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

* not meaningful

                                         Three Months Ended June 30,                   Six Months Ended June 30,
                                         2009                   2008                  2009                   2008
                                   Amount        %        Amount        %       Amount        %        Amount        %
Market Data:
Average Worldwide Rig Count: (1)
United States                        1,004        31        2,081        47       1,176        33        2,045        45
Canada                                  79         2          144         3         186         5          295         7
Non-North America                    2,200        67        2,205        50       2,214        62        2,174        48

Total                                3,283       100        4,430       100       3,576       100        4,514       100


Onshore                              2,694        82        3,849        87       2,985        83        3,937        87
Offshore                               589        18          581        13         591        17          577        13

Total                                3,283       100        4,430       100       3,576       100        4,514       100


Average Commodity Prices:
Crude Oil ($/Bbl) (2)              $ 59.79               $ 123.80               $ 51.68               $ 111.12
Natural Gas ($/mcf) (3)               3.81                  11.47                  4.13                  10.14

(1) Source: M-I
SWACO.

(2) Average daily West Texas Intermediate ("WTI") spot closing prices, as quoted by NYMEX.

(3) Average daily Henry Hub, Louisiana spot closing prices, as quoted by NYMEX.

M-I SWACO
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 just over 50 percent of the revenue base, and to exploration and production spending for land-based projects outside of North America, which contributes approximately one-third of the division's revenues. Offshore drilling programs, which accounted for 17 percent of the worldwide rig count during the first six months of 2009, are generally more revenue intensive than land-based projects due to the complex nature of the related drilling environment. For the three months ended June 30, 2009, revenues for the M-I SWACO segment were $1.01 billion - a decrease of 21 percent from the prior-year period. The revenue decline was concentrated in the United States and the Europe/Africa region. Lower U.S. volumes reflected the 52 percent downturn in U.S. drilling activity and, to a lesser extent, reduced exploration and development activity in the Gulf of Mexico. The Europe/Africa operations were impacted by reduced customer spending in the Caspian and North Sea markets, lower land-based drilling in Russia and the strengthening of the U.S. dollar relative to certain key European currencies in which a material portion of business is transacted. For the six-month period, M-I SWACO reported revenues of $2.17 billion - 14 percent below the amounts reported in the first half of 2008. The revenue decline was attributable to the reduced number of shallow-water drilling programs in Europe/Africa and the Middle East regions as well as lower demand in the U.S. onshore market, partially offset by a 19 percent expansion in deepwater business volumes.
Operating Income
Operating income for the M-I SWACO segment was $121.3 million for the three months ended June 30, 2009 - reflecting operating margins of 12.0 percent. After excluding severance charges of $3.0 million recorded in the June 2009 period, operating income was 12.3 percent of revenues. The margin decline reflects the impact of lower business volumes and, to a lesser extent, the loss of a higher proportion of environmental waste management and other service-based offerings which generate better overall margins. On an absolute dollar basis, operating income declined $91.0 million below the prior year's level. After considering charges related to cost reduction initiatives, operating income fell $88.0 million period-to-period as the impact of lower revenue volumes on gross profit levels were partially offset by reduced variable-based operating expenses. For the six months ended June 30, 2009, M-I SWACO operating income was $268.8 million - or 12.4 percent of revenues. After excluding $22.3 million in costs incurred in connection with cost reduction measures, operating income was

