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EX-32 - SECTION 906 CERTICATION OF CEO AND CFO - TESCO CORPtesco32.htm
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-Q

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x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the Quarterly Period Ended September 30, 2010
 
¨
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
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Tesco Corporation
(Exact name of registrant as specified in its charter)
¾¾¾¾¾¾¾
 
   
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)
¾¾¾¾¾¾¾
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 31, 2010:  37,838,030
 


 
 

 
 

 


TABLE OF CONTENTS
 
     
   
Page
PART I—FINANCIAL INFORMATION
     
   Item 1.
 1
   Item 2.
11
   Item 3.
17
   Item 4.
17
 
PART II—OTHER INFORMATION
   Item 1.
19
   Item 1A.
19
   Item 2.
19
   Item 3.
20
   Item 4.
20
   Item 5.
20
   Item 6.
20
 




 
i

 


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, 2009 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.
 
TESCO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in thousands)
 
             
   
September 30,
2010
 
   
December 31,
2009
 
 
ASSETS
           
Current assets
             
Cash and cash equivalents
 
$
42,020
   
$
39,930
   
Accounts receivable trade, net
   
66,863
     
53,970
   
Income taxes recoverable
   
14,809
     
10,945
   
Inventories, net
   
70,425
     
74,339
   
Deferred income taxes
   
13,999
     
13,836
   
Prepaid and other current assets
   
23,870
     
18,680
   
Total current assets
   
231,986
     
211,700
   
Property, plant and equipment, net
   
177,220
     
183,025
   
Goodwill
   
29,394
     
29,394
   
Deferred income taxes
   
12,257
     
12,986
   
Intangible and other assets, net
   
4,367
     
5,450
   
Total assets
 
$
455,224
   
$
442,555
   
                   
LIABILITIES AND SHAREHOLDERS’ EQUITY
                 
Current liabilities
                 
Accounts payable
 
$
20,002
   
$
15,992
   
Deferred revenues
   
16,975
     
14,007
   
Warranty reserves
   
1,823
     
2,251
   
Accrued and other current liabilities
   
29,196
     
27,075
   
Total current liabilities
   
67,996
     
59,325
   
Long-term debt
   
––
     
8,600
   
Deferred income taxes
   
13,726
     
12,471
   
Total liabilities
   
81,722
     
80,396
   
                   
Commitments and contingencies (Note 5)
   
––
     
––
   
                   
Shareholders’ equity
                 
Common shares; no par value; unlimited shares authorized;  37,836 and  37,750 shares issued and outstanding at September 30, 2010 and December 31, 2009
   
177,164
     
175,087
   
Contributed surplus
   
18,253
     
14,879
   
Retained earnings
   
142,584
     
136,692
   
Accumulated comprehensive income
   
35,501
     
35,501
   
Total shareholders’ equity
   
373,502
     
362,159
   
Total liabilities and shareholders’ equity
 
$
455,224
   
$
442,555
   
 
 
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 information)
 
                         
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Revenue
                       
Products
 
$
32,866
   
$
25,186
   
$
89,491
   
$
117,015
 
Services
   
60,240
     
47,423
     
175,010
     
154,205
 
     
93,106
     
72,609
     
264,501
     
271,220
 
Operating expenses
                               
Cost of sales and services
                               
Products
   
23,897
     
18,319
     
66,331
     
86,712
 
Services
   
50,876
     
43,012
     
149,484
     
144,970
 
     
74,773
     
61,331
     
215,815
     
231,682
 
Selling, general and administrative
   
11,385
     
6,811
     
34,053
     
33,909
 
Research and engineering
   
2,317
     
2,092
     
5,873
     
6,525
 
Total operating expenses
   
88,475
     
70,234
     
255,741
     
272,116
 
Operating income (loss)
   
4,631
     
2,375
     
8,760
     
(896
Other expense (income)
                               
Interest expense
   
155
     
497
     
406
     
1,451
 
Interest income
   
(33
)
   
(847
)
   
(128
)
   
(896
)
Foreign exchange losses
   
75
     
1,002
     
240
     
1,480
 
Other expense (income)
   
(153
)
   
(1
)
   
(623
)
   
143
 
Total other expense (income)
   
44
     
651
     
(105
)
   
2,178
 
Income (loss) before income taxes
   
4,587
     
1,724
     
8,865
     
(3,074
)
Income tax provision (benefit)
   
1,603
     
1,329
     
2,975
     
(6,785
Net income
 
$
2,984
   
$
395
   
$
5,890
   
$
3,711
 
Earnings per share:
                               
Basic
 
$
.08
   
$
.01
   
$
.16
   
$
.10
 
Diluted
 
$
.08
   
$
.01
   
$
.15
   
$
.10
 
Weighted average number of shares: 
                           
Basic
   
37,828
     
37,620
     
37,793
     
37,567
 
Diluted
   
38,678
     
38,348
     
38,679
     
38,446
 
 
 
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,
 
   
2010
   
2009
 
Cash flows from operating activities
           
Net income
 
$
5,890
   
$
3,711
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
26,459
     
27,199
 
Stock compensation expense
   
4,420
     
3,048
 
Bad debt expense (recovery)
   
(430
)
   
811
 
Deferred income taxes
   
1,627
     
3,950
 
Amortization of deferred financing costs
   
99
     
521
 
Gain on sale of operating assets
   
(2,051
)
   
(931
)
Impairment of assets held for sale
   
––
     
1,792
 
Changes in operating assets and liabilities:
               
Accounts receivable trade, net
   
(12,463
)
   
48,702
 
Inventories
   
4,069
     
3,216
 
Prepaid and other current assets
   
(5,190
)
   
(3,594
)
Accounts payable and accrued liabilities
   
9,809
     
(23,489
)
Income taxes recoverable
   
(3,668
)
   
