SMITH INTERNATIONAL INC, 10-K405, 1998-03-23

SMITH INTERNATIONAL INC
10-K405, 1998-03-23
MISCELLANEOUS CHEMICAL PRODUCTS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K

(MARK ONE)

(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

COMMISSION FILE NUMBER 1-8514

SMITH INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 95-3822631
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

16740 HARDY STREET 77032
HOUSTON, TEXAS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (281) 443-3370

SECURITIES REGISTERED PURSUANT TO SECTION 12(B)
OF THE ACT:

COMMON STOCK NEW YORK STOCK EXCHANGE, INC.
PACIFIC STOCK EXCHANGE, INC.
(TITLE OF CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE

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 X No
--- ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

The aggregate market value of the voting stock held by non-affiliates
on March 13, 1998 was $2,099,436,360 (39,472,364 shares at the closing price on
the New York Stock Exchange of $53.19). For this purpose all shares held by
officers and directors and their respective affiliates are considered to be
held by affiliates, but neither the Registrant nor such persons concede that
they are affiliates of the Registrant.

There were 40,333,637 shares of common stock outstanding at March 13,
1998.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement related to the Registrant's 1998
Annual Meeting of Shareholders are incorporated by reference into Part III of
this Form 10-K.

<PAGE> 2

PART I
ITEM 1. BUSINESS

GENERAL

Smith International, Inc. ("Smith" or the "Company") is a leading
worldwide supplier 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 equipment, waste
management services, three-cone drill bits, diamond drill bits, fishing
services, drilling tools, underreamers, sidetracking systems and liner hangers.
The Company was incorporated in the State of California in January 1937 and
reincorporated under Delaware law in May 1983. The Company's executive offices
are headquartered at 16740 Hardy Street, Houston, Texas 77032 (telephone number
281/443-3370).

The Company operates through five business units which provide
products and services throughout the world. The Company's business units are
(i) M-I Fluids, a division of M-I L.L.C. ("M-I"), which provides drilling and
completion fluid systems and services; (ii) M-I SWACO, a division of M-I, which
provides solids control, pressure control and rig instrumentation equipment and
waste management services; (iii) Smith Tool which manufactures and sells
three-cone drill bits for use in the oil and gas industry and in mining
operations; (iv) Smith Drilling & Completions which manufactures and markets
products and services used for drilling, workover, well completion, fishing and
well re-entry operations; and (v) Smith Diamond Technology which manufactures
and markets shear drill bits featuring cutters made of polycrystalline diamond
or natural diamond.

For information regarding revenues of the Company's five business
units see Management's Discussion and Analysis of Financial Condition and
Results of Operations included elsewhere in this Form 10-K.

The Company's business units supply products and provide services
primarily to the petroleum services segment. The information regarding business
segments and U.S. and non-U.S. operations appears in Note 12 of the Notes to
Consolidated Financial Statements included elsewhere in this Form 10-K.

ACQUISITIONS AND DISPOSITIONS

On January 19, 1998, Smith signed a definitive agreement to acquire
all of the equity interests of Wilson Industries, Inc. ("Wilson") in a
transaction expected to be accounted for as a pooling of interests. A
discussion of the Wilson transaction appears in Note 14 of the Notes to
Consolidated Financial Statements included elsewhere in this Form 10-K. In
addition to the planned Wilson acquisition, the Company has acquired and
disposed of certain other operations during the prior five year period. A
description of the material transactions follows.

Acquisitions of A-Z/Grant and Lindsey Completion Systems

On December 22, 1993, the Company acquired the product line assets of
A-Z/Grant and Lindsey Completion Systems ("A-Z/Grant" and "Lindsey") for $19.0
million in cash. The A-Z/Grant and Lindsey operations are leading providers of
downhole tools, remedial services and liner hangers to the oil and gas
industry.

Acquisition of M-I L.L.C.

On February 28, 1994, the Company acquired a 64 percent interest in
M-I in exchange for cash and a note payable totaling $160.0 million. M-I is a
Houston, Texas based provider of drilling and completion fluids and systems,
solids-control equipment and waste management services to the oil and gas
drilling industry.

Acquisition of Anchor Drilling Fluids, A.S.

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Acquisition of The Red Baron (Oil Tools Rental)Ltd.

On October 9, 1996, the Company acquired all of the outstanding shares
of The Red Baron (Oil Tools Rental) Ltd. ("Red Baron") in exchange for cash and
notes payable of approximately $40.3 million. Red Baron is an Aberdeen,
Scotland based supplier of fishing and other downhole remedial products and
services to the oil and gas industry.

Acquisition of Tri-Tech Fishing Services, L.L.C.

On April 16, 1997, the Company acquired all of the equity interests in
Tri-Tech Fishing Services, L.L.C. ("Tri-Tech") in exchange for consideration
totaling approximately $20.4 million. Tri-Tech is a supplier of fishing and
other downhole remedial products and services to the U.S. Gulf Coast area.

Acquisition of Fleming Oilfield Services, Ltd.

On October 16, 1997, the Company acquired all of the outstanding
shares of Fleming Oilfield Services, Ltd. ("Fleming") in exchange for cash of
approximately $17.3 million. Fleming is a Calgary, Alberta based supplier of
drilling fluids products and services to the Canadian oil and gas industry.

Sale of Directional Drilling Business

On March 29, 1993, the Company sold its directional drilling systems
and services ("DDS") business and certain of its subsidiaries and other
affiliates to Halliburton Company ("Halliburton") for 6,857,000 shares of
Halliburton common stock. In April 1993, the Halliburton common stock obtained
in the transaction was sold for $247.7 million with the Company utilizing a
portion of these proceeds to repay certain debt. As a result of the DDS sale,
the Company recorded income in 1993 from discontinued operations of $73.6
million, which included an $80.1 million gain related to the sale of the DDS
business.

INDUSTRY OVERVIEW

The Company's worldwide operations are largely driven by the level of
exploration and production activity in major energy producing areas and the
depth and drilling conditions of these projects. The level of worldwide
drilling activity is influenced by the prices of oil and natural gas but may
also be affected by political actions and uncertainties, environmental
concerns, capital expenditure plans of exploration and production companies and
the overall level of global economic growth and activity.

Management anticipates that total worldwide drilling activity will
continue to increase from historical activity levels; however, the rate of
growth is expected to be lower than the 1997 growth rate. The average worldwide
rig count increased approximately 16 percent over 1996 levels due to strong
North American growth driven by higher U.S. land-based activity and record
Canadian activity levels. The 1998 worldwide rig count is expected to increase
from 1997 levels due to balanced growth across all geographic areas. The level
of commodity prices may impact the forecasted growth in worldwide drilling
activity, particularly North American land-based drilling programs which are
generally more sensitive to the price of oil and gas.

BUSINESS OPERATIONS

M-I Fluids

Products and Services. Through a division of its majority-owned
subsidiary, the Company is the leading worldwide provider of drilling fluids
systems, products and technical services to end users engaged in drilling oil,
natural gas and geothermal wells. Drilling fluid products and systems are used
to cool and lubricate the bit during drilling operations, contain formation
pressures, suspend and remove rock cuttings from the hole and maintain the
stability of the wellbore. Technical services are provided to ensure that the
products and systems are applied effectively to optimize drilling operations.
These services include recommending products and services during the well
planning phase; testing

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drilling fluid properties and recommending adjustments during the drilling
phase; and analyzing well results after the project is complete to improve the
performance of wells to be drilled in the future.

M-I Fluids offers water-base, oil-base and synthetic-base drilling
fluid systems. Water-base drilling fluids are the most widely utilized system
around the world, having application in both land and offshore environments.
They are typically comprised of an engineered blend of weighting materials,
which are used to contain formation pressures, as well as a broad range of
chemical additives, which yield specific drilling performance features required
for a given drilling environment. Oil-base drilling fluids are used to drill
water-sensitive shales, to reduce torque and drag and to drill in areas where
stuck pipe is likely to occur. These systems are low viscosity systems that
sharply increase rates of penetration in certain drilling areas of the world.
Synthetic-base drilling fluids are used in similar drilling environments and
often exceed the superior performance characteristics of oil-base drilling
fluids.

Completion fluids, also known as clear brine fluids, are solids-free,
clear salt solutions that have high specific gravities. Combined with a range
of specialty chemicals, these fluids are used by operators in the oil and gas
industry to control bottom-hole pressures and to meet a well's specific
corrosion, inhibition, viscosity, and fluid loss requirements during the
completion and workover phases. These systems are specially designed to
maximize well production by minimizing formation damage that can be caused by
solids-laden systems. M-I Fluids provides a complete line of completion fluids
products and services, including a full range of low- and high-density brines,
specialty chemicals, filtration and chemical treatment services used in the
reclamation of these specialized fluids and technical engineering and
laboratory support services.

Competition. M-I Fluids competes in a number of distinct segments and
faces a number of different competitors within the oil service industry. The
major competitors in the worldwide drilling fluids industry are Baroid Drilling
Fluids (a division of Dresser Industries, Inc. ("Dresser")), INTEQ (a division
of Baker Hughes, Inc. ("Baker Hughes")) and Dowell Drilling Fluids (a division
of Schlumberger, Inc.). While these companies supply a majority of the market,
the drilling fluids industry is highly competitive, with a significant number
of smaller, locally-based competitors as well as limited product producers that
market their products without technical services. Competition is based upon
technical services provided at the wellsite, product quality and availability,
service response and price.

M-I Completion Fluids has four main competitors in the sale of clear
brine fluids to end-use markets: Baroid Completion Fluids (a division of
Dresser), Tetra Technologies, Inc., OSCA, Inc. (a subsidiary of Great Lakes
Chemical Corporation) and Ambar, Inc. This market is highly competitive, and
competition is based primarily on product availability, technical service and
price.

M-I SWACO

Products and Services. Through M-I's SWACO division, a complete line
of solids control, pressure control, rig instrumentation and waste management
services are offered to the worldwide drilling market on both a sale and rental
basis. Key products in the pressure control line include the D-Gasser and Super
Choke, which hold strong market positions, as well as the Super Mud Gas
Separator, which protects against the large pressure surges encountered in
underbalanced drilling operations used in horizontal wells. The solids control
product line of shakers, hydroclones and centrifuges has been designed to offer
operators the option to drill "dry locations", where drilling fluid waste is
minimized and handled in an environmentally safe manner. SWACO's rig
instrumentation line features the SMART(TM) and GEO-SMART Data Acquisition
Systems, advanced monitoring systems that measure, monitor and display the
drilling status of a well with high speed accuracy.

Competition. SWACO competes with Brandt/EPI (a subsidiary of Tuboscope
Vetco International Corporation), Derrick Oil Services and Martin Decker Totco
(a subsidiary of Varco Industries). Additionally, there are a number of
regional suppliers that provide a limited breadth of equipment and services
tailored for their local markets. Competition is based on product availability,
equipment performance, technical support and price.

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Smith Tool

Products. The Smith Tool business unit is a worldwide leader in the
design, manufacture and marketing of drill bits used in drilling oil and gas
wells and in mining applications under the Smith Tool(TM) and Smith Mining(TM)
product lines. Most bits manufactured by Smith Tool are three-cone drill bits
for the petroleum industry, which range in size from 3 1/2 to 28 inches in
diameter. These three-cone bits are comprised of two major components - the
body and the cones, which contain different types of pointed structures
referred to as "cutting structures" or "teeth." The cutting structures are
either an integral part of the steel cone with a hardmetal applied surface
(referred to as "milled tooth") or made of an inserted material (referred to as
"insert") which is usually tungsten carbide. In the last few years, there has
been a significant increase in demand for drill bits in which the tungsten
carbide insert is coated with polycrystalline diamond ("PDC"). Products with
diamond enhanced inserts last longer and increase penetration rates, which
decreases overall drilling costs in certain formations. Smith Tool is the
leading provider of drill bits utilizing diamond enhanced insert technology.

Competition. Besides the Company, Hughes Christensen (a division of
Baker Hughes), Security DBS (a division of Dresser) and Reed Tool (a division
of Camco International, Inc. ("Camco")) are the three major competitors in the
petroleum drill bit business. While the Company and Hughes Christensen maintain
the leading shares of worldwide revenues of three-cone drill bits, they compete
with over 20 other competitors. Competition for sales of petroleum drill bits
is generally based on a number of factors, including performance, quality,
reliability, service, price, technological advances and breadth of products.
Competition for sales of mining drill bits generally is based on a number of
factors, including price, performance and availability.

Smith Drilling & Completions

Products and Services. The Smith Drilling & Completions business unit
provides Drilling, Remedial and Completion products and services to end users
engaged in drilling oil, natural gas and geothermal wells. Approximately 80
percent of Smith Drilling & Completions' revenues are related to product
rentals and associated technical services with the remaining revenue generated
from product sales.

Drilling products and services include the Drilco/Grant product lines
and the TIPSA, S.A. and Faster Oilfield Services operations acquired in 1997.
The product and service offerings include: rotating drilling heads for
underbalanced drilling; automatic connection torque monitoring and control
systems; downhole drilling tools; tubular drill string components (drill
collars, subs, kellys, Hevi-WateTM drill pipe); drilling tool and drill string
inspection products and services; drill string repair and rebuild services; and
production tubulars and sucker rod inspection and repair.

Remedial products and services include the A-Z/Servco product lines,
Red Baron and Tri-Tech Fishing Services. The product and service offerings
include: remedial, re-entry, and fishing services used in specialized drilling
and workover operations; underrreaming and hole opening services to provide
additional annular space in the well bore for cementing and/or gravel packing;
coiled and thru-tubing products and services; mechanical, hydraulic, and
explosive pipe cutting to remove casing during a well or platform abandonment;
and multi-lateral installations. Products include the patented Reamaster(TM)
and Underream-While-Drilling System(TM) which allow two operations to be
performed simultaneously. The product group also includes the patented
Millmaster(TM) Performance Milling System, the patented Packstock(TM) and
Anchorstock(TM) Performance Window Cutting System and the newly developed
Trackmaster(TM).

Completion products and services include the Lindsey Completion
Systems which offers products and services including liner hangers, cementing
products and tools, liner top packers and tie-back equipment, setting tools,
permanent and temporary packers plus the service personnel to install these
products in the well bore.

In general, all products and services are manufactured, marketed, and
maintained by the same management, operations and sales personnel operating out
of 70 locations in 24 countries. Houston, Texas is the sales, management,
engineering, and manufacturing headquarters for this business unit.

Competition. The Company's major competitors in the drilling,
remedial, re-entry and fishing services markets are Weatherford Enterra, Inc.,
Baker Oil Tools (a division of Baker Hughes) and numerous small local
companies. The main competitors in the completion markets are Baker Oil Tools
and TIW Corporation. Competition in the drilling and

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completions sales, rentals and services market is primarily based on
performance, quality, reliability, service, price, response time and, in some
cases, breadth of products. Smith Drilling & Completions attributes its
competitive position to its commitment to technological advancements that add
value to the customer's programs plus the quality, performance and service of
its products and employees.

Smith Diamond Technology

Products. Smith Diamond Technology designs, manufactures and markets
shear drill bits featuring cutters made of polycrystalline diamond ("PDC") or
natural diamond. The Company manufactures PDC and cubic boron nitride at its
MegaDiamond and Supradiamant subsidiaries. These ultrahard materials are used
in the Company's three-cone and diamond drill bits and in other specialized
cutting tools. MegaDiamond developed and uses patented processes for applying
diamonds to a curved surface with multiple transition layers. Smith is the only
oilfield equipment manufacturer that develops, manufactures and markets its own
synthetic diamond materials, which provide the Company a cost and technological
advantage. In addition, the Company's in-house diamond research, engineering
and manufacturing capabilities enhance the Company's ability to develop the
application of diamond technology across other Smith product lines and into
several non-energy cutting tool markets. Diamond enhanced products last longer
and increase penetration rates, which decreases overall drilling costs in
certain formations. The Company believes that its ability to develop
specialized diamond inserts for specific applications has and continues to
provide new business opportunities such as Diamond Enhanced Insert roller cone
bits and Impax(TM) hammer bits as well as non-energy cutting tool applications.

Competition. The Company's major competitors in the petroleum shear
bit business are Hycalog (a division of Camco), Hughes Christensen (a division
of Baker Hughes) and Security DBS (a division of Dresser). Competition for
sales of petroleum shear bits is generally based on a number of factors,
including performance, quality, reliability, service, price, technological
advances and breadth of products. The Company believes its quality and
reliability as well as technological advances, such as the Diamond Enhanced
Inserts, provide its products with a competitive advantage.

NON-U.S. OPERATIONS

Sales to oil and gas exploration and production markets outside the
U.S. are a key strategic focus of Smith management. The Company markets its
products and services through subsidiaries, joint ventures and sales agents
located in virtually all petroleum producing areas of the world; including
Canada, the North Sea/Europe, the Middle East, Latin America, Asia/Pacific and
Africa. As a result, 61 percent of the Company's total revenues in 1997 were
generated from sales in non-U.S. markets.

Historically, drilling activity outside the U.S. has been less
volatile than U.S. based activity as the high cost of exploration and
production programs outside the U.S. are generally undertaken by major oil
companies, consortiums and national oil companies. These entities operate under
longer term strategic priorities than do the independent drilling operators
that are more common in the U.S. market.

SALES AND DISTRIBUTION

Sales and service efforts are directed to end users in the drilling
and completion industry including major and independent oil companies, national
oil companies and independent drilling contractors. The Company's products and
services are primarily marketed through the direct sales force of each business
unit. In certain non-U.S. markets where direct sales efforts are not
practicable, the Company utilizes independent sales agents, distributors, or
joint ventures.

Smith maintains field service centers, which function as repair and
maintenance facilities for rental tools, operations for remedial and completion
service and a base for the Company's global sales force, in every major oil and
gas producing area of the world. The location of these service centers near the
Company's customers is an important factor in maintaining favorable customer
relations.

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MANUFACTURING

The Company's manufacturing operations, along with quality control
support, are designed to ensure that all products and services marketed by the
Company will meet standards of performance and reliability consistent with the
Company's reputation in the industry.

Management believes that it generally has sufficient internal
manufacturing capacity to meet anticipated demand for its products and
services. During periods of peak demand certain business units utilize outside
resources to provide additional manufacturing capacity.

RAW MATERIALS

Through its company-owned mines located in the U.S. and abroad, M-I
has the capability to produce a large portion of its requirements for barite
and bentonite. Barite reserves are located in the U.S., the United Kingdom and
Morocco. Bentonite is produced from ore deposits in the U.S. and Greece. Mining
exploration activities continue worldwide to locate and evaluate ore bodies to
ensure deposits are ready for production when market conditions dictate. In
addition to its own production, M-I purchases a majority of its worldwide
barite requirements from suppliers outside the U.S., located mainly in the
People's Republic of China, India and Morocco.

The Company purchases a variety of raw materials for its Smith Tool,
Smith Diamond Technology and Smith Drilling & Completions units, including
alloy and stainless steel bars, tungsten carbide inserts and forgings.
Generally, the Company is not dependent on any single source of supply for any
of its raw materials or purchased components. The Company purchases a
significant amount of tungsten carbide inserts and U.S. forging requirements
from two suppliers under separate supply agreements. The Company believes that
numerous alternative supply sources are available for all such materials. The
Company produces PDC in Provo, Utah; Grenoble, France and Scurelle, Italy for
utilization in various Company products as well as direct customer sales. The
Company believes that it enjoys a competitive advantage in the manufacture of
diamond drill bits because it is the only diamond drill bit manufacturer
producing its own PDC.

PRODUCT DEVELOPMENT, ENGINEERING AND PATENTS

The Company's business units maintain product development and
engineering departments whose activities are focused on improving existing
products and services and developing new ones to meet customers demands for
improved drilling performance and environmental-based solutions for drilling
and completion operations. The Company's primary research facilities are
located in Houston, Texas; Stavanger, Norway and Bogota, Colombia.

The Company also maintains a drill bit database which records the
performance of substantially all drill bits used in the U.S. over the last 15
years, including those manufactured by competitors. This database gives the
Company the ability to monitor, among other things, drill bit failures and
performance improvements related to product development. Management believes
this proprietary data base gives the Company a competitive advantage in the
drill bit business.

The Company has historically invested significant resources in
research and engineering in order to provide customers with broader product
lines and technologically-advanced products and services. The Company's
expenditures for research and engineering activities amounted to $34.9 million
in 1997, $27.8 million in 1996 and $21.4 million in 1995.
In 1997, research and engineering expenditures approximated 2.2 percent of
revenues.

Although the Company has over 700 patents and regards its patents and
patent applications as important in the operation of its business, it does not
believe that any significant portion of its business is materially dependent
upon any single patent or group of patents or generally upon patent protection.

EMPLOYEES

At December 31, 1997, the Company had 7,342 full time employees throughout
the world. Most of the Company's employees in the U.S. are not covered by
collective bargaining agreements except in certain U.S. mining operations of
M-I. The Company considers its labor relations to be satisfactory.

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ITEM 2. PROPERTIES

The principal facilities and properties utilized by the Company at
December 31, 1997 are shown in the table below. Generally the facilities and
properties are owned by the Company with the exception of the Grenoble, France
location which is leased.

Approx.
Principal Products Processed Land Bldg. Space
Location or Manufactured (Acres) (sq. ft.)
- -------- ---------------------------- ------- -----------
<S> <C> <C> <C>
M-I L.L.C.:
Greybull, Wyoming........... Bentonite mine and processing 8,394 110,000
Appleton, Wisconsin......... Drilling fluid chemical products 10 93,000
Wharton County, Texas....... Drilling fluid chemical products 100 61,000
Milos, Greece............... Bentonite mine and processing 124 55,000
Karmoy, Norway.............. Barite and bentonite processing 5 51,000
Greystone, Nevada........... Barite mine and processing 268 50,000
Battle Mountain, Nevada..... Barite processing 23 43,000
Zelmou, Morocco............. Barite mine 3,954 41,000
Zavalla, Texas.............. Drilling fluid chemical products 33 36,000
Amelia, Louisiana........... Barite processing 26 25,000
Galveston, Texas............ Barite processing 6 21,000
Aberdeen, Scotland.......... Barite and bentonite processing 2 12,000
Foss/Aberfeldy, Scotland.... Barite mine and processing 102 10,000
Mountain Springs, Nevada.... Barite mine 900 --
Westlake, Louisiana......... Barite processing 3 --

Smith Tool, Smith Drilling & Completions and Smith Diamond Technology
Units:
Houston, Texas.............. Tubulars, surface and downhole
tools, remedial products, liner
hangers, diamond bits 82 618,000
Ponca City, Oklahoma........ Drill bits 15 207,000
Grenoble, France............ Synthetic diamond materials
and cubic boron nitride 17 160,000
Saline di Volterra, Italy... Drill bits 11 92,000
Aberdeen, Scotland.......... Downhole tools and remedial products 10 91,000
Nisku, Canada............... Tubulars and drill collars 10 42,000
Scurelle, Italy............. Synthetic diamond materials 4 31,000
Provo, Utah................. Synthetic diamond materials 4 30,000

</TABLE>

The Company considers its mines and manufacturing and processing
facilities to be in good condition and adequately maintained.

ITEM 3. LEGAL PROCEEDINGS

Information relating to various commitments and contingencies,
including legal proceedings, is described in Note 13 of the Notes to
Consolidated Financial Statements included elsewhere in this Form 10-K.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

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ITEM 4A. OFFICERS OF THE REGISTRANT

(a) The names and ages of all officers of the Company, all positions
and offices with the Company presently held by each person named and their
business experience during the last five years are stated below. Positions,
unless otherwise specified, are with the Company.

NAME, AGE AND POSITIONS PRINCIPAL OCCUPATION DURING PAST FIVE YEARS

<S> <C>
Douglas L. Rock (51)........... Chairman of the Board since February 1991; Chief Executive Officer, President and
Chairman of the Board, Chief Chief Operating Officer since March 1989.
Executive Officer, President
and Chief Operating Officer

Loren K. Carroll (54).......... President and Chief Executive Officer of M-I L.L.C. since March 1994; Executive
Executive Vice President of the Vice President since October 1992; Chief Financial Officer from October 1992 to
Company; President and Chief April 1997; member of the Board of Directors since November 1987.
Executive Officer of M-I L.L.C.

Neal S. Sutton (52)............ Senior Vice President--Administration since December 1994; Vice
Senior Vice President-- President--Administration from March 1992 to December 1994; Vice President,
Administration, General Secretary and General Counsel of the Company since January 1991.
Counsel and Secretary

John J. Kennedy (45)........... Senior Vice President, Chief Financial Officer and Treasurer since April 1997; Vice
Senior Vice President, Chief President, Chief Accounting Officer and Treasurer from March 1994 to April
Financial Officer and 1997; Treasurer from May 1991 to March 1994.
Treasurer

D. Barry Heppenstall (51)..... President, Smith Tool since May 1994; Vice President and General Manager--Drill Bits
President, Smith Tool from March 1992 to May 1994.

Richard A. Werner (56)......... President, Smith Drilling & Completions since May 1994; Vice President and General
President, Smith Drilling & Manager--Smith Drilling and Completion Services from December 1993 to May 1994;
Completions Vice President and General Manager--Drilco/Servco from March 1993 to December
1993; Vice President and General
Manager--Downhole Tools and
Services from May 1991 to March
1993.

Roger A. Brown (52)............ President, Smith Diamond Technology since April 1995; Vice President and General
President, Smith Diamond Manager, Eastern Hemisphere Operations, Reda Pump Company, Division of Camco
Technology International, Inc. from November 1993 to March 1995; President, Hycalog,
Division of Camco International, Inc. from November 1990 to October 1993.

