UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2007

OR

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

For the transition period from                      to                     

Commission file number 1-8514

Smith International, Inc.

(Exact name of Registrant as specified in its charter)

Delaware		95-3822631
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
16740 Hardy Street		77032
Houston, Texas		(Zip Code)
(Address of principal executive offices)

(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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer þ     Accelerated Filer o     Non-Accelerated Filer 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 200,315,917 shares of common stock outstanding, net of treasury shares held, on November 2, 2007.

 

 

INDEX

		Page
		No.
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS For the Three Months and Nine Months ended September 30, 2007 and 2006			2
CONSOLIDATED CONDENSED BALANCE SHEETS As of September 30, 2007 and December 31, 2006			3
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS For the Three Months and Nine Months ended September 30, 2007 and 2006			4
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
Item 3. Quantitative and Qualitative Disclosures about Market Risk			20
Item 4. Controls and Procedures			20
PART II – OTHER INFORMATION
Items 1-5			21
Item 6			22
SIGNATURES			23
EXHIBIT INDEX			24
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certification Pursuant to Section 1350

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

SMITH INTERNATIONAL, INC.

(In thousands, except per share data)

(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Revenues		$	2,245,059			$	1,914,184			$	6,467,156			$	5,334,568
Costs and expenses:
Costs of revenues			1,516,153				1,295,971				4,365,739				3,644,739
Selling expenses			300,084				253,569				859,579				703,018
General and administrative expenses			78,485				76,919				227,924				216,508
Total costs and expenses			1,894,722				1,626,459				5,453,242				4,564,265
Operating income			350,337				287,725				1,013,914				770,303
Interest expense			17,103				17,287				53,242				44,808
Interest income			(1,152	)			(830	)			(2,811	)			(2,123	)
Income before income taxes and minority interests			334,386				271,268				963,483				727,618
Income tax provision			106,579				88,600				300,569				232,172
Minority interests			60,974				49,743				182,870				136,472
Net income		$	166,833			$	132,925			$	480,044			$	358,974
Earnings per share:
Basic		$	0.83			$	0.66			$	2.40			$	1.79
Diluted		$	0.83			$	0.66			$	2.38			$	1.78
Weighted average shares outstanding:
Basic			200,070				200,009				200,184				200,484
Diluted			202,078				201,811				201,891				202,158

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

SMITH INTERNATIONAL, INC.

(In thousands, except par value data)

(Unaudited)

		September 30,				December 31,
		2007				2006
Assets
Current Assets:
Cash and cash equivalents		$	98,716			$	80,379
Receivables, net			1,770,691				1,592,230
Inventories, net			1,621,179				1,457,371
Deferred tax assets, net			53,139				51,070
Prepaid expenses and other			120,323				89,977
Total current assets			3,664,048				3,271,027
Property, Plant and Equipment, net			1,037,896				887,044
Goodwill, net			888,754				867,647
Other Intangible Assets, net			137,144				141,140
Other Assets			194,506				168,617
Total Assets		$	5,922,348			$	5,335,475
Liabilities and Stockholders’ Equity
Current Liabilities:
Short-term borrowings and current portion of long-term debt		$	153,701			$	287,704
Accounts payable			645,142				654,215
Accrued payroll costs			131,783				154,756
Income taxes payable			102,693				130,339
Other			145,886				152,454
Total current liabilities			1,179,205				1,379,468
Long-Term Debt			931,559				800,928
Deferred Tax Liabilities			157,348				143,124
Other Long-Term Liabilities			145,083				102,904
Minority Interests			1,073,116				922,114
Commitments and Contingencies (Note 14)
Stockholders’ Equity:
Preferred stock, $1 par value; 5,000 shares authorized; no shares issued or outstanding in 2007 or 2006			—				—
Common stock, $1 par value; 250,000 shares authorized; 216,906 shares issued in 2007 (214,947 shares issued in 2006)			216,906				214,947
Additional paid-in capital			515,256				442,155
Retained earnings			2,072,285				1,653,480
Accumulated other comprehensive income			60,733				23,227
Less – Treasury securities, at cost; 16,606 common shares in 2007 (15,031 common shares in 2006)			(429,143	)			(346,872	)
Total stockholders’ equity			2,436,037				1,986,937
Total Liabilities and Stockholders’ Equity		$	5,922,348			$	5,335,475

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

SMITH INTERNATIONAL, INC.

(In thousands)

(Unaudited)

		Nine Months Ended
		September 30,
		2007				2006
Cash flows from operating activities:
Net income		$	480,044			$	358,974
Adjustments to reconcile net income to net cash provided by operating activities, excluding the net effects of acquisitions:
Minority interests			182,870				136,472
Depreciation and amortization			141,461				106,937
Share-based compensation expense			25,352				20,173
Increase in LIFO inventory reserves			22,131				16,864
Deferred income tax provision (benefit)			7,536				(4,380	)
Provision for losses on receivables			2,740				5,443
Foreign currency translation losses			3,579				2,992
Gain on disposal of property, plant and equipment			(17,250	)			(16,060	)
Equity earnings, net of dividends received			(10,485	)			(7,310	)
Gain on sale of operations			(1,534	)			(5,930	)
Changes in operating assets and liabilities:
Receivables			(179,390	)			(284,765	)
Inventories			(169,290	)			(285,098	)
Accounts payable			(17,211	)			101,046
Other current assets and liabilities			(61,674	)			21,443
Other non-current assets and liabilities			(20,261	)			(22,318	)
Net cash provided by operating activities			388,618				144,483
Cash flows from investing activities:
Acquisition-related payments, net of cash acquired			(41,073	)			(224,305	)
Purchases of property, plant and equipment			(248,530	)			(198,824	)
Proceeds from disposal of property, plant and equipment			33,888				25,649
Proceeds from sale of operations			16,655				9,296
Net cash used in investing activities			(239,060	)			(388,184	)
Cash flows from financing activities:
Proceeds from issuance of long-term debt			233,175				646,471
Principal payments of long-term debt			(272,676	)			(250,443	)
Net change in short-term borrowings			36,129				(8,243	)
Purchases of common stock under Repurchase Program			(78,847	)			(91,119	)
Net proceeds related to long-term incentive awards			24,627				9,984
Excess tax benefit from share-based compensation			20,317				4,545
Payment of common stock dividends			(56,031	)			(44,114	)
Debt issuance costs			—				(4,744	)
Distributions to minority partner			(40,097	)			—
Net cash provided by (used in) financing activities			(133,403	)			262,337
Effect of exchange rate changes on cash			2,182				1,161
Increase in cash and cash equivalents			18,337				19,797
Cash and cash equivalents at beginning of period			80,379				62,543
Cash and cash equivalents at end of period		$	98,716			$	82,340
Supplemental disclosures of cash flow information:
Cash paid for interest		$	54,482			$	45,888
Cash paid for income taxes			271,883				206,199

