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

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

Commission file number 1-8514

Smith International, Inc.

(Exact name of Registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		95-3822631 (I.R.S. Employer Identification No.)
1310 Rankin Road Houston, Texas (Address of principal executive offices)		77073 (Zip Code)

(281) 443-3370
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ      No o

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

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

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

There were 220,536,730 shares of common stock outstanding, net of treasury shares held, on August 5, 2009.

 

 

INDEX

		Page
		No.
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS For the Three Months and Six Months ended June 30, 2009 and 2008			3
CONSOLIDATED CONDENSED BALANCE SHEETS As of June 30, 2009 and December 31, 2008			4
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS For the Six Months ended June 30, 2009 and 2008			5
CONSOLIDATED CONDENSED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME For the Six Months ended June 30, 2009 and 2008			6
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
Item 3. Quantitative and Qualitative Disclosures about Market Risk			25
Item 4. Controls and Procedures			25
PART II – OTHER INFORMATION
Items 1 - 1A			26
Items 2 - 5			27-28
Item 6			28
SIGNATURES			29
EXHIBIT INDEX			30
EX-31.1
EX-31.2
EX-32.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I – FINANCIAL INFORMATION

Item 1.		Financial Statements

SMITH INTERNATIONAL, INC.

(In thousands, except per share data)

(Unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
Revenues:
Oilfield operations		$	1,533,483			$	1,878,570			$	3,375,220			$	3,681,497
Distribution operations			410,806				615,588				980,548				1,183,659
Total revenues			1,944,289				2,494,158				4,355,768				4,865,156
Costs and expenses:
Cost of oilfield revenues			1,052,644				1,178,365				2,281,835				2,297,868
Cost of distribution revenues			362,615				508,341				852,601				978,352
Selling, general and administrative expenses			395,726				417,685				846,350				820,362
Total costs and expenses			1,810,985				2,104,391				3,980,786				4,096,582
Operating income			133,304				389,767				374,982				768,574
Interest expense			42,803				16,244				70,327				32,545
Interest income			(729	)			(752	)			(1,087	)			(1,648	)
Income before income taxes and noncontrolling interests			91,230				374,275				305,742				737,677
Income tax provision			27,957				121,555				98,275				238,846
Net income			63,273				252,720				207,467				498,831
Noncontrolling interests in net income of subsidiaries			38,887				69,447				86,146				140,567
Net income attributable to Smith		$	24,386			$	183,273			$	121,321			$	358,264
Earnings per share attributable to Smith:
Basic		$	0.11			$	0.91			$	0.55			$	1.78
Diluted			0.11				0.91				0.55				1.77
Weighted average shares outstanding:
Basic			219,307				200,938				219,254				200,873
Diluted			220,245				202,284				219,925				202,169

The accompanying notes are an integral part of these consolidated condensed financial statements.

SMITH INTERNATIONAL, INC.

(In thousands, except par value data)

(Unaudited)

		June 30,				December 31,
		2009				2008
Assets
Current Assets:
Cash and cash equivalents		$	224,184			$	162,508
Receivables, net			1,740,161				2,253,477
Inventories, net			2,120,929				2,367,166
Deferred tax assets, net			78,545				81,834
Prepaid expenses and other			162,585				221,399
Total current assets			4,326,404				5,086,384
Property, plant and equipment, net			1,866,301				1,844,036
Goodwill, net			3,020,236				3,016,425
Other intangible assets, net			613,350				637,450
Other assets			282,352				231,929
Total assets		$	10,108,643			$	10,816,224
Liabilities and Stockholders’ Equity
Current Liabilities:
Short-term borrowings and current portion of long-term debt		$	404,885			$	1,366,296
Accounts payable			598,924				979,000
Accrued payroll costs			145,082				178,040
Income taxes payable			22,615				92,922
Other			221,686				317,174
Total current liabilities			1,393,192				2,933,432
Long-term debt			2,051,474				1,440,525
Deferred tax liabilities			462,347				428,986
Other long-term liabilities			151,386				152,972
Commitments and contingencies (Note 13)
Stockholders’ Equity:
Preferred stock, $1 par value; 5,000 shares authorized; no shares issued or outstanding in 2009 or 2008			—				—
Common stock, $1 par value; 250,000 shares authorized; 236,995 shares issued in 2009 (236,726 shares issued in 2008)			236,995				236,726
Additional paid-in capital			1,998,460				1,975,102
Retained earnings			2,954,423				2,885,792
Accumulated other comprehensive income (loss)			(6,807	)			(73,833	)
Less – Treasury securities, at cost; 17,662 common shares in 2009 (17,616 common shares in 2008)			(475,492	)			(474,448	)
Smith stockholders’ equity			4,707,579				4,549,339
Noncontrolling interests in subsidiaries			1,342,665				1,310,970
Total stockholders’ equity			6,050,244				5,860,309
Total liabilities and stockholders’ equity		$	10,108,643			$	10,816,224

The accompanying notes are an integral part of these consolidated condensed financial statements.

SMITH INTERNATIONAL, INC.

