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, 2006

OR

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

FOR THE TRANSITION PERIOD FROM                      TO                     

Commission file number 1-2199

ALLIS-CHALMERS ENERGY INC.

(Exact name of registrant as specified in its charter)

DELAWARE		39-0126090
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

5075 WESTHEIMER, SUITE 890, HOUSTON, TEXAS 77056
(Address of principal executive offices) (Zip code)

(713) 369-0550

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, or a non-accelerated filer. See definition of “accelerated filer and larger accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o       Accelerated filer o       Non-accelerated filer þ

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 November 1, 2006 there were 24,831,155 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, 2006

TABLE OF CONTENTS

ITEM				PAGE
		PART I
1.		Financial Statements
		Consolidated Condensed Balance Sheets as of September 30, 2006 and December 31, 2005			3
		Consolidated Condensed Income Statements for the three and nine months ended September 30, 2006 and 2005			4
		Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2006 and 2005			5
		Notes to Consolidated Condensed Financial Statements			6
2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			24
3.		Quantitative and Qualitative Disclosures about Market Risk			34
4.		Controls and Procedures			35
		PART II
1.		Legal Proceedings			36
1A.		Risk Factors			36
2.		Unregistered Sales of Equity Securities and Use of Proceeds			41
6.		Exhibits			41
Signatures					41
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.

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

		September 30,				December 31,
		2006				2005
		(unaudited)
Assets
Cash and cash equivalents		$	50,311			$	1,920
Trade receivables, net			85,156				26,964
Inventory			25,813				5,945
Prepaid expenses and other			6,374				823
Total current assets			167,654				35,652
Property and equipment, net			341,483				80,574
Goodwill			12,417				12,417
Other intangible assets, net			6,802				6,783
Debt issuance costs, net			8,585				1,298
Other assets			155				631
Total assets		$	537,096			$	137,355
Liabilities and Stockholders’ Equity
Current maturities of long-term debt		$	8,493			$	5,632
Trade accounts payable			26,311				9,018
Accrued salaries, benefits and payroll taxes			10,050				1,271
Accrued interest			4,950				289
Accrued income taxes			2,901				668
Accrued expenses			13,853				3,682
Accounts payable, related parties			—				60
Total current liabilities			66,558				20,620
Accrued postretirement benefit obligations			304				335
Long-term debt, net of current maturities			262,466				54,937
Deferred income taxes			26,723				—
Other long-term liabilities			577				588
Total liabilities			356,628				76,480
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; 24,583,881 issued and outstanding at September 30, 2006 and 16,859,988 issued and outstanding at December 31, 2005)			246				169
Capital in excess of par value			153,135				58,889
Retained earnings			27,087				1,817
Total stockholders’ equity			180,468				60,875
Total liabilities and stockholders’ equity		$	537,096			$	137,355

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,
		2006				2005				2006				2005
Revenues		$	85,738			$	28,908			$	193,236			$	71,830
Cost of revenues
Direct costs			51,497				19,280				110,578				47,756
Depreciation			5,448				1,391				12,606				3,397
Total cost of revenues			56,945				20,671				123,184				51,153
Gross margin			28,793				8,237				70,052				20,677
General and administrative			9,058				4,261				24,540				10,720
Amortization			681				452				1,954				1,272
Income from operations			19,054				3,524				43,558				8,685
Other income (expense):
Interest, net			(4,660	)			(2,064	)			(12,085	)			(3,230	)
Other			(26	)			63				(6	)			221
Total other income (expense)			(4,686	)			(2,001	)			(12,091	)			(3,009	)
Net income before minority interest and income taxes			14,368				1,523				31,467				5,676
Minority interest in income of subsidiaries			—				—				—				(488	)
Provision for income taxes			(3,116	)			(230	)			(6,197	)			(559	)
Net income		$	11,252			$	1,293			$	25,270			$	4,629
Net income per common share:
Basic		$	0.52			$	0.09			$	1.33			$	0.33
Diluted		$	0.50			$	0.08			$	1.25			$	0.30
Weighted average shares outstanding:
Basic			21,644				14,985				18,944				14,197
Diluted			22,453				16,601				20,155				15,589