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. Basis of Presentation of Interim Financial Statements

The accompanying unaudited consolidated condensed financial statements of Smith International, Inc. and subsidiaries (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 2006 Annual Report on Form 10-K and other current filings with the Commission. All adjustments which 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 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.

2. Recent Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) which are adopted by the Company as of the specified effective date.

Effective January 1, 2007, the Company adopted Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”), which establishes accounting and disclosure requirements for uncertain tax positions. The adoption did not have a material impact on the Company’s results of operations or financial position. See Note 9 for further discussion regarding FIN 48.

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 condensed financial statements upon adoption.

3. Acquisitions and Dispositions

During the nine months ended September 30, 2007, the Company completed four acquisitions in exchange for aggregate cash consideration of $27.6 million and the assumption of certain liabilities. The majority of the current year acquisition consideration relates to the purchase of D.S.I. Inspection Services, Inc. (“DSI”), a U.S.-based provider of inspection, machine shop and other related services. The Company may be required to fund additional cash consideration of up to $2.0 million related to the DSI transaction upon the lapse of certain contingencies.

These acquisitions have been recorded using the purchase method of accounting and, accordingly, the acquired operations have been included in the results of operations since the date of acquisition. The excess of the purchase price over the estimated fair value of net assets acquired approximated $12.3 million, primarily pertaining to DSI, which has been recorded as goodwill in the September 30, 2007 consolidated condensed balance sheet. The purchase price allocations related to these acquisitions are based on preliminary information and are subject to change when additional data concerning final asset and liability valuations is obtained; however, material changes in the preliminary allocations are not anticipated by management.

In certain situations, the Company negotiates transaction terms which provide for the payment of additional consideration if various financial and/or business objectives are met. During the nine-month period ended September 30, 2007, the Company paid $13.5 million of additional purchase consideration to settle obligations related to earn-out arrangements. The acquisition-related payments are reflected in the September 30, 2007 consolidated condensed balance sheet as goodwill.

From time to time, the Company divests of non-core operations in the normal course of business. During the nine months ended September 30, 2007, the Company disposed of certain majority-owned venture operations in exchange for cash consideration of $16.7 million. Although the transaction had a positive effect on cash flows, it did not materially impact results of operations. The Company properly eliminated net assets related to the associated operations, which included $10.2 million of goodwill, during the second quarter of 2007.

Pro forma results of operations have not been presented because the effect of these transactions was not material to the Company’s consolidated condensed financial statements.

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 the three and nine-month periods ended September 30, 2007 and 2006, 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								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Basic EPS:
Net income		$	166,833			$	132,925			$	480,044			$	358,974
Weighted average number of common shares outstanding			200,070				200,009				200,184				200,484
Basic EPS		$	0.83			$	0.66			$	2.40			$	1.79
Diluted EPS:
Net income		$	166,833			$	132,925			$	480,044			$	358,974
Weighted average number of common shares outstanding			200,070				200,009				200,184				200,484
Dilutive effect of stock options and restricted stock units			2,008				1,802				1,707				1,674
			202,078				201,811				201,891				202,158
Diluted EPS		$	0.83			$	0.66			$	2.38			$	1.78

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 significant 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:

		September 30,				December 31,
		2007				2006
Raw materials		$	136,049			$	117,812
Work-in-process			171,627				147,543
Finished goods			1,429,177				1,285,558
			1,736,853				1,550,913
Reserves to state certain U.S. inventories (FIFO cost of $601,819 and $559,943 in 2007 and 2006, respectively) on a LIFO basis			(115,674	)			(93,542	)
		$	1,621,179			$	1,457,371

During the first nine months of 2007, the Company recorded additional LIFO reserves of $22.1 million. The increase primarily relates to the revaluation of on-hand inventories to current unit cost standards during the first quarter of 2007, which were increased to reflect modest cost inflation experienced in the Oilfield manufacturing operations.

6. Property, Plant and Equipment

Property, plant and equipment consist of the following:

		September 30,				December 31,
		2007				2006
Land and improvements		$	60,314			$	55,138
Buildings			220,751				181,419
Machinery and equipment			832,067				717,761
Rental tools			688,927				597,468
			1,802,059				1,551,786
Less – Accumulated depreciation			(764,163	)			(664,742	)
		$	1,037,896			$	887,044

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. Beginning and ending goodwill balances are presented net of accumulated amortization of $53.6 million.

