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Executives

Doug Rock - Chairman, CEO, President and COO

Donald McKenzie - President and CEO, M-I SWACO

Margaret K. Dorman - Sr. VP, CFO and Treasurer

Analysts

Kurt Hallead - Royal Banc of Canada

Robin Shoemaker - Citigroup

Dan Pickering - Tudor Pickering Holt

Charles Minervino - Goldman Sachs

Alan Laws - Merrill Lynch

Smith International, Inc. (SII) Q2 FY08 Earnings Call July 24, 2008 11:00 AM ET

Operator

Good morning ladies and gentlemen. And welcome to the Smith International, Inc. Second Quarter 2008 Investor Conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over Mr. Doug Rock, Mr. Rock you may begin.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Yes, thank you Michele. Good morning, welcome to the Smith International second quarter 2008 investor conference call. I am Doug Rock, Chairman and CEO of Smith and speaking today are Don McKenzie, President and CEO M-I SWACO and Margaret Dorman, Senior Vice President, Chief Financial Officer of Smith.

Don will be talking today from Calgary, where he is working on the fast recovering Canadian market. This morning Margaret, Don and I speak for about 30 minutes then we'll have another half hour for your questions. So everyone has a chance to ask questions, please ask no more than two questions at one time. If time permits you can re-queue and ask more questions later.

Before we get started with our discussion concerning Smith's second quarter 2008. I want to point out that this conference call is not about our current exchange offer for W-H Energy Services which expires on Monday August 4, 2008 unless extended. Any questions regarding this offer should be directed to our Information Agent, Dan Birch of Mackenzie Partners Incorporated. His phone number is 1-800-322-2885. Additionally, we won't discuss W-H [ph] Energy Services second quarter operating results or any information related to their past quarter's activities.

Now let's talk about Smith.

The second quarter 2008 was a superior growth quarter for Smith. Revenues of $2.49 billion, were up 5.2% sequentially, and 18% year-on-year. The $123 million sequential quarterly revenue gain, was the highest first to second quarter revenue gain, in Smith's history.

If we exclude the $88 million sequential quarterly revenue losses from Canada, due to the yearly breakup, worldwide non-Canadian revenues were up 10% in sequential quarters.

Quarterly combined company wide Latin American Eastern Hemisphere revenues were up 22% year-on-year and 7% sequentially. The strongest growth was from Latin America, up 41% year-on-year and 8% sequentially. Then Europe, Africa and the CIS up 26% year-on-year and 8% sequentially. And the Middle East and Far East up both 3% year-on-year and 3% sequentially.

Revenue growth comparisons for the Middle East, Far East region will be much more favorable in the third quarter 2008. The quarter we are in now due to higher activity levels and the elimination of the year-on-year quarterly comparison for the business unit that was sold in Oman in the late second quarter 2007.

Areas of particularly strong for second quarter with the Former Soviet Union, Norway, Egypt, Saudi Arabia, China, Argentina, Brazil, Mexico and [indiscernible], Congo and Gabon and the U.S.

Now looking at the third quarter 2008 growth will not slow down. We started the third quarter with the U.S. rig count at a 22.5 year high and Canadian rig count is recovering quickly from the break up and now stands above last year at this time.

Additionally, we begin a two year plus period of heavy offshore new and refurbished rig additions which have a positive effect on our revenues and margins.

Last quarter was our 22nd consecutive quarter of revenue and operating profit growth and we see this trend accelerating into third quarter 2008. We also mark our sixth consecutive year of second quarter revenue and income growth from outside Canada when revenue from outside Canada more than made up for the drop in Canada. This year we estimate the first to second quarter income reduction from Canada was about $0.07 per share inline with prior years. We should recover at least half that amount in the third quarter of 2008.

Now lets talk about margins, second quarter EBIT of 15.6% was down 10 basis points year-on-year and down 40 basis points sequentially revenues in our higher product margin Smith Technology and Smith Service Groups we curtailed more by the Canadian break up than some of our lower margin products, this happens every year.