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,
		2006				2005
Cash Flows from Operating Activities:
Net income		$	25,270			$	4,629
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			12,606				3,397
Amortization			1,954				1,272
Imputed interest			355				—
Write-off of deferred financing fees due to refinancing			—				653
Stock option expense			2,638				—
Provision for bad debts			353				—
Minority interest in income of subsidiaries			—				488
Deferred taxes			494				—
Gain on sale of property and equipment			(728	)			—
Changes in operating assets and liabilities, net of acquisitions:
(Increase) in trade receivable			(17,161	)			(7,250	)
(Increase) in inventory			(2,161	)			(2,844	)
Decrease in other current assets			1,322				1,322
Decrease (increase) in other assets			530				(171	)
(Decrease) increase in accounts payable			(1,609	)			1,058
Increase in accrued interest			4,661				497
Increase in accrued expenses			2,516				1,269
Increase (decrease) in accrued salaries, benefits and payroll taxes			3,110				(287	)
Decrease in other long-term liabilities			(813	)			(151	)
Net Cash Provided By Operating Activities			33,337				3,882
Cash Flows from Investing Activities:
Acquisition of businesses, net of cash received			(203,189	)			(15,416	)
Acquisition of assets			—				(21,249	)
Proceeds from sale of property and equipment			3,516				—
Purchase of property and equipment			(25,811	)			(9,585	)
Net Cash Used In Investing Activities			(225,484	)			(46,250	)
Cash Flows from Financing Activities:
Proceeds from exercises of options and warrants			5,406				—
Proceeds from issuance of common stock, net			46,484				15,888
Proceeds from long-term debt			257,820				45,700
Proceeds from line of credit			5,000				—
Repayments on long-term debt			(51,712	)			(21,438	)
Repayments on related party debt			(3,031	)			—
Repayments on line of credit			(11,400	)			—
Debt issuance costs			(8,029	)			(1,217	)
Net Cash Provided By Financing Activities			240,538				38,933
Net change in cash and cash equivalents			48,391				(3,435	)
Cash and cash equivalents at beginning of year			1,920				7,344
Cash and cash equivalents at end of period		$	50,311			$	3,909

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

We are a multi-faceted oilfield service company that provides services and equipment to oil and natural gas exploration and production companies, domestically in Texas, Louisiana, New Mexico, Colorado, Oklahoma, Mississippi, Utah, Wyoming, offshore in the Gulf of Mexico, and internationally in Argentina, Mexico and Bolivia. We operate in six sectors of the oil and natural gas service industry: directional drilling services; rental tools; international drilling; casing and tubing services; compressed air drilling services; and production 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, 2005. 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 July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. It prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the provisions of FIN 48 and have not yet determined the impact, if any, on our financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which is intended to increase consistency and comparability in fair value measurements by defining fair value, establishing a framework for measuring fair value and expanding disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the provisions of SFAS 157 and have not yet determined the impact, if any, on our financial statements.

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

NOTE 2 – ACQUISITIONS

Effective August 14, 2006, we acquired 100% of the outstanding stock of DLS Drilling, Logistics & Services Corporation, or DLS, based in Argentina, for a total consideration of approximately $117.9 million, which includes $93.7 million in cash, $38.1 million in our common stock, $3.4 million of acquisition costs, less approximately $17.3 million of debt assigned to us. DLS operates a fleet of 51 rigs, including 20 drilling rigs, 18 workover rigs and 12 pulling rigs in Argentina and one drilling rig in Bolivia. The following table summarizes the allocation of the purchase price to the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition (in thousands):

Current assets		$	54,370
Property and equipment			150,441
Other long-term assets			21
Total assets acquired			204,832
Current liabilities			36,530
Long-term debt, less current portion			6,114
Intercompany note			17,256
Other long-term liabilities			27,000
Total liabilities assumed			86,900
Net assets acquired		$	117,932