		Oilfield				Distribution				Consolidated
Balance as of December 31, 2006		$	826,996			$	40,651			$	867,647
Goodwill acquired			8,459				3,820				12,279
Goodwill related to disposed operations			(10,197	)			—				(10,197	)
Purchase price and other adjustments			18,298				727				19,025
Balance as of September 30, 2007		$	843,556			$	45,198			$	888,754

Other Intangible Assets

The Company amortizes other identifiable intangible assets on a straight-line basis over the periods expected to be benefited, ranging from two to 27 years. The components of these other intangible assets are as follows:

		September 30, 2007												December 31, 2006												Weighted
		Gross												Gross												Average
		Carrying				Accumulated								Carrying				Accumulated								Amortization
		Amount				Amortization				Net				Amount				Amortization				Net				Period (years)
Patents		$	112,096			$	31,667			$	80,429			$	101,269			$	19,547			$	81,722				13.3
License agreements			32,550				13,351				19,199				31,231				10,661				20,570				10.2
Non-compete agreements and trademarks			37,012				19,668				17,344				33,421				15,662				17,759				9.3
Customer lists and contracts			34,603				14,431				20,172				29,403				8,314				21,089				8.5
		$	216,261			$	79,117			$	137,144			$	195,324			$	54,184			$	141,140				11.7

Amortization expense of other intangible assets was $8.1 million and $5.3 million for the three-month periods ended September 30, 2007 and 2006, respectively, and $23.3 million and $12.5 million for the nine-month periods ended September 30, 2007 and 2006, respectively. On a calendar year basis, amortization expense is expected to approximate $31.0 million and $22.7 million for fiscal years 2007 and 2008, respectively. Additionally, amortization expense is anticipated to range between $11.4 million and $19.8 million per year for the 2009 – 2011 fiscal years.

8. Debt

The following summarizes the Company’s outstanding debt:

		September 30, 2007				December 31, 2006
Current:
Short-term borrowings		$	125,436			$	89,307
Current portion of long-term debt			28,265				198,397
Short-term borrowings and current portion of long-term debt		$	153,701			$	287,704
Long-Term:
Senior Notes, net of unamortized discounts		$	494,451			$	651,413
Bank revolvers payable			316,000				160,500
Term loans and other			149,373				187,412
			959,824				999,325
Less — current portion of long-term debt			(28,265	)			(198,397	)
Long-term debt		$	931,559			$	800,928

During the third quarter of 2007, the Company utilized amounts available under existing revolving credit facilities to retire $150.0 million of Senior Notes which matured in September 2007.

Principal payments, net of unamortized discounts, of long-term debt for the twelve-month periods subsequent to September 30, 2008 are as follows:

2009		$	26,938
2010			342,909
2011			246,594
2012			26,892
Thereafter			288,226
		$	931,559

9. Income Taxes

The Company adopted the provisions of FIN 48 on January 1, 2007. This interpretation addresses the determination of whether tax benefits claimed, or expected to be claimed, on a tax return should be recorded in the financial statements. Under FIN 48, the tax benefit from an uncertain tax position is to be recognized when, based on technical merits, it is more likely than not the position will be sustained on examination by the taxing authorities. Pursuant to this newly issued guidance, the Company was required to record an additional $1.2 million of tax liabilities, including related interest and penalties, with a corresponding reduction in stockholders’ equity during the first quarter of 2007. From a policy standpoint, penalty and interest amounts related to income tax matters are classified as income tax expense in the Company’s financial statements.

The Company’s balance sheet at January 1, 2007 reflected $30.8 million of tax liabilities for uncertain tax positions, including $7.0 million of accrued interest and penalties. Approximately $0.9 million of this amount was classified as Income Taxes Payable with the remainder included in Other Long-Term Liabilities. There were no material changes in the liability established for uncertain tax positions during the first nine months of 2007.

Although the Company does not expect to report a significant change in the amount of liabilities recorded for uncertain tax positions during the next twelve-month period, changes in the recorded reserves could impact future reported results. The tax liability for uncertain tax positions includes $17.5 million of reserves established for tax matters which, if allowed by the relevant taxing authorities, would reduce reported tax expense and the related effective tax rate.

The Company operates in more than 70 countries and is subject to income taxes in most of those jurisdictions. The following table summarizes the earliest tax years that remain subject to examination by taxing authorities in the major jurisdictions in which the Company operates:

Jurisdiction		Earliest Open Tax Period
Canada			2000
Italy			2001
Norway			1997
Russia			2004
United Kingdom			2001
United States			1999

10. Comprehensive Income

Comprehensive income includes net income and changes in the components of accumulated other comprehensive income during the periods presented. The Company’s comprehensive income is as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Net income		$	166,833			$	132,925			$	480,044			$	358,974
Currency translation adjustments			19,427				1,522				37,045				13,132
Changes in unrealized fair value of derivatives, net			312				354				461				1,995
Comprehensive income		$	186,572			$	134,801			$	517,550			$	374,101

Accumulated other comprehensive income in the accompanying consolidated condensed balance sheet consists of the following:

		September 30,				December 31,
		2007				2006
Currency translation adjustments		$	62,600			$	25,555
Unrealized fair value of derivatives			710				249
Pension liability adjustments			(2,577	)			(2,577	)
Accumulated other comprehensive income		$	60,733			$	23,227

11. Employee Benefit Plans

The Company maintains various noncontributory defined benefit pension plans covering certain U.S. and non-U.S. employees. In addition, the Company and certain subsidiaries have postretirement benefit plans, which provide health care benefits to a limited number of current, and in some cases, future retirees. Net periodic benefit expense related to the pension and postretirement benefit plans, on a combined basis, approximated $1.2 million and $1.0 million for each of the three-month periods ended September 30, 2007 and 2006, respectively, and $3.6 million and $2.9 million for each of the nine-month periods ended September 30, 2007 and 2006, respectively. Company contributions to the pension and postretirement benefit plans for the 2007 fiscal year are expected to approximate the $5 million amount funded in the prior year period.

