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EX-32 - SECTION 906 CERTIFICATIONS OF CEO AND CFO - TESCO CORPtesco32.htm
EX-31.1 - SECTION 302 CERTIFICATION OF CEO - TESCO CORPtesco311.htm
EX-31.2 - SECTION 302 CERTIFICATION OF CFO - TESCO CORPtesco312.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended September 30, 2009
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to
 
Commission file number: 001-34090

Tesco Corporation
(Exact name of registrant as specified in its charter)

   
Alberta
76-0419312
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
   
3993 West Sam Houston Parkway North
Suite 100
Houston, Texas
77043-1221
(Address of Principal Executive Offices)
(Zip Code)
 
713-359-7000
(Registrant’s telephone number, including area code)

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   x     No   ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   ¨     No   ¨
 
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 definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer   ¨
Accelerated Filer   x
Non-Accelerated Filer   ¨
Smaller Reporting Company   ¨
 
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ¨     No  x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.
 
Number of shares of Common Stock outstanding as of October 30, 2009: 37,660,446
 
 


 



TABLE OF CONTENTS
 
     
   
Page
PART I—FINANCIAL INFORMATION
     
Item 1.
 1
     
Item 2.
 24
     
Item 3.
43
     
Item 4.
44
 
PART II—OTHER INFORMATION
     
Item 1.
45
     
Item 1A.
46
     
Item 2.
46
     
Item 3.
46
     
Item 4.
46
     
Item 5.
46
     
Item 6.
 47
 


Caution Regarding Forward-Looking Information; Risk Factors
 
This quarterly report on Form 10-Q 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 quarterly report on Form 10-Q 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 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 quarterly report on Form 10-Q 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, 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), and risks associated with our intellectual property and with the performance of our technology. 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.
 
Copies of our Canadian public filings are available at www.tescocorp.com and on SEDAR at www.sedar.com. Our U.S. public filings are available at www.tescocorp.com and on EDGAR at www.sec.gov.
 
Please see Part I, Item 1A—Risk Factors of our annual report on Form 10-K for the year ended December 31, 2008 and Part II, Item 1A—Risk Factors of this quarterly report on Form 10-Q, for further discussion regarding our exposure to risks. Additionally, new risk factors emerge from time to time and it is not possible for us to predict all such factors, nor to assess the impact such factors might have on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.
 




PART I—FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS (UNAUDITED).
 
TESCO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in thousands)
 
             
   
September 30,
2009
   
December 31,
2008
 
ASSETS
           
CURRENT ASSETS
           
Cash and Cash Equivalents
  $ 45,761     $ 20,619  
Accounts Receivable Trade, net
    48,725       97,747  
Inventories, net
    97,716       96,013  
Deferred Income Taxes
    17,512       10,996  
Prepaid and Other Current Assets
    19,497       19,690  
Total Current Assets
    229,211       245,065  
Property, Plant and Equipment, net
    193,287       208,968  
Goodwill
    29,240       28,746  
Deferred Income Taxes
    13,190       9,066  
Intangible and Other Assets, net
    5,818       7,545  
TOTAL ASSETS
  $ 470,746     $ 499,390  
LIABILITIES & SHAREHOLDERS’ EQUITY
               
CURRENT LIABILITIES
               
Current Portion of Long Term Debt
  $ 2,525     $ 10,171  
Accounts Payable
    21,581       38,946  
Income Taxes Payable
    2,254       8,297  
Deferred Revenues
    6,744       16,638  
Accrued and Other Current Liabilities
    25,429       25,711  
Total Current Liabilities
    58,533       99,763  
Long Term Debt
    31,400       39,400  
Deferred Income Taxes
    14,929       8,197  
Total Liabilities
    104,862       147,360  
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY
               
Common Shares
    174,345       171,384  
Contributed Surplus
    15,272       15,708  
Retained Earnings
    143,304       142,752  
Accumulated Comprehensive Income
    32,963       22,186  
Total Shareholders’ Equity
    365,884       352,030  
TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY
  $ 470,746     $ 499,390  
 

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



TESCO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(in thousands, except per share and share information)
 
                         
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
REVENUE
                       
Products
  $ 25,186     $ 65,448     $ 117,015     $ 175,049  
Services
    47,423       74,573       154,205       220,497  
      72,609       140,021       271,220       395,546  
OPERATING EXPENSES
                               
Cost of Sales and Services
                               
Products
    18,319       39,069       86,712       110,279  
Services
    43,695       60,431       145,886       181,434  
      62,014       99,510       232,598       291,713  
Selling, General and Administrative
    6,811       12,550       33,633       36,875  
Research and Engineering
    2,092       2,561       6,525       8,140  
Total Operating Expenses
    70,917       114,621       272,756       336,728  
OPERATING INCOME (LOSS)
    1,692       25,400       (1,536 )     58,818  
OTHER EXPENSE
                               
Interest expense
    497       1,098       1,451       3,552  
Interest income
    (847 )     (45 )     (896 )     (306 )
Foreign exchange losses
    808       422       1,106       748  
Other (income) expense
    (1 )     (99 )     143       (53 )
Total Other Expense
    457       1,376       1,804       3,941  
INCOME (LOSS) BEFORE INCOME TAXES
    1,235       24,024       (3,340 )     54,877  
INCOME TAX PROVISION (BENEFIT)
    1,503       6,443       (3,892 )     13,939  
NET (LOSS) INCOME
  $ (268 )   $ 17,581     $ 552     $ 40,938  
(Loss) Earnings per share:
                               
Basic
  $ (0.01 )   $ 0.47     $ 0.01     $ 1.10  
Diluted
  $ (0.01 )   $ 0.46     $ 0.01     $ 1.08  
Weighted average number of shares:
                               
Basic
    37,620,269       37,473,597       37,567,286       37,125,680  
Diluted
    37,620,269       38,024,147       38,289,253       37,733,119  
 

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


TESCO CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
 
             
   
Nine Months Ended
September 30,
 
   
2009
   
2008
 
OPERATING ACTIVITIES
           
Net Income
  $ 552     $ 40,938  
Adjustments to reconcile net income to cash provided by operating activities:
               
Depreciation and amortization
    27,423       24,476  
Stock compensation expense
    3,048       4,603  
Deferred income taxes
    (3,065 )     1,366  
Amortization of financial items
    521       520  
Gain on sale of operating assets
    (931 )     (15,687 )
Impairment of assets held for sale
    1,792       ––  
Changes in components of working capital
               
Decrease (increase) in accounts receivable trade
    49,513       (13,354 )
Decrease (increase) in inventories
    4,037       (4,639 )
Increase in prepaid and other current assets
    (3,594 )     (5,151 )
Decrease in accounts payable
    (16,888 )     (11,888 )
(Decrease) increase in accrued and other current liabilities
    (6,978 )     13,911  
(Decrease) increase in income taxes payable
    (6,043 )     5,495  
Other, net
    (6 )     (1,427 )
Net cash provided by operating activities
    49,381       39,163  
INVESTING ACTIVITIES
               
Additions to property, plant and equipment
    (13,981 )     (57,713 )
Proceeds on sale of operating assets
    4,795       19,783  
Other, net
    (194 )     221  
Net cash used in investing activities
    (9,380 )     (37,709 )
FINANCING ACTIVITIES
               
Issuances of debt
    10,000       51,773  
Repayments of debt
    (25,643 )     (78,468 )
Proceeds from exercise of stock options
    492       9,153  
Debt issue costs
          (100 )
Excess tax benefit associated with equity based compensation
          1,036  
Net cash used in financing activities
    (15,151 )     (16,606 )
Effect of foreign exchange losses on cash balances
    292       5  
Net Increase (Decrease) in Cash and Cash Equivalents
    25,142       (15,147 )
Net Cash and Cash Equivalents, beginning of period
    20,619       23,072  
Net Cash and Cash Equivalents, end of period
  $ 45,761     $ 7,925  
                 
Supplemental Cash Flow Information
               
Cash paid during the period for interest
  $ 877     $ 3,372  
Cash paid during the period for income taxes
  $ 11,589     $ 6,649  
Cash receipts during the period for interest
  $ 901     $ 295  
Cash receipts during the period for income taxes
  $ 6,752     $ 391  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 


TESCO CORPORATION
 
Notes to Condensed Consolidated Financial Statements
 
Note 1—Summary of Significant Accounting Policies
 
Nature of Operations
 
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 people drill wells 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 include proprietary technology, including TESCO CASING DRILLING® (“CASING DRILLING”), TESCO’s Casing Drive System (“CDS”) and TESCO’s Multiple Control Line Running System (“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.
 
Basis of Presentation
 
These Condensed Consolidated Financial Statements have been prepared by management in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All references to US$ or $ are to U.S. dollars and references to C$ are to Canadian dollars.
 
The condensed 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. The Company is organized under the laws of Alberta and is therefore subject to the Business Corporation Act (Alberta). The Company is also a reporting issuer (or the equivalent) in each of the provinces of Canada. Effective December 31, 2006, the Company became a U.S. registrant and a domestic filer with the SEC.
 
The Company incurs costs directly and indirectly associated with its revenues at a business unit level. Direct costs include expenditures specifically incurred for the generation of revenue, such as personnel costs on location or transportation, maintenance and repair, and depreciation of its revenue-generating equipment. Overhead costs, such as field administration and field operations support, are not directly associated with the generation of revenue within a particular business segment.
 