Approximately $3.4 million of costs were incurred in relation to the DLS acquisition. DLS’ historical property and equipment values were increased by approximately $42.7 million based on third-party valuations

Effective April 1, 2006, we acquired 100% of the outstanding stock of Rogers Oil Tools, Inc., or Rogers, based in Lafayette, Louisiana, for a total consideration of approximately $13.7 million, which includes $11.3 million in cash, $1.6 million in our common stock and a $750,000 three-year promissory note. In addition, we purchased all the patents and proprietary technology that Tommie L. Rogers, Rogers’ founder and Chief Executive Officer, developed at Rogers. Rogers provides service for tubing tongs and casing tongs and rents and sells specialized automated power tongs to the snubbing and well control markets. Rogers also rents and sells drill pipe tongs, accessories, hydraulic power units and hydraulic tong positioners. The following table summarizes the allocation of the purchase price to the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition (in thousands):

Current assets		$	4,520
Property and equipment			9,866
Intangible assets			1,131
Total assets acquired			15,517
Current liabilities			1,717
Other long-term liabilities			100
Total liabilities assumed			1,817
Net assets acquired		$	13,700

Approximately $380,000 of costs were incurred in relation to the Rogers acquisition. Rogers’ historical property and equipment values were increased by approximately $8.4 million based on third-party valuations. Intangible assets include $981,000 assigned to patents and $150,000 assigned to non-compete based on third-party valuations and employment contracts. The intangibles have a weighted-average useful life of 9 years.

Effective January 1, 2006, we acquired 100% of the outstanding stock of Specialty Rental Tools, Inc., or Specialty, for $96.0 million in cash. The results of Specialty’s operations have been included in the consolidated financial statements since that date. Specialty, located in Lafayette, Louisiana, was engaged in the rental of high quality drill pipe, heavy weight spiral drill pipe, tubing work strings, blow-out preventors, choke manifolds and various valves and handling tools for oil and natural gas drilling. For the year ended December 31, 2005, Specialty had revenues of $32.7 million. The following table summarizes the allocation of the purchase price to the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition (in thousands):

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

NOTE 2 – ACQUISITIONS (Continued)

Accounts receivable		$	7,167
Other current assets			425
Property and equipment			90,540
Total assets acquired			98,132
Current liabilities			2,058
Long-term debt			74
Total liabilities assumed			2,132
Net assets acquired		$	96,000

Approximately $453,000 of costs were incurred in relation to the Specialty acquisition. Specialty’s historical property and equipment values were increased by approximately $71.5 million based on third-party valuations.

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.

Effective August 1, 2005, we acquired 100% of the outstanding capital stock of Target Energy Inc., or 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. The results of Target are included in our directional and horizontal drilling segment as their measurement while drilling, or MWD, equipment is utilized in that segment.

On July 11, 2005, we acquired the compressed air drilling assets of W.T. Enterprises, Inc., or WT, 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 L.L.C., or 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 to M-I a $4.0 million subordinated note bearing interest at 5% per annum. As a result, we now own 100% of AirComp.

On May 1, 2005, we acquired 100% of the outstanding capital stock of Capcoil Tubing Services, Inc., or 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 $184,000 and other identifiable intangible assets of $1.4 million were recorded in connection with the acquisition.

On April 1, 2005, we acquired 100% of the outstanding stock of Delta Rental Service, Inc., or 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.

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

NOTE 2 – ACQUISITIONS (Continued)

These 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 DLS, Rogers, Specialty, WT, the minority interest in AirComp, Capcoil and Delta as if the acquisitions had occurred as of January 1, 2005, based on the historical statements of operations (in thousands, except per share amounts).

