pacific. With the decline in oil prices and consequential decrease in drilling activity, customers have chosen to defer noncritical services and consume their inventories rather than replenish them.

Operating Loss
Products operating loss increased by $35.8 million in 2016 as compared to 2015 primarily due to the long-lived asset impairment charge discussed below and the decline in revenues for each product offering due to current market conditions which include a significant drop in rig count, declining oil prices and declining overall demand for oilfield services.

During the three months ended March 31, 2016, we identified indicators that could cause potential impairments to our long-lived assets. Due to these indicators, we conducted testing for impairment and determined that the carrying amount of our long-lived assets in our Products segment exceeded its fair value. Accordingly, we recognized an aggregate long-lived asset impairment of $33.6 million during the year ended December 31, 2016. For further discussion, see Part II, Item 8, "Financial Statements, Note 5", included in this report.

Beginning in 2015 and throughout 2016, due to the decline in the upstream energy industry and its corresponding impact on our business outlook, we initiated a company-wide reduction in workforce and other cost rationalization efforts which is intended to reduce costs and better align our workforce with anticipated activity levels in the current market. Accordingly, we recorded nonrecurring items related to restructuring costs of $1.8 million and $5.4 million during the years ended December 31, 2016 and 2015, respectively. In 2016, we incurred bad debt charges of $3.7 million related to certain customers in Mexico, $1.6 million of which was previously highlighted in Note 10 - Commitments and Contingencies of our Form 10-Q filed on November 7, 2016. Additionally, we recorded other nonrecurring items related to inventory reserves, exit costs related to the sale of our Venezuelan operations, and additional warranty and legal reserves of $3.8 million and $17.8 million during the years ended December 31, 2016 and 2015, respectively.


19


2015 as compared with 2014

Sales
Revenues decreased by $97.5 million, or 68%, in 2015 as compared to 2014 primarily due to a decrease in the number of units sold globally as a result of the decrease in demand, rig count and crude oil prices compared to the prior year. We experienced a significant decrease in the number of top drive units sold in North America based on current market conditions and in Russia due to the devaluation of the Ruble and uncertainty surrounding economic and political issues within the region. In 2015, we sold a total of 40 top drives, of which 35 were new and five were used and from our rental fleet, as compared to the previous year, where we sold 114 top drives, of which 110 were new and four were used and from our rental fleet. In 2015 we recognized revenue of $2.3 million related to the sale of five used top drive units from our rental fleet as compared to revenue of $4.3 million from the sale of four used top drive from our rental fleet units in 2014.

Rental Services
Revenues decreased by $42.1 million, or 41%, in 2015 as compared to 2014 primarily due to the depressed market demand within the industry causing a 45% decrease in our utilization as compared to 2014. In 2015, utilization declined to 29% due to fewer operating days and fewer contracted units. The decrease in activity compounded with price compression primarily impacted our revenues in Latin America, North America and Russia.

The rental fleet size decreased to 124 units, compared to 135 units in 2014. The decrease was primarily due to the sale of seven used top drives sold in connection with the sale of our Venezuelan fixed assets and inventory during the fourth quarter of 2015. (See Part II, Item 8, "Financial Statements and Supplementary Data, Note 12" in this Report).

Aftermarket Sales and Services
Revenues decreased by $33.4 million, or 46%, in 2015 as compared to 2014 primarily due to a decline in demand for parts and services primarily in North America. With the decline in oil prices and consequential decrease in drilling activity, customers have chosen to defer noncritical services and consume their inventories rather than replenish them.

Operating Income (Loss)
Products operating income decreased by $77.5 million in 2015 as compared to 2014 primarily due to a decline in revenues for each product offering due to current market conditions which include a significant drop in rig count, declining oil prices and declining overall demand for oilfield services. The significant decline in our manufacturing activities led to an under absorption of manufacturing overhead and increased bottom line cost. For the year ended December 31, 2015, under absorption was $18.3 million compared with an over absorption of $0.9 million for the year ended December 31, 2014.

During the year ended December 31, 2015, we noted declines in the market value of our common stock, oil and natural gas prices and utilization. Due to these indicators, step one of our annual goodwill impairment test concluded that the fair value of each of our reporting units was less than the carrying value of its net assets. As a result, we performed the second step of the impairment test, which compares the implied fair value to the carrying value of goodwill. The step two impairment test indicated a full impairment. Accordingly, we recognized an impairment charge of $1.7 million associated with our Products segment.

Beginning in 2015, due to the decline in the upstream energy industry and its corresponding impact on our business outlook, we initiated a company-wide reduction in workforce and other cost rationalization efforts which is intended to reduce costs and better align our workforce with anticipated activity levels in the current market. Accordingly, we recorded nonrecurring items related to restructuring costs of $5.4 million during the year ended December 31, 2015. Additionally, we recorded other nonrecurring items related to inventory reserves, bad debt, exit costs related to the sale of our Venezuelan operations and additional warranty and legal reserves of $17.8 million during the year ended December 31, 2015.

Tubular Services segment

We generate revenues in our Tubular Services segment through a suite of proprietary service offerings and conventional casing and tubing running services for both onshore and offshore markets, typically contracted on a callout basis; and sales of our proprietary "CDS" and accessories. Our services include personnel and equipment, including the "CDS", power tongs, pick up/lay-down units, torque monitoring services, "SESS" for cementing operations, and hammering services for new well construction, completion, and workover or re-entry operations.


20


2016 as compared with 2015

Land
Revenues decreased by $58.1 million, or 62%, in 2016 as compared to 2015 primarily due to decreased activity and demand in North America and Latin America. In North America, the decrease in rig count and overall drilling activity resulted in half the number of jobs being performed during the year ended December 31, 2016 as compared to the year ended December 31, 2015. Additionally, oil prices and tubular services competition compressed prices. The decline in revenue for Latin America was primarily due to a decrease in the number of jobs performed.

Offshore
Revenues decreased by $11.9 million, or 36%, in 2016 as compared to 2015 primarily due to a decrease in the number of operating rigs within the Asia Pacific region. This decrease was partially offset by offshore revenue in North America as our mix of services performed continued to shift towards higher revenue generating deepwater services.

"CDS", Parts & Accessories
Revenues decreased by $2.2 million, or 30%, in 2016 as compared to 2015 primarily due to customers postponing capital expenditures in light of the significant decline in oil prices and overall reduction in operating rigs. Revenue related to "CDS" equipment sales was $1.4 million for the year ended December 31, 2016 as compared to $3.5 million of sales during the year ended December 31, 2015. The decrease in revenues related to parts and accessories is tied to the decrease in land-based and offshore tubular services jobs performed in the Middle East during 2016.

Operating Loss
Tubular Services operating loss decreased by $15.9 million, or 35%, in 2016 as compared to 2015. Excluding the goodwill impairment charge of $32.7 million in 2015, operating loss increased by $16.8 million primarily due to the aforementioned declines in revenue partially offset by cost reductions achieved through aggressive cost rationalization efforts.

