UNITED STATE 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, 2005

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)

(713) 369-0550
Registrant’s telephone number, including area code

Title of Security:		Name of Exchange:
Common Stock, par value $0.01 per share		American Stock Exchange

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 an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No 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 o

At October 17, 2005 there were 16,572,328 shares of common stock outstanding.

 

 

ALLIS-CHALMERS ENERGY INC.

FORM 10-Q

For the Quarterly Period Ended September 30, 2005

TABLE OF CONTENTS

ITEM				PAGE
PART I
1.		Financial Statements
		Consolidated Condensed Balance Sheets as of September 30, 2005 and December 31, 2004			3
		Consolidated Condensed Income Statements for the three months and nine months ended September 30, 2005 and 2004			4
		Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2005 and 2004			5
		Notes to Consolidated Condensed Financial Statements			6
2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
3.		Quantitative and Qualitative Disclosures about Market Risk			30
4.		Controls and Procedures			31
PART II
1.		Legal Proceedings			32
2.		Unregistered Sales of Equity Securities and Use of Proceeds			32
4.		Submission of Matters to a Vote of Security Holders			32
6.		Exhibits			33
Signatures and Certifications					33
Certification of CEO pursuant to Section 302
Certification of CFO pursuant to Section 302
Certification of CEO and CFO pursuant to Section 906

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ALLIS-CHALMERS ENERGY INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands, except for share and per share amounts)

		September 30,				December 31,
		2005				2004
		(unaudited)
Assets
Cash and cash equivalents		$	3,909			$	7,344
Trade receivables, net			23,777				12,986
Inventory			5,217				2,373
Lease receivable, current			—				180
Prepaid expenses and other			1,014				1,495
Total current assets			33,917				24,378
Property and equipment, net			75,516				37,679
Goodwill			12,042				11,776
Other intangible assets, net			7,264				5,057
Debt issuance costs, net			783				685
Lease receivable, less current portion			—				558
Other assets			40				59
Total assets		$	129,562			$	80,192
Liabilities and Stockholders’ Equity
Current maturities of long-term debt		$	4,636			$	5,541
Trade accounts payable			8,703				5,694
Accrued salaries, benefits and payroll taxes			701				615
Accrued interest			462				470
Accrued expenses			4,688				1,852
Accounts payable, related parties			78				740
Total current liabilities			19,268				14,912
Accrued postretirement benefit obligations			335				687
Long-term debt, net of current maturities			51,491				24,932
Deferred income taxes			750				—
Other long-term liabilities			342				129
Total liabilities			72,186				40,660
Commitments and contingencies
Minority interests			—				4,423
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; 16,453,714 issued and outstanding at September 30, 2005 and 20,000,000 shares authorized and 13,611,525 issued and outstanding at December 31, 2004)			165				136
Capital in excess of par value			57,940				40,331
Accumulated deficit			(729	)			(5,358	)
Total stockholders’ equity			57,376				35,109
Total liabilities and stockholders’ equity		$	129,562			$	80,192

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

ALLIS-CHALMERS ENERGY INC.
CONSOLIDATED CONDENSED INCOME STATEMENTS
(in thousands, except per share amounts)
(unaudited)

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
						(Restated)								(Restated)
Revenues		$	28,908			$	11,888			$	71,830			$	32,989
Cost of revenues
Direct costs			19,280				7,633				47,756				22,395
Depreciation			1,391				591				3,397				1,796
Total cost of revenues			20,671				8,224				51,153				24,191
Gross margin			8,237				3,664				20,677				8,798
General and administrative			4,261				2,227				10,720				4,781
Amortization			452				198				1,272				600
Income from operations			3,524				1,239				8,685				3,417
Other income (expense):
Interest			(977	)			(566	)			(2,143	)			(1,634	)
Debt retirement			(1,087	)			—				(1,087	)			—
Other			63				19				221				224
Total other income (expense)			(2,001	)			(547	)			(3,009	)			(1,410	)
Net income before minority interest and income taxes			1,523				692				5,676				2,007
Minority interest in income of subsidiaries			—				(34	)			(488	)			(248	)
Provision for income taxes			(230	)			(139	)			(559	)			(359	)
Net income			1,293				519				4,629				1,400
Preferred stock dividend			—				—				—				(124	)
Net income attributed to common shareholders		$	1,293			$	519			$	4,629			$	1,276
Net income per common share:
Basic		$	0.09			$	0.06			$	0.33			$	0.21
Diluted		$	0.08			$	0.05			$	0.30			$	0.18
Weighted average shares outstanding:
Basic			14,985				8,298				14,197				6,168
Diluted			16,601				9,828				15,589				7,890