(15,829
)
Other noncurrent assets and liabilities, net
   
181
     
––
 
Other, net
   
1
     
(6
)
Net cash provided by operating activities
   
28,753
     
49,101
 
                 
Cash flows from investing activities
               
Additions to property, plant and equipment
   
(23,331
)
   
(13,701
)
Proceeds on sale of operating assets
   
5,376
     
4,795
 
Other, net
   
––
     
(194
)
Net cash used in investing activities
   
(17,955
)
   
(9,100
)
                 
Cash flows from financing activities
               
Issuances of debt
   
––
     
10,000
 
Repayments of debt
   
(8,600
)
   
(25,643
)
Proceeds from exercise of stock options
   
88
     
492
 
Excess tax benefit associated with equity compensation
   
(196
)
   
––
 
Net cash used in financing activities
   
(8,708
)
   
(15,151
)
Effect of foreign exchange losses on cash balances
   
––
     
292
 
Change in cash and cash equivalents
   
2,090
     
25,142
 
Net cash and cash equivalents, beginning of period
   
39,930
     
20,619
 
Net cash and cash equivalents, end of period
 
$
42,020
   
$
45,761
 
                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.




TESCO CORPORATION
 
Notes to Condensed Consolidated Financial Statements
 
Note 1—Preparation of Interim Financial Statements and Significant Accounting Policies
 
Nature of Operations

We are a global leader in the design, manufacture and service delivery of technology-based solutions for the upstream energy industry.  We seek to change the way wells are drilled by delivering safer and more efficient solutions that add real value by reducing the costs of drilling for and producing oil and natural 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
 
We prepared this quarterly report on Form 10-Q pursuant to instructions for quarterly reporting required to be filed with the Securities and Exchange Commission (“SEC”).  Because this is an interim period filing presented using a condensed format, it does not include all information and footnotes normally included in annual financial statements prepared in accordance with U.S. GAAP.  You should read this report along with our Annual Report on Form 10-K for the year ended December 31, 2009 (“2009 Annual Report on Form 10-K”), which contains a summary of our significant accounting policies and other disclosures.  The financial statements as of September 30, 2010 and for the quarters and nine months ended September 30, 2010 and 2009 are unaudited.  We derived the balance sheet as of December 31, 2009 from the audited balance sheet filed in our 2009 Annual Report on Form 10-K.  In our opinion, we have made adjustments, all of which were normal recurring adjustments unless otherwise disclosed herein, that we believe are necessary for a fair statement of the balance sheets, results of operations and cash flows, as applicable.  
 
The preparation of these financial statements requires us to make estimates and judgments that affect the amounts reported in the financial statements and the related disclosures.  Actual results may differ from our estimates.   Interim results should not be taken as indicative of the results that may be expected for the year ending December 31, 2010. 
 
All references to US$ or $ are to U.S. dollars and references to C$ are to Canadian dollars.
 
        Subsequent Events
 
We conducted our subsequent events review through the date these interim consolidated financial statements were filed with the SEC.

On October 18, 2010, we amended our credit facility with our existing lenders to change various debt covenants.  These changes include:
·  
Increasing the allowable amount of sales of obsolete assets in any fiscal year from $10 million to $15 million; and
·  
Increasing the allowable amount of capital expenditures permitted by us:
o  
For 2010, to $55 million plus the net cash proceeds from asset sales from an EBITDA-based formula which we previously calculated to be approximately $45 million;
o  
For 2011, to the lesser of $75 million or 100% of consolidated EBIDTA (as defined in the credit facility) plus the net cash proceeds from asset sales for 2011 as determined on a quarterly basis for the four then most recent quarters; and
o  
For 2012 and beyond, to 80% of consolidated EBIDTA plus the net cash proceeds from asset sales as determined on a quarterly basis for the four then most recent quarters.

On October 26, 2010,  we entered into a settlement with Weatherford International, Inc. and Weatherford/Lamb Inc. dismissing pending patent previously described in our 2009 Annual Report on Form 10-K.   For further discussion of the settlement, see Note 5—Commitments and Contingencies.


Significant Accounting Policies
 
The information below provides an update to the significant accounting policies and accounting pronouncements issued but not yet adopted and discussed in our 2009 Annual Report on Form 10-K.
 
 
4

        Foreign Currency Translation and Revaluation
 
 The U.S. dollar is the functional currency for all of our worldwide operations. Effective January 1, 2010, and resulting from an analysis of U.S. Dollar cash flows, we changed the functional currency for our Canadian operations from the Canadian dollar to the U.S. dollar.  Prior to January 1, 2010, assets and liabilities of our Canadian operations, which were denominated in foreign currencies, were translated into U.S. dollars at end-of-period exchange rates, and the resulting translation adjustments were reported, net of their related tax effects, as a component of accumulated comprehensive income in stockholders’ equity. As a result of the functional currency change discussed above, our cumulative translation adjustment of $35.5 million included in accumulated comprehensive income will be adjusted only in the event of a full or partial disposition of our investment in Canada. Prior to January 1, 2010, assets and liabilities denominated in currencies other than the functional currency were re-measured into the functional currency prior to translation into U.S. dollars, and the resulting exchange gains and losses were included in income in the period in which they occurred.
 

Restricted Cash

At September 30, 2010, we had $0.9 million of restricted cash included in prepaid and other current assets on the accompanying balance sheet.  We had no restricted cash at December 31, 2009.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The primary factors used in determining the allowance needed for accounts receivable are customer bankruptcies, delinquency and an estimate of our ability to collect outstanding receivables based on the number of days outstanding. At September 30, 2010 and December 31, 2009, the allowance for doubtful accounts on trade accounts receivable was $0.9 million and $1.5 million.