Beginning in 2015 and throughout 2016, due to the decline in the upstream energy industry and its corresponding impact on our business outlook, we conducted a company-wide reduction in workforce and other cost rationalization efforts to reduce costs and better align our workforce with anticipated activity levels in the current market. Accordingly, we recorded nonrecurring items related to restructuring costs of $3.4 million and $3.9 million during the years ended December 31, 2016 and 2015, respectively.

2015 as compared with 2014

Land
Revenues decreased by $62.9 million, or 40%, in 2015 as compared to 2014 primarily due to decreased activity and demand in North America and Latin America, of 68% and 19%, respectively. In North America, the decrease in rig count and overall activity resulted in half the number of jobs being performed during the year ended December 31, 2015 as compared to the year ended December 31, 2014. Additionally, oil prices and tubular services competition compressed prices. The decrease in revenue for Latin America was primarily due to a decrease in the number of jobs performed.

Offshore
Revenues decreased by $7.3 million, or 18%, in 2015 as compared to 2014 primarily due to fewer offshore jobs performed in Asia Pacific. Additionally, a one-off job performed during 2014 in Europe exaggerates the unfavorable variance when compared against the same period in 2015. Offshore revenues in North America offset these variances as our mix of services performed shifted towards higher revenue generating deep water services as compared to 2014.

"CDS", Parts & Accessories
Revenues decreased by $19.9 million, or 73%, in 2015 as compared to 2014 primarily due to customers postponing capital expenditures in light of the significant decline in oil prices and overall reduction in operating rigs. Revenue related to "CDS" equipment sales was $3.5 million for the year ended December 31, 2015 as compared to $15.6 million of sales during the year ended December 31, 2014. The decrease in revenues related to parts and accessories is tied to the decrease in land-based and offshore tubular services jobs performed in primarily in North America and Latin America during 2015.

Operating Income
Tubular Services operating income decreased by $81.6 million in 2015 as compared to 2014 primarily due to the impairment charge discussed below and a reduction in revenues of $90.1 million, which was a result of the decline in the energy market and oil prices. Contributors to the total decline were North America, Latin America and Asia Pacific.


21


During the year ended December 31, 2015, we noted declines in the market value of our stock, oil and natural gas prices and utilization. Due to these indicators, step one of our annual impairment test concluded that the fair value of each of our reporting units was less than the carrying value of its net assets. As a result, we performed the second step of the impairment test, which compares the implied fair value of the reporting unit goodwill to the carrying value of that goodwill. The step two impairment test indicated that the goodwill for our reporting units was fully impaired. Accordingly, we recognized an aggregate impairment of $32.7 million associated with our tubular services segment.

Beginning in 2015, due to the decline in the upstream energy industry and its corresponding impact on our business outlook, we initiated a company-wide reduction in workforce and other cost rationalization efforts which is intended to reduce costs and better align our workforce with anticipated activity levels in the current market. Accordingly, we recorded nonrecurring items related to restructuring costs of $3.9 million during the year ended December 31, 2015. Additionally, we recorded other nonrecurring items related to inventory reserves, exit costs related to the sale of our Venezuelan operations and bad debt of $4.2 million during the year ended December 31, 2015.

Research and Engineering segment

We are a technology-based company deploying new technologies to increase the degree of rig automation and mechanization and to enhance our field operations. We are working aggressively to drive increased integration between the drilling rig and tubular services technology. We continue to invest in our research and engineering in order to continually develop, commercialize and enhance our proprietary products relating to our current product offerings and new technologies in development.

2016 as compared with 2015

In line with the industry downturn and demand for new products, operating expenses decreased by $3.4 million, or 37%, in 2016 as compared to 2015 primarily due to decreased spending on material, equipment, and labor utilized in new product development.

2015 as compared with 2014

Operating expenses decreased by $0.4 million, or 4%, in 2015 as compared to 2014 primarily due to decreased spending on material, equipment, and labor utilized in new product development.

Corporate and Other segment

Corporate and other expenses primarily consist of overhead, general and administrative expenses and certain selling and marketing expenses. Corporate and other expenses as a percentage of revenues was 18%, 10% and 7% for the years ended December 31, 2016, 2015 and 2014, respectively.

2016 as compared with 2015

Operating expenses decreased by $4.0 million, or 14%, in 2016 as compared to 2015 primarily due to cost saving measures implemented in 2016 and 2015. The benefits of these cost saving measures are visible primarily in personnel cost and various austerity measures.

2015 as compared with 2014

Operating expenses decreased by $9.2 million, or 25%, in 2015 as compared to 2014 primarily due to cost saving measures implemented in 2015. The benefits of these cost saving measures are visible primarily in personnel cost and various austerity measures.


22


Other Expenses

Below is a detail of expenses that are not allocated to segments for the years ended December 31, 2016 and 2015 (in thousands, except percentages):
 
Year ended December 31,
 
Increase / Decrease
 
2016
 
2015
 
2014
 
2015 to 2016
 
2014 to 2015
Interest expense
807

 
1,607

 
1,193

 
(800
)
 
(50
)%
 
414

 
35%
Interest income
(513
)
 
(327
)
 
(204
)
 
(186
)
 
57
 %
 
(123
)
 
(60)%
Foreign exchange losses
2,678

 
15,135

 
7,140

 
(12,457
)
 
(82
)%
 
7,995

 
112%
Other (income) expense
258

 
(406
)
 
(30
)
 
664

 
(164
)%
 
(376
)
 
(1,253)%
Income before taxes
(118,013
)
 
(118,410
)
 
38,444

 
397

 
 %
 
(156,854
)
 
(408)%
Income tax provision
(85
)
 
15,344

 
17,008

 
(15,429
)
 
(101
)%
 
(1,664
)
 
(10)%
Net income (loss)
$
(117,928
)
 
$
(133,754
)
 
$
21,436

 
$
15,826

 
(12
)%
 
$
(155,190
)
 
(724)%

2016 as compared with 2015

Interest Expense
Interest expense decreased by $0.8 million, or 50%, in 2016 as compared to 2015 primarily due to interest expense on certain tax matters related to Colombia and Argentina.

Foreign Exchange Losses
Although our functional currency is the U.S. dollar, our operations have net assets and liabilities not denominated in the functional currency which exposes us to changes in foreign currency exchange rates that impact income. Foreign exchange losses decreased by $12.5 million, or 82%, in 2016 as compared to 2015 primarily due to exchange losses based upon currency movements and changes in the net monetary asset bases in Argentina, Colombia, Mexico Venezuela, Russia, and Egypt.

Income Tax Provision
Income tax provision decreased by $15.4 million as compared to 2015. The tax benefits of the loss before income taxes were significantly reduced due to valuation allowances recorded on the net deferred tax assets. Valuation allowances recorded during the year ended December 31, 2016 were $26.0 million compared to valuation allowances of $41.1 million recorded during the year ended December 31, 2015. Our effective tax rates were 0.1% and (13.0)% for 2016 and 2015, respectively.

2015 as compared with 2014

Interest Expense
Interest expense increased by $0.4 million, or 35%, in 2015 as compared to 2014 primarily due to interest expense on certain tax matters related to Colombia and Argentina.