We believe we will see good margin improvement in the third quarter 2008. We are also finding past on added costs from steel prices and fuel and transportation costs. We are using fuel surcharges, price increases and contractual pricing arrangements to offset these cost increases.

On contractual terms we sometimes have several months of lag time before we see any increases, though in some cases the increases are retroactive. The strong product demand environment is giving us an opportunity to increase prices now, in less than typical 12 month interval.

Overall second half 2008 business looks to be better than expected as annual Smith revenues for the year excluding any pick up from W-H Energy Services should exceed $10 billion. Because of our status of our current exchange offer for W-H Energy Services, which we anticipate closing next month. We won't update our 2008 earnings guidance till after the transaction closes. We will however have a consolidated plan to discuss with you at our third quarter 2008 conference call.

Now, back to some Smith's second quarter 2008 information. Revenue per employee for the quarter was a new Smith record, at $490,000 per employee per year, up 3% sequentially and up 6% year-on-year. We added 612 employees in the second quarter, and now have 20,668 full time people at Smith. Three quarters, of our new employee additions during the quarter from outside the U.S.

62% of our second quarter oilfield revenue was sourced from outside North America, compared to 60% in the second quarter 2007.

Product areas with significant growth in the quarter included environmental solutions. Wellbore productivity both tools and fluids, diamond bits, turbo drilling, three-cone bits, completion tools, whip stocks, remerge rotating heads, machine shop and inspection and Wilson distribution.

I would like to give John Kennedy and his team at Wilson special mention for their 8.4% sequential revenue gains and significant earnings improvement in the quarter that experienced the Canadian break up. There are obviously even better results to come from Wilson.

In summary 2008 looks to be better than originally planned. We just can't wait for the completion of the W-H Energy Services merger. Ken White and his team have built now standing company. With combination of our product and service operating plus our research and marketing capabilities. Will have people of both companies expand their personal opportunities and provide our customers with a broad range of world class products and services.

We'll talk about the merger in depth at our next and quarterly conference call.

Looking at our industry from the macros standpoint 2008 will be the sixth consecutive year for growth in the U.S. rig counts. Since back to use began keeping U.S. rig counts statistics in 1947 this is the longest growth streak in the U.S. rig count. And more importantly this is the tenth year of worldwide oil drilling growth that began after the 1998 Asian currency crisis.

Typical past cycles were in the 14 to 17 year range but this one could last 20 or more years due to soaring demand and sporadic production growth. Oil and gas industry assets will be an essential component of investor portfolios I believe for years to come.

I also want to welcome Mr. Luiz Rodolfo Landim Machado to our Board of Directors. Rodolfo had a 26 year distinguished career as a Senior Executive with Petrobras and is now Executive President of OGX Petroleo e Gas S.A., last month OGX was the largest capital IPO in history of the Belfast the OGX IPO market value for the IPO is $3.5 billion U.S.

Now, Don Mackenzie, has some comments.

Donald McKenzie - President and Chief Executive Officer, M-I SWACO

Thank you, Doug. Good morning, I am going to discuss M-I SWACO. First I will make some overall comments, address the deep water market and the individual business segments.

Overall comments; the second quarter was a successful quarter for M-I SWACO. Revenues increased almost 5% sequentially to 1.2858 billion following are some of the highlights for the quarter.

Despite a significant revenue reduction in Canada, North America revenues grew $1.2 million sequentially. The Lower 48 land and Gulf of Mexico markets recorded healthy revenue increases of 11% and 3% respectively.

Eastern Hemisphere led by strong gains in Norway, Russia, South Africa accounted for about 80% of the total sequential revenue gain.

Inflation deferred revenue which were exceptionally strong in number of markets increased $45 million or 39% sequentially.

Our produced water treatment business Epcon recorded revenues of $16 million this marked the first quarter we have seen significant water treatment equipment sales into West Africa, Asia and markets outside the traditional North Sea base.

Evidencing that we have market penetration with this key technology. Our offshore revenues for the quarter were $639 million and accounted for almost two-thirds of the increased revenue for the quarter.

Deepwater revenues accounted for 75% of the offshore revenue increase.

Now let's look at the deepwater.

