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 40.
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, Arkansas, Pennsylvania, Oklahoma, New Mexico, offshore in the Gulf of Mexico and internationally primarily in Argentina, Brazil, Bolivia 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 active rigs drilling, or the rig count, is an important indicator of activity levels in the oil and natural gas industry. The rig count in the United States peaked at 2,031 in August 2008 but then declined to 1,721 as of December 26, 2008. According to Baker Hughes, the United States rig count dropped to a recent low of 876 as of June 12, 2009 and has increased to 1,048 as of October 23, 2009 compared to 1,964 one year earlier. The rapid decline in the United States rig count is due to the economic slowdown in the United States and the decrease in natural gas and oil prices which has impacted the capital expenditures of our customers. The turmoil in the financial markets and its impact on the availability of capital for our customers has also affected drilling activity in the United States. Directional and horizontal rig counts, according to the Baker Hughes rig count in the United States, have also decreased and were 651 as of October 23, 2009 compared to 912 as of December 26, 2008 and 1,024 one year earlier.
While our revenue can be correlated to the rig count, our operating costs do not fluctuate in direct proportion to changes in revenues. Our operating expenses consist principally of our labor costs and benefits, equipment rentals, maintenance and repairs of our equipment, depreciation, insurance and fuel. Because many of our costs are fixed, our operating income as a percentage of revenues is generally affected by our level of revenues. Our 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 industry is 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 that our revenue and operating income for our Oilfield Services and Rental Services segment will continue to suffer in the fourth quarter of 2009, due to the reduction of our customers' spending, the low price of natural gas and some seasonal decline in the utilization of our services. While the United States rig count appears to have stabilized and we have seen an increase in our Oilfield Services segment revenues and operating results in the third quarter of 2009 compared to the second quarter of 2009, we have not seen the same improvement for our Rental Services segment. In 2009 we undertook steps to reduce costs, including laying off employees and closing unprofitable operating locations. We have also attempted to convert our direct labor costs to a variable job day-rate bonus structure, established a new customer account management system with financial incentives for our sales force and executed on a strategy to deploy under-utilized assets to the most attractive domestic and international markets. Even with these steps, our Oilfield Services and Rental Services segment may continue to generate negative operating income for the remainder of 2009 due to their reliance on the United States market. Our Drilling and Completion segment, with operations in Argentina, Brazil and Bolivia, has performed better than our domestic businesses due to the benefit of long-term contracts, the profile of its customer base and the stability of oil prices compared to natural gas prices. Nevertheless, we anticipate our Drilling and Completion segment results for the remainder of 2009 will continue to be impacted by the decrease in the utilization of drilling rigs in Argentina and one less available rig in Brazil due to a blow-out. We are redeploying rigs from Argentina to Brazil and other international locations.
We expect our general and administrative expenses for the fourth quarter of 2009 to be consistent with the third quarter of 2009 general and administrative expenses. Our net interest expense is dependent upon our level of debt and cash on hand, which are principally dependent on our capital expenditures and our cash flows from operations. We anticipate our interest expense for the fourth quarter of 2009 to be consistent with the third quarter of 2009 interest expense. In June 2009 we repaid $74.8 million of our outstanding senior notes and all outstanding borrowings under our revolving credit facility and have excess cash as a result of our backstopped rights offering and private placement of preferred stock. Offsetting some of those benefits will be the interest on our new $25.0 million loan facility utilized to acquire two new drilling rigs in May 2009.
Demand for our services is dependent upon our customers' capital spending plans. The capital expenditures of our customers have been impacted by the decrease in oil and natural gas prices compared to 2008, which affects their cash flow and the decrease in the availability of capital resulting from the recent banking and credit crisis. The slowdown in economic activity caused by the recession has reduced demand for energy and resulted in lower oil and natural gas prices compared to the prior year. We are monitoring the credit worthiness of our customers, as well as outstanding receivables, in light of the current credit crisis and as such increased our reserve for doubtful accounts significantly during 2009, but further reserves may be necessary in the fourth quarter of 2009.