Inventories
 
Inventories consist primarily of top drive, tubular services and casing drilling tool parts, spare parts, work in process and raw materials to support ongoing manufacturing operations and installed base of specialized equipment used throughout the world. At September 30, 2010 and December 31, 2009, inventories, net of reserves for excess and obsolete inventories, by major classification were as follows (in thousands):
             
   
September 30,
2010
   
December 31,
2009
 
Raw materials
 
$
37,574
   
$
34,056
 
Work in progress
   
2,192
     
2,328
 
Finished goods
   
30,659
     
37,955
 
   
$
70,425
   
$
74,339
 

Depreciation and Amortization
 
Depreciation and amortization expense is included in our income statement as follows (in thousands):

                         
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Cost of sales and services
 
$
8,614
   
$
8,506
   
$
25,687
   
$
26,146
 
Selling, general and administrative expense 
   
268
     
308
     
749
     
989
 
Research and engineering
   
10
     
40
     
23
     
64
 
 Total depreciation and amortization
 
$
8,892
   
$
8,854
   
$
26,459
   
$
27,199
 
 
Sale of Operating Assets

When top drive units from our rental fleet are sold, the sales proceeds are included in revenues and the net book value of the equipment sold is included in cost of sales and services.  Proceeds from the sale of used top drives are included in proceeds from the sale of operating assets and the difference between revenues and the cost of sales and services is included in gain on sale of operating assets in the accompanying statement of cash flows.

Fair Value Measurement
 
During the year ended December 31, 2009, we decided to sell certain operating assets within the next 12 months. These fixed assets had a carrying amount of $3.9 million and were written down to their estimated realizable value of $0.3 million during the year ended December 31, 2009. The estimated realizable fair value was derived from observable market prices in the form of quotations received from independent third parties. The following table presents our assets carried at fair value and the basis for determining their fair values (in thousands):
 
                               
   
As of
September 30,
2010
   
Quoted Prices in Active Markets
for Identical
Assets
   
Significant
Other
Observable
Inputs
   
Significant
Unobservable
Inputs
   
Total
Losses
 
Assets held for sale
 
$
147
   
$
   
$
147
     
   
$
3,559
 
 
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 our long-term debt depends primarily on current market interest rates for debt issued with similar maturities by companies with risk profiles similar to our own. We had no outstanding borrowings under our credit facility at September 30, 2010.

We have Canadian dollar-denominated stock option awards issued to non-Canadian employees that are recorded as a liability.  The fair value of these awards, which was approximately $0.8 million and $1.8 million at September 30, 2010 and December 31, 2009, is included in accrued and other current liabilities in the accompanying balance sheet. 

Warranty Accrual

    The following is a reconciliation of changes in our warranty accrual for the nine months ended September 30, 2010 (in thousands):
   
Nine Months Ended
September 30,
2010
 
Balance—beginning of period
 
$
2,251
 
Charged to expense, net
   
168
 
Deductions
   
(596
)
Balance—end of period
 
$
1,823
 

Severance Costs
 
We incurred no significant severance costs during the three and nine months ended September 30, 2010.  During the three and nine months ended September 30, 2009, we eliminated approximately 50 and 490 employee positions due to a review of our personnel structure and recorded termination expenses of $0.3 million and $3.2 million. These severance costs are recorded in cost of sales and services ($0.2 million and $1.5 million for the three and nine months ended September 30, 2009), in selling, general and administrative expense ($0 million and $1.3 million for the three and nine months ended September 30, 2009), and in research and engineering expense ($0.1 million and $0.4 million for the three and nine months ended September 30, 2009) in our income statement, based on the respective functions performed by those employees who were terminated during the period. These costs were recorded in our 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
 
 
Recent Accounting Pronouncements

Each reporting period, we consider all newly issued but not yet adopted accounting and reporting guidance applicable to our operations and the preparation of our consolidated financial statements. We do not believe that any issued accounting and reporting guidance not yet adopted will have a material impact on our financial statements other than as discussed below.

In June 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. We will adopt these provisions on January 1, 2011, and the adoption is not expected to have a material impact on the consolidated financial statements.
 
 
 Note 2—Earnings per Share and Common Stock

Earnings per Share Information

Earnings 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-based compensation 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” stock-based compensation 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,
 
   
2010
   
2009
   
2010
   
2009
 
Basic weighted average number of shares outstanding 
   
37,828
     
37,620
     
37,793
     
37,567
 
Dilutive effect of stock-based compensation
   
850
     
728
     
886
     
879
 
Diluted weighted average number of shares outstanding
   
38,678
     
38,348
     
38,679
     
38,446
 
Weighted average anti-dilutive common shares excluded from calculation due to grant price exceeding exercise prices
   
752
     
930
     
708
     
954
 
 
Common Stock
 
The following summarizes the activity in our common shares during the nine months ended September 30, 2010 (in thousands):
   
Nine Months Ended
September 30, 2010
 
   
Number of shares
   
Amount
 
Balance—beginning of period
   
37,750
   
$
175,087
 
Issued on exercise of options
   
12
     
141
 
Issuance from settlement of restricted stock
   
64
     
1,803
 
Other issuance of common stock
   
10
     
133
 
Balance—end of period
   
37,836
   
$
177,164
 

 
Note 3—Comprehensive Income
 
Comprehensive income includes unrealized gains and losses which have been recognized during the period as a separate component of shareholders’ equity. Our total comprehensive income for the three and nine months ended September 30, 2010 and 2009 was as follows (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
September 30,
 
 
Nine Months Ended
September 30,
 
 
 
2010
 
 
2009
 
 
2010
 
 
2009
 
Net income
 
$
2,984
 
 
$
395
 
 
$
5,890
 
 
$
3,711
 
Foreign currency translation adjustment, net of income taxes
 
 
 
 
 
5,427
 
 
 
 
 
 
10,275
 
Total comprehensive income
 
$
2,984
 
 
$
5,822
 
 
$
5,890
 
 
$
13,986
 


Note 4—Income Taxes
 
Tesco Corporation is an Alberta, Canada corporation.   We conduct business and are taxable on profits earned in a number of jurisdictions around the world.  Income taxes have been recorded based on the laws and rates in effect in the countries in which operations are conducted or in which we are considered a resident for income tax purposes.
 