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

ALLIS-CHALMERS ENERGY INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

		For the Nine Months Ended
		September 30,
		2005				2004
						(Restated)
Cash Flows from Operating Activities:
Net income		$	4,629			$	1,400
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			3,397				1,796
Amortization			1,272				600
Amortization of note discount			9				143
Fair value of warrant issued to consultant							14
Write-off of deferred financing due to refinancing			653				—
Minority interest in income of subsidiaries			488				248
Changes in operating assets and liabilities, net of acquisitions:
(Increase) in trade receivable			(7,250	)			(1,417	)
(Increase) in other current assets			(1,522	)			(412	)
(Increase) in other assets			(171	)			(39	)
Increase (decrease) in accounts payable			1,058				(725	)
Increase in accrued interest			497				131
Increase (decrease) in accrued expenses			1,269				(471	)
(Decrease) in accrued salaries, benefits and payroll taxes			(287	)			(557	)
(Decrease) in other long-term liabilities			(160	)			(141	)
Net Cash Provided By Operating Activities			3,882				570
Cash Flows from Investing Activities:
Acquisition of businesses, net of cash received			(15,416	)			(959	)
Acquisition of assets			(21,249	)			—
Purchase of equipment			(9,585	)			(2,120	)
Net Cash Used In Investing Activities			(46,250	)			(3,079	)
Cash Flows from Financing Activities:
Proceeds from issuance of common stock, net			15,888				16,946
Proceeds from long-term debt			45,700				—
Repayments on long-term debt			(21,438	)			(2,427	)
Debt issuance costs			(1,217	)			(317	)
Net Cash Provided By Financing Activities			38,933				14,202
Net change in cash and cash equivalents			(3,435	)			11,693
Cash and cash equivalents at beginning of period			7,344				1,299
Cash and cash equivalents at end of period		$	3,909			$	12,992
Supplemental information:
Interest paid		$	2,151			$	1,491
Foreign taxes paid		$	459			$	—
Non-cash transactions in connection with the acquisition of Target
Settlement of lease receivable		$	592			$	—
Deferred taxes		$	750			$	—

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

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

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

Nature of Operations

We provide services and equipment to oil and gas exploration and development companies, principally in Texas, Louisiana, New Mexico, Colorado, Oklahoma, offshore in the United States Gulf of Mexico, and offshore and onshore in Mexico. We currently operate in five sectors of the oilfield service industry: directional and horizontal drilling; casing and tubing; compressed air drilling; production services; and rental tools.

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. The price we charge for our services depends upon several factors, including the level of oil and 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. 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, 2004. 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.

In December 2004, the Financial Accounting Standards Board issued FASB Staff Position No. 109—1, Application of Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004, which provides guidance on the recently enacted American Jobs Creation Act of 2004. The Act provides a tax deduction for income from qualified domestic production activities. FSP 109—1 provides for the treatment of the deduction as a special deduction as described in SFAS No. 109. As such, the deduction will have no effect on existing deferred tax assets and liabilities. The impact of the deduction is to be reported in the period in which the deduction is claimed on our U.S. tax return. We do not expect that this deduction will have a material impact on our effective tax rate in future years. FSP 109—1 is effective prospectively as of January 1, 2005.

In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R revises SFAS No. 123, Accounting for Stock-Based Compensation, and focuses on accounting for share-based payments for services by employer to employee. The statement requires companies to expense the fair value of employee stock options and other equity-based compensation at the grant date. The statement does not require a certain type of valuation model and either a binomial or Black-Scholes model may be used. The provisions of SFAS No. 123R are effective for financial statements for annual or interim periods beginning after December 15, 2005. We are currently evaluating the provisions of SFAS No. 123R and will adopt SFAS No. 123R on January 1, 2006. Our future cash flows will not be impacted by the adoption of this standard.

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

NOTE 1 — NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which is effective for us beginning on December 15, 2005. SFAS No. 154 requires that all voluntary changes in accounting principles, including corrections of errors, are retrospectively applied to prior financial statements as if that principle had always been used, unless it is impracticable to do so. When it is impracticable to calculate the effects on all prior periods, SFAS No. 154 requires that the new principle be applied to the earliest period practicable. The adoption of SFAS No. 154 is not anticipated to have a material effect on our financial position or results of operations.

NOTE 2 — ACQUISITIONS

On April 1, 2005, we acquired 100% of the outstanding stock of Delta Rental Service, Inc. (“Delta”) for $4.6 million in cash, 223,114 shares of our common stock and two promissory notes totaling $350,000. The purchase price was allocated to fixed assets and inventory. Delta, located in Lafayette, Louisiana, is a rental tool company providing specialty rental items to the oil and gas industry such as spiral heavy weight drill pipe, test plugs used to test blow-out preventors, well head retrieval tools, spacer spools and assorted handling tools.

On May 1, 2005, we acquired 100% of the outstanding capital stock of Capcoil Tubing Services, Inc. (“Capcoil”) for $2.7 million in cash, 168,161 shares of our common stock and the payment or assumption of approximately $1.3 million of debt. Capcoil, located in Kilgore, Texas, is engaged in downhole well servicing by providing coil tubing services to enhance production from existing wells. Goodwill of $117,000 and other identifiable intangible assets of $1.4 million were recorded in connection with the acquisition.

