Summary of ALLIS CHALMERS ENERGY INC.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this report. This report contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in such forward-looking statements. Factors that might cause such differences include, but are not limited to, the general condition of the oil and natural gas drilling industry, demand for our oil and natural gas service and rental products, and competition. For more information on forward-looking statements please refer to the section entitled "Forward-Looking Statements" on page 38.
Overview of Our Business
We are a multi-faceted oilfield services company that provides services and equipment to oil and natural gas exploration and production companies, throughout the United States including Texas, Louisiana, New Mexico, Colorado, Oklahoma, Mississippi, Wyoming, Arkansas, West Virginia, offshore in the Gulf of Mexico and internationally primarily in Argentina and Mexico. We currently operate in three sectors of the oil and natural gas service industry: Oilfield Services; Drilling and Completion and Rental Services.
We derive operating revenues from rates per day and rates per job that we charge for the labor and equipment required to provide a service and rates per day for equipment and tools that we rent to our customers. The price we charge for our services depends upon several factors, including the level of oil and natural gas drilling activity and the competitive environment in the particular geographic regions in which we operate. Contracts are awarded based on price, quality of service and equipment, and the general reputation and experience of our personnel. The demand for drilling services has historically been volatile and is affected by the capital expenditures of oil and natural gas exploration and development companies, which can fluctuate based upon the prices of oil and natural gas, or the expectation for the prices of oil and natural gas. The number of working drilling rigs, typically referred to as the "rig count," is an important indicator of activity levels in the oil and natural gas industry. The rig count in the United States increased from 862 as of December 31, 2002, to 1,782 as of December 31, 2007 and to 1,964 on October 24, 2008, according to the Baker Hughes rig count. Furthermore, directional and horizontal rig counts increased from 283 as of December 31, 2002 to 1,024 on October 24, 2008, which accounted for 32.8% and 52.1% of the total U.S. rig count, respectively. During the same period, however, the offshore Gulf of Mexico rig count decreased 35.2% to 70 rigs on October 24, 2008 compared to 108 rigs at December 31, 2002. Beginning in the second half of 2007 many oil and gas operators mobilized drilling rigs to the international markets.
Our cost of revenues represents all direct and indirect costs associated with the operation and maintenance of our equipment. The principal elements of these costs are direct and indirect labor and benefits, repairs and maintenance of our equipment, insurance, equipment rentals, fuel and depreciation. Operating expenses do not fluctuate in direct proportion to changes in revenues because, among other factors, we have a fixed base of inventory of equipment and facilities to support our operations, and in periods of low drilling activity we may also seek to preserve labor continuity to market our services and maintain our equipment.
Cyclical Nature of Equipment Rental and Services Industry The oilfield services industry is highly cyclical. The most critical factor in assessing the outlook for the industry is the worldwide supply and demand for oil and the domestic supply and demand for natural gas. The peaks and valleys of demand are further apart than those of many other cyclical industries. This is primarily a result of the industry being driven by commodity demand and corresponding price increases. As demand increases, producers raise their prices. The price escalation enables producers to increase their capital expenditures. The increased capital expenditures ultimately result in greater revenues and profits for services and equipment companies. The increased capital expenditures also ultimately result in greater production, which historically has resulted in increased supplies and reduced prices.

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Company Outlook
We believe the level of our revenues are sustainable dependent on a favorable oil and natural gas price environment, a stable rig count and the level of capital expenditures of our customers. All of our segments experienced an increase in revenues for the three months ended September 30, 2008 compared to the three months ended June 30, 2008, Drilling and Completion revenue increased $7.9 million, Oilfield Services increased $4.7 million and Rental Services increased $2.5 million. We expect our Rental Services revenues to continue to improve as we develop new markets for our equipment. Our gross margin for the three months ended September 30, 2008 compared to the three months ended June 30, 2008, increased $2.0 million for our Drilling and Completion segment, and increased $333,000 for our Oilfield Services segment while our Rental Services segment had a $184,000 decrease in gross margin. We believe the increases in margin for our Drilling and Completion and our Oilfield Services segments are sustainable as we project utilization of our equipment to remain strong for the remainder of 2008. We believe the decrease in our Rental Services segment gross margin was somewhat impacted by Hurricanes Gustav and Ike. We expect our general and administrative and amortization expenses to remain stable throughout the balance of 2008, absent any significant acquisitions. Our net interest expense is dependent upon our level of debt and cash on hand, which are principally dependent on acquisitions we complete, our capital expenditures and our cash flows from operations.
