Good morning. My name is Julianne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Smith International Second Quarter 2007 Investor Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Doug Rock. Please go ahead, sir.

Thank you, Julianne. Good morning and welcome to the Smith International second quarter 2007 investor conference call. I'm Doug Rock, Chairman and CEO of Smith. And speaking today are Mike Pearce, who's President of Smith Technologies, and Margaret Dorman, Senior Vice President and Chief Financial Officer of Smith. This morning Margaret, Mike and I will speak for about 30 minutes, and then we'll have another half hour to answer your questions. So everyone has a chance to ask questions, please ask no more than two questions at a time. If time permits, you can re-queue and ask more questions later if the call. Now let's turn our attention to Smith's second quarter 2007 results. Our second quarter 2007 showed continuing strong growth outside North America. Worldwide oilfield segment revenues were up 3.4% sequentially and 26.5% year-over-year. But non-North American oilfield segment revenues were up 8.3% sequentially and 32.2% year-over-year. Operating earnings excluding last year's $0.02 per share tax gain were up 34% year-over-year. The two fastest growing oilfield segment areas were Latin America where revenues were up 18.5% sequentially and 29.7% year-over-year, and Middle East Asia were revenues were up 7.8% sequentially and 36.6% year-over-year. Mexico, Venezuela and Brazil had year-over-year average growth rates in excess of 45%. Collectively, India, China and Australia revenues more than doubled year-over-year, and Saudi Arabia, Egypt, and Qatar averaged over 55% growth year-over-year. Year-over-year revenue growth for Europe, Africa and Russia was also up strongly at 30.7%, and Russia and West Africa averaged better than 40% growth year-over-year. The biggest negative for the quarter was Canada, where revenues declined $98.4 million sequentially to $39.5 million year-over-year. However, our people in Canada did a great job of holding product margins and market share, and coupled with an increase in Eastern Canada offshore drilling, Smith lost…

Thanks, Doug. Appreciate the opportunity to speak to you this morning. I'm going to discuss Smith Technologies, one of four Smith's business units. We manufacture a range of high performance drilling products, including Smith drill bits, a foundation upon which Smith International was originally built and a full range of hole enlargement tools through our Smith Borehole Enlargement group. In addition, we provide high-speed turbo drilling services and advanced drilling engineering services, including our I-DRILL drilling simulation and analysis service. Smith Technologies saw improved performance in the second quarter, both sequentially and year-on-year, despite our strong market position in Canada, where drilling activity was particularly weak, with the rig count there declining 51% year-on-year and 74% sequentially. Second quarter revenues for Smith technologies were $248 million, which is up 2% sequentially and 16% year-on-year. Excluding the Canadian numbers, revenues grew 9% sequentially, outpacing the quarter's 1.5% rig activity increase. The sequential quarter-to-quarter growth was driven primarily by strong PDC rentals in the US Mid-Continent and ArkLaTex region. Pricing also contributed to the sequential quarter comparison. We realized incremental pricing not only in the US but also in Canada and in the international markets. In North America where 90% of the diamond bits are run under rental-type arrangements, performance is key to margin expansion. We've had some very good runs on our indictment products this quarter, which helped offset the lower revenue in Canada. Looking at the regional performance for the quarter versus results for the second quarter of last year, all geographic areas were up with the exception of Canada. Our biggest gains were in the eastern hemisphere where revenues grew 27%. Next, looking at our gains on a product line basis, Smith Borehole Enlargement growth was particularly noteworthy, up 33% versus last year and 7.5% higher sequentially. We recently…

Great. Thanks, Mike. Good morning, everyone. While the quarter's results evidenced the broad business base of our operations, net income was $53 million or 76 cents per share. That's flat with operating earnings reported in the first quarter and up 34% year-over-year on an operating basis. You may recall both the periods had favorable tax benefits, 4 cents last quarter and 2 cents in the June 2006 period. We're pleased with the reported results, particularly the sequential margin expansion and incrementals posted by the oilfield segment and the operating units did an outstanding job on the cash flow front this quarter. We generated $253 million in operating cash flow in the June period resulting from improved working capital management. And due to the limited amount of required capital investment, we saw a significant free cash flow in the quarter. As expected, the seasonal slowdown in Canada impacted the sequential comparison. Canadian land-based revenues fell $104 million below the March period, which translated into related earnings reduction of 7 cents. The Canadian revenue and earnings decline, however, was offset by strength in other market regions, including the North Sea, Mexico and Asian markets. Excluding the impact of our Canadian land-based operations, revenues increased 6% on a sequential quarter basis and earnings grew 11%. Consolidated revenues were flat sequentially and 22% above the prior-year levels. Oilfield segment revenues totaled 1.61 billion, 3% above the March quarter and were 26% higher on a year-over-year basis. Compared to the March quarter, the highest growth areas for the oilfield unit were Asia, which increased 21%, driven by higher revenue intensity in the offshore development area, strong revenue gains in markets such as India, Malaysia, and China, which on a combined basis grew 61% over the March quarter, contributed to the favorable comparison. The Latin American…

[Operator Instructions] Your first question is from the line of Ken Sill with Credit Suisse.