Foreign Exchange Losses
Although our functional currency is the U.S. dollar , our operations have net assets and liabilities not denominated in the functional currency which exposes us to changes in foreign currency exchange rates that impact income. Foreign exchange losses increased by $8.0 million in 2015 as compared to 2014 primarily due to exchange losses based upon currency movements and changes in the net monetary asset bases in Argentina, Colombia, Mexico and Venezuela.
 
Other (Income) Expenses
Other income increased by $0.4 million in 2015 as compared to 2014 primarily due to the favorable fair market value adjustment recorded in 2015 for the contingent earn-out obligation related to the acquisition of assets from Tech Field Services, LLC in 2014. The contingent earn-out obligation expired in May 2016.

Income Tax Provision
Income tax provision decreased by $1.7 million, or (10)%, as compared to 2014. The tax benefits of the loss before income taxes were significantly reduced due to valuation allowances recorded on the deferred tax assets. Valuation allowances recorded during the year ended December 31, 2015 were $41.1 million compared to valuation allowances of $0.9 million recorded during the year ended December 31, 2014. Our effective tax rates were (13.0)% and 44.2% for 2015 and 2014, respectively.
 

23


Liquidity and Capital Resources

We assess liquidity in terms of our ability to generate cash to fund operating, investing, and financing activities. Our primary sources of liquidity are cash flows generated from operations and available cash and cash equivalents. For the year ended December 31, 2016, cash and cash equivalents increased by $40.0 million to $91.5 million. We believe our current cash balance is more than adequate to conduct our business for at least the next 12 months.
The following table summarizes our net cash provided by (used in) operating, investing and financing activities for the years ended December 31, 2016, 2015 and 2014 as follows (in thousands):
 
 
Year Ended December 31,
 
 
2016
 
2015
 
2014
Cash provided by (used in) operating activities
 
$
(2,073
)
 
$
(6,614
)
 
$
40,580

Cash used in investing activities
 
(3,002
)
 
(6,887
)
 
(39,004
)
Cash provided by (used in) financing activities
 
45,057

 
(7,458
)
 
(26,387
)
Increase (decrease) in cash and equivalents
 
$
39,982

 
$
(20,959
)
 
(24,811
)

Certain sources and uses of cash, such as the level of discretionary capital expenditures and the issuance and repayment of debt and the payment of dividends are within our control and are adjusted as necessary based on market conditions. The following is a discussion of our cash flows for the years ended December 31, 2016, 2015 and 2014. This discussion should be read in conjunction with Item 8. Financial Statements and Supplementary Data in this report.

2016 as compared to 2015

Our cash and cash equivalents were $91.5 million at December 31, 2016, an increase of $40.0 million, or 78%, as compared to 2015. This is attributable to the following:

Operating Activities
Cash used in operating activities for the year ended December 31, 2016 was $2.1 million, as compared to $6.6 million in 2015. After adjusting for non-cash items, including a loss on impairment of fixed assets and intangibles of $35.5 million, the decrease in net cash used in operating activities was primarily due to the results of our operations, cash inflows of $27.0 million from decreasing receivables and $19.2 million from decreasing inventories, partially offset by decreasing accounts payable of $12.0 million.

Investing Activities
Cash used for investing activities for the year ended December 31, 2016 was $3.0 million, as compared to $6.9 million in 2015. Further, we used $7.1 million and $15.3 million in 2016 and 2015, respectively, for capital expenditures and sales of operating assets provided $4.1 million and $6.7 million of cash, respectively.

Financing Activities
Cash provided by financing activities was $45.1 million for the year ended December 31, 2016, as compared to cash used in financing activities of $7.5 million in 2015. In June 2016, we conducted a secondary public equity offering of 7.1 million common shares of the Company (including 130,752 shares issued pursuant to the underwriter's exercise of its option to purchase additional common shares of the company in July 2016), which generated aggregate proceeds of $47.6 million, net of underwriting discounts, commissions, issuance costs and expenses. The offering proceeds provide us optionality to address working capital and capital spending needs in an anticipated market recovery while also funding strategic initiatives to gain market share through technology offerings and possibly through acquisitions. We did not pay cash dividends in 2016 compared to $7.8 million paid in cash dividends in 2015.

2015 as compared to 2014

Our cash and cash equivalents were $51.5 million at December 31, 2015, a decrease of $21.0 million, or 29%, as compared to 2014. This is attributable to the following:

Operating Activities
Cash used in operating activities for the year ended December 31, 2015 was $6.6 million as compared to $40.6 million cash from operating activities in 2014. After adjusting for noncash items, including a loss on impairment of goodwill of $34.4 million, the

24


decrease in net cash used in operating activities was primarily due to the results of our operations, cash inflows of $61.5 million from decreasing receivables, offset by decreasing accounts payable of $41.3 million and $2.3 million of one-time retirement and transition bonus payments to the former CEO.

Investing Activities
Cash used for investing activities for the year ended December 31, 2015 was $6.9 million, as compared to $39.0 million in 2014. In 2014, we purchased substantially all of the assets of TFS for $5.0 million. Further, we used $15.3 million and $38.3 million in 2015 and 2014, respectively, for capital expenditures and sales of operating assets provided $6.7 million and $4.3 million of cash, respectively.

Financing Activities
Cash used for financing activities was $7.5 million for the year ended December 31, 2015, as compared to cash provided by financing activities of $26.4 million in 2014. We paid $7.8 million in cash dividends in 2015 compared to $6.0 million paid in cash dividends in 2014. In 2014, in connection with our stock repurchase program, we repurchased shares valued at $27.3 million. We did not repurchase any shares in 2015. Further, proceeds from stock options of $0.4 million and $6.5 million were recognized in 2015 and 2014, respectively.

Critical Accounting Policies and Estimates

Our significant accounting policies are described in Part II, Item 8, "Financial Statements and Supplementary Data, Note 2" in this Report. The preparation of financial statements in conformity with GAAP requires management to select appropriate accounting estimates and to make estimates and assumptions that affect the reported amount of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities. We consider our critical accounting estimates to be those that require difficult, complex or subjective judgment necessary in accounting for inherently uncertain matters and those that could significantly influence our financial results based on changes in those judgments. Changes in facts and circumstances may result in revised estimates and actual results may differ materially from those estimates. We believe the most critical accounting policies in this regard are those described below.

Deferred Taxes
We record deferred tax assets and liabilities to reflect the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. By their nature, tax laws are often subject to interpretation. In those cases where a tax position is open to interpretation, differences of opinion can result in differing conclusions as to the amount of tax benefits to be recognized. Valuation allowances are established to reduce deferred tax assets when it is more likely than not that some portion or all of the tax asset will not be realized. We consider estimates of future taxable income and ongoing tax planning in assessing the utilization of available tax losses and credits. Unforeseen events and industry conditions may impact forecasts of future taxable income which, in turn, can affect the carrying value of the deferred tax assets and liabilities and impact our future reported earnings. The level of evidence and documentation necessary to support a position prior to being given recognition and measurement within the financial statements is a matter of judgment that depends on all available evidence. A change in our forecast of future taxable income, or changes in circumstances, assumptions and clarification of uncertain tax regimes may require changes to any valuation allowances associated with our deferred tax assets, which could have a material effect on net income.
 
