Tesco Corporation 10-K 2010
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the Fiscal Year Ended December 31, 2009
For the transition period from to
Commission file number: 001-34090
(Exact name of registrant as specified in its charter)
(Registrant’s telephone number, including area code)
Securities to be registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
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 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. þ
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):
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
Aggregate market value of the voting and non-voting common equity held by nonaffiliates of the registrant: $298,560,301. This figure is estimated as of June 30, 2009, at which date the closing price of the registrant’s shares on the Nasdaq Global Market was $7.94 per share.
Number of shares of Common Stock outstanding as of February 25, 2010: 37,752,911
DOCUMENTS INCORPORATED BY REFERENCE
Listed below is the document parts of which are incorporated herein by reference and the part of this report into which the document is incorporated: Proxy Statement for 2010 Annual Meeting of Stockholders—Part III
Tesco Corporation (“TESCO” or the “Company”) is a global leader in the design, manufacture and service delivery of technology based solutions for the upstream energy industry. We seek to change the way wells are drilled by delivering safer and more efficient solutions that add real value by reducing the costs of drilling for and producing oil and gas. Our product and service offerings consist mainly of equipment sales and services to drilling contractors and oil and gas operating companies throughout the world. In addition to our top drive sales and service business, our service offerings include proprietary technology, including TESCO CASING DRILLING® (“CASING DRILLING”), TESCO’s Casing Drive System (“CDS™” or “CDS”) and TESCO’s Multiple Control Line Running System (“MCLRS™” or “MCLRS”). TESCO® is a registered trademark in Canada and the United States. TESCO CASING DRILLING® is a registered trademark in the United States. CASING DRILLING® is a registered trademark in Canada and CASING DRILLING™ is a trademark in the United States. Casing Drive System™, CDS™, Multiple Control Line Running System™ and MCLRS™ are trademarks in Canada and the United States.
TESCO was created on December 1, 1993 through the amalgamation of Shelter Oil and Gas Ltd., Coexco Petroleum Inc., Forewest Industries Ltd. and Tesco Corporation. The amalgamated corporation continued under the name Tesco Corporation, which is organized under the laws of Alberta, Canada. Unless the context indicates otherwise, a reference in this Form 10-K to “TESCO”, “the Company”, “we” or “us” includes Tesco Corporation and its subsidiaries.
Our principal executive offices are located at 3993 West Sam Houston Parkway North, Suite 100, Houston, Texas 77043; our telephone number is (713) 359-7000; and our Internet website address is www.tescocorp.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments thereto, are available free of charge on our Internet website. These reports are posted on our website as soon as reasonably practicable after such reports are electronically filed in the United States (“U.S.”) with the U.S. Securities and Exchange Commission (“SEC”) and in Canada on the System for Electronic Document Analysis and Retrieval (“SEDAR”). Our Code of Conduct Policy is also posted on our website. Our common stock is traded on the Nasdaq Global Market under the symbol “TESO.”
Basis of Presentation
These Consolidated Financial Statements have been prepared by management in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The consolidated financial statements include the accounts of the Company and its majority owned domestic and foreign subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Although we are a U.S. registrant with the SEC, TESCO is organized under the laws of Alberta and is therefore subject to the Business Corporation Act (Alberta). TESCO is also a reporting issuer (or the equivalent) in each of the provinces of Canada and is subject to securities legislation in each of those jurisdictions.
Foreign Currency Translation
Unless indicated otherwise, all amounts stated in this Form 10-K are denominated in U.S. dollars. All references to US$ or $ are to U.S. dollars and references to C$ are to Canadian dollars.
For foreign operations where the local currency is the functional currency, specifically the Company’s Canadian operations, assets and liabilities denominated in foreign currencies are translated into U.S. dollars at end-of-period exchange rates, and the resulting translation adjustments are reported, net of their related tax effects, as a component of Accumulated Comprehensive Income in Stockholders’ Equity. Assets and liabilities denominated in currencies other than the functional currency are remeasured into the functional currency prior to translation into U.S. dollars, and the resulting exchange gains and losses are included in income in the period in which they occur. Income and expenses are translated into U.S. dollars at the average exchange rates in effect during the period.
The reporting currency affects the presentation in our Consolidated Financial Statements, but not the underlying accounting records, which are maintained in the functional currency of our business units. The financial results for our Canadian operations have been translated into U.S. dollars as described in Note 3 of the Consolidated Financial Statements included in Part II, Item 8, “Financial Statements and Supplementary Data.”
Our four business segments are: Top Drive, Tubular Services, CASING DRILLING and Research and Engineering. Prior to December 31, 2008, we organized our activities into three business segments: Top Drives, Casing Services and Research and Engineering. Effective December 31, 2008, we segregated our Casing Services segment into Tubular Services and CASING DRILLING and our financial and operating data for the year ended December 31, 2007 has been recast in this Annual Report on Form 10-K to be presented consistently with this structure.
The Top Drive business is comprised of top drive sales, top drive rentals and after-market sales and service. The Tubular Services business includes both our proprietary and conventional Tubular Services. The CASING DRILLING segment consists of our proprietary CASING DRILLING technology. The Research and Engineering segment is comprised of our research and development activities related to our proprietary Tubular Services, CASING DRILLING technology and Top Drive model development. For financial information regarding each segment, including revenues from external customers and a measure of profit or loss, refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
For segment operating results and geographic information, see Note 13 to the Consolidated Financial Statements included in Part II, Item 8, “Financial Statements and Supplementary Data.”
Top Drive Segment
Our Top Drive segment sells equipment and provides services to drilling contractors and oil and gas operating companies throughout the world. We provide top drive rental services on a day-rate basis for land and offshore drilling rigs, and we provide after-market sales and service for our customers.
We primarily manufacture top drives that are used in drilling operations to rotate the drill string while suspended from the derrick above the rig floor. Our top drives offer portability and flexibility, permitting drilling companies to conduct top drive drilling for all or any portion of a well. 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. With each top drive we sell, we offer the services of top drive technicians who provide customers with training, installation and support services.
We offer six distinct model series of top drive systems, using hydraulic, permanent magnet alternating current (“AC”) and induction AC technology. We believe that we are industry leaders in the development and provision of permanent magnet technology in both portable and permanently installed top drive systems. This technology provides very high power density, allowing for high performance and low weight. We use AC induction technology and late generation power electronics in our smaller horsepower systems, such as our EMI machines, allowing the end user to specify its preferred power electronics and motor combination and permitting us to select components from a larger vendor base. EMI top drive units are available with 150 and 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 tons and generates 600 horsepower at the quill. 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 at the quill. The HXI machine has a load path rating of 250 tons and has a 700 horsepower self-contained diesel driven hydraulic power unit.
In addition to our top drive sales, we rent top drives on a day-rate basis for land and offshore drilling rigs. Our rental fleet offers a range of systems that can be installed in practically any mast configuration, including workover rigs. Our fleet is composed principally of hydraulically powered top drive systems, with power ratings of 460 to 1,350 horsepower and load path ratings of 150 to 750 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.
Our top drive rental fleet is deployed strategically around the world to be available to customers on a timely basis. The geographic distribution of the 117-unit fleet at December 31, 2009 included the following regions (in order of the size of our rental fleet in each region): the United States, South America, Mexico, Asia Pacific, Canada, Russia and the Middle East. Our fleet is highly transportable and we mobilize the top drive units to meet customer requests. Demand for our top drive rental services is directly tied to active rig count. According to data published by Baker Hughes in December 2009, operating rig count in the U.S. declined by approximately 35% from December 2008, and declined over 40% from peak operations in mid-2008. International operating rig count sustained better than the U.S. In response to these operating conditions, we redeployed over 10% of our U.S. fleet to international locations during 2009, including the Middle East, Latin America, Russia and Asia.
TESCO also provides after-market sales and services to our installed customer base around the globe. We maintain regional stocks of high-demand parts in order to expedite top quality, original replacement parts for top drive systems. Our service offerings include the commissioning of all new units and recertification of working units including top drives, power units and various other top drive product and component repairs. Our field-experienced personnel are available for the rig up and installation of all units – both rentals and customer-owned units. Our personnel also provide onsite training and top drive supervision. In addition, technicians are available to perform ongoing maintenance contracts.
Tubular Services Segment
Our Tubular Services business segment includes a suite of proprietary offerings, as well as conventional casing and tubing running services. Casing is steel pipe that is installed in oil, gas or geothermal wells to maintain the structural and pressure 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 using service companies, like ours, who use specialized equipment and personnel trained for this purpose. Wells can have from two to ten casing strings installed of various sizes. These jobs encompass wells from vertical holes to high angle extended reach wells and include both onshore and offshore applications.
