UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                      TO                     

ALLIS-CHALMERS ENERGY INC.

(Exact name of registrant as specified in its charter)

DELAWARE		39-0126090
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
5075 WESTHEIMER, SUITE 890, HOUSTON, TEXAS		77056
(Address of principal executive offices)		(Zip 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 þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer   o (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o      No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. At October 28, 2008 there were 35,513,739 shares of common stock, par value $0.01 per share, outstanding.

 

 

ALLIS-CHALMERS ENERGY INC.

FORM 10-Q

For the Quarterly Period Ended September 30, 2008

TABLE OF CONTENTS

		PAGE
PART I
ITEM
1. Financial Statements
Consolidated Condensed Balance Sheets as of September 30, 2008 and December 31, 2007			3
Consolidated Condensed Income Statements for the three and nine months ended September 30, 2008 and 2007			4
Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2008 and 2007			5
Notes to Consolidated Condensed Financial Statements			6
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			27
3. Quantitative and Qualitative Disclosures about Market Risk			38
4. Controls and Procedures			38
PART II
1A. Risk Factors			39
6. Exhibits			39
Signatures			40
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ALLIS-CHALMERS ENERGY INC.

(in thousands, except for share and per share amounts)

		September 30,				December 31,
		2008				2007
		(unaudited)
Assets
Cash and cash equivalents		$	6,810			$	43,693
Trade receivables, net			159,231				130,094
Inventories			35,816				32,209
Prepaid expenses and other			15,516				11,898
Total current assets			217,373				217,894
Property and equipment, net			694,040				626,668
Goodwill			137,548				138,398
Other intangible assets, net			30,670				35,180
Debt issuance costs, net			12,774				14,228
Note receivable			40,000				—
Other assets			41,472				21,217
Total assets		$	1,173,877			$	1,053,585
Liabilities and Stockholders’ Equity
Current maturities of long-term debt		$	8,819			$	6,434
Trade accounts payable			54,054				37,464
Accrued salaries, benefits and payroll taxes			20,063				15,283
Accrued interest			6,974				17,817
Accrued expenses			32,519				20,545
Total current liabilities			122,429				97,543
Long-term debt, net of current maturities			560,960				508,300
Deferred income taxes			35,680				30,090
Other long-term liabilities			2,641				3,323
Total liabilities			721,710				639,256
Commitments and contingencies
Stockholders’ Equity
Preferred stock, $0.01 par value (25,000,000 shares authorized, no shares issued)			—				—
Common stock, $0.01 par value (100,000,000 shares authorized; 35,513,739 issued and outstanding at September 30, 2008 and 35,116,035 issued and outstanding at December 31, 2007)			355				351
Capital in excess of par value			333,009				326,095
Retained earnings			118,803				87,883
Total stockholders’ equity			452,167				414,329
Total liabilities and stockholders’ equity		$	1,173,877			$	1,053,585

The accompanying Notes are an integral part of the Consolidated Condensed Financial Statements.

ALLIS-CHALMERS ENERGY INC.

(in thousands, except per share amounts)

(unaudited)

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Revenues		$	178,265			$	147,881			$	494,582			$	427,143
Cost of revenues
Direct costs			117,609				89,120				321,841				249,943
Depreciation			15,601				13,168				45,328				37,232
Gross margin			45,055				45,593				127,413				139,968
General and administrative			15,161				13,456				44,082				41,729
Gain on asset dispositions			(166	)			—				(166	)			(8,868	)
Amortization			1,027				989				3,214				3,015
Income from operations			29,033				31,148				80,283				104,092
Other income (expense):
Interest expense			(12,166	)			(11,805	)			(36,243	)			(37,671	)
Interest income			1,457				851				4,147				2,718
Other			115				32				591				308
Total other income (expense)			(10,594	)			(10,922	)			(31,505	)			(34,645	)
Income before income taxes			18,439				20,226				48,778				69,447
Provision for income taxes			(6,127	)			(7,239	)			(17,858	)			(24,791	)
Net income		$	12,312			$	12,987			$	30,920			$	44,656
Net income per common share:
Basic		$	0.35			$	0.37			$	0.88			$	1.32
Diluted		$	0.35			$	0.37			$	0.87			$	1.29
Weighted average shares outstanding:
Basic			35,156				34,784				35,004				33,934
Diluted			35,551				35,286				35,455				34,512

The accompanying Notes are an integral part of the Consolidated Condensed Financial Statements.

ALLIS-CHALMERS ENERGY INC.