The Company has performed an evaluation of potential recognition or disclosure of events or transactions subsequent to September 30, 2009 through November 4, 2009, which is the date the financial statements were issued.
 
Market for Common Stock
 
    TESCO’s common stock is 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.
 
Foreign Currency Translation
 
The U.S. dollar is the functional currency for all of the Company’s worldwide operations except for its Canadian operations. 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 Other 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.
  
    Revenue Recognition
 
The Company recognizes revenues when the earnings process is complete and collectability is reasonably assured. TESCO recognizes revenues for product sales when title and risk of loss of the equipment are transferred to the customer, with no right of return. Revenue in the Top Drive segment may be generated from contractual arrangements that include multiple deliverables. Revenue from these arrangements is recognized as each item or service is delivered based on their relative fair value and when the delivered items or services have stand-alone value to the customer. For project management services, service and repairs and rental activities, TESCO recognizes revenues as the services are rendered based upon agreed daily, hourly or job rates.
 
    The Company provides product warranties on equipment sold pursuant to manufacturing contracts and provides for the anticipated cost of its warranties in cost of sales when sales revenue is recognized. The accrual of warranty costs is an estimate based upon historical experience and upon specific warranty issues as they arise. The Company periodically reviews its warranty provision to assess its adequacy in light of actual warranty costs incurred. Because the warranty accrual is an estimate, it is reasonably possible that future warranty issues could arise that could have a significant impact on the Company’s financial statements.
 
The following is a reconciliation of changes in the Company’s warranty accrual for the nine months ended September 30, 2009 and the year ended December 31, 2008 (in thousands):
             
   
Nine Months Ended
September 30, 2009
   
Year Ended
December 31, 2008
 
Balance—beginning of period
  $ 3,326     $ 3,045  
Charged to expense, net
    161       1,684  
Charged to other accounts(a) 
    73       (129 )
Deductions
    (895 )     (1,274 )
Balance—end of period
  $ 2,665     $ 3,326  
 

(a)
Represents currency translation adjustments and reclassifications.
 
Deferred Revenues
 
The Company generally requires customers to pay a non-refundable deposit for a portion of the sales price for top drive units with their order. These customer deposits are deferred until the customer takes title and risk of loss of the product.
 
Allowance for Doubtful Accounts
 
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of the Company’s customers to make required payments. The primary factors used in determining the allowance needed for accounts receivable are customer bankruptcies, delinquency and management’s estimate of ability to collect outstanding receivables based on the number of days outstanding. At September 30, 2009 and December 31, 2008, the allowance for doubtful accounts on Trade Accounts Receivable was $2.2 million and $3.2 million, respectively.
 
Inventories
 
Inventory consists primarily of specialized tubular services and casing tool parts, spare parts, work in process, and raw materials to support the Company’s ongoing manufacturing operations and its installed base of specialized equipment used throughout the world. During the manufacturing process, the Company values its inventories (work in progress and finished goods) primarily using standard costs, which approximate actual costs, and such costs include raw materials, direct labor and manufacturing overhead allocations.
 
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. The Company performs obsolescence reviews on its slow-moving and excess inventories and establishes reserves based on such factors as usage of inventory on-hand, technical obsolescence and market conditions, as well as future expectations related to its manufacturing sales backlog, its installed base and the development of new products.
 
At September 30, 2009 and December 31, 2008, inventories, net of reserves for excess and obsolete inventories, by major classification were as follows (in thousands):
             
   
September 30,
2009
   
December 31,
2008
 
Raw materials
  $ 37,450     $ 26,049  
Work in progress
    2,835       2,648  
Finished goods
    57,431       67,316  
    $ 97,716     $ 96,013  
 
Property, Plant and Equipment
 
Property, plant and equipment are carried at cost. Maintenance and repairs are expensed as incurred. The costs of replacements, betterments and renewals are capitalized. When properties and equipment, other than top drive units in the Company’s rental fleet, are sold, retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the books and the resulting gain or loss is recognized in the accompanying Condensed Consolidated Statements of Income. When top drive units in the Company’s 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 in the accompanying Condensed Consolidated Statements of Income.
 
Drilling equipment includes related manufacturing costs and overhead. The net book value of used top drive rental equipment sold included in Cost of Sales and Services in the accompanying Condensed Consolidated Statements of Income was $1.9 million and $0.6 million for the three months ended September 30, 2009 and 2008, respectively and $2.9 million and $2.3 million for the nine months ended September 30, 2009 and 2008, respectively. During the three and nine months ended September 30, 2009, the Company recognized net gains of $1.6 million and $1.1 million, respectively related to the sales of ancillary operating equipment.
 
Depreciation and amortization expense is included in the Condensed Consolidated Statements of Income as follows (in thousands):
                         
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Cost of sales and services
  $ 8,730     $ 8,812     $ 26,370     $ 23,618  
Selling, general and administrative expense 
    308       236       989       774  
Research and engineering
    40       19       64       84  
    $ 9,078     $ 8,437     $ 27,423     $ 24,476  
 
Assets Held for Sale
 
During the year ended December 31, 2008, the Company listed for sale a building and land located in Canada. The Company incurred approximately $0.3 million and $0.9 million in soil remediation costs to prepare the property for sale during the three and nine months ended September 30, 2008, and $0.1 million and $0.1 million in soil remediation costs to prepare the property for sale during the three and nine months ended September 30, 2009.  These costs were capitalized and reported as an increase in the property’s net book value as of September 30, 2009. The property has a carrying value of $2.0 million and $1.7 million, net of accumulated depreciation as of September 30, 2009 and December 31, 2008, respectively, and is included in Property, Plant and Equipment in the accompanying Condensed Consolidated Balance Sheets.
 
During the three months ended June 30, 2009, the Company made the decision to sell operating assets located in North America within the next 12 months for an amount expected to be less than their current carrying amount.  As a result, the Company recorded a pre-tax impairment loss of approximately $1.8 million to write down the fixed assets to their estimated realizable value of $0.2 million as of June 30, 2009. The impairment loss is included in the Tubular Services segment as a part of Cost of Sales and Services in the accompanying Condensed Consolidated Statements of Income for the nine months ended September 30, 2009.  The Company ceased depreciating the assets at the time they were classified as held for sale and has reflected the current carrying amount in Property, Plant and Equipment in the accompanying Condensed Consolidated Balance Sheets.
 
Investments
 
The Company's securities are considered available-for-sale and are reported at fair value based upon quoted market prices in the accompanying Condensed Consolidated Balance Sheets. Unrealized gains and losses arising from the revaluation of available-for-sale securities are included, net of applicable deferred income taxes, in Accumulated Other Comprehensive Income within Shareholders’ Equity.  Realized gains and losses on sales of investments based on specific identification of securities sold are included in Other Expense in the Condensed Consolidated Statements of Income. The Company held no investments in securities during the three and nine months ended September 30, 2009 or 2008.
 
Goodwill and Other Intangible Assets
 
Goodwill, which represents the value of businesses acquired by the Company in excess of the fair market value of all of the identifiable tangible and intangible net assets of the acquired businesses at the time of their acquisition, is carried at the lower of cost or fair value. The Company’s goodwill has an indefinite useful life and is subject to an annual impairment test in the fourth quarter of each year or the occurrence of a triggering event. Any resulting impairment loss is charged to income and disclosed separately in the Condensed Consolidated Statements of Income.
 
During the three months ended June 30, 2009, the Company performed an interim impairment test of its goodwill due to events and changes in circumstances during the second quarter of 2009 that indicated an impairment might have occurred. The primary factor deemed by management to have constituted a potential impairment triggering event was a significant decline in revenues experienced in the second quarter of 2009. For purposes of the analysis, the Company made significant management assumptions including sales volumes and prices, costs of products and services, capital spending, working capital changes, terminal value multiples and the discount rate. The discount rate is commensurate with the risk inherent in the projected cash flows and reflects the rate of return required by an investor in the current economic conditions. Inherent in the Company’s projections are key assumptions relative to how long the current downward economic cycle might last. Furthermore, the financial and credit market volatility directly impacts the fair value measurement through the weighted-average cost of capital that was used to determine the discount rate. During times of volatility, significant judgment must be applied to determine whether credit changes are a short term or long term trend. No impairment losses were incurred as a result of this interim test. However, if actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, the Company could be exposed to future impairment losses that could be material to its results of operations.
 
The Company determined that no such triggering event occurred during the three months ended September 30, 2009, and accordingly, did not perform an impairment analysis on its goodwill during the current period.  The change in the carrying amount of goodwill of $0.5 million from December 31, 2008 to September 30, 2009 is due to the effect of foreign currency exchange rates.
 
The Company has capitalized certain identified intangible assets, primarily customer relationships, patents, licenses, and non-compete agreements, based on their estimated fair value at the date acquired. The customer relationships intangible assets are amortized on a straight-line basis over an estimated economic life of four to seven years, the patents are amortized on a straight-line basis over an estimated economic life of 10 to 14 years, and the non-compete agreements are amortized on a straight-line basis over the term of the agreements of four years. These amortizable intangible assets are reviewed at least annually for impairment or when circumstances indicate their carrying value may not be recoverable based on a comparison of fair value to carrying value. The Company determined that no such circumstance existed during the three or nine months ended September 30, 2009, and accordingly, did not perform an impairment analysis on its intangible assets. No impairment losses were incurred during the nine months ended September 30, 2009 or the year ended December 31, 2008. If a future impairment loss is recognized, it will be charged to income and disclosed separately in the Condensed Consolidated Statements of Income.
 