On July 11, 2005, we acquired the compressed air drilling assets of W.T. Enterprises, Inc. (“W.T.”), based in South Texas, for $6.0 million in cash. The equipment includes compressors, boosters, mist pumps and vehicles. Goodwill of $82,000 and other identifiable intangible assets of $1.5 million were recorded in connection with the acquisition.

On July 11, 2005, we acquired from M-I its 45% interest in AirComp LLC (“AirComp”) and subordinated note in the principal amount of $4.8 million issued by AirComp, for which we paid M-I $7.1 million in cash and issued to M-I a $4.0 million subordinated note bearing interest at 5% per annum. As a result, we now own 100% of AirComp. The note issued to M-I is convertible into up to 700,000 shares of our common stock at a conversion price equal to the market value of the common stock at the time of conversion.

On August 1, 2005, we acquired 100% of the outstanding capital stock of Target Energy Inc. (“Target”) for $1.3 million in cash and forgiveness of a lease receivable of approximately $0.6 million. The purchase price was allocated to the fixed assets of Target and resulted in the recording of a $0.8 million deferred tax liability. The results of Target are included in our directional and horizontal drilling segment as their Measure While Drilling equipment is utilized in that segment.

On September 1, 2005, we acquired the casing and tubing service assets of Patterson Services, Inc. for approximately $15.6 million. These assets are located in Corpus Christi, Texas; Kilgore, Texas; Lafayette, Louisiana and Houma, Louisiana.

The acquisitions were accounted for using the purchase method of accounting. The results of operations of the acquired entities since the date of acquisition are included in our consolidated condensed income statement. The following unaudited pro forma consolidated summary financial information illustrates the effects of the acquisitions of Delta, Capcoil, W.T. and the minority interest in AirComp and W.T. on our results of operations, based on the historical statements of operations, as if the transactions had occurred as of the beginning of the periods presented (in thousands, except per share amounts).

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Revenues		$	29,016			$	17,566			$	76,869			$	43,122
Operating income			3,558				1,887				9,667				4,717
Net income			1,321				892				5,692				2,037
Net income per common share:
Basic		$	0.10			$	0.10			$	0.40			$	0.31
Diluted		$	0.07			$	0.09			$	0.36			$	0.25

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

NOTE 3 — STOCK-BASED COMPENSATION

We account for our stock-based compensation using Accounting Principles Board Opinion No. 25. Under APB No. 25, compensation expense is only recognized for stock options with an exercise price that is less than the market price on the grant date of the option. For stock options with exercise prices at or above the market value of the stock on the grant date, we adopted the disclosure-only provisions of SFAS No. 123, Accounting For Stock-Based Compensation. None of our stock options have been granted with an exercise price below market and accordingly, no compensation cost has been recognized under APB No. 25.

Had compensation expense for the options granted been recorded based on the fair value at the grant date for the options, consistent with the provisions of SFAS No. 123, our net income and net income per share would have been decreased to the pro forma amounts indicated below (in thousands, except per share amounts):

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Net income as reported		$	1,293			$	519			$	4,629			$	1,276
Less: stock based employee compensation expense determined under fair value based method for all awards, net of tax			(863	)			—				(2,368	)			—
Pro forma net income		$	430			$	519			$	2,261			$	1,276

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Basic net income per common share:
As reported		$	0.09			$	0.06			$	0.33			$	0.21
Pro forma		$	0.03			$	0.06			$	0.16			$	0.21
Diluted net income per common share:
As reported		$	0.08			$	0.05			$	0.30			$	0.18
Pro forma		$	0.03			$	0.05			$	0.15			$	0.18

No options were granted in the third quarter of 2005 or during 2004. The following assumptions were applied in determining the pro forma compensation costs:

		For the Nine
		Months Ended
		September 30, 2005
Expected dividend yield			—
Expected price volatility			98.65	%
Risk-free interest rate			6.63	%
Expected life of options		7 years
Weighted average fair value of options granted at market value		$	3.12

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

NOTE 4 — INCOME PER COMMON SHARE

We compute income per common share in accordance with the provisions of SFAS No. 128, Earnings Per Share. SFAS No. 128 requires companies 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. For periods through April 12, 2004, preferred dividends are deducted from net income and have been considered in the calculation of income available to common stockholders in computing basic earnings per share. 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.

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,
		2005				2004				2005				2004
						(restated)								(restated)
Numerator:
Net income available for common stockholders		$	1,293			$	519			$	4,629			$	1,276
Plus income impact of assumed conversions:
Preferred stock dividends			—				—				—				124
Net income applicable to common stockholders plus assumed conversions		$	1,293			$	519			$	4,629			$	1,400
Denominator:
Basic earnings per share — weighted average shares outstanding			14,985				8,298				14,197				6,168
Effect of potentially dilutive common shares:
Convertible preferred stock and employee and director stock options and warrants			1,616				1,530				1,392				1,722
Diluted earnings per share — weighted average shares outstanding and assumed conversions			16,601				9,828				15,589				7,890
Net income per share — basic		$	0.09			$	0.06			$	0.33			$	0.21
Net income per share — diluted		$	0.08			$	0.05			$	0.30			$	0.18

NOTE 5 — GOODWILL AND INTANGIBLE ASSETS

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, 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 listed on the balance sheet totaled $12.0 million at September 30, 2005 and $11.8 million at December 31, 2004. Based on impairment testing performed during December of 2004 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 months and nine months ended September 30, 2005 were $324,000 and $975,000, respectively, compared to $104,000 and $340,000, respectively for the same periods last year. At September 30, 2005, net intangible assets totaled $7.3 million, net of $3.0 million of accumulated amortization.