The sustainability and future growth in our gross margin is principally dependent on our level of revenues and the pricing environment of our services. In addition, our sustainability and the demand for our services is dependent upon our customers' capital spending plans, which are largely driven by current commodity prices and their expectations of future commodity prices. Recent declines in both natural gas and oil prices may cause our customers to delay or curtail capital spending plans. In addition to the impact of the decline in natural gas prices on our customers' capital expenditures and overall liquidity, the recent credit crisis may limit the availability of funds, and therefore lead to decreased capital expenditures for our customers.
The global financial and credit crisis has reduced the availability of liquidity and credit to fund the continuation and expansion of industrial business operations worldwide. Although we do not expect the current economic climate to adversely affect our results for the fourth quarter of 2008, it is still too soon to predict to what extent current events will affect overall activity in 2009 and beyond, but a slowing in the rate of increase of customer spending is anticipated. The shortage of liquidity and credit combined with recent substantial losses in worldwide equity markets could lead to an extended global recession. A slowdown in economic activity caused by a recession would likely reduce demand for energy and result in lower oil and natural gas prices. Such a slowdown in economic activity would likely result in a corresponding decline in the demand for our equipment rental and other services, which could have a material adverse effect on our revenue and profitability. We are monitoring the credit worthiness of our customers, as well as outstanding receivable, in light of the current credit crisis.
In addition, many industry analysts are predicting a material decrease in the average rig count in the U.S. in 2009 due to the conditions in the credit markets, the economic slowdown and the decrease in natural gas prices. A significant decrease in the rig count will likely have an adverse impact on our operating results, particularly in the U.S. domestic market. We strive to mitigate cyclical risk through our international growth, by offering new equipment and technology to our customers and our focus on the U.S. land shale plays.
Results of Operations
In June 2007, we acquired all of the outstanding stock of Coker Directional, Inc., or Coker. In July 2007, we acquired all of the outstanding stock of Diggar Tools, LLC, or Diggar. In October 2007, we acquired all of the outstanding stock of Rebel Rentals, Inc., or Rebel. In November 2007, we acquired substantially all of the assets of Diamondback Oilfield Services, Inc., or Diamondback. We report the operations of Coker, Diggar, Rebel and Diamondback in our Oilfield Services segment. We consolidated the results of these acquisitions from the day they were acquired.
In June 2007, we sold our capillary assets and effective August 1, 2008 we sold our drill pipe tong manufacturing assets. Both of these asset groups were part of our Oilfield Services segment.
The foregoing transactions affect the comparability from period to period of our historical results, and our historical results may not be indicative of our future results.

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Comparison of Three Months Ended September 30, 2008 and 2007 Our revenues for the three months ended September 30, 2008 were $178.3 million, an increase of 20.5% compared to $147.9 million for the three months ended September 30, 2007. The increase in revenues is due to the increase in revenues in our Oilfield Services and Drilling and Completion segments, partly offset by a decrease in revenues in our Rental Services segment. Revenues increased in our Oilfield Services segment by $13.0 million in the third quarter of 2008 compared to the same period in the prior year due to our investment in new equipment in 2007 and in the first nine months of 2008, the opening of new operating locations and small acquisitions completed in the last half of 2007, which added downhole motors, measurement-while-drilling, or MWD tools, and directional drilling personnel. Revenues increased in our Drilling and Completion segment by $19.2 million in the third quarter of 2008 compared to the same period in the prior year due to increased pricing for our drilling and workover services in Argentina and the activation of eight new service rigs during the first quarter of 2008, two new service rigs during the second quarter of 2008 and six new service rigs and one drilling rig during the third quarter of 2008. Revenues decreased in our Rental Services segment by $1.8 million in the third quarter of 2008 compared to the same period in the prior year due to the decrease in rental services from the Gulf of Mexico and a more competitive pricing environment, which was partially offset by increased rental revenues from domestic land activity and new international contracts.