12. Long-Term Incentive Compensation

As of September 30, 2007, the Company had outstanding restricted stock units and stock options granted under the 1989 Long-Term Incentive Compensation Plan, as amended (the “Plan”). As of September 30, 2007, 1,918,609 shares were authorized for future issuance pursuant to the 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”). Activity under the Company’s restricted stock program for the nine-month period ended September 30, 2007 is presented below:

		Time-based Awards								Performance-based Awards								Total
		No. of				Fair				No. of				Fair				Restricted
		Units				Value(a)				Units				Value(a)				Stock Units
Outstanding at December 31, 2006			524,552			$	40.84				1,565,649			$	39.64				2,090,201
Granted			29,200				45.47				—				—				29,200
Forfeited			(14,609	)			40.11				(23,669	)			36.61				(38,278	)
Vested			(3,412	)			33.68				(301,948	)			38.74				(305,360	)
Outstanding at September 30, 2007			535,731			$	41.16				1,240,032			$	39.91				1,775,763

Restrictions on 395,087 performance-based units and 150,416 time-based units outstanding at September 30, 2007 are expected to lapse during the fourth quarter of 2007.

Stock Options

Activity under the Company’s stock option program for the nine-month period ended September 30, 2007 is presented below:

						Weighted				Weighted Average				Aggregate
		Shares				Average				Remaining				Intrinsic Value
		Under Option				Exercise Price				Contractual Life				(in thousands)
Outstanding at December 31, 2006			3,351,381			$	18.78
Granted			—				—
Forfeited			(54,254	)			21.32
Exercised			(1,612,044	)			17.39
Outstanding at September 30, 2007			1,685,083				20.03				5.8			$	86,570
Exercisable at September 30, 2007			973,467			$	18.02				5.2			$	51,963

Share-based Compensation Expense

Share-based compensation expense, consisting of restricted stock and stock options, was $8.6 million and $6.8 million for the three-month periods ended September 30, 2007 and 2006, respectively, and $25.4 million and $20.2 million for the nine-month periods ended September 30, 2007 and 2006, respectively.

Moreover, the total unrecognized share-based compensation expense for awards outstanding as of September 30, 2007 approximated $52.0 million, or $30.9 million net of taxes and minority interests, which will be recognized over a weighted-average period of 2.1 years.

13. Industry Segments

The Company provides premium products and services to the oil and gas exploration and production industry, aggregating its operations into two reportable segments: Oilfield and Distribution. The Oilfield segment consists of three business units: M-I SWACO, Smith Technologies and Smith Services. The Distribution segment includes the Wilson business unit. The following table presents financial information for each reportable segment and geographical revenues on a consolidated basis:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Revenues:
Oilfield		$	1,685,687			$	1,412,934			$	4,862,286			$	3,901,646
Distribution			559,372				501,250				1,604,870				1,432,922
		$	2,245,059			$	1,914,184			$	6,467,156			$	5,334,568
Revenues by Area:
United States		$	1,017,936			$	905,002			$	2,966,486			$	2,463,403
Canada			195,330				221,953				571,172				669,004
North America			1,213,266				1,126,955				3,537,658				3,132,407
Latin America			208,193				139,872				529,744				399,040
Europe/Africa			534,012				418,845				1,525,025				1,147,683
Middle East/Asia			289,588				228,512				874,729				655,438
Non-North America			1,031,793				787,229				2,929,498				2,202,161
		$	2,245,059			$	1,914,184			$	6,467,156			$	5,334,568
Operating Income:
Oilfield		$	336,482			$	270,710			$	970,435			$	722,453
Distribution			24,533				25,359				73,799				73,591
General corporate			(10,678	)			(8,344	)			(30,320	)			(25,741	)
		$	350,337			$	287,725			$	1,013,914			$	770,303

14. 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 $22.0 million of related liabilities are reflected in the accompanying consolidated condensed balance sheet, the Company was contingently liable for approximately $118.5 million of standby letters of credit and bid, performance and surety bonds at September 30, 2007. Management does not expect any material amounts to be drawn on these instruments.

Litigation

Rose Dove Egle v. John M. Egle, et al.
In April 1997, the Company acquired all of the equity interests in Tri-Tech Fishing Services, L.L.C. (“Tri-Tech”) in exchange for cash consideration of approximately $20.4 million (the “Transaction”).

In August 1998, the Company was added as a defendant in a First Amended Petition filed in the 15th Judicial District Court, Parish of Lafayette, Louisiana entitled Rose Dove Egle v. John M. Egle, et al.  In the amended petition, the plaintiffs alleged that, due to an improper conveyance of ownership interest by the Tri-Tech majority partner prior to the Transaction, Smith purchased a portion of its equity interest from individuals who were not legally entitled to their Tri-Tech shares.

After an extended period of litigation, the Egle matter was concluded in October 2007. The Louisiana Supreme Court denied the plaintiffs’ final appeal, effectively closing the matter.

Other

The Company is a defendant in various other 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.

As of September 30, 2007, the Company’s environmental reserve totaled $7.8 million. This amount reflects the future undiscounted estimated exposure related to identified properties, without regard to indemnifications from former owners. While actual future environmental costs may differ from estimated liabilities recorded at September 30, 2007, the Company does not believe that these differences will have a material impact on the Company’s financial position, results of operations or cash flows.

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

General

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 and the Company’s 2006 Annual Report on Form 10-K.

Company Products and Operations

The Company is a leading global provider of premium products and services to the oil and gas exploration and production industry. The Company provides a comprehensive line of technologically-advanced products and engineering services, including drilling and completion fluid systems, solids-control and separation equipment, waste-management services, oilfield production chemicals, three-cone and diamond drill bits, turbine products, tubulars, fishing services, drilling tools, underreamers, casing exit and multilateral systems, packers and liner hangers. 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 largely driven 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 approximately 81 percent 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 over three-quarters of 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 55 percent of the Company’s consolidated revenues were generated in North America during the first nine months of 2007, Smith’s profitability was largely dependent upon business levels in markets outside of North America. The Distribution segment, which accounts for approximately 25 percent of consolidated revenues and primarily supports a North American customer base, serves to distort the geographic revenue mix of the Company’s Oilfield segment operations. Excluding the impact of the Distribution segment, 58 percent of the Company’s revenues were generated in markets outside of North America during the first nine months of 2007.