Margaret K. Dorman (34)........ Vice President, Controller and Assistant Treasurer since February 1998; Director
Vice President, Controller and of Financial Reporting and Planning from December 1995 to February 1998;
Assistant Treasurer Various positions including Corporate Controller for Landmark Graphics
Corporation from November 1992 to November 1995.

Peter D. Nicholson (41)........ Vice President, Human Resources since February 1998; Director, Human Resources from
Vice President, Human Resources June 1997 to February 1998; International Human Resources Manager, Eastern Hemisphere
from December 1995 to June 1997; Director of Human Resources of Baker Hughes INTEQ
in Aberdeen from February 1993 to December 1995; Eastern Region Materials Manager
for Teleco Oilfield Services in Aberdeen from May 1990 to February 1993.

</TABLE>

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<TABLE>

<S> <C>
W. Lynn Perrin (43)............ Vice President, Information Technology since February 1998; Director of Information
Vice President, Information Technology from January 1995 to February 1998; Director of Financial and Administrative
Technology Systems of Halliburton Energy Services from March 1994 to January 1995; General Manager
Information Services of Halliburton Energy Services from October 1993 to March 1994;
Senior Manager of Application Systems for Halliburton Energy Services from
July 1991 to October 1993.

Earl M. Springer (47).......... Vice President, Business Development since February 1998; Manager of Business
Vice President, Business Development from July 1997 to February 1998; Manager of Technology Development
Development from August 1994 to July 1997; Senior Account Representative of M-I L.L.C. from
September 1993 to July 1994; District Manager of M-I L.L.C. from November 1990 to
September 1993.

Geri D. Wilde (47)............. Vice President, Taxes since February 1998; Director of Taxes from April 1997 to
Vice President, Taxes and February 1998; Assistant Treasurer since April 1997; Manager of Taxes and
Assistant Treasurer Payroll of M-I L.L.C. from December 1986 to April 1997.

</TABLE>

(b) All officers of the Company are elected annually by the Board of
Directors at the meeting of the Board of Directors held immediately following
the annual meeting of shareholders. They hold office until their successors are
elected and qualified.

9
<PAGE> 11

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS.

The common stock of the Company is traded on the New York Stock
Exchange and the Pacific Stock Exchange. The following are the high and low
sale prices for the Company's common stock as reported on the New York Stock
Exchange Composite Tape for the periods indicated.

COMMON STOCK
------------
HIGH LOW
---- ---
<S> <C> <C>
1996
First Quarter................... $ 25 1/2 $ 19 7/8
Second Quarter.................. 33 3/8 24 3/8
Third Quarter................... 36 5/8 29 3/8
Fourth Quarter.................. 48 35 1/4
1997
First Quarter................... 49 1/2 38 1/2
Second Quarter.................. 61 3/4 42 5/8
Third Quarter................... 81 60 3/4
Fourth Quarter.................. 87 7/8 53 9/16

</TABLE>

On March 13, 1998, the Company had 2,902 common stock holders of
record and the last reported closing price on the New York Stock Exchange
Composite Tape was $53.19.

The Company has not paid dividends on its common stock since the first
quarter of 1986. The determination of the amount of future cash dividends to be
declared and paid on the common stock, if any, will depend upon the Company's
financial condition, earnings and cash flow from operations, the level of its
capital expenditures, its future business prospects and other factors that the
Board of Directors deem relevant. In addition, the Company's debt agreements
contain covenants restricting the payment of cash dividends to the Company's
common stockholders based on net earnings and operating cash flow formulas as
defined.

10
<PAGE> 12

ITEM 6. SELECTED FINANCIAL DATA

FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------
1997 1996 1995 1994(a) 1993
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.......................................... $ 1,563,144 $ 1,156,658 $ 874,544 $ 653,901 $ 220,712
Gross profit...................................... 548,532 392,062 292,540 221,274 79,963
Income from continuing operations before
litigation settlement, interest
and taxes....................................... 217,491 132,520 86,248 60,104 18,575

Income (loss) from continuing operations
before discontinued operations and change
in accounting principle (b)..................... $ 102,351 $ 64,444 $ 45,592 $ 35,879 $ (3,995)
Income from discontinued operations............... 73,623
-- -- -- --
Loss from change in accounting principle.......... -- -- (1,300)
-- --
Net income........................................ $ 102,351 $ 64,444 $ 45,592 $ 35,879 $ 68,328

DILUTED PER SHARE DATA:
Net income (loss) applicable to common stock:
From continuing operations before
discontinued operations and change
in accounting principle....................... $ 2.55 $ 1.62 $ 1.16 $ 0.92 $ (0.13)
From discontinued operations.................... 1.95
-- -- -- --
From change in accounting principle.............
-- -- -- -- (0.03)
------------ ------------ ------------ ------------ ------------
Net income...................................... $ 2.55 $ 1.62 $ 1.16 $ 0.92 $ 1.79
============ ============ ============ ============ ============

BALANCE SHEET DATA:
Total assets...................................... $ 1,396,033 $ 1,074,582 $ 702,844 $ 619,780 $ 348,486

Long-term debt.................................... $ 306,279 $ 228,443 $ 117,238 $ 115,000 $ 46,000

Total shareholders' equity........................ $ 469,457 $ 368,536 $ 300,886 $ 253,121 $ 214,466

</TABLE>

The Notes to Consolidated Financial Statements and Management's
Discussion and Analysis of Financial Condition and Results of Operations
included elsewhere in this Form 10-K should be read in order to understand
factors such as accounting changes, business combinations, or other unusual
items which may affect the comparability of the information shown above.

(a) On February 28, 1994, the Company acquired a 64 percent interest in M-I
from Dresser Industries, Inc. in exchange for consideration of $160.0
million.
(b) In September 1993, the Company agreed to settle a class action civil
lawsuit which alleged violations of Section 1 of the Sherman Act. This
amount includes the impact of a $19.9 million charge related to the cost
of settlement, related legal fees and other costs and expenses.

11
<PAGE> 13

ITEM 7. 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. It should be
read in conjunction with the Consolidated Financial Statements of the Company
and the related notes thereto included elsewhere in this Form 10-K.

The Company's primary business is the manufacture and sale of premium products
and services to the oil and gas industry's exploration and production sectors.
The Company's worldwide operations are largely driven by the level of
exploration and production activity in major energy producing areas and the
depth and drilling conditions of these projects. The level of worldwide
drilling activity is influenced by the prices of oil and natural gas but may
also be affected by political actions and uncertainties, environmental
concerns, capital expenditure plans of exploration and production companies and
the overall level of global economic growth and activity.

Management also believes that, with the increase in offshore rig
dayrates and other fixed costs, operators are shifting exploration and
production spending toward value-added, technology-based products which reduce
the cost of their overall drilling programs. Additionally, the significant
level of extended-reach drilling programs, which often involve more difficult
drilling conditions, increases the need for efficient products and services
which reduce both drilling time and formation damage. The Company continues to
focus on investing in the development of technology-based products that
considerably improve the drilling process through increased efficiency and
rates of penetration. Management believes the overall savings realized by the
use of the Company's premium products, such as polycrystalline diamond drill
bits, diamond enhanced three-cone drill bits and synthetic drilling fluids,
compensate for the higher costs of these products over their non-premium
counterparts.

12
<PAGE> 14

RESULTS OF OPERATIONS

Revenues

The Company operates through five business units which market the
Company's products and services throughout the world. The following table
presents revenue and average rig count information for the periods shown (in
thousands, except rig count information):

FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
1997 1996 1995
---- ---- ----
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
---------- ---------- ------------ ---------- ---------- ---------
Revenues by Business Unit:

<S> <C> <C> <C> <C> <C> <C>
M-I Fluids............................... $ 872,290 56 $ 669,583 58 $ 495,135 57
M-I SWACO................................ 128,758 8 82,743 7 61,259 7
Smith Tool............................... 248,500 16 196,691 17 167,116 19
Smith Drilling & Completions............. 233,984 15 148,722 13 115,245 13
Smith Diamond Technology................. 79,612 5 58,919 5 35,789 4
---------- ---------- ----------- ---------- ---------- ---------

Total.................................. $1,563,144 100 $ 1,156,658 100 $ 874,544 100
========== ========== =========== ========== ========== ==========

Revenues by Area:

U.S...................................... $ 611,833 39 $ 451,147 39 $ 358,392 41
Export................................... 89,919 6 71,470 6 50,454 6
Non-U.S.................................. 861,392 55 634,041 55 465,698 53
---------- ---------- ----------- ---------- ---------- ---------

Total.................................. $1,563,144 100 $ 1,156,658 100 $ 874,544 100
========== ========== =========== ========== ========== =========

Average Annual Active Rig Count:

U.S...................................... 945 779 724
Canada................................... 375 270 231
Non-North America........................ 809 793 758
---------- ----------- ----------

Total 2,129 1,842 1,713
========== =========== ==========

</TABLE>

M-I Fluids

M-I Fluids, a division of M-I L.L.C. ("M-I"), provides drilling fluid
and completion fluid systems, engineering and technical services to the oil and
gas industry. M-I Fluids' 1997 revenues increased $202.7 million, or 30
percent, from 1996, and 1996 revenues increased $174.5 million, or 35 percent,
from 1995. The growth over 1996 relates to increased U.S. activity levels,
particularly in the U.S. Gulf Coast area, and the inclusion of revenues from
acquired operations. The revenue increase over 1995 was primarily attributable
to the incremental revenues associated with the Anchor Drilling Fluids A.S.
("Anchor") operations, which were acquired in June 1996, and an increased level
of deep-water drilling activity in the U.S. Gulf Coast area.

13
<PAGE> 15

M-I SWACO

M-I SWACO, a division of M-I, manufactures and markets equipment and
services for solids control, pressure control, rig instrumentation and waste
management. M-I SWACO's 1997 revenues increased $46.0 million, or 56 percent,
from 1996, and 1996 revenues increased $21.5 million, or 35 percent, from 1995.
The revenue growth over 1996 relates to increased demand for SWACO's solids
control equipment, particularly in Latin America and the U.S., and incremental
revenues from acquisitions. The increase over 1995 was attributable to
increased market penetration in Latin America combined with higher drilling
activity in Latin America and the U.S.

Smith Tool

Smith Tool manufactures and sells three-cone bits for use in the oil
and gas industry and in mining applications. Smith Tool's 1997 revenues
increased $51.8 million, or 26 percent, from 1996, and 1996 revenues increased
$29.6 million, or 18 percent, from 1995. The increase over 1996 is attributable
to higher unit sales and a favorable shift in the sales mix to the MagnumTM
line of premium bits introduced in the third quarter of 1996. On a geographical
basis, higher drilling activity in North America coupled with increased market
penetration in the Eastern Hemisphere accounted for the majority of the revenue
growth. The increase over 1995 related to improved pricing, increased unit
sales and a favorable shift in the sales mix toward premium bits. The majority
of the growth was generated in the U.S.; however, the introduction of the
MagnumTM line of premium bits in the North Sea contributed to a significant
increase in Europe/Africa revenues.

Smith Drilling & Completions

Smith Drilling & Completions manufactures and markets products and
services used in the oil and gas industry for drilling, workover, well
completion and well re-entry. Smith Drilling & Completions' 1997 revenues
increased $85.3 million, or 57 percent, over 1996, and 1996 revenues increased
$33.5 million, or 29 percent, from 1995. Over half of the increase from 1996
relates to incremental revenues from acquisitions, with higher levels of
re-entry drilling activity in the U.S. Gulf Coast area also contributing to the
growth. The variance over fiscal 1995 was attributable to the increased level
of re-entry activity in the U.S. Gulf Coast area and the addition of The Red
Baron (Oil Tools Rental) Ltd.'s ("Red Baron") operations in October 1996.

Smith Diamond Technology

Smith Diamond Technology manufactures and markets shear bits featuring
cutters made of polycrystalline diamond or natural diamond at its GeoDiamond
division. Smith Diamond Technology also manufactures polycrystalline diamond
and cubic boron nitride at its MegaDiamond and Supradiamant subsidiaries. These
ultrahard materials are used in the Company's three-cone and diamond drill bits
and in other specialized cutting tools. Smith Diamond Technology's 1997
revenues increased $20.7 million, or 35 percent, over 1996, and 1996 revenues
increased $23.1 million, or 65 percent, from 1995. Higher unit sales in
Europe/Africa, the Far East and Latin America, driven by increased market
penetration and continued expansion into new markets, accounted for the
increase over 1996. The increase over 1995 was attributable to higher unit
sales, primarily in the U.S. and Latin America, driven by increased market
growth, new product introductions and expansion into markets outside the U.S.

14
<PAGE> 16

For the periods indicated, the following table summarizes the results
of the Company and presents these results as a percentage of total revenues
(dollars in thousands):

FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------------ ------------ ------------ ------------ ------------ ------------

<S> <C> <C> <C> <C> <C> <C>
Revenues................................... $ 1,563,144 100 $ 1,156,658 100 $ 874,544 100
------------ ------------ ------------ ------------ ------------ ------------

Gross profit............................... 548,532 35 392,062 34 292,540 33

Operating expenses......................... 331,041 21 259,542 22 206,292 23
------------ ------------ ------------ ------------ ------------ ------------

Income before interest and taxes........... 217,491 14 132,520 12 86,248 10
Interest expense, net...................... 24,973 2 16,445 2 12,238 1
------------ ------------ ------------ ------------ ------------ ------------
Income before income taxes and minority
192,518 12 116,075 10 74,010 9
interests..................................
Income tax provision....................... 50,650 3 26,798 2 12,609 2
------------ ------------ ------------ ------------ ------------ ------------
Income before minority interests........... 141,868 9 89,277 8 61,401 7
Minority interests......................... 39,517 2 24,833 2 15,809 2
------------ ------------ ------------ ------------ ------------ ------------

Net income................................. $ 102,351 7 $ 64,444 6$ 45,592 5
============ ============ ============ ============ ============ ============

</TABLE>

1997 Versus 1996

Total revenues for 1997 increased $406.5 million, or 35 percent, from
the prior year as the Company experienced strong growth across all business
units and geographic areas. Half of the revenue increase was reported in North
America which benefited from higher drilling activity levels and, to a lesser
extent, the impact of acquired operations. The addition of the Anchor and Red
Baron operations, which had significant operations in the Eastern Hemisphere,
and increased market penetration in Latin America also contributed to the
revenue growth. Non-U.S. revenues continue to account for a significant portion
of the Company's operations approximating 61 percent of total revenues in both
fiscal years.

Gross profit increased $156.5 million, or 40 percent, from the 1996
fiscal year. Gross profit margins continue to improve with the Company
reporting a one percent increase in margins over the prior year. Increased
manufacturing efficiencies associated with the higher volumes, the effect of
price increases enacted during the year and the favorable impact of acquired
operations all contributed to the margin improvement.

Operating expenses, consisting of selling expenses and general and
administrative expenses, increased $71.5 million from the prior fiscal year;
however, as a percentage of revenues, operating expenses were reduced in excess
of one percentage point. The dollar variance over the prior year relates to
increased variable costs associated with the higher level of revenues and, to a
lesser extent, costs associated with acquired operations.

Net interest expense, which represents interest expense less interest
income, increased $8.5 million over the prior year. The increase in net
interest expense relates to the higher level of borrowings used to fund current
year acquisitions. Borrowings required to finance general working capital
needs, which increased as a result of the revenue growth experienced by the
Company, have also contributed to the higher net interest expense amounts.

15
<PAGE> 17

The effective tax rate for the year approximated 26 percent which is
higher than the prior year's effective rate and lower than the U.S. statutory
rate. The rate was higher than the prior year's effective rate as less benefit
was recorded in 1997 related to U.S. net operating loss carryforwards ("NOL
carryforwards") due to the full utilization of these amounts during the year.
The effective tax rate was lower than the statutory rate due to the impact of
NOL carryforwards and the method of recording the minority interest partner's
U.S. earnings. The effective rate is expected to remain below the statutory
rate as the Company properly consolidates the pretax income related to the
minority interest partner's share of U.S. partnership earnings but excludes the
related tax provision.

Minority interests represent the share of M-I's profits associated
with the 36 percent minority partner's interest in those operations and, to a
lesser extent, minority interests in investments in other joint ventures held
by M-I. Minority interests increased $14.7 million from the prior year due to
the increased profitability of the M-I operations.

1996 Versus 1995

Total revenues for 1996 increased $282.1 million, or 32 percent, from
the prior year with the Company experiencing growth across all business units
and geographic areas. The variance over the prior year is attributable to the
increased level of deep-water and re-entry drilling activity in the U.S. Gulf
Coast area and the incremental revenues associated with operations acquired
during 1996. The impact of the 1996 acquisitions, which had significant
operations in the Eastern Hemisphere, resulted in a shift in the Company's
non-U.S. revenues from 59 percent of total revenues in 1995 to 61 percent of
total revenues in 1996.

Gross profit increased $99.5 million, or 34 percent, from the prior
year. The higher gross profit resulted in an increase in the Company's gross
profit margin from 33 percent in 1995 to 34 percent in 1996. The improvement in
margins primarily resulted from the revenue growth and related cost
efficiencies generated by the Smith Diamond Technology operations, which became
a separate business unit in 1995.

Operating expenses, consisting of selling expenses and general and
administrative expenses, increased $53.3 million or 26 percent from the prior
year; however, as a percentage of revenues, operating expenses decreased from
23 percent in 1995 to 22 percent in 1996. The increase in absolute dollars is
due to increased variable costs associated with the higher level of revenues
and incremental costs associated with the acquired business operations for
which no amounts were included in the prior year.

Net interest expense, which represents interest expense less interest
income, increased $4.2 million over the prior year. The increase in net
interest expense relates to the higher level of borrowings to fund the business
acquisitions. To a lesser extent, borrowings required to finance general
working capital needs, which increased as a result of the revenue growth
experienced by the Company, also contributed to the higher net interest expense
amounts.

The effective tax rate for the year approximated 23 percent which is
higher than the prior year's effective rate and lower than the U.S. statutory
rate. The effective tax rate was higher than the prior year's rate and lower
than the statutory rate due primarily to the impact of NOL carryforwards
utilized.

Minority interests represent the share of M-I's profits associated
with the 36 percent minority partner's interest in those operations and, to a
lesser extent, minority interests in investments in other joint ventures held
by M-I. Minority interests increased $9.0 million from the prior year due to
the increased profitability of the M-I operations.

16
<PAGE> 18

LIQUIDITY AND CAPITAL RESOURCES

General

The Company's financial condition remained strong in 1997. Cash and
cash equivalents increased $3.4 million during the year and equaled $29.0
million at December 31, 1997. The Company's operations generated $42.5 million
of cash flows in 1997 which is a $12.4 million increase over the amounts
reported in the prior year. The improvement in cash flows from operations
resulted from the higher level of profitability, partially offset by increased
receivable levels associated with the revenue growth. Cash flows from
operations were not sufficient to fund the Company's acquisitions and capital
expenditure requirements resulting in increased borrowings of $94.4 million
under available facilities.

In 1997, the Company invested $76.2 million in property, plant and
equipment net of cash proceeds arising from certain asset disposals. Capital
expenditures for 1998 are expected to continue at this level, which includes
routine additions of equipment used to support the Company's operations as well
as expenditures to increase productivity and efficiency. The Company believes
funds generated from operations, cash on hand and amounts available under
existing credit facilities will be sufficient to finance capital expenditures
and other working capital needs of the existing operations for the foreseeable
future.

The Company completed $80.0 million of business acquisitions during
1997 and, subsequent to year-end, announced the signing of a definitive
agreement to acquire Wilson Industries, Inc. ("Wilson"). The Company has agreed
to issue 7.9 million shares of common stock in exchange for all of the equity
interests of Wilson and expects to account for the transaction as a pooling of
interests. Aside from the planned acquisition, management continues to evaluate
opportunities to acquire products or businesses complimentary to the Company's
operations. These 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's primary internal source of liquidity is cash flow
generated from operations. External sources of liquidity include debt and, if
needed, equity financing. The Company has various revolving line of credit
facilities in and outside the U.S. for operating and financing needs. The
Company had approximately $152 million of funds available under its long-term
revolving line of credit facilities at December 31, 1997. Additionally, the
Company had approximately $49 million of non-U.S. short-term borrowing
facilities with various banks which had available borrowing capacity of $20
million at year-end.

The Company has been named as a potentially responsible party in
connection with three sites on the U.S. Environmental Protection Agency's
National Priorities List. At December 31, 1997, the recorded liability for
estimated future clean-up costs for the Superfund as well as other
environmental sites was $3.2 million. As more information becomes available,
the Company may be required to provide for additional environmental clean-up
costs. Management, however, believes that none of these obligations will result
in liabilities having a material adverse effect on the Company's consolidated
financial position or results of operations. See Footnote 13, "Commitments and
Contingencies" for further discussion of environmental liabilities.

The Company believes that it has sufficient existing manufacturing
capacity to meet current demand for its products and services.

Because of the substantial level of operations outside the U.S., the
Company is exposed to currency fluctuations and exchange risks. To mitigate the
effect of fluctuations in exchange rates on foreign currency denominated
balances, the Company utilizes a protective hedge program. The program is
designed to hedge net balance sheet positions which expose the Company to
exchange rate risk. To the extent possible, the Company matches assets and
liabilities denominated in foreign currencies and uses hedging instruments to
cover certain unmatched positions. See Footnote 6, "Financial Instruments" for
further discussion of hedging instruments.

Inflation has not had a material effect on the Company in recent years,
and the effect is expected to be minor in the foreseeable future. In general,
the Company has been able to offset most of the effects of inflation through
productivity gains, cost reductions and price increases.

17
<PAGE> 19

NEW ACCOUNTING AND REGULATORY PRONOUNCEMENTS

In January 1997, the Securities and Exchange Commission adopted new
rules requiring quantitative and qualitative disclosures of market risk in the
1997 financial statements of companies with market capitalizations in excess of
$2.5 billion. The Company will be required to make the necessary disclosures
under this regulation in its 1998 financial statements.

In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130 ("SFAS 130") "Reporting
Comprehensive Income" effective for fiscal years beginning after December 15,
1997. This statement establishes standards for reporting and displaying
comprehensive income and its components. Had SFAS 130 been adopted as of
December 31, 1997, the primary adjustment required to disclose net income on a
comprehensive income basis would have related to changes in the cumulative
translation adjustment amounts reported.

YEAR 2000

The Company is currently in the process of identifying, evaluating and
implementing modifications to its business systems in order to achieve Year
2000 date conversion compliance without an effect on customers or business
operations. The Company is also communicating with suppliers, financial
institutions and others with whom it does business to address issues related to
the conversion.

A Corporate-wide task force was established during the year to address
Year 2000 issues. The task force consists of a group of multi-disciplined
personnel assigned from various areas within the Company. The team has been
tasked with ensuring that all of the Company's enterprise business systems are
Year 2000 compliant by mid-1999, with the majority of the systems expected to
be in compliance by the end of 1998.

The Company's business systems are comprised of a mix of off-the-shelf
and internally-developed systems that vary greatly in size, complexity and
technical architecture. The task force has defined five separate categories for
review and is in the process of identifying the critical and non-critical
components within these groups. Most of the necessary changes in computer
instructional code can be made by upgrading the off-the-shelf software in which
the application was created. In February 1998 the Company implemented Oracle
10.7, an upgrade which brought most of the Company's enterprise applications
into compliance. Except for certain applications used in international
locations, part of the Company's normal upgrade migration plans include Year
2000 compliance as a matter of course. The Company does not believe that the
necessary changes for the remaining systems will require any significant level
of external resources, or that failure to implement the proposed changes for
the remaining systems would have a material effect on the Company's
consolidated financial position or results of operations.

The Company has not yet determined the complete status of Year 2000
compliance of its suppliers and financial institutions or what additional
costs, if any, might be required by the Company. Management believes that
non-compliance by the Company's suppliers will not have a material effect.
However, the failure of its financial institutions to become Year 2000
compliant could have a material effect on the Company's consolidated financial
position or results of operations.

18
<PAGE> 20

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Smith International, Inc.:

We have audited the accompanying consolidated balance sheets of Smith
International, Inc. (a Delaware corporation) and subsidiaries as of December
31, 1997 and 1996, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of Smith
International, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles.

ARTHUR ANDERSEN LLP

Houston, Texas
January 30, 1998

19
<PAGE> 21
SMITH INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1997 1996 1995
----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<S> <C> <C> <C>
Revenues.................................................. $1,563,144 $1,156,658 $874,544

Costs and expenses:
Costs of revenues....................................... 1,014,612 764,596 582,004
Selling expenses........................................ 251,278 194,875 158,300
General and administrative expenses..................... 79,763 64,667 47,992
----------- ----------- -----------
Total costs and expenses............................. 1,345,653 1,024,138 788,296
----------- ----------- -----------

Income before interest and taxes.......................... 217,491 132,520 86,248

Interest expense.......................................... 26,854 18,654 14,101
Interest income........................................... (1,881) (2,209) (1,863)
----------- ----------- -----------

Income before income taxes and minority interests......... 192,518 116,075 74,010
Income tax provision...................................... 50,650 26,798 12,609
----------- ----------- -----------

Income before minority interests.......................... 141,868 89,277 61,401

Minority interests........................................ 39,517 24,833 15,809
----------- ----------- -----------

Net income................................................ $ 102,351 $64,444 $45,592
=========== =========== ===========

Earnings per share:
Basic................................................... $ 2.58 $ 1.64 $ 1.17
=========== =========== ===========
Diluted................................................. $ 2.55 $ 1.62 $ 1.16
=========== =========== ===========

Weighted average shares outstanding:
Basic................................................... 39,604 39,352 39,043
=========== =========== ===========
Diluted................................................. 40,183 39,880 39,383
=========== =========== ===========
</TABLE>

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

20
<PAGE> 22

SMITH INTERNATIONAL, INC.