Loss Contingencies
We accrue loss contingency reserves when our assessments indicate that it is probable that a liability has been incurred or an asset will not be recovered and an amount can be reasonably estimated. Estimates of our liabilities are based on an evaluation of potential outcomes and currently available facts. Actual results may differ from our estimates and our estimates can be revised in the future, either negatively or positively, depending upon actual outcomes or changes in expectations based on the facts surrounding each matter.

Revenue Recognition
We recognize revenue when the earnings process is complete, persuasive evidence of an arrangement exists, price is fixed or determinable and collectability is reasonably assured. For product sales, revenue is recognized upon delivery when title and risk of loss of the equipment is transferred to the customer, with no right of return. For the sale of our pipe handling equipment, we determine the transfer of title and risk of loss in accordance with contracts with our customers and the related International Commercial Terms. Revenue in the Products segment may be generated from contractual arrangements that include multiple deliverables. Revenue from these arrangements is recognized as each item or service is delivered based on their relative fair value and when the delivered items or services have stand-alone value to the customer. For revenue other than product sales, we recognize revenue as the services are rendered based upon agreed daily, hourly or job rates.


25


Accounts Receivable
Accounts receivable trade consist of amounts due to us arising from normal course of business activities measured at net realizable value. This value includes an allowance for estimated uncollectible accounts to reflect any loss expected on the accounts receivable trade balances and charged to the provision for doubtful accounts.

Allowance for Doubtful Accounts Receivable
The determination of the collectability of amounts due from customer accounts requires the Company to make judgments regarding future events and trends. Allowances for doubtful accounts are determined based on a continuous process of assessing the Company’s portfolio on an individual customer basis taking into account current market conditions and trends. This process consists of a thorough review of historical collection experience, current aging status of the customer accounts and financial condition of the Company’s customers. Based on a review of these factors, the Company will establish or adjust allowances for specific customers. A substantial portion of the Company’s revenues come from international oil companies, international oilfield service companies and government-owned or government-controlled oil companies. Therefore, the Company has significant receivables in many international jurisdictions. If worldwide oil and gas drilling activity or changes in economic conditions in international jurisdictions deteriorate, the creditworthiness of the Company’s customers could also deteriorate and they may be unable to pay these receivables and additional allowances could be required. As of December 31, 2016 and 2015, allowance for doubtful accounts totaled $9.1 million and $8.9 million, or 21.5% and 12.2% of gross accounts receivable, respectively.

Purchase Price Allocation of Acquisitions
The Company allocates the purchase price of an acquired business to its identifiable assets and liabilities based on estimated fair values. The excess of the purchase price over the amount allocated to the assets and liabilities, if any, is recorded as goodwill. The Company uses all available information to estimate fair values including quoted market prices, the carrying value of acquired assets and widely accepted valuation techniques such as discounted cash flows. The Company engages third party appraisal firms to assist in fair value determination of inventories, identifiable intangible assets and any other significant assets or liabilities when appropriate. The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, could materially impact the Company’s results of operations.

Service and Product Warranties
The Company provides service and warranty policies on certain of its products. The Company accrues liabilities under service and warranty policies based upon specific claims and a review of historical warranty and service claim experience in accordance with ASC 420, Contingencies. Adjustments are made to accruals as claim data and historical experience change. In addition, the Company incurs discretionary costs to service its products in connection with product performance issues and recognizes them when they are incurred. As of December 31, 2016 and 2015, service and product warranties totaled $0.5 million and $0.9 million, respectively.

Excess and Obsolete Inventory Provisions
Inventory is carried at the lower of cost or estimated net realizable value. The Company determines reserves for inventory based on historical usage of inventory on-hand, assumptions about future demand and market conditions and estimates about potential alternative uses, which are usually limited. The Company’s inventory consists of specialized spare parts, work in process and raw materials to support ongoing assembly operations. Customers rely on the Company to stock these specialized items to ensure that their equipment can be repaired and serviced in a timely manner. The Company’s estimated carrying value of inventory therefore depends upon demand driven by oil and gas drilling and well remediation activity, which depends in turn upon oil and gas prices, the general outlook for economic growth worldwide, available financing for the Company’s customers, political stability in major oil and gas producing areas and the potential obsolescence of various types of equipment we sell, among other factors. As of December 31, 2016 and 2015, inventory reserves totaled $9.1 million and $11.8 million, or 10.7% and 11.0% of gross inventory, respectively.

Goodwill and Long-Lived Assets
Long-lived assets, which include goodwill, property, plant and equipment and intangible assets, comprise a substantial portion of our assets. The carrying value of goodwill is reviewed for impairment on an annual basis and the carrying value of other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable.

In accordance with generally accepted accounting principles, we test goodwill on a reporting unit basis for impairment using a fair value approach using both the (1) Income Approach and (2) Market Approach. We perform the valuation to test goodwill impairment annually as of December 31 or upon the occurrence of a triggering event. Goodwill impairment exists when the estimated fair value of goodwill is less than its carrying value. We estimate the fair value of goodwill based on discounted cash flow method (the Income Approach) and guideline comparable company method (Market Approach). The Income Approach is dependent on a number of significant management assumptions including markets and market share, sales volumes and prices,

26


costs to produce, capital spending, working capital changes, terminal value multiples and the discount rate. The discount rate is commensurate with the risk inherent in the projected cash flows and reflects the rate of return required by an investor in the current economic conditions. During times of economic volatility, significant judgment must be applied to determine our weighted-average cost of capital that we use to determine the discount rate. The Market Approach is based on a list of public peer companies and its performance metrics as applied to each reporting unit. The Market Approach assumes that the peer companies operate in the same industry and share similar characteristics to us and that our values will correlate to those characteristics. Therefore, a comparison of our reporting units to similar peer companies whose financial information is publicly available may provide a reasonable basis to estimate our fair value of each reporting unit. Once the valuation based on each methodology is completed, the Company's management will consider the weighting of the Market Approach vs. the Income Approach and the percentages associated with each approach are tested for reasonableness. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed to goodwill impairment losses that could be material to our results of operations. During the year ended December 31, 2015 we fully impaired our goodwill and recognized an impairment loss of $34.4 million.

If having concluded an impairment indicator exists, we evaluate long lived assets other than goodwill (such as property, plant and equipment) by comparing the carrying value of the asset to the asset’s estimated, future net cash flows (undiscounted and without interest charges). If the estimated future cash flows are less than the carrying value of the asset, we calculate and recognize an impairment loss. This process requires management to apply judgment in estimating future cash flows and asset fair values, including forecasting useful lives of the assets held and used, estimating future operating activities, future business conditions or technological developments. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values or if we encounter significant, unanticipated changes in circumstances, we may be required to lower the carrying value of our long-lived assets by recording an impairment charge that could be material to our results of operations. During the year ended December 31, 2016 we recognized $0.9 million of impairment related to intangible assets and $34.6 million to reduce the carrying values of our fixed assets to estimated fair value in our Products operating segment.