We continue to monitor the effect of the global economic downturn on our industry, and the resulting impact on the capital spending budgets of our customers in order to estimate the effect on our company. We have reduced our planned capital spending significantly in 2009 compared to 2008. So far 2009 has been an extremely challenging year for our operations. We are optimistic that our cost saving measures and the $125.6 million in gross equity proceeds received in June 2009 from our backstopped rights offering and private placement of preferred stock, our strategy of international growth, offering new equipment and technology to our customers, and our focus on the United States land shale plays, will carry us through the current recession. Results of Operations
In December 2008, we acquired all of the outstanding stock of BCH Ltd, or BCH, which is reported as part of our Drilling and Completion segment. In August 2008, we sold our drill pipe tong manufacturing assets, which were reported in our Oilfield Services segment. We consolidated the results of these transactions from the date they were effective.
The foregoing acquisition and disposition 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, 2009 and 2008 Our revenues for the three months ended September 30, 2009 were $120.0 million, a decrease of 32.7% compared to $178.3 million for the three months ended September 30, 2008. All of our operating segments experienced a decline in revenue in the three months ended September 30, 2009 compared to the three months ended September 30, 2008. However, revenues increased in the third quarter of 2009 for our Oilfield Services and Drilling and Completion segments compared to the second quarter of 2009. Both our Oilfield Services segment and Rental Services segment have a strong concentration in the United States domestic oil and natural gas market. Due to the decline in oil and natural gas prices and drilling activity compared to 2008, we have experienced a significant deterioration in both equipment utilization and pricing. Revenues in our Drilling and Completion segment declined in spite of the contribution of $11.0 million in revenues during the three months ended September 30, 2009 from our December 2008 acquisition of BCH. Our Drilling and Completion revenues from Argentina declined in the quarter ended September 30, 2009 due to decreased rig utilization and a decrease in rig rates as a result of lower commodity prices. Our direct costs for the three months ended September 30, 2009 decreased 22.4% to $90.8 million, or 75.6% of revenues, compared to $116.9 million, or 65.6%, of revenues for the three months ended September 30, 2008. The increase in the percentage of direct costs to revenue between periods is primarily due to the change in our revenue mix and the fact that not all of our direct costs are variable and therefore do not fluctuate with revenues. For the three months ended September 30, 2009, our higher margin Rental Services segment only comprised 9.8% of our total revenues compared to 15.2% of our total revenues for the three months ended September 30, 2008. Our direct costs in our Oilfield Services and Rental Services segments decreased in absolute dollars in the three months ended September 30, 2009 compared to the three months ended September 30, 2008, but our revenues in our Oilfield Services and Rental Services segments decreased faster during the quarter than the reduction in direct costs. Our Oilfield Services segment direct costs for the three months ended September 30, 2009 decreased 49.6% from direct costs for the three months ended September 30, 2008, while the revenues decreased 56.5% over that same period. Our Oilfield Services segment has also been impacted by pricing pressure that decreases revenues but has no impact on direct costs.
Our direct costs for the Rental Services segment for the three months ended September 30, 2009 decreased 51.2% from direct costs for the three months ended September 30, 2008, while the revenues decreased 56.4% over that same period. Our direct costs for the Rental Services segment are largely fixed because they primarily relate to yard expenses to maintain the rental inventory. In addition, pricing pressure has reduced our Rental Services revenues but had no impact on our direct costs. Direct costs in our Drilling and Completion segment increased $2.8 million for the three months ended September 30, 2009 compared to the three months ended September 30, 2008. Direct costs related to our December 2008 acquisition of BCH were $7.4 million during the three months ended September 30, 2009 and were offset by reduced costs as a result of reduced activity in our Drilling and Completion operation in Argentina. Our Drilling and Completion segment direct costs for the three months ended September 30, 2009 increased 4.7% from direct costs for the three months ended September 30, 2008, while the revenues decreased 1.1% over that same period. This unfavorable variance is primarily attributed to lower utilization of our drilling and service rigs during the three months ended September 30, 2009 compared to the same period of the prior year. Additionally, workforce reductions in response to market conditions are difficult and costly to implement in the labor environment in Argentina. We incurred $1.1 million in severance costs in Argentina during the three months ended September 30, 2009 to reduce our workforce.