Our income tax provision (benefit) for the three and nine months ended September 30, 2010 and 2009 was as follows (in thousands):
                         
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Current
 
$
(1,689
)
 
$
(10,777
)
 
$
1,348
   
$
(10,735
Deferred
   
3,292
     
12,106
     
1,627
     
3,950
 
Income tax provision (benefit)
 
$
1,603
   
$
1,329
   
$
2,975
   
$
(6,785
)

Our effective tax rate for the three and nine months ended September 30, 2010 was 35% and 34% compared to 77% and 221% for the same periods in 2009. The effective tax rate for the three months ended September 30, 2009 was affected by several one-time adjustments, including $1.1 million of tax expense related to provision to return adjustments as a result of filing an amended 2008 tax return in Canada.  The effective tax rate for the nine months ended September 30, 2009 was also affected by several one-time adjustments, including the recognition of a $4.5 million tax benefit associated with a Canadian tax law change.
 
           As of September 30, 2010 and December 31, 2009, we had an accrual for uncertain tax positions of $1.2 million. This liability is offset by net income tax receivables and is included in income taxes recoverable in the accompanying balance sheets as we anticipate these uncertainties will be resolved in the next 12 months. The resolution of these uncertainties should not have a material impact on our effective tax rate.
 
Certain state and foreign tax filings remain open to examination. We believe that any assessment on these filings will not have a material impact to our financial position, results of operations or cash flows. We believe 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 5—Commitments and Contingencies
 
Legal Contingencies
 
We are subject to legal proceedings brought against us in the normal course of business. We recognize liabilities for contingencies when we have an exposure that, when fully analyzed, indicates it is both probable that a liability has been incurred and the amount of loss can be reasonably estimated. Where the most likely outcome of a contingency can be reasonably estimated, we accrue a liability for that amount. Where the most likely outcome cannot be estimated, a range of potential losses is established and if no one amount in that range is more likely than any other, the low end of the range is accrued.

The estimates below represent management’s best estimates of outstanding legal contingencies based on consultation with internal and external legal counsel. There can be no assurance as to the eventual outcome or the amount of loss we may suffer as a result of these proceedings.

In December 2009, we received an administrative subpoena from the Department of the Treasury, Office of Foreign Assets Control (OFAC) regarding a past shipment of oilfield equipment made from our Canadian manufacturing facility in 2006 to Sudan. We reviewed this matter and have provided a timely response to the subpoena. Our internal investigation revealed that in 2006 and 2007, a total of five top drive units were shipped to Sudan from our Canadian manufacturing facility. Technicians were also dispatched from one of our regional offices outside of the United States to install the top drive units. The total revenues from these activities with respect to the periods involved were approximately 0.5% and 1.0% of total revenues in 2006 and 2007.   Our policy is not to conduct any business in or sell any products to Sudan and we have implemented strengthened controls and procedures designed to ensure compliance with this policy. We disclosed the results of our internal investigation to, and are fully cooperating with, OFAC.  We continue to evaluate the potential outcome of this matter. The effect on our consolidated financial position, results of operations or cash flows is not reasonably determinable at this time. Accordingly, we have not accrued a reserve for this matter as of September 30, 2010.

Weatherford International, Inc. and Weatherford/Lamb Inc. (“Weatherford”) filed suit against us in the U.S. District Court for the Eastern District of Texas, Marshall Division in December 2007 (the “Marshall Suit”), alleging that various of our technologies infringe 10 different patents held by Weatherford. Weatherford sought monetary damages and an injunction against further infringement. Our technologies referred to in the claim included the CDS, the CASING DRILLING system and method, a float valve, and the locking mechanism for the controls of the tubular handling system. We filed a general denial seeking a judicial determination that we did not infringe the patents in question and/or that the patents are invalid.

In August 2009, we filed suit against several competitors in the U.S. District Court for the Southern District of Texas – Houston Division, including Weatherford (the “Houston Suit”).  The suit claims infringement of two of our patents related to our CDS.  On October 26, 2010, we entered into a settlement with Weatherford (the “Settlement”) dismissing both the Marshall Suit and the Houston Suit (as it relates to Weatherford) with prejudice. Among other provisions, the Settlement contains the following terms:
 
 
·
Non-exclusive irrevocable worldwide and royalty free cross licenses with respect to all the patents asserted by Weatherford in the Marshall Case and by us in the Houston Case, as well as certain other U.S. and foreign equivalents and counterparts; and
 
 
 
·
Weatherford has agreed to purchase for five years 67% of its worldwide top drive requirements from us, as long as we can meet production requirements, and to designate us as a preferred provider of after-market sales and service for top drives. The prices we charge Weatherford will be equal to or lower than the prices we charge to any other customer of similar volume of purchases and/or services.
 
We and Weatherford have committed to sign a formal settlement agreement consistent with the terms of the Settlement. We continue to prosecute the Houston Suit against the other defendants.

In 2006, we received a claim for withholding tax, penalties and interest related to payments over the periods from 2000 to 2004 in a foreign jurisdiction. We disagree with this claim and are currently litigating this matter. In November 2009, we received a favorable decision from a lower level court regarding payments made during 2000, which is subject to appeal. During 2006, we accrued an estimated pre-tax exposure of $3.8 million and continue to accrue interest for this matter for a total accrual of $4.6 million as of September 30, 2010.
 
In 2009, we settled a lawsuit with 48 plaintiffs related to certain wage and hour regulations under the U.S. Fair Labor Standards Act. Subsequent to that settlement, another 18 employees raised similar wage claims against us. During the first quarter of 2010, we agreed to settle all of those claims for an aggregate amount of approximately $0.4 million.


 Other Contingencies
 
We are contingently liable under letters of credit and similar instruments that we are required to provide from time to time in connection with the importation of equipment to foreign countries and to secure our performance on certain contracts. At September 30, 2010 and December 31, 2009, our total exposure under outstanding letters of credit was $7.5 million and $7.1 million.