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

NOTE 6 — RESTATEMENT

Earnings Per Share.
We understated diluted earnings per share due to an incorrect calculation of our weighted shares outstanding for the third quarter of 2003, for each of the first three quarters of 2004, for the years ended December 31, 2003 and 2004 and for the quarter ended March 31, 2005. We have restated our financial statements for each of those periods. In addition, we understated basic earnings per share due to an incorrect calculation of our weighted average basic shares outstanding for the quarter ended September 30, 2004. The incorrect calculation resulted from a mathematical error and an improper application of SFAS No. 128. The effect of the restatement is to reduce weighted average basic and diluted shares outstanding for the three and nine months ended September 30, 2004. Consequently, weighted average basic and diluted earnings per share for the three and nine months ended September 30, 2004 were increased.

A restated earnings per share calculation for the three and nine months ended September 30, 2004 to our results as previously restated (see following section), is presented below. The amounts are in thousands, except for per share amounts.

		Three Months Ended September 30, 2004
		As								As
		Reported				Adjustments				Restated
Income per common share — basic		$	0.04			$	0.02			$	0.06
Income per common share- diluted		$	0.04			$	0.01			$	0.05
Weighted average number of common shares outstanding:
Basic			11,599				(3,301	)			8,298
Diluted			14,407				(4,579	)			9,828

		Nine Months Ended September 30, 2004
		As								As
		Reported				Adjustments				Restated
Income per common share — basic		$	0.18			$	0.03			$	0.21
Income per common share- diluted		$	0.13			$	0.05			$	0.18
Weighted average number of common shares outstanding:
Basic			7,285				(1,117	)			6,168
Diluted			9,980				(2,090	)			7,890

AirComp Acquisition.
In connection with the formation of AirComp in 2003, we, along with M-I L.L.C. contributed assets to AirComp in exchange for a 55% interest and 45% interest, respectively, in AirComp. We originally accounted for the formation of AirComp as a joint venture. However in February 2005, we determined that the transaction should have been accounted for using purchase accounting pursuant to SFAS No. 141, Business Combinations and recorded the sale of an interest in a subsidiary, in accordance with SEC Staff Accounting Bulletin No. 51, Accounting for Sales of Stock by a Subsidiary. Consequently, we restated our financial statements for the quarter ended September 30, 2003, for the year ended December 31, 2003 and for the three quarters ended September 30, 2004, to reflect the following adjustments:

Increase in Book Value of Fixed Assets.
Under joint venture accounting, we originally recorded the value of the assets contributed by M-I to AirComp at M-I’s historical cost of $6.9 million. Under purchase accounting, we increased the recorded value of the assets contributed by M-I by approximately $3.3 million to $10.3 million to reflect their fair market value as determined by a third party appraisal. In addition, under joint venture accounting, we established negative goodwill which reduced fixed assets in the amount of $1.6 million. The negative goodwill was amortized by us over the lives of the related fixed assets. Under purchase accounting, we increased fixed assets by $1.6 million to reverse the negative goodwill previously recorded and reversed amortization expenses recorded in 2004. As a result of the increase in fixed assets and the reversal of amortization of negative goodwill, depreciation expense increased by $298,000 for the nine months ended September 30, 2004 and $218,000 for the year ended December 31, 2003. Therefore, fixed assets were increased by a total of $4.5 million at September 30, 2004.

Increase in Minority Interest and Capital in Excess of Par Value.
Under purchase accounting, minority interest was increased by $1.5 million, which was partially offset by minority interest expense of $67,000 for the nine months ended September 30, 2004 and $44,000 for the year ended December 31, 2003. Under purchase accounting, the capital in excess of par was increased by $955,000.

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

NOTE 6 — RESTATEMENT (Continued)

A restated consolidated balance sheet, reflecting the above adjustments follows (in thousands):