Selling, general and administrative expense was $11.4 million for the three months ended September 30, 2009 compared to $15.8 million for the three months ended September 30, 2008. Selling, general and administrative expense decreased due to cost reduction steps that were made in 2009 in response to market conditions and a decrease related to the amortization of share-based compensation arrangements. Selling, general and administrative expense includes share-based compensation expense of $1.2 million in the third quarter of 2009 and $1.8 million in the third quarter of 2008. During the three months ended September 30, 2009, we recorded bad debt expense of $0.5 million compared to $0.9 million for the three months ended September 30, 2008. As a percentage of revenues, selling, general and administrative expenses were 9.5% for the three months ended September 30, 2009 compared to 8.9% for the same period in the prior year.
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 and we recognized a gain of $166,000 on the sale.
Depreciation and amortization expense increased 25.6% to $20.9 million for the three months ended September 30, 2009 from $16.6 million for the three months ended September 30, 2008. The primary increase in depreciation expense is due to our capital expenditure programs in 2008, principally the addition of new service rigs and one drilling rig in Argentina and the expansion of our coiled tubing fleet. Depreciation and amortization expense as a percentage of revenues increased to 17.4% for the third quarter of 2009, compared to 9.3% for the third quarter of 2008, due to the decrease in revenues as a result of the decline in United States drilling activity. The acquisition of BCH at the end of 2008 contributed an additional $0.8 million of depreciation and amortization expense in the three months ended September 30, 2009.

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We had a $3.1 million loss from operations for the three months ended September 30, 2009, compared to $29.0 million in income from operations for the three months ended September 30, 2008, for a total decrease of $32.1 million. The loss from operations in the third quarter of 2009 is due to the decrease in revenues and the increase in direct costs and depreciation as a percentage of revenues, as revenues decreased more quickly than our cost reductions. Our interest expense was $10.8 million for the three months ended September 30, 2009, compared to $12.2 million for the three months ended September 30, 2008. During 2009, we decreased our debt outstanding compared to September 30, 2008. On June 29, 2009 we prepaid the then $35.0 million outstanding loan balance under our revolving credit facility with proceeds from the $125.6 million equity issuances. This compares to an outstanding loan balance of $38.5 million at September 30, 2008 under our revolving credit facility. In addition we purchased $74.8 million of our senior notes on June 29, 2009 from those same equity proceeds. Partially offsetting these debt reductions was a new $25.0 million term loan facility used to fund a portion of the purchase price of two new drilling rigs. Debt also increased due to the acquisition of BCH at the end of 2008. BCH had a $22.1 million term loan facility at December 31, 2008 which was reduced to $16.2 million at September 30, 2009. Interest expense includes amortization expense of debt issuance costs of $539,000 and $525,000 for the three months ended September 30, 2009 and 2008, respectively.
Our interest income was $39,000 for the three months ended September 30, 2009, compared to $1.5 million for the three months ended September 30, 2008. In January 2008, we invested $40.0 million into a 15% convertible subordinated secured debenture with BCH. We earned interest on this note up until December 31, 2008, when we acquired all of the outstanding stock of BCH. Our income tax benefit for the three months ended September 30, 2009 was $4.1 million, or 29.9%, compared to an income tax expense of $6.1 million, or 33.2% of our net income before income taxes for 2008. Our United States effective tax rate was 34.0% for the three months ended September 30, 2009, compared to 38.5% for the same period in the prior year. The effective tax rate is lower as not all of our domestic losses generate state income tax benefit and, in fact, we incurred state income tax expense in one state even though we have a loss. Our international effective tax rate was 44.8% for the three months ended September 30, 2009, compared to 29.6% for the same period in the prior year due to one of our international subsidiaries generating a tax net operating loss and the future utilization of such net operation loss for tax purposes is uncertain.