Note 6—Segment Information
 
Business Segments
 
Our four business segments are: Top Drives, Tubular Services, CASING DRILLING and Research and Engineering. The Top Drive business is comprised of sales, rental services, and after-market sales and service of top drives. The Tubular Services business includes both our proprietary and conventional tubular services. The CASING DRILLING segment consists of our proprietary CASING DRILLING technology.  The Research and Engineering segment is comprised of our internal research and development activities related to tubular services, CASING DRILLING technology and top drive model development.
 
These segments report their results of operations to the level of operating income. At a business segment level, we incur costs directly and indirectly associated with revenues. 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 our revenue-generating equipment.

Assets are allocated to the Top Drive, Tubular Services, CASING DRILLING or Research and Engineering business segments to which they specifically relate. Our goodwill has been allocated to the Tubular Services segment. Our chief operating decision maker is not provided a measure of assets by business segment and, as such, this information is not presented.
 
Certain sales and marketing activities, corporate general and administrative expenses, and field administration and operations support expenses are not allocated to the business segments.
 



Significant financial information relating to our business segments is presented below (in thousands):
                                     
   
Three Months Ended September 30, 2010
 
   
Top
Drive
   
Tubular
Services
   
CASING
DRILLING
   
Research &
Engineering
   
Corporate and
Other
   
Total
 
Revenues
 
$
61,381
   
$
28,639
   
$
3,086
   
$
   
$
   
$
93,106
 
Depreciation and amortization
   
2,766
     
4,376
     
1,081
     
10
     
659
     
8,892
 
Operating income (loss)
   
15,907
     
1,893
     
(2,815
)
   
(2,317
)
   
(8,037
)
   
4,631
 
Other expense
                                           
44
 
Income before income taxes
                                         
$
4,587
 


   
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
   
1,674
     
4,992
     
1,115
     
40
     
1,033
     
8,854
 
Operating income (loss)
   
14,053
     
(1,440
)
   
(3,072
)
   
(2,092
)
   
(5,074
)
   
2,375
 
Other expense
                                           
651
 
Income before income taxes
                                         
$
1,724
 


   
Nine Months Ended September 30, 2010
 
   
Top
Drive
   
Tubular
Services
   
CASING
DRILLING
   
Research &
Engineering
   
Corporate and
Other
   
Total
 
Revenues
 
$
166,954
   
$
89,194
   
$
8,353
   
$
   
$
   
$
264,501
 
Depreciation and amortization
   
7,682
     
13,425
     
3,193
     
23
     
2,136
     
26,459
 
Operating income (loss)
   
41,303
     
7,075
     
(8,633
)
   
(5,873
)
   
(25,112
)
   
8,760
 
Other income
                                           
(105
)
Income before income taxes
                                         
$
8,865
 

   
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
   
5,443
     
15,645
     
3,491
     
64
     
2,556
     
27,199
 
Operating income (loss)
   
41,172
     
(949
)
   
(9,298
)
   
(6,525
)
   
(25,296
)
   
(896
)
Other expense
                                           
2,178
 
Loss before income taxes
                                         
$
(3,074
)

Geographic Areas
 
We attribute 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 title transfers to the customer.  Prior period geographic information has been adjusted to conform to the new segment presentation. Our revenues occurred in the following areas of the world (in thousands):
  
                 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2010
 
2009
 
2010
 
2009
United States
$
45,129
 
$
26,108
 
$
125,996
 
$
123,718
Asia Pacific
 
9,845
   
10,256
   
27,523
   
33,128
Canada
 
9,782
   
7,885
   
25,226
   
26,058
South America
 
8,465
   
7,846
   
24,975
   
22,839
Russia
 
7,294
   
2,466
   
17,155
   
4,755
Mexico
 
6,976
   
9,291
   
25,056
   
25,488
Europe, Africa and Middle East
 
5,615
   
8,757
   
18,570
   
35,234
Total
$
93,106
 
$
72,609
 
$
264,501
 
$
271,220
                       
 
ITEM 2.
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” in Part II, Item IA below and in our Annual Report on Form 10-K for the year ended December 31, 2009, for a discussion of the uncertainties, risks and assumptions associated with these statements.
 
OVERVIEW AND OUTLOOK

TESCO is a global leader in the design, manufacture and service delivery of technology based solutions for the upstream energy industry. We seek to change the way wells are drilled by delivering safer and more efficient solutions that add real value by reducing the costs of drilling for and producing oil and natural gas.
 
Our four business segments are:
·  
Top Drives
·  
Tubular Services
·  
CASING DRILLING
·  
Research and Engineering

During the nine months ended September 30, 2010, our Top Drive segment continued to provide a strong base of earnings and our Tubular Services segment performance has improved substantially from the same period in 2009.  Our proprietary tubular services offering continues to gain market acceptance, and we remain committed to growing this segment as we believe that every top drive rig will eventually convert to running casing with an automated system, such as the system we offer.

Business Environment

The global economy continues to be affected by the economic crisis that started in late 2008, which led to a significant global economic downturn.  In addition to these factors, during April 2010 the semisubmersible drilling rig, Deepwater Horizon, sank in the Gulf of Mexico after an explosion and fire onboard the rig. We provided no products or services to the Deepwater Horizon or for the drilling of this well. The cause of the explosion, fire, and resulting oil spill is being investigated by numerous industry participants, governmental agencies and Congressional committees. During May 2010, the United States Department of the Interior issued an order imposing a six month moratorium on all offshore deepwater drilling projects. A preliminary injunction was issued blocking enforcement of the moratorium during June 2010, and the Department of the Interior issued a new moratorium of deepwater drilling in July 2010, which was set to expire in November 2010. This moratorium had a negative impact on our tubular services business during the three months ended September 30, 2010.
 