The average that we have raised operating in the US deepwater market declined 2.8 rigs or 7.5% in the second quarter. The rig count engaged in drilling and completion operations averaged 35.8 units. The decrease was due primarily to rig mobilizations to Brazil.

Of the 36 rigs 62% were engaged in drilling operations while the rest were engaged in work over and completion. M-I SWACO serviced and average of 18 of the total as compared to 22 rigs in the first quarter and generated revenues of $83.7 million. This is an increase of approximately 4% over the first quarter.

The international deepwater average 72.7 rigs during the quarter up 10.7 rigs from the first quarter. Our international deepwater revenues were $97.8 million up 34% compared to our first quarter mainly due to improved activity in West Africa and North Sea.

The deepwater market should grow substantially in the third and fourth quarters of 2008. As new or refurbished rigs join the fleet. Based upon current delivery schedules we expect 19 new or refurbished deepwater capable rigs to be delivered during the final two quarters of 2008.

Of that number seven are scheduled for delivery in the next four weeks. And should be fully operational in the fourth quarter.

M-I SWACO has been awarded contracts on four of those seven rigs.

Now we will view M-I's new technology revenue. Premium fluids which include all of the high performance synthetic and water based fluids were $114 million for the quarter, which is an increase of $4.6 billion from the first quarter 2008.

Total synthetic revenues for the quarter were $82.7 million down slightly from the first quarter. Also drilled revenues increased by 3% due to higher sales in the Asia-Pacific region and work revenues were up significantly versus the first quarter.

New technology revenues which are generated from technology that is less then five years old, were $271 million for the quarter. This is up 12% sequentially and 8% from a year ago.

Now I'll discuss our products segments. Our fluid segment revenue which includes drilling fluids and production chemicals, was $806.3 million for the second quarter of 8008. Second quarter revenue decreased by $14.4 million, over 1.8% from the first quarter, but increased $95.8 million or 13.5% from the second quarter of 2007. The bulk of the sequential decline occurred in the Middle East. Due to the completion of our production chemicals contract. The environmental and process solution segment includes drilling waste management and solids control, pressure control equipment.

Second quarter revenue, was $274.1 million, up 9% as compared to the first quarter of 2008. Compared to the second quarter of 2007, revenue grew 26.6% or approximately $57.7 million. The growth in the quarter was driven by produced water treatment, equipment sales and capital equipment sales in to Russia.

Our wellbore productivity segment includes drilling... reservoir drilling fluids, completion fluids, specialized tools and filtration equipments and services. Revenues were $205.4 million for the quarter which was an increase of 31.4% versus the first quarter of 2008. And was result of increase completion activity in North Sea, Sub-Saharan Africa and Gulf of Mexico.

Compared to the second quarter of 2007 wellbore product company revenues increased 28.7%. Growth in wellbore productivity more than offset the sequential decline in drilling solutions revenues as rigs and number of areas switched from drilling operations to completion operations.

The growth in deepwater Gulf of Mexico was due work over and completion rigs increasing back four over the first quarter. As Doug, previously noted we are fighting to pass on rapidly escalating prices for transportation, steel and other commodities to our customers.

Some of our prices are indexed, others are increased by negotiations with clients, which is a continuing process. The most visible impact in escalating cost during the quarter was in transportation costs.

Which increased proportionally with the price of diesel. We're confident that we will recover these increases, at our whole of the rate of change in prices is beginning to moderate.

We've remain optimistic about growth about growth in the second half of 2008, especially in North America.

I will now turn the call over to, Margaret.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Thanks, Don. And good morning, we appreciate everyone taking time to joining us on the call today.

We had a good quarter on a number of fronts. Our oilfield segment businesses continue to strengthen, and we are extremely pleased with the level of performance in the distribution operations, this quarter. The results are straight forward. Earnings were $0.91 a share on a diluted basis. This reflects year-over-year earnings growth of 20% and a sequential profitability improvement of 5%.

As is typically the case in the second quarter, a seasonal down turn in Canadian activity level impacted second quarter revenues, margins, and profits. Excluding influence of our Canadian operations, oilfield earnings grew 9% above the March quarter, and our revenues improved 7%.