Derivative Financial Instruments
 
As a result of its worldwide operations, the Company is exposed to market risks from changes in interest and foreign currency exchange rates, which may affect its operating results and financial position. The Company manages its risks from fluctuations in interest and foreign currency exchange rates through its normal operating and financing activities. However, from time to time, the Company may manage its interest and foreign exchange rate risks through the use of derivative financial instruments. The Company does not use derivative financial instruments for trading or speculative purposes.
 
During the nine months ended September 30, 2008, the Company entered into a series of 14 monthly foreign currency forward contracts with notional amounts aggregating C$50.8 million. The Company subsequently settled two of these contracts and terminated the remaining 12 contracts, and recognized a loss of $0.2 million for the nine months ended September 30, 2008, which was included in Foreign exchange losses in the Condensed Consolidated Statements of Income. In the Consolidated Statement of Cash Flows, cash receipts or payments related to these exchange contracts are classified consistent with the cash flows from the transaction being hedged.
 
The Company was not party to any derivative financial instruments as of September 30, 2009 or December 31, 2008.
 
Fair Value Measurement
 
The Company measures and reports its financial assets and liabilities at fair value, defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  To obtain fair values, observable market prices are used if available. In some instances, observable market prices are not readily available for certain financial instruments and fair value is determined using present value or other techniques appropriate for a particular financial instrument. These techniques involve some degree of judgment and as a result are not necessarily indicative of the amounts the Company would realize in a current market exchange. The use of different assumptions or estimation techniques may have a material effect on the estimated fair value amounts. These valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. The Company uses a three-level hierarchy for disclosure to show the extent and level of judgment used to estimate fair value measurements:
 
Level 1 Inputs—Quoted prices for identical instruments in active markets.
 
Level 2 Inputs—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
 
Level 3 Inputs—Instruments with primarily unobservable value drivers.
 
The Company held no assets or liabilities carried at fair value as of December 31, 2008. During the three months ended June 30, 2009, the Company made the decision to sell operating assets located in North America within the next 12 months.  These fixed assets had a carrying amount of $2.0 million, and were written down to their estimated realizable value of $0.2 million during the nine months ended September 30, 2009. The estimated realizable fair value was derived from observable market prices in the form of quotations received from independent third parties (“Level 2” inputs). The resulting impairment charge of $1.8 million is included in Cost of Sales and Services in the accompanying Condensed Consolidated Statements of Income for the nine months ended September 30, 2009. The following table presents the Company’s assets at fair value and the basis for determining their fair values (in thousands):
                               
   
As of
September 30,
2009
   
Quoted Prices in Active Markets
for Identical
Assets
   
Significant
Other
Observable
Inputs
   
Significant
Unobservable
Inputs
   
Total
Losses
 
Assets held for sale
  $ 200     $     $ 200           $ 1,800  
 
The Company was party to derivative contracts during the nine months ended September 30, 2008.  The Company uses a market approach to value the assets and liabilities for outstanding derivative contracts, which historically consisted solely of foreign currency forward contracts as discussed in Note 1 above. These contracts are valued using current market information in the form of foreign currency spot rates as of the reporting date. The Company recognizes the unrealized net gains or losses on these contracts on the accrual basis in Foreign exchange losses in the Condensed Consolidated Statements of Income. The Company was not party to any derivative financial instruments as of September 30, 2009 or December 31, 2008.
 
The carrying value of cash, accounts receivable, accounts payable and accrued liabilities approximate their fair value due to the relatively short-term period to maturity of the instruments.
 
The fair value of the Company’s long term debt depends primarily on current market interest rates for debt issued with similar maturities by companies with risk profiles similar to TESCO. The fair value of its debt related to the Company’s credit facility at September 30, 2009 of $31.4 million is estimated to be $29.8 million. The Company also has short term debt in the form of a term loan. The fair value of the Company’s term loan of $2.5 million at September 30, 2009 is estimated to be $2.5 million.
 
Accounting for Operating Leases
 
The Company has entered into non-cancelable operating lease agreements primarily involving office space. Certain of these leases contain escalating lease payments and the Company recognizes expense on a straight line basis which is more representative of the time pattern in which the leased property is physically employed. In certain instances the Company is also entitled to reimbursements for part or all of leasehold improvements made and records a deferred credit for such reimbursements which is amortized over the remaining life of the lease term as a reduction in lease expense.
 
Research and Engineering Expenses
 
The Company expenses research and engineering costs when incurred. Payments received from third parties, including payments for the use of equipment prototypes, during the research or development process are recognized as a reduction in research and engineering expense when the payments are received.
 
Severance Costs
 
During the three and nine months ended September 30, 2009, the Company eliminated approximately 50 and 490 employee positions, respectively, due to a review of its personnel structure and recorded $0.3 million and $3.2 million, respectively, in termination benefits associated with the reductions. These severance costs were recorded in Cost of Sales and Services ($0.2 million and $1.5 million for the three and nine months ended September 30, 2009, respectively), Research and Engineering expense ($0.1 million and $0.4 million for the three and nine months ended September 30, 2009, respectively) and Selling, General and Administrative expense ($0 million and $1.3 million for the three and nine months ended September 30, 2009, respectively) in the accompanying Condensed Consolidated Statements of Income based on the respective functions performed by those employees who were terminated during the period. These costs were recorded in the Company’s operating segments as follows (in thousands):
 
   
Three Months Ended
September 30, 2009
   
Nine Months Ended
September 30, 2009
 
Top Drive                                                                            
  $ 171     $ 1,059  
Tubular Services                                                                            
    50       398  
Casing Drilling                                                                            
    18       157  
Research and Engineering                                                                            
    91       417  
Corporate and Other
    ––       1,193  
Total Severance Costs
  $ 330     $ 3,224  


 
Accrued severance costs were included in Accrued and Other Current Liabilities in the accompanying Condensed Consolidated Balance Sheets as follows (in thousands):
 
   
Three Months Ended
September 30, 2009
   
Nine Months Ended
September 30, 2009
 
Balance—beginning of period                                                                            
  $ 589     $ ––  
Charged to expense                                                                            
    330       3,224  
Payments                                                                            
    (794 )     (3,099 )
Balance—end of period                                                                            
  $  125     $  125  
 
During the nine months ended September 30, 2008, the Company eliminated approximately 100 employee positions due to a review of its personnel structure and recorded termination benefits of $1.1 million associated with the reduction. These severance costs are recorded in Cost of Sales and Services ($0.1 million and $0.9 million for the three and nine months ended September 30, 2008, respectively), Research and Engineering expense ($0.0 million and $0.1 million for the three and nine months ended September 30, 2008, respectively) and Selling, General and Administrative expense ($0.0 million and $0.1 million for the three and nine months ended September 30, 2008, respectively) in the accompanying Condensed Consolidated Statements of Income based on the respective functions performed by those employees who were terminated during the period.
 
Income Taxes
 
The liability method is used to account for income taxes. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect of a change in tax rates on deferred income tax assets or liabilities is recognized in the period that the change occurs. A valuation allowance for deferred tax assets is recorded when it is more likely than not that some or all of the benefit from the deferred tax asset will not be realized. Estimates of future taxable income and ongoing tax planning have been considered in assessing the utilization of available tax losses and credits. Changes in circumstances, assumptions and clarification of uncertain tax regimes may require changes to any valuation allowances associated with the Company’s deferred tax assets.
 
Stock-Based Compensation
 
On May 18, 2007, the Company’s shareholders approved amendments to its 2005 Incentive Plan to, among other things, provide for a variety of forms of equity compensation awards to be granted to employees, directors and other persons. As a result, the Company changed the method by which it provides stock-based compensation to its employees by reducing the number of stock options granted and instead issuing restricted stock awards as a form of compensation. The Company has granted two different types of restricted stock awards: restricted stock units (“RSU”s) which are subject to time based vesting criteria and performance share units (“PSU”s) which contain both time and performance based criteria. Both RSUs and PSUs may be settled by delivery of shares or the payment of cash equal to the market value of TESCO shares that would otherwise be deliverable at the time of settlement at the discretion of the Company. For further description of the Company’s stock-based compensation plan, see Note 4 below.
The Company measures stock-based compensation cost for equity-classified awards as of grant date or the employee start date for pre-employment grants, based on the estimated fair value of the award less an estimated rate for pre-vesting forfeitures, and recognizes compensation expense on a graded basis over the vesting period. Compensation expense is recognized with an offsetting credit to Contributed Surplus, which is then transferred to Common Shares when the award is distributed or the option is exercised. Consideration received on the exercise of stock options is credited to Common Shares. For stock option grants, the Company uses a Black-Scholes valuation model to determine the estimated fair value.
 
During the preparation of the Company’s financial statements for the three months ended June 30, 2009, the Company determined that Canadian dollar-denominated stock option awards previously issued to non-Canadian employees qualify for liability classification due to the Company’s voluntary delisting from the TSX effective June 30, 2008. Accordingly, the fair value of these awards was reclassified from Contributed Surplus to Accrued and Other Current Liabilities in the accompanying Condensed Consolidated Balance Sheet as of June 30, 2009, and is adjusted to fair value at the end of each subsequent reporting period. The impact to the Company’s financial statements for the three month periods ended September 30, 2008, December 31, 2008 and March 31, 2009 and for the year ended December 31, 2008 was not material. At September 30, 2009, the fair value of these awards was approximately $0.8 million.
 