            On October 12, 2010, the Department of the Interior lifted the moratorium, which includes more comprehensive plans to deal with potential blowouts and improvements to workplace safety as well as inspections and design reviews of blowout preventers by independent third parties. It is expected some permits for resumed drilling will be approved by the end of 2010 as operators come into full compliance.  We do not know the extent of the impact on our future revenue or earnings from the moratorium on all Gulf of Mexico offshore deepwater drilling projects, but our customers’ actions, the potential movement of deepwater rigs to other markets, and the possible shift of drilling activity from deepwater to other types of drilling, such as more traditional land-based drilling and alternative shale gas drilling, could affect our results. For a list of possible risk factors affecting risks associated with the oil and natural gas industry, see Part I, Item 1A—Risk Factors included in our 2009 Annual Report on Form 10-K.

The current outlook for the global economy varies widely, but generally points toward a slow recovery in 2011. Current global macro-economic conditions make any projections difficult and uncertain; however, each of our revenue generating segments continues to show positive trends and we anticipate moderately improved activity through the remainder of 2010 and into 2011.  We intend to continue our focus on international opportunities, where we believe drilling activity will be more robust as compared to especially with the anticipated flat to modest recovery in drilling activity in the United States and Canada.






OPERATING RESULTS

Below is a summary of our operating results for the three and nine months ended September 30, 2010 and 2009:
                                 
   
Three Months Ended September 30,
             
Nine Months Ended September 30,
           
   
Increase/Decrease
2010 to 2009
 
Increase/Decrease
 2010 to 2009
   
2010
   
2009
   
2010
   
2009
 
(in thousands, except percentages)
                                     
Segment revenues
                                           
Top Drive
 
$
61,381
   
$
45,192
   
$
16,189
     
36%
 
$
166,954
   
$
171,118
   
$
(4,164
)
   
(2%)
Tubular Services
   
28,639
     
24,285
     
4,354
     
18%
   
89,194
     
89,210
     
(16
)
   
––%
CASING DRILLING
   
3,086
     
3,132
     
(46
)
   
(1%)
   
8,353
     
10,892
     
(2,539
)
   
(23%)
Consolidated revenues
 
$
93,106
   
$
72,609
   
$
20,497
     
28%
 
$
264,501
   
$
271,220
   
$
(6,719
)
   
(2%)
                                                             
Segment operating income (loss)
                                                     
Top Drive
 
$
15,907
   
$
14,053
   
$
1,854
     
13%
 
$
41,303
   
$
41,172
   
$
131
     
––%
Tubular Services
   
1,893
     
(1,440
)
   
3,333
     
231%
   
7,075
     
(949
)
   
8,024
     
846%
CASING DRILLING
   
(2,815
)
   
(3,072
)
   
257
     
8%
   
(8,633
)
   
(9,298
)
   
665
     
7%
Research and engineering
   
(2,317
)
   
(2,092
)
   
(225
)
   
(11%)
   
(5,873
)
   
(6,525
)
   
652
     
10%
     
12,668
     
7,449
     
5,219
     
70%
   
33,872
     
24,400
     
9,472
     
39%
Corporate and other
   
(8,037
)
   
(5,074
)
   
(2,963
)
   
(58%
   
(25,112
)
   
(25,296
)
   
184
     
1%
Consolidated operating income (loss)
   
4,631
     
2,375
     
2,256
     
95%
   
8,760
     
(896
)
   
9,656
     
1078%
Other expense (income)
   
44
     
651
     
(607
)
   
(93%)
   
(105
)
   
2,178
     
(2,283
)
   
(105%)
Income tax provision (benefit)
   
1,603
     
1,329
     
274
     
21%
   
2,975
     
(6,785
)
   
9,760
     
144%
Net income
 
$
2,984
   
$
395
   
$
2,589
     
655%
 
$
5,890
   
$
3,711
   
$
2,179
     
59%


Top Drive Segment

Our Top Drive business segment sells equipment and provides services to drilling contractors and oil and natural gas operating companies throughout the world. We primarily manufacture top drives that are used in drilling operations to rotate the drill string 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.
                                 
   
Three Months Ended September 30,
             
Nine Months Ended September 30,
           
   
Increase/Decrease
 2010 to 2009
 
Increase/Decrease
 2010 to 2009
   
2010
   
2009
   
2010
   
2009
 
(in thousands, except percentages)
                                       
Top Drive revenues
                                           
Sales
 
$
19,836
   
$
14,343
   
$
5,493
     
38%
 
$
54,775
   
$
70,903
   
$
(16,128
)
   
(23%)
Rental services
   
28,514
     
20,005
     
8,509
     
43%
   
77,463
     
61,660
     
15,803
     
26%
After-market sales and services
   
13,031
     
10,844
     
2,187
     
20%
   
34,716
     
38,555
     
(3,839
)
   
(10%)
   
$
61,381
   
$
45,192
   
$
16,189
     
36%
 
$
166,954
   
$
171,118
   
$
(4,164
)
   
(2%)
                                                             
Top Drive operating income
 
$
15,907
   
$
14,053
   
$
1,854
     
13%
 
$
41,303
   
$
41,172
   
$
131
     
––%
                                                             
Number of top drive sales:
                                                           
New
   
16
     
10
     
6
     
60%
   
38
     
68
     
(30
)
   
(44%)
Used
   
2
     
3
     
(1
)
   
(33%)
   
7
     
5
     
2
     
40%
     
18
     
13
     
5
     
38%
   
45
     
73
     
(28
)
   
(38%)
End of period number of top drives in rental fleet:
   
123
     
123
     
––
     
––%
   
123
     
123
     
––
     
––%
Rental operating days
   
6,144
     
4,441
     
1,703
     
38%
   
17,041
     
12,796
     
4,245
     
33%
Top drive rental utilization
   
64%
 
   
45%
 
           
19%
   
62%
 
   
44%
 
           
18%

Top Drive sales revenues  The increase in revenue for the three months ended September 30, 2010 compared to the same period in 2009 is due to an increase in the number of units sold during the respective periods as a result of being in the midst of a severe economic downturn during the third quarter of 2009 and being in a slight economic recovery in the third quarter of 2010.  The decrease in revenues for the nine months ended September 30, 2010 compared to the same period in 2009 is due to a decrease in the number of units sold during the same period, primarily due to our strong results in the first half of 2009 being driven by the fulfillment of backlog orders that were placed in 2008, prior to the downturn in the drilling industry in late 2008.