From a revenue perspective, consolidated business volumes gained 18% over the year earlier period and 5% sequentially. Our consolidated North American revenue base increased 15% year-over-year and improved 4% over the March period, with the sequential increase, mostly influenced, by the strong performance of the U.S. distribution operations.

Although, each of our oilfield operating units, continue to benefit from a higher number of land-based drilling programs in the U.S., all of the segment sequential net revenue improvement in over 80% of its year-on-year growth came out of the international markets.

The key geographic contributors to the oilfield segment sequential revenue growth were first the Former Soviet Union in which we saw 14% higher sales volumes due to increased demands for drilling fluids, fluid processing equipment and to lesser extent projects utilizing our turbine motor drilling technology.

Next the Latin American market mainly Mexico and Brazil where our revenues have grown 12% sequentially influenced by drilling fluids for onshore projects in both of these markets as well as exceptionally strong drill bit sales which have significantly out paced the underlying rig count growth.

And finally the North Africa market where we generated 30% sequential revenue growth influence by new contract awards for Smith Services under which we've provided completion equipment and services as well as increased drilling and completion fluid demand.

From a business unit prospective, Don, has covered in M-I SWACO. So I'll make a few brief comments on the other units. The Smith Technology's unit continues to be in a important contributor to our performance our revenues improved to $281 million for the second quarter 13% above the year earlier period and in spite of the weakness in Canada. Our markets that make up a significant portion of our bit revenues sequential revenues grew about 2%.

We benefited from the performance of the U.S. operations as further expansion in unconventional and horizontal drilling activity has contributed to increased demand for our ideal roller-cone bit products.

We also had a very solid quarter in Latin America. Our growth was concentrated in Brazil, Argentina and Venezuela which on combined basis increased roughly 30% over the March period influenced by continued market penetration.

And finally we benefited from the inclusion of several modest, export orders, improved drill bit pricing in the U.S. market and increased use of turbine drilling motor technology and operators drilling programs.

Smith Services was also a key contributor to our quarterly performance, revenues improved to $311 million for the second quarter, 11% above the year earlier period and 4% above the march quarter.

The primary sequential growth drivers for premium fibular drill collar sales as well as increased customer demand for our TrackMaster Plus casing exit technology in the U.S. onshore market.

As I noted few minutes ago we benefited from further geographic expansion into Europe, Africa and the Asian market and announcing revenues which relate the contract awards received in the past 12 to 18 months period in market such as North Africa and Far East.

And finally the distribution segment had another outstanding quarter year-on-year revenue growth to 23% and 8% with the sequential growth of any of our unit.

The improvement over the March 2008 quarter primarily reflects increased demand for line pipes and other operating supplies associated with unconventional drilling projects in the U.S. markets. We also benefited from the increased number of engineering and construction projects in both the energy and the down stream end of our business. These factors were partially offset by the impact seasonal drilling slowdown in Canada which impacted the level of drilling and completion activity and associated revenues.

Let me make just couple of high level comments on the income statements starting with operating income.

Consolidated earnings before interest and taxes, totaled $390 million or 15.6% of revenues. Consolidated EBIT improved $11 million over the March 2008 period and overall margins declined about 40 basis points.

Smith Oilfield operating earnings totaled $366 million translating into operating margins of 19.5%. This 60 basis point sequential margin decline came from the loss of high margin product sale associated with the Canadian drilling down turn.

Including impact of our Canadian oilfield operations margin grew roughly 20 basis points on a sequential quarter basis.

Year-over-year oilfield margins... year-over-year oilfield incremental margins were 16%, influenced by lower incremental M-I earnings associated with the upward pressure on overall distribution cost. Primarily, the transportation related outlays, Don, just spoke to, in the flat year-on-year premium fluid product sales mix.

Operating margins in the distribution segments improved 70 basis points in the June quarter. Operating income increased to $36 million, $7 million higher than the first quarter on revenue growth, was about $48 million.

The sequential incremental were influenced by the improved tubular volumes and pricing, and a favorable sales mix in our industrial and downstream operations.