13.4 percent of revenue. The margin decline is, again, attributable to the sharp reduction in revenue volumes and product mix factors. On an absolute dollar basis, operating income fell $151.3 million below the levels reported in the first half of 2008. After adjusting for charges associated with cost reduction efforts, operating income declined $129.0 million from the prior-year level influenced by the decline in revenues on gross profit levels and partially offset by reduced variable-related operating expenses. Smith Oilfield
Revenues
The Smith Oilfield segment provides three-cone and diamond drill bits, tubulars, borehole enlargement tools, drill motors, directional drilling, measurement-while-drilling, and logging-while-drilling services, as well as completions, coiled tubing, cased-hole wireline and drilling-related services. Just over 60 percent of the segment's business base is concentrated in North America driven, in part, by the significance of increased unconventional drilling projects in the U.S. land-based market and the complexity of drilling programs - which drive demand for a wider range of product offerings. Smith Oilfield revenues totaled $520.5 million for the three-month period ended June 30, 2009, a 12 percent decline from the amounts reported in the prior-year quarter. The revenue comparison is influenced by the addition of the W-H operations, which helped offset the impact of the significant downturn in North American drilling activity. Excluding the impact of acquired operations, base business levels fell 35 percent from the prior-year period, primarily reflecting lower demand for drill bits, drill pipe and premium tubular products in our U.S. customer base. Increased competitive pricing in the U.S. market, most of which has been concentrated in the W-H business lines, also influenced the period-to-period revenue comparison. For the six-month period, Smith Oilfield segment revenues totaled $1.20 billion - three percent above the amounts reported in the comparable prior-year period attributable to the inclusion of the W-H operations. Base business revenues were 26 percent below the levels generated in the first half of 2008, impacted by the steep decline in North American business volumes and lower U.S. product and service pricing. Operating Income
Operating income for the Smith Oilfield segment was $47.6 million for the three months ended June 30, 2009 - translating into reported operating income of 9.1 percent of revenues. After excluding charges of $8.6 million associated with cost reduction measures, operating margins were 10.8 percent of revenues. The margin decline primarily reflects changes in the business mix and the impact of increased competitive pricing pressure in the U.S. market. Inclusion of the acquired W-H product and service lines, which contribute lower-relative margins, coupled with the loss of high-margin drill bit and premium tubular sales influenced the reported business mix. On an absolute dollar basis, operating income fell $115.2 million below the prior year's level. After considering charges related to cost restructuring efforts, operating income was $106.6 million below the prior year's level reflecting the impact of lower base business volumes on gross profit and, to a lesser extent, reduced product and service pricing. For the six months ended June 30, 2009, Smith Oilfield segment operating income was $153.4 million - reflecting operating income of 12.8 percent of revenues. After excluding $21.0 million of charges associated with cost reduction initiatives, operating margins were 14.5 percent. Compared to the prior six-month period, the margin deterioration, again, reflected a shift in the overall business mix and increased pricing pressure in the U.S. market. On an absolute dollar basis, operating income fell $172.5 million below the levels reported in the first half of 2008. After considering charges related to cost reduction efforts, operating income fell $151.5 million from the comparable prior year levels influenced by the sharp decline in base business volumes and related pricing pressure experienced in the U.S. market. Distribution
Revenues
The Distribution segment 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 95 percent of current year revenue base concentrated in those markets. Moreover, approximately one-quarter of the segment'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 impacted by crude oil and natural gas prices. During the quarter ended June 30, 2009, the Distribution segment generated revenues of $410.8 million, down 33 percent from the prior-year period. Approximately two-thirds of the reported sales decline was driven by reduced demand and market pricing for line pipe products. Additionally, lower customer spending in the midstream energy sector associated with unconventional drilling projects also impacted the period-to-period

revenue comparison. For the six-months ended June 30, 2009, the Distribution operations reported revenues of $980.5 million. Business volumes declined 17 percent from the comparable prior-year period as continued weakness in the U.S. market impacted customer spending for maintenance, repair and operating supplies ("MRO") in the energy sector operations and demand for line pipe products in the downstream and industrial customer base. To a lesser extent, lower Canadian drilling and completion activity levels also influenced the six-month revenue performance.
Operating Income
The Distribution segment reported an operating loss of $9.8 million for the three months ended June 30, 2009. After excluding the impact of $1.3 million of severance-related costs included in the June 2009 period, the segment operating loss totaled $8.5 million. The period-to-period operating margin decline was influenced by the significant reduction in revenue volumes, which had an unfavorable impact on fixed-cost coverage, increased competitive pricing pressures and higher line pipe inventory product costs. On an absolute dollar basis, operating results declined $46.3 million from the prior-year level. After considering charges related to cost reduction efforts, operating results were $45.0 million below the prior-year period as the gross profit impact of significant volume reductions and pricing erosion was partially offset by lower variable-based operating expenses. For the first six months of 2009, Distribution operating income was $5.7 million and, after adjusting for $1.9 million in severance-related costs, operating income totaled $7.6 million. Compared to the prior six-month period, the margin deterioration was, again, influenced by the year-over-year decline in business volumes, lower product pricing and higher line pipe costs. On an absolute dollar basis, operating income fell $60.7 million below the amount reported in the first half of 2008. After considering charges related to cost reduction efforts, operating income declined $58.8 million from the comparable prior-year period reflecting lower revenue levels and pricing, partially offset by a reduction in variable-based operating expenditures.
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 (dollars in thousands):

                                                Three Months Ended June 30,                                      Six Months Ended June 30,
                                           2009                            2008                            2009                            2008
                                   Amount             %            Amount             %            Amount             %            Amount             %
Revenues                         $ 1,944,289           100       $ 2,494,158           100       $ 4,355,768           100       $ 4,865,156           100

Gross profit                         529,030            27           807,452            33         1,221,332            28         1,588,936            33

Selling, general and
administrative expenses              395,726            20           417,685            17           846,350            19           820,362            17


Operating income                     133,304             7           389,767            16           374,982             9           768,574            16

Interest expense                      42,803             2            16,244             1            70,327             2            32,545             1
Interest income                         (729 )           -              (752 )           -            (1,087 )           -            (1,648 )           -


Income before income taxes
and noncontrolling interests          91,230             5           374,275            15           305,742             7           737,677            15

Income tax provision                  27,957             2           121,555             5            98,275             2           238,846             5

Noncontrolling interests in
net income of subsidiaries            38,887             2            69,447             3            86,146             2           140,567             3

Net income attributable to
Smith                            $    24,386             1       $   183,273             7       $   121,321             3       $   358,264             7

Consolidated revenues were $1.94 billion for the second quarter of 2009, 22 percent below the level reported in the prior-year period and 28 percent lower after excluding revenues from the retained W-H operations. The majority of the decline related to a 30 percent reduction in North American business volumes driven by a substantial slowdown in land-based drilling and completion activity, . . .