Recent Accounting Pronouncements

See Part II, Item 8, "Financial Statements and Supplementary Data, Note 2", under the heading "Recent accounting pronouncements" included in this Report.

Off-Balance Sheet Arrangements

As of December 31, 2016, we have no off-balance sheet arrangements other than the contractual obligations and letters of credit noted below.

Contractual Obligations
 
We are party to various contractual obligations. The following is a summary of our contractual cash obligations as of December 31, 2016 (in thousands):

 
Payments due by period
 
Total
 
< 1 year
 
1-3 years
 
3-5 years
 
> 5 years
Operating lease obligations (a)
21,963

 
6,289

 
7,887

 
4,167

 
3,620

Purchase commitments (b)
7,264

 
7,264

 

 

 

 
$
29,227

 
$
13,553

 
$
7,887

 
$
4,167

 
$
3,620


(a) 
We have operating lease commitments expiring at various dates, principally administrative offices, operation facilities and equipment.
(b) 
Represents purchase commitments for executed purchase orders that have been submitted to the respective vendor.

Letters of Credit
 
We enter into letters of credit in the ordinary course of business. As of December 31, 2016, we had outstanding letters of credit of approximately $2.7 million.

On August 9, 2016, we terminated our Second Amended and Restated Credit Agreement (the "Credit Facility") in order to eliminate certain fees and expenses associated with maintaining an undrawn credit facility and wrote off the remaining unamortized balance

27


of debt issuance cost of $0.1 million related to the facility. Letters of credit that had been outstanding within the Revolver prior to its termination have now been collateralized by cash on deposit. At December 31, 2016, we maintain $1.9 million on deposit as collateral for outstanding letters of credit. This deposit is classified as restricted cash within prepaid and other assets on the balance sheet at December 31, 2016. See Part II, Item 8, "Financial Statements and Supplementary Data, Note 6", included in this Report.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

We are exposed to market risks in our normal business activities. Market risk is the potential loss that may result from market changes associated with an existing or forecasted financial transaction. The types of market risks we are exposed to are credit risk and foreign currency risk.

Credit Risk
Certain of our assets are potentially subject to concentrations of credit risk, primarily cash, cash equivalents and accounts receivable. Cash and cash equivalents - such as deposits, investments in short-term commercial paper, and other money market instruments - are held by major banks. Our accounts receivable are principally with oil and natural gas service companies and "E&P" companies, and are subject to normal industry credit risks. For a further discussion, see Part II, Item 8, "Financial Statements and Supplementary Data, Note 12" included in this Report.

Foreign Currency Risk
We have extensive operations in foreign countries. Consistent with much of the oil and gas industry, our functional currency is the U.S. dollar globally, which exposes us to changes in foreign currency exchange rates that impact income. In addition, our operations have net assets and liabilities not denominated in the functional currency. In 2016, Over 70% of our revenue was denominated in U.S. dollars. However, outside the United States, a significant portion of our expenses are incurred in foreign currencies. Accordingly, weakening of currencies against the U.S. dollar may create losses in future periods. Conversely, when local currencies strengthen in relation to the U.S. dollar we experience foreign exchange gains. During the years ended December 31, 2016, 2015 and 2014, the Company reported foreign currency losses of $2.7 million, $15.1 million and $7.1 million, respectively.

28


Item 8. Financial Statements and Supplementary Data.
 
INDEX TO FINANCIAL STATEMENTS OF TESCO CORPORATION
AND CONSOLIDATED SUBSIDIARIES
 


29


Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of Tesco Corporation and subsidiaries

We have audited the accompanying consolidated balance sheets of Tesco Corporation and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tesco Corporation and subsidiaries at December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Tesco Corporation’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 3, 2017 expressed an unqualified opinion thereon.


/s/Ernst and Young LLP
Houston, Texas
March 3, 2017

30


Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of Tesco Corporation and subsidiaries

We have audited Tesco Corporation and subsidiaries internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Tesco Corporation and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Tesco Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Tesco Corporation and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2016 and our report dated March 3, 2017, expressed an unqualified opinion thereon.


/s/Ernst and Young LLP
Houston, Texas
March 3, 2017

31


TESCO CORPORATION
Consolidated Balance Sheets
(in thousands)

 
December 31,
 
2016
 
2015
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
91,489

 
$
51,507

Accounts receivable trade, net of allowance for doubtful accounts of $9,134 and $8,894 as of December 31, 2016 and 2015, respectively
33,320

 
64,270

Inventories, net
76,226

 
95,459

Income taxes recoverable
4,906

 
7,656

Prepaid and other current assets
15,034

 
17,594

Total current assets
220,975

 
236,486

Property, plant and equipment, net
120,743

 
177,716

Deferred income taxes

 
598

Intangible and other assets, net
2,561

 
6,894

Total assets
$
344,279

 
$
421,694

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities
 
 
 
Accounts payable
13,492

 
14,332

Deferred revenue
4,369

 
4,382

Income taxes payable
2,120

 
1,430

Accrued payroll and benefits
6,293

 
12,448

Accrued taxes other than income taxes
4,301

 
4,173

Other current liabilities
2,135

 
6,148

Total current liabilities
32,710

 
42,913

Other liabilities
1,580

 
2,239

Deferred income taxes
406

 
1,588

Total liabilities
34,696

 
46,740

Commitments and contingencies


 


Shareholders’ equity
 
 
 
Common shares; no par value; unlimited shares authorized; 46,688 and 39,218 shares issued and outstanding at December 31, 2016 and 2015, respectively
264,940

 
212,383

Retained earnings
9,142

 
127,070

Accumulated other comprehensive income
35,501

 
35,501

Total shareholders’ equity
309,583

 
374,954

Total liabilities and shareholders’ equity
$
344,279

 
$
421,694

 
The accompanying notes are an integral part of these consolidated financial statements.

32


TESCO CORPORATION
Consolidated Statements of Income
(in thousands, except per share information)
 
 
For the years ended December 31,
 
2016
 
2015
 
2014
Revenue
 
 
 
 
 
Products
$
48,046

 
$
87,534

 
$
230,717

Services
86,691

 
192,204

 
312,274

 
134,737

 
279,738

 
542,991

Operating expenses
 

 
 

 
 

Cost of sales and services
 

 
 

 
 

Products
61,719

 
99,630

 
177,135

Services
116,325

 
197,009

 
256,503

 
178,044

 
296,639

 
433,638

 
 
 
 
 
 
Selling, general and administrative
30,212

 
41,901

 
53,236

Goodwill impairment

 
34,401

 

Long-lived asset impairments
35,514

 

 

Research and engineering
5,750

 
9,198

 
9,574

Total operating expenses
249,520

 
382,139

 
496,448

Operating income (loss)
(114,783
)
 
(102,401
)
 
46,543

Other (income) expense
 

 
 

 
 

Interest expense
807

 
1,607

 
1,193

Interest income
(513
)
 
(327
)
 
(204
)
Foreign exchange losses
2,678

 
15,135

 
7,140

Other (income) expense
258

 
(406
)
 
(30
)
Total other expense
3,230

 
16,009

 
8,099

Income (loss) before income taxes
(118,013
)
 
(118,410
)
 
38,444

Income tax provision (benefit)
(85
)
 
15,344

 
17,008

Net income (loss)
$
(117,928
)
 
$
(133,754
)
 
$
21,436

Earnings (loss) per share:
 

 
 

 
 

Basic
$
(2.73
)
 
$
(3.43
)
 
$
0.54

Diluted
$
(2.73
)
 
$
(3.43
)
 
$
0.53

Dividends declared per share:
 
 
 
 
 
Basic
$

 
$
0.20

 
$
0.15

Weighted average number of shares:
 

 
 

 
 
Basic
43,151

 
39,005

 
39,912

Diluted
43,151

 
39,005

 
40,517

 


The accompanying notes are an integral part of these consolidated financial statements.