Stock compensation expense is recorded in Cost of Sales and Services, Research and Engineering expense and Selling, General and Administrative expense in the accompanying Condensed Consolidated Statements of Income based on the respective functions for those employees receiving stock option grants. Stock compensation expense is included in the Condensed Consolidated Statements of Income as follows (in thousands):
                         
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Cost of Sales and Services
  $ 168     $ 306     $ 627     $ 1,230  
Selling, General and Administrative Expense 
    78       958       2,207       2,991  
Research and Engineering
    43       105       214       382  
    $ 289     $ 1,369     $ 3,048     $ 4,603  
 
During the three and nine months ended September 30, 2009, the Company recorded a reversal of approximately $0.7 million and $0.9 million, respectively, in stock compensation expense related to performance stock units in response to the current year’s operating results.
 
Per Share Information
 
    Per share information is computed using the weighted average number of common shares outstanding during the year. Diluted per share information is calculated, including the dilutive effect of stock options which are determined using the treasury stock method. The treasury stock method assumes that the proceeds that would be obtained upon exercise of “in the money” options would be used to purchase common shares at the average market price during the period. No adjustment to diluted earnings per share is made if the result of this calculation is anti-dilutive.
 
The following table reconciles basic and diluted weighted average shares (in thousands):
                         
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Basic weighted average number of shares outstanding 
    37,620       37,474       37,567       37,126  
Dilutive effect of stock compensation awards
    ––       550       722       607  
Diluted weighted average number of shares outstanding
    37,620       38,024       38,289       37,733  
Weighted average anti-dilutive options excluded from calculation due to exercise prices
    944       87       3,850       1,034  
Weighted average anti-dilutive options excluded from calculation due to reported net loss
    656       ––       ––       ––  
 
For the three months ended September 30, 2009, the weighted average diluted shares outstanding excluded 656,388 shares because the Company reported a loss during the period, and including them would have had an anti-dilutive effect on loss per share.
 
 
Recent Accounting Pronouncements
 
    In June 2009, the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification™ (“Codification”) became the single source of authoritative U.S. GAAP.  The Codification did not create any new U.S. GAAP standards but incorporated existing accounting and reporting standards into a new topical structure with a new referencing system to identify authoritative accounting standards, replacing the prior references to Statement of Financial Accounting Standards (“SFAS”), Emerging Issues Task Force (“EITF”), FASB Staff Position (“FSP”) and other publications.  Authoritative standards included in the Codification are designated by their Accounting Standards Codification (“ASC”) topical reference, and new standards will be designated as Accounting Standards Updates (ASU), with a year and assigned sequence number.  Beginning with this interim report for the third quarter of 2009, references to prior standards have been updated to reflect the new referencing system.
 
    In October 2009, the FASB issued updated guidance that allows for more flexibility in determining the value of separate elements in revenue arrangements with multiple deliverables.  This guidance modifies the requirements for determining whether a deliverable can be treated as a separate unit of accounting by removing the criteria that verifiable and objective evidence of fair value exists for the undelivered elements.  All entities must adopt no later than the beginning of their first fiscal year beginning on or after June 15, 2010. Upon adoption, entities may choose between the prospective application for transactions entered into or materially modified after the date of adoption, or the retroactive application for all revenue arrangements for all periods presented.  Disclosures will be required when changes in either those judgments or the application of this guidance significantly affect the timing or amount of revenue recognition.  The Company will adopt these provisions on January 1, 2011. The Company is currently evaluating the potential impact these standards may have on the consolidated financial statements.
 
In June 2009, the FASB issued new accounting guidance that  clarifies the characteristics that identify a variable interest entity (“VIE”) and changes how a reporting entity identifies a primary beneficiary that would consolidate the VIE from a quantitative risk and rewards calculation to a qualitative approach based on which variable interest holder has controlling financial interest and the ability to direct the most significant activities that impact the VIE’s economic performance. This guidance requires the primary beneficiary assessment to be performed on a continuous basis. It also requires additional disclosures about an entity’s involvement with VIE, restrictions on the VIE’s assets and liabilities that are included in the reporting entity’s consolidated balance sheet, significant risk exposures due to the entity’s involvement with the VIE, and how its involvement with a VIE impacts the reporting entity’s consolidated financial statements. This update is effective for fiscal years beginning after November 15, 2009. The Company will adopt these provisions on January 1, 2010 and the adoption is not expected to have a material impact on the consolidated financial statements.
 
In June 2009, the FASB issued new accounting guidance that enhances the information provided to financial statement users to provide greater transparency about transfers of financial assets and a transferor’s continuing involvement, if any, with transferred financial assets. Under this Statement, many types of transferred financial assets that would have been derecognized previously are no longer eligible for derecognition. This Statement requires enhanced disclosures about the risks to which a transferor continues to be exposed due to its continuing involvement in transferred financial assets. This Statement also clarifies and improves certain provisions in previously issued statements that have resulted in inconsistencies in the application of the principles on which that Statement is based. These updates are effective for annual reporting periods beginning after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Company will adopt these provisions on January 1, 2010 and the adoption is not expected to have a material impact on the consolidated financial statements.
 
In May 2009, the FASB issued new accounting guidance which establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events. The Company adopted the new disclosure requirements of its financial statements issued for the period ended June 30, 2009 and the adoption did not have a material impact on the consolidated financial statements. See “Basis of Presentation,” above.
 
In April 2009, the FASB issued new guidance that requires that a registrant to disclose the fair value of all financial instruments for interim reporting periods and in its financial statements for annual reporting periods, whether recognized or not recognized in the statement of financial position. The Company adopted the updated guidance for the interim reporting period ended March 31, 2009 and the adoption did not have a material impact on the Company’s consolidated financial statements as the Statement required additional disclosures but no change in accounting policy. See “Fair Value Measurement,” above.
 
In April 2008, the FASB issued an update to existing accounting standards that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent of the update  is to improve the consistency between the useful life of a recognized intangible asset under existing accounting standards and the period of expected cash flows used to measure the fair value of the asset under accounting guidance for business combinations and other applicable accounting literature. The Company adopted the updated guidance on January 1, 2009 and the adoption did not have a material impact on the Company’s consolidated financial statements.
 
In March 2008, the FASB issued an update to existing accounting standards enhances required disclosures regarding derivatives and hedging activities, including enhanced disclosures regarding how: (a) an entity uses derivative instruments; (b) derivative instruments and related hedged items are accounted for under previously issued standards and (c) derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The Company adopted the provisions of the updated guidance on January 1, 2009 and the adoption did not have a material impact on the Company’s consolidated financial statements.
   
    In December 2007, the FASB issued an update to previously issued accounting guidance to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Additionally, this Statement requires that consolidated net income include the amounts attributable to both the parent and the noncontrolling interest. The Company adopted the updated guidance on January 1, 2009 and the adoption did not have a material impact on the Company’s consolidated financial statements.
 
In December 2007, the FASB issued a revision to previously issued accounting standards which significantly changes the principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The update also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This guidance is effective on a prospective basis to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, and early adoption is prohibited. In February 2009, the FASB issued additional updates which amended the provisions related to the initial recognition and measurement, subsequent measurement and disclosure of assets and liabilities arising from contingencies in a business combination under the guidance. The Company adopted both of the updates on a prospective basis effective January 1, 2009 and the adoption did not have a material impact on the Company’s consolidated financial statements.
 
In April 2009, the FASB issued new accounting guidance that affirms that the objective of fair value when the market for an asset is not active; clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset in an inactive market; eliminates the proposed presumption that all transactions are distressed and requires an entity to disclose a change in valuation technique (and the related inputs) resulting from the application of the guidance.   The updated guidance must be applied prospectively and retrospective application is not permitted. The Company elected to adopt the updated guidance in the first quarter of 2009, and the adoption did not have a material impact on the Company’s consolidated financial statements.
 
Note 2—Out of Period Adjustments
 
    During the preparation of the Company’s financial statements for the nine months ended September 30, 2009, the Company discovered errors in the financial statements for the years ended December 31, 2007 and 2008. The errors related to foreign currency translation adjustments of deferred tax assets and understated accrued liabilities. As a result of these errors, deferred tax assets were overstated by $1.3 million and understated by $1.0 million as of December 31, 2007 and 2008, respectively, and accrued liabilities as of December 31, 2008 were understated by $0.6 million. In addition, net income for the years ended December 31, 2007 and 2008 was understated by $0.2 million and overstated by $2.7 million, respectively, and other comprehensive income was overstated by $3.3 million and understated by $1.7 million, respectively.
 
The Company assessed the materiality of the errors mentioned above and aggregated with other identified errors and concluded that they were immaterial to previously reported annual or interim amounts and that the correction of the errors in 2009 would not be material to estimated full year 2009 results of operations. Accordingly, the Company corrected these errors in the financial statements for the nine months ended September 30, 2009 and did not restate its consolidated financial statements for the years ended December 31, 2007 and 2008. The effect of recording these corrections in the accompanying Condensed Consolidated Income Statement was a decrease in net income of $0.7 million for the nine months ended September 30, 2009.
 