Business Outlook

After experiencing 15 percent compound annual rig count growth in North America over the past five-year period, North American activity levels are forecasted to remain relatively flat during the near-term. Markets outside North America should continue to expand as the increased number of drilling programs in Europe/Africa and Latin America, combined with the addition of a number of newbuild offshore rigs scheduled for delivery in 2008 and beyond, contribute to increased customer spending levels.

Although a number of factors influence forecasted exploration and production spending, the Company’s business is highly dependent on the general economic environment in the United States and other major world economies – which ultimately impacts energy consumption and the resulting demand for our products and services. High crude oil prices, which have risen over 50 percent during the past six month period, could contribute to a global economic slowdown – adversely impacting business volumes across the operations and the future financial results of the Company.

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” 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, 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, changes in laws or regulations and other risk factors outlined in the Company’s Form 10-K for the fiscal year ended December 31, 2006, 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

The Company markets its products and services throughout the world through four business units which are aggregated into two reportable segments. The Oilfield segment consists of three business units: M-I SWACO, Smith Technologies and Smith Services. The Distribution segment includes the Wilson business unit. The revenue discussion below has been summarized by business unit in order to provide additional information in analyzing the Company’s operations.

		Three Months Ended September 30,																Nine Months Ended September 30,
		2007								2006								2007								2006
		Amount				%				Amount				%				Amount				%				Amount				%
Financial Data: (dollars in thousands)
Revenues:
M-I SWACO		$	1,110,542				49			$	942,191				49			$	3,232,150				50			$	2,593,875				48
Smith Technologies(1)			259,104				12				228,765				12				751,489				12				643,494				12
Smith Services(1)			316,041				14				241,978				13				878,647				13				664,277				13
Oilfield			1,685,687				75				1,412,934				74				4,862,286				75				3,901,646				73
Distribution			559,372				25				501,250				26				1,604,870				25				1,432,922				27
Total		$	2,245,059				100			$	1,914,184				100			$	6,467,156				100			$	5,334,568				100
Geographic Revenues:
United States:
Oilfield		$	606,254				27			$	539,995				28			$	1,781,080				28			$	1,465,504				27
Distribution			411,682				18				365,007				19				1,185,406				18				997,899				19
Total United States			1,017,936				45				905,002				47				2,966,486				46				2,463,403				46
Canada:
Oilfield			83,861				4				104,902				6				252,548				4				296,571				6
Distribution			111,469				5				117,051				6				318,624				5				372,433				7
Total Canada			195,330				9				221,953				12				571,172				9				669,004				13
Non-North America:
Oilfield			995,572				44				768,037				40				2,828,658				43				2,139,571				40
Distribution			36,221				2				19,192				1				100,840				2				62,590				1
Total Non-North America			1,031,793				46				787,229				41				2,929,498				45				2,202,161				41
Total Revenue		$	2,245,059				100			$	1,914,184				100			$	6,467,156				100			$	5,334,568				100
Operating Income:
Oilfield		$	336,482				20			$	270,710				19			$	970,435				20			$	722,453				19
Distribution			24,533				4				25,359				5				73,799				5				73,591				5
General Corporate			(10,678	)			*				(8,344	)			*				(30,320	)			*				(25,741	)			*
Total		$	350,337				16			$	287,725				15			$	1,013,914				16			$	770,303				14
Market Data:
Average Worldwide Rig Count: (2)
United States			1,998				45				1,947				47				1,944				46				1,874				47
Canada			313				7				437				10				307				7				424				10
Non-North America			2,087				48				1,778				43				1,979				47				1,707				43
Total			4,398				100				4,162				100				4,230				100				4,005				100
Onshore			3,819				87				3,627				87				3,669				87				3,468				87
Offshore			579				13				535				13				561				13				537				13
Total			4,398				100				4,162				100				4,230				100				4,005				100
Average Commodity Prices:
Crude Oil ($/Bbl) (3)		$	73.24							$	70.60							$	66.22							$	68.29
Natural Gas ($/mcf) (4)		$	6.56							$	6.18							$	7.03							$	6.88

Oilfield Segment

Revenues

M-I SWACO primarily provides drilling and completion fluid systems, engineering and technical services to the oil and gas industry. Additionally, these operations provide oilfield production chemicals and manufacture and market equipment and services used for solids-control, particle separation, pressure control, rig instrumentation and waste-management. M-I SWACO is significantly influenced by its exposure to the global offshore market, which constitutes over 50 percent of the revenue base, and to exploration and production spending for land-based projects outside of North America, which contributes approximately 30 percent of the unit’s revenues. Offshore drilling programs, which account for approximately 13 percent of the worldwide rig count, are generally more revenue-intensive than land-based projects due to the complex nature of the related drilling environment. M-I SWACO’s revenues totaled $1.1 billion for the third quarter of 2007, an 18 percent increase from the prior year quarter. Approximately 85 percent of the year-over-year revenue growth was reported in the Eastern Hemisphere operations, driven by increased customer activity and new contract awards in the Former Soviet Union, West Africa and North Sea markets. To a lesser extent, increased offshore project activity in the Middle East/Asia region also contributed to the Eastern Hemisphere revenue growth. The remainder of the reported increase related to higher land-based revenues in Latin America influenced, in part, by the impact of recent drilling fluid contract awards in Mexico. For the nine-month period, M-I SWACO reported revenues of $3.2 billion, a 25 percent increase over the amounts reported in the nine months ended September 30, 2006. Approximately three-fourths of the revenue improvement was attributable to growth in Eastern Hemisphere markets, largely reflecting a 42 percent increase in offshore business volumes related to new contract awards and increased customer activity. Western Hemisphere revenues grew 13 percent above the comparable nine-month period of 2006 due to the impact of new land-based contract awards in Latin America and higher customer spending in the revenue-intensive U.S. offshore market.