Operating cash flow, or EBITDA for the distribution segment increased to roughly $37 million in the June 2008 quarter or a $147 million, if we analyze the second quarter's result. Operating margins for the distribution segment improved to 5.8% in the second quarter with the energy and industrial sector margins for Wilson currently in the 9% range.

As for the rest of the income statements interest expense in our effective tax rate were consistent with the levels reported in the March quarter. From a guidance standpoint we believe our tax rate for the 2008 fiscal year should remain in the 32.5% range.

Our detailed balance sheet information has been included as part of earnings release documents. I'll make just a few brief comments. Our balance sheet remains very strong. We added a just over a $130 million of net working capital in the quarter influenced by modest inventory build for the upcoming customer projects and to avoid some anticipated near term material price increases.

At the end of June, total debt approximated $930 million and debt to total capitalization stood at 18% a 70 basis point declines for the March level. Net capital spending in the June quarter totaled $77 million roughly $18 million above the first quarter amount largely driven by a higher level of investment in drilling equipment for new contract awards.

After eliminating our minority partners interesting capital additions, capital spending approximated $56 million for the period. We expect our CapEx spending to increase modestly in the back half of the year which would result in Smith full year 2008 net capital spending approximating $310 million.

On a net basis which is the CapEx number you see on the cash flow statement. We believe the 2008 spending forecast compares to full year depreciation and amortization estimate of about $215 million. Depreciation in the second quarter of 2008 was $52 million which translates into $40 million after considering our minority partners interest.

So with that I will hand the call back to, Michele, for questions.

Question And Answer

Operator

Thank you, we will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Kurt Hallead from Royal Banc of Canada. Please go ahead.

Kurt Hallead - Royal Banc of Canada

Hi good morning.

Unidentified Company Representative

Yes, hi good morning.

Kurt Hallead - Royal Banc of Canada

Hey, Doug. I just want... heard a number of different things over the last week here coming into your earnings call. Most of you have been reflected of your positive commentary and question relates to the increased horizontal drilling that we are seeing in U.S. in the Shale Plays. What do you guess is the revenue intensity of these plays, vis-à-vis kind of standard drilling?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

We think that the average horizontal wells that being drilled in a Shale play is in the $2.5 million to $3 million dollar range which is a little bit more than double what you have seen as non-horizontal prior to that. And that the main beneficiaries for that are the pressure pumping and the directional. That's why we see the directional business growing at about this year we think it's growing about 18% I think that's consistent with the spirit numbers year-over-year and could be in that range next year. And pressure pumping in some of these wells, right now is actually more than the rig costs. So I'd say those are primary beneficiaries.

Kurt Hallead - Royal Banc of Canada

And you referenced a comment in general about pricing, I may have missed part of that, I don't think you got as any specific product line and I think your referenced it, you expect to get some element of net pricing, did I understand that correctly?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

I have not way that but we did mention that we thought that price increases will accelerate and we wouldn't need to wait the normal one year time frame as you have seen in the past because the demand for the product and for relative product performance.

Kurt Hallead - Royal Banc of Canada

All right. One of your peers highlighted a 10% to 15% price increase for North America, obviously that's on a growth basis not on net bases. Your other primary big at it was mentioned in increases as well for a bit specifically. Are we still talking kind of single digit type changes on growth basis or cost really ramping up to the point where we had to start talking about double digit increase?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

But I can't talk about future prices and those numbers I wasn't aware of. But essentially on bits and things like that where there is not a high transportation component the costs aren't up, that might which I think we can get a much better margin spread. Because steel is a very small component of bits and it's mainly labor and the labor cost aren't up nearly that much. So we are only seeing really price increases as Margaret, mentioned on the transportation side on some of the oil related fluids.

Even automobiles, I thing we got 5000 trucks and cars in the company. So we actually see about finding a quarter something like that just every dollar fuel goes up per gallon, so these are some areas we are working on. But in general if we get those kind of price increases they would be significant margin improvements because with cost relationship is much less than that.