		At September 30, 2004
		As
		Previously								As
		Reported				Adjustments				Restated
Assets
Cash and cash equivalents		$	12,992			$	—			$	12,992
Trade receivables, net			10,419				—				10,419
Lease receivable, current			180				—				180
Prepaid expenses and other			1,496				—				1,496
Total current assets			25,087				—				25,087
Property and equipment, net			28,818				4,491				33,309
Goodwill			10,331				—				10,331
Other intangible assets, net			3,089				—				3,089
Debt issuance costs, net			635				—				635
Lease receivable, less current portion			590				—				590
Other			79				—				79
Total Assets		$	68,629			$	4,491			$	73,120
Liabilities and Stockholders’ Equity
Current maturities of long-term debt		$	4,858			$	—			$	4,858
Trade accounts payable			2,566				—				2,566
Accrued salaries, benefits and payroll taxes			481				—				481
Accrued interest			283				—				283
Accrued expenses			1,331				—				1,331
Accounts payable, related parties			406				—				406
Total current liabilities			9,925				—				9,925
Accrued postretirement benefit obligations			510				—				510
Long-term debt, net of current maturities			25,241				—				25,241
Other long-term liabilities			129				—				129
Redeemable warrants			1,500				—				1,500
Total Liabilities			37,305				—				37,305
Commitments and contingencies
Minority interests			886				1,388				2,274
Stockholders’ Equity
Common stock			130				—				130
Capital in excess of par value			37,425				955				38,380
Accumulated (deficit)			(7,117	)			2,148				(4,969	)
Total Stockholders’ Equity			30,438				3,103				33,541
Total Liabilities and Stockholders’ Equity		$	68,629			$	4,491			$	73,120

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

NOTE 6 — RESTATEMENT (Continued)

Increase in Net Income.
As a result of the increase in fixed assets, depreciation expense was increased for the three months ended September 30, 2004 by $49,000. As a result of the reversal of amortization of negative goodwill, depreciation expense for the three months was increased by $30,000. These items, along with a decrease in minority interest expense of $22,000 for the three months ended September 30, 2004, resulted in a reduction in net income attributable to common stockholders of $57,000 for the three months ended September 30, 2004.

A restated consolidated income statement reflecting the above adjustments follows (in thousands, except per share amounts):

		Three Months Ended September 30, 2004
		As
		Previously								As
		Reported				Adjustments				Restated
Revenue		$	11,888			$	—			$	11,888
Cost of revenues
Direct costs			7,633				—				7,633
Depreciation			512				79				591
Total cost of revenues			8,145				79				8,224
Gross margin			3,743				(79	)			3,664
General and administrative expense			2,227				—				2,227
Amortization			198				—				198
Income (loss) from operations			1,318				(79	)			1,239
Other income (expense):
Interest			(566	)			—				(566	)
Minority interests in income of subsidiaries			(56	)			22				(34	)
Other			19				—				19
Total other income (expense)			(603	)			22				(581	)
Net income (loss) before income taxes			715				(57	)			658
Provision for foreign income tax			(139	)			—				(139	)
Net income (loss)			576				(57	)			519
Preferred stock dividend			—				—				—
Net income (loss) attributed to common stockholders		$	576			$	(57	)		$	519
Net income per common share — basic		$	0.05			$	(0.01	)		$	0.04
Net income per common share — diluted		$	0.04			$	—			$	0.04
Weighted average number of common shares outstanding:
Basic			11,599				—				11,599
Diluted			14,407				—				14,407

NOTE 6 — RESTATEMENT (Continued)

Increase in Net Income.
As a result of the increase in fixed assets, depreciation expense was increased for the nine months ended September 30, 2004 by $148,000. As a result of the reversal of amortization of negative goodwill, depreciation expense for the nine months was increased by $150,000. These items, along with a decrease in minority interest expense of $67,000 for the nine months ended September 30, 2004, resulted in a reduction in net income attributable to common stockholders of $231,000 for the nine months ended September 30, 2004.

A restated consolidated income statement reflecting the above adjustments follows (in thousands, except per share amounts):

		Nine Months Ended September 30, 2004
		As
		Previously								As
		Reported				Adjustments				Restated
Revenue		$	32,989			$	—			$	32,989
Cost of revenues
Direct costs			22,395				—				22,395
Depreciation			1,498				298				1,796
Total cost of revenues			23,893				298				24,191
Gross margin			9,096				(298	)			8,798
General and administrative expense			4,781				—				4,781
Amortization			600				—				600
Income (loss) from operations			3,715				(298	)			3,417
Other income (expense):
Interest			(1,634	)			—				(1,634	)
Minority interests in income of subsidiaries			(315	)			67				(248	)
Other			224				—				224
Total other income (expense)			(1,725	)			67				(1,658	)
Net income (loss) before income taxes			1,990				(231	)			1,759
Provision for foreign income tax			(359	)			—				(359	)
Net income (loss)			1,631				(231	)			1,400
Preferred stock dividend			(124	)			—				(124	)
Net income (loss) attributed to common stockholders		$	1,507			$	(231	)		$	1,276
Net income per common share — basic		$	0.21			$	(0.03	)		$	0.18
Net income per common share — diluted		$	0.15			$	(0.02	)		$	0.13
Weighted average number of common shares outstanding:
Basic			7,285				—				7,285
Diluted			9,980				—				9,980

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

NOTE 6 — RESTATEMENT (Continued)

A restated consolidated statement of cash flows reflecting the adjustments follows (in thousands):