Our proprietary service offerings use certain components of our CASING DRILLING technology, in particular the patented Casing Drive System (“CDS”), to provide a safer and more automated method for running casing and, if required, reaming the casing into the hole. The CDS is a tool which facilitates running and reaming casing into a well bore on any rig 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.
We also offer installation service of deep water smart well completion equipment using our Multiple Control Line Running System (“MCLRS”) proprietary and patented technology. We believe this technology substantially improves the quality of the installation of high-end well completions by eliminating damage and splices to control and injection lines. We also believe this technology improves the speed and safety of the completion process by splitting the work area between personnel making up the tubing and personnel installing completion equipment.
CASING DRILLING Segment
TESCO’s CASING DRILLING process uses oilfield casing in place of drill pipe to simultaneously drill and case the well, reducing both drilling time and the chance of unscheduled drilling events. CASING DRILLING technology minimizes the use of conventional drill pipe and drill collars and enables the operators to eliminate pipe trips and case the interval while drilling. This avoids well bore exposure during tripping and mitigates associated risks such as borehole collapse, lost circulation problems, and stuck tools or pipe.
The CASING DRILLING retrievable bottomhole assembly, which is comprised of the drill bit and other downhole tools, such as drilling motors, rotary steerable drilling systems, measurement–while–drilling and logging–while–drilling equipment, are lowered via wireline, drill pipe or a tubing string inside the casing and latched to the bottom joint of casing, retaining the ability to maintain the circulation of drilling fluid at all times. Tools are recovered in a similar fashion, by use of wireline, or alternatively drill pipe or a tubing string. Since the casing remains on bottom in the well at all times, wellbore integrity is preserved, and the risk of a well control incident is reduced. Because the well is cased as it is drilled, the potential for unintentional sidetracking is significantly reduced. The risk of tool loss in the hole is also reduced.
Research and Engineering Segment
As a technology driven company, we continue to invest significantly in research and development activities, primarily related to our proprietary technologies in Tubular Services, CASING DRILLING and top drive model development. We hold rights, through patents and patent license agreements, to patented and/or patent pending technologies for the innovations that have significant potential application to our core businesses. Our patent portfolio currently includes 114 issued patents and 137 pending patent applications. We will continue to invest in the development, commercialization and enhancements of our proprietary technologies.
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 the contractor fleet can access drilling locations that are only accessible when frozen. However, we feel we have limited exposure to this issue because as of December 31, 2009, approximately 10% of our top drive rental fleet operated in Canada and Russia.
In certain Asia Pacific and South American regions, we are subject to decline in activities due to seasonal rains. Further, seasonal variations in the demand for hydrocarbons and accessibility of certain drilling locations in North America can affect our business, as our activity follows the active drilling rig count reasonably closely. We actively manage our highly mobile rental fleet around the world to minimize the impact of geographically specific seasonality.
Our customers for top drive sales and after-market sales and service primarily consist of drilling contractors, rig builders and equipment brokers and occasionally include major and independent oil and gas companies and national oil companies who wish to own and manage their own top drive systems. Our customers for our rental fleet include drilling contractors, major and independent oil and gas companies and national oil companies. Demand for our top drive products depends primarily upon capital spending of drilling contractors and oil and gas companies and the level of drilling activity. Our top drive business is distributed globally with 48% of our top drive revenues generated from the North American markets (excluding Mexico) and 52% from international markets.
Our Tubular Services and CASING DRILLING customers also primarily consist of oil and gas operating companies, including major and independent companies, national oil companies and, on occasion, drilling contractors that have contractual obligations to provide tubular running and handling services. Demand for our Tubular Services and CASING DRILLING services strongly depends upon capital spending of oil and gas companies and the level of drilling activity. Our Tubular Services business is primarily focused in the North American markets (excluding Mexico) where 66% of our 2009 Tubular Services revenues were generated with the remaining 34% from international markets. Our CASING DRILLING business is distributed globally with approximately 46% of our 2009 CASING DRILLING revenues generated in North American markets (excluding Mexico) and 54% from international markets.
Our inventory consists primarily of completed top drives and component parts, proprietary, specialized tubular services and casing tool parts, spare parts, work in process, and raw materials to support our ongoing manufacturing operations and our installed base of specialized equipment used throughout the world. Customers rely on us to stock these specialized items to ensure that their equipment can be repaired and serviced in a timely manner. We maintain a supply of high-demand, fast-moving parts in regional locations to provide prompt service to our global customer base. We also have a global distribution center that manages an inventory of long lead time items and semi-finished goods to support our after-market sales and service business and our manufacturing operations.
Inventory costs for manufactured equipment are stated at the lower of cost or market using specific identification. Inventory costs for spare parts are stated at the lower of cost or market using the average cost method. We also perform an obsolescence review on our slow-moving and excess inventories and establish reserves based on such factors as usage of inventory on-hand, technical obsolescence and market conditions, as well as future expectations related to our manufacturing sales backlog, our installed asset base and the development of new products.
The recent global economic downturn, coupled with the global financial and credit market disruptions, has had a significant negative impact on the oil and gas industry. These events have contributed to a sharp decline in crude oil and natural gas prices and a sharp drop in demand. This decreased demand is evident in our top drive sales backlog; we ended 2009 with a backlog of 11 units, with a total value of $16.1 million, compared to a backlog of 65 top drive units at December 31, 2008, with a total value of $56.9 million. We considered the long-term effects of the economic downturn as we evaluated the carrying value of our global inventory in connection with the completion of our 2010 operating forecasts. This analysis included part-by-part evaluation of inventory turnover, obsolescence due to technological advances and projected sales estimates based on the current operating environment and the timing of forecasted economic recovery. Based on this analysis, we recorded a charge of $14.4 million to reflect the net realizable value of that inventory. Please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
We procure raw materials and components from many different vendors located throughout the world. A portion of these components are electrical in nature, including permanent magnet motors, induction motors and drives. We also purchase hydraulic components, such as motors, from certain suppliers located in the United States. In order to manufacture many of our proprietary parts, we require substantial quantities of steel. We select our component sources from, and establish supply relationships with, vendors who are prepared to develop components and systems that allow us to produce high performance, reliable and compact machines. For both our electric and hydraulic top drive systems we source key components, such as AC motors, power electronics, and hydraulic systems, from vendors who have developed these components for commercial, often non-oilfield applications, and who have adapted them for service conditions specific to our applications. Consequently, our ability to maintain timely deliveries and to provide long term support of certain models may depend on the supply of these components and systems. We attempt to minimize risks associated with this dependency through the development of supply agreements to maintain acceptable levels of ready components.
We believe that top drive backlog is a leading indicator of how our business will be affected by changes in the global macro-economic environment. We consider a product sale order as backlog when the customer has signed a purchase contract, submitted the purchase order and, if required by the purchase agreement, paid a non-refundable deposit. As a result of the weakened economic and industry conditions in 2009, we experienced a lower order rate and ended the year with a backlog of 11 units, with a total value of $16.1 million, compared to a backlog of 65 top drive units at December 31, 2008, with a total value of $56.9 million. While we have seen a recent increase in sales activity, our customers have maintained their focus on lowering project costs and, accordingly, we have adjusted our sales prices on selected product offerings. We believe that for our top drive business, a backlog of two quarters of production is reasonable and allows us to effectively manage our supply chain and workforce, yet be responsive to our client base.
In response to declining demand for our top drives due to industry and operating conditions, we downsized our manufacturing operations substantially during 2009. We have maintained a core team, which can continue to deliver a reasonable number of top drives each month to meet current and expected demand. Our current manufacturing capacity allows us to build up to four to six top drive units per month, depending on system complexity, down from 2008’s peak production levels of 12 to 16 units per month. Our manufacturing operations are flexible, and we will continue to manage our production levels to meet demand. We believe that our top drive business needs to maintain manufacturing inventory of one to two quarters of production to limit our exposure in the event that the sales market softens and allows us to effectively manage our supply chain and workforce.
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.
We were the first top drive manufacturer to provide portable top drives for land drilling rigs, thereby accelerating the growth of the onshore top drive market. We estimate that approximately 60% of land drilling rigs are currently equipped with top drive systems, including the former Soviet Union and China where few rigs operate with top drives today. By contrast, we estimate that approximately 95% of offshore rigs are equipped with top drives. We believe that significant further market potential exists for our top drive drilling system technology, including both portable and permanently installed applications. Further, where many top drive systems approach the end of their useful lives and are inefficient or may not have legacy parts available, we believe that a market for replacement systems will be created. This represents an important opportunity for us.
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. We have the second largest customer installed base and are the number two global provider of top drives, following NOV. Of the three major top drive system providers, we are the only company that maintains a sizeable fleet of assets solely for the purposes of rental. Competition in the sale of top drive systems takes place primarily on the basis of the features and capacities of the equipment, the quality of the services and technical support offered, delivery lead time and, to a varying extent, price.