(in thousands)

(unaudited)

		For the Nine Months Ended
		September 30,
		2008				2007
Cash Flows from Operating Activities:
Net income		$	30,920			$	44,656
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			48,542				40,247
Amortization and write-off of deferred financing fees			1,563				2,686
Stock-based compensation			6,212				2,132
Allowance for bad debts			1,505				441
Deferred taxes			4,315				3,142
Gain on sale of property and equipment			(1,206	)			(1,085	)
Gain on asset dispositions			(166	)			(8,868	)
Changes in operating assets and liabilities, net of acquisitions:
(Increase) in trade receivable			(30,642	)			(36,801	)
(Increase) in inventories			(6,961	)			(4,998	)
Decrease in prepaid expenses and other current assets			544				10,551
(Increase) decrease in other assets			(2,271	)			173
Increase in trade accounts payable			16,590				1,326
(Decrease) in accrued interest			(10,843	)			(5,093	)
Increase in accrued expenses			12,083				9,957
Increase in accrued salaries, benefits and payroll taxes			4,780				2,412
(Decrease) in other long-term liabilities			(682	)			(68	)
Net Cash Provided By Operating Activities			74,283				60,810
Cash Flows from Investing Activities:
Investment in note receivable			(40,000	)			—
Deposits on asset commitments			(9,219	)			—
Acquisition of businesses, net of cash received			—				(12,860	)
Purchase of investment interests			(5,763	)			(498	)
Proceeds from sale of property and equipment			6,004				5,988
Proceeds from asset dispositions			3,000				16,250
Purchase of property and equipment			(117,835	)			(86,087	)
Net Cash Used In Investing Activities			(163,813	)			(77,207	)
Cash Flows from Financing Activities:
Proceeds from issuance of stock, net			—				100,055
Proceeds from exercises of options			633				3,252
Proceeds from long-term debt			20,001				250,000
Net borrowings under line of credit			38,500				—
Payments on long-term debt			(6,451	)			(307,542	)
Tax benefits on stock-based compensation plans			73				1,559
Debt issuance costs			(109	)			(7,581	)
Net Cash Provided By Financing Activities			52,647				39,743
Net change in cash and cash equivalents			(36,883	)			23,346
Cash and cash equivalents at beginning of year			43,693				39,745
Cash and cash equivalents at end of period		$	6,810			$	63,091

The accompanying Notes are an integral part of the Consolidated Condensed Financial Statements.

ALLIS-CHALMERS ENERGY INC.

NOTE 1 — NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Allis-Chalmers Energy Inc. and subsidiaries (“Allis-Chalmers”, “we”, “our” or “us”) is a multi-faceted oilfield service company that provides services and equipment to oil and natural gas exploration and production companies, throughout the United States including Texas, Louisiana, New Mexico, Colorado, Oklahoma, Mississippi, Wyoming, Arkansas, West Virginia, offshore in the Gulf of Mexico, and internationally, primarily in Argentina and Mexico. We operate in three sectors of the oil and natural gas service industry: Oilfield Services; Drilling and Completion and Rental Services.

We derive operating revenues from rates per day and rates per job that we charge for the labor and equipment required to provide a service and rates per day for equipment and tools that we rent to our customers. The price we charge for our services depends upon several factors, including the level of oil and natural gas drilling activity and the competitive environment in the particular geographic regions in which we operate. Contracts are awarded based on price, quality of service and equipment and general reputation and experience of our personnel. The principal operating costs are direct and indirect labor and benefits, repairs and maintenance of our equipment, insurance, equipment rentals, fuel, depreciation and general and administrative expenses.

Basis of Presentation

Our unaudited consolidated condensed financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC. Accordingly, certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. We believe that the presentations and disclosures herein are adequate to make the information not misleading. The unaudited consolidated condensed financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the interim periods. These unaudited consolidated condensed financial statements should be read in conjunction with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year.

Certain reclassifications have been made to the prior year’s consolidated condensed financial statements to conform with the current period presentation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Future events and their effects cannot be perceived with certainty. Accordingly, our accounting estimates require the exercise of judgment. While management believes that the estimates and assumptions used in the preparation of the consolidated financial statements are appropriate, actual results could differ from those estimates. Estimates are used for, but are not limited to, determining the following: allowance for doubtful accounts, recoverability of long-lived assets and intangibles, useful lives used in depreciation and amortization, income taxes and valuation allowances. The accounting estimates used in the preparation of the consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes.

On January 29, 2008, we created the positions of Senior Vice President – Oilfield Services and Senior Vice President – Rental Services. In conjunction with this organizational change, we reviewed the presentation of our reporting segments during the first quarter of 2008. Based on this review, we determined that our operational performance would be segmented and reviewed by the Oilfield Services, Drilling and Completion and Rental Services segments. The Oilfield Services segment includes our underbalanced drilling, directional drilling, tubular services and production services operations. The Drilling and Completion segment includes our international drilling operations. As a result, we realigned our financial reporting segments and now report the following operations as separate, distinct reporting segments: (1) Oilfield Services, (2) Drilling and Completion and (3) Rental Services. Our historical segment data previously reported for the three and nine months ended September 30, 2007 and year ended December 31, 2007 have been restated to conform to the new presentation (see Note 11).