Kurt Hallead - Royal Banc of Canada

Great, thank you.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Kurt, with your comment on this pricing I would tell you this. The bit operating management has a done a very good job of realizing the price increase that we put out earlier this year. And as, Doug, said, if and when we think the timing is right we would look at price increase does not just in bit but in other areas.

Kurt Hallead - Royal Banc of Canada

That's a great color. I appreciate it, thanks.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Yes. You are welcome

Operator

Our next question comes from Robin Shoemaker from Citigroup. Please go ahead.

Robin Shoemaker - Citigroup

Thanks, Doug. Wanted to ask you in some of your international markets particularly Latin America where you are seeing good revenue growth. Could you comment on to what extent these are coming from integrated projects, where you are partnered up with or what's the kind of the participation that you have in some of those projects?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

The smaller amount is on integrated projects as we mentioned mention last year the 11 contracts we gotten in Mexico to the end last year and they are all started up by two of them more in integrated projects. So it's a important part but it's not huge. I think we've mentioned in the past but percentage of integrated projects for M-I SWACO's revenues were in the 5% range. Actually running a lit bit to less than that. So it's important buts it not huge number.

Robin Shoemaker - Citigroup

And how are positioned apart from Sunbridge [ph] with other major service company's that carrying out integrated projects?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Well the interesting part to ask is that sometimes service industry talks as though we are the one who put together the projects its really our customers the national oil companies, the integrated oil companies and many places that we have our products and services on other peoples integrated projects because of the customers, that's the environmental solutions we want, those are the bits we want, those are the down hole tools distributions. So if you made a list of all the innovative you'd find Smith having some services in some products on most if not all of them.

Robin Shoemaker - Citigroup

Okay, then just one final question if I may on the incremental margin in oilfield you decided transportation cost impacting this 16% year-on-year incremental margin. Anything else there that would or could you give us a sense of order of magnitude that how transportation or other costs might have impacted that number?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

No Robin, I don't that are going to a lot of specifics on that but I think as I pointed out certainly transportation had an impact if you think about first quarter year-over-year also the incremental were in that 20% range. So year-over-year incremental in second quarter aren't that much lower than what we saw in the March period and I would tell you that the... downward pressure on the incremental came from transportation and to a lesser extent from the mix of business in project.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Yes, certainly we had very low utilization in Canada as, Don, might want to comments that's thus picking up significantly right now.

Donald McKenzie - President and Chief Executive Officer, M-I SWACO

Yes, if you take a look at the Canadian market in Calgary today, we anticipate that the third quarter its going to be substantially better than the second and the fourth quarter I think its going to be a very-very good.

Robin Shoemaker - Citigroup

Great, thank you.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

You're welcome.

Operator

Our next question comes from Dan Pickering from Tudor Pickering Holt. Please go ahead.

Dan Pickering - Tudor Pickering Holt

Good morning.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Good morning, Dan.

Dan Pickering - Tudor Pickering Holt

Margaret, I didn't hear in your remarks any discussion of either share repurchase or acquisitions, were there either during the quarter?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

No. I mean, we consider ourselves to be in a registration period, so there were no.

Dan Pickering - Tudor Pickering Holt

Okay.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Share repurchases.

Dan Pickering - Tudor Pickering Holt

Okay. So we should not read anything into no share repurchases, other than its just problematic?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Absolutely not. We were advised, we couldn't enter into any share repurchases this quarter.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Yes. We've started the process, prior to the beginning of the quarter. As you'll notice in the scores. So there was really no time that we could.

Dan Pickering - Tudor Pickering Holt

Okay. And then on the distribution business, can you talk a little bit about the sustainability of that margin level. And how if any of... kind of that whole pipe business, steel inventory et cetera. Played into the recovery and margin?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Looking forward we see that business certainly expanding through the next two or three quarters. Its hard to say beyond that. I would hope it would go beyond that. But I think it's a general pick up in business. We've got a number of new contractual arrangements certainly with all the new gas wells being drilled you get an awful lot of new line pipe, I mean whether it's in the Haynesville or the Fayetteville or the Barnett. I guess from ourselves really I would start to pick up yet.