Hi, good morning.

Hi, Ken.

Looking at the results, everything seems to be doing pretty well. I guess, I'm kind of interested as you look out into next year, you've got really strong project awards, international strength is very, very good. What kind of year-over-year growth do you guys expect to see, over the next few years on the international versus North American side?

This is Doug. I mean, it's hard to put a number on it right now. Certainly, on the international, we talked about 32% growth non-North America on the oilfield segment. Whether it continued – we’re seeing I mean from where I sit right now compared to where we were last quarter at this time, I'm certainly more positive because of the number of... not just the number of contracts, but the duration of those contracts, as Margaret mentioned, averaging better than three years, so we feel good about that. The unknown is how many of the new rigs come in, how many we see a lot of additional land rigs being built for the international markets, which is hard to estimate. But certainly we see going forward the kind of growth that we have right now. And it could accelerate if all those rigs go to work quickly.

So you're not seeing any deceleration, you actually think, it's going to be maintain this growth or better as we're go forward?

No in fact it’s the big markets that I mentioned, some of them more than doubling they’ve really just getting started. I mean it's taken three or four years for the higher oil prices to sink in, to get a number and particularly when you go into Asia Pacific area, we're just really seeing that market heat up.

Okay. And then kind of a housekeeping question for Margaret, that depreciation guidance for the year, I'm assuming that's $195 would be the gross number?

That's correct, Ken.

Okay. And did you have a net number or just assume that we're going to have about the same amount?

I'd use about the same percentage. I can give you a net number, but, yeah, that's gross number.

That's fine. And then, on the share repurchases, share count was actually still up a little bit. Are you guys, planning to try to keep the share count roughly flat or is there any kind of overarching strategy in the share repurchase?

With the number of shares still authorized to purchase, we actually hope to be reducing it. We've been doing some acquisitions and some buybacks, but if we don't do a lot of acquisitions, we'll do more buybacks. But the intention isn’t to keep it flat, it’s to reduce it.

All right. Thanks. I'll let somebody else ask a question.

You're welcome.

Your next question is from the line of Dan Pickering with Pickering Energy Partners. Mr. Pickering, your line is open.

Good morning, sorry about that.

Yeah, morning, Dan.

I don't know how to operate the mute button, I guess. Mike, since we've got you on the line here, bit pricing, we continue to hear competitors talk about efforts to push price. Can you just give us a view for what you're seeing in the marketplace from a competitive perspective, is that market remains disciplined, anybody looking for share out there?

Hi, Dan. As always, Dan, if you deliver value and performance to the customers, especially in North America where everything is on a rental basis. If you're delivering performance, they're going to allow you to charge more, you'll get more runs, more footage, and that will equate to more margin dollars. So we don't see that changing.

Mike, is there any, I guess, with activity relatively flat, do you see this rental market... is it in general taking share from bit sales and is that a net positive for Smith?

Margaret?

I think, Dan, you're just talking about the margins on a rental versus a sale.

Correct.

And again, I think as Mike pointed out, with some of the runs, I think, if you look at the quarter's results, I was very pleased with the amount of pricing that we received, not only on the sale side, but also the footage basis for the rentals. So we'd tell you the margins are very good in both the sale as well as the rental business.

Okay. That's helpful. And then Margaret, while I've got you, you were helpful in terms of helping us understand the incrementals ex the Canadian business. I guess, if we looked on a year-over-year basis now, I'm thinking about incrementals, and the oil patch for you guys has been very consistent, running right around 27%, 28%. As you look out into '08, is there any reason to think that that number would pick up with an international mix increase or do we hold steady kind of right here at this level?

I mean you're right, Dan. And if you look at the oilfields, the incrementals year-over-year, we're talking around 27% and they've been in that high 20 range. It's really going to be dependent on the business and the mix of the business. I think we had a very good, as we pointed out in our commentary, we had a very good mix this quarter and it's all going to be dependent on where you see the business, you’re adding thing done.

Yeah. Just with Canada being so very high in margins particularly embeds to some other tools, its back-up to the mid-300 kind of rigs, which will help. But if we can get that up into the 400 to 500 range, that certainly helps our margins. That's why we tend to have flatter margins from first to second quarter every year, because we lose a lot of that high Canadian margin business.

Okay. Great. So we should see some pickup there as we move into the second half of the year.

Yeah. We help above with Canada picking up, yeah Canada is still running 30% year-over-year under where it was, so you're not going to see the strength in pickup. At least for right now, that you saw on prior years, so for the $ 0.06 that we lost, which includes the offshore penny that we gained in Canada first to second, and you may see a couple cent pickup, but typically, we were talking $0.03or $0.04 in the past when the rate count would get back up to 500-550 quickly in the third or fourth quarter little bit moderated.