The Company has revised its Condensed Consolidated Balance Sheet as of December 31, 2008 to correct an error in the classification of Prepaid Value Added Taxes (“VAT”). This revision does not impact the Condensed Consolidated Statements of Operations or the Consolidated Statement of Cash Flows for any period. During the preparation of the Company’s financial statements for the three months ended June 30, 2009, the Company noted that the December 31, 2008 balance for outstanding prepaid VAT was misclassified on the balance sheet. The Company assessed the materiality of the error and concluded that it was immaterial to previously reported financial statements. Accordingly, the Company corrected this error in the accompanying Condensed Consolidated Balance Sheets and did not restate its Consolidated Financial Statements for the year ended December 31, 2008. The accompanying Condensed Consolidated Balance Sheet as of December 31, 2008 is presented in revised form by increasing prepaid and other current assets by $6.2 million and increasing accrued liabilities by $6.2 million.
 
Note 3—Long Term Debt
 
Long term debt consists of the following (in thousands):
             
   
September 30,
2009
   
December 31,
2008
 
Secured Revolver, maturity date of June 5, 2012, 1.50% and 1.99% interest rate at
    September 30, 2009 and December 31, 2008, respectively
  $ 31,400     $ 39,400  
Secured Term Loan, maturity date of October 31, 2009, 1.50% and 4.44% interest rate at
    September 30, 2009 and December 31, 2008, respectively
    2,525       10,018  
Other
          153  
Total Debt
    33,925       49,571  
Less—Current Portion of Long Term Debt
    (2,525 )     (10,171 )
Non-Current Portion of Long Term Debt
  $ 31,400     $ 39,400  
 
Amounts outstanding under the Secured Term Loan issued under the Company’s credit agreement require quarterly payments on the principal amount outstanding.
 
On June 5, 2007, the Company and its existing lenders entered into an amended and restated credit agreement (the “Amended Credit Agreement”) to provide up to $100 million in revolving loans including up to $15 million of swingline loans (collectively, the “Revolver”) and a term loan which had a balance of $25.0 million as of June 5, 2007 with required quarterly payments through October 31, 2009. The Amended Credit Agreement has a term of five years and all outstanding borrowings on the Revolver will be due and payable on June 5, 2012. In December 2007, the Company entered into the first amendment to the Amended and restated Credit agreement to increase the Revolver to provide up to $145 million. In March 2008, it entered into a second amendment to the Amended Credit Agreement in order to increase the limit on permitted capital expenditures during the quarters ending March 31, June 30 and September 30, 2008 from 70% to 85% of consolidated EBITDA (as defined in the Amended Credit Agreement). Amounts available under the Revolver are reduced by letters of credit issued under the Amended Credit Agreement not to exceed $20 million in the aggregate of all undrawn amounts and amounts that have yet to be disbursed under all existing letters of credit. The availability of future borrowings may be limited in order to maintain certain financial ratios required under the covenants. Amounts available under the swingline loans may also be reduced by letters of credit or by means of a credit to a general deposit account of the applicable borrower.
 
Note 4—Shareholders’ Equity and Stock-Based Compensation
 
Common Stock
 
The following summarizes the activity in the Company’s common shares during the nine months ended September 30, 2009 and for the year ended December 31, 2008 (dollar amounts in thousands):
                         
   
Nine Months Ended
September 30, 2009
   
Year Ended
December 31, 2008
 
   
No. of shares
   
Amount
   
No. of shares
   
Amount
 
Balance—beginning of period
    37,513,861     $ 171,384       36,844,763     $ 154,332  
Issued on exercise of options
    43,000       542       626,535       15,698  
Issuance from settlement of restricted stock
    84,586       2,285       31,159       1,129  
Other issuance of common stock
    17,539       134       11,404       225  
Balance—end of period
    37,658,986     $ 174,345       37,513,861     $ 171,384  
   
    Stock-Based Compensation
 
Under the terms of the Company’s stock option plan, as amended, 3,765,899 shares of common stock were authorized as of September 30, 2009 for the grant of stock and stock options to eligible directors, officers, employees and other persons. At September 30, 2009, the Company had approximately 1,584,170 shares available for future grants.
 
In May 2007, the Company amended and restated its incentive plan, now called the Amended and Restated Tesco Corporation 2005 Incentive Plan (the “Restated Plan”). Prior to May 2007, the Company granted stock options denominated only in Canadian dollars. Under the Restated Plan, stock options and other stock based awards may be denominated in Canadian dollars or U.S. dollars, at the Company’s discretion. During the preparation of the Company’s financial statements for the three months ended June 30, 2009, the Company determined that Canadian dollar-denominated stock option awards previously issued to non-Canadian employees qualify for liability classification due to the Company’s voluntary delisting from the TSX effective June 30, 2008. Accordingly, the fair value of these awards was reclassified from Contributed Surplus to Accrued and Other Current Liabilities in the accompanying Condensed Consolidated Balance Sheet as of September 30, 2009, and is adjusted to fair value at the end of each reporting period. The impact to the Company’s financial statements for the three month periods ended September 30, 2008, December 31, 2008 and March 31, 2009 and for the year ended December 31, 2008 was not material. At September 30, 2009, the fair value of these awards was approximately $0.8 million. No payments were made for stock-based awards classified as liabilities during the three and nine months ended September 30, 2009.
 
With all shares of common stock being traded on the NASDAQ, the Company plans to denominate all future grants of equity-based awards in U.S. dollars. Options granted by the Company have historically vested ratably over a three year period and expired no later than seven years from the date of grant, although the Board of Directors may choose different parameters in the future. The exercise price of stock options under the plan may not be less than the fair value on the date of the grant, as defined in the Restated Plan.
 
 
Stock Options
 
The following summarizes option activity for the options issued in Canadian dollars during the nine months ended September 30, 2009 and 2008:
                         
   
Nine Months Ended
September 30, 2009
   
Nine Months Ended
September 30, 2008
 
   
No. of options
   
Weighted-average
exercise
price
   
No. of options
   
Weighted-Average
Exercise
price
 
Outstanding—beginning of period
    831,954     C$ 20.69       1,593,962     C$ 18.62  
Granted
        C$  —       46,300     C$ 24.44  
Exercised
    (20,000 )   C$  9.89       (626,535 )   C$ 14.87  
Cancelled
    (121,759 )   C$ 20.25       (174,033 )   C$ 23.41  
Outstanding—end of period
    690,195     C$ 21.08       839,694     C$ 20.75  
Exercisable—end of period
    595,397     C$ 20.58       525,919     C$ 18.43  

    The following summarizes option activity for the options issued in U.S. dollars during the nine months ended September 30, 2009 and 2008:
                         
   
Nine Months Ended
September 30, 2009
   
Nine Months Ended
September 30, 2008
 
   
No. of options
   
Weighted-Average
Exercise
price
   
No. of options
   
Weighted-Average
Exercise
price
 
Outstanding—beginning of period
    647,100     $ 13.15           $  
Granted
    45,000     $ 8.60       195,800     $ 28.54  
Exercised
    (23,000 )   $ 7.51           $  
Cancelled
    (82,067 )   $ 11.29       (26,900 )   $ 25.65  
Outstanding—end of period
    587,033     $ 13.28       168,900     $ 29.00  
Exercisable—end of period
    51,521     $ 29.41           $  

    The assumptions used in the Black-Scholes option pricing model during the nine months ended September 30, 2009 and 2008 were:
                         
   
U.S. Dollar Options
Nine Months Ended
September 30,
   
Canadian Dollar Options
Nine Months Ended
September 30,
 
Assumptions
 
2009
   
2008
   
2009
(Note A)
   
2008
 
Weighted average risk-free interest rate
    2.20 %     3.01 %     2.32 %     3.50 %
Expected dividend
  $ -0-     $ -0-     $ -0-     $ -0-  
Expected option life (years)
    4.5       4.5       1.8       4.5  
Weighted average expected volatility
    66 %     50 %     79 %     51 %
Weighted average expected forfeiture rate
    8 %     9 %     11 %     17 %
 

Note A:
Assumptions used in the Black-Scholes pricing model during the nine months ended September 30, 2009 for Canadian dollar options were used for revaluing liability-classified stock option awards to fair value.
 
    Restricted Stock
 
Beginning in 2007, the Company began granting two different types of stock-based awards: Restricted Stock Units (“RSU”s), which vest equally in three annual installments from date of grant and entitle the grantee to receive the value of one share of TESCO common stock upon vesting, and Performance Stock Units (“PSU”s), which vest in full after three years and include a performance measure. PSU awards entitle the grantee to receive the value of one share of TESCO common stock for each PSU, subject to adjustments based on the performance measure. The PSU performance objective multiplier can range from zero when threshold performance is not met to a maximum of 2.5 times the initial award. Both RSUs and PSUs may be settled by delivery of shares or the payment of cash based on the market value of a TESCO share at the time of settlement at the discretion of the Company.
 
The following summarizes restricted stock activity during the nine months ended September 30, 2009:
                         
   
U.S. Dollars
   
Canadian Dollars
 
   
Shares
   
Weighted-
Average
grant date
fair value
   
Shares
   
Weighted-
Average
Grant date
fair value
 
Outstanding—beginning of period
    625,200     $ 12.22       119,407     C$  33.10  
Granted
    22,500     $ 8.64           C$  —  
Vested
    (45,309 )   $ 23.09       (39,277 )   C$  32.99  
Cancelled
    (83,335 )   $ 11.46       (9,535 )   C$  33.57  
                                 
Outstanding—end of period
    519,056     $ 11.23       70,595     C$  33.10  
                                 
 
The following summarizes restricted stock activity during the nine months ended September 30, 2008:
                         
   
U.S. Dollars
   
Canadian Dollars
 
   
Shares
   
Weighted-
Average
grant date
fair value
   
Shares
   
Weighted-
Average
Grant date
fair value
 
Outstanding—beginning of period
    ––     $ ––       141,100     C$  36.15  
Granted
    156,400     $ 27.22       35,600     C$  24.67  
Vested
    ––     $ ––       (31,159 )   C$  36.22  
Cancelled
    (19,100 )   $ 25.12       (25,200 )   C$  34.30  
Outstanding—end of period
    137,300     $ 27.51       120,341     C$  33.13  


    The weighted average expected forfeiture rate is 14% for RSUs and 5% for PSUs.
 