(In thousands)

(Unaudited)

		Six Months Ended
		June 30,
		2009				2008
Cash flows from operating activities:
Net income		$	207,467			$	498,831
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			182,807				104,419
Deferred income tax provision			8,286				(5,108	)
Increase in LIFO inventory reserves			4,969				28,909
Share-based compensation expense			23,139				20,868
Provision for losses on receivables			7,346				1,908
Foreign currency translation gains			(5,611	)			(846	)
Gain on disposal of property, plant and equipment			(22,364	)			(16,658	)
Equity earnings, net of dividends received			(6,549	)			(10,686	)
Changes in operating assets and liabilities:
Receivables			518,720				(188,565	)
Inventories			266,775				(283,281	)
Accounts payable			(384,502	)			160,275
Other current assets and liabilities			(117,778	)			(38,922	)
Other non-current assets and liabilities			(31,451	)			(8,380	)
Net cash provided by operating activities			651,254				262,764
Cash flows from investing activities:
Purchases of property, plant and equipment			(169,730	)			(163,004	)
Proceeds from disposal of property, plant and equipment			38,701				26,190
Proceeds from sale of operations			65,019				—
Acquisitions, net of cash acquired			(14,268	)			(27,937	)
Net cash used in investing activities			(80,278	)			(164,751	)
Cash flows from financing activities:
Proceeds from issuance of long-term debt			1,000,000				26,812
Principal payments of long-term debt			(340,352	)			(67,974	)
Principal payment of short-term bridge loan			(1,000,000	)			—
Net change in short-term borrowings			(8,790	)			(18,130	)
Debt issuance costs			(9,855	)			—
Settlement of interest rate derivative contract			(33,383	)			—
Payment of common stock dividends			(52,598	)			(44,163	)
Distributions to noncontrolling joint venture partner			(64,000	)			(14,747	)
Purchases of common stock under Repurchase Program			—				(8,647	)
Proceeds (payments) related to long-term incentive awards			(531	)			1,845
Tax impact of share-based compensation			(2,406	)			7,591
Net cash used in financing activities			(511,915	)			(117,413	)
Effect of exchange rate changes on cash			2,615				2,636
Increase (decrease) in cash and cash equivalents			61,676				(16,764	)
Cash and cash equivalents at beginning of period			162,508				158,267
Cash and cash equivalents at end of period		$	224,184			$	141,503
Supplemental disclosures of cash flow information:
Cash paid for interest		$	47,526			$	32,378
Cash paid for income taxes			173,603				228,659

The accompanying notes are an integral part of these consolidated condensed financial statements.

SMITH INTERNATIONAL, INC.

(In thousands)

														Accumulated
						Additional								Other								Smith				Noncontrolling				Total
		Common				Paid-in				Retained				Comprehensive				Treasury				Stockholders’				Interests in				Stockholders’
		Stock				Capital				Earnings				Income (Loss)				Securities				Equity				Subsidiaries				Equity
Balance, December 31, 2008		$	236,726			$	1,975,102			$	2,885,792			$	(73,833	)		$	(474,448	)		$	4,549,339			$	1,310,970			$	5,860,309
Net income			—				—				121,321				—				—				121,321				86,146				207,467
Changes in fair value of derivatives			—				—				—				39,676				—				39,676				—				39,676
Currency translation adjustments and other			—				—				—				27,350				—				27,350				9,549				36,899
Comprehensive income			—				—				121,321				67,026				—				188,347				95,695				284,042
Common stock dividends declared			—				—				(52,690	)			—				—				(52,690	)			—				(52,690	)
Distributions to noncontrolling joint venture partner			—				—				—				—				—				—				(64,000	)			(64,000	)
Long-term incentive compensation activity			269				23,358				—				—				(1,044	)			22,583				—				22,583
Balance, June 30, 2009		$	236,995			$	1,998,460			$	2,954,423			$	(6,807	)		$	(475,492	)		$	4,707,579			$	1,342,665			$	6,050,244

														Accumulated
						Additional								Other								Smith				Noncontrolling				Total
		Common				Paid-in				Retained				Comprehensive				Treasury				Stockholders’				Interests in				Stockholders’
		Stock				Capital				Earnings				Income (Loss)				Securities				Equity				Subsidiaries				Equity
Balance, December 31, 2007		$	217,586			$	533,429			$	2,219,224			$	67,840			$	(443,182	)		$	2,594,897			$	1,130,773			$	3,725,670
Net income			—				—				358,264				—				—				358,264				140,567				498,831
Changes in fair value of derivatives			—				—				—				(801	)			—				(801	)			—				(801	)
Currency translation adjustments and other			—				—				—				12,028				—				12,028				2,081				14,109
Comprehensive income			—				—				358,264				11,227				—				369,491				142,648				512,139
Purchases of common stock under Repurchase Program			—				—				—				—				(8,647	)			(8,647	)			—				(8,647	)
Common stock dividends declared			—				—				(48,221	)			—				—				(48,221	)			—				(48,221	)
Distributions to noncontrolling joint venture partner			—				—				—				—				—				—				(14,747	)			(14,747	)
Long-term incentive compensation activity			626				38,027				—				—				(6,596	)			32,057				—				32,057
Balance, June 30, 2008		$	218,212			$	571,456			$	2,529,267			$	79,067			$	(458,425	)		$	2,939,577			$	1,258,674			$	4,198,251

The accompanying notes are an integral part of these consolidated condensed financial statements.

SMITH INTERNATIONAL, INC.