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

In September 2006, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements, or SFAS No. 157. SFAS No. 157 clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. Subsequently, the FASB provided for a one-year deferral of the provisions of SFAS No. 157 for non-financial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a non-recurring basis. We adopted with no impact on our financial statements all requirements of SFAS No. 157 on January 1, 2008, except as they relate to nonfinancial assets and liabilities, which will be adopted on January 1, 2009, as allowed under SFAS No. 157. We have not yet determined the impact, if any, on our financial statements for nonfinancial assets and liabilities.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, or SFAS No. 159, which permits entities to elect to measure many financial instruments and certain other items at fair value.  Upon adoption of SFAS No. 159, an entity may elect the fair value option for eligible items that exist at the adoption date. Subsequent to the initial adoption, the election of the fair value option should only be made at the initial recognition of the asset or liability or upon a re-measurement event that gives rise to the new-basis of accounting. All subsequent changes in fair value for that instrument are reported in earnings.  SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be recorded at fair value nor does it eliminate disclosure requirements included in other accounting standards.  SFAS No. 159 is effective as of the beginning of each reporting entity’s first fiscal year that begins after November 15, 2007.  We adopted SFAS No. 159 on January 1, 2008 and there was no impact on our financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations, or SFAS No. 141(R). SFAS No. 141(R) changes the requirements for an acquirer’s recognition and measurement of the assets acquired and the liabilities assumed in a business combination. SFAS No. 141(R) is effective for annual periods beginning after December 15, 2008 and should be applied prospectively for all business combinations entered into after the date of adoption.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Non-controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51, or SFAS No. 160. SFAS No. 160 requires (i) that non-controlling (minority) interests be reported as a component of shareholders’ equity, (ii) that net income attributable to the parent and to the non-controlling interest be separately identified in the consolidated statement of operations, (iii) that changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions, (iv) that any retained non-controlling equity investment upon the deconsolidation of a subsidiary be initially measured at fair value, and (v) that sufficient disclosures are provided that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. SFAS No. 160 is effective for annual periods beginning after December 15, 2008 and should be applied prospectively. The presentation and disclosure requirements of the statement shall be applied retrospectively for all periods presented. We will adopt SFAS No. 160 on January 1, 2009 and have not yet determined the impact, if any, on our financial statements.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133, or SFAS No. 161. SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative data about the fair value of and gains and losses on derivative contracts, and details of credit-risk-related contingent features in hedged positions. The statement also requires enhanced disclosures regarding how and why entities use derivative instruments, how derivative instruments and related hedged items are accounted and how derivative instruments and related hedged items affect entities’ financial position, financial performance, and cash flows. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. We will adopt SFAS No. 161 on January 1, 2009 and do not expect the adoption to have a material impact on our financial statements.

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

In April 2008, the FASB issued FASB Staff Position SFAS 142-3, Determination of the Useful Life of Intangible Assets, or FSP SFAS 142-3. FSP SFAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, or SFAS No. 142. The objective of FSP SFAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141R, Business Combinations, and other U.S. GAAP principles. FSP SFAS 142-3 is effective for fiscal years beginning after December 15, 2008. We will adopt FSP SFAS 142-3 on January 1, 2009 and have not yet determined the impact, if any, on our financial statements.

NOTE 2 – ASSET DISPOSITIONS

Effective August 1, 2008, we sold our drill pipe tong manufacturing assets for approximately $7.5 million. We received cash of approximately $2.0 million at the time of sale, a 90-day note for $1.0 million and a 10-year non-interest bearing note for $4.5 million. Repayment on the 10-year note is tied to various performance targets and we have assigned a fair value of approximately $3.1 million to this note. We reported a gain of approximately $166,000 on this transaction. The assets sold represented a small portion of our Oilfield Services segment.

On June 29, 2007, we sold our capillary tubing units and related equipment for approximately $16.3 million. We reported a gain of approximately $8.9 million on this transaction. The assets sold represented a small portion of our Oilfield Services segment.

NOTE 3 – STOCK-BASED COMPENSATION

We adopted Statement of Financial Accounting Standards No. 123R, Share-Based Payment, effective January 1, 2006. This statement requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their grant-date fair values. We estimated forfeiture rates for the first nine months of 2008 and 2007 based on our historical experience.

The Black-Scholes model incorporates assumptions to value stock-based awards. The risk-free rate of interest is the related U.S. Treasury yield curve for periods within the expected term of the option at the time of grant. The dividend yield on our common stock is assumed to be zero as we have historically not paid dividends and have no current plans to do so in the future. The expected volatility is based on historical volatility of our common stock.