We had a net loss of $9.7 million for the three months ended September 30, 2009, compared to net income of $12.3 million for the three months ended September 30, 2008 due to the foregoing reasons.
During the three months ended September 30, 2009, we recorded a preferred stock dividend of $0.6 million related to the issuance of our preferred stock in June 2009.
The following table compares revenues and income (loss) from operations for each of our business segments for the quarter ended September 30, 2009 and 2008. Income (loss) from operations consists of our revenues and the loss on an asset disposition less direct costs, selling, general and administrative expenses, depreciation and amortization:

                                              Revenues                                 Income (Loss) from Operations
                                         Three Months Ended                                  Three Months Ended
                                            September 30,                                      September 30,
                               2009             2008            Change             2009              2008           Change
                                                                     (in thousands)
Oilfield Services            $  31,904        $  73,390        $ (41,486 )      $   (4,211 )       $ 13,831        $ (18,042 )
Drilling and Completion         76,299           77,761           (1,462 )           5,508           11,337           (5,829 )
Rental Services                 11,813           27,114          (15,301 )          (1,218 )          8,545           (9,763 )
General corporate                    -                -                -            (3,149 )         (4,680 )          1,531


Total                        $ 120,016        $ 178,265        $ (58,249 )      $   (3,070 )       $ 29,033        $ (32,103 )

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Oilfield Services
Revenues for our Oilfield Services segment were $31.9 million for the three months ended September 30, 2009, a decrease of 56.5% compared to $73.4 million in revenues for the three months ended September 30, 2008. Income from operations decreased $18.0 million and resulted in a loss from operations of $4.2 million in the third quarter of 2009 compared to income from operations of $13.8 million in the third quarter of 2008. Our Oilfield Services segment revenues and operating income for the third quarter of 2009 decreased compared to the third quarter of 2008 due to weak market conditions that resulted in reduced demand and pricing for our services. Depreciation and amortization expense for the Oilfield Services segment increased by $2.0 million or 32.4% in the third quarter of 2009 compared to the third quarter of the previous year, due to capital expenditures completed during 2008, including six coiled tubing units delivered in the last half of 2008. We have not realized the benefits of these capital expenditures due to decreased utilization and pricing of our equipment as a result of the decline in United States drilling activity. Drilling and Completion
Revenues for the quarter ended September 30, 2009 for the Drilling and Completion segment were $76.3 million compared to $77.8 million in revenues for the quarter ended September 30, 2008. Income from operations decreased to $5.5 million in the third quarter of 2009 compared to $11.3 million in the third quarter of 2008. This reduction was due to: (1) reduced rig utilization and rig rates in Argentina; (2) an increase of $1.8 million, or 47.4%, in depreciation and amortization; (3) increased labor and other costs in Argentina; and (4) $1.1 million of severance costs during the three months ended September 30, 2009 related to workforce reductions in Argentina as a result of lower activity. The increase in depreciation and amortization expense was the result of the addition of new rigs in Argentina and the acquisition of BCH. Our Drilling and Completion segment revenues for the third quarter of 2009 included $11.0 million of revenue generated from the acquisition of BCH at the end of 2008. Rental Services
Revenues for the quarter ended September 30, 2009 for the Rental Services segment were $11.8 million, a decrease from $27.1 million in revenues for the quarter ended September 30, 2008. Income from operations decreased to a $1.2 million operating loss in the third quarter of 2009 compared to $8.5 million operating income in the third quarter of 2008. Our Rental Services segment revenues and operating income for the third quarter of 2009 decreased compared to the prior year due to the decrease in revenues as a result of the decrease in utilization of our rental equipment and a more competitive pricing environment due to a decrease in drilling activity in the United States In addition, depreciation and amortization expense for our Rental Services segment increased $0.6 million, or 8.7%, in the third quarter of 2009 compared to the third quarter of 2008 due to capital expenditures made during 2008. General Corporate