		Nine Months Ended September 30, 2004
		As
		Previously								As
		Reported				Adjustments				Restated
Cash Flows From Operating Activities:
Net income (loss)		$	1,631			$	(231	)		$	1,400
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization expense			2,098				298				2,396
Fair value of warrant issued to consultant			14				—				14
Amortization of discount on debt			143				—				143
Minority interest in income of subsidiaries			315				(67	)			248
Changes in operating assets and liabilities:
(Increase) in accounts receivable			(1,417	)			—				(1,417	)
(Increase) in other current assets			(609	)			—				(609	)
Decrease in other assets			158				—				158
Increase in accounts payable			(725	)			—				(725	)
Increase in accrued interest			131				—				131
(Decrease) in accrued expenses			(471	)			—				(471	)
(Decrease) in other long-term liabilities			(141	)			—				(141	)
(Decrease) in accrued employee benefits and payroll taxes			(557	)			—				(557	)
Net Cash Provided by Operating Activities			570				—				570
Cash Flows From Investing Activities:
Purchase of equipment			(2,120	)			—				(2,120	)
Acquisition of Safco, net of cash acquired			(959	)			—				(959	)
Net Cash Used by Investing Activities			(3,079	)			—				(3,079	)
Cash Flows From Financing Activities:
Proceeds from issuance of common stock, net			16,946				—				16,946
Repayments of long-term debt			(2,427	)			—				(2,427	)
Debt issuance costs			(317	)			—				(317	)
Net Cash Provided by Financing Activities			14,202				—				14,202
Net decrease in cash and cash equivalents			11,693				—				11,693
Cash and cash equivalents at beginning of the year			1,299				—				1,299
Cash and cash equivalents at end of the period		$	12,992			$	—			$	12,992
Supplemental information:
Interest paid		$	1,491			$	—			$	1,491

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

NOTE 7 — INVENTORIES

Inventories are comprised of the following (in thousands):

		September 30,				December 31,
		2005				2004
Hammer bits
Finished goods		$	952			$	857
Work in process			713				385
Raw materials			90				151
Total hammer bits			1,755				1,393
Hammers			524				417
Drive pipe			651				—
Rental supplies			234				—
Chemicals			191				254
Coiled tubing and related inventory			1,096				309
Shop supplies and related inventory			766				—
Total inventory		$	5,217			$	2,373

NOTE 8 — DEBT

Our long-term debt by the company where the debt relates consists of the following (in thousands):

		September 30,				December 31,
		2005				2004
Allis-Chalmers Energy Inc
Revolving line of credit		$	3,700			$	2,353
Bank term loan			42,000				6,335
Notes payable to former directors			96				402
Allis-Chalmers Tubular Service, Inc.
Subordinated seller note			3,031				4,000
Note payable under non-compete agreement			329				514
Bank term loans			958				584
Strata Directional Technology, Inc.
Vendor financing			420				1,164
Safco Oil Field Products, Inc. and Delta
Note payable under non-compete agreement			125				150
Note payable to former owners of Delta			350				—
Downhole Injection Services, LLC and Capcoil
Vehicle and equipment installment notes			128				60
Note payable under non-compete agreements			330				—
Mountain Compressed Air Inc.
Term loan			160				198
Seller note			500				1,600
AirComp
Revolving line of credit			—				1,520
Bank term loan			—				6,775
Subordinated note payable to M-I			4,000				4,818
Total debt			56,127				30,473
Less: short-term debt and current maturities			4,636				5,541
Long-term debt obligations		$	51,491			$	24,932

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

NOTE 8 — DEBT (Continued)

On July 11, 2005, we replaced our credit agreement with a new credit agreement which provides for the following senior secured credit facilities:

	•		A $13.0 million revolving line of credit. Borrowings are limited to 85% of eligible accounts receivable and 50% of eligible inventory (up to a maximum of $2.0 million of borrowings based on inventory). This facility is used to finance working capital requirements and other general corporate purposes, including the issuance of standby letters of credit. Outstanding borrowings under this line of credit were $3.7 million at prime as of September 30, 2005.
	•		Two term loans totaling $42.0 million. Outstanding borrowings under these term loans were $42.0 million as of September 30, 2005. These loans are at LIBOR rates approximating 7.2%

We borrowed $43.0 million against the facilities to refinance our prior credit facility and the AirComp credit facility, to fund the acquisition of M-I’s interest in AirComp and the air drilling assets of W.T. and to pay transaction costs related to the refinancing and the acquisitions. We incurred debt retirement expense of $1.1 million related to the refinancing. This amount includes prepayment penalties and the write-off of deferred financing fees of the previous financing.

Our credit facilities mature in July 2007. Amounts outstanding under the term loans as of July 2006 will be repaid in monthly principal payments based on a 48 month repayment schedule with the remaining balance due at maturity. Additionally, during the second year, we will be required to prepay the remaining balance of the term loans by 75% of excess cash flow, if any, after debt service and capital expenditures. The interest rate payable on borrowings is based on a margin over the London Interbank Offered Rate, referred to as LIBOR, or the prime rate, and there is a 0.5% fee on the undrawn portion of the revolving line of credit. The margin over LIBOR will increase by 1.0% in the second year. The credit facilities are secured by substantially all of our assets and contain customary events of default and financial and other covenants, including limitations on our ability to incur additional indebtedness, make capital expenditures, pay dividends or make other distributions, create liens and sell assets.