Our net income for the three months ended September 30, 2008 and 2007 includes approximately $1.8 million and $1.0 million, respectively, of compensation costs related to share-based payments. Our net income for the nine months ended September 30, 2008 and 2007 includes approximately $6.2 million and $2.1 million, respectively, of compensation costs related to share-based payments. As of September 30, 2008, there is $1.7 million of unrecognized compensation expense related to non-vested stock option grants. We expect approximately $230,000 to be recognized over the remainder of 2008, and approximately $918,000 and $532,000 to be recognized during the years ended 2009 and 2010, respectively.

A summary of our stock option activity and related information is as follows:

						Weighted				Weighted
		Shares				Average				Average				Aggregate
		Under				Exercise				Contractual				Intrinsic Value
		Option				Price				Life (Years)				(millions)
Balance at December 31, 2007			986,763			$	10.77
Granted			—				—
Canceled			(7,328	)			10.53
Exercised			(71,703	)			8.83
Outstanding at September 30, 2008			907,732				10.93				7.21			$	3.59
Exercisable at September 30, 2008			731,732			$	8.30				6.82			$	3.59

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the closing price of our common stock on the last trading day of the third quarter of 2008 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2008. The total intrinsic value of options exercised during the three months and nine months ended September 30, 2008 was $64,000 and $542,000, respectively. The total cash received from option exercises during the three months and nine months ended September 30, 2008 was $24,000 and $633,000, respectively.

No options were granted during the nine months ended September 30, 2008. The following summarizes the assumptions used for the options granted in the three and nine months ended September 30, 2007 Black-Scholes model:

		For the Three Months Ended				For the Nine Months Ended
		September 30,				September 30,
		2007				2007
Expected dividend yield			—				—
Expected price volatility			66.17	%			66.21	%
Risk free interest rate			4.82	%			4.81	%
Expected life of options		5 years				5 years
Weighted average fair value of options granted at market value		$	12.90			$	12.86

Restricted stock awards, or RSAs, activity during the nine months ended September 30, 2008 were as follows: 

						Weighted Average
		Number of				Grant-Date Fair Value
		Shares				Per Share
Nonvested at December 31, 2007			993,203			$	17.45
Granted			97,667				16.76
Vested			(252,574	)			17.06
Forfeited			—				—
Nonvested at September 30, 2008			838,296			$	17.49

We determine the fair value of RSAs based on the market price of our common stock on the date of grant. Compensation cost for RSAs is primarily recognized on a straight-line basis over the vesting or service period and is net of forfeitures. As of September 30, 2008, there was $10.0 million of total unrecognized compensation cost related to nonvested RSAs. We expect approximately $1.4 million to be recognized over the remainder of 2008, and approximately $5.6 million, $2.3 million, $528,000 and $209,000 to be recognized during fiscal years 2009, 2010, 2011 and 2012, respectively.

NOTE 4 – INCOME PER COMMON SHARE

We compute income per common share in accordance with the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share, or SFAS No. 128. SFAS No. 128 requires companies with complex capital structures to present basic and diluted earnings per share. Basic earnings per share are computed on the basis of the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is similar to basic earnings per share, but presents the dilutive effect on a per share basis of potential common shares (e.g., convertible preferred stock, stock options, etc.) as if they had been converted. Potential dilutive common shares that have an anti-dilutive effect (e.g., those that increase income per share) are excluded from diluted earnings per share.

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

The components of basic and diluted earnings per share are as follows (in thousands, except per share amounts):

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Numerator:
Net income		$	12,312			$	12,987			$	30,920			$	44,656
Denominator:
Weighted average common shares outstanding excluding nonvested restricted stock			35,156				34,784				35,004				33,934
Effect of potentially dilutive common shares:
Warrants and employee and director stock options and restricted shares			395				502				451				578
Weighted average common shares outstanding and assumed conversions			35,551				35,286				35,455				34,512
Net income per common share
Basic		$	0.35			$	0.37			$	0.88			$	1.32
Diluted		$	0.35			$	0.37			$	0.87			$	1.29
Potentially dilutive securities excluded as anti-dilutive			786				905				776				1,031

NOTE 5 – GOODWILL AND INTANGIBLE ASSETS

In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, or SFAS No. 142, goodwill and indefinite-lived intangible assets are not permitted to be amortized. Goodwill and indefinite-lived intangible assets remain on the balance sheet and are tested for impairment on an annual basis, or when there is reason to suspect that their values may have been diminished or impaired. Goodwill and indefinite-lived intangible assets listed on the balance sheet totaled $137.5 million and $138.4 million at September 30, 2008 and December 31, 2007, respectively.  The decrease in the value of Goodwill and indefinite-lived intangible assets is attributable to the value of assets sold in conjunction with the sale or our drill pipe tong manufacturing. Based on impairment testing performed during 2007 pursuant to the requirements of SFAS No. 142, these assets were not impaired.