33


TESCO CORPORATION
Consolidated Statements of Shareholders’ Equity
(in thousands)

 
Common stock shares
 
Common shares
 
Retained earnings
 
Accumulated other comprehensive income
 
Total
Balances at December 31, 2013
39,680

 
$
224,666

 
$
253,195

 
$
35,501

 
$
513,362

Net income

 

 
21,436

 

 
21,436

Dividends declared

 

 
(6,004
)
 

 
(6,004
)
Share repurchase
(1,635
)
 
(27,324
)
 

 

 
(27,324
)
Stock compensation related activity
904

 
11,657

 

 

 
11,657

Balances at December 31, 2014
38,949

 
208,999

 
268,627

 
35,501

 
513,127

Net loss

 

 
(133,754
)
 

 
(133,754
)
Dividends declared

 

 
(7,803
)
 

 
(7,803
)
Stock compensation related activity
269

 
3,384

 

 

 
3,384

Balances at December 31, 2015
39,218

 
212,383

 
127,070

 
35,501

 
374,954

Net loss

 

 
(117,928
)
 

 
(117,928
)
Stock issuance, net of issue costs
7,131

 
47,554

 

 

 
47,554

Stock compensation related activity
339

 
5,003

 

 

 
5,003

Balances at December 31, 2016
46,688

 
$
264,940

 
$
9,142

 
$
35,501

 
$
309,583


 

 
The accompanying notes are an integral part of these consolidated financial statements.


34


TESCO CORPORATION
Consolidated Statements of Cash Flows
(in thousands)
 
For the years ended December 31,
 
2016
 
2015
 
2014
Operating Activities
 
 
 
 
 
Net income (loss)
$
(117,928
)
 
$
(133,754
)
 
$
21,436

Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities
 
 
 

 
 

Depreciation and amortization
29,327

 
38,135

 
42,009

Stock compensation expense
5,003

 
3,472

 
4,744

Bad debt expense
3,782

 
3,115

 
4,771

Deferred income taxes
(202
)
 
10,177

 
(3,479
)
Amortization of financial items
406

 
305

 
304

Gain on sale of operating assets
(1,347
)
 
(1,784
)
 
(1,026
)
Goodwill impairment

 
34,401

 

Long-lived asset impairments
35,514

 

 

Changes in the fair value of contingent earn-out obligations
(74
)
 
(940
)
 
(368
)
Venezuela charges

 

 
3,256

Changes in operating assets and liabilities:
 

 
 

 
 

Accounts receivable trade, net
26,969

 
61,478

 
6,133

Inventories
19,233

 
19,403

 
(17,160
)
Prepaid and other current assets
5,057

 
7,612

 
2,602

Accounts payable and accrued liabilities
(12,000
)
 
(41,324
)
 
(26,017
)
Income taxes payable (recoverable)
2,913

 
(7,144
)
 
1,974

Other noncurrent assets and liabilities, net
1,274

 
234

 
1,401

Net cash provided by (used in) operating activities
(2,073
)
 
(6,614
)
 
40,580

Investing Activities
 

 
 

 
 

Additions to property, plant and equipment
(7,091
)
 
(15,284
)
 
(38,308
)
Cash paid for acquisitions, net of cash acquired

 

 
(5,000
)
Proceeds on sale of operating assets
4,089

 
6,729

 
4,260

Other, net

 
1,668

 
44

Net cash used in investing activities
(3,002
)
 
(6,887
)
 
(39,004
)
Financing Activities
 

 
 

 
 

Repayments of debt

 
(25
)
 
(387
)
Proceeds from exercise of stock options

 
370

 
6,450

Dividend distribution

 
(7,803
)
 
(6,004
)
Share repurchase program

 

 
(27,324
)
Excess tax benefit associated with equity based compensation

 

 
878

Proceeds from stock issuance
47,918

 

 

Equity issuance costs
(364
)
 

 

Changes in restricted cash
(2,497
)
 

 

Net cash provided by (used in) financing activities
45,057

 
(7,458
)
 
(26,387
)
Change in cash and cash equivalents
39,982

 
(20,959
)
 
(24,811
)
Cash and cash equivalents, beginning of period
51,507

 
72,466

 
97,277

Cash and cash equivalents, end of period
$
91,489

 
$
51,507

 
$
72,466

Supplemental cash flow information
 

 
 

 
 

Cash payments for interest
$
355

 
$
513

 
$
462

Cash payments (refunds) for income taxes
(1,808
)
 
16,131

 
19,834

Property, plant and equipment accrued in accounts payable
2,087

 
976

 
3,343


The accompanying notes are an integral part of these consolidated financial statements.

35


TESCO CORPORATION
Notes to the Consolidated Financial Statements
 
Note 1— Nature of Operations and Basis of Presentation

Nature of operations
Tesco Corporation is a global leader in the design, assembly, and service delivery of technology-based solutions for the upstream energy industry. The Company seeks to improve the way wells are drilled by delivering safer and more efficient solutions that add value by reducing the costs of drilling for, and producing, oil and natural gas. Product and service offerings consist mainly of equipment sales and services to major oil and natural gas service companies and "E&P" operating companies throughout the world.

Basis of presentation

These consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") and include the accounts of all consolidated subsidiaries after the elimination of all intercompany accounts and transactions. In the opinion of management, the accompanying consolidated financial statements include all adjustments necessary for a fair presentation of operating results for the periods presented. All references to $ are to U.S. dollars.

Subsequent Events

We conducted our subsequent events review through the date these consolidated financial statements were filed with the U.S. Securities and Exchange Commission ("SEC").

Note 2— Summary of Significant Accounting Policies

Use of estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to reserves for excess and obsolete inventory, uncollectible accounts receivable, valuation of goodwill, intangible assets and long-lived assets, determination of income taxes, contingent liabilities, self-insurance liabilities, stock-based compensation and warranty provisions. We base our estimates on historical experience and various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of our assets and liabilities not readily apparent from other sources. Actual results could differ from those estimates.

Cash and cash equivalents

Cash equivalents are highly liquid, short-term investments with original maturities of less than three months, which are readily convertible to known amounts of cash.  We also maintain other cash balances, primarily as collateral for outstanding letters of credit, that are considered restricted in nature, and are classified in our financial statements in other current assets. The aggregate carrying amounts of our restricted cash was $3.5 million and $1.0 million at December 31, 2016 and 2015, respectively.