Our gross margin for the quarter ended September 30, 2008 was $45.1 million, or 25.3% of revenues, compared to $45.6 million, or 30.8% of revenues, for the three months ended September 30, 2007. The decrease in gross profit is principally due to the decrease in Rental Services revenue, which has a higher gross margin percentage than our other segments. Our gross margin also decreased due to the increase in depreciation expense. Depreciation expense increased 18.5% to $15.6 million for the third quarter of 2008 compared to $13.2 million for the third quarter of 2007 due to additional depreciable assets resulting from capital expenditures and acquisitions. The decrease in gross profit as a percentage of revenues is primarily due to the decrease in revenue contribution and a more competitive pricing environment in our Rental Services segment and, higher wages and the significant increase in our labor force and labor related expenses in connection with the delivery of new rigs prior to their activation in our Drilling and Completion segment. Finally, the gross margin percentage for our Oilfield Services segment was adversely impacted by hurricanes in the third quarter of 2008. Our cost of revenues consists principally of our labor costs and benefits, equipment rentals, maintenance and repairs of our equipment, depreciation, insurance and fuel.
General and administrative expense was $15.2 million in the three months ended September 30, 2008 compared to $13.5 million for the three months ended September 30, 2007. We recorded an expense of $1.8 million related to share-based compensation expense for the three months ended September 30, 2008 compared to $1.0 million for the three months ended September 30, 2007. During the quarter ended September 30, 2008, we recorded bad debt expense of $869,000 compared to $231,000 in the same period in the prior year. The additional bad debt expense was booked to reflect the age of certain receivables. We also recorded $600,000 of corporate bonus expense for the quarter ended September 30, 2008 compared to $3,000 for the same period of 2007. As a percentage of revenues, general and administrative expenses decreased to 8.5% in the third quarter of 2008 compared to 9.1% in the third quarter of 2007.
Effective August 1, 2008, we sold our drill pipe tong manufacturing assets that were acquired in our acquisition of Rogers Oil Tools, Inc., or Rogers, and that were part of our Oilfield Services segment. The total sale agreement was for $7.5 million. We recognized a gain of $166,000 related to the sale of these assets.
Amortization expense was $1.0 million in the three months ended September 30, 2008 compared to $989,000 in the three months ended September 30, 2007. The increase in amortization expense is due to the amortization of intangible assets in connection with our acquisitions in the later half of 2007.
Income from operations for the three months ended September 30, 2008 totaled $29.0 million, a decrease of 6.8% compared to income from operations of $31.1 million for the three months ended September 30, 2007, primarily due to the decrease in our gross margin in the third quarter of 2008 and the increase in our general and administrative expenses for the same period. Our income from operations as a percentage of revenues decreased to 16.3% for the third quarter of 2008, from 21.1% for the third quarter of 2007, due to the decrease in our gross margin as a percentage of revenues offset partially by the decrease in general and administrative expenses as a percentage of revenues.

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Our net interest expense was $10.7 million in the three months ended September 30, 2008, compared to $11.0 million for the three months ended September 30, 2007. Net interest expense decreased in the third quarter of 2008 due to an increase in interest income offset in part by an increase in our average outstanding debt. Our net interest expense includes interest income of $1.5 million in the third quarter of 2008 from our $40.0 million 15% subordinated convertible debenture due from BCH Ltd. which closed on January 31, 2008.
Our provision for income taxes for the three months ended September 30, 2008 was $6.1 million, or 33.2% of our net income before income taxes, compared to $7.2 million, or 35.8% of our net income before income taxes for the three months ended September 30, 2007. The decrease in our effective tax rate is primarily attributable to our Drilling and Completion operations, which had an effective tax rate of 29.6% for the three months ended September 30, 2008 compared to 32.2% for three months ended September 30, 2007. This decrease in effective tax rate percentage is attributable to the impact of currency exchange rates of the taxing jurisdictions compared to the currency rate of the U.S. dollar.
We had net income of $12.3 million for the three months ended September 30, 2008, a decrease of 5.2% compared to net income of $13.0 million for the three months ended September 30, 2007.