(All dollar amounts are expressed in thousands, unless otherwise noted)

(Unaudited)

1. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated condensed financial statements of Smith International, Inc. and subsidiaries (“Smith” or the “Company”) were prepared in accordance with U.S. generally accepted accounting principles and applicable rules and regulations of the Securities and Exchange Commission (the “Commission”) pertaining to interim financial information. These interim financial statements do not include all information or footnote disclosures required by generally accepted accounting principles for complete financial statements and, therefore, should be read in conjunction with the audited financial statements and accompanying notes included in the Company’s 2008 Annual Report on Form 10-K and other current filings with the Commission. All adjustments that are, in the opinion of management, of a normal and recurring nature and are necessary for a fair presentation of the interim financial statements have been included.

Preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosed amounts of contingent assets and liabilities and the reported amounts of revenues and expenses. If the underlying estimates and assumptions, upon which the financial statements are based, change in future periods, actual amounts may differ from those included in the accompanying consolidated condensed financial statements.

Management is also required to consider material events that occur after the date, but prior to the issuance, of the financial statements and evaluate whether such events require modification to the reported results or footnote disclosures. Our subsequent event review has been conducted through August 7, 2009, immediately prior to the filing of the financial statements with the Commission.

Management believes the consolidated condensed financial statements present fairly the financial position, results of operations and cash flows of the Company as of the dates indicated. The results of operations for the interim period presented may not be indicative of results which may be reported on a fiscal year basis.

Recently Adopted Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”). The following standards were adopted by the Company on the specified effective date.

During the first quarter of 2009, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 141(R), “Business Combinations” (“SFAS 141(R)”) which revises the accounting and disclosure requirements for acquisition transactions. SFAS 141(R) differs from the previous standard in that it requires the Company to expense professional fees and other transaction-related costs as incurred instead of capitalizing these costs as purchase price consideration. Additionally, the Company will be required to estimate contingent assets, liabilities and transaction-related consideration as of the purchase date with future changes in the underlying estimates recognized in the statement of operations. Finally, SFAS 141(R) requires the Company to reflect any adjustments to deferred tax asset valuation allowances and income tax uncertainties associated with acquisitions completed prior to January 1, 2009 as income tax expense rather than an adjustment to goodwill.

During the first quarter of 2009, the Company implemented SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51” (“SFAS 160”) which modifies the accounting and disclosure requirements for subsidiaries which are not wholly-owned. In accordance with the provisions of SFAS 160, the Company has reclassified the noncontrolling interest previously reflected as a long-term liability and included the amount as a component of stockholders’ equity in the accompanying consolidated condensed balance sheets. Additionally, the Company has presented the net income attributable to the Company and the noncontrolling ownership interests separately in the accompanying consolidated condensed statements of operations.

During the first quarter of 2009, the Company adopted SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133” which requires enhanced disclosure about derivative instruments. The standard requires the inclusion of tabular information reflecting the impact of derivative financial instruments on the Company’s consolidated financial position and results of operations.

During the second quarter of 2009, the Company adopted FASB Staff Position No. 107-1 and Accounting Principles Board Opinion No. 28-1, “Interim Disclosure about Fair Value of Financial Instruments” which requires additional fair value disclosure with respect to financial instruments in our interim financial statements.

During the second quarter of 2009, the Company adopted the provisions of SFAS No. 165, “Subsequent Events” which requires the disclosure of specifics related to the Company’s subsequent review, including the date through which such review was completed.

Management believes the impact of other recently issued standards, which are not yet effective, will not have a material impact on the Company’s consolidated financial position, results of operations or cash flows upon adoption.

2. Employee Severance and Other Costs

Due to the significant deterioration in North American drilling activity, the Company has undertaken a number of cost reduction initiatives during the first six months of 2009. These measures included personnel reductions and, to a lesser extent, the closing of certain manufacturing and production facilities. The Company has reduced its global workforce by 11 percent from December 31, 2008, primarily associated with a 22 percent reduction in U.S. personnel levels. In connection with these activities, the Company incurred costs of approximately $13.0 million and $45.3 million, respectively, for the three-month and six-month periods ended June 30, 2009.

3. Acquisitions and Dispositions

Acquisitions

From time to time, the Company enters into transactions involving the purchase of a full or partial ownership interest in complementary business operations. No material acquisitions were completed during the first six months of 2009.

On August 25, 2008, Smith completed the acquisition of W-H Energy Services, Inc. (“W-H”). The transaction has been recorded using the purchase method of accounting and, accordingly, the acquired operations have been included in the results of operations since the closing date. The following unaudited pro forma supplemental information presents consolidated results of operations as if the W-H acquisition had occurred on January 1, 2008. The unaudited pro forma data is based on historical information and does not include estimated cost savings; therefore, it does not purport to be indicative of the results of operations had the combination been in effect at the date indicated or of future results for the combined entities (in thousands, except per share amounts):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
Revenues		$	1,944,289			$	2,841,095			$	4,355,768			$	5,513,061
Net income attributable to Smith		$	24,386			$	208,258			$	121,321			$	402,954
Earnings per share attributable to Smith:
Basic		$	0.11			$	0.95			$	0.55			$	1.84
Diluted		$	0.11			$	0.95			$	0.55			$	1.83

Dispositions

During the first six months of 2009, the Company disposed of certain non-core operations acquired in connection with the W-H transaction. The Company received cash proceeds of $65.0 million and is entitled to future consideration in the event financial metrics established under earn-out arrangements are met. The accompanying consolidated condensed financial statements reflect no gain or loss associated with the sale of these operations.