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Revenues		$	107,617			$	44,531			$	299,219			$	200,634
Operating income			20,530				9,685				56,668				25,552
Net income			12,843				2,400				28,568				4,858
Net income per common share:
Basic		$	0.56			$	0.11			$	1.19			$	0.24
Diluted		$	0.54			$	0.11			$	1.14			$	0.22

NOTE 3 – STOCK-BASED COMPENSATION

We adopted SFAS 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. Compensation cost for awards granted prior to, but not vested, as of January 1, 2006 would be based on the grant date attributes originally used to value those awards for pro forma purposes under SFAS No. 123. We adopted SFAS No. 123R using the modified prospective transition method, utilizing the Black-Scholes option pricing model for the calculation of the fair value of our employee stock options. Under the modified prospective method, we record compensation cost related to unvested stock awards as of December 31, 2005 by recognizing the unamortized grant date fair value of these awards over the remaining vesting periods of those awards with no change in historical reported earnings. We estimated forfeiture rates for the first nine months of 2006 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.

Prior to January 1, 2006, we accounted for our stock-based compensation using Accounting Principle Board Opinion No. 25. Under APB No. 25, compensation expense is 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. We also adopted the disclosure-only provisions of SFAS No. 123 for the stock options granted to our employees and directors. Accordingly, no compensation cost was recognized under APB No. 25. Our net income for the three and nine months ended September 30, 2006 includes approximately $860,000 and $2,638,000 of compensation costs related to share-based payments. As of September 30, 2006 there is $1.6 million of unrecognized compensation expense related to non-vested stock option grants. We expect approximately $660,000 to be recognized over the remainder of 2006, approximately $900,000 to be recognized in 2007 and approximately $14,000 to be recognized in 2008.

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

NOTE 3 – STOCK-BASED COMPENSATION (Continued)

A summary of our stock option activity and related information as of September 30, 2006 is as follows:

						Weighted				Weighted
		Share				Average				Average				Aggregate
		Under				Exercise				Contractual				Intrinsic Value
		Option				Price				Life (Years)				(millions)
Balance at beginning of period			2,860,867			$	5.10
Granted			15,000				14.74
Canceled			(53,234	)			5.85
Exercised			(1,335,166	)			3.46
Outstanding at end of period			1,487,467				6.65				8.56			$	11.9
Exercisable at end of period			668,136				5.69				8.31			$	6.0

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 2006 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, 2006. The total intrinsic value of options exercised during the three and nine months ended September 30, 2006 was $1.5 million and $17.7 million, respectively. The total cash received from option exercises during the three and nine months ended September 30, 2006 was $445,000 and $4.6 million, respectively.

The following summarizes the assumptions used in the September 30, 2006 and 2005 Black-Scholes model:

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Expected dividend yield			—				—				—				—
Expected price volatility			72.28	%			98.65	%			72.28	%			98.65	%
Risk free interest rate			5.07	%			6.63	%			5.07	%			6.63	%
Expected life of options		7 years				7 years				7 years				7 years
Weighted average fair value of options granted at market value		$	10.58			$	3.12			$	10.58			$	3.12

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

NOTE 3 – STOCK-BASED COMPENSATION (Continued)

The following table illustrates the pro-forma effect on net income and net income per share for the three and nine months ended September 30, 2005 had we applied the fair value recognition provisions of SFAS No. 123R (in thousands, except per share amounts):

										Three Months				Nine Months
										Ended September 30,
										2005				2005
Net income: As reported										$	1,293			$	4,629
Less total stock based employee compensation expense determined under fair value based method for all awards net of tax related effects											(863	)			(2,368	)
Pro forma net income										$	430			$	2,261
Net income per share:
Basic		As reported								$	0.09			$	0.33
		Pro forma								$	0.03			$	0.16
Diluted		As reported								$	0.08			$	0.30
		Pro forma								$	0.03			$	0.15

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 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.