Smith Technologies designs and manufactures three-cone and diamond drill bits, turbines and borehole enlargement tools for use in the oil and gas industry. Due to the nature of its product offerings, revenues for these operations typically correlate more closely to the rig count than any of the Company’s other businesses. Moreover, Smith Technologies has a high level of North American revenue exposure driven, in part, by the significance of its Canadian operations. Smith Technologies reported revenues of $259.1 million for the quarter ended September 30, 2007, an increase of 13 percent over the comparable prior year period. The majority of the revenue growth was generated in markets outside North America, driven by higher activity levels and increased customer demand for borehole enlargement tools. To a lesser extent, improved business volumes in the U.S. operations, influenced by higher diamond bit rental volumes and price increases introduced during the past 12-month period, also contributed to the favorable year-over-year comparison. For the nine-month period, Smith Technologies reported revenues of $751.5 million, a 17 percent improvement over the comparable period of 2006. More than 60 percent of the year-over-year revenue growth was reported outside North America, benefiting from higher activity levels and strong drill bit sales volumes in Europe/Africa and Asia. Growing demand for borehole enlargement products outside North America also contributed to the year-over-year revenue expansion. Revenue growth in North America compared favorably to the nine-month period of 2006 and the corresponding change in activity levels, largely reflecting the influence of improved diamond bit rental volumes and pricing realization in the U.S. across all core product lines.

Smith Services manufactures and markets products and services used in the oil and gas industry for drilling, work-over, well completion and well re-entry. Excluding the impact of tubular sales volumes, which are not highly correlated to drilling activity levels, revenues for Smith Services are relatively balanced between North America and the international markets. In addition, Smith Services’ revenues are heavily influenced by the complexity of drilling projects, which drive demand for a wider range of its product offerings. Smith Services’ revenues for the three months ended September 30, 2007 totaled $316.0 million, 31 percent above the prior year period. The majority of the year-over-year revenue increase was attributable to growth in U.S. business volumes, driven by increased demand for tubular products. To a lesser extent, improved activity levels contributed to higher sales of drilling products and services in the U.S. and Eastern Hemisphere markets. For the nine months ended September 30, 2007, Smith Services reported revenues of $878.6 million, a 32 percent increase from the comparable prior year period. Excluding tubular sales and rentals, revenues were 17 percent above the level reported in the first nine months of 2006, driven by increased demand for high-performance drilling and remedial products and services, including the hydra-jar^® tool, and higher activity levels outside North America.

Operating Income

Operating income for the Oilfield segment was $336.5 million, or 20.0 percent of revenues, for the three months ended September 30, 2007. Oilfield segment margins increased 80 basis points above the prior year quarter. The margin expansion was influenced by improved fixed cost coverage in general and administrative support functions and higher gross profit margins attributable to offshore business volume growth and the impact of year-over-year pricing initiatives. On an absolute dollar basis, third quarter 2007 operating income increased $65.8 million over the prior year quarter, primarily reflecting the impact of higher business volumes and, to a lesser extent, pricing on gross profit. On a year-to-date basis, Oilfield operating margins improved 1.5 percentage points, reflecting gross margin expansion related to increased business volumes and pricing initiatives period-to-period and, to a lesser extent, improved fixed cost coverage associated with general and administrative support functions. On an absolute dollar basis, nine-month operating income was $248.0 million above the first nine months of 2006, largely attributable to the impact of higher revenue volumes on the segment’s reported gross profit, partially offset by growth in variable-based operating expenses associated with the expanding business base.

Distribution Segment

Revenues

Wilson markets pipe, valves, fittings and mill, safety and other maintenance products to energy and industrial markets, primarily through an extensive network of supply branches in the United States and Canada. The segment has the most significant North American revenue exposure of any of the Company’s operations with 94 percent of Wilson’s third quarter 2007 revenues generated in those markets. Moreover, approximately 24 percent of Wilson’s revenues relate to sales to the downstream energy sector, including petrochemical plants and refineries, whose spending is largely influenced by the general state of the U.S. economic environment. Additionally, certain customers in this sector utilize petroleum products as a base material and, accordingly, are adversely impacted by increases in crude oil and natural gas prices. Distribution revenues were $559.4 million for the third quarter of 2007, 12 percent above the comparable prior year period. The year-over-year revenue growth was reported by the energy operations, reflecting increased drilling and completion activity in the upstream sector and, to a lesser extent, additional spending for line pipe projects by midstream customers. On a geographic basis, approximately one-fourth of the year-over-year improvement is attributable to the Europe/Africa region, due to increased project-related spending in the engineering and construction market. In the first nine months of 2007, Wilson reported revenues totaling $1.6 billion, an increase of 12 percent from the nine months ended September 30, 2006. Three-fourths of the revenue variance from the prior year period was generated by the upstream energy operations, influenced by higher U.S. drilling activity levels and increased line pipe project spending. The impact of lower Canadian business volumes for the first nine months of 2007, related to the corresponding decline in drilling activity levels, was partially offset by new project-related spending in Europe/Africa.