And then you have see an awful lot of activity even up in the Bakken areas like that. So yes with the rigs coming in I noticed right now we've got almost 70 rigs running in the Bakken and trying to develop some networks for the performing of that oil. So it's yes we see it continuing.

Dan Pickering - Tudor Pickering Holt

Thank you.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

You are welcome.

Operator

Our next question comes from Chuck Minervino from Goldman Sachs. Please go ahead.

Charles Minervino - Goldman Sachs

Hi, good morning.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Good morning, Chuck.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Good morning, Chuck.

Charles Minervino - Goldman Sachs

If I got your numbers correctly I think you said that seven of the loader contracts have been awarded and you want four of them. Is it safe to say that the other 12 will likely be awarded this quarter?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

No, we didn't mean to say that they been awarded the contract is actually with the operator and is using multi-year. So what we meant to convey is that of the 7 coming in we already have those contracts with the operators four of them. And I think what we are also saying is that we look at over the next couple of years certainly there are new contracts coming and going. But we will expect to have at least half of those rigs coming under M-I SWACO because of the relationship and longer term contract with the operator.

Charles Minervino - Goldman Sachs

Okay. And were the others three awarded yet or?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Yes, I mean...

Charles Minervino - Goldman Sachs

Okay.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Some of the operators have contracts with one of our competitors, that's correct.

Charles Minervino - Goldman Sachs

Okay. And when we just think about that from a revenue standpoint going forward on a revenue per rig basis is it fairly similar to your current revenue per rig?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

What, we'll say for deepwater is that with our mix of products we get some of them we have the environmental solutions. In the wellbore productivity. In the $3 million to $4 million per rig per quarter range is what we look at for our deepwater market.

Charles Minervino - Goldman Sachs

Okay. Thank you very much.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

You're welcome.

Operator

Our next question comes from Jeff Skybert from Weeden [ph]. Please go ahead.

Unidentified Analyst

Good morning.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Good morning.

Unidentified Analyst

Just wanted to come back on that question about Wilson and the margin performance I mean, how much of the both of revenue and the profitability improvement is upstream versus downstream?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

I would tell you, Jeff, that its pretty mix. But we did have a very good quarter as I talked of that in my comments had a very big quarter in industrial and downstream areas of business. And also the line pipe which some of the special projects but the rest of it is sprinkled in the energy as well as the downstream had very good pricing and close room the line pipe is for us.

Unidentified Analyst

And on the industrial and downstream businesses. Are they trending in meaningfully way from the upstream resistance... if Wilson's exposure to those market kind of... your old same thing rising commodity prices all the others things we've been talking about?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

I would say that Wilson is doing a better and better job of getting contracts and getting profitability. Certainly on the engineering and construction side. I mean the mainly the energy verticals. So these are energy related things that's certainly picking up with the investment. But on the general and industrial side I think they are just doing a better job getting some revenue, getting some more flow through and managing their cost well. So it's I think that's management performance issue.

Unidentified Analyst

And it sounded like you are pretty confident with the margin performance being sustained, if not improved upon?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Certainly the business is growing. Hopefully the margins, it will continue right with it.

Unidentified Analyst

Okay. And just as, each one of the three pieces of M-I SWACO is becoming,, fairly substantial. Are there meaningful margin differences between the fluids; the wellbore productivity and the environmental solutions?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Yes, what we'll just say is just give a general guidance, about 40% of M-I, now may be a little bit more, is not in fluids. Its in the environmental, its in the wellbore productivity and the rest. And those margins are higher than just the straight fluids. But on the other side, if you look at the very high end fluids, if you look at the Alfred Drill [ph], if you look at the work on those things. Those individual fluids may have higher margins of some of the products in wellbore productivity or in the environmental solutions. But in general, the 40 somewhat percent is non-fluids related on average as higher margins. One of the reasons that we are growing at such a strong rate.

Unidentified Analyst

Thanks very much.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Yes, you're welcome.

Operator

Our next question comes from Alan Laws from Merrill Lynch. Please go ahead.

Alan Laws - Merrill Lynch

Good morning.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Good morning Allan.