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,
		2006				2005				2006				2005
Numerator:
Net income		$	11,252			$	1,293			$	25,270			$	4,629
Denominator:
Basic earnings per share – weighted average shares outstanding			21,644				14,985				18,944				14,197
Effect of potentially dilutive common shares:
Warrants and employee and director stock options			809				1,616				1,211				1,392
Diluted earnings per share – weighted average shares outstanding and assumed conversions			22,453				16,601				20,155				15,589
Net income per share — basic		$	0.52			$	0.09			$	1.33			$	0.33
Net income per share — diluted		$	0.50			$	0.08			$	1.25			$	0.30

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

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 and indefinite-lived intangible assets listed on the balance sheet totaled $12.4 million at September 30, 2006 and December 31, 2005. Based on impairment testing performed during 2005 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, 2006 were $399,000 and $1,212,000, respectively, compared to $324,000 and $975,000, respectively for the same periods last year. At September 30, 2006, intangible assets totaled $10.6 million, net of $3.8 million of accumulated amortization.

NOTE 6 – INVENTORY

Inventory is comprised of the following (in thousands):

		September 30,				December 31,
		2006				2005
Hammer bits
Finished goods		$	1,453			$	1,402
Work in process			1,880				787
Raw materials			2,726				233
Total hammer bits			6,059				2,422
Hammers			884				584
Drive pipe			762				666
Rental supplies			335				64
Chemicals and drilling fluids			1,837				201
Rig parts and related inventory			10,243				—
Coiled tubing and related inventory			1,270				1,145
Shop supplies and related inventory			4,423				863
Total inventory		$	25,813			$	5,945

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

NOTE 7- DEBT

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

		September 30,				December 31,
		2006				2005
Senior notes		$	255,000			$	—
Bank term loans			7,946				42,090
Revolving line of credit			—				6,400
Subordinated note payable to M-1 LLC			—				4,000
Subordinated seller note			—				3,031
Seller notes			900				850
Obligations under non-compete agreements			332				698
Notes payable to former directors			32				96
Real estate loan			—				548
Rig, equipment and vehicle installment notes			4,398				1,939
Insurance premium financing			1,808				—
Capital lease obligations			543				917
Total debt			270,959				60,569
Less: current maturities			8,493				5,632
Long-term debt obligations		$	262,466			$	54,937

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 and DLS, to repay existing debt and for general corporate purposes.

Prior to January 18, 2006, we were party to a July 2005 credit agreement that provided for the following senior secured credit facilities:

	•		A $13.0 million revolving line of credit. Borrowings were limited to 85% of eligible accounts receivable plus 50% of eligible inventory (up to a maximum of $2.0 million of borrowings based on inventory). This line of credit was to be 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 $6.4 million at a margin above prime and LIBOR rates plus margin averaging approximately 8.1% as of December 31, 2005.
	•		Two term loans totaling $42.0 million. Outstanding borrowings under these term loans were $42.0 million as of December 31, 2005. These loans were at LIBOR rates plus a margin which averages approximately 7.8% at December 31, 2005.

Borrowings under the July 2005 credit facilities were to mature in July 2007. Amounts outstanding under the term loans as of July 2006 were to 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 were to 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 was based on a margin over the London Interbank Offered Rate, referred to as LIBOR, or the prime rate, and there was a 0.5% fee on the undrawn portion of the revolving line of credit. The margin over LIBOR was to increase by 1.0% in the second year.

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

NOTE 7 – DEBT (Continued)

All amounts outstanding under our July 2005 credit agreement were paid off with the proceeds of our senior notes offering on January 18, 2006. On January 18, 2006, we also executed an amended and restated credit agreement which provides for a $25.0 million revolving line of credit with a maturity of January 2010. Our January 2006 amended and restated 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 January 2006 amended and restated credit agreement are secured by substantially all of our assets.

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 2 to 5 years. The weighted average margin was 1.6% at September 30, 2006. The bank loans are denominated in U.S. dollars and the outstanding amount due as of September 30, 2006 was $7.9 million.

Notes payable and real estate loan

On July 11, 2005, we acquired from M-I its 45% equity interest in AirComp and the 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 5.0% per annum. The subordinated note issued to M-I required quarterly interest payments and the principal amount was due October 9, 2007. Contingent upon a future equity offering, the subordinated note was 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. This note was repaid from the proceeds of our offering of $95.0 million of 9.0% senior notes, which we completed in August 2006.