Intangible assets with definite lives continue to be amortized over their estimated useful lives.  Definite-lived intangible assets that continue to be amortized under SFAS No. 142 relate to our purchase of customer-related and marketing-related intangibles. These intangibles have useful lives ranging from five to ten years. Amortization of intangible assets for the three and nine months ended September 30, 2008 were $1.0 million and $3.2 million, respectively, compared to $989,000 and $3.0 million for the same periods last year.  At September 30, 2008, intangible assets totaled $30.7 million, net of $8.3 million of accumulated amortization.

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

NOTE 6 – INVENTORIES

Inventories consisted of the following (in thousands):

		September 30,				December 31,
		2008				2007
Manufactured
Finished goods		$	2,984			$	2,198
Work in process			1,393				1,781
Raw materials			1,389				4,464
Total manufactured			5,766				8,443
Hammers			2,077				1,434
Drive pipe			549				420
Rental supplies			3,372				2,261
Chemicals and drilling fluids			3,753				3,236
Rig parts and related inventory			10,724				9,985
Coiled tubing and related inventory			2,272				1,014
Shop supplies and related inventory			7,303				5,416
Total inventories		$	35,816			$	32,209

NOTE 7 – NOTE RECEIVABLE

In January 2008, we invested $40.0 million in cash in BCH Ltd., or BCH, in the form of a 15% Convertible Subordinated Secured debenture with a maturity date of January 31, 2010. The debenture is convertible, at any time, at our option into 49% of the common equity of BCH. At the end of two years, we have the option to acquire the remaining 51% of BCH from its parent, BrazAlta Resources Corp., or BrazAlta, based on an independent valuation from a mutually acceptable investment bank. BrazAlta is a publicly traded Canadian-based international oil and gas corporation with operations in Brazil, Northern Ireland, and Canada (TSX.V:BRX).

In addition, we acquired 2,192,750 shares of BCH, or approximately 15% of the outstanding shares of BCH, in September 2008. We converted accrued interest on the debenture into 840,739 shares and paid $5.6 million in cash for the other 1,352,011 shares. BrazAlta owns the remaining 85% of BCH.

BCH is a Canadian-based oilfield services company engaged in contract drilling operations exclusively in Brazil. BCH has six drilling rigs under one to three year contracts with Petroleo Brasileiro S.A., and a contract for one service rig with BrazAlta for a term of three years.

NOTE 8 – DEBT

Our long-term debt consisted of the following (in thousands):

		September 30,				December 31,
		2008				2007
Senior notes		$	505,000			$	505,000
Bank term loans			23,109				4,926
Revolving line of credit			38,500				—
Seller notes			1,250				2,350
Notes payable to former directors			32				32
Equipment and vehicle installment notes			—				595
Insurance premium financing			1,888				1,707
Obligations under non-compete agreements			—				110
Capital lease obligations			—				14
Total debt			569,779				514,734
Less: current maturities			8,819				6,434
Long-term debt obligations		$	560,960			$	508,300

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

Senior notes, bank loans and line of credit agreements

On January 18, 2006 and August 14, 2006, we closed on private offerings, to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, of $160.0 and $95.0 million aggregate principal amount of our senior notes, respectively. The senior notes are due January 15, 2014 and bear interest at 9.0%. The proceeds were used to fund the acquisitions of Specialty Rental Tools, Inc. and DLS Drilling, Logistics & Services Corporation, or DLS, to repay existing debt and for general corporate purposes.

In January 2007, we closed on a private offering, to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, of $250.0 million aggregate principal amount of 8.5% senior notes due 2017. The proceeds of the senior notes offering, together with a portion of the proceeds of our concurrent common stock offering, were used to repay the debt outstanding under our $300.0 million bridge loan facility, which we incurred to finance our acquisition of substantially all the assets of Oil & Gas Rental Services, Inc., or OGR.

On January 18, 2006, we also executed an amended and restated credit agreement which provided for a $25.0 million revolving line of credit with a maturity of January 2010. On April 26, 2007, we entered into a Second Amended and Restated Credit Agreement, which increased our revolving line of credit to $62.0 million, and has a final maturity date of April 26, 2012. On December 3, 2007, we entered into a First Amendment to the Second Amended and Restated Credit Agreement, which increased our revolving line of credit to $90.0 million. The credit agreement contains customary events of default and financial covenants and limits our ability to incur additional indebtedness, make capital expenditures, pay dividends or make other distributions, create liens and sell assets. Our obligations under the amended and restated credit agreement are secured by substantially all of our assets located in the United States. We were in compliance with all debt covenants as of September 30, 2008. The credit agreement loan rates are based on prime or LIBOR plus a margin. The interest rate was 4.6% at September 30, 2008. The outstanding amount as of September 30, 2008 and December 31, 2007, was $38.5 million and $0, respectively.