The conventional tubular services market consists principally of several 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 this market are Weatherford International, Inc. (“Weatherford International”), Franks International, Inc. and BJ Services Company. Competition in the conventional tubular services market takes place primarily on the basis of the quality of the services offered, the quality and utility of the equipment provided, the proximity of the service provider and equipment to the work site and, to a certain extent, on price.
We are aware of competitive technology similar to our CDS tool. We believe that we continue to be the market leader in this technology. Other companies offering similar technology include NOV, Weatherford International and Franks International, Inc. Our CDS system is easily and quickly installed on any top drive system and we have the advantage of being able to offer skilled and trained personnel at the field level who have specialized knowledge of top drive drilling system operations.
We are not currently aware of any commercially or technically viable direct competition for our proprietary CASING DRILLING retrievable process, services or products, although several of our competitors are known to have developed prototypes that are similar, and in some cases have deployed them in a field environment. We continue to be the only company offering customers a broad range of tool sizes and the possibility of using casing to drill directional wells combined with specialized equipment that can be readily retrieved when the drilling is complete.
We believe that the that primary competition to our CASING DRILLING process is the traditional drill pipe drilling process and, to a lesser extent, other methods for casing while drilling that do not involve a retrievable bottom hole assembly. Such alternative methods of casing while drilling offer limited applications because of the cutting structure, and they cannot be combined with directional tools which facilitate the drilling of directional (i.e. non-vertical) wells. While we offer such alternative (i.e. non-retrievable) methods in addition to our proprietary CASING DRILLING process, we believe that Weatherford International has the largest share of the non-retrievable portion of the market, although Baker Hughes is supplying an increasing number of EZCaseTM bits (a trademark held by Baker Hughes) which our CASING DRILLING team is using on behalf of the operators.
We pursue patent protection in appropriate jurisdictions for the innovations that have significant potential application to our core businesses. We hold patents and patent applications in the United States, Canada, Europe, Norway, and various other countries. We also hold rights, through patent license agreements, to other patented and/or patent pending technologies. Our patent portfolio currently includes 114 issued patents and 137 pending patent applications.
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.
The overall design of our portable top drive assembly is protected by patents that will continue in force for several more years. Various specific aspects of the design of the top drive and related equipment are also patented, including the torque track system that improves operational handling by absorbing the torque generated by our top drive.
Our CASING DRILLING method and retrievable apparatus are protected by patents that will continue in force for several more years. In addition, we have patents that protect the combination of the retrievable drill bit assembly with a rotary steerable tool. Our CDS is protected by patents on some of the gripping tools and on the “link tilt” system, which is a method used to handle casing.
We hold numerous patents related to the installation and utilization of certain accessories for casing for purposes of casing rotation. Various other related methods and tools are patent protected as well.
Please see Part I, Item 1A “Risk Factors— We have been party to patent infringement claims and we may not be able to protect or enforce our intellectual property rights.” In addition, for a discussion of legal proceedings involving our intellectual property, please see Part I, Item 3 “Legal Proceedings.”
We are subject to numerous environmental, legal, and regulatory requirements related to our operations worldwide. In the United States, these laws and regulations include, among others:
In addition to the federal laws and regulations, states and other countries where we do business may have numerous environmental, legal, and regulatory requirements by which we must abide. We evaluate and address the environmental impact of our operations by assessing and remediating contaminated properties in order to comply with environmental, legal, and regulatory requirements and to avoid future liabilities. On occasion, we are involved in specific environmental claims, including the remediation of properties we own or have operated, as well as efforts to meet or correct compliance-related matters. Our Quality, Health, Safety and Environment group has programs in place to maintain environmental compliance and to prevent the occurrence of environmental contamination.
We do not expect costs related to these remediation activities to have a material adverse effect on our consolidated financial position, results of operations or cash flows. During 2009, we completed the sale of a building and land located in Canada. We incurred approximately $0.1 million and $0.9 million during the years ended December 31, 2009 and 2008, respectively, in soil remediation costs to prepare the property for sale. These costs were capitalized and added to the property’s net book value. Other than these expenditures, we did not incur any material costs in 2009, 2008 or 2007 as a result of environmental protection requirements, nor do we anticipate environmental protection requirements to have any material financial or operational effects on our capital expenditures, earnings or competitive position in future years.
As of December 31, 2009, the total number of employees of TESCO and its subsidiaries worldwide was 1,301. We believe that our relationship with our employees is good. We work to maintain a high level of employee satisfaction and we believe our employee compensation systems are competitive.
Our business, financial condition, results of operations and cash flows are subject to various risks, including the following:
Risks Associated with the Global Economy
The current global economic environment may continue to impact industry fundamentals, and the related decrease in demand for drilling rigs could cause current downturn in the oil and gas industry to continue. 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. 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 and CASING DRILLING businesses. These reductions could adversely affect the future net realizability of assets, including inventory, fixed assets goodwill and other intangible assets.
We are exposed to risks associated with turmoil in the financial markets.
U.S. and global credit and equity markets have recently undergone significant disruption, making it difficult for many businesses to obtain financing on acceptable terms. In addition, equity markets are continuing to experience wide fluctuations in value. As a result, an increasing number of financial institutions and insurance companies have reported significant deterioration in their financial condition. While we intend to finance our operations with existing cash, cash flow from operations and borrowing under our existing credit facility, we may require additional financing to support our growth. If any of the significant lenders, insurance companies or other financial institutions are unable to perform their obligations under our credit agreements, insurance policies or other contracts, and we are unable to find suitable replacements on acceptable terms, our results of operations, liquidity and cash flows could be adversely affected.
We also face challenges relating to the impact of the disruption in the global financial markets on other parties with whom we do business, such as our customers and vendors. Many of our customers access the credit markets to finance their oil and natural gas drilling and production activity. Companies that planned to finance exploration or development projects through the capital markets may be forced to curtail, reduce, postpone or delay drilling activity, and also may experience an inability to pay suppliers, including us. Such reductions or delays could negatively impact our revenues, cash flows and earnings. The inability of these parties to obtain financing on acceptable terms could impair their ability to perform under their agreements with us and lead to various negative effects on the Company, including business disruption, decreased revenues and increases in bad debt write-offs. A sustained decline in the financial stability of these parties could have an 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 future terrorist attacks could adversely affect the economies of the United States and other developed countries. A lower level of economic activity could result in a decline in energy consumption, which could cause a decrease in spending by oil and 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 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 and certain parts and supplies to or from foreign locations. Any restrictions on travel or shipments to and from foreign locations, due to the occurrence of natural disasters such as earthquakes, floods or hurricanes, or an epidemic or outbreak of diseases, including the recent H1N1 Flu, 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.
Risks Associated with the Oil and Gas Industry
We face risks due to the cyclical nature of the energy industry and the corresponding credit risk of our customers.
Changing political, economic or military circumstances throughout the energy producing regions of the world can impact the market price of oil and gas for extended periods of time. As most of our accounts receivable are with customers involved in the oil and gas industry, any significant change in such circumstances could result in financial exposure in relation to affected customers.
Fluctuations in the demand for and prices of oil and gas would negatively impact our business.
Fluctuations in the demand for and prices of oil and gas impact the levels of drilling activity by our customers and potential customers. The prices are primarily determined by supply, demand, government regulations relating to oil and 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 prices and therefore margins.
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.
In December 2009, the U.S. Environmental Protection Agency (“EPA”) officially published its findings that emissions of carbon dioxide, which is a byproduct of the burning of refined oil products, and methane, which is a primary component of natural gas, and other “greenhouse gases” present an endangerment to human health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the Earth’s atmosphere and other climatic changes. These findings by the EPA allow the agency to proceed with the adoption and implementation of regulations that would restrict emissions of greenhouse gases under existing provisions of the federal Clean Air Act. In September 2009, the EPA had proposed two sets of regulations in anticipation of finalizing its findings that would require a reduction in emissions of greenhouse gases from motor vehicles and that could also lead to the imposition of greenhouse gas emission limitations in Clean Air Act permits for certain stationary sources. In addition, the EPA issued a final rule in September 2009 requiring the reporting of greenhouse gas emissions from specified large greenhouse gas emission sources in the United States beginning in 2011 for emissions occurring in 2010. The adoption and implementation of any regulations imposing reporting obligations on, or limiting emissions of greenhouse gases from, our equipment and operations could require us to incur increased costs to reduce emissions of greenhouse gases associated with our operations and could adversely affect demand for the oil and natural gas.