Prior to July 11, 2005, we had a credit agreement dated December 7, 2004 that provided for the following credit facilities:

	•		A $10.0 million revolving line of credit. Borrowings were limited to 85% of eligible accounts receivables, as defined.
	•		A term loan with a principal balance payable in monthly payments of principal of $105,583. We were also required to prepay this term loan by an amount equal to 20% of receipts from our largest customer in Mexico.
	•		A $6.0 million capital expenditure and acquisition line of credit. Borrowings under this facility were payable monthly over four years beginning in January 2006.

These credit facilities were to mature on December 31, 2008 and were secured by liens on substantially all of our assets. The agreement governing these credit facilities contained customary events of default and financial covenants. It also limited our ability to incur additional indebtedness, make capital expenditures, pay dividends or make other distributions, create liens and sell assets. Interest accrued at an adjustable rate based on the prime rate. We paid a 0.5% per annum fee on the undrawn portion of the revolving line of credit and the capital expenditure line.

Our Tubular Services subsidiary (formerly known as Jens’ Oilfield) has a subordinated note with a balance of $3.0 million at September 30, 2005 payable to Jens Mortensen, who sold Tubular Services to us and is one of our directors. The note accrues interest at a fixed rate of 7.5% and provides for quarterly interest payments. In July 2005, the maturity of the subordinated note was extended from January 2006 to October 2007 and we made a $300,000 principal pre-payment on August 31, 2005. In connection with the purchase of Tubular Services in 2002, we also agreed to pay a total of $1.2 million to Mr. Mortensen in exchange for a non-compete agreement. We are required to make monthly payments of $20,576 through January 31, 2007. As of September 30, 2005, the balance due was approximately $329,000, including $247,000 classified as short-term. The note is subordinated to the rights of our bank lenders.

Tubular Services also has several small equipment financings and a real estate loan which in the aggregate total $1.0 million as of September 30, 2005. Tubular Services has two bank term loans aggregating $129,000 which accrue interest at an adjustable rate based on the prime rate (8.75% at September 30, 2005) and which require monthly payments of $13,000 plus accrued interest. The maturity date of one of the loans, with a balance of $95,000, is September 17, 2006, while the second loan, with a balance of $34,000, matures January 12, 2007. Our Tubular Services subsidiary also has a five-year equipment loan with a principal balance of $277,000 at September 30, 2005. The loan is payable in monthly installments of principal and interest

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

NOTE 8 — DEBT (Continued)

equal to $6,449 per month through December 2009. Finally, we have has a real estate loan which is payable in equal monthly installments of $4,344 with the remaining outstanding balance due on January 1, 2010. The interest rate floats based on the prime rate. The outstanding principal balance was $552,000 at September 30, 2005.

Our Strata subsidiary entered into a short-term vendor financing agreement that provides extended payment terms for the purchase, lease and repair costs related to downhole drill motors. As of September 30, 2005, the outstanding balance was $420,000. Interest is payable monthly at a fixed rate of 8.0% and the principal is due in December 2005.

In connection with the purchase of Safco, we agreed to pay a total of $150,000 to the sellers in exchange for a non-compete agreement. We are required to make annual payments of $50,000 through September 30, 2007. As of September 30, 2005, the balance due was $125,000. In connection with the purchase of Delta, we issued to the sellers a note in the amount of $350,000. The note bears interest at 2% and the principal and accrued interest is due on April 1, 2006. As of September 30, 2005, the balance was $350,000.

Our Downhole subsidiary has various vehicle installment notes totaling $128,000 at September 30, 2005. In connection with the purchase of our Capcoil subsidiary, we agreed to pay the sellers $500,000 in exchange for a non-compete agreement. As of September 30, 2005, the balance due was $330,000 and is payable in 3 annual installments of $110,000.

Prior to July 11, 2005, AirComp had the credit facilities described below. These credit facilities were repaid in connection with our acquisition of the minority interest in AirComp and the refinancing of our bank credit facilities described above.

	•		A $3.5 million bank line of credit. Interest accrued at an adjustable rate based on the prime rate. We paid a 0.5% per annum fee on the undrawn portion. Borrowings under the line of credit were subject to a borrowing base consisting of 80% of eligible accounts receivable.
	•		A term loan that accrued interest at an adjustable rate based on either LIBOR or the prime rate. Principal payments of $286,000 plus interest were due quarterly, with a final maturity date of June 27, 2007.
	•		A “delayed draw” term loan facility in the amount of $1.5 million to be used for capital expenditures. Interest accrued at an adjustable rate based on either the LIBOR or the prime rate. Quarterly principal payments were to commence on March 31, 2006 in an amount equal to 5.0% of the outstanding balance as of December 31, 2005, with a final maturity of June 27, 2007.