4. Earnings Per Share

Basic earnings per share (“EPS”) is computed using the weighted average number of common shares outstanding during the period. Diluted EPS gives effect to the potential dilution of earnings that could have occurred if additional shares were issued for stock option and restricted stock awards under the treasury stock method. For each of the periods presented, an immaterial number of outstanding stock-based awards were excluded from the computation of diluted EPS because they were anti-dilutive. The following schedule reconciles the income and shares used in the basic and diluted EPS computations (in thousands, except per share data):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
Net income attributable to Smith		$	24,386			$	183,273			$	121,321			$	358,264
Weighted average number of common shares outstanding			219,307				200,938				219,254				200,873
Basic EPS		$	0.11			$	0.91			$	0.55			$	1.78
Net income attributable to Smith		$	24,386			$	183,273			$	121,321			$	358,264
Weighted average number of common shares outstanding			219,307				200,938				219,254				200,873
Dilutive effect of stock options and restricted stock units			938				1,346				671				1,296
			220,245				202,284				219,925				202,169
Diluted EPS		$	0.11			$	0.91			$	0.55			$	1.77

5. Inventories

Inventories are stated at the lower of cost or market. Cost is determined using the average cost method for the majority of the Company’s inventories; however, a portion of the Company’s U.S.-based inventories are valued utilizing the last-in, first-out (“LIFO”) method. Inventory costs, consisting of materials, labor and factory overhead, are as follows:

		June 30,				December 31,
		2009				2008
Raw materials		$	180,743			$	190,790
Work-in-process			174,220				202,019
Finished goods			1,982,781				2,186,203
			2,337,744				2,579,012
Reserves to state certain U.S. inventories (FIFO cost of $983,203 and $1,044,345 in 2009 and 2008, respectively) on a LIFO basis			(216,815	)			(211,846	)
		$	2,120,929			$	2,367,166

For the six months ended June 30, 2009, the Company recorded additional LIFO reserves of $5.0 million, primarily related to modest cost inflation experienced in the oilfield manufacturing operations which resulted in the revaluation of on-hand inventories to current unit cost standards. To a lesser extent, the higher cost of steel and alloy products purchased in the Distribution segment contributed to the increase in LIFO reserves.

6. Property, Plant and Equipment

Property, plant and equipment consist of the following:

		June 30,				December 31,
		2009				2008
Land and improvements		$	78,679			$	77,463
Buildings			334,371				322,569
Machinery and equipment			1,107,760				1,048,821
Rental tools			1,370,136				1,292,796
			2,890,946				2,741,649
Less – Accumulated depreciation			(1,024,645	)			(897,613	)
		$	1,866,301			$	1,844,036

7. Goodwill and Other Intangible Assets

Goodwill

The following table presents goodwill on a segment basis as of the dates indicated as well as changes in the account during the period shown. Consolidated beginning and ending goodwill balances are presented net of accumulated amortization of $53.6 million.

						Smith
		M-I SWACO				Oilfield				Distribution				Consolidated
Balance as of December 31, 2008		$	714,663			$	2,250,675			$	51,087			$	3,016,425
Purchase price and other adjustments			—				3,811				—				3,811
Transfer between segments			10,320				(10,320	)			—				—
Balance as of June 30, 2009		$	724,983			$	2,244,166			$	51,087			$	3,020,236

Other Intangible Assets

The components of other intangible assets are as follows:

		June 30, 2009												December 31, 2008
		Gross Carrying				Accumulated								Gross Carrying				Accumulated
		Amount				Amortization				Net				Amount				Amortization				Net
Patents		$	427,066			$	67,631			$	359,435			$	426,772			$	52,175			$	374,597
Trademarks(a)			205,031				4,077				200,954				205,031				3,764				201,267
License agreements			33,857				18,863				14,994				32,416				17,311				15,105
Non-compete agreements			37,928				25,845				12,083				37,928				23,122				14,806
Customer relationships and contracts			58,438				32,554				25,884				58,438				26,763				31,675
		$	762,320			$	148,970			$	613,350			$	760,585			$	123,135			$	637,450

Intangible amortization expense totaled $12.9 million and $5.9 million for the three-month periods ended June 30, 2009 and 2008, respectively, and $25.8 million and $13.3 million for the six-month periods ended June 30, 2009 and 2008, respectively. The weighted average life for other intangible assets subject to amortization, which excludes certain indefinite-lived trademarks, approximates 13 years. Intangible amortization expense is expected to approximate $51 million for fiscal year 2009, $48 million for fiscal year 2010 and is anticipated to range between $34 million and $41 million per year for the 2011 – 2013 fiscal years.

8. Debt

The following summarizes the Company’s outstanding debt:

		June 30,				December 31,
		2009				2008
Current:
Short-term borrowings		$	87,653			$	1,096,443
Current portion of long-term debt			317,232				269,853
Short-term borrowings and current portion of long-term debt		$	404,885			$	1,366,296
Long-Term:
Notes, net of unamortized discounts		$	1,493,450			$	494,638
Revolving credit facilities			45,000				260,000
Term loans			830,256				955,740
			2,368,706				1,710,378
Less – Current portion of long-term debt			(317,232	)			(269,853	)
Long-term debt		$	2,051,474			$	1,440,525

During the first quarter of 2009, the Company completed a public offering of $300.0 million five-year and $700.0 million ten-year Senior Notes issued under an existing Indenture. Net proceeds of $991.1 million were received in connection with the offering and were used to repay outstanding indebtedness under a $1.0 billion bridge loan facility expiring August 2009. The Senior Notes are unsecured obligations of the Company, carry a combined effective interest rate of 9.44 percent and require semi-annual interest payments.