In addition, in June 2009, the U.S. House of Representatives passed the “American Clean Energy and Security Act of 2009” (“ACESA”), which would establish an economy-wide cap-and-trade program to reduce U.S. emissions of greenhouse gases, including carbon dioxide and methane. ACESA would require a 17% reduction in greenhouse gas emissions from 2005 levels by 2020, and just over an 80% reduction of such emissions by 2050. Under this legislation, the EPA would issue a capped and steadily declining number of tradable emissions allowances to certain major sources of greenhouse gas emissions so that such sources could continue to emit greenhouse gases into the atmosphere. The cost of these allowances would be expected to escalate significantly over time. The net effect of ACESA would be to impose increasing costs on the combustion of carbon-based fuels such as oil, refined petroleum products, and natural gas. The U.S. Senate has begun work on its own legislation for restricting domestic greenhouse gas emissions, and the Obama administration has indicated its support of legislation to reduce greenhouse gas emissions through an emission allowance system. In addition, several states have considered initiatives to regulate emissions of greenhouse gases, primarily through the planned development of greenhouse gas emissions inventories and/or regional greenhouse gas cap and trade programs. Although it is not possible at this time to predict when the U.S. Senate may act on climate change legislation or how any bill passed by the Senate would be reconciled with ACESA, any future federal or state laws or regulations that may be adopted to address greenhouse gas emissions could require us to incur increased operating costs and could adversely affect the demand for the oil and natural gas.
Our revenues and earnings are subject to fluctuations period over period and are difficult to forecast.
Our revenues and earnings may vary significantly from quarter to quarter depending upon:
In addition, our fixed costs cause our margins to decrease when demand is low and service capacity is underutilized.
Any significant consolidation or loss of end-user customers could have a negative impact on our business.
Exploration and production company operators and drilling contractors have undergone substantial consolidation in recent years. Additional consolidation is probable. In addition, many oil and gas properties could be transferred over time to different potential customers.
Consolidation of drilling contractors results in fewer end-users for our products and could result in the combined contractor standardizing its equipment preferences in favor of a competitor’s products.
Merger activity among both major and independent oil and gas companies also affects exploration, development and production activity, as these consolidated companies attempt to increase efficiency and reduce costs. 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 budgets. Moreover, some end-users prefer not to use relatively new products or premium products in their drilling operations.
We operate in an intensively competitive industry and if we fail to compete effectively our business will suffer.
Competitive risks may include decisions by existing competitors to attempt to increase market share by reducing prices and decisions by customers to adopt competing technologies. The drilling industry is driven primarily by cost minimization. Our strategy is aimed at reducing drilling costs through the application of new technology. Our competitors, many of whom have a more diverse product line and access to greater amounts of capital, 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 a prolonged price war and maintain the 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:
We may encounter resource 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 revenues may be materially and adversely affected. Moreover, 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 our Business
We have been party to patent infringement claims and we may not be able to protect or enforce our intellectual property rights.
In three separate actions, we were sued by VARCO I/P, Inc. (“Varco”), Franks International, Inc. and Weatherford International, who have alleged that our CDS tool and other equipment and processes violate certain of their patents. See Part I, Item 3 “Legal Proceedings.” We believe that these suits are without merit and we intend to continue to defend ourselves vigorously. In the event that we are not successful in defending ourselves in one or more of these matters, it may have a material adverse effect on our Tubular Services and CASING DRILLING segments and, therefore, on our business. In addition, in the future we may be subject to other infringement claims and if any of our products were found to be infringing, our consolidated financial results may be adversely affected.
Some of our products and the processes used to produce them have been granted U.S. and international patent protection, or have patent applications pending. Nevertheless, patents may not be granted from our applications and, if patents are issued, the claims allowed may not be sufficient to protect our technology. Recent 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 on 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.
We are currently involved in legal proceedings described in Part I, Item 3 “Legal Proceedings.” 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. We are also subject to complaints or allegations from former, current or prospective employees from time to time, alleging violations of employment-related laws. 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.
Restrictions imposed by our credit agreement may limit our ability to finance future operations or capital needs.
The amount of borrowings available under our credit agreement is limited by the maintenance of certain financial ratios. Decreases in our financial performance could prohibit us from borrowing available amounts under our revolver or could force us to make repayments of outstanding total debt in order to remain in compliance with our credit agreements. These restrictions may negatively impact our ability to finance future operations, implement our business strategy or fund our capital needs. Compliance with these financial ratios may be affected by events beyond our control, including the risks and uncertainties described in the other risk factors discussed elsewhere in this report.
Our debt and other financing obligations restrict our ability to take certain actions and require the maintenance of certain financial ratios; failure to comply with these requirements could result in acceleration of our debt.
Our debt and other financing obligations contain restrictive covenants. A breach of any of these covenants could preclude us or our subsidiaries from issuing letters of credit, from borrowing under our credit agreements and could accelerate our debt and other financing obligations and those of our subsidiaries. If this were to occur, we might not be able to repay such debt and other financing obligations. Additionally, our credit agreements are collateralized by equity interests in our subsidiaries. A breach of the covenants under these agreements could permit the lenders to exercise their rights to foreclose on these collateral interests.
We have outstanding debt that is not contracted at market rates.
Our credit facility contains provisions for interest rates on borrowings and commitment fees that were established prior to the credit crisis and probably could not be replaced at the same value in today’s market. If we needed to replace our credit facility in today’s uncertain bank loan market, for any reason, including an event of default on our part, we may be unable to negotiate lending terms at the same rates, or for the same borrowing capacity, that we currently hold. Any change in the terms of our fees or borrowing capacity could adversely affect our liquidity and results of operations.
At this time it is difficult to forecast the future state of the bank loan market. As a result of the uncertain state of various financial institutions and the credit markets generally, we may be unable to maintain our current borrowing capacity in the event of bank or banks failure to fund any commitments under the current credit facility, and we may not be able to refinance our bank facility in the same amount and on the same terms as we currently hold, which could negatively impact our liquidity and results of operations.
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. We have in the past experienced quality problems with raw material vendors, which required us to recall and replace certain equipment and components. We have also in the past 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.
Concentration of our revenue and management in the United States involves risk.
In 2009 approximately 45% of our revenue was obtained from operations in the U.S. (compared to 52% during 2008). The concentration of revenue and management functions in the U.S. involves certain risks, including the following:
Our business operations in countries outside the United States are subject to a number of U.S. federal laws and regulations, including restrictions imposed by the Foreign Corrupt Practices Act as well as trade sanctions administered by the Office of Foreign Assets Control and the Commerce Department.>
Our business operations in countries outside the United States are subject to a number of U.S. federal laws and regulations, including restrictions imposed by the Foreign Corrupt Practices Act (“FCPA”) as well as trade sanctions administered by the Office of Foreign Assets Control (“OFAC”) and the Commerce Department. If we fail to comply with these laws and regulations, we could be exposed to claims for damages, financial penalties, reputational harm, and incarceration of our employees or restrictions on our operations, which could have a material adverse effect on our financial condition, results of operations or cash flows.
Our foreign operations and investments involve special risks.
We sell products and provide services in parts of the world where the political and legal systems are very different from those in the United States and Canada. 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 can expose us to risks related to cultural, political and economic factors of foreign jurisdictions which are beyond our control. As a general rule, we have elected not to carry political risk insurance against these risks. Such risks include the following:
We are subject to foreign exchange and currency risks.
We operate internationally, giving rise to exposure to market risks from changes in foreign currency exchange rates to the extent that transactions are not denominated in U.S. Dollars. We typically endeavor to denominate all of our contracts in U.S. Dollars to mitigate exposure to fluctuations in foreign currencies. However, inflation and future devaluations in foreign currencies could adversely impact our operations and financial results. A portion of our accounts receivable as of December 31, 2009 was denominated in Venezuelan currency. Effective January 11, 2010, the Venezuelan government devalued its currency and moved to a two-tier exchange structure. We expect this devaluation will have an impact to our results of operations for the upcoming quarterly period ended March 31, 2010.
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 may adversely impact our ability to meet delivery commitments. If we fail to deliver products according to contract terms, we may suffer 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 sub-assembly services from many different vendors located in Canada, the United States, 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. 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.
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 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, especially CASING DRILLING. We compete for these professionals, not only with other companies in the same industry, but with oil and 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 over other companies and loss of customer satisfaction.
The loss or incapacity of certain key employees for any reason, including our President and Chief Executive Officer, Julio M. Quintana, could have a negative impact on our ability to implement our business plan due to the specialized knowledge these individuals possess.
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 high level of service.
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. For example, the unexpected failure of a top drive to rotate a drill string during drilling operations could result in the loss of control over a well, leading to blowout and the discharge of pollutants into the environment. Damages arising from an occurrence at a location where our products are used have in the past and may in the future result in the assertion of potentially large claims against us.
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 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 and local laws and regulations. The adoption of laws and regulations curtailing exploration and development drilling for oil and 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 gas exploration and production 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 have identified material weaknesses in our internal controls.