Alan Laws - Merrill Lynch

I have a couple of questions here on I am not going to ask the Wilson ones since you just talked about that. How strategic is Wilson do you given solid results now and good operational execution is there a potential divestiture here in the future or there is a candidate for that?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Well, as we have mentioned before is not just Wilson any of our businesses if there were an opportunity to sell or to combine joint venture whatever with someone else to the benefit of shareholders we'll do it and we probably look to as many opportunities with Wilson as anything else. But yes, the opportunity is still there.

Alan Laws - Merrill Lynch

So people are still getting approached on this and its still on an active part of your... I guess your M&A type discussions?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

I wouldn't say they are active but there are certainly people that are interested I wouldn't say I have got any active numbers or anything of that nature.

Alan Laws - Merrill Lynch

Okay. Then a follow up to that would be another strategic kind of question. Can you comment on your expanding products and service line beyond W-H and you would party your strategy be to become more of a Shale player given the trends there?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Well certainly part of the reasoning for the directional side of W-H I mean that great coil tubing group. They have got a great group that's involved in case total logging superior renal tools, moulds and things like that. From the pathfinder side the big current issue really is the unconventional Shale plays but also the real opportunity to taking lot of those businesses where they complement Smith Services to take them internationally. So you got both sides of that clearly that's the where we are going.

Alan Laws - Merrill Lynch

We have seen that, of that mix, the only thing that's really not there in pressure pumping. Are you interested, you already have core turbine business, and sort of part of that or would that be something that you would be interested in. As if know there is a number of smaller players out there with build up capacity, and there may be targets that--

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Well, all of our major competitors, clearly Becker Hughes operates without pressure pumping. So we need it as a product. We could contract that, so I wouldn't say at this point that it critical.

Alan Laws - Merrill Lynch

Okay. All right. And then the last thing was just a quick reminder kind of a question. I am just wondering you remind us of the magnitude of revenue potential in the M-I business from deepwater, say versus jack-up and land rigs?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Yes, again. We say that in the three to four million per rig per quarter kind of range for deepwater. So if we figure we have 50% market share, just take the rigs that are coming on and use that all of them, I think you get pretty close.

Alan Laws - Merrill Lynch

All right. Great, thank you.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

You are welcome.

Operator

Our next question comes from Daken Shah from Icast. Please go ahead.

Unidentified Analyst

Hi I just had a question about the timing can you talk about the timing of the closer of the merger and also the HSR is set to expire on August 18th. So I was just curious to see if you are expecting second year re-class or non-issue with that and potentially early acceleration of the HSR?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Yes, as we said of the beginning any questions involving the that we would like you to report to our Information Agent which Dan Birch of Mackenzie Partners on his phone numbers 1-800-322-2885 as I mentioned earlier in the call the offer expire on the four. So we think it's coming up soon.

Unidentified Analyst

Okay.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Specifics that need to come through our information agent.

Unidentified Analyst

Okay. Just one follows up question. There has been some concern because of the Hurricanes Dolly and potential other hurricanes. That you may have... we may have can you talk about how the company has impacted for that matter of the emerging may be in fact firm from those hurricanes or extremes?

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Merger would have nothing to do with the hurricanes. Typical revenue declines based on hurricanes in past years have been $15 million to $20 million we just had very minimal from, Dolly, you might even not see that. But a couple of more came through it could have effect I mean in that kind of range but its not that high. Particularly with the jack-up rigs being so low right now. The shelf gas drilling and actually the gas component from the Gulf actually falling down into the just about the mid teens. In term of the total U.S. gas. Its declining less, unless this part is an impact from hurricanes on Smith has raised the potential.

Unidentified Analyst

Great thank you.

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

You're welcome.

Operator

[Operator Instructions].

Doug Rock - Chairman, Chief Executive Officer, President and Chief Operating Officer

Well, there no further questions. I want to thank you for joining us and look forward to talking to you in the end of October for our third quarter results. Thanks for joining us.

Operator

Thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect.

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Source: Smith International, Inc. Q2 2008 Earnings Call Transcript

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