Note 5—Comprehensive Income
 
Comprehensive income includes unrealized gains and losses of the Company which have been recognized during the period as a separate component of Shareholders’ Equity. The Company’s total comprehensive income for the three and nine months ended September 30, 2009 and 2008 were as follows (in thousands):
                         
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Net (Loss) Income
 
$
(268
)
 
$
17,581
   
$
552
   
$
40,938
 
Foreign currency translation adjustment, net of income taxes
   
5,233
     
(2,260
)
   
10,777
     
(4,049
)
Total Comprehensive Income
 
$
4,965
   
$
15,321
   
$
11,329
   
$
36,889
 
 
Note 6—Income Taxes
 
Tesco Corporation is an Alberta (Canada) corporation. The Company and its subsidiaries conduct business and are taxable on profits earned in a number of jurisdictions around the world. Income taxes have been provided based on the laws and rates in effect in the countries in which operations are conducted or in which TESCO or its subsidiaries are considered resident for income tax purposes.
 
The Company’s income tax provision for the three and nine month periods ended September 30, 2009 and 2008 consisted of the following (in thousands):
                         
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Current
  $ (5,787 )   $ 5,503     $ (827 )   $ 12,573  
Deferred
    7,290       940       (3,065 )     1,366  
Income tax provision
  $ 1,503     $ 6,443     $ (3,892 )   $ 13,939  

The Company’s effective tax rate for the three and nine months ended September 30, 2009 was 122% and 117% respectively, compared to 27% and 25%, respectively, for the same periods in 2008. The effective tax rate for the three months ended September 30, 2009 reflects a $1.1 million charge related to tax provision to return adjustments as a result of filing an amended 2008 tax return in Canada and the Company's 2008 U.S. income tax returns. The effective tax rate for the nine months ended September 30, 2009 reflects the recognition of a $1.6 million tax benefit associated with a Canadian tax law change that occurred during the first quarter of 2009, a $0.4 million tax benefit for research and development credits generated during 2009 and cumulative net tax benefits of $2.5 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 effective tax rate for the nine months ended September 30, 2009 also includes a $0.4 million charge related to an audit assessment received in a foreign jurisdiction, a $0.5 million charge related to provision to return adjustments as a result of filing the Company’s U.S. income tax returns in September 2009 and $0.5 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.
 
As of September 30, 2009 and December 31, 2008, the Company had an accrual for uncertain tax positions of $1.1 million and $1.2 million, respectively. This liability is offset by the Company’s net income tax receivables and is included in Income Taxes Payable in the accompanying Condensed Consolidated Balance Sheets as the Company anticipates that these uncertainties will be resolved in the next twelve months. The resolution of these uncertainties should not have a material impact on the Company’s effective tax rate.
 
TESCO and its subsidiaries are subject to Canada federal and provincial income tax and have concluded substantially all Canada federal and provincial tax matters for tax years through 2001. TESCO and its subsidiaries are also subject to U.S. federal and state income tax and have concluded substantially all U.S. federal income tax matters for tax years through 2005. One U.S. subsidiary has been audited through the tax year ended October 31, 2005. During the nine months ended September 30, 2009, an audit of the Company’s consolidated tax return for the year 2006 was concluded with no impact to the Company’s financial position, results of operations or cash flows.
 
TESCO has been advised by the Mexican tax authorities that they believe significant expenses incurred by the Company’s 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 the Company appealed to the Mexican court system. TESCO has obtained final court rulings deciding all years in dispute in the Company’s favor, except for 1996 (discussed below), and 2001 and 2002, both of which are currently before the Mexican Tax Court. The outcome of such appeals is uncertain. However, TESCO recorded an accrual of $0.3 million during 2008 for the Company’s 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). TESCO continues 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 the Company’s financial position, results of operations or cash flows.
 
In May 2002, TESCO paid a deposit of $3.3 million with the Mexican tax authorities in order to appeal the reassessment for 1996. In 2007 the Company requested and received a refund of approximately $3.7 million (the original deposit amount of $3.3 million plus $0.4 million in interest). Therefore, in the third quarter of 2007 the Company 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 TESCO was 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. The Company believes the second reassessment is invalid, and has appealed it to the Mexican Tax Court. In January 2009, the Tax Court issued a decision accepting the Company’s arguments in part, which is now final, and may entitle the Company to request an additional refund. Due to uncertainty regarding the ultimate outcome, TESCO has not recognized the additional interest in dispute as an asset.
 
In addition to the material jurisdictions above, other state and foreign tax filings remain open to examination. TESCO believes that any assessment on these filings will not have a material impact to the Company’s financial position, results of operations or cash flows. TESCO believes that appropriate provisions for all outstanding issues have been made for all jurisdictions and all open years. However, audit outcomes and the timing of audit settlements are subject to significant uncertainty. Therefore, additional provisions on tax-related matters could be recorded in the future as revised estimates are made or the underlying matters are settled or otherwise resolved.
 
Note 7—Commitments and Contingencies
 
Legal Contingencies
 
The Company, in the normal course of its business, is subject to legal proceedings brought against it and its subsidiaries. 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 the Company may suffer as a result of these proceedings.
 
The amount of loss the Company may suffer as a result of these proceedings is not generally reasonably estimable until settlement is reached or judgment obtained. Management does not believe that any such proceedings currently underway against the Company, either individually or in the aggregate, will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
 
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. The Company 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. The Company 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 the nine months ended September 30, 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 nine months ended September 30, 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. The Company has filed a general denial seeking a judicial determination that it does not infringe the patents in question and/or that the patents are invalid. In November 2008, the Company 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.
 
In July 2006, the Company received a claim for withholding tax, penalties and interest related to payments over the periods from 2000 to 2004 in a foreign jurisdiction. The Company disagrees with this claim and is currently litigating this matter. However, at June 30, 2006 the Company accrued its estimated pre-tax exposure on this matter at $3.8 million, with $2.6 million of expense included in Other (income) expense and $1.2 million included in Interest expense. During 2008 and the nine months ended September 30, 2009, the Company accrued an additional $0.2 million and $0.2 million, respectively, of interest expense related to this claim.
 
In August 2008, the Company 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. The Company disagrees with this claim and is currently litigating the matter. Due to considerable uncertainty regarding the ultimate outcome of this matter, the Company has not provided an accrual for this contingency.
 
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 the Company 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 the Company 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. No trial date has been set. The 22 plaintiffs covered under the Plan have subsequently initiated arbitration proceeding with the American Arbitration Association in Houston. Additional plaintiffs have subsequently joined both proceedings. TESCO intends to vigorously defend all the allegations asserted in both proceedings. The outcome and amount of any potential financial impact from the litigation and arbitration proceedings are not determinable at this time.
 
Other Contingencies
 
The Company is contingently liable under letters of credit and similar instruments that it is required to provide from time to time in connection with the importation of equipment to foreign countries and to secure its performance on certain contracts. At September 30, 2009 and December 31, 2008, the total exposure to the Company under outstanding letters of credit was $6.5 million and $6.4 million, respectively.
 
Note 8—Segment Information
 
Business Segments
 
Historically, the Company organized its activities into three business segments: Top Drives, Casing Services and Research and Engineering. Effective December 31, 2008, the Company determined that the CASING DRILLING segment no longer met the criteria which allowed it to be aggregated with Tubular Services in the Casing Services segment and therefore changed the presentation of its Tubular Services activities and CASING DRILLING activities into two separate segments. The financial and operating data for the three and nine months ended September 30, 2008 have been recast to be presented consistently with this structure. The Company’s four business segments are: Top Drives, Tubular Services, CASING DRILLING and Research and Engineering. 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, and the Research and Engineering segment is comprised of our research and development activities related to Tubular Services technology, CASING DRILLING technology and top drive model development.
 
These segments report their results of operations to the level of operating income. Certain functions, including certain sales and marketing activities and corporate general and administrative expenses, are provided centrally from the corporate office. The costs of these functions, together with Other expense and Income tax provision (benefit), are not allocated to these segments. Assets are allocated to the Top Drive, Tubular Services, CASING DRILLING or Research and Engineering segments to which they specifically relate. All of the Company’s goodwill has been allocated to the Tubular Services segment. The Company’s chief operating decision maker is not provided a measure of assets by business segment and as such this information is not presented.
 
The Company incurs costs directly and indirectly associated with its revenues at a business unit level. Direct costs include expenditures specifically incurred for the generation of revenue, such as personnel costs on location or transportation, maintenance and repair, and depreciation of the Company’s revenue-generating equipment. Overhead costs, such as field administration and field operations support, are not directly associated with the generation of revenue within a particular business segment.
 
At the end of 2008, the Company identified sales of certain accessories that were previously included as part of top drive after-market support activities. However, since these accessories are directly related to its proprietary and patented Tubular Services technology, the Company now includes them with its proprietary information. Accordingly, the Company has reclassified prior year revenues of approximately $0.4 million and $1.4 million for the three and nine months ended September 30, 2008, respectively, and operating income of approximately $0.3 million and $1.0 million for the three and nine months ended September 30, 2008, respectively, related to these sales from top drive after-market support to proprietary Tubular Services to conform to current year presentation.
 