CONSOLIDATED BALANCE SHEETS

ASSETS

DECEMBER 31,
-----------------------------------------------
1997 1996
---- ----
(IN THOUSANDS)

CURRENT ASSETS:

<S> <C> <C>
Cash and cash equivalents................................................ $ 28,971 $ 25,540
Receivables, less allowance for doubtful accounts of $5,804 and
$6,424 in 1997 and 1996, respectively................................ 409,765 309,062
Inventories.............................................................. 358,361 295,041
Deferred tax assets, net................................................. 25,254 8,979
Prepaid expenses and other............................................... 28,620 26,655
--------- ---------

Total current assets................................................... 850,971 665,277
--------- ---------

PROPERTY, PLANT AND EQUIPMENT:

Land..................................................................... 22,226 17,880
Buildings................................................................ 46,046 40,170
Machinery and equipment.................................................. 387,016 305,491
--------- ---------

455,288 363,541

Less - accumulated depreciation.......................................... 184,347 158,290
--------- ---------

Net property, plant and equipment........................................ 270,941 205,251
--------- ---------

OTHER ASSETS, including assets held for sale of
$1,831 and $3,173 in 1997 and 1996, respectively......................... 64,786 43,257

GOODWILL, net of accumulated amortization of $11,451 and $6,043
in 1997 and 1996, respectively........................................... 209,335 160,797
-------- --------

TOTAL ASSETS................................................................ $1,396,033 $1,074,582
========== ==========

</TABLE>

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

21
<PAGE> 23

SMITH INTERNATIONAL, INC.

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS' EQUITY

DECEMBER 31,
----------------------------------------
1997 1996
---- ----
(IN THOUSANDS, EXCEPT PAR VALUE DATA)

CURRENT LIABILITIES:

<S> <C> <C>
Short-term borrowings and current portion of long-term debt.............. $ 91,523 $ 74,983
Accounts payable.............................................................. 119,353 106,962
Accrued payroll costs......................................................... 54,620 42,836
Income taxes payable.......................................................... 25,796 19,706
Other......................................................................... 81,635 56,014
-------- --------

Total current liabilities................................................... 372,927 300,501
-------- --------

LONG-TERM DEBT.................................................................. 306,279 228,443

DEFERRED TAX LIABILITIES........................................................ 16,578 2,059

OTHER LONG-TERM LIABILITIES..................................................... 24,087 20,302

MINORITY INTERESTS.............................................................. 206,705 154,741

COMMITMENTS AND CONTINGENCIES (Note 13)......................................... -- --

SHAREHOLDERS' EQUITY:

Preferred stock, $1 par value; 5,000 shares authorized; no shares issued
or outstanding in 1997 or 1996.............................................. -- --
Common stock, $1 par value; 60,000 shares authorized; 40,316 shares
issued and outstanding in 1997 (40,157 in 1996)............................. 40,316 40,157
Additional paid-in capital.................................................... 282,772 278,955
Retained earnings............................................................. 164,833 62,482
Cumulative translation adjustments............................................ (10,762) (5,356)
Less - treasury securities, at cost; 656 common shares in 1997 and 1996....... (7,702) (7,702)
-------- --------

Total shareholders' equity.................................................. 469,457 368,536
-------- --------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY...................................... $1,396,033 $1,074,582
========== ==========

</TABLE>

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

22
<PAGE> 24

SMITH INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT SHARE AND WARRANT DATA)

COMMON STOCK COMMON STOCK WARRANTS
--------------------------- ---------------------- ADDITIONAL
NUMBER NUMBER PAID-IN
OF SHARES AMOUNT OF WARRANTS AMOUNT CAPITAL
------------- ------------ ------------ ---------- ----------

<S> <C> <C> <C> <C> <C>
Balance, December 31, 1994 39,432,833 $ 39,433 2,525,191 $ 7,278 $ 272,483
Exercise of stock options and stock grants 230,940 230 -- -- 1,908
Exercise of common stock warrants 143,572 144 (143,572) -- 1,041
Expiration of common stock warrants -- -- (1,930,262) -- --
Net income -- -- -- -- --
Translation adjustment for the period -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Balance, December 31, 1995 39,807,345 $ 39,807 451,357 $ 7,278 $ 275,432
Exercise of stock options and stock grants 349,233 350 -- -- 3,523
Expiration of common stock warrants -- -- (451,357) (7,278) --
Purchases of treasury stock -- -- -- -- --
Net income -- -- -- -- --
Translation adjustment for the period -- -- -- -- --
---------- ---------- ---------- ---------- ----------

Balance, December 31, 1996 40,156,578 $ 40,157 -- $ -- $ 278,955
Exercise of stock options 159,021 159 -- -- 3,817
Net income -- -- -- -- --
Translation adjustment for the period -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Balance, December 31, 1997 40,315,599 $ 40,316 -- $ -- $ 282,772
========== ========== ========== ========== ==========

</TABLE>

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

TREASURY SECURITIES
----------------------------------------------------
RETAINED COMMON STOCK WARRANTS
EARNINGS CUMULATIVE ---------------------- ------------------------
(ACCUMULATED TRANSLATION NUMBER OF NUMBER OF
DEFICIT) ADJUSTMENTS SHARES AMOUNT WARRANTS AMOUNT
------------ ----------- ----------- --------- --------- ---------

<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 $ (47,554) $ (4,605) (628,583) $ (6,636) (451,357) $ (7,278)
Exercise of stock options and stock grants -- -- -- -- -- --
Exercise of common stock warrants -- -- -- -- -- --
Expiration of common stock warrants -- -- -- -- -- --
Net income 45,592 -- -- -- -- --
Translation adjustment for the period -- (1,150) -- -- -- --
---------- ---------- ---------- --------- -------- ---------
Balance, December 31, 1995 $ (1,962) $ (5,755) (628,583) $ (6,636) (451,357) $ (7,278)
Exercise of stock options and stock grants -- -- -- -- -- --
Expiration of common stock warrants -- -- -- -- 451,357 7,278
Purchases of treasury stock -- -- (27,271) (1,066) -- --
Net income 64,444 -- -- -- -- --
Translation adjustment for the period -- 399 -- -- -- --
---------- ---------- ---------- --------- -------- ---------
Balance, December 31, 1996 $ 62,482 $ (5,356) (655,854) $ (7,702) -- $ --
Exercise of stock options -- -- -- -- -- --
Net income 102,351 -- -- -- -- --
Translation adjustment for the period -- (5,406) -- -- -- --
---------- ---------- ---------- --------- -------- ---------
Balance, December 31, 1997 $ 164,833 $ (10,762) (655,854) $ (7,702) -- $ --
========== ========== ========== ========= ======== =========
</TABLE>

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

23
<PAGE> 25

SMITH INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------
1997 1996 1995
---- ---- ----
(IN THOUSANDS)

<S> <C> <C> <C>
Cash flows from operating activities:
Net income............................................................... $102,351 $64,444 $45,592
Adjustments to reconcile net income to net cash
provided by operating activities, excluding the
net effects of acquisitions:
Depreciation and amortization........................................ 46,704 31,601 25,540
Minority interests................................................... 39,517 24,833 15,809
Provision for losses on receivables.................................. 1,612 1,490 1,024
Provision for LIFO inventory reserves................................ 2,992 1,282 2,956
Gain on disposal of property, plant and equipment.................... (2,225) (4,100) (4,198)
Foreign currency translation losses.................................. 138 62 1,112
Changes in operating assets and liabilities:
Receivables............................................................ (95,605) (37,756) (29,847)
Inventories, net....................................................... (58,250) (54,273) (22,917)
Accounts payable....................................................... 10,172 18,712 3,448
Other current assets and liabilities................................... (18,057) (945) (72)
Other non-current assets and liabilities............................... 13,183 (15,254) (11,259)
-------- -------- -------
Net cash provided by operating activities.......................... 42,532 30,096 27,188
-------- -------- ------

Cash flows from investing activities:
Acquisition of businesses, net of cash acquired.......................... (80,036) (104,683) (6,131)
Purchases of property, plant and equipment............................... (82,787) (72,958) (35,126)
Proceeds from disposal of property, plant and equipment.................. 6,540 11,711 10,042
-------- -------- ------
Net cash used in investing activities.............................. (156,283) (165,930) (31,215)
-------- -------- -------

Cash flows from financing activities:
Proceeds from issuance of long-term debt................................. 276,548 124,641 12,238
Principal payments of long-term debt..................................... (193,602) (14,910) (10,401)
Net increase in short-term borrowings.................................... 16,653 34,121 8,038
Proceeds from exercise of stock options and warrants..................... 1,794 3,873 3,323
Purchases of treasury stock.............................................. -- (1,066) --
Contributions from (distributions to) minority interest partner.......... 16,092 -- (2,520)
-------- --------
Net cash provided by financing activities.......................... 117,485 146,659 10,678
-------- -------- -------
Effect of exchange rate changes on cash.................................... (303) (130) 49
-------- -------- -------
Increase in cash and cash equivalents...................................... 3,431 10,695 6,700
Cash and cash equivalents at beginning of year............................. 25,540 14,845 8,145
-------- -------- -------
Cash and cash equivalents at end of year................................... $28,971 $25,540 $14,845
======== ======== =======
</TABLE>

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

<PAGE> 26

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (ALL DOLLAR AMOUNTS ARE EXPRESSED IN
THOUSANDS, UNLESS OTHERWISE NOTED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

Smith International, Inc. (the "Company") is engaged in the
manufacture and sale of premium products and services to customers in the oil
and gas industry. The consolidated financial statements include the accounts of
the Company and all wholly and majority-owned subsidiaries. Investments in
affiliates in which ownership interest ranges from 20 to 50 percent, and the
Company exercises significant influence over operating and financial policies,
are accounted for on the equity method. All other investments are carried at
cost, which does not exceed the estimated net realizable value of such
investments. All significant intercompany accounts and transactions have been
eliminated.

Significant Risks and Uncertainties

Preparation of financial statements in conformity with 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. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid financial instruments
purchased with an original maturity of three months or less to be cash
equivalents.

Fixed Assets

Fixed assets, consisting of rental equipment and property, plant and
equipment, are stated at cost. The Company computes depreciation on fixed
assets using principally the straight-line method. The estimated useful lives
used in computing depreciation generally range from 20 to 40 years for
buildings, 3 to 25 years for machinery and equipment, and 5 to 7 years for
rental equipment. Leasehold improvements are amortized over the lives of the
leases or the estimated useful lives of the improvements, whichever is shorter.
For income tax purposes, accelerated methods of depreciation are used.

Cost of major renewals and betterments are capitalized as fixed
assets. Expenditures for maintenance, repairs and minor improvements are
charged to expense when incurred. When fixed assets are sold or retired, the
remaining cost and related reserves are removed from the accounts and the
resulting gain or loss is included in the Consolidated Statements of
Operations.

Valuation of Inventories

Inventories are stated at the lower of cost or market. Cost is determined
by the last-in, first-out ("LIFO") method for certain U.S. inventories and the
first-in, first-out ("FIFO") method for all other inventories. Inventory costs
consist of materials, labor and factory overhead.

25
<PAGE> 27

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

Goodwill

Goodwill, which represents the excess of costs over the fair value of
net assets acquired, is amortized on a straight-line basis over 40 years. The
Company continually evaluates whether subsequent events or circumstances have
occurred that indicate the remaining useful life of goodwill may warrant
revision or that the remaining balance of goodwill may not be recoverable.
Management believes that there have been no events or circumstances which
warrant revision to the remaining useful life or which affect the
recoverability of goodwill.

Foreign Currency Translation and Transactions

Gains and losses resulting from balance sheet translation of
operations outside the U.S. where the applicable foreign currency is the
functional currency are included as a separate component of shareholders'
equity. Gains and losses resulting from balance sheet translation of operations
outside the U.S. where the U.S. dollar is the functional currency are included
in the Consolidated Statements of Operations.

All foreign currency transaction gains and losses are recognized
currently in the Consolidated Statements of Operations.

Financial Instruments

The Company enters into various instruments, including derivatives, to
manage interest rate and foreign exchange risks. Derivatives are limited in use
and are not entered into for speculative purposes.

The Company enters into interest rate swaps to manage interest rate
risk on a portion of its long-term borrowings. The differential to be received
or paid is accrued, as interest rates change, and recognized over the life of
the agreement.

The Company enters into foreign exchange contracts to hedge foreign
currency denominated assets or liabilities and currency commitments. Gains and
losses on foreign exchange contracts are recognized currently and are generally
offset by gains or losses on the related assets or liabilities. If the
transaction qualifies as a hedge, the resulting gains and losses are deferred.

Environmental Obligations

Expenditures for environmental obligations that relate to current
operations are expensed or capitalized, as appropriate. Expenditures that
relate to an existing condition caused by past operations and which do not
contribute to current or future revenue generation are expensed. Liabilities
are recorded when remedial efforts are probable and the costs can be reasonably
estimated.

Income Taxes

The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109 "Accounting for Income Taxes".
This standard requires an asset and liability approach for financial accounting
and income tax reporting based on enacted tax rates.

Revenue Recognition

The Company's revenues are composed of product sales and rental,
service and other revenues. The Company recognizes product sales revenues upon
delivery to the customer. Rental, service and other revenues are recorded when
such services are performed.

26
<PAGE> 28

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

Minority Interests

The Company records minority interests expense which primarily
represents the portion of the earnings of M-I L.L.C. ("M-I") applicable to the
36 percent minority interest partner. In addition, minority interests includes
income and expense associated with the minority interest ownership positions in
other joint ventures.

Employee Benefits

The Company accounts for postretirement benefits in accordance with
SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions". This standard requires the cost of postretirement benefits to be
recognized over the employee service periods.

The provisions of SFAS No. 87, "Employers' Accounting for Pensions",
require an additional minimum liability to be recognized for a defined benefit
plan to the extent that the accumulated pension benefit obligation exceeds the
fair value of pension plan assets and any accrued pension liabilities. An
offsetting intangible asset is recorded in the amount of the additional minimum
liability, not to exceed the amount of any unrecognized prior service costs and
any unrecognized transition obligation. Amounts exceeding the unrecognized
prior service costs and unrecognized transition obligation are reflected in
other current liabilities in the Consolidated Balance Sheets.

New Accounting Pronouncements

Reclassifications

Certain prior year amounts have been reclassified to conform to
current year presentation.

2. ACQUISITIONS

Acquisition of Anchor Drilling Fluids, A.S.

On June 11, 1996, M-I acquired the assets of Anchor Drilling Fluids,
A.S. ("Anchor") in exchange for cash of approximately $105.3 million. Anchor is
a Stavanger, Norway based operation which is principally engaged in providing
drilling fluid products and services to the offshore oil and gas industry. The
Company utilized $73.4 million of borrowings under new loan agreements to
finance their portion of the purchase price and retire certain debt assumed in
the acquisition. The minority partner contributed $41.3 million to fund their
portion of the purchase price and retire certain debt, which is included in
Minority Interests in the accompanying Consolidated Balance Sheets.

Acquisition of The Red Baron (Oil Tools Rental) Ltd.

Acquisition of Tri-Tech Fishing Services, L.L.C.

27
<PAGE> 29

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

Acquisition of Fleming Oilfield Services, Ltd.

Other Acquisitions

In 1997, the Company has completed the acquisitions of seven other
operations for an aggregate purchase price of $42.3 million. Additionally,
several other acquisitions were completed in 1996 and 1995 in exchange for
consideration of $6.2 million and $7.8 million, respectively. These
acquisitions have generally been financed with cash, new term loans or
borrowings against available lines of credit.

The above acquisitions have been recorded using the purchase method of
accounting and, accordingly, the acquired operations have been included in the
results of operations since their respective acquisition dates. The purchase
price was allocated to the net assets acquired based upon their estimated fair
market values at the dates of acquisition. The excess of the purchase price
over the estimated fair value of the net assets acquired amounted to
approximately $53.9 million in 1997 and $119.6 million in 1996, which has been
recorded as goodwill.

The balances included in the Consolidated Balance Sheets related to
the current year acquisitions are based upon preliminary information and are
subject to change when additional information concerning final asset and
liability valuations is obtained. Material changes in the preliminary
allocations are not anticipated by management.

The following unaudited pro forma supplemental information presents
consolidated results of operations as if the Company's current and prior year
acquisitions had occurred on January 1, 1996 (in thousands, except per share
amounts):

1997 1996
---- ----
(UNAUDITED)
<S> <C> <C>
Revenues............................................................... $ 1,611,796 $1,293,623
Net income............................................................. $ 105,904 $ 65,678
Earnings per share :
Basic............................................................ $ 2.67 $ 1.67
Diluted.......................................................... $ 2.64 $ 1.65

</TABLE>

The unaudited pro forma supplemental information is based on
historical information and does not include estimated cost savings; therefore,
it does not purport to be indicative of the results of operations had the
combinations been in effect at the dates indicated or of future results for the
combined entities.

The following schedule summarizes investing activities related to current
year acquisitions included in the Consolidated Statements of Cash Flows:

<TABLE>

<S> <C>
Fair value of assets, net of cash acquired of $1,957................. $55,142
Goodwill recorded.................................................... 53,946
Less: Total liabilities assumed..................................... (29,052)
-------
Cash paid for acquisition of businesses, net of cash acquired........ $80,036
=======
</TABLE>

28
<PAGE> 30

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

3. EARNINGS PER COMMON SHARE

During 1997, the Company adopted SFAS No. 128 "Earnings per Share".
The Statement is effective for financial statements for both interim and fiscal
periods ending after December 15, 1997 and requires restatement of all
prior-period earnings per share ("EPS") data. SFAS No. 128, which conforms the
U.S. method of computing EPS with international accounting standards, requires
dual presentation of basic and diluted EPS data. Basic 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 which could have
occurred if additional shares were issued for stock option exercises under the
treasury stock method. The following schedule reconciles the income and shares
used in the basic and diluted EPS computations (in thousands, except per share
data):

1997 1996 1995
---- ---- ----
BASIC EPS
<S> <C> <C> <C>
Net income................................ $102,351 $64,444 $45,592
======== ======= =======

Weighted average number of common
shares outstanding...................... 39,604 39,352 39,043
------ ------ ------

Basic EPS................................. $ 2.58 $ 1.64 $ 1.17
====== ======= ======

</TABLE>

1997 1996 1995
---- ---- ----
DILUTED EPS
<S> <C> <C> <C>
Net income................................ $102,351 $64,444 $45,592
======== ======= =======

Weighted average number of common
shares outstanding...................... 39,604 39,352 39,043
Dilutive effect of stock options.......... 579 528 340
-------- --------- --------
40,183 39,880 39,383
------ ------ ------

Diluted EPS............................... $ 2.55 $ 1.62 $1.16
====== ======= =====
</TABLE>

4. INVENTORIES

Inventories consist of the following at December 31:
<TABLE>
<CAPTION>

1997 1996
---- ----

<S> <C> <C>
Raw materials............................... $ 35,206 $ 30,614
Work-in-process............................. 72,233 45,985
Finished goods.............................. 268,611 233,139
--------- ---------
376,050 309,738

Reserves to state certain U.S. inventories
($146,431 in 1997 and $117,360 in 1996)
on a LIFO basis........................... (17,689) (14,697)
-------- --------
$358,361 $295,041
======== ========

</TABLE>

29
<PAGE> 31

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

5. DEBT

<TABLE>
<CAPTION>
The following summarizes the Company's outstanding debt at
December 31:

1997 1996
--------- ---------

CURRENT:
<S> <C> <C>
Short-term borrowings................................................. $ 61,010 $ 49,178
Current portion of long-term debt..................................... 30,513 25,805
--------- ---------
Short-term borrowings and current portion of long-term debt......... 91,523 74,983
--------- ---------

LONG-TERM:

Notes:
7% Senior Notes maturing September 2007 with an effective interest
rate of 7.07%. Interest payable semi-annually (presented net of
unamortized discount of $1,009)....................................... 148,991 --

Notes payable to insurance companies maturing between 1998 and 2006.
Interest payable quarterly or semi-annually at rates ranging
from 6.02% to 9.83% .................................................. 100,889 116,000

Bank revolvers payable:
$120.0 million revolving note expiring December 2002. Interest payable
quarterly at base rate (8.50% at December 31, 1997) or adjusted
Eurodollar interbank rate, as defined (6.24% at December
31, 1997) and described below......................................... 10,600 55,000

M-I L.L.C. $80.0 million revolving note expiring December
2002. Interest payable quarterly at base rate (8.50% at December
31, 1997) or adjusted Eurodollar interbank rate, as defined (6.20%
at December 31, 1997) and described below............................. 37,000 37,200

Term Loans:
320.0 million Norwegian Krone term loan facility with a bank group.
Principal due in semi-annual installments of 32.0 million Krone through
December 2000, remainder due March 2001. Interest payable semi-annually
at a Eurokrone rate (4.55% at
December 31, 1997), ranging from NIBOR + 3/8 to NIBOR + 3/4........... 30,498 44,626

Other 8,814 1,422
--------- ---------
336,792 254,248
Less current portion of long-term debt................................ (30,513) (25,805)
--------- ---------
Long-term debt........................................................ $ 306,279 $ 228,443
========= =========

Principal payments of long-term debt for years subsequent to 1998 are
as follows:

1999............................................................... $ 20,942
2000............................................................... 20,942
2001............................................................... 49,884
2002............................................................... 51,702
Thereafter......................................................... 162,809
---------
$ 306,279
=========

</TABLE>
30
<PAGE> 32
SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

The Company's short-term borrowings consist of amounts outstanding
under short-term lines of credit and a short-term loan. Certain subsidiaries of
the Company have unsecured short-term line of credit facilities with banks
aggregating approximately $49 million. At December 31, 1997, approximately $20
million of additional borrowing capacity was available under these facilities.
These lines of credit had a weighted average interest rate of 11 percent and 12
percent at December 31, 1997 and 1996, respectively. The remainder of the
balance relates to a short-term loan with a bank which carries interest at 7.5
percent and is scheduled to mature on March 31, 1998.

Additionally, the Company has $200.0 million of unsecured revolving
credit agreements at December 31, 1997. These agreements provide for the
election of interest at a base rate or a Eurodollar rate ranging from LIBOR +
1/4 to LIBOR + 5/8 and require the payment of a quarterly commitment fee ranging
from .09 percent to .20 percent of the unutilized credit facility. The interest
and commitment fee percentages are determined based upon the senior debt rating
of the Company, as defined. As of December 31, 1997 the borrowing capacity under
these lines of credit approximated $152 million.

During 1997 the Company completed a public debt offering for $150.0
million of unsecured 7% Senior Notes. The Notes are redeemable by the Company,
in whole or in part, at any time prior to maturity at a redemption price equal
to accrued interest plus the greater of the principal amount or the present
value of the remaining principal and interest payments.

The Company was in compliance with all of its loan covenants under the
various loan indentures at December 31, 1997 and 1996. The indentures relating
to its long-term debt contain certain covenants restricting the payment of cash
dividends to the Company's common shareholders based on net income and operating
cash flow formulas, as defined. The Company has not paid dividends on its Common
Stock since the first quarter of 1986.

Interest paid during the years ended December 31, 1997, 1996 and 1995
amounted to $24.9 million, $17.5 million and $14.3 million, respectively.

6. FINANCIAL INSTRUMENTS

Interest Rate Contracts

From time to time the Company enters into interest rate swaps with the
intent of managing the exposure to interest rate risk. Interest rate swaps are
contractual agreements between two parties for the exchange of interest payments
on a notional principal amount and agreed upon fixed or floating rates, for
defined time periods.

At December 31, 1997 and 1996, the Company had notional principal
amounts of interest rate swaps on outstanding debt of $80.5 million and $90.6
million, respectively. Gains and losses from interest rate swaps are recognized
currently in the Consolidated Statements of Operations. All swap agreements,
which are hedges against certain debt obligations, are classified as for
"purposes other than trading" under the provisions of SFAS No. 119.

In the unlikely event that the counterparty fails to perform under the
contract, the Company bears the credit risk that payments due to the Company may
not be made.

Foreign Currency Contracts and Options

From time to time, the Company enters into spot and forward contracts
as a hedge against foreign currency denominated assets and liabilities and
currency commitments. Market value gains and losses on such forward contracts
are recognized currently, and the resulting amounts generally offset foreign
exchange gains or losses on the related accounts. Gains or losses on contracts
are deferred if the transaction qualifies as a hedge. At December 31, 1997 and
1996, foreign exchange contracts outstanding totaled $20.9 million and $17.3
million, respectively.

31
<PAGE> 33
SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

The Company also purchases foreign exchange option contracts to hedge
certain operating exposures. Premiums paid under these contracts are expensed
over the life of the option contract. Gains arising on these options are
recognized at the time the options are exercised. The Company had $12.0 million
and $12.3 million of foreign exchange option contracts outstanding at December
31, 1997 and 1996, respectively.