The following table compares revenues and income from operations for each of our business segments and loss of income for general corporate purposes. Income
(loss) from operations consists of revenues less cost of revenues, general and administrative expenses, and depreciation and amortization:

                                              Revenues                                Income (Loss) from Operations
                                         Three Months Ended                                Three Months Ended
                                           September 30,                                      September 30,
                               2008             2007            Change            2008              2007           Change
                                                                    (in thousands)
Oilfield Services            $  73,390        $  60,432        $ 12,958        $   13,831         $ 11,782        $  2,049
Drilling and Completion         77,761           58,546          19,215            11,337           10,262           1,075
Rental Services                 27,114           28,903          (1,789 )           8,545           12,519          (3,974 )
General corporate                    -                -               -            (4,680 )         (3,415 )        (1,265 )


Total                        $ 178,265        $ 147,881        $ 30,384        $   29,033         $ 31,148        $ (2,115 )

Oilfield Services
Revenues were $73.4 million for the three months ended September 30, 2008, an increase of 21.4% compared to $60.4 million in revenues for the three months ended September 30, 2007. Our Oilfield Services segment revenues for the third quarter of 2008 increased compared to the third quarter of 2007 due primarily to our investment in new equipment in 2007 and the first nine months of 2008, including air-drilling compressors, foam units, casing and tubing tools and coiled tubing units. Results in the Oilfield Services segment also improved due to small acquisitions completed in the last half of 2007, which added downhole motors, MWD tools and directional drillers and enabled us to expand our directional drilling business in the Northern Rocky Mountains, the Mid-Continent and Northeast areas. Income from operations increased to $13.8 million in the third quarter of 2008 compared to $11.8 million in the third quarter of 2007. Drilling and Completion
Revenues for the quarter ended September 30, 2008 for the Drilling and Completion segment were $77.8 million, an increase of 32.8% compared to $58.5 million in revenues for the quarter ended September 30, 2007. Income from operations increased to $11.3 million in the third quarter of 2008 compared to $10.3 million in the third quarter of 2007. Our Drilling and Completion segment revenues increased in the third quarter of 2008 due to increased pricing for our drilling and workover services in Argentina and the activation of eight new service rigs during the first quarter of 2008, two new service rigs during the second quarter of 2008 and six new service rigs and one new drilling rig during the third quarter of 2008. Operating income as a percentage of revenues for the third quarter of 2008 decreased compared to the prior year. This was due primarily to higher wages, which included other payroll expenses, and the increase in administrative costs all relating to labor concessions in Argentina granted by the oil industry in the last half of 2007 and a significant increase in our labor force and labor-related expenses in connection with the delivery of new rigs prior to their activation.

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Rental Services
Revenues for the quarter ended September 30, 2008 for the Rental Services segment were $27.1 million, a decrease from $28.9 million in revenues for the quarter ended September 30, 2007. Income from operations decreased to $8.5 million in the third quarter of 2008 compared to $12.5 million in the third quarter of 2007. Our Rental Services segment revenues and operating income for the third quarter of 2008 decreased compared to the prior year due primarily to a more competitive pricing environment, and a decrease in rental services from the Gulf of Mexico, offset in part by increased rental revenues from domestic land drilling and new international contracts. General Corporate
General corporate expenses for the quarter ended September 30, 2008 were $4.7 million, an increase from $3.4 million for the three months ended September 30, 2007. We recorded an expense of $1.5 million related to share-based compensation expense at the general corporate level for the three months ended September 30, 2008 compared to $717,000 for the three months ended September 30, 2007. We also recorded $600,000 of corporate bonus expense for the quarter ended September 30, 2008 compared to $3,000 for the same period of 2007. Comparison of Nine Months Ended September 30, 2008 and 2007 Our revenues for the nine months ended September 30, 2008 were $494.6 million, an increase of 15.8% compared to $427.1 million for the nine months ended September 30, 2007. The increase in revenues is due to the increase in revenues in our Oilfield Services and Drilling and Completion segments, partly offset by a decrease in revenues in our Rental Services segment. Revenues for the nine months ended September 30, 2008 increased in our Oilfield Services segment by $36.0 million compared to the same period in the prior year due to our investment in new equipment in 2007 and in 2008, the opening of new operating locations and small acquisitions completed in the last half of 2007 which added downhole motors, MWD tools and directional drilling personnel. Revenues for the nine months ended September 30, 2008 increased in our Drilling and Completion segment by $50.3 million compared to the same period in the prior year due to increased pricing for our drilling and workover services in Argentina and the activation of eight new service rigs during the first quarter of 2008, two new service rigs in the second quarter of 2008 and six new service rigs and one drilling rig during the third quarter of 2008. Revenues for the nine months ended September 30, 2008 decreased in our Rental Services by $18.9 million compared to the same period of the prior year, due to a more competitive pricing environment, and a decrease in rental services from the Gulf of Mexico. Our gross margin for the nine months ended September 30, 2008 decreased to $127.4 million, or 25.8% of revenues, compared to $140.0 million, or 32.8%, of revenues for the nine months ended September 30, 2007. The decrease in gross profit is principally due to the decrease in Rental Services revenue. Our gross margin also decreased due to the increase in depreciation expense. The decrease in gross profit as a percentage of revenues is primarily due to the decrease in Rental Services revenues, the decrease in our gross margin percentage in our Drilling and Completion segment and the increase in depreciation expense. Depreciation expense increased 21.7% to $45.3 million for the first nine months of 2008 compared to $37.2 million for the first nine months of 2007 due to additional depreciable assets resulting from capital expenditures and acquisitions. The decrease in the gross margin percentage in our Drilling and Completion segment is due to higher wages and the impact of labor strikes and work slowdowns in the second quarter of 2008 as a result of the labor and political environment in Argentina and the significant increase in our labor force and labor related expenses in connection with the delivery of new rigs prior to their activation. Our cost of revenues consists principally of our labor costs and benefits, equipment rentals, maintenance and repairs of our equipment, depreciation, insurance and fuel.