In March 2009, the Company also entered into a $525.0 million term loan facility with a syndicate of financial institutions (the “Lenders”) which remained undrawn at June 30, 2009. Subsequent to quarter-end, the Company requested termination of the term loan facility and entered into a new $375.0 million unsecured revolving credit facility with the Lenders. The revolving credit agreement allows for the election of interest at a base rate, or a Eurodollar rate of LIBOR plus 250 basis points, and requires the payment of a quarterly commitment fee of 32.5 basis points on the unutilized portion of the facility. The credit agreement, which contains a debt-to-total capitalization limitation and other customary covenants, expires on July 23, 2010.

Principal payments of long-term debt for the twelve-month periods ending subsequent to June 30, 2010 are as follows:

2011		$	274,711
2012			491,972
2013			11,007
2014			299,262
Thereafter			974,522
		$	2,051,474

The Company was in compliance with its loan covenants under the various loan indentures, as amended, at June 30, 2009.

9. Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive income (loss) in the accompanying consolidated condensed balance sheets consist of the following:

		June 30,				December 31,
		2009				2008
Currency translation adjustments		$	3,023			$	(24,235	)
Changes in unrealized fair value of derivatives, net			(2,813	)			(42,489	)
Pension liability adjustments			(7,017	)			(7,109	)
Accumulated other comprehensive income (loss)		$	(6,807	)		$	(73,833	)

10. Financial Instruments

Foreign Exchange and Interest Rate Derivative Instruments

The nature of the Company’s business activities involves the management of various financial and market risks, including those related to changes in currency exchange rates and interest rates. In an effort to mitigate these risks, the Company enters into derivative financial instruments which are accounted for as fair value or cash flow hedges in accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). The Company does not enter into derivative instruments for speculative purposes.

For foreign exchange and interest rate derivative instruments that do not qualify as cash flow hedges, realized and unrealized gains and losses are recognized currently through earnings. Non-cash flow foreign exchange hedge contracts with a notional amount of $103.9 million were outstanding at June 30, 2009.

For foreign exchange and interest rate derivative instruments that qualify as cash flow hedges, realized and unrealized gains and losses are deferred to accumulated other comprehensive income (loss) (“AOCI”) and recognized in the consolidated statement of operations when the hedged item affects earnings. As of June 30, 2009, the Company had one outstanding interest rate cash flow hedge contract with a notional amount of $77.0 million and no outstanding foreign exchange cash flow hedge contracts.

The Company entered into three interest rate contracts and subsequent extensions during fiscal 2008 in anticipation of a planned public debt issuance. At December 31, 2008, unrealized mark-to-market losses of $59.8 million associated with these cash flow hedge transactions were deferred as a component of AOCI. Contract extensions expiring subsequent to December 31, 2008 did not qualify as cash flow hedge transactions resulting in the recognition of a $56.9 million mark-to-market gain in the first quarter of 2009.

The 2009 public debt transaction did not include a longer-tenor debt issuance as contemplated in the cash flow hedge transaction and a future transaction of this tenor is probable of not occurring. Accordingly, $59.3 million of the mark-to-market loss previously deferred as a component of AOCI was reclassified into earnings during the first quarter of 2009 offsetting the $56.9 million mark-to-market gain discussed above. Approximately $2.2 million of losses deferred in AOCI related to cash flow foreign exchange and interest rate derivative contracts, or $1.0 million net of taxes and noncontrolling interests, will be reclassified into earnings during the remainder of fiscal 2009.

In addition to the $2.4 million net mark-to-market interest rate derivative loss included in the first quarter of 2009, the Company has recognized $3.8 million and $10.9 million of derivative contract losses in the consolidated condensed statements of operations for the three-month and six-month periods ended June 30, 2009. The following table provides required information with respect to the classification and loss amounts recognized in income as well as the derivative-related contract losses deferred in AOCI during the 2009 periods shown:

Derivatives Designated		Gain (Loss)								Location of				Gain (Loss)								Location of Gain (Loss)				Gain (Loss)
as Cash Flow Hedging		Recognized								Gain (Loss) Reclassified				Reclassified from								Recognized in Income				Recognized in Income
Instruments under SFAS 133 -		in AOCI								from AOCI to Income				AOCI to Income								(Ineffective)				(Ineffective)
		Three				Six								Three				Six								Three				Six
		Months				Months								Months				Months								Months				Months
Interest rate contracts		$	(464	)		$	(954	)		Interest expense				$	(725	)		$	(1,367	)		Selling, general and administrative expenses				$	—			$	(76	)
Foreign exchange Contracts			—				(1,061	)		Cost of oilfield revenues					(908	)			(2,316	)							—				—
Total		$	(464	)		$	(2,015	)						$	(1,633	)		$	(3,683	)						$	—			$	(76	)

Derivatives Not Designated

as Hedging Instruments

Location of Gain (Loss)

Gain (Loss)

under SFAS 133 –

Recognized in Income

Recognized in Income

Three

Six

Months

Months

Foreign exchange contracts

Selling, general and administrative expenses

$

(2,216

)

$

(7,161

)

Fair Value Measurement

The fair value of outstanding foreign exchange derivative instruments is determined using composite pricing from published financial market sources whereas the fair value of the outstanding interest rate derivative instruments is determined by obtaining quoted prices in active markets for identical contracts. Both measurement methodologies are classified as Level Two tier under SFAS 157. The recorded fair value of derivative instruments at June 30, 2009 is as follows:

		Asset Derivatives								Liability Derivatives
		Classification				Fair Value				Classification				Fair Value
Derivatives Designated as Hedging Instruments under SFAS 133 –
Interest rate contracts						$	—			Other current liabilities				$	(5,373	)
Foreign exchange contracts		Prepaid expenses and other					12								—
Derivatives Not Designated as Hedging Instruments under SFAS 133 –
Foreign exchange contracts		Prepaid expenses and other					8,061			Other current liabilities					(8,029	)
Total						$	8,073							$	(13,402	)

The fair value of outstanding long-term debt instruments is determined using quoted prices for identical debt instruments, which is classified as a Level Two tier measurement methodology under SFAS 157. At June 30, 2009, the fair value of long-term debt instruments approximated $2.44 billion and the recorded value totaled $2.37 billion. The fair and recorded values of long-term debt instruments totaled $1.63 billion and $1.71 billion, respectively, at December 31, 2008.

The fair value of the remaining financial instruments, including cash and cash equivalents, receivables, payables and short-term borrowings, approximates the carrying value due to the nature of these instruments.

11. Long-Term Incentive Compensation

As of June 30, 2009, the Company had outstanding restricted stock units and stock options granted under the Amended and Restated 1989 Long-Term Incentive Compensation Plan (the “LTIC Plan”). As of June 30, 2009, approximately 1.9 million shares were authorized for future issuance pursuant to the LTIC Plan.

Restricted Stock

The restricted stock program consists of a combination of performance-based restricted stock units (“performance-based units”) and time-based restricted stock units (“time-based units”). The number of performance-based units issued under the program, which can range from zero to 130 percent of the target units granted, is solely dependent upon financial metrics achieved by the Company in the fiscal year subsequent to the award. Activity under the Company’s restricted stock program for the six-month period ended June 30, 2009 is presented below (in thousands, except per share data):

		Time-Based Awards								Performance-Based Awards								Total
		No. of				Fair				No. of				Fair				Restricted
		Units				Value(a)				Units(b)				Value(a)				Stock Units
Outstanding at December 31, 2008			2,599			$	32.57				1,639			$	31.60				4,238
Granted			145				21.64				—				—				145
Forfeited			(155	)			35.70				(60	)			31.64				(215	)
Vested			(58	)			59.29				—				—				(58	)
Outstanding at June 30, 2009			2,531			$	31.14				1,579			$	31.58				4,110

Restrictions on approximately 1.1 million restricted stock units outstanding at June 30, 2009 are expected to lapse and issue during the 2009 fiscal year.

Stock Options

Activity under the Company’s stock option program for the six-month period ended June 30, 2009 is presented below (in thousands, except per share data):

		Shares				Weighted				Weighted Average
		Under				Average				Remaining				Aggregate
		Option				Exercise Price				Contractual Life				Intrinsic Value
Outstanding at December 31, 2008			1,150			$	19.58
Forfeited			(9	)			23.26
Exercised			(35	)			14.88
Outstanding at June 30, 2009			1,106			$	19.69				3.93			$	7,498
Exercisable at June 30, 2009			1,104			$	19.65				3.93			$	7,498

Share-based Compensation Expense

Share-based compensation expense, consisting of restricted stock unit and stock option awards, was $10.8 million and $10.2 million for the three-month periods ended June 30, 2009 and 2008, respectively, and $23.1 million and $20.9 million for each of the six-month periods ended June 30, 2009 and 2008, respectively.

Assuming achievement of target-level financial metrics for performance-based awards granted in December 2008, unrecognized share-based compensation expense totaled $99.3 million for awards outstanding as of June 30, 2009. After adjusting for taxes and noncontrolling interests, approximately $57.9 million of additional share-based compensation is expected to be recognized over a weighted average period of 2.6 years.

12. Industry Segments and International Operations

The Company is a global provider of products and services used during the drilling, completion and production phases of oil and natural gas development activities. Our business is segregated into three operating divisions, M-I SWACO, Smith Oilfield and Distribution, which is the basis upon which we report our results.

The M-I SWACO segment consists of a majority-owned drilling fluid and environmental services joint venture operation. The Smith Oilfield segment is comprised of our wholly-owned drilling and completion services operations, which includes drill bits, directional drilling services and downhole tools. The Distribution segment consists of the Wilson distribution operations and a majority-owned interest in CE Franklin Ltd., a publicly-traded Canadian distribution company. Finally, general corporate primarily reflects expenses related to corporate personnel, administrative support functions and long-term incentive compensation programs.