Our management has concluded that our disclosure controls and procedures and internal control over financial reporting were not effective as of December 31, 2009. As a result, this Form 10-K includes an adverse opinion from PricewatehouseCoopers LLP, our independent registered public accounting firm, on our internal control over financial reporting. A description of the material weakness in our internal controls over financial reporting is included in Item 9A, “Controls and Procedures,” in this Form 10-K.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.
The material weakness resulted in misstatements of the deferred tax assets, the income tax provision, foreign exchange gains and losses, cumulative translation adjustments accounts and related financial disclosures. The material weakness also resulted in restatements of the Company’s condensed consolidated financial statements as of and for each of the quarters ended March 31, 2009, June 30, 2009 and September 30, 2009 and resulted in audit adjustments to the Company's consolidated financial statements as of and for the year ended December 31, 2009. Additionally, inadequate internal control over financial reporting could cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading of our securities.
The following table details our principal facilities, including (i) all properties which we own, and (ii) those leased properties which serve as corporate or regional headquarters.
In addition, we lease operational facilities at locations in Texas, Colorado, Pennsylvania, Arkansas, North Dakota and Wyoming. Each of these locations supports operations in its local area, primarily for the Tubular Services segment.
Outside the U.S., we lease additional operating facilities in Canada, Mexico, Venezuela, Colombia, Ecuador, Argentina, Brazil, Norway, Russia, Dubai, Singapore, Indonesia, Australia and New Zealand. The majority of these facilities support the Top Drive, Tubular Services and CASING DRILLING segments.
Our existing equipment and facilities are considered by management to be adequate to support our operations.
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 the current assets of TESCO and its subsidiaries on a consolidated basis.
The estimates below represent management’s best estimates based on consultation with internal and external legal counsel. There can be no assurance as to the eventual outcome or the amount of loss we may suffer as a result of these proceedings.
Varco I/P, Inc. (“Varco”) filed suit against TESCO in April 2005 in the U.S. District Court for the Western District of Louisiana, alleging that our CDS infringes certain of Varco’s U.S. patents. Varco seeks monetary damages and an injunction against further infringement. We filed a countersuit against Varco in June 2005 in the U.S. District Court for the Southern District of Texas, Houston Division seeking invalidation of the Varco patents in question. In July 2006, the Louisiana case was transferred to the federal district court in Houston, and as a result, the issues raised by Varco have been consolidated into a single proceeding in which we are the plaintiff. We also filed a request with the U.S. Patent and Trademark Office (“USPTO”) for reexamination of the patents on which Varco’s claim of infringement is based. The USPTO accepted the Varco patents for reexamination, and the district court stayed the patent litigation pending the outcome of the USPTO reexamination. In May 2009, the USPTO issued a final action rejecting all of the Varco patent claims that TESCO had contested. Varco has appealed this decision with the USPTO. The outcome and amount of any future financial impacts from this litigation are not determinable at this time.
Frank’s International, Inc. and Frank’s Casing Crew and Rental Tools, Inc. (“Franks”) filed suit against TESCO in the U.S. District Court for the Eastern District of Texas, Marshall Division, on January 10, 2007, alleging that its Casing Drive System infringes two patents held by Franks. TESCO filed a response denying the Franks allegation and asserting the invalidity of its patents. In May 2008, Franks withdrew its claims with respect to one of the patents, and, in July 2008, TESCO filed a request with the USPTO for reexamination of the other patent. In September 2008, the USPTO ordered a reexamination of that patent. During 2009, TESCO, Franks, and a third party from whom TESCO had a license agreed on terms of a settlement, pursuant to which TESCO paid $1.8 million to Franks and $0.4 million to the third party. Under the terms of the settlement, TESCO received from the third party a release of any royalty obligation under the license and received from Franks a fully-paid, perpetual, world-wide nonexclusive license under the two patents at issue. Franks requested the court to dismiss its lawsuit with prejudice. TESCO accrued and paid this $2.2 million settlement during the year ended December 31, 2009.
Weatherford International, Inc. and Weatherford/Lamb Inc. (“Weatherford”) filed suit against TESCO in the U.S. District Court for the Eastern District of Texas, Marshall Division, on December 5, 2007, alleging that various TESCO technologies infringe 10 different patents held by Weatherford. Weatherford seeks monetary damages and an injunction against further infringement. The TESCO technologies referred to in the claim include the CDS, the CASING DRILLING system and method, a float valve, and the locking mechanism for the controls of the tubular handling system. We have filed a general denial seeking a judicial determination that we do not infringe the patents in question and/or that the patents are invalid. In November 2008, we filed requests with the USPTO, seeking invalidation of substantially all of the Weatherford patent claims in the suit. The trial is set for May 2011. The outcome and amount of any future financial impacts from this litigation are not determinable at this time.
We have been advised by the Mexican tax authorities that they believe significant expenses incurred by our Mexican operations from 1996 through 2002 are not deductible for Mexican tax purposes. Between 2002 and 2008, formal reassessments disallowing these deductions were issued for each of these years, all of which we appealed to the Mexican court system. We have obtained final court rulings deciding all years in dispute in our favor, except for 1996 as discussed below, and 2001 and 2002, both of which are currently before the Mexican Tax Court. The outcome of such appeals is uncertain. However, we recorded an accrual of $0.3 million during 2008 for our anticipated exposure on these issues ($0.2 million related to interest and penalties was included in Other Income and $0.1 million was included in Income Tax Expense). We continue to believe that the basis for these reassessments was incorrect, and that the ultimate resolution of those outstanding matters that remain will likely not have a material adverse effect on our financial position, results of operations or cash flows.
In May 2002, we paid a deposit of $3.3 million with the Mexican tax authorities in order to appeal the reassessment for 1996. In 2007, we requested and received a refund of approximately $3.7 million (the original deposit amount of $3.3 million plus $0.4 million in interest). In 2007, we reversed an accrual for taxes, interest and penalties ($1.4 million related to interest and penalties was included in Other Income and $0.7 million benefit in Income Tax Expense). With the return of the $3.3 million deposit, the Mexican tax authorities issued a resolution indicating that we were owed an additional $3.4 million in interest but this amount had been retained by the tax authorities to satisfy a second reassessment for 1996. We believe the second reassessment is invalid, and we appealed it to the Mexican Tax Court. In January 2009, the Tax Court issued a decision accepting our arguments in part, which is subject to further appeal. Due to uncertainty regarding the ultimate outcome, we have not recognized the additional interest in dispute as an asset.
In July 2006, we received a claim for withholding tax, penalties and interest related to payments over the periods from 2000 to 2004 in a foreign jurisdiction. We disagree with this claim and are currently litigating this matter. In November 2009, we received a favorable decision from a lower level court regarding payments made during 2000, which is subject to appeal. At June 30, 2006, we accrued our estimated pre-tax exposure on this matter of $3.8 million, with $2.6 million included in other expense and $1.2 million included in interest expense. During 2008 and 2009, we accrued an additional $0.2 million and $0.2 million, respectively, of interest expense related to this claim.
In August 2008, we received a claim in Mexico for $1.1 million in fines and penalties related to the exportation of certain temporarily imported equipment that remained in Mexico beyond the authorized time limit for its return. We disagree with this claim and are currently litigating the matter. In December 2009, we received a decision from the Mexican Tax Court in our favor, which is subject to further appeal. The ultimate outcome of this litigation is uncertain.
In February 2009, we received notification of a regulatory review of our payroll practices in one of our North American business districts. The review was concluded during 2009 without a material financial impact to the Company.
In August 2009, we filed suit against several competitors in the U.S. District Court for the Southern District of Texas – Houston Division, including Weatherford International, Inc. (“Weatherford Inc.”). The suit claims infringement of two TESCO patents related to our CDS. Weatherford Inc. has petitioned for and been granted a reexamination of the Tesco patents by the USPTO. That reexamination is ongoing. The outcome of this examination and any resulting financial impact, if any, is uncertain.
A former employee of one of TESCO’s U.S. subsidiaries filed suit in the U.S. District Court for the Southern District of Texas—Houston Division on January 29, 2009 on behalf of a number of similarly situated claimants, alleging we failed to comply with certain wage and hour regulations under the U.S. Fair Labor Standards Act. The lawsuit was dismissed on July 22, 2009 on the basis that several of the plaintiffs were bound to arbitrate their claims against us pursuant to the TESCO Dispute Resolution Program (“Plan”). Five plaintiffs not covered by the Plan re-filed their lawsuit on July 30, 2009 in the same court and those plaintiffs covered by the Plan initiated arbitration proceedings with the American Arbitration Association. Additional plaintiffs were subsequently added to each of these actions for a total of 48 plaintiffs. In December 2009, we agreed in mediation to settle the claims of all plaintiffs for a total of approximately $2.3 million. The settlement agreement has been executed by all plaintiffs. During 2009, we accrued the entire $2.3 million settlement related to these claims.