As part of our acquisition of DLS, we assumed various bank loans with floating interest rates based on LIBOR plus a margin and terms ranging from two to five years. The weighted average interest rates were 5.1% and 6.7% at September 30, 2008 and December 31, 2007, respectively. The bank loans are denominated in U.S. dollars and the outstanding amount as of September 30, 2008 and December 31, 2007 were $3.1 million and $4.9 million, respectively.

On February 15, 2008, through our DLS subsidiary in Argentina, we entered into a $25.0 million import finance facility with a bank. Borrowings under this facility will be used to fund a portion of the purchase price of the new drilling and service rigs ordered for our Drilling and Completion segment. The facility is available for borrowings until December 31, 2008. Each drawdown shall be repaid over four years in equal semi-annual installments beginning one year after each disbursement with the final principal payment due not later than March 15, 2013. The import finance facility is unsecured and contains customary events of default and financial covenants and limits DLS’ ability to incur additional indebtedness, make capital expenditures, create liens and sell assets. We were in compliance with all debt covenants as of September 30, 2008. The bank loan rates are based on LIBOR plus a margin. The interest rate was 6.7% at September 30, 2008. The bank loans are denominated in U.S. dollars and the outstanding amount as of September 30, 2008 was $20.0 million.

Notes payable

In connection with the acquisition of Rogers Oil Tool Services, Inc., we issued to the seller a note in the amount of $750,000. The note bears interest at 5.0% and is due April 3, 2009. In connection with the acquisition of Coker Directional, Inc., we issued to the seller a note in the amount of $350,000. The interest rate on the note was 8.25% and was repaid on June 29, 2008. In connection with the acquisition of Diggar Tools, LLC, we issued to the seller a note in the amount of $750,000. The interest rate on the note was 6.0% and was repaid on July 28, 2008. In connection with the acquisition of Rebel Rentals, Inc., we issued to the sellers notes in the aggregate amount of $500,000. The notes bear interest at 5.0% and were paid October 29, 2008.

In 2000 we compensated directors, including current directors Nederlander and Toboroff, who served on the board of directors from 1989 to March 31, 1999 without compensation, by issuing promissory notes totaling $325,000. The notes bore interest at the rate of 5.0%. At September 30, 2008 and December 31, 2007, the principal and accrued interest on these notes totaled approximately $32,000.

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

We had various equipment and vehicle financing loans with interest rates ranging from 8.3% to 8.7% and two year terms. As of September 30, 2008 and December 31, 2007, the outstanding balances for equipment and vehicle financing loans were $0 and $595,000, respectively.

In April and August 2007, we obtained insurance premium financings in the aggregate amount of $4.4 million with a fixed weighted average interest rate of 5.9%. Under terms of the agreements, amounts outstanding are paid over 10 month and 11 month repayment schedules. The outstanding balance of these notes was approximately $0 and $1.7 million as of September 30, 2008 and December 31, 2007, respectively. In April and August 2008, we obtained insurance premium financings in the aggregate amount of $3.0 million with a weighted average interest rate of 4.9%. Under terms of the agreements, amounts outstanding are paid over 10 month and 11 month repayment schedules. The outstanding balance of these notes was approximately $1.9 million as of September 30, 2008.

Other debt

In connection with the purchase of Capcoil Tubing Services, Inc., we agreed to pay a total of $500,000 to two management employees in exchange for non-compete agreements. We were required to make annual payments of $110,000 through May 2008. Total amounts due under these non-compete agreements at September 30, 2008 and December 31, 2007 were $0 and $110,000, respectively.

We also had various capital leases with terms that expired in 2008. As of September 30, 2008 and December 31, 2007, amounts outstanding under capital leases were $0 and $14,000, respectively.

NOTE 9 – STOCKHOLDERS’ EQUITY

We had options exercised in the first nine months of 2008, which resulted in 71,703 shares of our common stock being issued for approximately $633,000. We recognized approximately $6.2 million of compensation expense related to share-based payments in the first nine months of 2008 that was recorded as capital in excess of par value (see Note 3). We also recorded approximately $73,000 of tax benefit related to our stock compensation plans for the nine months ended September 30, 2008.

NOTE 10 – CONDENSED CONSOLIDATING FINANCIAL INFORMATION

Set forth on the following pages are the condensed consolidating financial statements of (i) Allis-Chalmers Energy Inc., (ii) its subsidiaries that are guarantors of the senior notes and revolving credit facility and (iii) the subsidiaries that are not guarantors of the senior notes and revolving credit facility (in thousands, except for share and per share amounts).