General corporate expenses decreased $1.5 million to $3.1 million for the three months ended September 30, 2009 compared to $4.7 million for the three months ended September 30, 2008. The decrease was due to the decrease in payroll costs and benefits due to reduced management and accounting and administrative staff and the decrease in share-based compensation expense. Share-based compensation expense included in general corporate expense was $1.0 million in the third quarter of 2009 compared to $1.5 million in the third quarter of 2008. Comparison of Nine Months Ended September 30, 2009 and 2008 Our revenues for the nine months ended September 30, 2009 were $377.6 million, a decrease of 23.6% compared to $494.6 million for the nine months ended September 30, 2008. The decrease in revenues is due to the decrease in revenues in our Oilfield Services and our Rental Services segments, offset in part by an increase in revenues in our Drilling and Completion segment. The increase in revenues in our Drilling and Completion segment was due to the acquisition of BCH in Brazil offset by lower rig utilization and pricing in our Drilling and Completion operation conducted in Argentina. The Drilling and Completion segment generated $223.2 million in revenues for the nine months ended September 30, 2009 compared to $210.6 million for the nine months ended September 30, 2008. BCH generated $31.8 million of revenues for the nine months ended September 30, 2009. Our Oilfield Services segment revenues decreased to $105.8 million for the nine months ended September 30, 2009 compared to $209.9 million for the nine months ended September 30, 2008. Revenues for our Rental Services segment decreased to $48.6 million for the nine months ended September 30, 2009 compared to $74.0 million for the nine months ended September 30, 2008. The decline in oil and natural gas prices and the resulting decrease in drilling activity caused a significant deterioration in both equipment utilization and pricing for our Oilfield Services and Rental Services segments.

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Our direct costs for the nine months ended September 30, 2009 decreased 12.1% to $281.1 million, or 74.5% of revenues, compared to $319.8 million, or 64.7% of revenues, for the nine months ended September 30, 2008. The increase in the percentage of direct costs to revenue between periods is primarily due to the change in our revenue mix and the fact that not all of our direct costs are variable and therefore do not fluctuate with revenues. For the nine months ended September 30, 2009, our higher margin Rental Services segment only comprised 12.9% of our total revenues compared to 15.0% of our total revenues for the nine months ended September 30, 2008. Our direct costs in our Oilfield Services and Rental Services segments decreased in absolute dollars in the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008, but our revenues in our Oilfield Services and Rental Services segments decreased faster during that same period than the reduction in direct costs. Our Oilfield Services segment direct costs for the nine months ended September 30, 2009 decreased 37.8% from direct costs for the nine months ended September 30, 2008, while the revenues decreased 49.6% over that same period. In addition, our Oilfield Services segment had $1.2 million of expenses recorded during the nine months ended September 30, 2009 related to severance payments, the closing of unprofitable locations and downsizing other locations. Our Oilfield Services segment has also been impacted by pricing pressure that decreases revenues but has no impact on direct costs.
Our Rental Services segment direct costs for the nine months ended September 30, 2009 decreased 23.1% from direct costs in the Rental Services segment for the nine months ended September 30, 2008, while the revenues decreased 34.4% over that same period. Our direct costs for the Rental Services segment are largely fixed because they primarily relate to yard expenses to maintain the rental inventory. In addition, pricing pressure has reduced our Rental Services revenues but had no impact on our direct costs. Direct costs in our Drilling and Completion segment increased $17.4 million for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. Direct costs related to our December 2008 acquisition of BCH were $20.8 million during the nine months ended September 30, 2009. Our Drilling and Completion segment direct costs for the nine months ended September 30, 2009 increased 10.7% from direct costs for the nine months ended September 30, 2008, while the revenues increased 6.0% over that same period. This unfavorable variance is primarily attributed to lower utilization of our drilling and service rigs during the nine . . .