Allowance for doubtful accounts

We establish an allowance for doubtful accounts receivable based on our historical experience and our assessment of specific outstanding accounts that are probable of loss. Uncollectible accounts receivable are written off when a settlement is reached for an amount less than the outstanding historical balance or when we determine the balance will not be collected.
 
Inventories and inventory reserves

Inventories primarily consist of raw material and component parts used to support ongoing assembly operations, spare parts used in support of AMSS at our installed base, work in process, and finished goods. We have several valuation methods for our various types of inventories and consistently use the following methods for each type of inventory:

We value our work in process manufactured equipment using actual costs for raw materials, direct labor and appropriate manufacturing overhead allocations;

36


We value our finished manufactured equipment at the lower of cost or market using specific identification; and
We value our spare parts at the lower of cost or market using the average cost method.

Research and engineering expenses and selling, general and administrative expenses are reported as period costs and excluded from inventory cost. We establish reserves for obsolete inventory and for inventory in excess of demand based on our usage of inventory on-hand, technical obsolescence and market conditions, as well as our expectations of future demand based on our manufacturing sales backlog, our installed base and our development of new products.

Property, plant and equipment

Property, plant and equipment are carried at cost. Maintenance and repairs are expensed as incurred. The costs of replacements, betterments and renewals that extend the useful life are capitalized. Generally, when fixed assets are sold, retired, or otherwise disposed of, the related cost and accumulated depreciation are removed from the books and the resulting gain or loss is recognized on our consolidated statement of income. However, when pipe handling products that we manufacture are used in our rental fleet and sold, the sales proceeds are included in revenue and the net book value of the equipment sold is included in cost of sales and services within product sales of our Products segment. Similarly, when "CDS" products that we manufacture are employed in our operations and sold, the sales proceeds are included in revenue and the net book value of the equipment sold is included in cost of sales and services within "CDS", parts and accessories of our Tubular Services segment.

We evaluate potential impairment of long-lived tangible and intangible assets subject to amortization when indicators of impairment are present. Circumstances that could indicate a potential impairment include significant adverse changes in industry trends, economic climate, legal factors, and an adverse action or assessment by a regulator. More specifically, significant adverse changes in industry trends include substantial declines in revenue rates, utilization rates, oil and natural gas market prices and industry rig counts. In performing an impairment evaluation, we estimate the future undiscounted net cash flows from the use and eventual disposition of long-lived tangible and intangible assets grouped at the lowest level that cash flows can be identified, which is our operating segments. If the sum of the estimated future undiscounted net cash flows is less than the carrying amount of the asset group, then we determine the fair value of the asset group. The amount of an impairment charge is measured as the difference between the carrying amount and the fair value of the asset group.

During the year ended December 31, 2016 when impairment indicators were present, we reviewed our property, plant and equipment for impairment. As a result of our review, we recognized a $34.6 million impairment to our property, plant and equipment. See Note 5 for further discussion of our impairment analysis.

Depreciation and amortization of property, plant and equipment, including capital leases, is computed on the following basis:
Asset Category
 
Description
 
Method
 
Life 
Land, buildings and leaseholds
 
Buildings
Leasehold improvements
 
Straight-line
Straight-line
 
20 years
Lease term
 
 
 
 
 
 
 
Drilling equipment
 
Top drive rental units
Tubular services equipment
Support equipment
 
Usage
Straight-line
Straight-line
 
2,600 operating days
5 – 7 years
3 – 7 years
 
 
 
 
 
 
 
Manufacturing equipment
 
 
 
 Straight-line
 
 5 – 7 years
 
 
 
 
 
 
 
Office equipment and other
 
Computer hardware and software
IT development costs
Furniture and equipment
Vehicles
 
Straight-line
Straight-line
Straight-line
Straight-line
 
2 – 5 years
5 years
5 years
3 – 4 years

Goodwill and other intangible assets

Goodwill, resulting from business combinations, is initially recorded at acquisition-date fair value. Goodwill is not amortized but is subject to an annual impairment test, which we perform as of December 31, or upon the occurrence of a triggering event. An impairment loss is recognized when the fair value of the recording unit is less than the carrying value. We perform our goodwill impairment tests at the reporting unit level using the Income Approach and Market Approach.


37


As a result of our annual impairment test as of December 31, 2015, we fully impaired $32.7 million and $1.7 million of goodwill assigned to our Tubular Services and Products segments, respectively. During the year ended December 31, 2014 management concluded that goodwill was not impaired.
 
Intangible assets that have finite useful lives are capitalized at their acquisition-date fair value and amortized on a straight-line basis over their estimated useful lives. Our intangible assets that have finite useful lives consist primarily of customer relationships and patents. We review our intangible assets for impairment when circumstances indicate their carrying values may not be recoverable as measured by the amount their carrying values are exceeded by their fair values. Our intangible assets are evaluated for impairment as a component of the fixed asset groups discussed above. As a result of this evaluation, during the year ended December 31, 2016, we recognized an impairment to our intangible assets of $0.9 million. See Note 5 and Note 9 for further discussion of our impairment analysis.

Deferred income taxes

Deferred income taxes are determined using the liability method and are provided on all temporary differences between the financial reporting basis and the tax basis of our assets and liabilities, except for deferred taxes on income considered to be permanently reinvested in certain international subsidiaries. Deferred income taxes are measured using enacted tax rates and laws expected to apply to taxable income in the years in which the temporary differences are expected to reverse. The effect of a change in tax rates applied to deferred income taxes is recognized in the period that the change is enacted. A valuation allowance is established to reduce deferred tax assets when it is more likely than not some or all of the benefit from the deferred tax asset will not be realized. Accrued interest and penalties related to unrecognized tax benefits are reflected in interest expense and other expense, respectively, on our consolidated statements of income.

Contingent liabilities

We recognize liabilities for loss contingencies, including legal costs expected to be incurred in connection with such loss contingencies, when we believe a loss is probable and the amount of the probable loss can be reasonably estimated. Such estimates may be based on advice from third parties or on management’s judgment, as appropriate. Revisions to our contingent liabilities are reflected in income in the period in which facts become known or circumstances change that affect our previous judgments with respect to the likelihood or amount of the probable loss.

Warranties

We provide product warranties on new equipment sold pursuant to manufacturing contracts and recognize the anticipated cost of these warranties in cost of sales and services when sales revenue is recognized. We estimate our warranty liability based upon historical warranty claim experience and specific warranty claims. We periodically review our warranty provision and make adjustments to the provision as claim data and historical experience change.

Per share information

Basic earnings (loss) per share of common stock is calculated using the weighted average number of our shares outstanding during the period. Diluted earnings (loss) per share of common stock is calculated using the treasury stock method, under which we assume proceeds obtained upon exercise of "in the money" share-based payments, granted under our compensation plan, would be used to purchase our common shares at the average market price during the period. Diluted earnings (loss) per share includes the shares used in the basic net income calculation, plus our unvested restricted shares, performance stock units and outstanding stock options, to the extent that these instruments dilute earnings (loss) per share. No adjustment to basic earnings (loss) per share is made if the result of the diluted earnings (loss) per share calculation is anti-dilutive.