 
Significant financial information relating to these segments is as follows (in thousands):
 
                                     
   
Three Months Ended September 30, 2009
 
   
Top
Drive
   
Tubular
Services
   
CASING
DRILLING
   
Research &
Engineering
   
Corporate and
Other
   
Total
 
Revenues
  $ 45,192     $ 24,285     $ 3,132     $     $     $ 72,609  
Depreciation and amortization
    1,898       4,992       1,115       40       1,033       9,078  
Operating income (loss)
    13,370       (1,440 )     (3,072 )     (2,092 )     (5,074 )     1,692  
Other expense
                                            457  
Income before income taxes
                                          $ 1,235  

   
Three Months Ended September 30, 2008
 
   
Top
Drive
   
Tubular
Services
   
CASING
DRILLING
   
Research &
Engineering
   
Corporate and
Other
   
Total
 
Revenues
  $ 90,700     $ 42,784     $ 6,537     $     $     $ 140,021  
Depreciation and amortization
    2,239       4,472       1,150       19       557       8,437  
Operating income (loss)
    32,090       7,396       (3,055 )     (2,560 )     (8,471 )     25,400  
Other expense
                                            1,376  
Income before income taxes
                                          $ 24,024  


   
Nine Months Ended September 30, 2009
 
   
Top
Drive
   
Tubular
Services
   
CASING
DRILLING
   
Research &
Engineering
   
Corporate and
Other
   
Total
 
Revenues
  $ 171,118     $ 89,210     $ 10,892     $     $     $ 271,220  
Depreciation and amortization
    5,667       15,645       3,491       64       2,556       27,423  
Operating income (loss)
    39,511       (484 )     (9,298 )     (6,525 )     (24,740 )     (1,536 )
Other expense
                                            1,804  
Loss before income taxes
                                          $ (3,340 )

   
Nine Months Ended September 30, 2008
 
   
Top
Drive
   
Tubular
Services
   
CASING
DRILLING
   
Research &
Engineering
   
Corporate and
Other
   
Total
 
Revenues
  $ 251,414     $ 123,439     $ 20,693     $     $     $ 395,546  
Depreciation and amortization
    6,136       13,624       2,953       84       1,679       24,476  
Operating income (loss)
    82,227       16,960       (9,184 )     (8,140 )     (23,045 )     58,818  
Other expense
                                            3,941  
Income before income taxes
                                          $ 54,877  
 
 
Geographic Areas
 
    The Company attributes revenues to geographic regions based on the location of the customer. Generally, for service activities, this will be the region in which the service activity occurs and, for equipment sales, this will be the region in which the customer’s purchasing office is located. The Company’s revenues occurred in the following areas of the world (in thousands):
 
             
   
Three Months Ended
September 30,
 
   
2009
   
2008
 
United States
  $ 26,108     $ 72,636  
Europe, Africa and Middle East
    11,223       17,731  
Asia Pacific
    10,256       12,489  
Canada
    7,885       13,640  
Mexico
    9,291       7,546  
South America
    7,846       15,979  
Total
  $ 72,609     $ 140,021  
                 
   
Nine Months Ended
September 30,
 
      2009       2008  
United States
  $ 123,718     $ 203,786  
Europe, Africa and Middle East
    39,989       38,502  
Asia Pacific
    33,128       52,839  
Canada
    26,058       43,633  
Mexico
    25,488       15,765  
South America
    22,839       41,021  
Total
  $ 271,220     $ 395,546  
                 
 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes thereto included elsewhere in this report. This discussion contains forward-looking statements. Please see “Caution Regarding Forward-Looking Information; Risk Factors” above and “Risk Factors” below and in our Annual Report on Form 10-K for the year ended December 31, 2008, for a discussion of the uncertainties, risks and assumptions associated with these statements.
 
OVERVIEW
 
Business
 
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 people drill wells 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 include proprietary technology, including TESCO CASING DRILLING® (“CASING DRILLING”), TESCO’s Casing Drive System (“CDS”) and TESCO’s Multiple Control Line Running System (“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 Drives, 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 determined that CASING DRILLING no longer met the criteria which allowed it to be aggregated with Tubular Services within the Casing Services segment and therefore changed the presentation of our Tubular Services activities and CASING DRILLING activities into two separate segments. The financial and operating data for the three and nine months ended September 30, 2008 have been recast to be presented consistently with this structure.
 
Our Top Drive segment sells equipment and provides services to drilling contractors and oil and gas operating companies throughout the world. 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. We also provide top drive rental services on a day-rate basis for land and offshore drilling rigs, and we provide after-market sales and support for our customers.
 
Our Tubular Services business includes both proprietary and conventional services, which are typically offered as a “call out” service on a well-by-well basis.
 
Our proprietary Tubular Service business is based on our Proprietary Casing Running Service technology, which uses certain components of our CASING DRILLING technology, in particular the CDS, and provides an efficient method for running casing and, if required, reaming the casing into the hole. Additionally, our proprietary Tubular Service business includes the installation service of deep water smart well completion equipment using our MCLRS, a proprietary and patented technology which improves the quality of the installation of high-end well completions.
 
Our conventional Tubular Service business provides 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 CASING DRILLING business is based on our proprietary CASING DRILLING technology, which uses patented equipment and processes to allow an oil or gas well to be drilled using standard well casing pipe. In contrast, conventional or straight practice rotary drilling requires the use of specialized drill pipe and drillstring components. The demonstrated benefits of using well casing to drill the well compared with conventional drilling include a reduction in the risk of unscheduled downhole events that typically result in non-productive time and additional cost and operational risk to the drilling contractor and well operator.
 
 
RESULTS OF OPERATIONS
 
For the Three Months Ended September 30, 2009 and 2008
 
Our revenues, operating income and net income for the three months ended September 30, 2009 decreased compared to the same period in 2008, primarily due to decreased top drive product sales, decreased top drive rental activities, decreased Tubular Services revenues, and decreased CASING DRILLING activity, partially offset by decreased operating expenses. Revenues, operating income and net income for the three months ended September 30, 2009 and 2008 were as follows:
                               
   
Three Months Ended September 30,
   
%
Change
 
   
2009
   
2008
 
         
% of
Revenues
         
% of
Revenues
 
REVENUES
                             
Top Drive
                             
-Sales
  $ 14,343           $ 45,958             (69 )
-Rental services
    20,005             27,720             (28 )
-After-market sales and service(1) 
    10,844             17,022             (36 )
Total Top Drive
    45,192       62       90,700       65       (50 )
Tubular Services(2)
                                       
-Conventional
    4,052               18,882               (79 )
-Proprietary(1) 
    20,233               23,902               (15 )
Total Tubular Services
    24,285       33       42,784       31       (43 )
CASING DRILLING
    3,132       4       6,537       4       (52 )
Total Revenues
  $ 72,609       100     $ 140,021       100       (48 )
                                         
OPERATING INCOME
                                       
Top Drive
  $ 13,370       30     $ 32,090       35       (58 )
Tubular Services
    (1,440 )     (6 )     7,396       17       (119 )
CASING DRILLING
    (3,072 )     (98 )     (3,055 )     (47 )     1  
Research and Engineering
    (2,092 )     n/a       (2,560 )     n/a       18  
Corporate and Other
    (5,074 )     n/a       (8,471 )     n/a       40  
Total Operating Income
  $ 1,692       2     $ 25,400       18       (93 )
                                         
NET (LOSS) INCOME
  $ (268 )     (0 )   $ 17,581       13       (102 )
                                         
 

(1)
At the end of 2008, we identified sales of certain accessories that were previously included as part of our top drive after-market support activities. However, since these accessories are directly related to our proprietary and patented Tubular Services technology, we now include them with our proprietary information. Accordingly, we have reclassified prior year revenues and operating income of approximately $0.4 million and $0.3 million, respectively, related to these sales from top drive after-market support to proprietary Tubular Services to conform to our current year presentation.
 
(2)
At the end of 2008, we commenced the presentation of our Tubular Services business and CASING DRILLING as two separate segments. Accordingly, we have reclassified prior year revenues of approximately $6.5 million and prior year operating losses of approximately $3.1 million from the former Casing Services segment to the CASING DRILLING segment to conform to the current year presentation.
 
 
Revenues for the three months ended September 30, 2009 were $72.6 million, compared to $140.0 million in the same period in 2008, a decrease of $67.4 million, or 48%. This decrease is due to a $45.5 million decrease in the Top Drive segment, an $18.5 million decrease in the Tubular Services segment and a $3.4 million decrease in the CASING DRILLING segment. Each segment is discussed in further detail below.
 
Operating Income for the three months ended September 30, 2009 was $1.7 million, compared to $25.4 million in the three months ended September 30, 2008, a decrease of $23.7 million, or 93%. This decrease is primarily due to lower revenues in all of our segments, decreased margins due to ongoing pricing pressures associated with depressed drilling activity and $0.3 million in severance costs, partially offset by a $1.6 million gain on the sale of operating equipment, as discussed further below.
 
Net Loss for the three months ended September 30, 2009 was $0.3 million, compared to income of $17.6 million in the same period in 2008, a decrease of $17.9 million, or 102%. This decrease is primarily due to decreased operating income as discussed above and a $0.4 million increase in foreign exchange losses and an increase in our effective tax rate during the current year’s period, partially offset by a $0.6 million decrease in interest expense and a $0.8 million increase in interest income, as discussed below.
 