As of December 31, 2005, Allis-Chalmers Tubular Services Inc., or Tubular, had a subordinated note outstanding and payable to Jens Mortensen, the seller of Tubular and one of our directors, in the amount of $4.0 million with a fixed interest rate of 7.5%. Interest was payable quarterly and the final maturity of the note was January 31, 2006. The subordinated note was subordinated to the rights of our bank lenders. The balance of this subordinated note was repaid in full in January 2006 with proceeds from our senior notes offering.

As part of the acquisition of Mountain Compressed Air Inc., or 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 holders of the note $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. At September 30, 2006 and December 31, 2005 the outstanding amounts due were $150,000 and $500,000, respectively.

In connection with the purchase of Delta, we issued to the sellers a note in the amount of $350,000. The note bore interest at 2% and the principal and accrued interest was repaid on its maturity of April 1, 2006. In connection with the acquisition of Rogers, 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 purchase of Tubular, we agreed to pay a total of $1.2 million to Mr. Mortensen in exchange for a non-compete agreement. Monthly payments of $20,576 are due under this agreement through January 31, 2007. In connection with the purchase of Safco-Oil Field Products, Inc., or Safco, we also 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. In connection with the purchase of Capcoil, we agreed to pay a total of $500,000 to two management employees in exchange for non-compete agreements. We are required to make annual payments of $110,000 through May 2008. Total amounts due under these non-compete agreements at September 30, 2006 and December 31, 2005 were $332,000 and $698,000, respectively.

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 bear interest at the rate of 5.0%. At September 30, 2006 and December 31, 2005, the principal and accrued interest on these notes totaled approximately $32,000 and $96,000, respectively.

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

NOTE 7 – DEBT (Continued)

We also had a real estate loan which was payable in equal monthly installments of $4,344 with the remaining outstanding balance due on January 1, 2010. The loan had a floating interest rate based on prime plus 2.0%. The outstanding principal balance was $548,000 at December 31, 2005. The balance of this loan was repaid in full in January 2006 with proceeds from our senior notes offering.

Other debt

We have various rig and equipment financing loans with interest rates ranging from 5.0% to 8.7% and terms of 2 to 5 years. As of September 30, 2006 and December 31, 2005, the outstanding balances for rig and equipment financing loans were $4.4 million and $1.9 million, respectively. In April 2006 and August 2006, we obtained insurance premium financings in the amount of $1.9 million and $896,000 with fixed interest rates of 5.6% and 6.0%, respectively. 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 $1.8 million as of September 30, 2006. We also have various capital leases with terms that expire in 2008. As of September 30, 2006 and December 31, 2005, amounts outstanding under capital leases were $543,000 and $917,000, respectively. In January 2006, we prepaid $350,000 of the outstanding equipment loans with proceeds from our senior notes offering.

NOTE 8 – STOCKHOLDERS’ EQUITY

We issued 125,285 and 2,500,000 shares of our common stock in relation to the Roger’s and DLS acquisition, respectively (see Note 2).

On August 14, 2006 we closed on a public offering of 3,450,000 shares of our common stock at a public offering price of $14.50 per share. Net proceeds from the public offering of $47.5 million were used to fund a portion of our acquisition of DLS.

We also had options and warrants exercised in the first nine months of 2006, which resulted in 1,648,608 shares of our common stock being issued for approximately $5.4 million. We recognized approximately $2.6 million of compensation expense related to stock options in the first nine months of 2006 that was recorded as capital in excess of par value (see Note 3).