Operating Income

Operating income for the Distribution segment was $24.5 million, or 4.4 percent of revenues, for the quarter ended September 30, 2007. Segment operating margins were 70 basis points below the prior year period, reflecting the impact of an increased proportion of line pipe sales and project orders, which carry relatively lower margins, on gross profit. On an absolute dollar basis, third quarter 2007 operating income decreased $0.8 million below the amount reported in the prior year period driven by the impact of an unfavorable shift in product mix on gross profit. On a year-to-date basis, Distribution operating margins deteriorated 50 basis points, again, driven by an unfavorable shift in business mix consisting of a higher proportion of line pipe and international project business volumes. The impact of lower Canadian activity levels also contributed to the decline in operating margins. On an absolute dollar basis, operating income was $0.2 million above the amount reported in the first nine months of 2006, largely reflecting improved fixed selling and administrative cost coverage.

Consolidated Results

For the periods indicated, the following table summarizes the results of operations of the Company and presents these results as a percentage of total revenues:

		Three Months Ended September 30,																Nine Months Ended September 30,
		2007								2006								2007								2006
		Amount				%				Amount				%				Amount				%				Amount				%
Revenues		$	2,245,059				100			$	1,914,184				100			$	6,467,156				100			$	5,334,568				100
Gross profit			728,906				33				618,213				32				2,101,417				33				1,689,829				31
Operating expenses			378,569				17				330,488				17				1,087,503				17				919,526				17
Operating income			350,337				16				287,725				15				1,013,914				16				770,303				14
Interest expense			17,103				1				17,287				1				53,242				1				44,808				1
Interest income			(1,152	)			—				(830	)			—				(2,811	)			—				(2,123	)			—
Income before income taxes and minority interests			334,386				15				271,268				14				963,483				15				727,618				13
Income tax provision			106,579				5				88,600				5				300,569				5				232,172				4
Minority interests			60,974				3				49,743				2				182,870				3				136,472				2
Net income		$	166,833				7			$	132,925				7			$	480,044				7			$	358,974				7

Consolidated revenues were $2.2 billion for the third quarter of 2007, 17 percent above the prior year period. More than three-fourths of the revenue growth was attributable to increased demand for Oilfield segment product offerings. Oilfield segment revenues grew 19 percent year-over-year primarily driven by higher Eastern Hemisphere offshore business volumes and the impact of new Latin American land-based drilling fluid contracts. To a lesser extent, higher demand for tubular and diamond drilling bit products in the U.S. market, which more than offset the impact of lower Canadian activity levels, also contributed to the year-over-year Oilfield revenue expansion. The Distribution operations reported a 12 percent increase from the prior year quarter, driven by higher drilling and completion activity in the U.S. and, to a lesser extent, project activity in the West Africa market. For the first nine months of 2007, consolidated revenues were $6.5 billion, 21 percent above the comparable 2006 period, with Oilfield segment business volumes contributing approximately 85 percent of the revenue growth. Oilfield segment revenues rose 25 percent over amounts reported in the prior year period, driven by higher global offshore business volumes due, in part, to a favorable customer mix and increased activity levels outside North America. To a lesser extent, the revenue comparison to the nine-month period ended September 30, 2006 also reflects the impact of a 75 percent increase in tubular sales and rentals in the U.S. market.

Gross profit totaled $728.9 million for the third quarter of 2007, or 33 percent of revenues — approximately 20 basis points above the level reported in the prior year period. For the nine-month period, gross profit totaled $2.1 billion, or 33 percent of revenues, 80 basis points above the gross profit margins reported in the first nine months of 2006. The results for both periods reflect improved Oilfield margins and, to a lesser extent, an increased proportion of Oilfield revenues, which generate higher comparable margins. On an absolute dollar basis, gross profit increased $110.7 million, or 18 percent, over the prior year quarter and $411.6 million, or 24 percent, above the nine-month period ended September 30, 2006, with the improvement for both comparisons largely attributable to higher sales volumes in the Oilfield operations.

Operating expenses, consisting of selling, general and administrative expenses, increased $48.1 million from the prior year quarter; however, as a percentage of revenues, decreased 40 basis points. Improved fixed cost coverage in general and administrative functions accounted for the operating expense percentage decline. The majority of the absolute dollar increase was attributable to variable-related costs associated with the improved business volumes, including increased investment in personnel and infrastructure in support of the expanding business base. Compared to the first nine months of 2006, operating expenses increased $168.0 million; although, as a percentage of revenues, decreased 40 basis points, again, reflecting improved coverage of general and administrative costs.

Net interest expense, which represents interest expense less interest income, equaled $16.0 million in the third quarter of 2007. Net interest expense decreased $0.5 million from the prior year quarter, influenced by lower average short-term interest rates. For the first nine months of 2007, net interest expense increased $7.7 million from the comparable period of 2006, reflecting higher average debt levels largely associated with acquisition-related borrowings in the later half of 2006.

The effective tax rate approximated 32 percent and 31 percent for the three and nine-month periods ended September 30, 2007, approximately 70 basis points below the effective rates reported for the comparable periods of 2006. The favorable comparison to the prior year effective rates, as well as to the U.S. statutory rate, was influenced by the higher proportion of M-I SWACO’s U.S. partnership earnings and lower state income tax accrual rates. Based on the structure of M-I SWACO’s U.S. operations, the minority partner is directly responsible for taxes on its share of U.S. partnership earnings. Accordingly, the Company properly consolidates the pretax income related to the minority partner’s share of U.S. partnership earnings but excludes the related tax provision.

Minority interest expense reflects the portion of the results of majority-owned operations which are applicable to the minority interest partners. Minority interest expense was $11.2 million and $46.4 million above amounts reported in the prior year quarter and first nine months of 2006, respectively, primarily associated with improved profitability levels in the M-I SWACO joint venture.

Liquidity and Capital Resources

General

At September 30, 2007, cash and cash equivalents equaled $98.7 million. During the first nine months of 2007, the Company generated $388.6 million of cash flows from operations, significantly above the amount reported in the comparable prior year period. The favorable comparison was attributable to the year-over-year increase in overall profitability levels and, to a lesser extent, the reduced level of incremental working capital investment.