Top Drive Segment
 
Our Top Drive segment consists of top drive sales, after-market sales and service and top drive rental service activities.
 
Revenues—Revenues for the three months ended September 30, 2009 decreased $45.5 million, or 50%, compared to the same period in 2008, primarily driven by a $31.6 million decrease in top drive sales, a $7.7 million decrease in top drive rental operations and a $6.2 million decrease in after-market sales and service.
 
Revenues from top drive sales decreased $31.6 million to $14.3 million for the three months ended September 30, 2009 as compared to the same period in 2008. This decrease is primarily due to a decrease in the number of Top Drive units sold during the current year in connection with the current downturn in the drilling industry.  We sold 13 units (10 new and 3 used) during the three months ended September 30, 2009, compared to 38 units sold (32 new and 6 used) during the same period in 2008. Revenues related to the sale of used top drive units during the three months ended September 30, 2009 were $2.9 million, down from $7.1 million during the three months ended September 30, 2008.
 
Revenues from top drive rental service activities decreased $7.7 million to $20.0 million during the three months ended September 30, 2009 as compared to the same period in 2008, primarily due to a decrease in the number of rental operating days, primarily in North America, during the current year’s period. Our rental fleet worked 4,441 operating days during the three months ended September 30, 2009, down from 6,014 operating days in the same period last year. 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 approximately 40%. At September 30, 2009, we had 123 top drives in our rental fleet.
 
Revenues from after-market sales and service decreased $6.2 million to $10.8 million for the three months ended September 30, 2009 as compared to the same period in 2008, primarily due to the decline in industry conditions during the current year’s period compared to the prior year. During 2009, weakened economic conditions resulted in a marked decrease in active rig count and drilling activities. Accordingly, our customers have decreased their demand for after-market parts and maintenance and repair services. This decrease in demand has resulted in pricing pressures and thus, decreased revenues per job.
 
Operating Income—Top Drive operating income for the three months ended September 30, 2009 decreased $18.7 million to $13.4 million as compared to the same period in 2008. The decrease in operating income during the current period is primarily due to the decrease in the number of top drives sold during the current period, as discussed above. In addition, operating margins were negatively impacted by pricing pressures on our after-market sales and service businesses, as described above. This was partially offset by a $1.6 million gain on the sale of certain ancillary Top Drive equipment.
 
Outlook—We had a third-party backlog of three top drive units as of September 30, 2009 compared to a third-party backlog of 10 units as of June 30, 2009 and 65 units as of December 31, 2008. With this drop in backlog, we have downsized our manufacturing operations substantially to better reflect current market conditions. 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. We plan to minimize our costs for the next several quarters and improve our business processes so as to substantially improve efficiencies as the business turns around. While we have seen an increase in activity, particularly in the rental portion of our business, our customers have maintained their focus on lowering project costs and, given the continued pricing pressures, we expect to see continued margin compression over the remainder of 2009 and throughout 2010. We will continue to monitor our operations and cost structure in response to any further changes in demand.
 
Tubular Services Segment
 
Revenues—Revenues for the three months ended September 30, 2009 decreased $18.5 million, or 43%, to $24.3 million as compared to the same period in 2008. This was primarily due to a $14.8 million decrease in our conventional Tubular Services business and a $3.7 million decrease in our proprietary service offerings. The decrease in our revenues is due to a significant decline in North American drilling activity over the past 12 months. Our conventional business is primarily conducted in North America and has been severely impacted by the decline in active rig count discussed above.  We continue to shift our customers to our proprietary product offerings. We completed 683 jobs during the three months ended September 30, 2009, up 38% compared to 496 jobs during the three months ended September 30, 2008.  While the number of jobs performed has increased, revenue per job has been negatively impacted by pricing pressures resulting from decreased drilling activity.
Operating Income—Tubular Services’ operating income for the three months ended September 30, 2009 decreased $8.8 million to a $1.4 million loss compared to income of $7.4 million for the same period in 2008, primarily due to the decrease in revenues described above.
 
Outlook—We expect the current year’s operations will remain depressed in the near term due to the current status of worldwide economies and the current excess supply of oil and natural gas. Our customers have maintained their focus on lowering project costs and accordingly, given the continued pricing pressures, we expect to see continuing margin compression over the remainder of 2009 and throughout 2010. We will continue to monitor our operations and cost structure in response to any further changes in demand. We continue to believe that the fundamentals driving our global business remain intact and that our financial condition will enable us to weather the current conditions and poise us for future growth when conditions improve.
 
CASING DRILLING Segment
 
Revenues—Revenues for the three months ended September 30, 2009 were $3.1 million compared to $6.5 million in the same period last year, a decrease of $3.4 million or 52%. This decrease was due to a continuing decline in available work in connection with current industry operating conditions.  As mentioned above, worldwide active rig count has declined approximately 40% during the past 12 months.
 
Operating Income—CASING DRILLING’s operating loss for the three months ended September 30, 2009 was $3.1 million, virtually unchanged from last year.  While revenues decreased as discussed above, operating losses were minimized by reducing headcount in locations experiencing significant activity declines, combining under-performing operations and streamlining internal processes.
 
Outlook—As mentioned above, we expect the current year’s operations will continue to decline in the near term due to the current status of the drilling industry. We remain confident that our CASING DRILLING business will be a valuable part of our future operations. Accordingly, we are focusing on maintaining our existing infrastructure around the world while reducing headcount in locations experiencing significant activity declines, combining under-performing operations and streamlining internal processes.
 
Research and Engineering Segment
 
Research and Engineering’s operating expenses are comprised of our activities related to the design and enhancement of our top drive models and proprietary equipment and were $2.1 million for the three months ended September 30, 2009, a decrease of $0.5 million from operating expenses of $2.6 million for the three months ended September 30, 2008. This decrease is primarily due to our focus on reducing costs during the current year’s period, partially offset by $0.1 million in severance costs incurred during the current quarter. We will continue to invest in the development, commercialization and enhancements of our proprietary technologies.
 
Corporate and Other Segment
 
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 expenses for the three months ended September 30, 2009 decreased $3.4 million to $5.1 million, compared to $8.5 million for the same period in 2008. This decrease is primarily due to decreased legal expenses and employee compensation costs during the current year’s period.  In addition, our non-cash stock compensation expense decreased $0.7 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
 
Net (loss) income for the three months ended September 30, 2009 and 2008 was as follows (in thousands):
                         
   
Three Months Ended September 30,
 
   
2009
   
2008
 
         
% of
revenue
         
% of
revenue
 
Operating Income
  $ 1,692       2     $ 25,400       18  
Interest expense
    497       1       1,098       1  
Interest income
    (847 )           (45 )      
Foreign exchange losses (gains)
    808             422       ––  
Other (income)
    (1 )           (99 )      
Income taxes
    1,503       2       6,443       4  
Net (Loss) Income
  $ (268 )     (0 )   $ 17,581       13  
                                 
 
    Interest Expense—Interest expense for the three months ended September 30, 2009 decreased $0.6 million compared to the same period in 2008. During the three months ended September 30, 2009, average daily debt balances were $42.6 million, approximately $25.3 million lower than the same period last year. In addition, the weighted average interest rate decreased by 277 basis points during the current year due to market conditions, resulting in lower interest expense during the current year period.
 
Interest Income—Interest income for the three months ended September 30, 2009 increased $0.8 million compared to the same period in 2008, primarily due to $0.8 million in interest received on an overpayment of prior years’ U.S. federal income taxes.
 
Foreign Exchange Losses —Foreign exchange losses increased to $0.8 million during the three months ended September 30, 2009 from $0.4 million during the same period in 2008, primarily due to the comparative weakening of the Canadian dollar versus the U.S. dollar.
 
Other (Income) Expense—Other (income) expense for the three months ended September 30, 2009 was relatively flat compared to the same period during 2008.
 
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. Please see Note 6 to the Condensed Consolidated Financial Statements included in Item 1, “Financial Statements (Unaudited),” above for a description of our Mexican tax matters.
 
Our effective tax rate for the three months ended September 30, 2009 was 122% compared to 27% for the same period in 2008. The effective tax rate for the three months ended September 30, 2009 reflects a $1.1 million charge related to tax provision to return adjustments as a result of filing an amended 2008 tax return in Canada and our 2008 U.S. income tax returns.
 
As discussed in Note 6 to the Condensed Consolidated Financial Statements included in Item 1 above, our tax returns are subject to examination in each of the jurisdictions in which we operate, and the audit outcomes and the timing of audit settlements are subject to significant uncertainty. Therefore, additional provisions on tax-related matters could be recorded in the future as revised estimates are made or the underlying matters are settled or otherwise resolved.
29


    For the Nine Months Ended September 30, 2009 and 2008
 
Our revenues, operating income and net income for the nine months ended September 30, 2009 decreased compared to the same period in 2008 primarily due to decreased top drive product sales, decreased top drive rental activities, decreased conventional Tubular Services revenues, and decreased CASING DRILLING activity, partially offset by increased activities in proprietary Tubular Services. Revenues, operating income and net income for the nine months ended September 30, 2009 and 2008 were as follows:
 
                               
   
Nine Months Ended September 30,
   
%
Change
 
   
2009
   
2008
 
         
% of
Revenues
         
% of
Revenues
 
REVENUES
                             
Top Drive