NOTE 9 – 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. Prior to the acquisition of DLS, all of our subsidiaries were guarantors of our 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

NOTE 9 – CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

CONDENSED CONSOLIDATING BALANCE SHEETS
September 30, 2006 (unaudited)

		Allis-Chalmers								Subsidiary
		(Parent/				Subsidiary				Non-				Consolidating				Consolidated
		Guarantor)				Guarantors				Guarantors				Adjustments				Total
Assets
Cash and Cash equivalents		$	—			$	48,679			$	1,632			$	—			$	50,311
Trade receivables, net			—				53,342				31,814				—				85,156
Inventory			—				10,723				15,090				—				25,813
Intercompany receivables			110,149				—				—				(110,149	)			—
Note receivable from affiliate			5,897				—				—				(5,897	)			—
Prepaid expenses and other			—				2,816				3,558				—				6,374
Total current assets			116,046				115,560				52,094				(116,046	)			167,654
Property and equipment, net			—				189,452				152,031				—				341,483
Goodwill			—				12,417				—				—				12,417
Other intangible assets, net			609				6,096				97				—				6,802
Debt issuance costs, net			8,585				—				—				—				8,585
Note receivable from affiliates			10,354				—				—				(10,354	)			—
Investments in affiliates			306,349				—				—				(306,349	)			—
Other assets			5				129				22				(1	)			155
Total Assets		$	441,948			$	323,654			$	204,244			$	(432,750	)		$	537,096
Liabilities and Stockholders’ Equity
Current maturities of long-term debt		$	—			$	4,919			$	3,574			$	—			$	8,493
Trade accounts payable			31				9,861				16,419				—				26,311
Accrued salaries, benefits and payroll taxes			—				2,644				7,406				—				10,050
Accrued interest			4,950				—				—				—				4,950
Accrued income taxes			3				53				2,845				—				2,901
Accrued expenses			129				8,280				5,444				—				13,853
Intercompany payables			—				110,149				—				(110,149	)			—
Note payable to affiliate			—				—				5,897				(5,897	)			—
Total current liabilities			5,113				135,906				41,585				(116,046	)			66,558
Accrued postretirement benefit obligations			304				—				—				—				304
Long-term debt, net of current maturities			255,782				1,200				5,484				—				262,466
Note payable to affiliate			—				—				10,354				(10,354	)			—
Deferred income taxes			281				213				26,229				—				26,723
Other long-term liabilities			—				577				—				—				577
Total liabilities			261,480				137,896				83,652				(126,400	)			356,628
Commitments and contingencies
Stockholder’s Equity
Common Stock			246				3,425				42,963				(46,388	)			246
Capital in excess of par value			153,135				133,918				74,969				(208,887	)			153,135
Retained earnings			27,087				48,415				2,660				(51,075	)			27,087
Total stockholders’ equity			180,468				185,758				120,592				(306,350	)			180,468
Total liabilities and stock holder’s equity		$	441,948			$	323,654			$	204,244			$	(432,750	)		$	537,096

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

NOTE 9 – CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

CONDENSED CONSOLIDATING INCOME STATEMENTS
For the Three Months Ended September 30, 2006 (unaudited)

		Allis-Chalmers								Subsidiary
		(Parent/				Subsidiary				Non-				Consolidating				Consolidated
		Guarantor)				Guarantors				Guarantors				Adjustments				Total
Revenues		$	—			$	61,885			$	23,853			$	—			$	85,738
Cost of revenues
Direct costs			—				34,173				17,324				—				51,497
Depreciation			—				3,949				1,499				—				5,448
Total cost of revenues			—				38,122				18,823				—				56,945
Gross margin			—				23,763				5,030				—				28,793
General and administrative			637				7,534				887				—				9,058
Amortization			293				385				3				—				681
Income from operations			(930	)			15,844				4,140				—				19,054
Other income (expense):
Equity earnings in affiliates, net of tax			16,872				—				—				(16,872	)			—
Interest, net			(4,701	)			264				(223	)			—				(4,660	)
Other			11				(20	)			(17	)			—				(26	)
Total other income (expense)			12,182				244				(240	)			(16,872	)			(4,686	)
Net income before income taxes			11,252				16,088				3,900				(16,872	)			14,368
Provision for income taxes			—				(1,876	)			(1,240	)			—				(3,116	)
Net income		$	11,252			$	14,212			$	2,660			$	(16,872	)		$	11,252