In December 2009, we received an administrative subpoena from the Department of the Treasury, Office of Foreign Assets Control regarding a past shipment of oilfield equipment made from our Canadian manufacturing facility in 2006 to Sudan. We are reviewing the matter and have provided a timely response to the subpoena. The outcome of our internal review and any future financial impact resulting from this matter are not determinable at this time.
Our outstanding shares of common stock, without par, are traded on The Nasdaq Global Market (“NASDAQ”) under the symbol “TESO.” Until June 30, 2008, TESCO’s common stock was also traded on the Toronto Stock Exchange (“TSX”) under the symbol “TEO.” Effective June 30, 2008, the Company voluntarily delisted its shares from the TSX. The following table outlines the share price trading range and volume of shares traded by quarter for 2009 and 2008.
As of February 25, 2010, there were approximately 246 holders of record of TESCO common stock, including brokers and other nominees.
We have not declared or paid any dividends since 1993 and do not expect to declare or pay dividends in the near future. Any decision to pay dividends on our Common Shares will be made by our Board of Directors on the basis of our earnings, financial requirements and other relevant conditions existing at the time. Pursuant to our Amended and Restated Credit Agreement, we are currently prohibited from paying dividends to shareholders.
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, 2004 and ending on December 31, 2009 on our common shares (assuming a $100 investment was made on December 31, 2004) with the total cumulative return of the S&P 500 Composite Index and the Philadelphia Oil Service Sector Index (“OSX”) assuming reinvestment of dividends.
TESCO CORPORATION AND CONSOLIDATED SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL DATA
NOTE: Our consolidated financial statements for the three years ended December 31, 2009, which are discussed in the following notes, are included in this Form 10-K under Item 8. The 2008 and 2007 financial data has been revised as discussed in Revisions to Previously Issued Financial Statements in Item 7.
FORWARD-LOOKING INFORMATION AND RISK FACTORS
This annual report on Form 10-K contains forward-looking statements within the meaning of Canadian and United States securities laws, including the United States Private Securities Litigation Reform Act of 1995. From time to time, our public filings, press releases and other communications (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”, “intend”, “forecast”, “target”, “project”, “may”, “will”, “should”, “could”, “estimate”, “predict” or similar words suggesting future outcomes or language suggesting an outlook. Forward-looking statements in this annual report on Form 10-K include, but are not limited to, statements with respect to expectations of our prospects, future revenues, earnings, activities and technical results.
Forward-looking statements and information are based on current beliefs as well as assumptions made by, and information currently available to, us concerning our anticipated financial performance, business prospects, strategies and regulatory developments. Although management considers these assumptions to be reasonable based on information currently available to it, they may prove to be incorrect. The forward-looking statements in this annual report on Form 10-K are made as of the date it was issued and 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.
These risks and uncertainties include, but are not limited to, changes in the global economy and credit markets, the impact of changes in oil and natural gas prices and worldwide and domestic economic conditions on drilling activity and demand for and pricing of our products and services, other risks inherent in the drilling services industry (e.g. operational risks, potential delays or changes in customers’ exploration or development projects or capital expenditures, the uncertainty of estimates and projections relating to levels of rental activities, uncertainty of estimates and projections of costs and expenses, risks in conducting foreign operations, the consolidation of our customers, and intense competition in our industry); risks, including litigation risks, associated with our intellectual property and risks associated with the performance of our technology and other risks set forth in Part I, Item 1A, “Risk Factors.” These risks and uncertainties may cause our actual results, levels of activity, performance or achievements to be materially different from those expressed or implied by any forward-looking statements. When relying on our forward-looking statements to make decisions, investors and others should carefully consider the foregoing factors and other uncertainties and potential events. The forward-looking statements in this document are provided for the limited purpose of enabling current and potential investors to evaluate an investment in TESCO. Readers are cautioned that such statements may not be appropriate, and should not be used for other purposes.
Copies of our Canadian public filings are available at www.tescocorp.com and at www.sedar.com. Our U.S. public filings are available at www.tescocorp.com and at www.sec.gov.
The following review of TESCO’s financial condition and results of operations should be read in conjunction with our financial statements and related notes included in this Form 10-K. Unless indicated otherwise, all dollar amounts in this annual report on Form 10-K are denominated in United States (U.S.) dollars. All references to US$ or to $ are to U.S. dollars and references to C$ are to Canadian dollars.
Certain reclassifications have been made to prior years’ presentation to conform to the current year presentation.
TESCO is a global leader in the design, manufacture and service delivery of technology based solutions for the upstream energy industry. We seek to change the way wells are drilled by delivering safer and more efficient solutions that add real value by reducing the costs of drilling for and producing oil and gas. Our product and service offerings consist mainly of equipment sales and services to drilling contractors and oil and gas operating companies throughout the world. In addition to our top drive sales and service business, our service offerings include proprietary technology, including TESCO CASING DRILLING® (“CASING DRILLING”), TESCO’s Casing Drive System (“CDS™” or “CDS”) and TESCO’s Multiple Control Line Running System (“MCLRS™” or “MCLRS”). TESCO® is a registered trademark in Canada and the United States. TESCO CASING DRILLING® is a registered trademark in the United States. CASING DRILLING® is a registered trademark in Canada and CASING DRILLING™ is a trademark in the United States. Casing Drive System™, CDS™, Multiple Control Line Running System™ and MCLRS™ are trademarks in Canada and the United States.
Our four business segments are: Top Drive, Tubular Services, CASING DRILLING and Research and Engineering. Prior to December 31, 2008, we organized our activities into three business segments: Top Drives, Casing Services and Research and Engineering. Effective December 31, 2008, we segregated our Casing Services segment into Tubular Services and CASING DRILLING and our financial and operating data for the year ended December 31, 2007 has been recast to be presented consistently with this structure.
The Top Drive business is comprised of top drive sales, top drive rentals and after-market sales and service. The Tubular Services business includes both our proprietary and conventional Tubular Services. The CASING DRILLING segment consists of our proprietary CASING DRILLING technology. The Research and Engineering segment is comprised of our research and development activities related to our proprietary Tubular Services and CASING DRILLING technology and Top Drive model development. For a detailed description of these business segments, see Part I, Item 1, “Business.”
A global economic crisis hit the financial and credit markets in late 2008 which led to a significant global economic slowdown. Major central banks have responded vigorously, but credit and financial markets have not yet fully recovered, and a credit-driven worldwide economic recession deepened during the second quarter of 2009. Higher oil and gas prices over the past several years led to high levels of exploration and development drilling in many oil and gas basins around the globe by 2008, but activity slowed sharply in 2009 with lower oil and gas prices and tightening credit availability. Current conditions point to continued slow economic activity through 2010 with ongoing wide-ranging volatility in oil and gas prices. Many oil and gas operators reliant on external financing to fund their drilling programs have significantly curtailed their drilling activity, which appears to have had the greatest impact on gas drilling across North America (excluding Mexico). In addition, international rig count has also exhibited modest declines. One of the key indicators of our business is the number of active drilling rigs and this number has varied widely in recent months. The average annual number of active drilling rigs is as follows:
During 2009, North American average rig activity continued its sharp decline from 2008 peak levels with a modest recovery beginning late in the year. We believe that 2010 will be a year in which drilling activity in the United States and Canada will continue to recover from early 2009 levels, and drilling activity in other areas of the world will rebound more strongly than in the U.S.
Drilling activity for the last three years has been and the forecast for 2010 is as follows:
The current outlook for the global economy varies widely, but generally points toward a modest recovery in 2010. In particular, the U.S. and Canadian rig activity is projected to increase approximately 15% from average 2009 levels according to World Oil. International demand is expected to improve more than U.S. demand, but this is contingent on increased commodity pricing.
Current global macro-economic conditions make any projections difficult and uncertain. However, we believe top drive backlog is a leading indicator of how our business will be affected by changes in the global macro-economic environment. As a result of the weakened economic and industry conditions in 2009 and limited liquidity resulting from tightened credit markets, our customers reduced their top drive orders and purchases, and we ended the year with a backlog of 11 units, with a total value of $16.1 million, compared to a backlog of 65 top drive units at December 31, 2008, with a total value of $56.9 million. Based upon 2009 drilling levels and current economic forecasts, we expect our order rate to moderately increase in 2010 compared to our 2009 net orders of 25 new top drive units. While we have seen a recent increase in sales activity, our customers have maintained their focus on lowering project costs and, accordingly, we have adjusted our sales prices on selected product offerings.