The AirComp credit facilities were secured by liens on substantially all of AirComp’s assets. The agreement governing these credit facilities contained customary events of default and required that AirComp satisfy various financial covenants. It also limited AirComp’s ability to incur additional indebtedness, make capital expenditures, pay dividends or make other distributions, create liens and sell assets. We guaranteed 55% of the obligations of AirComp under these facilities.

On July 11, 2005, we acquired from M-I its 45% equity interest in AirComp and a subordinated note in the principal amount of $4.8 million issued by AirComp, for which we paid M-I $7.1 million in cash and issued a new $4.0 million subordinated note bearing interest at 5% per annum. The subordinated note issued to M-I requires quarterly interest payments and the principal amount is due October 9, 2007. The subordinated note is convertible into up to 700,000 shares our common stock at a conversion price equal to the market value of the common stock at the time of conversion.

In 2000, we compensated directors, including current directors Nederlander and Toboroff, who served on our board of directors from 1989 to March 31, 1999 without compensation by issuing promissory notes totaling $325,000. The notes accrued interest at the rate of 5.0% per annum and matured on March 31, 2005. As of September 30, 2005, notes totaling $96,300, including accrued interest, remained outstanding.

As part of the acquisition of Mountain Air in 2001, we issued a note to the sellers of Mountain Air in the original amount of $2.2 million accruing interest at a rate of 5.75% per annum. The note was reduced to $1.5 million as a result of the settlement of a legal action against the sellers in 2003. In March 2005, we reached an agreement with the sellers and holders of the note as a result of an action brought against us by the sellers. Under the terms of the agreement, we paid the plaintiff $1.0 million in cash, and agreed to pay an additional $350,000 on June 1, 2006, and an additional $150,000 on June 1, 2007, in settlement of all claims. (See Note 11 — Legal Matters). Mountain Air also has a term loan in the amount of $160,000 at September 30, 2005 accruing interest of 5.0% per annum. Principal and interest of $5,039 are payable monthly with a final maturity date of June 30, 2008.

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

NOTE 8 — DEBT (Continued)

Our Chief Executive Officer and Chairman, Munawar H. Hidayatallah, was a personal guarantor of the Tubular Services subordinated seller note. We have paid Mr. Hidayatallah an annual guarantee fee equal to one-quarter of one percent of the total amount of the debt guaranteed by Mr. Hidayatallah. These fees aggregated $7,250 during the nine months ended September 30, 2005. As of July 2005, Mr. Hidayatallah was no longer a guarantor of any of our debt.

NOTE 9 — STOCKHOLDERS’ EQUITY

As of January 1, 2005, we executed a business development agreement with CTTV Investments LLC, an affiliate of ChevronTexaco Inc., whereby we issued 20,000 shares of our common stock to CTTV and further agreed to issue up to an additional 60,000 shares to CTTV contingent upon our subsidiaries receiving certain levels of revenues in 2005 from ChevronTexaco and its affiliates. CTTV was a minority owner of Downhole, which we acquired in 2004.

In connection with the Delta and Capcoil acquisitions (See Note 2 — Acquisitions), we issued 223,114 and 168,161 shares of our common stock, respectively.

During the third quarter of 2005, we completed a secondary public offering in which we sold 1.7 million shares for approximately $15.6 million, net of expenses. In connection with the offering, warrants were exercised under the cashless option which resulted in 543,097 shares of our common stock being issued.

We also had options and warrants exercised in the third quarter of 2005, those exercises resulted in 126,783 shares of our common stock being issued for $330,723.

On August 11, 2005, our stockholders approved an amendment to our certificate of incorporation to increase the authorized number of shares of our common stock from 20 million to 100 million and to increase our authorized preferred stock from 10 million shares to 25 million shares.

NOTE 10- SEGMENT INFORMATION

At September 30, 2005, we had five operating segments including Directional Drilling Services (Strata), Casing and Tubing Services (Tubular Service), Compressed Air Drilling Services (AirComp), Production Services (Downhole and Capcoil) and Rental Tools (Safco and Delta). All of the segments provide services to the energy industry. The revenues, operating income (loss), depreciation and amortization, interest, capital expenditures and assets of each of the reporting segments, plus the corporate function, are reported below (in thousands):

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
						(Restated)								(Restated)
Revenues
Directional drilling services		$	11,383			$	6,677			$	32,218			$	18,352
Casing and tubing services			5,103				2,831				12,596				7,218
Compressed air drilling services			7,637				2,380				16,684				7,419
Production services			3,226				—				6,833				—
Rental tools			1,559				—				3,499				—
		$	28,908			$	11,888			$	71,830			$	32,989
Operating Income (Loss):
Directional drilling services		$	1,696			$	1,048			$	5,069			$	2,435
Casing and tubing services			1,336				949				4,015				2,174
Compressed air drilling services			1,802				130				3,331				723
Production services			(128	)			—				(130	)			—
Rental tools			454				—				780				—
General corporate			(1,636	)			(888	)			(4,380	)			(1,915	)
		$	3,524			$	1,239			$	8,685			$	3,417