Fair Value

<TABLE>
<CAPTION>
1997 1996
--------------------------- -----------------------------
Recorded Fair Recorded Fair
Value Value Value Value
---------- ---------- ---------- ----------

<S> <C> <C> <C> <C>
Long-term debt ....................... $ 336,792 $ 338,787 $ 254,248 $ 257,259
Interest rate swaps .................. -- (1,239) -- (482)
</TABLE>

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

7. INCOME TAXES

The geographical sources of income before income taxes and minority
interests for the three years ended December 31, 1997, were as follows:

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Income before income taxes and minority interests:
U.S .......................................................... $117,836 $ 68,564 $ 54,896
Non-U.S ...................................................... 74,682 47,511 19,114
-------- -------- --------
Total ........................................................ $192,518 $116,075 $ 74,010
======== ======== ========
</TABLE>

The income tax provision is summarized as follows:

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Current -
U.S ...................................................... $ 20,599 $ 9,159 $ 1,605
Non-U.S .................................................. 26,784 17,808 10,700
State .................................................... 1,655 1,319 1,245
-------- -------- --------
49,038 28,286 13,550
-------- -------- --------
Deferred -
U.S ...................................................... (2,775) (1,940) 7
Non-U.S .................................................. 4,387 452 (948)
-------- -------- --------
1,612 (1,488) (941)
-------- -------- --------
Income tax provision ....................................... $ 50,650 $ 26,798 $ 12,609
======== ======== ========
</TABLE>

Deferred taxes are principally attributable to timing differences
related to depreciation expense and net operating loss ("NOL") and tax credit
carryforwards. In 1997, 1996 and 1995, the Company reported the tax benefit of
operating loss carryforwards as a reduction in the provision for income taxes in
accordance with SFAS No. 109.

32
<PAGE> 34

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

The consolidated effective tax rate (as a percentage of income before
income taxes and minority interests) is reconciled to the U.S. Federal Statutory
rate as follows:

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----

<S> <C> <C> <C>
U.S. Federal statutory tax rate ................................. 35.0% 35.0% 35.0%
Utilization of U.S. net operating
loss and credit carryforwards ................................. (5.7) (9.2) (18.4)
Minority interest's share of U.S. partnership earnings .......... (6.2) (5.6) (7.2)
Permanent differences ........................................... 2.2 1.8 2.3
State taxes, net ................................................ 1.1 1.2 1.7
Non-U.S. tax provisions which vary from the
U.S. rate/non-U.S. losses with no
tax benefit realized .......................................... 0.2 0.9 4.2
Other items, net ................................................ (0.3) (1.0) (0.6)
---- ---- ----
Effective tax rate ............................................ 26.3% 23.1% 17.0%
==== ==== ====
</TABLE>

The components of deferred taxes at December 31 are as follows:

<TABLE>
<CAPTION>
NET
1997 1996 CHANGE
---- ---- ------
<S> <C> <C> <C>
Deferred tax liabilities attributed
to the excess of net book basis
over remaining tax basis
(principally depreciation):
U.S ......................................................... $(12,035) $(11,037) $ (998)
Non-U.S ..................................................... (11,124) (9,789) (1,335)
-------- -------- --------
Total deferred tax liabilities ................................ (23,159) (20,826) (2,333)
-------- -------- --------

Deferred tax assets attributed to
net operating loss and tax credit
carryforwards:
U.S ......................................................... 10,265 23,986 (13,721)
Non-U.S ..................................................... 27,095 27,860 (765)

Other deferred tax assets (principally accrued
liabilities not deductible until paid):
U.S ......................................................... 21,401 16,125 5,276
Non-U.S ..................................................... 5,899 7,910 (2,011)
-------- -------- --------
Subtotal .................................................. 64,660 75,881 (11,221)

Valuation allowance ............................................. (33,332) (46,725) 13,393
-------- -------- --------

Subtotal deferred tax assets .................................. 31,328 29,156 2,172
-------- -------- --------

Net deferred tax assets ....................................... $ 8,169 $ 8,330 $ (161)
======== ======== ========

Balance sheet presentation:

Deferred tax assets, net ...................................... $ 25,254 $ 8,979
Other assets .................................................. -- 1,410
Other current liabilities ..................................... (507) --
Deferred tax liabilities ...................................... (16,578) (2,059)
-------- --------
Net deferred tax assets .................................... $ 8,169 $ 8,330
======== ========
</TABLE>

33
<PAGE> 35

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

For U.S. tax reporting purposes, the Company utilized all cumulative
NOL and investment and other business credits available during 1997. At December
31, 1997, alternative minimum tax credits of $10.3 million, with no expiration,
are available to reduce future U.S. income taxes.

Income taxes paid during the years ended December 31, 1997, 1996 and
1995 amounted to $41.3 million, $17.4 million and $3.8 million, respectively.

The Company has provided additional taxes for the anticipated
repatriation of certain earnings of its non-U.S. subsidiaries. Undistributed
earnings above the amounts upon which additional taxes have been provided, which
approximated $26.6 million at December 31, 1997, are intended to be permanently
invested by the Company. It is not practicable to determine the amount of
applicable taxes that would be incurred if any of such earnings were
repatriated.

8. CAPITAL STOCK

Common stock warrants

All outstanding common stock warrants, which allowed for conversion
into shares of the Company's common stock, were exercised or expired during 1995
and 1996. In 1995, approximately $1.2 million was received upon the exercise of
143,572 warrants into an equivalent number of common shares. No common stock
warrants were outstanding at December 31, 1997 or 1996.

9. STOCKHOLDERS' RIGHTS PLAN

During 1990, the Company adopted a Stockholders' Rights Plan ("Rights
Plan"). As part of the Rights Plan, the Company's Board of Directors declared a
dividend of one preferred stock purchase right ("Right") for each share of the
Company's common stock outstanding on June 29, 1990. The Board also authorized
the issuance of one such Right for each share of the Company's common stock
issued after June 29, 1990 until the occurrence of certain events.

Each Right entitles the holder thereof (except an Acquiring Person) to
purchase, at an exercise price of $50, shares of the Company's common stock
having a market value of twice the Right's exercise price. The Rights are
exercisable upon the occurrence of certain events related to a person acquiring
or announcing the intention to acquire beneficial ownership of 20 percent or
more of the Company's common stock. The Rights are not exercisable in the event
the Company's common stock is acquired pursuant to a Qualifying Offer, as
defined in the Rights Plan. In addition, if the Company is involved in a merger
or other business combination transaction, or sells 50 percent or more of its
assets or earning power to another entity, each Right will entitle its holder to
purchase, at the Right's then current exercise price, shares of common stock of
such other entity having a value of twice the Right's exercise price.

The Rights are subject to redemption at the option of the Board of
Directors at a price of $0.01 per Right until the occurrence of certain events.
The Rights currently trade with the Company's common stock, have no voting or
dividend rights and expire on June 19, 2000.

34
<PAGE> 36

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

10. EMPLOYEE STOCK OPTIONS

As of December 31, 1997, the Company had outstanding stock options
granted under the 1989 Long-Term Incentive Compensation Plan ("1989 Plan").
Options are generally granted at fair market values on the date of grant with
matters such as vesting periods and expiration of options determined on a
grant-by-grant basis. The options, exercisable at various dates through December
2007, are conditioned upon continued employment.

During 1997, all options remaining under the 1982 Stock Option Plan
were exercised or forfeited. No further options may be granted under this Plan.

The Company has adopted the reporting standards of SFAS No. 123 ("SFAS
123") "Accounting for Stock-Based Compensation". SFAS 123, which was effective
for fiscal years beginning after December 15, 1995, established financial
accounting and reporting standards for stock-based employee compensation plans
and for transactions in which equity instruments are issued to non-employees for
the acquisition of goods and services. SFAS No. 123 required, among other
things, that compensation cost be calculated for fixed stock options at the
grant date by determining fair value using an option-pricing model. The Company
has the option of recognizing the compensation cost over the vesting period as
an expense in the Consolidated Statements of Operations or making pro forma
disclosures in the notes to the financial statements.

The Company continues to apply APB Opinion 25 and related
Interpretations in accounting for the plan. Accordingly, no compensation cost
has been recognized in the accompanying consolidated financial statements for
its stock option plan. Had the Company elected to apply the accounting standards
of SFAS 123, the Company's net income and earnings per share would have
approximated the pro forma amounts indicated below:

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C> <C>
Net income As reported $ 102,351 $ 64,444 $ 45,592
Pro forma $ 101,062 $ 63,958 $ 45,495

Earnings per share As reported:
Basic $ 2.58 $ 1.64 $ 1.17
Diluted $ 2.55 $ 1.62 $ 1.16

Pro forma:
Basic $ 2.55 $ 1.63 $ 1.17
Diluted $ 2.52 $ 1.60 $ 1.16
</TABLE>

The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model which resulted in a
weighted-average fair value of $18.68, $12.37 and $7.50 for grants made during
the years ended December 31, 1997, 1996 and 1995, respectively. The following
assumptions were used for option grants in 1997, 1996 and 1995, respectively;
dividend yield of 1.5 percent, 1.6 percent and 1.0 percent; expected volatility
of 19 percent, 23 percent and 38 percent, risk-free interest rates of 5.7
percent, 6.2 percent and 6.9 percent and an expected life of six years. The
compensation expense included in the above pro forma net income may not be
indicative of amounts to be included in future periods as the fair value of
options granted prior to 1995 was not determined.

35
<PAGE> 37

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

A summary of the Company's stock option plans as of December 31, 1997,
1996 and 1995, and changes during those years is presented below:

<TABLE>
<CAPTION>
Weighted-Average
Shares Exercise
Under Option Price
---------------- ----------------
<S> <C> <C>
Outstanding at December 31, 1994 ................. 1,377,075 $ 11.22

Options granted .................................. 225,485 16.82
Options forfeited ................................ (13,574) 11.62
Options exercised ................................ (228,940) 9.35
---------

Outstanding at December 31, 1995 ................. 1,360,046 12.43

Options granted .................................. 252,670 40.79
Options forfeited ................................ (1,290) 17.88
Options exercised ................................ (348,408) 11.13
---------

Outstanding at December 31, 1996 ................. 1,263,018 18.46

Options granted .................................. 284,500 69.06
Options forfeited ................................ (19,335) 18.03
Options exercised ................................ (159,021) 11.39
---------

Outstanding at December 31, 1997 ................. 1,369,162 $ 29.79
</TABLE>

The number of outstanding fixed stock options exercisable at December
31, 1996 and 1995 was 481,606 and 494,889, respectively. These options had a
weighted average exercise price of $12.13 and $11.56 at December 31, 1996 and
1995, respectively. The following summarizes information about fixed stock
options outstanding at December 31, 1997:

<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Prices Outstanding Contractual Life Price Exercisable Price
- --------------- ----------- ---------------- -------- ----------- ---------

At December 31, 1997, there were 173,916 shares of common stock
reserved under the 1989 Plan for the future granting of stock options, awarding
of additional restricted stock options and/or awarding of additional Stock
Appreciation Rights.

36
<PAGE> 38
SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

11. EMPLOYEE BENEFITS

Pension Plans

The Company has pension plans in the U.S. and the United Kingdom
("U.K."). Benefit accruals under the Company's U.S. pension plan, which have
been frozen since 1987, covered substantially all the U.S. employees of the
Company at that date. Due to the freezing of U.S. pension benefits and fully
funding those benefits in 1987, no material contributions were made to the Plan
in 1997, 1996 or 1995. Most of the employees of M-I are not covered by a pension
plan.

During 1997, a decision was made to terminate the U.K. pension plan and
replace it with a defined contribution plan. All current and future obligations
to plan participants are expected to be settled in 1998.

The following tables detail the components of pension expense for the
three years ended December 31, 1997, the funded status of the plans and major
assumptions used to determine these amounts:

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----

<S> <C> <C> <C>
Service cost ................................ $ 323 $ 311 $ 286
Interest cost ............................... 1,129 1,020 942
Actual return on plan assets ................ (1,298) (1,771) (796)
Prior service cost .......................... 6 6 8
Net amortization and deferral
and other ................................. (38) 685 (199)
------- ------- -------
Net periodic pension cost ................... $ 122 $ 251 $ 241
======= ======= =======
</TABLE>

Reconciliation of Funded Status of the Plan:

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Actuarial present value of benefit obligations:

Vested benefit obligation ........................................ $ 17,158 $ 13,252 $ 11,672
======== ======== ========

Accumulated benefit obligation ................................... $ 17,329 $ 13,375 $ 11,834
======== ======== ========

Projected benefit obligation ..................................... $ 18,522 $ 14,481 $ 12,700
Plan assets at fair value ........................................ 18,626 15,804 12,926
-------- -------- --------

Projected benefit obligation less than Plan assets ............... $ 104 $ 1,323 $ 226
Unrecognized prior service cost .................................. 43 28 34
Unrecognized net loss (gain) ..................................... 432 (759) 211
Additional minimum liability ..................................... (1,283) (480) (880)
-------- -------- --------

Pension asset (liability)recognized in the Balance Sheet ......... $ (704) $ 112 $ (409)
======== ======== ========

Weighted-average assumed discount rate ............................. 7.0% - 8.0% 7.8% - 9.0% 7.0% - 9.0%

Rate of compensation increases in the U.K. (none in the U.S.
due to freezing of benefits) ....................................... 6.5% 7.0% 7.5%

Weighted-average expected long-term rate of return on Plan
assets ............................................................. 8.0% - 9.0% 8.5% - 9.0% 8.5% - 9.0%
</TABLE>

The Company has several other pension plans covering certain U.S. and
non-U.S. employees as well as a pension plan covering directors. Pension
expense, total accumulated plan benefits and net assets available for benefits
for these plans were not material at December 31, 1997, 1996 or 1995.

37
<PAGE> 39

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

Retirement Plans

The Company established the Smith International, Inc. 401(k) Retirement
Plan (the "Plan") for the benefit of all eligible employees. Employees may
voluntarily contribute up to 12 percent of compensation, as defined, to the
Plan. The Company makes retirement, matching and, in certain cases,
discretionary matching contributions to each participant's account under the
Plan. Participants receive a full match of the first 1 1/2 percent of their
contributions along with a retirement contribution ranging from 2 percent to 6
percent of their qualified compensation. In addition, the Company may provide
discretionary matching contributions to participants who are employed by the
Company on December 31. The Company's contributions to the Plan totaled
approximately $6.9 million, $4.9 million and $3.9 million in 1997, 1996 and
1995, respectively.

M-I has a Company Profit-Sharing and Savings Plan (the "M-I Plan")
under which participating employees may defer up to 12 percent of their
compensation, as defined. Under the terms of the M-I Plan, qualified employees
are eligible to receive basic, matching and profit-sharing contributions with
the approval of the Employee Benefits Committee, and in certain instances, the
Board of Directors. Participants are eligible to receive a basic contribution
equal to 3 percent of qualified compensation, and a full match of the first 1
1/2 percent of their contributions. Further, effective January 1, 1996, the
Board of Directors approved an additional profit-sharing match of up to 2 1/2
percent of participant's voluntary contributions. Total contributions under the
M-I Plan approximated $5.0 million in 1997, $4.2 million in 1996 and $2.2
million in 1995.

Postretirement Benefit Plans

The Company and its subsidiaries provide certain health care benefits
for retired employees. Many of the employees who retire from the Company are
eligible for these benefits.

The Smith International, Inc. Retiree Medical Plan ("Smith Medical
Plan") provides postretirement medical benefits to retirees and their spouses.
The retiree medical plan has an annual limitation (a "cap") on the dollar amount
of the Company's portion of the cost of benefits incurred by retirees under the
Plan. The remaining cost of benefits in excess of the cap is the responsibility
of the participants. The cap will be adjusted annually for inflation, which is
currently assumed to be 4 percent.

M-I provides retiree medical coverage to eligible retirees and their
dependents under the M-I Drilling Fluids Retiree Medical Plan ("M-I Medical
Plan"). Eligibility for inclusion in that plan; however, was closed as of
January 1, 1994, to the majority of M-I's employees. M-I contributes to the cost
of the benefits under this plan; however, these costs are reviewed annually for
inflation, and limited to a maximum 5 percent increase in M-I's contribution per
year. Any costs in excess of M-I's maximum contribution are the responsibility
of the retiree or their dependents.

38
<PAGE> 40

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

The following table sets forth the plans' unfunded status reconciled
with the amount shown in the Company's Consolidated Balance Sheets at December
31:

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Accumulated postretirement benefit obligation:
Retirees ..................................... $ (7,199) $ (5,538) $ (5,105)
Actives ...................................... (4,690) (3,773) (3,543)
Plan assets at fair value ........................ -- -- --
-------- -------- --------
Accumulated postretirement
benefit obligation in excess of
plan assets .................................... (11,889) (9,311) (8,648)
Unrecognized net loss (gain) and
prior service cost ............................. 866 (1,487) (1,832)
-------- -------- --------
Accrued postretirement
benefit obligation ............................. $(11,023) $(10,798) $(10,480)
======== ======== ========
</TABLE>

Postretirement benefit expense recognized in the Consolidated
Statements of Operations for the three years ended December 31, 1997, is
summarized as follows:

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----

<S> <C> <C> <C>
Service cost ..................................... $ 109 $ 103 $ 83
Interest cost on accumulated
postretirement benefit obligation
and other ...................................... 723 704 686
Net amortization ................................. (46) (116) (170)
----- ----- -----
Postretirement benefit expense ................... $ 786 $ 691 $ 599
===== ===== =====
</TABLE>

The health care cost trend rate assumption can have a significant
effect on the amounts reported. For measurement purposes, the Smith Medical Plan
assumes an 8 percent, 9 percent and 10 percent annual rate of increase in the
per capita cost of covered health care benefits for 1997, 1996 and 1995,
respectively; and the M-I Medical Plan assumes a 5 percent increase for the
periods presented. The Smith Medical Plan rate was assumed to gradually decrease
to 5 percent for 2000 and to remain at that level thereafter. An increase of one
percentage point in the health care cost trend rate would increase the
accumulated postretirement benefit obligation and the aggregate of the service
and interest cost components of the postretirement benefits expense by $1.3
million and $0.1 million, respectively.

The weighted-average discount rates used in determining the accumulated
postretirement benefit obligation for 1997, 1996 and 1995 were 7.0 percent, 8.0
percent and 8.4 percent, respectively.

39
<PAGE> 41
SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

12. INDUSTRY SEGMENTS AND INTERNATIONAL OPERATIONS

The Company operates primarily in one industry segment, the petroleum
services segment. The products and services of the petroleum services segment
are primarily used in the drilling of oil and gas wells. No single customer
represented in excess of 10 percent of total revenues during any of the years
presented.

The following table presents financial information about non-U.S. and
U.S. operations and export sales:

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Revenues:
United States:
Domestic .................................. $ 611,833 $ 451,147 $ 358,392
Export .................................... 89,919 71,470 50,454
North Sea/Europe ............................ 285,655 242,828 168,135
Latin America ............................... 210,409 153,540 112,587
Other ....................................... 365,328 237,673 184,976
---------- ---------- ----------
$1,563,144 $1,156,658 $ 874,544
========== ========== ==========

Income before interest and taxes:
United States ............................. $ 84,175 $ 56,387 $ 37,115
North Sea/Europe .......................... 45,427 29,289 15,129
Latin America ............................. 37,515 22,296 21,307
Other ..................................... 64,338 36,337 23,083
---------- ---------- ----------
$ 231,455 $ 144,309 $ 96,634
========== ========== ==========

Identifiable assets:
United States ............................. $ 642,365 $ 466,711 $ 418,588
North Sea/Europe .......................... 311,780 309,791 94,648
Latin America ............................. 166,030 138,988 87,322
Other ..................................... 275,858 159,092 102,286
---------- ---------- ----------
$1,396,033 $1,074,582 $ 702,844
========== ========== ==========
</TABLE>

General corporate expenses have been excluded from income before
interest and taxes in the table above. Results of operations as reported in the
accompanying consolidated financial statements include general corporate
expenses of $14.0 million in 1997, $11.8 million in 1996 and $10.4 million in
1995.

Transfers between geographic areas, which are eliminated upon
consolidation, are excluded from the above presentation. These transfers are
recorded by the Company and its subsidiaries based on their various intercompany
pricing agreements. U.S. sales to affiliates amounted to $210.8 million, $169.5
million and $126.1 million in 1997, 1996 and 1995, respectively. Non-U.S. sales
to affiliates approximated $136.5 million, $93.0 million and $58.2 million in
1997, 1996 and 1995, respectively.

The Company's revenues are derived principally from uncollateralized
sales to customers in the oil and gas industry. This industry concentration has
the potential to impact the Company's exposure to credit risk, either positively
or negatively, because customers may be similarly affected by changes in
economic or other conditions. The creditworthiness of this customer base is
strong, and the Company has not experienced significant credit losses on such
receivables.

<PAGE> 42

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

13. COMMITMENTS AND CONTINGENCIES

Leases

The Company routinely enters into operating and capital leases for
certain of its facilities and equipment. Amounts related to assets under capital
lease were immaterial for the periods presented. Rent expense totaled $17.9
million, $13.8 million and $12.9 million in 1997, 1996 and 1995, respectively.

Future minimum payments under all non-cancelable operating leases
having initial terms of one year or more are as follows:

<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31, AMOUNT
------------ ------

<S> <C>
1998 $15,771
1999 13,017
2000 8,384
2001 6,618
2002 5,384
Thereafter 31,664
-------
$80,838
=======
</TABLE>

Year 2000

The Company is currently in the process of identifying, evaluating and
implementing modifications to its business systems in order to achieve Year 2000
date conversion compliance without an effect on customers or business
operations. The Company expects that all of its enterprise business systems will
be Year 2000 compliant by mid-1999, with the majority of the systems expected to
be in compliance by the end of 1998. Most of the necessary changes in computer
instructional code can be made by upgrading the off-the-shelf software in which
the application was created. Subsequent to year end, the Company's systems were
upgraded to Oracle version 10.7 which brought most of the Company's enterprise
applications into compliance. The Company does not believe that the necessary
changes for the remaining systems will require any significant level of external
resources, or that failure to implement the proposed changes for the remaining
systems would have a material effect on the Company's consolidated financial
position or results of operations.

The Company has not yet determined the complete status of Year 2000
compliance of its suppliers and financial institutions or what additional costs,
if any, might be required by the Company. Management believes that
non-compliance by the Company's suppliers will not have a material effect.
However, the failure of its financial institutions to become Year 2000 compliant
could have a material effect on the Company's consolidated financial position or
results of operations.

Litigation

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

The Company is involved in several actions relating to alleged
liability in connection with the U.S. Environmental Protection Agency's ("EPA")
National Priorities List ("NPL") sites:

Sheridan. On March 31, 1987, the Sheridan Site Committee (the
"Committee") filed a claim on behalf of itself and 59 potentially responsible
parties ("PRPs") at the Sheridan Disposal Services site in Hempstead, Texas, a
NPL site. The claim was based on the Company's alleged liability to the
claimants for "contribution and potential cost recovery for administrative and
remedial work" expenses incurred and to be incurred by them in connection with
the Sheridan Disposal

41
<PAGE> 43
SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

site. On August 28, 1987, the Company reached a settlement
and agreed to pay its allocable share of response costs incurred by the
Committee, such share to be limited to the lesser of $3.0 million or 2.93
percent of actual response costs. Based upon an EPA Record of Decision ("ROD"),
total remediation costs are estimated to be approximately $28 million. On this
basis, the Company's share would be $0.8 million.

Operating Industries. Under the Comprehensive Environmental Response,
Compensation and Liability Act of 1980 (the "Superfund Act"), the EPA has been
conducting various activities at the Operating Industries, Inc. ("OII") site, an
NPL disposal site located in Monterey Park, California. On June 14, 1988, the
United States District Court entered an order approving a Stipulation and
Agreement to Compromise and Settle EPA's claim against the Company (the "OII
Settlement Agreement"). Under the OII Settlement Agreement, the Company agreed
to pay its allocable share of total future site response costs at the OII site,
which is limited to the lesser of $5.0 million or 0.65 percent of future site
response costs.

Actual remediation of the OII Site is likely to extend for a number of
years after a final remedy is selected for the site. The EPA issued the ROD with
respect to the OII Site, estimating remediation costs of $300 million. The
Company is presently unable to determine the amount it may ultimately have to
contribute to the OII site pursuant to the OII Settlement Agreement. This amount
will range from approximately $150,000 that the Company has already paid to the
$5.0 million at which the Company's liability is capped under the OII Settlement
Agreement.

Chemform. The Company operated a business and held a leasehold interest
in property located in Pompano Beach, Florida (the "Chemform Site") between May
14, 1976 and March 16, 1979, at which time the Company sold the business and
assigned the lease. The EPA placed the Chemform Site on the NPL on October 4,
1989. On September 22, 1992, the EPA issued the ROD for a portion of the
Chemform Site. The ROD selected a "No Action with Monitoring" alternative,
requiring groundwater to be monitored quarterly for at least one year. Although
the Company and two other PRPs completed four quarters of groundwater
monitoring, the Florida Department of Environmental Protection ("Florida DEP")
requested additional monitoring. The Company and two other PRPs performed the
additional monitoring and are presently conducting discussions with the EPA and
the Florida DEP regarding what, if any, additional monitoring work will be
required. The final scale of any monitoring work is not yet known. It is also
not yet known whether any groundwater remediation work will thereafter be
required.