The following table presents financial information for each reportable segment:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
Revenues:
M-I SWACO		$	1,013,016			$	1,285,754			$	2,172,353			$	2,514,183
Smith Oilfield			520,467				592,816				1,202,867				1,167,314
Distribution			410,806				615,588				980,548				1,183,659
		$	1,944,289			$	2,494,158			$	4,355,768			$	4,865,156
Operating Income:
M-I SWACO		$	121,325			$	212,294			$	268,833			$	420,092
Smith Oilfield			47,622				162,864				153,387				325,870
Distribution			(9,799	)			36,518				5,722				66,402
General corporate			(25,844	)			(21,909	)			(52,960	)			(43,790	)
		$	133,304			$	389,767			$	374,982			$	768,574

The following table summarizes charges associated with employee severance and other non-recurring items on a reportable segment basis:

		Three Months Ended				Six Months Ended
		June 30, 2009				June 30, 2009
Employee Severance and Other Charges:
M-I SWACO		$	2,983			$	22,284
Smith Oilfield			8,593				20,952
Distribution			1,265				1,916
General corporate			160				2,641
		$	13,001			$	47,793

The following table presents consolidated revenues by region:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
United States		$	772,535			$	1,145,960			$	1,862,075			$	2,158,639
Canada			133,612				146,453				325,896				380,878
North America			906,147				1,292,413				2,187,971				2,539,517
Latin America			227,499				244,543				503,606				471,520
Europe/Africa			510,689				646,527				1,050,504				1,243,019
Middle East/Asia			299,954				310,675				613,687				611,100
Non-North America			1,038,142				1,201,745				2,167,797				2,325,639
		$	1,944,289			$	2,494,158			$	4,355,768			$	4,865,156

13. Commitments and Contingencies

Standby Letters of Credit

In the normal course of business with customers, vendors and others, the Company is contingently liable for performance under standby letters of credit and bid, performance and surety bonds. Certain of these outstanding instruments guarantee payment to insurance companies with respect to certain liability coverages of the Company’s insurance captive. Excluding the impact of these instruments, for which $24.1 million of related liabilities are reflected in the accompanying consolidated condensed balance sheet, the Company was contingently liable for $237.9 million of standby letters of credit and bid, performance and surety bonds at June 30, 2009. Management does not expect any material amounts to be drawn on these instruments.

Insurance

The Company maintains insurance coverage for various aspects of its business and operations. The Company has elected to retain a portion of losses that occur through the use of deductibles and retentions under its insurance programs. Amounts in excess of the self-insured retention levels are fully insured to limits believed appropriate for the Company’s operations. Self-insurance accruals are based on claims filed and an estimate for claims incurred but not reported. While management believes that amounts accrued in the accompanying consolidated condensed financial statements are adequate for expected liabilities arising from the Company’s portion of losses, estimates of these liabilities may change as circumstances develop.

Litigation

The Company is a defendant in various legal proceedings arising in the ordinary course of business. In the opinion of management, these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

Environmental

The Company routinely establishes and reviews the adequacy of reserves for estimated future environmental clean-up costs for properties currently or previously operated by the Company. In the opinion of management, these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is provided to assist readers in understanding the Company’s financial performance during the periods presented and significant trends which may impact the future performance of the Company. This discussion should be read in conjunction with the consolidated condensed financial statements of the Company and the related notes thereto included elsewhere in this Form 10-Q, the Company’s 2008 Annual Report on Form 10-K and other current filings with the Commission.

Company Products and Operations

The Company is a leading global provider of premium products and services used during the drilling, completion and production phases of oil and natural gas development activities. In August 2008, we broadened our capabilities in key drilling and completion-related product technologies with the acquisition of W-H Energy Services, Inc. (“W-H”). We provide a comprehensive line of technologically-advanced products and engineering services, including drilling and completion fluid systems, solids-control and separation equipment, waste-management services, three-cone and diamond drill bits, borehole enlargement services, tubulars, directional systems, measurement-while-drilling and logging-while-drilling services, coiled tubing, cased-hole wireline and other complementary downhole tools and services. The Company also offers supply-chain management solutions through an extensive North American branch network providing pipe, valves and fittings as well as mill, safety and other maintenance products.

The Company’s operations are driven principally by the level of exploration and production (“E&P”) spending in major energy-producing regions around the world and the depth and complexity of these projects. Although E&P spending is significantly influenced by the market price of oil and natural gas, it may also be affected by supply and demand fundamentals, finding and development costs, decline and depletion rates, political actions and uncertainties, environmental concerns, the financial condition of independent E&P companies and the overall level of global economic growth and activity. In addition, approximately six percent of the Company’s consolidated revenues relate to the downstream energy sector, including petrochemical plants and refineries, whose spending is largely impacted by the general condition of the U.S. economy.

Capital investment by energy companies is largely divided into two markets, which vary greatly in terms of primary business drivers and associated volatility levels. North American drilling activity is primarily influenced by natural gas fundamentals, with two-thirds of the current rig count focused on natural gas finding and development activities. Conversely, drilling in areas outside of North America is more dependent on crude oil fundamentals, which influence 78 percent of current international drilling activity. Historically, business in markets outside of North America has proved to be less volatile as the high cost E&P programs in these regions are generally undertaken by major oil companies, consortiums and national oil companies as part of a longer-term strategic development plan. Although 50 percent of the Company’s consolidated revenues were generated in North America during the first six months of 2009, Smith’s profitability was influenced by business levels in markets outside of North America. The Distribution segment, which accounts for approximately one-fourth of consolidated revenues and primarily supports a North American customer base, serves to distort the geographic revenue mix of the Company’s oilfield operations. Excluding the impact of the Distribution segment, approximately 63 percent of the Company’s revenues were generated in markets outside of North America during the first half of 2009.

Business Outlook

The Company’s current year results will be influenced by a material reduction in average worldwide drilling activity attributable to the significant economic slowdown and the ongoing weakness in global credit markets. We believe the impact of lower activity levels will be partially offset by the addition of the acquired W-H business lines and the concentration of our oilfield business base in markets outside North America, areas which tend to be more stable from an oil and gas investment standpoint. The majority of the rig count decline from the prior year is expected to occur in the United States where drilling activity is currently 50 percent below the average level reported in 2008. The decrease in U.S. drilling activity is primarily attributable to the lower number of land-based and shallow-depth offshore programs, which are generally more sensitive to commodity prices. Customer spending in most international and deepwater drilling markets, which are primarily driven by oil-directed activities, have not been significantly impacted to date.