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

NOTE 9 – CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

CONDENSED CONSOLIDATING INCOME STATEMENTS
For the Nine Months Ended September 30, 2006 (unaudited)

		Allis-Chalmers								Subsidiary
		(Parent/				Subsidiary				Non-				Consolidating				Consolidated
		Guarantor)				Guarantors				Guarantors				Adjustments				Total
Revenues		$	—			$	169,383			$	23,853			$	—			$	193,236
Cost of revenues
Direct costs			—				93,254				17,324				—				110,578
Depreciation			—				11,107				1,499				—				12,606
Total cost of revenues			—				104,361				18,823				—				123,184
Gross margin			—				65,022				5,030				—				70,052
General and administrative			2,032				21,621				887				—				24,540
Amortization			777				1,174				3				—				1,954
Income from operations			(2,809	)			42,227				4,140				—				43,558
Other income (expense):
Equity earnings in affiliates, net of tax			39,644				—				—				(39,644	)			—
Interest, net			(11,601	)			(261	)			(223	)			—				(12,085	)
Other			36				(25	)			(17	)			—				(6	)
Total other income (expense)			28,079				(286	)			(240	)			(39,644	)			(12,091	)
Net income before income taxes			25,270				41,941				3,900				(39,644	)			31,467
Provision for income taxes			—				(4,957	)			(1,240	)			—				(6,197	)
Net income		$	25,270			$	36,984			$	2,660			$	(39,644	)		$	25,270

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

NOTE 9 – CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOW
September 30, 2006 (unaudited)

		Allis-								Other
		Chalmers								Subsidiaries
		(Parent/				Subsidiary				(Non-				Consolidating				Consolidated
		Guarantor)				Guarantors				Guarantors)				Adjustments				Total
Cash Flows from Operating Activities:
Net income		$	25,270			$	36,984			$	2,660			$	(39,644	)		$	25,270
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			—				11,107				1,499				—				12,606
Amortization			777				1,177				—				—				1,954
Imputed interest			—				355				—				—				355
Stock option expense			1,655				983				—				—				2,638
Provision for bad debts			—				353				—				—				353
Equity earnings in affiliates			(39,644	)			—				—				39,644				—
Deferred taxes			281				213				—				—				494
(Gain) loss on sale of equipment			—				(729	)			1				—				(728	)
Changes in operating assets and liabilities, net of acquisitions:
(Increase) decrease in trade receivables			—				(17,883	)			722				—				(17,161	)
(Increase) decrease in inventory			—				(2,325	)			164				—				(2,161	)
Decrease in other current assets			396				660				266				—				1,322
(Increase) decrease in other assets			548				79				(97	)			—				530
(Decrease) increase in accounts payable			(82	)			(1,159	)			(368	)			—				(1,609	)
(Decrease) increase in accrued interest			4,703				(42	)			—				—				4,661
(Decrease) increase in accrued expenses			(387	)			3,560				(657	)			—				2,516
(Decrease) increase in accrued salaries, benefits and payroll taxes			(1,957	)			2,988				2,079				—				3,110
Increase in other long- term liabilities			(31	)			(782	)			—				—				(813	)
Net Cash Provided By Operating Activities			(8,471	)			35,539				6,269				—				33,337
Cash Flows from Investing Activities:
Acquisition of businesses, net of cash			(191,940	)			(11,667	)			418				—				(203,189	)
Notes receivable from affiliates			1,005				—				—				(1,005	)			—
Proceeds from sale of equipment			—				3,516				—				—				3,516
Purchase of property and equipment			—				(22,721	)			(3,090	)			—				(25,811	)
Net Cash Used in Investing Activities			(190,935	)			(30,872	)			(2,672	)			(1,005	)			(225,484	)
Cash Flows from Financing Activities:
Proceeds from exercises of options/warrants			5,406				—				—				—				5,406
Proceeds from issuance of common stock,			46,484				—				—				—				46,484
Accounts receivable from affiliates			(51,691	)			—				—				51,691				—