We expect international demand for our top drive rental services to continue to sustain better than U.S. demand. Thus, we may continue to shift the location of several fleet units during 2010 to meet market demand. We will re-route our units in a manner that minimizes disruptions to our rental operations.
Over the long term, we believe that our top drive business needs to maintain manufacturing inventory of two quarters of production to limit our exposure to fluctuations in sales markets and to allow effective management of our supply chain and workforce. In addition, we must maintain additional inventory of long lead time items and semi-finished goods to support our after-market sales and service business and our manufacturing operations. We considered the long-term effects of the economic downturn as we evaluated the carrying value of our global inventory in connection with the completion of our 2010 operating forecasts. This analysis included part-by-part evaluation of inventory turnover and projected sales estimates based on the current operating environment and the timing of forecasted economic recovery. Based on this analysis, we recorded a charge of $14.4 million to reflect the net realizable value of that inventory. This was recorded in the Top Drive segment ($5.4 million), the Tubular Services segment ($2.0 million) and the CASING DRILLING segment ($7.0 million).
We continue to develop relationships with new and existing customers in both our Tubular Services and CASING DRILLING segments. For Tubular Services, we expect our CDS proprietary casing business and MCLRS activities to grow moderately in 2010 compared to 2009 and our conventional casing activities to recover more slowly as we continue to focus our efforts on the expansion of our proprietary casing service offerings. In addition, we continue to expand our tubular services activities in selected international locations to further expand our global footprint. With respect to our CASING DRILLING business, we plan to maintain our existing infrastructure around the world while optimizing headcount in locations with higher demand and streamlining internal processes. We remain confident that our CASING DRILLING business will be a valuable part of our future operations.
As described in “Overview—Business Environment,” our operating activities continue to shift to international locations (as a percentage of revenue and operating income). We intend to continue our focus on international opportunities, especially with the anticipated modest rate of recovery in drilling activity in the United States and Canada during 2010.
REVISIONS TO PREVIOUSLY ISSUED FINANCIAL STATEMENTS
In February 2009, Canada enacted a new tax law that allowed for the filing of Tesco’s Canadian income tax return on a U.S. dollar basis. The effect of the new tax law and Tesco’s election for adoption was required to be reflected in Tesco's consolidated financial statements for the first quarter of 2009. As such, Tesco recorded a $1.6 million income tax benefit, which thereby increased net income, during the first quarter of 2009 to account for this change in tax law. We have determined that the $1.6 million income tax benefit was calculated in error and that an additional $2.9 million income tax benefit should have been recorded during the first quarter of 2009. In addition, $0.4 million of foreign exchange loss should not have been recorded in Tesco’s income statement in the first three quarters of 2009. This error resulted from the incorrect re-measurement and translation into U.S. dollars of one of the Company’s foreign assets. As a result of these errors, we have restated the condensed consolidated financial statements and filed amended Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2009, June 30, 2009 and September 30, 2009.
Additionally, we have identified certain immaterial errors that originated in prior periods. We considered the impact of the misstatements on each of the quarterly periods affected and on a cumulative basis and concluded the items were not material to our annual results for the years ended December 31, 2008 and 2007. However, the correction of the results would have been material to our interim results for each of the quarters and the annual results in the year ended December 31, 2009. As a result of this evaluation and based on the accounting guidance, we have revised our consolidated financial statements for the years ended December 31, 2008 and 2007 to reflect the cumulative impact of this correction. We do not consider the aforementioned changes to the consolidated financial statements to be material.
The following tables summarize the effects of the restatements and the revision of the immaterial errors on the Consolidated Financial Statements as of and for the years ended December 31, 2008 and 2007 (in thousands):
The restatement and the revision of the immaterial errors had no impact on cash provided by operating activities, cash used in investing activities or cash used in financing activities for the year ended December 31, 2007.
RESULTS OF OPERATIONS
Years Ended December 31, 2009 and 2008
Revenues for the year ended December 31, 2009 were $356.5 million, compared to $534.9 million in 2008, a decrease of $178.4 million, or 33%. This decrease is primarily due to a $116.5 million decrease in the Top Drive segment, a $48.2 million decrease in the Tubular Services segment and a $13.7 million decrease in the CASING DRILLING segment. Results for each business segment are discussed in further detail below.
Operating (Loss) Income for the year ended December 31, 2009 was a loss of $14.8 million, compared to income of $74.8 million in 2008, a decrease of $89.6 million. This decrease is primarily due to lower revenues in all of our segments, decreased margins due to severe pricing pressures associated with the current economic and market conditions, $14.4 million of impairment charges incurred to reduce the carrying amount of our global inventory to net realizable value, $3.6 million of impairments for fixed assets held for sale, $6.0 million in expenses for litigation reserves and $4.0 million in severance and relocation costs. Results for each business segment are discussed in further detail below.
Net (Loss) Income for the year ended December 31, 2009 was a loss of $5.3 million, or $0.14 per diluted share, compared to income of $49.9 million in 2008, or $1.32 per diluted share, a decrease of $55.2 million. This decrease primarily results from decreased operating income discussed above and a $1.2 million increase in Foreign Currency Losses from a loss of $0.2 million in 2008 to a loss of $1.4 million in 2009 due to the comparative strengthening of the Canadian dollar versus the U.S. dollar during 2009, offset by a $2.6 million decrease in interest expense due to lower average debt balances and decreased interest rates during 2009.
Revenues and Operating (Loss) Income by segment and Net (Loss) Income for the years ended December 31, 2009 and 2008 were as follows (in thousands):
Top Drive Segment
Our Top Drive segment is comprised of top drive sales, after-market sales and support and top drive rental activities.
Revenues—Revenues for the year ended December 31, 2009 decreased $116.5 million, or 34%, compared to 2008, primarily driven by a $72.7 million decrease in top drive sales, a $28.1 million decrease in top drive rental services and a $15.7 million decrease in top drive after-market support.
Revenues from top drive sales decreased $72.7 million, or 44%, to $91.4 million as compared to 2008 in connection with the current downturn in the drilling industry. During 2009, we sold 90 top drive units, of which 79 were new units and 11 were used units. During 2008, we sold 137 top drive units, of which 118 were new units and 19 were used units. The selling price per unit varies significantly depending on the model, whether the unit was previously operated in our rental fleet and whether a power unit was included in the sale. When top drive units in our rental fleet are sold, the sales proceeds are included in revenues and the net book value of the equipment sold is included in cost of sales and services. Revenues related to the sale of used units sold in 2009 and 2008 were $10.4 million and $20.1 million, respectively.
Revenues from top drive rental service activities decreased $28.1 million, or 25%, to $83.8 million as compared to 2008, primarily due to a decrease in the number of rental operating days during 2009, particularly in North America where, according to Baker Hughes, active drilling activity declined in excess of 30% over the past 12 months. Demand for our top drive rental services is directly tied to active rig count; on a year-over-year basis, we estimate that the worldwide active rig count has declined in excess of 20%. The number of top drive operating days and average daily operating rates for 2009 and 2008 and the number of rental units in our fleet at year-end 2009 and 2008 were as follows:
We define an operating day as a day that a unit in our rental fleet is under contract and operating. We do not include stand-by days in our definition of an operating day.
A stand-by day is a day in which we are paid an amount, which may be less than the full contract rate, to have a top drive rental unit available to a customer but that unit is not operating. In 2009, stand-by revenues from rental services decreased $3.8 million to $5.6 million due to decreased operating demand for our top drive rental units.
In addition to selling top drive units, we provide after-market sales and service to support our installed base. Revenues from after-market sales and service decreased $15.7 million to $49.6 million for 2009 as compared to $65.3 million in 2008, primarily due to the current year’s decline in active rig count and drilling activities. The steep drop in rig count substantially decreased the available number operating top drives in need of repairs, thus shrinking the market for after-market sales and service. In an effort to minimize costs, many drilling contractors also began to perform their own maintenance on units we have historically maintained. Accordingly, our customers have decreased their demand for after-market parts and maintenance and repair services. This decrease in demand has also resulted in pricing pressures and thus, decreased revenues per job.
Operating Income—Top Drive Operating Income for the year ended December 31, 2009 decreased $57.3 million to $49.5 million compared to 2008. This decrease was primarily driven by the decrease in the number of top drive units sold in 2009 compared to 2008 (90 units in 2009 compared to 137 units in 2008), a $3.8 million legal settlement and $1.3 million in severance costs. Operating margins were negatively impacted by pricing pressures on our after-market sales and service businesses, as described above. Additionally, we performed an analysis of our Top Drive inventory parts in connection with our current backlog, continued depressed demand for drilling and related services and operating forecasts. Based on this analysis, we recorded a charge of $5.4 million to reflect the net realizable value of our Top Drive inventory. These charges were partially offset by a $1.6 million gain on the sale of certain ancillary Top Drive equipment and a $1.3 million gain on the sale of a building and property located in Canada.