General and administrative expense was $44.1 million in the first nine months of 2008 compared to $41.7 million for the first nine months of 2007. We recorded an expense of $6.2 million related to share-based compensation expense for the nine months ended September 30, 2008 compared to $2.1 million for the nine months ended September 30, 2007. The amount of share-based compensation expense recorded in general and administrative expense was $6.2 million for the first nine months of 2008 and $2.0 million for the first nine months of 2007 with the balance being recorded as a direct cost. As a percentage of revenues, general and administrative expenses decreased to 8.9% in the first nine months of 2008 compared to 9.8% in the first nine months of 2007.
Effective August 1, 2008, we sold our drill pipe tong manufacturing assets that were acquired in our acquisition of Rogers and that were part of our Oilfield Services segment. The total sale agreement was for $7.5 million. We recognized a gain of $166,000 related to the sale of these assets. On June 29, 2007, we sold our capillary tubing assets that were part of our Oilfield Services segment. The total sale agreement was for $16.3 million in cash. We recognized a gain of $8.9 million related to the sale of these assets in the second quarter of 2007.

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Amortization expense was $3.2 million in the first nine months of 2008 compared to $3.0 million in the first nine months of 2007. The increase in amortization expense is due to the amortization of intangible assets in connection with our acquisitions completed in the second half of 2007.
Income from operations for the nine months ended September 30, 2008 totaled $80.3 million, a decrease of 22.9% compared to income from operations of $104.1 million for the nine months ended September 30, 2007, reflecting the decrease in our gross margin, the $8.9 million gain from asset disposition in the second quarter of 2007 and increased general and administrative expenses. Our income from operations as a percentage of revenues decreased to 16.2% for the first nine months of 2008, from 24.4% for the first nine months of 2007, due to the $8.9 million asset sale gain in the second quarter of 2007 and the decrease in our gross margin as a percentage of revenues offset partially by the decrease in general and administrative expenses as a percentage of revenues. Our net interest expense was $32.1 million in the first nine months of 2008, compared to $35.0 million for the first nine months of 2007. Interest expense decreased in the first nine months of 2008 due to an increase in interest income, offset in part by an increase in our average outstanding debt. Our net interest expense includes interest income of $4.0 million in the first nine months of 2008 from our $40.0 million 15% subordinated convertible debenture due from BCH Ltd. which closed on January 31, 2008. In January 2007, we issued $250.0 million of senior notes bearing interest at 8.5% to pay off, in part, the bridge loan utilized to complete the acquisition of the assets of Oil & Gas Rental Services, Inc., or OGR, and for working capital. The bridge loan was outstanding until January 29, 2007 and had an average interest rate of 10.6%. Interest expense for the first nine months of 2007 includes the write-off of deferred financing fees of $1.2 million related to the repayment of the bridge loan.
Our provision for income taxes for the nine months ended September 30, 2008 was $17.9 million, or 36.6% of our net income before income taxes, compared to $24.8 million, or 35.7% of our net income before income taxes for the nine months ended September 30, 2007. The increase in our effective tax rate is primarily attributable to our Drilling and Completion operations, which had an effective tax rate of 35.8% for the nine months ended September 30, 2008 compared to 33.3% for the nine months ended September 30, 2007. This increase in effective tax rate percentage is attributable to the impact of currency exchange rates of the taxing jurisdictions compared to the currency rate of the U.S. dollar, as our Drilling and Completion segment operates primarily in Argentina. . . .