On September 16, 1993, the EPA issued the ROD for the remainder of the
Chemform Site, which addressed site-related soil contamination. The ROD
determined that no further action was necessary to address Operable Unit Two at
the site; however, the Florida DEP requested that additional soil be removed at
the Chemform Site. The Company and the two other PRPs performed the soil removal
requested under the oversight of the Florida DEP and has provided a Technical
Memorandum summarizing this action to the EPA and the Florida DEP. The Company
has not received any written response from either the EPA or the Florida DEP. In
April 1996, the Company and the other PRPs received a letter from the EPA
demanding approximately $0.8 million in response and oversight costs. The
Company and the other PRP's are contesting this claim and are requesting
additional information. As the EPA still retains jurisdiction over the Chemform
Site, it is possible that additional issues may arise which would require
further resolution, including the claim by the EPA for payment of past oversight
or response costs incurred. The Company intends to scrutinize and, if necessary,
vigorously contest any such claims made by the EPA.

At December 31, 1997, the remaining recorded liability for estimated
future clean-up costs for the sites discussed above as well as properties
currently or previously owned or leased by the Company was $3.2 million. As
additional information becomes available, the Company may be required to provide
for additional environmental clean-up costs for Superfund sites and for
properties currently or previously owned or leased by the Company. However, the
Company believes that none of its clean-up obligations will result in
liabilities having a material adverse effect on the Company's consolidated
financial position or results of operations.

42
<PAGE> 44

SMITH INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

14. SUBSEQUENT EVENT

On January 20, 1998, the Company announced the signing of a definitive
agreement to acquire Wilson Industries, Inc. ("Wilson") in a transaction
expected to be accounted for as a pooling of interest. Wilson, which operates
through Wilson Supply and Houston Engineers, is a privately-held company based
in Houston, Texas. Wilson Supply is a U.S.-based stocking distributor of
materials for drilling, production, refining and petrochemical plants and
pipeline operations. Houston Engineers provides drilling and fishing tools and
directional drilling services worldwide to the exploration and production
industry. The Company expects to issue 7.9 million shares of common stock in
exchange for all of the equity interests of Wilson.

The transaction is subject to, among other conditions, approval by the
Wilson shareholders and various U.S. governmental entities. There are no
assurances as to whether this transaction will be ultimately consummated.

15. QUARTERLY INFORMATION (UNAUDITED)

<TABLE>
<CAPTION>
1997 FIRST SECOND THIRD FOURTH YEAR
----- ------ ----- ------ ----

<S> <C> <C> <C> <C> <C>
Revenues ............................... $ 357,484 $ 383,163 $ 396,629 $ 425,868 $1,563,144
============= ============= ============ =========== ==========
Gross profit ........................... $ 121,265 $ 133,194 $ 140,040 $ 154,033 $ 548,532
============= ============= ============ =========== ==========
Net income ............................. $ 21,113 $ 23,929 $ 27,264 $ 30,045 $ 102,351
============= ============= ============ =========== ==========
Basic earnings per share ............... $ 0.53 $ 0.60 $ 0.69 $ 0.76 $ 2.58
============= ============= ============ =========== ==========
Diluted earnings per share ............. $ 0.53 $ 0.60 $ 0.68 $ 0.75 $ 2.55
============= ============= ============ =========== ==========
<CAPTION>
1996 FIRST SECOND THIRD FOURTH YEAR
----- ------ ----- ------ ----

<S> <C> <C> <C> <C> <C>
Revenues ............................... $ 238,820 $ 270,272 $ 310,657 $ 336,909 $1,156,658
============= ============= ============ =========== ==========
Gross profit ........................... $ 80,909 $ 90,323 $ 103,398 $ 117,432 $ 392,062
============= ============= ============ =========== ==========
Net income ............................. $ 12,948 $ 14,981 $ 16,604 $ 19,911 $ 64,444
============= ============= ============ =========== ==========
Basic earnings per share ............... $ 0.33 $ 0.38 $ 0.42 $ 0.51 $ 1.64
============= ============= ============ =========== ==========
Diluted earnings per share ............. $ 0.33 $ 0.38 $ 0.42 $ 0.50 $ 1.62
============= ============= ============ =========== ==========
</TABLE>

43
<PAGE> 45

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

For information concerning directors of the Registrant, see the
information set forth following the caption "ELECTION OF DIRECTORS" in the
Company's definitive proxy statement to be filed no later than 120 days after
the end of the fiscal year covered by this Form 10-K (the "Proxy Statement"),
which information is incorporated herein by reference. For information
concerning executive officers of the Registrant, see Item 4A appearing in Part I
of this Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION

The information set forth following the caption "EXECUTIVE
COMPENSATION" in the Company's Proxy Statement is incorporated herein by
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information set forth following the captions "ELECTION OF
DIRECTORS" and "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS" in the
Company's Proxy Statement is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information set forth following the captions "ELECTION OF
DIRECTORS" and "EXECUTIVE COMPENSATION" in the Company's Proxy Statement is
incorporated herein by reference.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(A) FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
REFERENCE
---------
<S> <C> <C>
(1) Financial statements included in this report:
Report of Independent Public Accountants........................................................... 19
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995................................................................. 20
Consolidated Balance Sheets at December 31, 1997 and 1996.......................................... 21-22
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1997, 1996 and 1995........................................................... 23
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995................................................................. 24
Notes to Consolidated Financial Statements......................................................... 25-43

(2) Financial statement schedule for the years ended December 31, 1997,
1996 and 1995:
Report of Independent Public Accountants on Financial Statement Schedule........................... 49
Schedule II-Valuation and Qualifying Accounts and Reserves......................................... 50
</TABLE>

44
<PAGE> 46
All other schedules have been omitted since the required information is
not present or not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the Consolidated
Financial Statements or notes thereto.

(3) EXHIBITS AND INDEX TO EXHIBITS

3.l -- Restated Certificate of Incorporation of the
Company as amended to date. Filed as Exhibit 3.1 to
the Company's report on Form 10-K for the year
ended December 31, 1993 and incorporated herein by
reference.

3.2 -- Bylaws of the Company as amended to date. Filed
as Exhibit 3.2 to the Company's report on Form 10-K
for the year ended December 31, 1993 and
incorporated herein by reference.

4.1 -- Rights Agreement, dated as of June 19, 1990,
between the Company and First Chicago Trust Company
of New York.

4.2 -- Form of Indenture between the Company and The
Bank of New York, as Trustee. Filed as Exhibit 4.1
to the Company's Registration Statement on Form S-3
dated August 22, 1997 and incorporated herein by
reference.

4.3 -- Form of Note. Filed as Exhibit 4.2 to Amendment
No. 1 to the Company's Registration Statement on
Form S-3 dated September 9, 1997 and incorporated
herein by reference.

9. -- Not applicable.

10.1 -- Smith International, Inc. Supplemental Pension
Plan as amended to date. Filed as Exhibit 10.1 to
the Company's report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by
reference.

10.2 -- Smith International, Inc. 1982 Stock Option
Plan. Filed as Exhibit 10.2 to the Company's report
on Form 10-K for the year ended December 31, 1995
and incorporated herein by reference.

10.3 -- Smith International, Inc. 1989 Long Term
Incentive Compensation Plan, as amended to date.
Filed as Exhibit 10.3 to the Company's report on
Form 10-K for the year ended December 31, 1994 and
incorporated herein by reference.

10.4 -- Smith International, Inc. Directors' Retirement
Plan as amended to date. Filed as Exhibit 10.4 to
the Company's report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by
reference.

10.5 -- Smith International, Inc. Supplemental Executive
Retirement Plan, as amended. Filed as Exhibit 10.5
to the Company's report on Form 10-K for the year
ended December 31, 1993 and incorporated herein by
reference.

10.6 -- Supply Agreement dated April 2, 1987 between the
Company and TCM Holding Corporation and Rogers Tool
Works, Inc. for the supply of tungsten carbide
products. Filed as Exhibit 10.6 to the Company's
report on Form 10-K for the year ended December 31,
1995 and incorporated herein by reference.

45
<PAGE> 47

10.7 -- Amendment to Supply Agreement dated January 22,
1993 between the Company and Rogers Tool Works,
Inc. Filed as Exhibit 10.7 to the Company's report
on Form 10-K for the year ended December 31, 1995
and incorporated herein by reference.

10.8 -- Supply Agreement dated October 1, 1989 between
the Company and Amforge-Smith Forge Company for the
supply of forgings. Filed as Exhibit 10.8 to the
Company's report on Form 10-K for the year ended
December 31, 1995 and incorporated herein by
reference.

10.9 -- Employment Agreement dated December 10, 1987
between the Company and Douglas L. Rock. Filed as
Exhibit 10.11 to the Company's report on Form 10-K
for the year ended December 31, 1993 and
incorporated herein by reference.

10.10 -- Employment Agreement dated December 10, 1987
between the Company and D. Barry Heppenstall. Filed
as Exhibit 10.12 to the Company's report on Form
10-K for the year ended December 31, 1993 and
incorporated herein by reference.

10.11 -- Employment Agreement dated January 2, 1991
between the Company and Neal S. Sutton. Filed as
Exhibit 10.11 to the Company's report on Form 10-K
for the year ended December 31, 1996 and
incorporated herein by reference.

10.12 -- Employment Agreement dated May 1, 1991 between
the Company and Richard A. Werner. Filed as Exhibit
10.12 to the Company's report on Form 10-K for the
year ended December 31, 1996 and incorporated
herein by reference.

10.13 -- Employment Agreement dated April 3, 1995 between
the Company and Roger A. Brown. Filed as Exhibit
10.13 to the Company's report on Form 10-K for the
year ended December 31, 1995 and incorporated
herein by reference.

10.14 -- Amendment to Employment Agreement dated October
16, 1989 between the Company and Douglas L. Rock.
Filed as Exhibit 10.14 to the Company's report on
Form 10-K for the year ended December 31, 1995 and
incorporated herein by reference.

10.15 -- Amendment to Employment Agreement dated October
16, 1989 between the Company and D. Barry
Heppenstall. Filed as Exhibit 10.15 to the
Company's report on Form 10-K for the year ended
December 31, 1995 and incorporated herein by
reference.

10.16 -- Amendment to Employment Agreement dated January
2, 1991 between the Company and Neal S. Sutton.
Filed as Exhibit 10.16 to the Company's report on
Form 10-K for the year ended December 31, 1996 and
incorporated herein by reference.

10.17 -- Amendment to Employment Agreement dated May 1,
1991 between the Company and Richard A. Werner.
Filed as Exhibit 10.17 to the Company's report on
Form 10-K for the year ended December 31, 1996 and
incorporated herein by reference.

10.18 -- First Amendment to Amendment to Employment
Agreement dated November 12, 1992 between the
Company and Doug Rock. Filed as Exhibit 10.18 to
the Company's report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by
reference.

46
<PAGE> 48
10.19 -- First Amendment to Amendment to Employment
Agreement dated November 12, 1992 between the
Company and Barry Heppenstall. Filed as Exhibit
10.19 to the Company's report on Form 10-K for the
year ended December 31, 1995 and incorporated
herein by reference.

10.20 -- First Amendment to Amendment to Employment
Agreement dated November 12, 1992 between the
Company and Neal S. Sutton. Filed as Exhibit 10.20
to the Company's report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by
reference.

10.21 -- First Amendment to Amendment to Employment
Agreement dated November 12, 1992 between the
Company and Dick Werner. Filed as Exhibit 10.21 to
the Company's report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by
reference.

10.22 -- Note Agreement, dated as of May 21, 1996,
between the Company and Principal Mutual Life
Insurance Company, John Hancock Mutual Life
Insurance Company, John Hancock Variable Life
Insurance Company, IDS Certificate Company, Mellon
Bank, N.A., as Trustee for AT&T Master Pension
Trust and The Maritime Life Assurance Company.
Filed as Exhibit 10.3 to the Company's report on
Form 10-Q for the quarter ended June 30, 1996 and
incorporated herein by reference.

10.23 -- Loan Agreement dated as of April 4, 1996, by and
among the Company and Texas Commerce Bank National
Association, a national banking association,
individually and as Agent, and the other financial
institutions parties thereto. Filed as Exhibit 10.1
to the Company's report on Form 10-Q for the
quarter ended June 30, 1996 and incorporated herein
by reference.

10.24 -- Loan Agreement dated as of April 4, 1996, by and
among M-I Drilling Fluids Company, L.L.C., Texas
Commerce Bank National Association, individually
and as Agent, and the other financial institutions
parties thereto. Filed as Exhibit 10.2 to the
Company's report on Form 10-Q for the quarter ended
June 30, 1996 and incorporated herein by reference.

10.25 -- First Amendment to Loan Agreement dated April 8,
1997, by and among the Company and Texas Commerce
Bank National Association, a national banking
association, individually and as Agent, and the
other financial institutions parties thereto. Filed
as Exhibit 10.1 to the Company's report on Form
10-Q for the quarter ended June 30, 1997 and
incorporated herein by reference.

10.26 -- First Amendment to Loan Agreement dated April 8,
1997, by and among M-I Drilling Fluids, L.L.C.,
Texas Commerce Bank National Association, a
national banking association, individually and as
Agent, and the other financial institutions parties
thereto. Filed as Exhibit 10.2 to the Company's
report on Form 10-Q for the quarter ended June 30,
1997 and incorporated herein by reference.

10.27 -- Second Amendment to Loan Agreement dated
December 23, 1997, by and among the Company and
Texas Commerce Bank National Association, a
national banking association, individually and as
Agent, and the other financial institutions parties
thereto.

47
<PAGE> 49

10.28 -- Second Amendment to Loan Agreement dated
December 23, 1997, by and among M-I Drilling
Fluids, L.L.C., Texas Commerce Bank National
Association, a national banking association,
individually and as Agent, and the other financial
institutions parties thereto.

11. -- Not applicable.

12. -- Not applicable.

13. -- Not applicable.

18. -- Not applicable.

19. -- Not applicable.

21.1 -- Subsidiaries of the Company

23.1 -- Consent of Independent Public Accountants.

27.1 -- Financial Data Schedule

(B) REPORTS ON FORM 8-K.

No reports on Form 8-K were filed during the last quarter of the period
covered by this report.

48
<PAGE> 50

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE

To Smith International, Inc.:

We have audited, in accordance with generally accepted auditing
standards, the consolidated balance sheets of Smith International, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
three years in the period ended December 31, 1997, included in this Form 10-K,
and have issued our report thereon dated January 30, 1998. Our audits were made
for the purpose of forming an opinion on the basic consolidated financial
statements taken as a whole. The financial statement schedule listed in Part IV,
Item 14(A)(2) for Smith International, Inc. and subsidiaries is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This financial statement schedule has been
subjected to the auditing procedures applied in the audits of the basic
financial statements and, in our opinion, fairly states in all material respects
the financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.

ARTHUR ANDERSEN LLP

Houston, Texas
January 30, 1998

49
<PAGE> 51

SCHEDULE II

SMITH INTERNATIONAL, INC.

VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)

<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED BALANCE
BEGINNING TO AT END
OF YEAR EXPENSE WRITE-OFFS OTHER OF YEAR
------- ------- ---------- ----- -------
<S> <C> <C> <C> <C> <C>
Allowance for Doubtful Accounts:
Year Ended--December 31,
1997 .................................... $ 6,424 $ 1,612 $(2,257) $ 25(a) $ 5,804
Year Ended--December 31,
1996 .................................... $ 6,838 $ 1,490 $(2,338) $ 434(a) $ 6,424
Year Ended--December 31,
1995 .................................... $ 8,679 $ 1,024 $(2,865) -- $ 6,838
</TABLE>

(a) Amounts represent accounts receivable reserves related to acquisitions made
by the Company during the years presented.

50
<PAGE> 52

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

SMITH INTERNATIONAL, INC.

By: /s/ DOUGLAS L. ROCK
-------------------------------------
Douglas L. Rock
Chief Executive Officer,
President and Chief Operating Officer

March 23, 1998

Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities on the date indicated:

<TABLE>

<S> <C> <C>
/s/ DOUGLAS L. ROCK Chairman of the Board, Chief
- ---------------------------- Executive Officer, President and
(Douglas L. Rock) Chief Operating Officer March 23, 1998

/s/ LOREN K. CARROLL Executive Vice President March 23, 1998
- ----------------------------
(Loren K. Carroll)

/s/ JOHN J. KENNEDY Senior Vice President, Chief Financial
- ---------------------------- Officer and Treasurer March 23, 1998
(John J. Kennedy)

/s/ BENJAMIN F. BAILAR Director March 23, 1998
- ----------------------------
(Benjamin F. Bailar)

/s/ G. CLYDE BUCK Director March 23, 1998
- ----------------------------
(G. Clyde Buck)

/s/ JAMES R. GIBBS Director March 23, 1998
- ----------------------------
(James R. Gibbs)

/s/ JERRY W. NEELY Director March 23, 1998
- ----------------------------
(Jerry W. Neely)

/s/ H. MOAK ROLLINS Director March 23, 1998
- ----------------------------
(H. Moak Rollins)
</TABLE>

51
<PAGE> 53

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- ------------

<S> <C>
3.l -- Restated Certificate of Incorporation of the Company as amended
to date. Filed as Exhibit 3.1 to the Company's report on Form 10-K
for the year ended December 31, 1993 and incorporated herein by
reference.

3.2 -- Bylaws of the Company as amended to date. Filed as Exhibit 3.2
to the Company's report on Form 10-K for the year ended December
31, 1993 and incorporated herein by reference.

4.1 -- Rights Agreement, dated as of June 19, 1990, between the
Company and First Chicago Trust Company of New York.

4.2 -- Form of Indenture between the Company and The Bank of New York,
as Trustee. Filed as Exhibit 4.1 to the Company's Registration
Statement on Form S-3 dated August 22, 1997 and incorporated
herein by reference.

4.3 -- Form of Note. Filed as Exhibit 4.2 to Amendment No. 1 to the
Company's Registration Statement on Form S-3 dated September 9,
1997 and incorporated herein by reference.

9. -- Not applicable.

10.1 -- Smith International, Inc. Supplemental Pension Plan as amended
to date. Filed as Exhibit 10.1 to the Company's report on Form
10-K for the year ended December 31, 1995 and incorporated herein
by reference.

10.2 -- Smith International, Inc. 1982 Stock Option Plan. Filed as
Exhibit 10.2 to the Company's report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by reference.

10.3 -- Smith International, Inc. 1989 Long Term Incentive Compensation
Plan, as amended to date. Filed as Exhibit 10.3 to the Company's
report on Form 10-K for the year ended December 31, 1994 and
incorporated herein by reference.

10.4 -- Smith International, Inc. Directors' Retirement Plan as amended
to date. Filed as Exhibit 10.4 to the Company's report on Form
10-K for the year ended December 31, 1995 and incorporated herein
by reference.

10.5 -- Smith International, Inc. Supplemental Executive Retirement
Plan, as amended. Filed as Exhibit 10.5 to the Company's report on
Form 10-K for the year ended December 31, 1993 and incorporated
herein by reference.

10.6 -- Supply Agreement dated April 2, 1987 between the Company and
TCM Holding Corporation and Rogers Tool Works, Inc. for the supply
of tungsten carbide products. Filed as Exhibit 10.6 to the
Company's report on Form 10-K for the year ended December 31, 1995
and incorporated herein by reference.
</TABLE>

<PAGE> 54

<TABLE>
<S> <C>
10.7 -- Amendment to Supply Agreement dated January 22, 1993 between
the Company and Rogers Tool Works, Inc. Filed as Exhibit 10.7 to
the Company's report on Form 10-K for the year ended December 31,
1995 and incorporated herein by reference.

10.8 -- Supply Agreement dated October 1, 1989 between the Company and
Amforge-Smith Forge Company for the supply of forgings. Filed as
Exhibit 10.8 to the Company's report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by reference.

10.9 -- Employment Agreement dated December 10, 1987 between the
Company and Douglas L. Rock. Filed as Exhibit 10.11 to the
Company's report on Form 10-K for the year ended December 31, 1993
and incorporated herein by reference.

10.10 -- Employment Agreement dated December 10, 1987 between the
Company and D. Barry Heppenstall. Filed as Exhibit 10.12 to the
Company's report on Form 10-K for the year ended December 31, 1993
and incorporated herein by reference.

10.11 -- Employment Agreement dated January 2, 1991 between the Company
and Neal S. Sutton. Filed as Exhibit 10.11 to the Company's report
on Form 10-K for the year ended December 31, 1996 and incorporated
herein by reference.

10.12 -- Employment Agreement dated May 1, 1991 between the Company and
Richard A. Werner. Filed as Exhibit 10.12 to the Company's report
on Form 10-K for the year ended December 31, 1996 and incorporated
herein by reference.

10.13 -- Employment Agreement dated April 3, 1995 between the Company
and Roger A. Brown. Filed as Exhibit 10.13 to the Company's report
on Form 10-K for the year ended December 31, 1995 and incorporated
herein by reference.

10.14 -- Amendment to Employment Agreement dated October 16, 1989
between the Company and Douglas L. Rock. Filed as Exhibit 10.14 to
the Company's report on Form 10-K for the year ended December 31,
1995 and incorporated herein by reference.

10.15 -- Amendment to Employment Agreement dated October 16, 1989
between the Company and D. Barry Heppenstall. Filed as Exhibit
10.15 to the Company's report on Form 10-K for the year ended
December 31, 1995 and incorporated herein by reference.

10.16 -- Amendment to Employment Agreement dated January 2, 1991 between
the Company and Neal S. Sutton. Filed as Exhibit 10.16 to the
Company's report on Form 10-K for the year ended December 31, 1996
and incorporated herein by reference.

10.17 -- Amendment to Employment Agreement dated May 1, 1991 between the
Company and Richard A. Werner. Filed as Exhibit 10.17 to the
Company's report on Form 10-K for the year ended December 31, 1996
and incorporated herein by reference.

10.18 -- First Amendment to Amendment to Employment Agreement dated
November 12, 1992 between the Company and Doug Rock. Filed as
Exhibit 10.18 to the Company's report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by reference.
</TABLE>

<PAGE> 55

<TABLE>
<S> <C>
10.19 -- First Amendment to Amendment to Employment Agreement dated
November 12, 1992 between the Company and Barry Heppenstall. Filed
as Exhibit 10.19 to the Company's report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by reference.

10.20 -- First Amendment to Amendment to Employment Agreement
dated November 12, 1992 between the Company and Neal S. Sutton.
Filed as Exhibit 10.20 to the Company's report on Form 10-K for
the year ended December 31, 1995 and incorporated herein by
reference.

10.21 -- First Amendment to Amendment to Employment Agreement dated
November 12, 1992 between the Company and Dick Werner. Filed as
Exhibit 10.21 to the Company's report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by reference.

10.22 -- Note Agreement, dated as of May 21, 1996, between the Company
and Principal Mutual Life Insurance Company, John Hancock Mutual
Life Insurance Company, John Hancock Variable Life Insurance
Company, IDS Certificate Company, Mellon Bank, N.A., as Trustee
for AT&T Master Pension Trust and The Maritime Life Assurance
Company. Filed as Exhibit 10.3 to the Company's report on Form
10-Q for the quarter ended June 30, 1996 and incorporated herein
by reference.

10.23 -- Loan Agreement dated as of April 4, 1996, by and among the
Company and Texas Commerce Bank National Association, a national
banking association, individually and as Agent, and the other
financial institutions parties thereto. Filed as Exhibit 10.1 to
the Company's report on Form 10-Q for the quarter ended June 30,
1996 and incorporated herein by reference.

10.24 -- Loan Agreement dated as of April 4, 1996, by and among M-I
Drilling Fluids Company, L.L.C., Texas Commerce Bank National
Association, individually and as Agent, and the other financial
institutions parties thereto. Filed as Exhibit 10.2 to the
Company's report on Form 10-Q for the quarter ended June 30, 1996
and incorporated herein by reference.

10.25 -- First Amendment to Loan Agreement dated April 8, 1997, by and
among the Company and Texas Commerce Bank National Association, a
national banking association, individually and as Agent, and the
other financial institutions parties thereto. Filed as Exhibit
10.1 to the Company's report on Form 10-Q for the quarter ended
June 30, 1997 and incorporated herein by reference.

10.26 -- First Amendment to Loan Agreement dated April 8, 1997, by and
among M-I Drilling Fluids, L.L.C., Texas Commerce Bank National
Association, a national banking association, individually and as
Agent, and the other financial institutions parties thereto. Filed
as Exhibit 10.2 to the Company's report on Form 10-Q for the
quarter ended June 30, 1997 and incorporated herein by reference.

10.27 -- Second Amendment to Loan Agreement dated December 23, 1997, by
and among the Company and Texas Commerce Bank National
Association, a national banking association, individually and as
Agent, and the other financial institutions parties thereto.
</TABLE>

<PAGE> 56

<TABLE>
<S> <C>
10.28 -- Second Amendment to Loan Agreement dated December 23, 1997, by
and among M-I Drilling Fluids, L.L.C., Texas Commerce Bank
National Association, a national banking association, individually
and as Agent, and the other financial institutions parties
thereto.

11. -- Not applicable.

12. -- Not applicable.

13. -- Not applicable.

18. -- Not applicable.

19. -- Not applicable.

21.1 -- Subsidiaries of the Company

23.1 -- Consent of Independent Public Accountants.