The selling price per unit varies significantly depending on the model, whether the unit was previously operated in our rental fleet and whether a power unit was included in the sale. Revenues related to the sale of used top drive units were $2.4 million and $2.9 million during the three months ended September 30, 2010 and 2009 and $7.1 million and $4.9 million for the nine months ended September 30, 2010 and 2009.

Top Drive rental services revenues — The increase in revenue for the three and nine months ended September 30, 2010 compared to the same period in 2009 is due to improved operating days and utilization rates during the respective periods.

Top Drive after-market sales and services revenues — Revenues for the three months ended September 30, 2010 have improved when compared to the same period in 2009, but revenues have decreased for the nine months ended September 30, 2010 compared to the same period in 2009.  This is due to this sector of the oil and natural gas industry being affected by pricing pressures from customers and decreased sales as a result of prolonged weakness during the latter part of 2009 and earlier part of 2010 with some improvement in the third quarter of 2010.

Top Drive operating income — The improvement in Top Drive operating income for the three months ended September 30, 2010 is a function of improved revenues for Top Drive sales, rental services, and after-market sales and services mentioned above, which were offset by pricing pressures from competition in Asia-Pacific and North America and costs to enter new markets for this sector in Latin American and Russia.  Top Drive operating income for the nine months ended September 30, 2010 is virtually unchanged from the same period in 2009, which is a function of lower Top Drive sales offset by higher Top Drive rental services operating days and improved utilization.

Outlook — Based upon existing drilling and bidding levels and current economic forecasts, we expect our top drive order rate and rental activity to moderately increase through the remainder of 2010.   Our outstanding backlog was 26 units at September 30, 2010 compared to 11 units at December 31, 2009.


Tubular Services Segment

Our Tubular Services business segment 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 services of deep water smart well completion equipment using our MCLRS, a proprietary and patented technology that improves the quality of the installation of high-end well completions.  Our conventional Tubular 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.

                                 
   
Three Months Ended September 30,
             
Nine Months Ended September 30,
           
   
Increase/Decrease
2010 to 2009
 
Increase/Decrease
2010 to 2009
   
2010
   
2009
   
2010
   
2009
 
(in thousands, except percentages)
                                       
Tubular Services revenues
                                           
Proprietary
 
$
23,107
   
$
20,233
   
$
2,874
     
14%
 
$
73,806
   
$
71,063
   
$
2,743
     
4%
Conventional
   
5,532
     
4,052
     
1,480
     
37%
   
15,388
     
18,147
     
(2,759
)
   
(15%)
   
$
28,639
   
$
24,285
   
$
4,354
     
18%
 
$
89,194
   
$
89,210
   
$
(16
)
   
––%
                                                             
Tubular Services operating income
 
$
1,893
   
$
(1,440
)
 
$
3,333
     
231%
 
$
7,075
   
$
(949
)
 
$
8,024
     
846%
                                                             
Number of proprietary jobs
   
770
     
683
     
87
     
13%
   
2,350
     
1,787
     
563
     
32%
                                                             

 The increase in Tubular Services revenues for the three months ended September 30, 2010 compared to the same period in 2009 is due to increased demand for our tubular services from customers active in shale gas exploration and production in the United States and Canada, partially offset by a decline in demand for our tubular services in the North Sea region.  Tubular Services revenues for the nine months ended September 30, 2010 were consistent with revenues for the same period in 2009, however, the nine months ended September 30, 2009 included $7.6 million of revenue for CDS equipment sales to one customer while no CDS equipment sales were made during the same period in 2010.

The improvement in Tubular Services operating income for the three months ended September 30, 2010 as compared to the same period in 2009 is a function of increased revenues as described above.  In addition, Tubular Services operating income increased significantly due to the restructuring of our North America Tubular Services division during 2009, which has resulted in cost savings of $1.2 million and $5.1 million in overhead and selling, general and administrative expenses for the three and nine months ended September 30, 2010 as compared to the same periods in 2009.
 
Outlook — We expect our proprietary services business to continue to grow moderately for the remainder of 2010 compared to 2009 and our conventional casing activities to maintain current levels or slightly decline as we continue to focus our efforts on the expansion of our proprietary casing service offerings. In addition, we continue to expand our tubular services activities in selected international locations and most major gas shale regions in North America.
 
 CASING DRILLING Segment

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 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.

                                 
   
Three Months Ended September 30,
             
Nine Months Ended September 30,
           
   
Increase/Decrease
 2010 to 2009
 
Increase/Decrease
2010 to 2009
   
2010
   
2009
   
2010
   
2009
 
(in thousands, except percentages)
                                       
CASING DRILLING revenues
 
$
3,086
   
$
3,132
   
$
(46
)
   
(1%)
 
$
8,353
   
$
10,892
   
$
(2,539
)
   
(23%)
CASING DRILLING operating income
 
$
(2,815
)
 
$
(3,072
)
 
$
257
     
8%
 
$
(8,633
)
 
$
(9,298
)
 
$
665
     
7%


CASING DRILLING revenues for the three months ended September 30, 2010 are comparable with the same period in 2009, while revenues for the nine months ended September 30, 2010 have decreased as compared to the same period in 2009.  This decrease is due to the delay or lack of work for CASING DRILLING in the first half of 2010 due to weak demand in this sector of the oil and natural gas industry.

The decrease in CASING DRILLING operating loss for the three and nine months ended September 30, 2010 compared to the same periods in 2009 is due to various cost reduction measures implemented in 2009 as well as a loss on sale of operating assets of $0.5 million in Latin America during the nine months ended September 30, 2009.