Tubular Services Segment
Revenues—Revenues for the year ended December 31, 2009 decreased $48.2 million, or 29%, to $118.3 million as compared to 2008. The decrease in revenues reflects a $56.6 million, or 71%, decrease in conventional casing running revenues, offset by an increase of approximately $8.4 million, or 10%, in proprietary revenues.
Our conventional business is primarily conducted in North America and has been severely impacted by the decline in active rig count discussed above. We provide equipment and personnel for the installation of tubing and casing, including power tongs, pick-up/lay-down units, torque monitoring services, connection testing services and power swivels for new well construction and in work-over and re-entry operations. Our conventional Tubular Services business generated revenues of $22.9 million in 2009, a decrease of $56.6 million from 2008, primarily due to declining industry operating conditions during 2009 and our shift in job focus from conventional to proprietary services. During 2009, we continued to gain market acceptance of our services that use our proprietary and patented technology.
Our proprietary tubular services business generated revenues of $95.4 million in 2009, an increase of $8.4 million, or 10%, from 2008, which is primarily due to our proprietary job activity. Our proprietary job count increased from 1,971 in 2008 to 2,554 in 2009 and is a reflection of increased utilization of our CDS tools. Most of the U.S. drilling activity in 2009 was in several shale formations that require directional and horizontal drilling techniques, which are a good application for our proprietary service offerings. While the number of jobs performed has increased, revenues per job has been negatively impacted by pricing pressures. In certain cases, we strategically lowered our prices to obtain multi-well projects. Our revenues related to the sale of CDS and related equipment and revenues from MCLRS projects decreased by approximately $6.2 million and $1.6 million, respectively, from 2008 as a result of depressed economic conditions affecting capital spending in North America and throughout the world.
Operating Income (Loss)—Tubular Services’ operating income for the year ended December 31, 2009 decreased $25.4 million to a loss of $2.9 million compared to 2008. The decrease was primarily driven by decreased revenues and depressed margins resulting from pricing pressures as discussed above, $1.8 million in impairments of assets held for sale and severance costs of $0.4 million. Additionally, we performed an analysis of our Tubular Services inventory parts in connection with our operating activities for the past two years and operating forecasts. Based on this analysis, we recorded a charge of $2.0 million to reflect the net realizable value of our Tubular Services inventory.
CASING DRILLING Segment
Revenues—Revenues for 2009 were $13.3 million compared to $27.0 million in 2008, a decrease of $13.7 million or 51%. The decrease in 2009 was attributable to a decline in available work, particularly in Latin America and the U.S., in connection with current industry operating conditions.
Operating Income (Loss)—CASING DRILLING’s operating loss for the year ended December 31, 2009 increased $8.4 million to $21.0 million compared to a loss of $12.6 million in 2008. During the year ended December 31, 2009, we performed an analysis of our CASING DRILLING inventory to determine excess or slow moving items based on our operating activities and projections of future demand. Due to the ongoing technological advances in our CASING DRILLING technology, combined with the usage forecasts inherent in the analysis, we recorded a charge of $7.0 million to reflect the net realizable value of our CASING DRILLING inventory. Operating losses were also negatively impacted by $1.8 million in impairments of assets held for sale, a $0.5 million loss on the sale of operating assets and severance costs of $0.2 million, partially offset by reduced management and overhead expenses. We continue to establish the infrastructure needed to supply our CASING DRILLING services in locations around the world.
Research and Engineering Segment
Research and Engineering’s operating expenses are comprised of activities related to the design and enhancement of our top drive models and proprietary equipment and were $7.4 million for 2009, a decrease of $3.6 million from 2008’s operating expenses of $11.0 million. This decrease is primarily due to decreased product development activities on our top drive models and our focus on reducing costs during 2009. We will continue to invest in the development, commercialization and enhancements of our proprietary technologies.
Corporate and Other
Corporate and Other expenses primarily consist of the corporate level general and administrative expenses and certain operating level selling and marketing expenses. Corporate and Other’s operating loss for the year ended December 31, 2009 increased $2.1 million to a $33.0 million loss compared to 2008. This increase is primarily due to $2.2 million in legal settlements and $1.4 million in severance costs, partially offset by a $3.8 million decrease in bonus accruals and a $1.5 million decrease in marketing expenses during the current year’s period. In addition, our non-cash stock compensation expense decreased $0.9 million during the current period related to performance stock units, which declined in value in response to the current year’s operating levels.
Net (Loss) Income (in thousands):
Interest Expense— Interest expense for 2009 decreased $2.6 million compared to the previous year. This decrease was a result of decreased debt and a 293-basis point decrease in the weighted average interest rate during the current year due to market conditions. During the year ended December 31, 2009, average daily debt balances were $37.2 million; approximately $31.1 million lower than 2008.
Interest Income—Interest income for 2009 increased $0.6 million to $1.0 million, primarily due to $0.8 million in interest received on an overpayment of prior years’ U.S. federal income taxes.
Foreign Exchange Losses (Gains) — Foreign exchange losses were $1.4 million in 2009 and $0.2 million in 2008, primarily due to the comparative weakening of the Canadian dollar versus the U.S. dollar.
Other Income—Other Income includes non-operating income and expenses, including investment activities. The following is a detail of the significant items that are included in Other Expense (Income) for 2009 and 2008 (in thousands):
For a description of these items, see Notes 3, 9 and 11 to the Consolidated Financial Statements included in Part II, Item 8, “Financial Statements and Supplementary Data.”
Income Taxes—TESCO is an Alberta, Canada corporation. We conduct business and are taxed on profits earned in a number of jurisdictions around the world. Our income tax expense is provided based on the laws and rates in effect in the countries in which operations are conducted or in which TESCO and/or its subsidiaries are considered residents for income tax purposes. Income tax expense as a percentage of pre-tax earnings fluctuates from year to year based on the level of profits earned in each jurisdiction in which we operate and the tax rates applicable to such profits.
Our effective tax rate for 2009 was 70% compared to 30% in 2008. The 2009 effective tax rate reflects the recognition of a $4.5 million tax benefit associated with a Canadian tax law change that occurred during the first quarter of 2009, a $0.3 million tax benefit for research and development credits generated during 2009, a $1.5 million tax benefit associated with a reduction in the valuation allowance established against foreign subsidiary net operating loss carryforwards and cumulative net tax benefits of $3.8 million related to earnings or losses generated in jurisdictions with statutory tax rates higher or lower than the Canadian federal and provincial statutory tax rates. The 2009 effective tax rate also includes a $0.4 million charge related to an audit assessment received in a foreign jurisdiction and $0.7 million of tax expense associated with a reduction in deferred tax assets attributable to a change in the period in which we expect to utilize such assets.
The 2008 effective tax rate reflects a $0.8 million tax benefit for research and development credits generated during 2008 offset by a $1.2 million charge related to valuation allowances established against foreign subsidiary losses, a $2.1 million charge related to foreign exchange gains, and a $1.1 million charge related to a reduction in deferred tax assets attributable to a change in the period in which we expect to utilize such assets.
No provision is made for taxes that may be payable on the repatriation of accumulated earnings in our foreign subsidiaries on the basis that these earnings will continue to be used to finance the activities of these subsidiaries.
For a further description of income tax matters, see Note 9 to the Consolidated Financial Statements included in Part II, Item 8, “Financial Statements and Supplementary Data.”
Years Ended December 31, 2008 and 2007
Revenues for the year ended December 31, 2008 was $534.9 million, compared to $462.4 million in 2007, an increase of $72.5 million, or 16%. This increase is primarily due to a $52.3 million increase in the Top Drive segment, a $12.4 million increase in CASING DRILLING revenues and a $7.8 million increase in the Tubular Services segment.
Operating Income for the year ended December 31, 2008 was $74.8 million, compared to $48.2 million in 2007, an increase of $26.6 million. This increase is primarily attributable to increased operating income in the Top Drive and in the Tubular Services segments, decreased losses from our CASING DRILLING segment and decreased costs in our Research and Engineering segment, partially offset by increased Corporate and Other expenses. Results for each business segment are discussed in further detail below.
Net Income for the year ended December 31, 2008 was $49.9 million, or $1.32 per diluted share, compared to $32.1 million in 2007, or $0.86 per diluted share, an increase of $17.9 million. This increase primarily results from increased operating income discussed above and a $2.7 million change in foreign currency losses from a loss of $2.9 million in 2007 to a loss of $0.2 million in 2008 due to the strengthening of the U.S. dollar during 2008, partially offset by a $0.8 million decrease in interest income due to interest received on a Mexican tax deposit during 2007.
Revenues and operating income by segment and net income for the years ended December 31, 2008 and 2007 were as follows (in thousands):