27.1 -- Financial Data Schedule
</TABLE>

<PAGE> 1

EXHIBIT 4.1

SMITH INTERNATIONAL, INC.

and

FIRST CHICAGO TRUST COMPANY

OF NEW YORK

Rights Agent

_________________________________________________

Rights Agreement

Dated as of June 19, 1990
<PAGE> 2
Table of Contents

<TABLE>
<CAPTION>
Section Page
<S> <C> <C>
1 Certain Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

2 Appointment of Rights Agent . . . . . . . . . . . . . . . . . . . . . . . . . . 4

3 Issue of Rights Certificates . . . . . . . . . . . . . . . . . . . . . . . . . 5

4 Form of Rights Certificates . . . . . . . . . . . . . . . . . . . . . . . . . . 6

5 Countersignature and Registration . . . . . . . . . . . . . . . . . . . . . . . 7

6 Transfer, Split Up, Combination and
Exchange of Rights Certificates;
Mutilated, Destroyed, Lost or
Stolen Rights Certificates . . . . . . . . . . . . . . . . . . . . . . . . 7

7 Exercise of Rights; Purchase
Price; Expiration Date of Rights . . . . . . . . . . . . . . . . . . . . . 8

8 Cancellation and Destruction of
Rights Certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

9 Reservation and Availability of
Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

10 Preferred Stock Record Date . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

11 Adjustment of Purchase Price,
Number and Kind of Shares or
Number of Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

12 Certificate of Adjusted Purchase
Price or Number of Shares . . . . . . . . . . . . . . . . . . . . . . . . 17

13 Consolidation, Merger or Sale
or Transfer of Assets or Earning
Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

14 Fractional Rights and Fractional
Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

15 Rights of Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

16 Agreement of Rights Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
</TABLE>

<PAGE> 3
<TABLE>
<CAPTION>
Section Page
- ------- ----
<S> <C> <C>
17 Rights Certificate Holder Not Deemed
a Stockholder . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

18 Concerning the Rights Agent . . . . . . . . . . . . . . . . . . . . . . . . . . 22

19 Merger or Consolidation or Change of
Name of Rights Agent . . . . . . . . . . . . . . . . . . . . . . . . . . 22

20 Duties of Rights Agent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

21 Change of Rights Agent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

22 Issuance of New Rights Certificates . . . . . . . . . . . . . . . . . . . . . . 25

23 Redemption and Termination . . . . . . . . . . . . . . . . . . . . . . . . . . 25

24 Notice of Certain Events . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

25 Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

26 Supplements and Amendments . . . . . . . . . . . . . . . . . . . . . . . . . . 27

27 Successors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

28 Determinations and Actions
by the Board of Directors, etc. . . . . . . . . . . . . . . . . . . . . . 28

29 Benefits of this Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . 28

30 Severability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

31 Governing Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

32 Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

33 Descriptive Headings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
</TABLE>

Exhibit A -- Certificate of Designation, Preferences and Rights

Exhibit B -- Form of Rights Certificate

Exhibit C -- Form of Summary of Rights

ii
<PAGE> 4
RIGHTS AGREEMENT

RIGHTS AGREEMENT, dated as of June 19, 1990 (the "Agreement"),
between Smith International, Inc., a Delaware corporation (the "Company"), and
First Chicago Trust Company of New York, an Illinois banking corporation (the
"Rights Agent").

W I T N E S S E T H

WHEREAS, on June 19, 1990 (the "Rights Dividend Declaration
Date"), the Board of Directors of the Company authorized and declared a
dividend distribution of one right (as hereinafter defined) for each share of
common stock, par value $1.00 per share, of the Company (the "Common Stock")
outstanding at the Close of Business on June 29, 1990 (the "Record Date"), and
has authorized the issuance of one such right (as such number may hereinafter
be adjusted pursuant to the provisions of Section 11(p) hereof) for each share
of Common Stock issued between the Record Date (whether originally issued or
delivered from the Company's treasury) and the Distribution Date (as defined in
Section 3(a)), and in certain circumstances provided in Section 22 hereof,
after the Distribution Date, each such right initially representing the right
to purchase one one-hundredth of a share of Series A Junior Participating
Preferred Stock of the Company, having the rights, powers and preferences set
forth in the form of Certificate of Designation, Preferences and Rights
attached hereto as Exhibit A, upon the terms and subject to the conditions
hereinafter set forth (the "Rights");

NOW, THEREFORE, in consideration of the premises and the mutual
agreements herein set forth, the parties hereby agree as follows:

Section 1. Certain Definitions. For purposes of this Agreement,
the following terms have the meanings indicated:

(a) "Acquiring Person" shall mean any Person who
or which, together with all Affiliates and Associates of such Person, shall be
the Beneficial Owner of 20% or more of the shares of Common Stock then
outstanding other than pursuant to a Qualifying Offer, but shall not include
the Company, any Subsidiary of the Company, any employee benefit plan of the
Company or of any Subsidiary of the Company, or any Person or entity organized,
appointed or established by the Company for or pursuant to the terms of any
such plan provided, however, that "Acquiring Person" shall not include any
Person who, at the Rights Dividend Declaration Date and only as long as such
person is the Beneficial Owner of 20% or more of the shares of Common Stock
then outstanding (an "Existing Holder") unless and until the Existing Holder
shall be the Beneficial Owner of additional shares of Common Stock constituting
1% or more of the then outstanding shares of Common Stock other than pursuant
to a Qualifying offer, and further, provided, that "Acquiring Person" shall not
include any Person who becomes an Acquiring Person solely as a result of a
reduction in the number of shares of Common Stock outstanding due to the
repurchase of shares of Common Stock by the Company, unless and until such
Person shall purchase or otherwise become the Beneficial Owner of additional
shares of Common Stock constituting 1% or more of the then outstanding shares
of Common Stock other than pursuant to a Qualifying Offer.

(b) "Act" shall mean the Securities Act of 1933.

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<PAGE> 5
(c) "Adjustment Shares" shall have the meaning set
forth in Section 11(a)(ii) hereof.

(d) "Affiliate" and "Associate" shall have the
respective meanings ascribed to such terms in Rule 12b-2 of the General Rules
and Regulations under the Exchange Act.

(e) A Person shall be deemed the "Beneficial Owner"
of, and shall be deemed to "beneficially own," any securities:

(i) which such Person or any of such Person's
Affiliates or Associates, directly or indirectly, has the right to
acquire (whether such right is exercisable immediately or only after
the passage of time) pursuant to any agreement, arrangement or
understanding whether or not in writing) or upon the exercise of
conversion rights, exchange rights, rights, warrants or options, or
otherwise; provided, however, that a Person shall not be deemed the
"Beneficial Owner" of, or to "beneficially own," (A) securities
tendered pursuant to a tender or exchange offer made by such Person or
any of such Person's Affiliates or Associates until such tendered
securities are accepted for purchase or exchange, or (B) securities
issuable upon exercise of Rights at any time prior to the occurrence
of a Triggering Event, or (C) securities issuable upon exercise of
Rights from and after the occurrence of a Triggering Event which
Rights were acquired by such Person or any of such Person's Affiliates
or Associates prior to the Distribution Date or pursuant to Section
3(a) or Section 22 hereof (the "Original Rights") or pursuant to
Section 11(i) hereof in connection with an adjustment made with
respect to any Original Rights;

(ii) which such Person or any of such
Person's Affiliates or Associates, directly or indirectly, has the
right to vote or dispose of or has "beneficial ownership" of (as
determined pursuant to Rule l3d-3 of the General Rules and Regulations
under the Exchange Act), including pursuant to any agreement,
arrangement or understanding, whether or not in writing; provided,
however, that a Person shall not be deemed the "Beneficial Owner" of,
or to "beneficially own," any security under this subparagraph (ii) as
a result of an agreement, arrangement or understanding to vote such
security if such agreement, arrangement or understanding: (A) arises
solely from a revocable proxy given in response to a public proxy or
consent solicitation made pursuant to, and in accordance with, the
applicable provisions of the General Rules and Regulations under the
Exchange Act, and (B) is not also then reportable by such Person on
Schedule 13D under the Exchange Act (or any comparable or successor
report); or

(iii) which are beneficially owned, directly
or indirectly, by any other Person (or any Affiliate or Associate
thereof) with which such Person (or any of such Person's Affiliates or
Associates) has any agreement, arrangement or understanding (whether
or not in writing), for the purpose of acquiring, holding, voting
(except pursuant to a revocable proxy as described in the proviso to
subparagraph (ii) of this paragraph (c)) or disposing of any voting
securities of the Company; provided, however, that nothing in this
paragraph (c) shall cause a person engaged in business as an
underwriter of securities to be the "Beneficial Owner" of, or to
"beneficially own," any securities acquired through such person's
participation in good faith in a firm commitment underwriting until
the expiration of forty days after the date of such acquisition.

(f) "Business Day" shall mean any day other than
a Saturday, Sunday or a day on which banking institutions in the State of New
York or the State of Texas are authorized or obligated by law or executive
order to close.

2
<PAGE> 6
(g) "Close of Business" on any given date shall
mean 5:00 P.M., New York City time, on such date; provided, however, that if
such date is not a Business Day it shall mean 5:00 P.M., New York City time, on
the next succeeding Business Day.

(h) "Common Stock" shall mean the common stock,
par value $1.00 per share, of the Company, except that "Common Stock" when used
with reference to any Person other than the Company shall mean the capital
stock of such Person with the greatest voting power, or the equity securities
or other equity interest having power to control or direct the management, of
such Person.

(i) "Common Stock Equivalents" shall have the
meaning set forth in Section 11(a)(iii) hereof.

(j) "Continuing Director" shall mean (i) any member
of the Board of Directors of the Company, while such Person is a member of the
Board, who is not an Acquiring Person, or an Affiliate or Associate of an
Acquiring Person, or a representative of an Acquiring Person, or of any such
Affiliate or Associate, and was a member of the Board prior to the date of this
Agreement, or (ii) any Person who subsequently becomes a member of the Board,
while such Person is a member of the Board, who is not an Acquiring Person, or
an Affiliate or Associate of an Acquiring Person, or a representative of an
Acquiring Person or of any such Affiliate or Associate, if such Person's
nomination for election or election to the Board is recommended or approved by
a majority of the Continuing Directors, provided, however, that in connection
with any proposal to redeem the Rights or amend this Agreement in order to
facilitate any transaction with the Company or its stockholders, any member of
the Board of Directors of the Company who may have an interest in such
transaction other than stockholders or employees of the Company generally,
shall not be a Continuing Director.

(k) "Current Market Price" shall have the meaning
set forth in Section 11(d)(i) hereof.

(l) "Current Value" shall have the meaning set
forth in Section 11(a)(iii) hereof.

(m) "Distribution Date" shall have the meaning set
forth in Section 3(a) hereof.

(n) "Exchange Act" shall mean the Securities
Exchange Act of 1934, as amended and in effect on the date of this Agreement.

(o) "Expiration Date" shall have the meaning set
forth in Section 7(a) hereof.

(p) "Final Expiration Date" shall mean the Close
of Business on June 19, 2000.

(q) "Person" shall mean any individual, firm
corporation, partnership or other entity.

(r) "Preferred Stock" shall mean shares of Series
A Junior Participating Preferred Stock, par value $1.00 per share, of the
Company, and, to the extent that there are not a sufficient number of shares of
Series A Junior Participating Preferred Stock authorized to permit the full
exercise of the Rights, any other series of Preferred Stock, par value $1.00 per
share, of the Company designated for such purpose containing terms substantially
similar to the terms of the Series A Junior Participating Preferred Stock.

(s) "Principal Party" shall have the meaning set
forth in Section 13(b) hereof.

3
<PAGE> 7
(t) "Purchase Price" shall have the meaning set
forth in Section 4(a) hereof.

(u) "Qualifying Offer" shall have the meaning set
forth in Section 11(a)(ii).

(v) "Record Date" shall be June 29, 1990.

(w) "Redemption Price" shall have the meaning set
forth in Section 23(a) hereof.

(x) "Rights" shall have the meaning set forth in
the WHEREAS clause at the beginning of this Agreement.

(y) "Rights Certificate" shall have the meaning set
forth in Section 3(a) hereof.

(z) "Rights Dividend Declaration Date" shall be
June 19, 1990.

(aa) "Section 11(a)(ii) Trigger Date" shall have the
meaning set forth in Section 11(a)(iii) hereof.

(bb) "Section 11(a)(ii) Event" shall mean any event
described in Section 11(a)(ii) hereof.

(cc) "Section 13 Event" shall mean any event
described in clauses (x), (y) or (z) of Section 13(a) hereof.

(dd) "Spread" shall have the meaning set forth in
Section 11(a)(iii) hereof.

(ee) "Stock Acquisition Date" shall mean the first
date of public announcement which, for purposes of this definition, shall
include, without limitation, a report filed pursuant to Section 13(d) under the
Exchange Act) by the Company or an Acquiring Person that an Acquiring Person
has become such.

(ff) "Subsidiary" shall mean, with reference to any
Person, any corporation or other entity of which an amount of voting securities
sufficient to elect at least a majority of the directors or Persons having
similar authority of such corporation or other entity is beneficially owned,
directly or indirectly, by such Person, or otherwise controlled by such Person.

(gg) "Substitution Period" shall have the meaning
set forth in Section 11(a)(iii) hereof.

(hh) "Summary of Rights" shall have the meaning set
forth in Section 3(b) hereof.

(ii) "Trading Day" shall have the meaning set forth
in Section 11(d)(i) hereof.

(jj) "Triggering Event" shall mean any Section
11(a)(ii) Event or any Section 13 Event.

Section 2. Appointment of Rights Agent. The Company
hereby appoints the Rights Agent to act as agent for the Company and the
holders of the Rights (who, in accordance with Section 3 hereof, shall prior to
the Distribution Date also be the holders of the Common Stock) in accordance
with the terms and conditions

4
<PAGE> 8
hereof, and the Rights Agent hereby accepts such appointment. The Company may
from time to time appoint such Co-Rights Agents as it may deem necessary or
desirable.

Section 3. Issue of Rights Certificates.

(a) Until the earlier of (i) the Close of Business on
the tenth business day after the Stock Acquisition Date (or, if the tenth day
after the Stock Acquisition Date occurs before the Record Date, the Close of
Business on the Record Date), and (ii) the Close of Business on the tenth
business day (or such later date as the Board shall determine) after the date
that a tender or exchange offer by any Person (other than the Company, any
Subsidiary of the Company, any employee benefit plan of the Company or of any
Subsidiary of the Company, or any Person or entity organized, appointed or
established by the Company for or pursuant to the terms of any such plan) is
first published or sent or given within the meaning of Rule 14d-2(a) of the
General Rules and Regulations under the Exchange Act, if upon consummation
thereof, such Person would be the Beneficial Owner of 20% or more of the shares
of Common Stock then outstanding (the earlier of (i) and (ii) being herein
referred to as the "Distribution Date"), (x) the Rights will be evidenced
(subject to the provisions of paragraph (b) of this Section 3) by the
certificates for the Common Stock registered in the names of the holders of the
Common Stock (which certificates for Common Stock shall be deemed also to be
certificates for Rights) and not by separate certificates, and (y) the Rights
will be transferable only in connection with the transfer of the underlying
shares of Common Stock (including a transfer to the Company). As soon as
practicable after the Distribution Date, the Rights Agent will send by
first-class, insured, postage prepaid mail, to each record holder of the Common
Stock as of the Close of Business on the Distribution Date, at the address of
such holder shown on the records of the Company, one or more right
certificates, in substantially the form of Exhibit B hereto (the "Rights
Certificates") evidencing one Right for each share of Common Stock so held,
subject to adjustment as provided herein. In the event that an adjustment in
the number of Rights per share of Common Stock has been made pursuant to
Section 11(p) hereof, at the time of distribution of the Rights Certificates,
the Company shall make the necessary and appropriate rounding adjustments (in
accordance with Section 14(a) hereof) so that Rights Certificates representing
only whole numbers of Rights are distributed and cash is paid in lieu of any
fractional Rights. As of and after the Distribution Date, the Rights will be
evidenced solely by such Rights Certificates.

(b) As promptly as practicable following the Record
Date, the Company will send a copy of a Summary of Rights, in substantially the
form attached hereto as Exhibit C (the "Summary of Rights"), by first-class,
postage prepaid mail, to each record holder of the Common Stock as of the Close
of Business on the Record Date, at the address of such holder shown on the
records of the Company. With respect to certificates for the Common Stock
outstanding as of the Record Date, until the Distribution Date, the Rights will
be evidenced by such certificates for the Common Stock and the registered
holders of the Common Stock shall also be the registered holders of the
associated Rights. Until the earlier of the Distribution Date or the Expiration
Date, the transfer of any certificates representing shares of Common Stock in
respect of which Rights have been issued shall also constitute the transfer of
the Rights associated with such shares of Common Stock.

(c) Rights shall be issued in respect of all shares
of Common Stock which are issued (whether originally issued or from the
Company's treasury) after the Record Date but prior to the earlier of the
Distribution Date or the Expiration Date, or, in certain circumstances provided
in Section 22 hereof, after the Distribution Date. Certificates representing
such shares of Common Stock shall also be deemed to be certificates for Rights,
and shall bear the following legend:

This certificate also evidences and
entitles the holder hereof to certain Rights as set forth in
the Rights Agreement between Smith International, Inc. (the
"Company") and First Chicago Trust Company of New York (the
"Rights Agent") dated as of June 19, 1990

5
<PAGE> 9
(the "Rights Agreement"), the terms of which are hereby
incorporated herein by reference and a copy of which is on
file at the principal offices of the Company. Under certain
circumstances, as set forth in the Rights Agreement, such
Rights will be evidenced by separate certificates and will no
longer be evidenced by this certificate. The Company will mail
to the holder of this certificate a copy of the Rights
Agreement, as in effect on the date of mailing, without charge
promptly after receipt of a written request therefor. Under
certain circumstances set forth in the Rights Agreement,
Rights issued to, or held by, any Person who is, was or
becomes an Acquiring Person or any Affiliate or Associates
thereof (as such terms are defined in the Rights Agreement),
whether currently held by or on behalf of such Person or by
any subsequent holder, may become null and void.

With respect to such certificates containing the foregoing legend, until the
earlier of (i) the Distribution Date or (ii) the Expiration Date, the Rights
associated with the Common Stock represented by such certificates shall be
evidenced by such certificates alone and registered holders of Common Stock
shall also be the registered holders of the associated Rights, and the transfer
of any of such certificates shall also constitute the transfer of the Rights
associated with the Common Stock represented by such certificates.

Section 4. Form of Rights Certificates.

(a) The Rights Certificates (and the forms of
election to purchase and of assignment to be printed on the reverse thereof)
shall each be substantially in the form set forth in Exhibit B hereto and may
have such marks of identification or designation and such legends, summaries or
endorsements printed thereon as the Company may deem appropriate and as are not
inconsistent with the provisions of this Agreement, or as may be required to
comply with any applicable law or with any rule or regulation made pursuant
thereto or with any rule or regulation of any stock exchange on which the
Rights may from time to time be listed, or to conform to usage. Subject to the
provisions of Section 11 and Section 22 hereof, the Rights Certificates,
whenever distributed, shall be dated as of the Record Date and on their face
shall entitle the holders thereof to purchase such number of one one-hundredths
of a share of Preferred Stock as shall be set forth therein at the price set
forth therein (such exercise price per one one-hundredth of a share, the
"Purchase Price"), but the amount and type of securities purchasable upon the
exercise of each Right and the Purchase Price thereof shall be subject to
adjustment as provided herein.

(b) Any Rights Certificate issued pursuant to Section
3(a) or Section 22 hereof that represents Rights beneficially owned by: (i) an
Acquiring Person or any Associate or Affiliate of an Acquiring Person, (ii) a
transferee of an Acquiring Person (or of any such Associate or Affiliate) who
becomes a transferee after the Acquiring Person becomes such, or (iii) a
transferee of an Acquiring Person (or of any such Associate or Affiliate) who
becomes a transferee prior to or concurrently with the Acquiring Person
becoming such and receives such Rights pursuant to either (A) a transfer
(whether or not for consideration) from the Acquiring Person to holders of
equity interests in such Acquiring Person or to any Person with whom such
Acquiring Person has any continuing agreement, arrangement or understanding
regarding the transferred Rights or (B) a transfer which the Board of Directors
of the Company has determined is part of a plan, arrangement or understanding
which has as a primary purpose or effect avoidance of Section 7(e) hereof, and
any Rights Certificate issued pursuant to Section 6 or Section 11 hereof upon
transfer, exchange, replacement or adjustment of any other Rights Certificate
referred to in this sentence, shall contain (to the extent feasible) the
following legend:

The Rights represented by this Rights
Certificate are or were beneficially owned by a Person who
was or became an Acquiring Person or an Affiliate or
Associate of an Acquiring

6
<PAGE> 10
Person (as such terms are defined in the Rights Agreement).
Accordingly, this Rights Certificate and the Rights
represented hereby may become null and void in the
circumstances specified in Section 7(e) of such Agreement.

Section 5. Countersignature and Registration.

(a) The Rights Certificates shall be executed on
behalf of the Company by its Chairman of the Board, its President or any Vice
President, either manually or by facsimile signature, and shall have affixed
thereto the Company's seal or a facsimile thereof which shall be attested by
the Secretary or an Assistant Secretary of the Company, either manually or by
facsimile signature. The Rights Certificates shall be manually countersigned by
the Rights Agent and shall not be valid for any purpose unless so
countersigned. In case any officer of the Company who shall have signed any of
the Rights Certificates shall cease to be such officer of the Company before
countersignature by the Rights Agent and issuance and delivery by the Company,
such Rights Certificates, nevertheless, may be countersigned by the Rights
Agent and issued and delivered by the Company with the same force and effect as
though the person who signed such Rights Certificates had not ceased to be such
officer of the Company; and any Rights Certificates may be signed on behalf of
the Company by any person who, at the actual date of the execution of such
Rights Certificate, shall be a proper officer of the Company to sign such
Rights Certificate, although at the date of the execution of this Rights
Agreement any such person was not such an officer.

(b) Following the Distribution Date, the Rights Agent
will keep or cause to be kept, at its principal office or offices designated as
the appropriate place for surrender of Rights Certificates upon exercise or
transfer, books for registration and transfer of the Rights Certificates issued
hereunder. Such books shall show the names and addresses of the respective
holders of the Rights Certificates, the number of Rights evidenced on its face
by each of the Rights Certificates and the date of each of the Rights
Certificates.

Section 6. Transfer, Split Up, Combination and Exchange
of Rights Certificates; Mutilated, Destroyed, Lost or Stolen Rights
Certificates. (a) Subject to the provisions of Section 4(b), Section 7(e) and
Section 14 hereof, at any time after the Close of Business on the Distribution
Date, and at or prior to the Close of Business on the Expiration Date, any
Rights Certificate or Certificates may be transferred, split up, combined or
exchanged for another Rights Certificate or Certificates, entitling the
registered holder to purchase a like number of one one-hundredths of a share of
Preferred Stock (or, following a Triggering Event, Common Stock, other
securities, cash or other assets, as the case may be) as the Rights Certificate
or Certificates surrendered then entitled such holder (or former holder in the
case of a transfer) to purchase. Any registered holder desiring to transfer,
split up, combine or exchange any Rights Certificate or Certificates shall make
such request in writing delivered to the Rights Agent, and shall surrender the
Rights Certificate or Certificates to be transferred, split up, combined or
exchanged at the principal office or offices of the Rights Agent designated for
such purpose, Neither the Rights Agent nor the Company shall be obligated to
take any action whatsoever with respect to the transfer of any such surrendered
Rights Certificate until the registered holder shall have completed and signed
the certificate contained in the form of assignment on the reverse side of such
Rights Certificate and shall have provided such additional evidence of the
identity of the Beneficial Owner (or former Beneficial Owner) or Affiliates or
Associates thereof as the Company shall reasonably request. Thereupon the Rights
Agent shall, subject to Section 4(b), Section 7(e) and Section 14 hereof,
countersign and deliver to the Person entitled thereto a Rights Certificate or
Rights Certificates, as the case may be, as so requested. The Company may
require payment of a sum sufficient to cover any tax or governmental charge that
may be imposed in connection with any transfer, split up, combination or
exchange of Rights Certificates.

7
<PAGE> 11
(b) Upon receipt by the Company and the Rights Agent
of evidence reasonably satisfactory to them of the loss, theft, destruction or
mutilation of a Rights Certificate, and, in case of loss, theft or destruction,
of indemnity or security reasonably satisfactory to them, and reimbursement to
the Company and the Rights Agent of all reasonable expenses incidental thereto,
and upon surrender to the Rights Agent and cancellation of the Rights
Certificate if mutilated, the Company will execute and deliver a new Rights
Certificate of like tenor to the Rights Agent for countersignature and delivery
to the registered owner in lieu of the Rights Certificate so lost, stolen,
destroyed or mutilated.

Section 7. Exercise of Rights; Purchase Price;
Expiration Date of Rights. (a) Subject to Section 7(e) hereof, the registered
holder of any Rights Certificate may exercise the Rights evidenced thereby
(except as otherwise provided herein including, without limitation, the
restrictions on exercisability set forth in Section 9(c), Section 11(a)(iii)
and Section 23(a) hereof) in whole or in part at any time after the
Distribution Date upon surrender of the Rights Certificate, with the form of
election to purchase and the certificate on the reverse side thereof duly
executed, to the Rights Agent at the principal office or offices of the Rights
Agent designated for such purpose, together with payment of the aggregate
Purchase Price with respect to the total number of one one-hundredths of a
share (or other securities, cash or other assets, as the case may be) as to
which such surrendered Rights are then exercisable, at or prior to the earlier
of (i) the Close of Business on June 19, 2000 (the "Final Expiration Date"), or
(ii) the time at which the Rights are redeemed as provided in Section 23 hereof
(the earlier of (i) and (ii) being herein referred to as the "Expiration
Date").