Revenue recognition

We recognize revenue when the earnings process is complete, persuasive evidence of an arrangement exists, price is fixed or determinable and collectability is reasonably assured. For product sales, revenue is recognized upon delivery when title and risk of loss of the equipment is transferred to the customer, with no right of return. For revenue other than product sales, we recognize revenue as the services are rendered based upon agreed daily, hourly or job rates.

Product Sales - We determine the transfer of title and risk of loss in accordance with contracts with our customers and the related International Commercial Terms. We generally require customers to pay a nonrefundable deposit with their purchase orders. Customer advances or deposits are deferred and recognized as revenue when we have completed all of our performance obligations related to the sale.

38


Pipe Handling Equipment Rentals and Tubular Services - Revenue generated from specific time, materials, and equipment contracts is based upon agreed daily, hourly, or job rates and price and is recognized as amounts are earned in accordance with the contract terms. 

Shipping and handling costs billed to customers are recognized in net revenue. Shipping and handling costs are included in cost of sales and services.

Operating leases

We have entered into non-cancelable operating lease agreements primarily involving office space. Certain of these leases contain escalating lease payments and we recognize expense on a straight-line basis, which is more representative of the time pattern in which the leased property is physically employed. In certain instances, we are also entitled to reimbursements for part or all of leasehold improvements made and record a deferred credit for such reimbursements, which is amortized over the remaining life of the lease term as a reduction in lease expense.

Research and engineering expenses

We expense research and engineering costs when incurred. Payments received from third parties, including payments for the use of equipment prototypes, during the research or development process are recognized as a reduction in research and engineering expense when the payments are received. We include in research and engineering expense, costs for buildings and properties, salaries and employee benefits, materials and equipment, administrative activities and allocations of corporate costs.

Stock-based compensation

Our stock-based compensation plan provides for the grants of stock options, restricted stock, restricted stock units, performance stock units and other stock-based awards to eligible directors, officers, employees and other persons. We measure stock-based compensation cost for awards as of grant date, based on the estimated fair value of the award. For stock option grants, we use a Black-Scholes valuation model to determine the estimated fair value. For market-based performance awards, we use a Monte Carlo simulation model to determine the estimated fair value. For restricted stock units, the fair value is the average of the high and low price of our stock as traded on the NASDAQ Stock Market on the date of grant.

For equity-classified awards, we recognize compensation expense on a graded basis over the vesting period. The graded basis of amortization accelerates the recognition of compensation expense for a three year vesting period, with generally 62% being recognized in the first year, 27% being recognized in the second year and 11% being recognized in the third year.  Compensation expense for our equity-classified awards is recorded as an increase to common shares. Consideration received on the exercise of stock options is recorded as an increase to common shares. For liability-classified awards, we recognize compensation expense based on the fair value of the award for the portion of the service period fulfilled at the end of each reporting period. The liability is recorded in accrued and other current liabilities on our consolidated balance sheet with the corresponding increase or decrease to compensation expense.

The tax benefit for stock-based compensation is included as a cash inflow in the Consolidated Statements of Cash Flows. We recognize a tax benefit only to the extent it reduces our income taxes payable. For purposes of determining the amount of tax attributes utilized in a given year as compared to the deduction for stock-based compensation, we apply the with-and-without approach. This approach considers deductions for stock-based compensation to be the last item of tax benefit recognized after all other deductions and utilization of prior year carryforwards.

Foreign currency translation

The U.S. dollar is the functional currency for all of our worldwide operations. Our cumulative translation adjustment of $35.5 million included in accumulated other comprehensive income resulted from the translation of assets and liabilities of our Canadian operations, which used the Canadian dollar as the functional currency prior to January 1, 2010. This cumulative translation adjustment will be adjusted only in the event of a full or partial disposition of our Canadian operations.  


39


Recent accounting pronouncements

In May 2014 the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606), which clarifies the principles for recognizing revenue. This guidance includes the required steps to achieve the core principle that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The update will be effective January 1, 2018. Early adoption is permitted on January 1, 2017. We will adopt the standard as of January 1, 2018. The standard provides for adoption retrospectively for each period presented (full retrospective) or retrospectively with the cumulative effect recognized as of the date of initial adoption (modified retrospective). We plan to apply the modified retrospective approach. 

We have the necessary resources dedicated to carry out the evaluation and adoption of the new standard and are currently reviewing the Company’s existing contracts under the principles of the new standard and identifying the modifications needed to our current revenue recognition accounting policy, business processes and system requirements. We anticipate the adoption of the new standard may require us to make significant changes to our business processes, and we are currently evaluating the overall impact this guidance will have on the consolidated financial statements and related disclosures of the Company.

In February 2016, FASB issued ASU 2016-02, Leases (Topic 842), which is a comprehensive new lease standard that amends various aspects of existing accounting guidance for leases. It will require recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The update will be effective January 1, 2019. Early adoption is permitted. We are evaluating the impact that this new guidance will have on our Consolidated Financial Statements and related Note disclosures.

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718), which requires income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It will also allow an employer to repurchase more of an employees' shares for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur. The update will be effective January 1, 2017. Early adoption is permitted. We early adopted this standard as of December 31, 2016, effective January 1, 2016, and elected to account for forfeitures as they occur to determine the amount of compensation cost to be recognized. The impact of this change in accounting policy was $0.1 million and was recorded as a cumulative effect adjustment to retained earnings for the increase to stock compensation expense. We further elected to apply the presentation requirements for cash flows related to excess tax benefits prospectively. The impact of the adoption of other provisions of the update did not have a material impact on our consolidated financial statements.

In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, which requires inventory not measured using either the last in, first out ("LIFO") or the retail inventory method to be measured at the lower of cost and net realizable value.  Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable cost of completion, disposal and transportation.  The new standard will be effective January 1, 2017 and will be applied prospectively.  Early adoption is permitted. We early adopted this update as of October 1, 2016. There was no impact to our consolidated financial statements as of December 31, 2016 as the provisions of the update are to be applied prospectively.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows: Restricted Cash. The standard provides guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows. This pronouncement is effective for annual reporting periods beginning after December 15, 2017. Early adoption is permitted. The amendments in this ASU should be applied using a retrospective approach. We have not completed an evaluation of the impact the pronouncement will have on our consolidated financial statements and related disclosures, but the impact is not expected to be material.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740). The standard improves the accounting for income tax consequences of intra-entity transfers of assets other than inventory. This pronouncement is effective for annual reporting periods beginning after December 15, 2017. The amendments in this ASU should be applied using a modified retrospective approach. We have not completed an evaluation of the impact the pronouncement will have on our consolidated financial statements and related disclosures, but the impact is not expected to be material.

In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. The standard addresses the classification and presentation of eight specific cash flow issues that currently result in diverse practices. This pronouncement is effective for annual reporting periods beginning after December 15, 2017. Early adoption for annual and quarterly reports is permitted. The amendments in this ASU should be applied using a retrospective approach. We have not completed an evaluation of the impact the pronouncement will have on our consolidated financial statements and related disclosures, but the impact is not expected to be material.


40


Note 3