During the first nine months of 2007, cash flows used in investing activities totaled $239.1 million, primarily consisting of amounts required to fund capital expenditures and, to a lesser extent, acquisition-related payments. The Company invested $214.6 million in property plant and equipment, after taking into consideration cash proceeds arising from certain asset disposals. Cash invested in acquired business operations, net of dispositions, totaled $24.4 million during the first nine months of 2007. The amount was attributable to the DSI purchase and, to a lesser extent, the settlement of certain earn-out arrangements related to previously acquired operations. Net cash used in investing activities declined significantly from the prior year period due to lower required acquisition funding levels.

Cash flows used in financing activities totaled $133.4 million for the first nine months of 2007.  The significant level of borrowings required in the prior year period were not necessary in the first nine months of 2007, attributable to improved operating cash flow generation and lower acquisition funding needs.

The Company’s primary internal source of liquidity is cash flow generated from operations.  Cash flows generated from operations is primarily influenced by the level of worldwide drilling activity, which affects profitability levels and working capital requirements. Capacity under revolving credit agreements is also available, if necessary, to fund operating or investing activities.  During the third quarter of 2007, the Company utilized available capacity under its existing U.S. revolving credit facilities to retire $150.0 million of debt that matured during the period. Accordingly, as of September 30, 2007, the Company had $316.0 million drawn and $4.5 million of letters of credit issued under its U.S. revolving credit facilities, resulting in $79.5 million of capacity available for future operating or investing needs.  The Company also has revolving credit facilities in place outside of the United States, which are generally used to finance local operating needs.  At September 30, 2007, the Company had available borrowing capacity of $105.4 million under the non-U.S. borrowing facilities.

The Company’s external sources of liquidity include debt and equity financing in the public capital markets, if needed.  The Company carries an investment-grade credit rating with recognized rating agencies, generally providing the Company with access to debt markets.  The Company’s overall borrowing capacity is, in part, dependent on maintaining compliance with financial covenants under the various credit agreements.  As of September 30, 2007, the Company was well within the covenant compliance thresholds under its various loan indentures, as amended, providing the ability to access available borrowing capacity.  Management believes funds generated by operations, amounts available under existing credit facilities and external sources of liquidity will be sufficient to finance capital expenditures and working capital needs of the existing operations for the foreseeable future.

Management also continues to evaluate opportunities to acquire products or businesses complementary to the Company’s operations. Additional acquisitions, if they arise, may involve the use of cash or, depending upon the size and terms of the acquisition, may require debt or equity financing.

The Company makes regular quarterly distributions under a dividend program. The current annualized payout under the program of approximately $80 million is expected to be funded with future cash flows from operations and, if necessary, amounts available under existing credit facilities.  The level of future dividend payments will be at the discretion of the Company’s Board of Directors and will depend upon the Company’s financial condition, earnings, cash flows, compliance with certain debt covenants and other relevant factors.

The Company’s Board of Directors has authorized a share buyback program that allows for the repurchase of up to 20.0 million shares of the Company’s common stock, subject to regulatory issues, market considerations and other relevant factors. As of September 30, 2007, the Company had 15.8 million shares remaining under the current authorization. Future repurchases under the program may be executed from time to time in the open market or in privately negotiated transactions and will be funded with cash flows from operations or amounts available under existing credit facilities.

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 $22.0 million of related liabilities are reflected in the accompanying consolidated condensed balance sheet, the Company was contingently liable for approximately $118.5 million of standby letters of credit and bid, performance and surety bonds at September 30, 2007. Management does not expect any material amounts to be drawn on these instruments.

Litigation

Rose Dove Egle v. John M. Egle, et al.

In April 1997, the Company acquired all of the equity interests in Tri-Tech Fishing Services, L.L.C. (“Tri-Tech”) in exchange for cash consideration of approximately $20.4 million (the “Transaction”).

In August 1998, the Company was added as a defendant in a First Amended Petition filed in the 15th Judicial District Court, Parish of Lafayette, Louisiana entitled Rose Dove Egle v. John M. Egle, et al.  In the amended petition, the plaintiffs alleged that, due to an improper conveyance of ownership interest by the Tri-Tech majority partner prior to the Transaction, Smith purchased a portion of its equity interest from individuals who were not legally entitled to their Tri-Tech shares.

After an extended period of litigation, the Egle matter was concluded in October 2007. The Louisiana Supreme Court denied the plaintiffs’ final appeal, effectively closing the matter.

Other

The Company is a defendant in various other 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.

As of September 30, 2007, the Company’s environmental reserve totaled $7.8 million. This amount reflects the future undiscounted estimated exposure related to identified properties, without regard to indemnifications from former owners. While actual future environmental costs may differ from estimated liabilities recorded at September 30, 2007, the Company does not believe that these differences will have a material impact on the Company’s financial position, results of operations or cash flows.

Critical Accounting Policies and Estimates

The discussion and analysis of financial condition and results of operations are based upon the Company’s consolidated condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company evaluates its estimates on an ongoing basis, based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. In its 2006 Annual Report on Form 10-K, the Company has described the critical accounting policies that require management’s most significant judgments and estimates. There have been no material changes in these critical accounting policies.

Recent Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) which are adopted by the Company as of the specified effective date.

Effective January 1, 2007, the Company has adopted Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”), which establishes accounting and disclosure requirements for uncertain tax positions. The adoption did not have a material impact on the Company’s results of operations or financial position. See Note 9 to the consolidated condensed financial statements for further discussion regarding FIN 48.

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 condensed financial statements upon adoption.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to certain market risks arising from transactions that are entered into in the normal course of business which are primarily related to interest rate changes and fluctuations in foreign exchange rates. During the reporting period, no events or transactions have occurred which would materially change the information disclosed in the Company’s 2006 Annual Report on Form 10-K.

Item 4. Controls and Procedures