Near-term drilling activity will largely be driven by the seasonal recovery in Canada, supported by a rebound in the number of land-based, oil-targeted drilling projects from the levels experienced in the second quarter of 2009. Drilling activity in markets outside of Canada is expected to remain relatively flat throughout the remainder of the year influenced by weak global energy demand and record U.S. natural gas storage levels. Near-term activity levels may also be impacted by tropical weather disturbances in the Gulf of Mexico, which are typically experienced during the third calendar quarter. Seasonal weather conditions in the Gulf affect the level of planned drilling programs and, in certain circumstances, may result in the curtailment of some offshore and land-based drilling operations. Although the long-term outlook for the energy sector is favorable due to supply and demand fundamentals, continued deterioration in the global economic environment could lead to lower exploration and production spending — further reducing demand for the Company’s products and services and adversely impacting future results.

Forward-Looking Statements

This document contains forward-looking statements within the meaning of the Section 21E of the Securities Exchange Act of 1934, as amended, concerning, among other things, our outlook, financial projections and business strategies, all of which are subject to risks, uncertainties and assumptions. These forward-looking statements are identified by their use of terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “project,” “should” and similar terms. These statements are based on certain assumptions and analyses that we believe are appropriate under the circumstances. Such statements are subject to, among other things, overall demand for and pricing of the Company’s products and services, general economic and business conditions, the level of oil and natural gas exploration and development activities, global economic growth and activity, political stability of oil-producing countries, finding and development costs of operations, decline and depletion rates for oil and natural gas wells, seasonal weather conditions, industry conditions, and changes in laws or regulations and other risk factors that are discussed beginning on page 26 of this Form 10-Q, in the Company’s Form 10-K for the fiscal year ended December 31, 2008, and other documents filed with the Securities and Exchange Commission, many of which are beyond the control of the Company. Should one or more of these risks or uncertainties materialize, or should the assumptions prove incorrect, actual results may differ materially from those expected, estimated or projected. Management believes these forward-looking statements are reasonable. However, you should not place undue reliance on these forward-looking statements, which are based only on our current expectations. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to publicly update or revise any of them in light of new information, future events or otherwise.

Results of Operations

Segment Discussion

Our business is segregated into three operating divisions, M-I SWACO, Smith Oilfield and Distribution, which is the basis upon which we report our results. The M-I SWACO segment consists of a majority-owned drilling fluid and environmental services joint venture operation. The Smith Oilfield segment is comprised of our wholly-owned drilling and completion services operations, which includes drill bits, directional drilling services and downhole tools. The Distribution segment consists of the Wilson distribution operations and a majority-owned interest in CE Franklin, Ltd., a publicly-traded Canadian distribution company. Finally, general corporate primarily reflects expenses related to corporate personnel, administrative support functions and long-term incentive compensation programs.

		Three Months Ended June 30,																Six Months Ended June 30,
		2009								2008								2009								2008
		Amount				%				Amount				%				Amount				%				Amount				%
Financial Data: (Dollars in thousands)
Revenues:
M-I SWACO		$	1,013,016				52			$	1,285,754				52			$	2,172,353				50			$	2,514,183				52
Smith Oilfield			520,467				27				592,816				23				1,202,867				28				1,167,314				24
Distribution			410,806				21				615,588				25				980,548				22				1,183,659				24
Total		$	1,944,289				100			$	2,494,158				100			$	4,355,768				100			$	4,865,156				100
Geographic Revenues:
United States:
M-I SWACO		$	204,250				11			$	327,121				13			$	464,139				11			$	633,386				13
Smith Oilfield			274,208				14				330,444				13				671,689				15				639,506				13
Distribution			294,077				15				488,395				20				726,247				17				885,747				18
Total United States			772,535				40				1,145,960				46				1,862,075				43				2,158,639				44
Canada:
M-I SWACO			22,742				1				26,663				1				63,668				1				73,025				2
Smith Oilfield			17,525				1				24,579				1				55,463				1				72,173				1
Distribution			93,345				5				95,211				4				206,765				5				235,680				5
Total Canada			133,612				7				146,453				6				325,896				7				380,878				8
Non-North America:
M-I SWACO			786,024				40				931,970				37				1,644,546				38				1,807,772				37
Smith Oilfield			228,734				12				237,793				10				475,715				11				455,635				10
Distribution			23,384				1				31,982				1				47,536				1				62,232				1
Total Non-North America			1,038,142				53				1,201,745				48				2,167,797				50				2,325,639				48
Total Revenues		$	1,944,289				100			$	2,494,158				100			$	4,355,768				100			$	4,865,156				100
Operating Income:
M-I SWACO		$	121,325				12			$	212,294				17			$	268,833				12			$	420,092				17
Smith Oilfield			47,622				9				162,864				27				153,387				13				325,870				28
Distribution			(9,799	)			(2	)			36,518				6				5,722				1				66,402				6
General corporate			(25,844	)			*				(21,909	)			*				(52,960	)			*				(43,790	)			*
Total		$	133,304				7			$	389,767				16			$	374,982				9			$	768,574				16