(b) The Purchase Price for each one one-hundredth of a
share of Preferred Stock pursuant to the exercise of a Right shall initially be
$________, and shall be subject to adjustment from time to time as provided in
Sections 11 and 13(a) hereof and shall be payable in accordance with paragraph
(c) below.

(c) Upon receipt of a Rights Certificate representing
exercisable Rights, with the form of election to purchase and the certificate
duly executed, accompanied by payment, with respect to each Right so exercised,
of the Purchase Price per one one-hundredth of a share of Preferred Stock (or
other shares, securities, cash or other assets, as the case may be) to be
purchased as set forth below and an amount equal to any applicable transfer
tax, the Rights Agent shall, subject to Section 20(k) hereof, thereupon
promptly (i) (A) requisition from any transfer agent of the shares of Preferred
Stock (or make available, if the Rights Agent is the transfer agent for such
shares) certificates for the total number of one one-hundredths of a share of
Preferred Stock to be purchased and the Company hereby irrevocably authorizes
its transfer agent to comply with all such requests, or (B) if the Company
shall have elected to deposit the total number of shares of Preferred Stock
issuable upon exercise of the Rights hereunder with a depositary agent,
requisition from the depositary agent depositary receipts representing such
number of one one-hundredths of a share of Preferred Stock as are to be
purchased (in which case certificates for the shares of Preferred Stock
represented by such receipts shall be deposited by the transfer agent with the
depositary agent) and the Company will direct the depositary agent to comply
with such request, (ii) requisition from the Company the amount of cash, if
any, to be paid in lieu of fractional shares in accordance with Section 14
hereof, (iii) after receipt of such certificates or depositary receipts, cause
the same to be delivered to or upon the order of the registered holder of such
Rights Certificate, registered in such name or names as may be designated by
such holder, and (iv) after receipt thereof, deliver such cash, if any, to or
upon the order of the registered holder of such Rights Certificate. The payment
of the Purchase Price (as such amount may be reduced pursuant to Section
11(a)(iii) hereof) shall be made in cash or by certified bank check or bank
draft payable to the order of the Company. In the event that the Company is
obligated to issue other securities (including Common Stock) of the Company,
pay cash and/or distribute other property pursuant to Section 11(a) hereof, the
Company will make all arrangements necessary so that such other securities,
cash and/or other property are available for distribution by the Rights Agent,
if and when appropriate.

8
<PAGE> 12
The Company reserves the right to require prior to the occurrence of a
Triggering Event that, upon any exercise of Rights, a number of Rights be
exercised so that only whole shares of Preferred Stock would be issued.

(d) In case the registered holder of any Rights
certificate shall exercise less than all the Rights evidenced thereby, a new
Rights Certificate evidencing Rights equivalent to the Rights remaining
unexercised shall be issued by the Rights Agent and delivered to, or upon the
order of, the registered holder of such Rights Certificate, registered in such
name or names as may be designated by such holder, subject to the provisions of
Section 14 hereof.

(e) Notwithstanding anything in this Agreement to the
contrary, from and after the first occurrence of a Section 11(a)(ii) Event, any
Rights beneficially owned by (i) an Acquiring Person or an Associate or
Affiliate of an Acquiring Person, (ii) a transferee of an Acquiring Person (or
of any such Associate or Affiliate) who becomes a transferee after the
Acquiring Person becomes such, or (iii) a transferee of an Acquiring Person (or
of any such Associate or Affiliate) who becomes a transferee prior to or
concurrently with the Acquiring Person becoming such and receives such Rights
pursuant to either (A) a transfer whether or not for consideration) from the
Acquiring Person to holders of equity interests in such Acquiring Person or to
any Person with whom the Acquiring Person has any continuing agreement,
arrangement or understanding regarding the transferred Rights or (B) a transfer
which the Board of Directors of the Company has determined is part of a plan,
arrangement or understanding which has as a primary purpose or effect the
avoidance of this Section 7(e), shall become null and void without any further
action and no holder of such Rights shall have any rights whatsoever with
respect to such Rights, whether under any provision of this Agreement or
otherwise. The Company shall use all reasonable efforts to insure that the
provisions of this Section 7(e) and Section 4(b) hereof are complied with, but
shall have no liability to any holder of Rights Certificates or other Person as
a result of its failure to make any determinations with respect to an Acquiring
Person or its Affiliates, Associates or transferees hereunder. The Company may
require (or cause the Rights Agent or any transfer agent of the Company to
require) any Person who submits a Rights Certificate (or a certificate
representing shares of Common Stock that evidences, or but for the provisions
of this Section 7(e) would evidence, Rights) for transfer on the registry books
or to exercise the Rights represented thereby to establish to the satisfaction
of the Company in its sole discretion that such Rights have not become null and
void pursuant to the provisions of this Section 7(e).

(f) Notwithstanding anything in this Agreement to the
contrary, neither the Rights Agent nor the Company shall be obligated to
undertake any action with respect to a registered holder upon the occurrence of
any purported exercise as set forth in this Section 7 unless such registered
holder shall have (i) completed and signed the certificate contained in the
form of election to purchase set forth on the reverse side of the Rights
Certificate surrendered for such exercise, and (ii) provided such additional
evidence of the identity of the Beneficial Owner (or former Beneficial owner)
or Affiliates or Associates thereof as the Company shall reasonably request.

Section 8. Cancellation and Destruction of Rights
Certificates. All Rights Certificates surrendered for the purpose of
exercise, transfer, split up, combination or exchange shall, if surrendered to
the Company or any of its agents, be delivered to the Rights Agent for
cancellation or in cancelled form, or, if surrendered to the Rights Agent,
shall be cancelled by it, and no Rights Certificates shall be issued in lieu
thereof except as expressly permitted by any of the provisions of this
Agreement. The Company shall deliver to the Rights Agent for cancellation and
retirement, and the Rights Agent shall so cancel and retire, any other Rights
Certificate purchased or acquired by the Company otherwise than upon the
exercise thereof. The Rights Agent shall deliver all cancelled Rights
Certificates to the Company, or shall, at the written request of the Company,
destroy such cancelled Rights Certificates, and in such case shall deliver a
certificate of destruction thereof to the Company.

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<PAGE> 13
Section 9. Reservation and Availability of Capital
Stock. (a) The Company covenants and agrees that it will cause to be reserved
and kept available out of its authorized and unissued shares of Preferred Stock
(and, following the occurrence of a Triggering Event, out of its authorized and
unissued shares of Common Stock and/or other securities or out of its
authorized and issued shares held in its treasury), the number of shares of
Preferred Stock (and, following the occurrence of a Triggering Event, Common
Stock and/or other securities) that, as provided in this Agreement including
Section 11(a)(iii) hereof, will be sufficient to permit the exercise in full of
all outstanding Rights.

(b) So long as the shares of Preferred Stock (and,
following the occurrence of a Triggering Event, Common Stock and/or other
securities) issuable and deliverable upon the exercise of the Rights may be
listed on any national securities exchange, the Company shall use its best
efforts to cause, from and after such time as the Rights become exercisable
(but only to the extent that it is reasonably likely that the Rights will be
exercised), all shares reserved for such issuance to be listed on such exchange
upon official notice of issuance upon such exercise.

(c) The Company shall use its best efforts to (i)
file, as soon as practicable following the earliest date after the first
occurrence of a Section 11(a)(ii) Event on which the consideration to be
delivered by the Company upon exercise of the Rights has been determined in
accordance with Section 11(a)(iii) hereof, a registration statement under the
Act, with respect to the securities purchasable upon exercise of the Rights on
an appropriate form, (ii) cause such registration statement to become effective
as soon as practicable after such filing, and (iii) cause such registration
statement to remain effective (with a prospectus at all times meeting the
requirements of the Act) until the earlier of (A) the date as of which the
Rights are no longer exercisable for such securities, and (B) the date of the
expiration of the Rights. The Company will also take such action as may be
appropriate under, or to ensure compliance with, the securities or "blue sky"
laws of the various states in connection with the exercisability of the Rights.
The Company may temporarily suspend, for a period of time not to exceed ninety
(90) days after the date set forth in clause (i) of the first sentence of this
Section 9(c), the exercisability of the Rights in order to prepare and file
such registration statement and permit it to become effective. Upon any such
suspension, the Company shall issue a public announcement stating that the
exercisability of the Rights has been temporarily suspended, as well as a
public announcement at such time as the suspension is no longer in effect. In
addition, if the Company shall determine that a registration statement is
required following the Distribution Date, the Company may temporarily suspend
the exercisability of the Rights until such time as a registration statement
has been declared effective. Notwithstanding any provision of this Agreement to
the contrary, the Rights shall not be exercisable in any jurisdiction if the
requisite qualification in such jurisdiction shall not have been obtained, the
exercise thereof shall not be permitted under applicable law or a registration
statement shall not have been declared effective.

(d) The Company covenants and agrees that it will
take all such action as may be necessary to ensure that all one one-hundredths
of a share of Preferred Stock (and, following the occurrence of a Triggering
Event, Common Stock and/or other securities) delivered upon exercise of Rights
shall, at the time of delivery of the certificates for such shares (subject to
payment of the Purchase Price), be duly and validly authorized and issued and
fully paid and nonassessable.

(e) The Company further covenants and agrees that it
will pay when due and payable any and all federal and state transfer taxes and
charges which may be payable in respect of the issuance or delivery of the
Rights Certificates and of any certificates for a number of one one-hundredths
of a share of Preferred Stock (or Common Stock and/or other securities, as the
case may be) upon the exercise of Rights. The Company shall not, however, be
required to pay any transfer tax which may be payable in respect of any
transfer or delivery of

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<PAGE> 14
Rights Certificates to a Person other than, or the issuance or delivery of a
number of one one-hundredths of a share of Preferred Stock (or Common Stock
and/or other securities, as the case may be) in respect of a name other than
that of, the registered holder of the Rights Certificates evidencing Rights
surrendered for exercise or to issue or deliver any certificates for a number
of one one-hundredths of a share of Preferred Stock (or Common Stock and/or
other securities, as the case may be) in a name other than that of the
registered holder upon the exercise of any Rights until such tax shall have
been paid (any such tax being payable by the holder of such Rights Certificate
at the time of surrender) or until it has been established to the Company's
satisfaction that no such tax is due.

Section 10. Preferred Stock Record Date. Each person in
whose name any certificate for a number of one one-hundredths of a share of
Preferred Stock (or Common Stock and/or other securities, as the case may be)
is issued upon the exercise of Rights shall for all purposes be deemed to have
become the holder of record of such fractional shares of Preferred Stock (or
Common Stock and/or other securities, as the case may be) represented thereby
on, and such certificate shall be dated, the date upon which the Rights
Certificate evidencing such Rights was duly surrendered and payment of the
Purchase Price (and all applicable transfer taxes) was made; provided, however,
that if the date of such surrender and payment is a date upon which the
Preferred Stock (or Common Stock and/or other securities, as the case may be)
transfer books of the Company are closed, such Person shall be deemed to have
become the record holder of such shares (fractional or otherwise) on, and such
certificate shall be dated, the next succeeding Business Day on which the
Preferred Stock (or Common Stock and/or other securities, as the case may be)
transfer books of the Company are open. Prior to the exercise of the Rights
evidenced thereby, the holder of a Rights Certificate shall not be entitled to
any rights of a stockholder of the Company with respect to shares for which the
Rights shall be exercisable, including, without limitation, the right to vote,
to receive dividends or other distributions or to exercise any preemptive
rights, and shall not be entitled to receive any notice of any proceedings of
the Company, except as provided herein.

Section 11. Adjustment of Purchase Price, Number and Kind
of Shares or Number of Rights. The Purchase Price, the number and kind of
shares covered by each Right and the number of Rights outstanding are subject
to adjustment from time to time as provided in this Section 11.

(a)(i) In the event the Company shall at any
time after the date of this Agreement (A) declare a dividend on the Preferred
Stock payable in shares of Preferred Stock, (B) subdivide the outstanding
Preferred Stock, (C) combine the outstanding Preferred Stock into a smaller
number of shares, or (D) issue any shares of its capital stock in a
reclassification of the Preferred Stock (including any such reclassification in
connection with a consolidation or merger in which the Company is the
continuing or surviving corporation), except as otherwise provided in this
Section 11(a) and Section 7(e) hereof, the Purchase Price in effect at the time
of the record date for such dividend or of the effective date of such
subdivision, combination or reclassification, and the number and kind of shares
of Preferred Stock or capital stock, as the case may be, issuable on such date,
shall be proportionately adjusted so that the holder of any Right exercised
after such time shall be entitled to receive, upon payment of the Purchase
Price then in effect, the aggregate number and kind of shares of Preferred
Stock or capital stock, as the case may be, which, if such Right had been
exercised immediately prior to such date and at a time when the Preferred Stock
transfer books of the Company were open, he would have owned upon such exercise
and been entitled to receive by virtue of such dividend, subdivision,
combination or reclassification. If an event occurs which would require an
adjustment under both this Section 11(a)(i) and Section 11(a)(ii) hereof, the
adjustment provided for in this Section 11(a)(i) shall be in addition to, and
shall be made prior to, any adjustment required pursuant to Section 11(a)(ii)
hereof.

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<PAGE> 15
(ii) In the event any Person (other than the Company, any
Subsidiary of the Company,any employee benefit plan of the Company or
of any Subsidiary of the Company, or any Person or entity organized,
appointed or established by the Company for or pursuant to the terms
of any such plan), alone or together with its Affiliates and
Associates, shall, at any time after the Rights Dividend Declaration
Date, become an Acquiring Person, unless the event causing such Person
to become an Acquiring Person is a transaction set forth in Section
13(a) hereof, or is an acquisition of shares of Common Stock pursuant
to a tender offer or an exchange offer for all outstanding shares of
Common Stock at a price and on terms determined by at least a majority
of the members of the Board of Directors who are not officers of the
Company and who are not representatives, nominees, Affiliates or
Associates of an Acquiring Person, after receiving advice from one or
more investment banking firms, to be (a) at a price which is fair to
stockholders (taking into account all factors which such members of
the Board deem relevant including, without limitation, prices which
could reasonably be achieved if the Company or its assets were sold on
an orderly basis designed to realize maximum value) and (b) otherwise
in the best interests of the Company and its stockholders (an offer
meeting the requirements set forth above being referred to herein as a
"Qualifying Offer") then, promptly following five (5) days after the
date of the occurrence of any such event, proper provision shall be
made so that each holder of a Right (except as provided below and in
Section 7(e) hereof) shall thereafter have the right to receive, upon
exercise thereof at the then current Purchase Price in accordance with
the terms of this Agreement, in lieu of a number of one one-
hundredths of a share of Preferred Stock, such number of shares of
Common Stock of the Company as shall equal the result obtained by (x)
multiplying the then current Purchase Price by the then number of one
one-hundredths of a share of Preferred Stock for which a Right was
exercisable immediately prior to the first occurrence of a Section
11(a)(ii) Event, and (y) dividing that product (which, following such
first occurrence, shall thereafter be referred to as the "Purchase
Price" for each Right and for all purposes of this Agreement) by 50%
of the Current Market Price (determined pursuant to Section 11(d)
hereof) per share of Common Stock on the date of such first occurrence
(such number of shares, the "Adjustment Shares").

(iii) Subject to such limitations existing as of the date
hereof as are necessary to prevent a default under any agreement
to which the Company is a party, in the event that the number of shares
of Common Stock which are authorized by the Company's certificate of
incorporation but not outstanding or reserved for issuance for purposes
other than upon exercise of the Rights are not sufficient to permit the
exercise in full of the Rights in accordance with the foregoing
subparagraph (ii) of this Section 11(a), the Company shall (A)
determine the excess of (1) the value of the Adjustment Shares issuable
upon the exercise of a Right determined as set forth below (the
"Current Value") over (2) the Purchase Price (such excess, the
"Spread"), and (B) with respect to each Right (subject to Section 7(e)
hereof), make adequate provision to substitute for the Adjustment
Shares, upon the exercise of a Right and payment of the applicable
Purchase Price, (1) cash, (2) a reduction in the Purchase Price, (3)
Common Stock or other equity securities of the Company (including,
without limitation, shares, or units of shares, of preferred stock,
such as the Preferred Stock, which the Board has deemed to have
essentially the same value or economic rights as shares of Common Stock
(such shares of preferred stock being referred to as "Common Stock
Equivalents"), (4) debt securities of the Company, (5) other assets, or
(6) any combination of the foregoing, having an aggregate value equal
to the Current Value (less the amount of any reduction in the Purchase
Price), where such aggregate value has been determined by the Board
based upon the advice of a nationally recognized investment banking
firm selected by the Board; provided, however, that if the Company
shall not have made adequate provision to deliver value pursuant to
clause (B) above within thirty (30) days following the later of (x) the
first occurrence of a Section 11(a)(ii) Event and (y) the date on which
the Company's right of redemption pursuant to Section 23(a) expires
(the later of (x) and (y) being referred to herein as the "Section
11(a)(ii) Trigger Date"), then the

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<PAGE> 16
Company shall be obligated to deliver, upon the surrender for exercise
of a Right and without requiring payment of the Purchase Price, shares
of Common Stock (to the extent available) and then, if necessary,
cash, which shares and/or cash have an aggregate value equal to the
Spread. If the Board determines in good faith that it is likely that
sufficient additional shares of Common Stock could be authorized for
issuance upon exercise in full of the Rights, the thirty (30) day
period set forth above may be extended to the extent necessary, but
not more than ninety (90) days after the Section 11(a)(ii) Trigger
Date, in order that the Company may seek shareholder approval for the
authorization of such additional shares (such thirty (30) day period,
as it may be extended, is herein called the "Substitution Period"). To
the extent that action is to be taken pursuant to the first and/or
second sentences of this Section 11(a)(iii), the Company (1) shall
provide, subject to Section 7(e) hereof, that such action shall apply
uniformly to all outstanding Rights, and (2) may suspend the
exercisability of the Rights until the expiration of the Substitution
Period in order to seek such shareholder approval for such
authorization of additional shares and/or to decide the appropriate
form of distribution to be made pursuant to such first sentence and to
determine the value thereof. In the event of any such suspension, the
Company shall issue a public announcement stating that the
exercisability of the Rights has been temporarily suspended, as well
as a public announcement at such time as the suspension is no longer
in effect. For purposes of this Section 11(a)(iii), the Current Value
of each Adjustment Share shall be the Current Market Price per share
of the Common Stock on the Section 11(a)(ii) Trigger Date and the per
share or per unit value of any Common Stock Equivalent shall be deemed
to equal the Current Market Price per share of the Common Stock on
such date.

(b) In case the Company shall fix a record date
for the issuance of rights, options or warrants to all holders of Preferred
Stock entitling them to subscribe for or purchase (for a period expiring within
forty-five (45) calendar days after such record date) Preferred Stock (or shares
having the same rights, privileges and preferences as the shares of Preferred
Stock ("equivalent preferred stock")) or securities convertible into Preferred
Stock or equivalent preferred stock at a price per share of Preferred Stock or
per share of equivalent preferred stock (or having a conversion price per share,
if a security convertible into Preferred Stock or equivalent preferred stock)
less than the Current market Price (as determined pursuant to Section 11(d)
hereof) per share of Preferred Stock on such record date, the Purchase Price to
be in effect after such record date shall be determined by multiplying the
Purchase Price in effect immediately prior to such record date by a fraction,
the numerator of which shall be the number of shares of Preferred Stock
outstanding on such record date, plus the number of shares of Preferred Stock
which the aggregate offering price of the total number of shares of Preferred
Stock and/or equivalent preferred stock so to be offered (and/or the aggregate
initial conversion price of the convertible securities so to be offered) would
purchase at such current market price, and the denominator of which shall be the
number of shares of Preferred Stock outstanding on such record date, plus the
number of additional shares of Preferred stock and/or equivalent preferred stock
to be offered for subscription or purchase (or into which the convertible
securities so to be offered are initially convertible). In case such
subscription price may be paid by delivery of consideration part or all of which
may be in a form other than cash, the value of such consideration shall be as
determined in good faith by the Board of Directors of the Company, whose
determination shall be described in a statement filed with the Rights Agent and
shall be binding on the Rights Agent and the holders of the Rights. Shares of
Preferred Stock owned by or held for the account of the Company shall not be
deemed outstanding for the purpose of any such computation. Such adjustment
shall be made successively whenever such a record date is fixed, and in the
event that such rights or warrants are not so issued, the Purchase Price shall
be adjusted to be the Purchase Price which would then be in effect if such
record date had not been fixed.

(c) In case the Company shall fix a record date
for a distribution to all holders of Preferred Stock (including any such
distribution made in connection with a consolidation or merger in which the

13
<PAGE> 17
Company is the continuing corporation) of evidences of indebtedness, cash
(other than a regular quarterly cash dividend out of the earnings or retained
earnings of the Company), assets (other than a dividend payable in Preferred
Stock, but including any dividend payable in stock other than Preferred Stock)
or subscription rights or warrants (excluding those referred to in Section
11(b) hereof), the Purchase Price to be in effect after such record date shall
be determined by multiplying the Purchase Price in effect immediately prior to
such record date by a fraction, the numerator of which shall be the current
market price (as determined pursuant to Section 11(d) hereof) per share of
Preferred Stock on such record date, less the fair market value (as determined
in good faith by the Board of Directors of the Company, whose determination
shall be described in a statement filed with the Rights Agent) of the portion
of the cash, assets or evidences of indebtedness so to be distributed or of
such subscription rights or warrants applicable to a share of Preferred Stock
and the denominator of which shall be such current market price (as determined
pursuant to Section 11(d) hereof) per share of Preferred Stock. Such
adjustments shall be made successively whenever such a record date is fixed,
and in the event that such distribution is not so made, the Purchase Price
shall be adjusted to be the Purchase Price which would have been in effect if
such record date had not been fixed.

(d) (i) For the purpose of any computation
hereunder, other than computations made pursuant to Section 11(a)(iii)
hereof, the Current Market Price (as defined below) per share of
Common Stock on any date shall be deemed to be the average of the
daily closing prices per share of such Common Stock for the thirty
(30) consecutive Trading Days (as defined below) immediately prior to
such date, and for purposes of computations made pursuant to Section
11(a)(iii) hereof, the Current Market Price per share of Common Stock
on any date shall be deemed to be the average of the daily closing
prices per share of such Common Stock for the ten (10) consecutive
Trading Days immediately following such date; provided, however, that
in the event that the Current Market Price per share of the Common
Stock is determined during a period following the announcement by the
issuer of such Common Stock of (A) a dividend or distribution on such
Common Stock payable in shares of such Common Stock or securities
convertible into shares of such Common Stock (other than the Rights),
or (B) any subdivision, combination or reclassification of such Common
Stock, and the ex-dividend date for such dividend or distribution, or
the record date for such subdivision, combination or reclassification
shall not have occurred prior to the commencement of the requisite
thirty (30) Trading Day or ten (10) Trading Day period, as set forth
above, then, and in each such case, the Current Market Price shall be
properly adjusted to take into account ex-dividend trading. The
closing price for each day shall be the last sale price, regular way,
or, in case no such sale takes place on such day, the average of the
closing bid and asked prices, regular way, in either case as reported
in the principal consolidated transaction reporting system with
respect to securities listed or admitted to trading on the New York
Stock Exchange or, if the shares of Common Stock are not listed or
admitted to trading on the New York Stock Exchange, as reported in the
principal consolidated transaction reporting system with respect to
securities listed on the principal national securities exchange on
which the shares of Common Stock are listed or admitted to trading or,
if the shares of Common Stock are not listed or admitted to trading on
any national securities exchange, the last quoted price or, if not so
quoted, the average of the high bid and low asked prices in the
over-the-counter market, as reported by the National Association of
Securities Dealers, Inc. Automated Quotation System or such other
system then in use, or, if on any such date the shares of Common Stock
are not quoted by any such organization, the average of the closing
bid and asked prices as furnished by a professional market maker
making a market in the Common Stock selected by the Board. If on any
such date no market maker is making a market in the Common Stock, the
fair value of such shares on such date as determined in good faith by
the Board shall be used. The term "Trading Day" shall mean a day on
which the principal national securities exchange on which the shares
of Common Stock are listed or admitted to trading is open for the
transaction of business or, if the shares of Common Stock are not
listed or admitted to trading on any national securities exchange, a
Business Day. If the

14
<PAGE> 18
Common Stock is not publicly held or not so listed or traded, Current
Market Price per share shall mean the fair value per share as
determined in good faith by the Board, whose determination shall be
described in a statement filed with the Rights Agent and shall be
conclusive for all purposes.

(ii) For the purpose of any computation
hereunder, the Current Market Price per share of Preferred Stock shall
be determined in the same manner as set forth above for the Common
Stock in clause (i) of this Section 11(d) (other than the last
sentence thereof). If the Current Market Price per share of Preferred
Stock cannot be determined in the manner provided above or if the
Preferred Stock is not publicly held or listed or traded in a manner
described in clause (i) of this Section 11(d), the Current Market
Price per share of Preferred Stock shall be conclusively deemed to be
an amount equal to 100 (as such number may be appropriately adjusted
for such events as stock splits, stock dividends and recapitalizations
with respect to the Common Stock occurring after the date of this
Agreement) multiplied by the Current Market Price per share of the
Common Stock. If neither the Common Stock nor the Preferred Stock is
publicly held or so listed or traded, Current Market Price per share
of the Preferred Stock shall mean the fair value per share as
determined in good faith by the Board, whose determination shall be
described in a statement filed with the Rights Agent and shall be
conclusive for all purposes. For all purposes of this Agreement, the
Current Market Price of one one-hundredth of a share of Preferred
Stock shall be equal to the Current Market Price of one share of
Preferred Stock divided by 100.