Outlook — Although we are have seen increased demand for CASING DRILLING in the third quarter of 2010, we have experienced losses in the CASING DRILLING segment over the past few years and expect losses to continue in the near term.  We routinely assess whether impairment indicators of our long-lived assets are present based on triggering events that include continued declines in the market or not achieving our internal projections in future years.  We believe that our CASING DRILLING business will be profitable in the future and become a more valuable and significant part of our operations.  Accordingly, we plan to maintain our existing CASING DRILLING infrastructure around the world while monitoring costs and streamlining internal processes.  If, in the future, we determine that an impairment of our CASING DRILLING long-lived assets has occurred, the amount of such impairment expense could be material to our results of operations, but we expect that it would not materially impact our cash flows or overall viability. 

Research and Engineering Segment

Our Research and Engineering segment is comprised of our internal research and development activities related to Tubular Services technology, CASING DRILLING technology and top drive model development.

                                 
   
Three Months Ended September 30,
             
Nine Months Ended September 30,
           
   
Increase/Decrease
 2010 to 2009
 
Increase/Decrease
 2010 to 2009
   
2010
   
2009
   
2010
   
2009
 
(in thousands, except percentages)
                                       
Research and engineering expense
 
$
2,317
   
$
2,092
   
$
225
     
11%
 
$
5,873
   
$
6,525
   
$
(652
)
   
(10%)

Research and engineering expenses increased in the third quarter of 2010 compared to the same period in 2009 as we continue to invest in the development, commercialization and enhancements of our proprietary technologies.  Research and engineering expense has decreased for the nine months ended September 30, 2010 due to non-recurring expenses recorded during the same period in 2009, including $0.4 million in severance costs and $0.2 million in relocation costs.

Corporate and Other Segment

Corporate and other expenses primarily consist of the corporate level general and administrative expenses and certain selling and marketing expenses.



                                 
   
Three Months Ended September 30,
             
Nine Months Ended September 30,
           
   
Increase/Decrease
 2010 to 2009
 
Increase/Decrease
 2010 to 2009
   
2010
   
2009
   
2010
   
2009
 
(in thousands, except percentages)
                                       
Corporate and other expenses
 
$
8,037
   
$
5,074
   
$
2,963
     
58%
 
$
25,112
   
$
25,296
   
$
(184
)
   
(1%)
Corporate and other expenses as a % of revenues
   
9%
     
7%
             
2%
   
9%
     
9%
             
––%
                                                             

The increase in corporate and other expenses for the three months ended September 30, 2010 compared to the same period in 2009 is due to increased incentive cash and stock compensation expense of $1.2 million and increased legal fees of $1.1 million in the third quarter of 2010.  Additionally, corporate and other expense was lower in the third quarter of 2009 due to the collection of $1.0 million of accounts receivable previously recorded as bad debt.    Corporate and other expenses as a total and as a percentage of revenues for the nine months ended September 30, 2010 were consistent with the same period in 2009.   

Other Expense (Income)

                                 
   
Three Months Ended September 30,
             
Nine Months Ended September 30,
           
   
Increase/Decrease
 2010 to 2009
 
Increase/Decrease
 2010 to 2009
   
2010
   
2009
   
2010
   
2009
 
(in thousands, except percentages)
                                       
Other expense (income)
                                           
Interest expense
 
$
155
   
$
497
   
$
(342
)
   
(69%)
 
$
406
   
$
1,451
   
$
(1,045
)
   
(72%)
Interest income
   
(33
)
   
(847
)
   
814
     
96%
   
(128
)
   
(896
)
   
768
     
86%
Foreign exchange losses
   
75
     
1,002
     
(927
)
   
(93%)
   
240
     
1,480
     
(1,240
)
   
(84%)
Other expense (income)
   
(153
)
   
(1
)
   
(152
)
   
nm
   
(623
)
   
143
     
(766
)
   
nm
Total other expense (income)
 
$
44
   
$
651
   
$
(607
)
   
(93%)
 
$
(105
)
 
$
2,178
   
$
(2,283
)
   
105%
 
nm  ––
Percentage is not meaningful

 Interest expense — Interest expense has decreased for the three and nine months ended September 30, 2010 as compared to the same period in 2009 as a result of the payment of all outstanding amounts owed under our credit facility in the first quarter of 2010.  Our average outstanding debt balance for the three and nine months ended September 30, 2010 was zero and less than $1 million compared to $42.6 million and $43.8 million for the same periods in 2009.

  Interest income — Interest income has decreased for the three and nine months ended September 30, 2010 as compared to the same period in 2009 primarily due to interest of $0.8 million received on a tax refund during the third quarter of 2009.
 
Foreign exchange losses — Effective January 1, 2010, and resulting from an analysis of U.S. dollar cash flows, we changed our functional currency in our Canadian operations from the Canadian dollar to the U.S. dollar. As a result, we have decreased exposure to fluctuations in the Canadian dollar during 2010 compared to the same periods in 2009.

 Other expense (income) — Other expense (income) has increased for the three and nine months ended September 30, 2010 as compared to the same periods in 2009 due to royalty income earned in 2010.


  Income Tax Provision (Benefit)
                     
   
Three Months Ended September 30,
       
Nine Months Ended September 30,
     
   
Increase/Decrease
2010 to 2009
 
Increase/Decrease
2010 to 2009
   
2010
   
2009
   
2010
   
2009
 
                                 
Effective income tax rate
   
35%
 
   
77%
 
   
(42%)
 
   
34%
 
   
221%
 
   
(187%)
 

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 rate is based on the laws and rates in effect in the countries in which our operations are conducted or in which we are considered a resident 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 earnings.
 
The effective tax rate for the three months ended September 30, 2009 was affected by several one-time adjustments, including $1.1 million of tax expense related to provision to return adjustments as a result of filing an amended 2008 tax return in Canada.  The effective tax rate for the nine months ended September 30, 2009, which resulted in recording an income tax benefit of $6.8 million based on a loss before income taxes