Okay. Thank you.

You’re welcome.

[Operator Instructions] Your next question is from the line of Bill Sanchez with Howard Weil.

Good morning.

Yeah. Good morning, Bill.

Good morning, Bill.

Margaret, I was hoping perhaps you could update us, just as it relates to kind of the overall oilfield EBIT margin outlook for the balance of the year. I think in earlier comments, you had expressed maybe as much as 200 to 300 basis points of margin improvement in oilfield on a year-over-year basis. Just curious and certainly I appreciate the high decrementals in Canada, but given the continued mix shift we see certainly the impressive offshore revenue growth we saw on the quarter, which is also a high margin. Can you give us a feel of kind of how overall EBIT margins you’re thinking about over the year?

Yeah. I think what we have traditionally talked about, Bill is, our expectation, we've targeted 200 to 300 basis point growth in our year-over-year oilfield margin, so this year, year-over-year, the second quarter, we saw just under that, 180 basis points. So with what we see in the business, I think we were pretty pleased with the reported margin expansion. We've seen good pricing, we've seen a good mix. Our expectation is still going to try to put those margins 200, 300 basis points year-over-year, but we're focused on doing as well as we can with the business growth that we see. And I think we're going to continue to try to get the best margins... margin expansion that we can.

I would comment that with the rollout of all of our new contracts, we are training record numbers of people and there is always a slight depression getting ready for those contracts. If we ever hit a steady state point, which I'm not predicting over the next couple years, there certainly would be a natural increase in margins. In fact, we just graduated some... the whole class full of field bit technology people and they're training with us six months each. So I mean these are quite costly things.

Understand. Mark, can you update us, has there been any change as it relates to your market share on the deepwater fluid side? I believe in the first quarter you had seen that share going to 55% up from 50% in the fourth quarter, was there any noticeable shift in the second quarter results on the deepwater fluids?

No. And you're talking about the US?

No. I'm just talking about overall just deepwater as a whole.

US, I think at the end of June, we were on 22 out of 38 deepwater rigs. So that's about 58%, and I think, you know, on a worldwide basis, we're still, you know, right over half of the market.

Yeah. That was a US gulf number. So it's about the same.

Okay. Thank you.

You're welcome.

You're welcome.

Your next question is from the line of Alan Laws with Merrill Lynch.

Good morning.

Good morning, Alan.

Good morning, Alan.

It's kind of a maybe a little different question, but a few years back you were trying to consolidate the distribution business with your interest in CE Franklin there, you had a deal on the table that didn't quite work out, but now that the Canadian market has sort of gone into a little bit of a dive here, and valuations are lower, perhaps, for than in other periods of time, like even two years ago, is it maybe time to look at that again, and Is there any strategy around that? Have you thought about that?

Yeah. I always thought. I mean, I can't talk about specific thing. But certainly, we believe that consolidation is the way to go and we're continuing to talk to other parties and there's still an opportunity there. I can't talk about one versus the other. But that opportunity is still there, and we're continuing to pursue it.

Okay. That's all I had. Thanks.

Thank you.

Your next question is from the line of Scott Gill with Simmons & Company.

Margaret, on the... when you talk about the M-I business, you mentioned five contracts awarded during the first half of 2007 from Mexico. I guess, I'm wondering, what's kind of the outlook for the back half of the year, are there still more contracts being evaluated for award, number one, and number two, if you can talk about how your other product lines either fit into those contracts or, you know, what the prospects are outside of those contracts?

Scott, let me clarify. M-I was awarded nine.

Right.

Nine new contracts in the first half of the year. Again, a mix of half-and-half IPM and directly with PEMEX. I want to say that seven of those started during the quarter. We see a couple more that began in the third quarter, but I think the outlook for the year is very strong. Mike, do you want to add on what you're seeing on the SBE front?

Yeah. Both SBE and bit sales should be enhanced with these contracts, both with IPM and D&M contracts.

And Mike, just for you, on your... when we talk about the North America business model moving more and more towards rentals as opposed to sales, is that model going to unfold for the international market as well, do you think?

Probably not. In that model in the US is... it's there. I mean we're at probably 90% rental right now. And the problems you have internationally is, you've got customs and taxes associated with the importation of a lot of these bits, so it's really not set up to accommodate a rental-type scenario. Plus, you need a rental repair facility.

Would you say that that is a more ideal business model for the bit business or, which one is kind of the ideal from a profitability standpoint?

They are both very profitable.

Okay. All right. Thank you.

There are no further questions at this time. Mr. Rock, are there any closing remarks?

Yeah. Thank you for joining us for our second quarter conference call, and we look forward to speaking with you in about three months at our third quarter call. Thanks again.

This concludes today's conference call. You may now disconnect.