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

CONDENSED CONSOLIDATING BALANCE SHEETS
September 30, 2008 (unaudited)

		Allis-Chalmers								Subsidiary
		(Parent/				Subsidiary				Non-				Consolidating				Consolidated
		Guarantor)				Guarantors				Guarantors				Adjustments				Total
Assets
Cash and cash equivalents		$	—			$	5,637			$	1,173			$	—			$	6,810
Trade receivables, net			—				96,251				62,988				(8	)			159,231
Inventories			—				18,246				17,570				—				35,816
Intercompany receivables			23,675				—				—				(23,675	)			—
Note receivable from affiliate			17,297				—				—				(17,297	)			—
Prepaid expenses and other			7,742				4,126				3,648				—				15,516
Total current assets			48,714				124,260				85,379				(40,980	)			217,373
Property and equipment, net			—				489,567				204,473				—				694,040
Goodwill			—				136,025				1,523				—				137,548
Other intangible assets, net			517				30,122				31				—				30,670
Debt issuance costs, net			12,774				—				—				—				12,774
Note receivable from affiliates			13,428				—				—				(13,428	)			—
Investments in affiliates			892,308				—				—				(892,308	)			—
Note receivable			40,000				—				—				—				40,000
Other assets			9,830				26,510				5,132				—				41,472
Total Assets		$	1,017,571			$	806,484			$	296,538			$	(946,716	)		$	1,173,877
Liabilities and Stockholders’ Equity
Current maturities of long-term debt		$	782			$	2,388			$	5,649			$	—			$	8,819
Trade accounts payable			—				22,491				31,571				(8	)			54,054
Accrued salaries, benefits and payroll taxes			—				4,767				15,296				—				20,063
Accrued interest			6,780				23				171				—				6,974
Accrued expenses			973				16,641				14,905				—				32,519
Intercompany payables			—				380,208				1,185				(381,393	)			—
Note payable to affiliate			—				—				17,297				(17,297	)			—
Total current liabilities			8,535				426,518				86,074				(398,698	)			122,429
Long-term debt, net of current maturities			543,500				—				17,460				—				560,960
Note payable to affiliate			—				—				13,428				(13,428	)			—
Deferred income taxes			13,369				13,695				8,616				—				35,680
Other long-term liabilities			—				75				2,566				—				2,641
Total liabilities			565,404				440,288				128,144				(412,126	)			721,710
Commitments and contingencies
Stockholders’ Equity
Common stock			355				3,526				42,963				(46,489	)			355
Capital in excess of par value			333,009				167,508				74,969				(242,477	)			333,009
Retained earnings			118,803				195,162				50,462				(245,624	)			118,803
Total stockholders’ equity			452,167				366,196				168,394				(534,590	)			452,167
Total liabilities and stockholders’ equity		$	1,017,571			$	806,484			$	296,538			$	(946,716	)		$	1,173,877

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

For the Nine Months Ended September 30, 2008 (unaudited)

		Allis-Chalmers								Subsidiary
		(Parent/				Subsidiary				Non-				Consolidating				Consolidated
		Guarantor)				Guarantors				Guarantors				Adjustments				Total
Revenues		$	—			$	283,961			$	210,640			$	(19	)		$	494,582
Cost of revenues
Direct costs			—				158,887				162,973				(19	)			321,841
Depreciation			—				35,070				10,258				—				45,328
Gross margin			—				90,004				37,409				—				127,413
General and administrative			5,480				30,814				7,788				—				44,082
Gain on asset dispositions			—				(166	)			—				—				(166	)
Amortization			35				3,154				25				—				3,214
Income (loss) from operations			(5,515	)			56,202				29,596				—				80,283
Other income (expense):
Equity earnings in affiliates, net of tax			67,898				—				—				(67,898	)			—
Interest, net			(31,520	)			62				(638	)			—				(32,096	)
Other			57				97				437				—				591
Total other income (expense)			36,435				159				(201	)			(67,898	)			(31,505	)
Net income (loss)before income taxes			30,920				56,361				29,395				(67,898	)			48,778
Provision for income taxes			—				(7,329	)			(10,529	)			—				(17,858	)
Net income (loss)		$	30,920			$	49,032			$	18,866			$	(67,898	)		$	30,920

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

CONDENSED CONSOLIDATING INCOME STATEMENTS
For the Three Months Ended September 30, 2008 (unaudited)

		Allis-Chalmers								Subsidiary
		(Parent/				Subsidiary				Non-				Consolidating				Consolidated
		Guarantor)				Guarantors				Guarantors				Adjustments				Total
Revenues		$	—			$	100,510			$	77,761			$	(6	)		$	178,265
Cost of revenues
Direct costs			—				57,642				59,973				(6	)			117,609
Depreciation			—				11,903				3,698				—				15,601
Gross margin			—				30,965				14,090				—				45,055
General and administrative			1,590				10,826				2,745				—				15,161
Gain on asset dispositions			—				(166	)			—				—				(166	)
Amortization			12				1,007				8				—				1,027
Income (loss) from operations			(1,602	)			19,298				11,337				—				29,033
Other income (expense):
Equity earnings in affiliates, net of tax			24,198				—				—				(24,198	)			—
Interest, net			(10,299	)			2				(412	)			—				(10,709	)
Other			15				73				27				—				115
Total other income (expense)			13,914				75				(385	)			(24,198	)			(10,594	)
Net income (loss)before income taxes			12,312				19,373				10,952				(24,198	)			18,439
Provision for income taxes			—				(2,880	)			(3,247	)			—				(6,127	)
Net income (loss)		$	12,312			$	16,493			$	7,705			$	(24,198	)		$	12,312

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOW
For the Nine Months Ended September 30, 2008 (unaudited)

		Allis-								Other
		Chalmers								Subsidiaries
		(Parent/				Subsidiary				(Non-				Consolidating				Consolidated
		Guarantor)				Guarantors				Guarantors)				Adjustments				Total
Cash Flows from Operating Activities:
Net income (loss)		$	30,920			$	49,032			$	18,866			$	(67,898	)		$	30,920
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization			35				38,224				10,283				—				48,542
Amortization and write-off of deferred financing fees			1,563				—				—				—				1,563
Stock based compensation			6,212				—				—				—				6,212
Allowance for bad debts			—				1,505				—				—				1,505
Equity earnings in affiliates			(67,898	)			—				—				67,898				—
Deferred taxes			4,708				(108	)			(285	)			—				4,315
Gain on sale of property and equipment			—				(1,097	)			(109	)			—				(1,206	)
Gain on asset dispositions			—				(166	)			—				—				(166	)
Changes in operating assets and liabilities, net of acquisitions:
(Increase) in trade receivables			—				(14,627	)			(16,015	)			—				(30,642	)
(Increase) in inventories			—				(5,901	)			(1,060	)			—				(6,961	)
(Increase) decrease in prepaid expenses and other current assets			(8	)			1,319				(767	)			—				544
(Increase) decrease in other assets			(4,073	)			1,034				768				—				(2,271	)
Increase in trade accounts payable			—				5,673				10,917				—				16,590
(Decrease) increase in accrued interest			(10,929	)			(10	)			96				—				(10,843	)
(Decrease) increase in accrued expenses			(687	)			9,623				3,147				—				12,083
Increase in accrued salaries, benefits and payroll taxes			—				1,055				3,725				—				4,780
(Decrease) in other long- term liabilities			(31	)			(167	)			(484	)			—				(682	)
Net Cash Provided By (Used In) Operating Activities			(40,188	)			85,389				29,082				—				74,283
Cash Flows from Investing Activities:
Notes receivable from affiliates			(6,075	)			—				—				6,075				—
Investment in note receivable			(40,000	)			—				—				—				(40,000	)
Deposits on asset commitments			—				(19,544	)			10,325				—				(9,219	)
Purchase of investment interests			(5,742	)			(21	)			—				—				(5,763	)
Proceeds from sale of property and equipment			—				5,738				266				—				6,004
Proceeds from asset disposition			—				3,000				—				—				3,000
Purchase of property and equipment			—				(52,560	)			(65,275	)			—				(117,835	)
Net Cash Provided By (Used in) Investing Activities			(51,817	)			(63,387	)			(54,684	)			6,075				(163,813	)

ALLIS-CHALMERS ENERGY INC.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOW
For the Nine Months Ended September 30, 2008 (unaudited)

		Allis-								Other
		Chalmers								Subsidiaries
		(Parent/				Subsidiary				(Non-				Consolidating				Consolidated
		Guarantor)				Guarantors				Guarantors)				Adjustments				Total
Cash Flows from Financing Activities:
Accounts receivable from affiliates			52,908				—				—				(52,908	)			—
Accounts payable to affiliates			—				(52,908	)			—				52,908				—
Note payable to affiliate			—				—				6,075				(6,075	)			—
Proceeds from exercises of options			633				—				—				—				633
Proceeds from long-term debt			—				—				20,001				—				20,001
Net borrowing under line of credit			38,500				—				—				—				38,500
Payments on long-term debt			—				(4,633	)			(1,818	)			—				(6,451	)
Tax benefit on stock-based compensation plans			73				—				—				—				73
Debt issuance costs			(109	)			—				—				—				(109	)
Net Cash Provided By (Used In) Financing Activities			92,005				(57,541	)			24,258				(6,075	)			52,647
Net change in cash and cash equivalents			—				(35,539	)			(1,344	)			—				(36,883	)
Cash and cash equivalents at beginning of year			—				41,176				2,517				—				43,693
Cash and cash equivalents at end of period		$	—			$	5,637			$	1,173			$	—			$	6,810