(e) Anything herein to the contrary
notwithstanding, no adjustment in the Purchase Price shall be required unless
such adjustment would require an increase or decrease of at least one percent
(1%) in the Purchase Price; provided, however, that any adjustments which by
reason of this Section 11(e) are not required to be made shall be carried
forward and taken into account in any subsequent adjustment. All calculations
under this Section 11 shall be made to the nearest cent or to the nearest
ten-thousandth of a share of Common Stock or other share or one-millionth of a
share of Preferred Stock, as the case may be. Notwithstanding the first
sentence of this Section 11(e), any adjustment required by this Section 11
shall be made no later than the earlier of (i) three (3) years from the date of
the transaction which mandates such adjustment, or (ii) the Expiration Date.

(f) If as a result of an adjustment made pursuant
to Section 11(a)(ii) or Section 13(a) hereof, the holder of any Right
thereafter exercised shall become entitled to receive any shares of capital
stock other than Preferred Stock, thereafter the number of such other shares so
receivable upon exercise of any Right and the Purchase Price thereof shall be
subject to adjustment from time to time in a manner and on terms as nearly
equivalent as practicable to the provisions with respect to the Preferred Stock
contained in Sections 11(a), (b), (c), (e), (g), (h), (i), (j), (k) and (m),
and the provisions of Sections 7, 9, 10, 13 and 14 hereof with respect to the
Preferred Stock shall apply on like terms to any such other shares.

(g) All Rights originally issued by the Company
subsequent to any adjustment made to the Purchase Price hereunder shall
evidence the right to purchase, at the adjusted Purchase Price, the number of
one one-hundredths of a share of Preferred Stock purchasable from time to time
hereunder upon exercise of the Rights, all subject to further adjustment as
provided herein.

(h) Unless the Company shall have exercised its
election as provided in Section 11(i), upon each adjustment of the Purchase
Price as a result of the calculations made in Sections 11(b) and (c), each
Right outstanding immediately prior to the making of such adjustment shall
thereafter evidence the right to purchase, at the adjusted Purchase Price, that
number of one one-hundredths of a

15
<PAGE> 19
share of Preferred Stock (calculated to the nearest one-millionth) obtained by
(i) multiplying (x) the number of one one-hundredths of a share covered by a
Right immediately prior to this adjustment, by (y) the Purchase Price in effect
immediately prior to such adjustment of the Purchase Price, and (ii) dividing
the product so obtained by the Purchase Price in effect immediately after such
adjustment of the Purchase Price.

(i) The Company may elect on or after the date of
any adjustment of the Purchase Price to adjust the number of Rights, in lieu of
any adjustment in the number of one one-hundredths of a share of Preferred
Stock purchasable upon the exercise of a Right. Each of the Rights outstanding
after the adjustment in the number of Rights shall be exercisable for the
number of one one-hundredths of a share of Preferred Stock for which a Right
was exercisable immediately prior to such adjustment. Each Right held of record
prior to such adjustment of the number of Rights shall become that number of
Rights (calculated to the nearest one-ten-thousandth) obtained by dividing the
Purchase Price in effect immediately prior to adjustment of the Purchase Price
by the Purchase Price in effect immediately after adjustment of the Purchase
Price. The Company shall make a public announcement of its election to adjust
the number of Rights, indicating the record date for the adjustment, and, if
known at the time, the amount of the adjustment to be made. This record date
may be the date on which the Purchase Price is adjusted or any day thereafter,
but, if the Rights Certificates have been issued, shall be at least ten (10)
days later than the date of the public announcement. If Rights Certificates
have been issued, upon each adjustment of the number of Rights pursuant to this
Section 11(i), the Company shall, as promptly as practicable, cause to be
distributed to holders of record of Rights Certificates on such record date
Rights Certificates evidencing, subject to Section 14 hereof, the additional
Rights to which such holders shall be entitled as a result of such adjustment,
or, at the option of the Company, shall cause to be distributed to such holders
of record in substitution and replacement for the Rights Certificates held by
such holders prior to the date of adjustment, and upon surrender thereof, if
required by the Company, new Rights Certificates evidencing all the Rights to
which such holders shall be entitled after such adjustment. Rights Certificates
so to be distributed shall be issued, executed and countersigned in the manner
provided for herein (and may bear, at the option of the Company, the adjusted
Purchase Price) and shall be registered in the names of the holders of record
of Rights Certificates on the record date specified in the public announcement.

(j) Irrespective of any adjustment or change
in the Purchase Price or the number of one one-hundredths of a share of
Preferred Stock issuable upon the exercise of the Rights, the Rights
Certificates theretofore and thereafter issued may continue to express the
Purchase Price per one one-hundredth of a share and the number of one
one-hundredth of a share which were expressed in the initial Rights Certificates
issued hereunder.

(k) Before taking any action that would cause an
adjustment reducing the Purchase Price below the then stated value, if any, of
the number of one one-hundredths of a share of Preferred Stock issuable upon
exercise of the Rights, the Company shall take any corporate action which may,
in the opinion of its counsel, be necessary in order that the Company may
validly and legally issue fully paid and nonassessable such number of one
one-hundredths of a share of Preferred Stock at such adjusted Purchase Price.

(l) In any case in which this Section 11 shall
require that an adjustment in the Purchase Price be made effective as of a
record date for a specified event, the Company may elect to defer until the
occurrence of such event the issuance to the holder of any Right exercised after
such record date the number of one one-hundredths of a share of Preferred Stock
and other capital stock or securities of the Company, if any, issuable upon such
exercise over and above the number of one one-hundredths of a share of Preferred
Stock and other capital stock or securities of the Company, if any, issuable
upon such exercise on the basis of the Purchase Price in effect prior to such
adjustment; provided, however, that the Company shall deliver to such holder a
due bill or other appropriate instrument evidencing such holder's right to
receive such additional shares (fractional or otherwise) or securities upon the
occurrence of the event requiring such adjustment.

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<PAGE> 20
(m) Anything in this Section 11 to the contrary
notwithstanding, the Company shall be entitled to make such reductions in the
Purchase Price, in addition to those adjustments expressly required by this
Section 11, as and to the extent that in their good faith judgment the Board of
Directors of the Company shall determine to be advisable in order that any (i)
consolidation or subdivision of the Preferred Stock, (ii) issuance wholly for
cash of any shares of Preferred Stock at less than the current market price,
(iii) issuance wholly for cash of shares of Preferred Stock or securities which
by their terms are convertible into or exchangeable for shares of Preferred
Stock, (iv) stock dividends or (v) issuance of rights, options or warrants
referred to in this Section 11, hereafter made by the Company to holders of its
Preferred Stock shall not be taxable to such stockholders.

(n) The Company covenants and agrees that it
shall not, at any time after the Distribution Date, (i) consolidate with any
other Person (other than a Subsidiary of the Company in a transaction which
complies with Section 11(o) hereof), (ii) merge with or into any other Person
(other than a Subsidiary of the Company in a transaction which complies with
Section 11(o) hereof), or (iii) sell or transfer (or permit any Subsidiary to
sell or transfer), in one transaction, or a series of related transactions,
assets or earning power aggregating more than 50% of the assets or earning
power of the Company and its Subsidiaries (taken as a whole) to any other
Person or Persons (other than the Company and/or any of its Subsidiaries in one
or more transactions each of which complies with Section 11(o) hereof), if (x)
at the time of or immediately after such consolidation, merger or sale there
are any rights, warrants or other instruments or securities outstanding or
agreements in effect which would substantially diminish or otherwise eliminate
the benefits intended to be afforded by the Rights or (y) prior to,
simultaneously with or immediately after such consolidation, merger or sale,
the shareholders of the Person who constitutes, or would constitute, the
"Principal Party" for purposes of Section 13(a) hereof shall have received a
distribution of Rights previously owned by such Person or any of its Affiliates
and Associates.

(o) The Company covenants and agrees that, after
the Distribution Date, it will not, except as permitted by Section 23 or
Section 26 hereof, take (or permit any Subsidiary to take) any action if at the
time such action is taken it is reasonably foreseeable that such action will
diminish substantially or otherwise eliminate the benefits intended to be
afforded by the Rights.

(p) Anything in this Agreement to the contrary
notwithstanding, in the event that the Company shall at any time after the
Rights Dividend Declaration Date and prior to the Distribution Date (i) declare
a dividend on the outstanding shares of Common Stock payable in shares of
Common Stock, (ii) subdivide the outstanding shares of Common Stock, or (iii)
combine the outstanding shares of Common Stock into a smaller number of shares,
the number of Rights associated with each share of Common Stock then
outstanding, or issued or delivered thereafter but prior to the Distribution
Date, shall be proportionately adjusted so that the number of Rights thereafter
associated with each share of Common Stock following any such event shall equal
the result obtained by multiplying the number of Rights associated with each
share of Common Stock immediately prior to such event by a fraction the
numerator which shall be the total number of shares of Common Stock outstanding
immediately prior to the occurrence of the event and the denominator of which
shall be the total number of shares of Common Stock outstanding immediately
following the occurrence of such event.

Section 12. Certificate of Adjusted Purchase Price or
Number of Shares. Whenever an adjustment is made as provided in Section 11 and
Section 13 hereof, the Company shall (a) promptly prepare a certificate setting
forth such adjustment and a brief statement of the facts accounting for such
adjustment, (b) promptly file with the Rights Agent, and with each transfer
agent for the Preferred Stock and the Common Stock, a copy of such certificate,
and (c) mail a brief summary thereof to each holder of a Rights Certificate
(or,

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<PAGE> 21
if prior to the Distribution Date, to each holder of a certificate representing
shares of Common Stock) in accordance with Section 25 hereof. The Rights Agent
shall be fully protected in relying on any such certificate and on any
adjustment therein contained.

Section 13. Consolidation, Merger or Sale or Transfer of
Assets or Earning Power.

(a) In the event that, following the Stock Acquisition
Date, directly or indirectly, (x) the Company shall consolidate with, or merge
with and into, any other Person (other than a Subsidiary of the Company in a
transaction which complies with Section 11(o) hereof), and the Company shall
not be the continuing or surviving corporation of such consolidation or merger,
(y) any Person (other than a Subsidiary of the Company in a transaction which
complies with Section 11(o) hereof) shall consolidate with, or merge with or
into, the Company, and the Company shall be the continuing or surviving
corporation of such consolidation or merger and, in connection with such
consolidation or merger, all or part of the outstanding shares of Common Stock
shall be changed into or exchanged for stock or other securities of any other
Person or cash or any other property, or (z) the Company shall sell or
otherwise transfer (or one or more of its Subsidiaries shall sell or otherwise
transfer), in one transaction or a series of related transactions, assets or
earning power aggregating more than 50% of the assets or earning power of the
Company and its Subsidiaries (taken as a whole) to any Person or Persons (other
than the Company or any Subsidiary of the Company in one or more transactions
each of which complies with Section 11(o) hereof), then, and in each such case
(except as may be contemplated by Section 13(d) hereof), proper provision shall
be made so that: (i) each holder of a Right, except as provided in Section 7(e)
hereof, shall thereafter have the right to receive, upon the exercise thereof
at the then current Purchase Price in accordance with the terms of this
Agreement, such number of validly authorized and issued, fully paid,
non-assessable and freely tradeable shares of Common Stock of the Principal
Party (as such term is hereinafter defined), not subject to any liens,
encumbrances, rights of first refusal or other adverse claims, as shall be
equal to the result obtained by (1) multiplying the then current Purchase Price
by the number of one one-hundredth of a share of Preferred Stock for which a
Right is exercisable immediately prior to the first occurrence of a Section 13
Event (or, if a Section 11(a)(ii) Event has occurred prior to the first
occurrence of a Section 13 Event, multiplying the number of such one
one-hundredths of a share for which a Right was exercisable immediately prior
to the first occurrence of a Section 11(a)(ii) Event by the Purchase Price in
effect immediately prior to such first occurrence), and dividing that product
(which, following the first occurrence of a Section 13 Event, shall be referred
to as the "Purchase Price" for each Right and for all purposes of this
Agreement) by (2) 50% of the Current Market Price (determined pursuant to
Section 11(d)(i) hereof) per share of the Common Stock of such Principal Party
on the date of consummation of such Section 13 Event; (ii) such Principal Party
shall thereafter be liable for, and shall assume, by virtue of such Section 13
Event, all the obligations and duties of the Company pursuant to this
Agreement; (iii) the term "Company" shall thereafter be deemed to refer to such
Principal Party, it being specifically intended that the provisions of Section
11 hereof shall apply only to such Principal Party following the first
occurrence of a Section 13 Event; (iv) such Principal Party shall take such
steps (including, but not limited to, the reservation of a sufficient number of
shares of its Common Stock) in connection with the consummation of any such
transaction as may be necessary to assure that the provisions hereof shall
thereafter be applicable, as nearly as reasonably may be, in relation to its
shares of Common Stock thereafter deliverable upon the exercise of the Rights;
and (v) the provisions of Section 11(a)(ii) hereof shall be of no effect
following the first occurrence of any Section 13 Event.

(b) "Principal Party" shall mean

(i) in the case of any transaction described in
clause (x) or (y) of the first sentence of Section 13(a), the Person
that is the issuer of any securities into which shares of Common

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<PAGE> 22
Stock of the Company are converted in such merger or consolidation,
and if no securities are so issued, the Person that is the other party
to such merger or consolidation; and

(ii) in the case of any transaction described in
clause (z) of the first sentence of Section 13(a), the Person that is
the party receiving the greatest portion of the assets or earning
power transferred pursuant to such transaction or transactions;
provided, however, that in any such case, (1) if the Common Stock of
such Person is not at such time and has not been continuously over the
preceding twelve (12) month period registered under Section 12 of the
Exchange Act, and such Person is a direct or indirect Subsidiary of
another Person the Common Stock of which is and has been so
registered, "Principal Party" shall refer to such other Person; and
(2) in case such Person is a Subsidiary, directly or indirectly, of
more than one Person, the Common Stocks of two or more of which are
and have been so registered, "Principal Party" shall refer to
whichever of such Persons is the issuer of the Common Stock having the
greatest aggregate market value.

(c) The Company shall not consummate any such
consolidation, merger, sale or transfer unless the Principal Party shall have a
sufficient number of authorized shares of its Common Stock which have not been
issued or reserved for issuance to permit the exercise in full of the Rights in
accordance with this Section 13 and unless prior thereto the Company and such
Principal Party shall have executed and delivered to the Rights Agent a
supplemental agreement providing for the terms set forth in paragraphs (a) and
(b) of this Section 13 and further providing that, as soon as practicable after
the date of any consolidation, merger or sale of assets mentioned in paragraph
(a) of this Section 13, the Principal Party will

(i) prepare and file a registration statement
under the Act, with respect to the Rights and the securities
purchasable upon exercise of the Rights on an appropriate form, and
will use its best efforts to cause such registration statement to (A)
become effective as soon as practicable after such filing and (B)
remain effective (with a prospectus at all times meeting the
requirements of the Act) until the Expiration Date; and

(ii) will deliver to holders of the Rights
historical financial statements for the Principal Party and each of
its Affiliates which comply in all respects with the requirements for
registration on Form 10 under the Exchange Act.

The provisions of this Section 13 shall similarly apply to successive mergers
or consolidations or sales or other transfers. In the event that a Section 13
Event shall occur at any time after the occurrence of a Section 11(a)(ii)
Event, the Rights which have not theretofore been exercised shall thereafter
become exercisable in the manner described in Section 13(a).

(d) Notwithstanding anything in this Agreement to the
contrary, Section 13 shall not be applicable to a transaction described in
subparagraphs (x) and (y) of Section 13(a) if (i) such transaction is
consummated with a Person or Persons who acquired shares of Common Stock
pursuant to a Qualifying Offer (or a wholly owned Subsidiary of any such Person
or Persons), (ii) the price per share of Common Stock offered in such
transaction is not less than the price per share of Common Stock paid to all
holders of shares of Common Stock whose shares were purchased pursuant to such
tender offer or exchange offer and (iii) the form of consideration being
offered to the remaining holders of shares of Common Stock pursuant to such
transaction is the same as the form of consideration paid pursuant to such
tender offer or exchange offer. Upon consummation of any such transaction
contemplated by this Section 13(d), all Rights hereunder shall expire.

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<PAGE> 23
Section 14. Fractional Rights and Fractional Shares.

(a) The Company shall not be required to issue fractions
of Rights, except prior to the Distribution Date as provided in Section 11(p)
hereof, or to distribute Rights Certificates which evidence fractional Rights.
In lieu of such fractional Rights, there shall be paid to the registered
holders of the Rights Certificates with regard to which such fractional Rights
would otherwise be issuable, an amount in cash equal to the same fraction of
the current market value of a whole Right. For purposes of this Section 14(a),
the current market value of a whole Right shall be the closing price of the
Rights for the Trading Day immediately prior to the date on which such
fractional Rights would have been otherwise issuable. The closing price of the
Rights for any day shall be the last sale price, regular way, or, in case no
such sale takes place on such day, the average of the closing bid and asked
prices, regular way, in either case as reported in the principal consolidated
transaction reporting system with respect to securities listed or admitted to
trading on the New York Stock Exchange or, if the Rights are not listed or
admitted to trading on the New York Stock Exchange, as reported in the
principal consolidated transaction reporting system with respect to securities
listed on the principal national securities exchange on which the Rights are
listed or admitted to trading, or if the Rights are not listed or admitted to
trading on any national securities exchange, the last quoted price or, if not
so quoted, the average of the high bid and low asked prices in the
over-the-counter market, as reported by NASDAQ or such other system then in use
or, if on any such date the Rights are not quoted by any such organization, the
average of the closing bid and asked prices as furnished by a professional
market maker making a market in the Rights selected by the Board of Directors
of the Company. If on any such date no such market maker is making a market in
the Rights the fair value of the Rights on such date as determined in good
faith by the Board of Directors of the Company shall be used.

(b) The Company shall not be required to issue fractions
of shares of Preferred Stock (other than fractions which are integral multiples
of one one-hundredth of a share of Preferred Stock) upon exercise of the Rights
or to distribute certificates which evidence fractional shares of Preferred
Stock (other than fractions which are integral multiples of one one-hundredth of
a share of Preferred Stock). In lieu of fractional shares of Preferred Stock
that are not integral multiples of one one-hundredth of a share of Preferred
Stock, the Company may pay to the registered holders of Rights Certificates at
the time such Rights are exercised as herein provided an amount in cash equal to
the same fraction of the current market value of one one-hundredth of a share of
Preferred Stock. For purposes of this Section 14(b), the current market value of
one one-hundredth of a share of Preferred Stock shall be one one-hundredth of
the closing price of a share of Preferred Stock (as determined pursuant to
Section 11(d)(ii) hereof) for the Trading Day immediately prior to the date of
such exercise.

(c) Following the occurrence of a Triggering Event, the
Company shall not be required to issue fractions of shares of Common Stock upon
exercise of the Rights or to distribute certificates which evidence fractional
shares of Common Stock. In lieu of fractional shares of Common Stock, the
Company may pay to the registered holders of Rights Certificates at the time
such Rights are exercised as herein provided an amount in cash equal to the same
fraction of the current market value of one (1) share of Common Stock. For
purposes of this Section 14(c), the current market value of one share of Common
Stock shall be the closing price of one share of Common Stock (as determined
pursuant to Section 11(d)(i) hereof) for the Trading Day immediately prior to
the date of such exercise.

(d) The holder of a Right by the acceptance of the Rights
expressly waives his right to receive any fractional Rights or any fractional
shares upon exercise of a Right, except as permitted by this Section 14.

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<PAGE> 24
Section 15. Rights of Action. All rights of action in respect of
this Agreement are vested in the respective registered holders of the Rights
Certificates (and, prior to the Distribution Date, the registered holders of
the Common Stock); and any registered holder of any Rights Certificate (or,
prior to the Distribution Date, of the Common Stock), without the consent of
the Rights Agent or of the holder of any other Rights Certificate (or, prior to
the Distribution Date, of the Common Stock), may, in his own behalf and for his
own benefit, enforce, and may institute and maintain any suit, action or
proceeding against the Company to enforce, or otherwise act in respect of, his
right to exercise the Rights evidenced by such Rights Certificate in the manner
provided in such Rights Certificate and in this Agreement. Without limiting
the foregoing or any remedies available to the holders of Rights, it is
specifically acknowledged that the holders of Rights would not have an adequate
remedy at law for any breach of this Agreement and shall be entitled to
specific performance of the obligations hereunder and injunctive relief against
actual or threatened violations of the obligations hereunder of any Person
subject to this Agreement.

Section 16. Agreement of Rights Holders. Every holder of a Right
by accepting the same consents and agrees with the Company and the Rights Agent
and with every other holder of a Right that:

(a) prior to the Distribution Date, the Rights will
be transferable only in connection with the transfer of Common Stock;

(b) after the Distribution Date, the Rights
Certificates are transferable only on the registry books of the Rights Agent if
surrendered at the principal office or offices of the Rights Agent designated
for such purposes, duly endorsed or accompanied by a proper instrument of
transfer and with the appropriate forms and certificates fully executed;

(c) subject to Section 6(a) and Section 7(f) hereof,
the Company and the Rights Agent may deem and treat the person in whose name a
Rights Certificate (or, prior to the Distribution Date, the associated Common
Stock certificate) is registered as the absolute owner thereof and of the
Rights evidenced thereby (notwithstanding any notations of ownership or writing
on the Rights Certificates or the associated Common Stock certificate made by
anyone other than the Company or the Rights Agent) for all purposes whatsoever,
and neither the Company nor the Rights Agent, subject to the last sentence of
Section 7(e) hereof, shall be required to be affected by any notice to the
contrary; and

(d) notwithstanding anything in this Agreement to the
contrary, neither the Company nor the Rights Agent shall have any liability to
any holder of a Right or other Person as a result of its inability to perform
any of its obligations under this Agreement by reason of any preliminary or
permanent injunction or other order, decree or ruling issued by a court of
competent jurisdiction or by a governmental, regulatory or administrative
agency or commission, or any statute, rule, regulation or executive order
promulgated or enacted by any governmental authority, prohibiting or otherwise
restraining performance of such obligation; provided, however, the Company must
use its best efforts to have any such order, decree or ruling lifted or
otherwise overturned as soon as possible.

Section 17. Rights Certificate Holder Not Deemed a Stockholder.
No holder, as such, of any Rights Certificate shall be entitled to vote,
receive dividends or be deemed for any purpose the holder of the number of one
one-hundredths of a share of Preferred Stock or any other securities of the
Company which may at any time be issuable on the exercise of the Rights
represented thereby, nor shall anything contained herein or in any Rights
Certificate be construed to confer upon the holder of any Rights Certificate,
as such, any of the rights of a stockholder of the Company or any right to vote
for the election of directors or upon any matter submitted to stockholders at
any meeting thereof, or to give or withhold consent to any corporate action, or
to receive

21
<PAGE> 25
notice of meetings or other actions affecting stockholders (except as provided
in Section 24 hereof), or to receive dividends or subscription rights, or
otherwise, until the Right or Rights evidenced by such Rights Certificate shall
have been exercised in accordance with the provisions hereof.

Section 18. Concerning the Rights Agent.

(a) The Company agrees to pay to the Rights Agent reasonable
compensation for all services rendered by it hereunder and, from time to time,
on demand of the Rights Agent, its reasonable expenses and counsel fees and
disbursements and other disbursements incurred in the administration and
execution of this Agreement and the exercise and performance of its duties
hereunder. The Company also agrees to indemnify the Rights Agent for, and to
hold it harmless against, any loss, liability, or expense, incurred without
negligence, bad faith or willful misconduct on the part of the Rights Agent,
for anything done or omitted by the Rights Agent in connection with the
acceptance and administration of this Agreement, including the costs and
expenses of defending against any claim of liability in the premises.

(b) The Rights Agent shall be protected and shall incur no
liability for or in respect of any action taken, suffered or omitted by it in
connection with its administration of this Agreement in reliance upon any
Rights Certificate or certificate for Common Stock or for other securities of
the Company, instrument of assignment or transfer, power of attorney,
endorsement, affidavit, letter, notice, direction, consent, certificate,
statement, or other paper or document believed by it to be genuine and to be
signed, executed and, where necessary, verified or acknowledged, by the proper
Person or Persons.

Section 19. Merger or Consolidation or Change of Name of Rights Agent.

(a) Any corporation into which the Rights Agent or any
successor Rights Agent may be merged or with which it may be consolidated, or
any corporation resulting from any merger or consolidation to which the Rights
Agent or any successor Rights Agent shall be a party, or any corporation
succeeding to the corporate trust business of the Rights Agent or any successor
Rights Agent, shall be the successor to the Rights Agent under this Agreement
without the execution or filing of any paper or any further act on the part of
any of the parties hereto; provided, however, that such corporation would be
eligible for appointment as a successor Rights Agent under the provisions of
Section 21 hereof. In case at the time such successor Rights Agent shall
succeed to the agency created by this Agreement, any of the Rights Certificates
shall have been countersigned but not delivered, any such successor Rights
Agent may adopt the countersignature of a predecessor Rights Agent and deliver
such Rights Certificates so countersigned; and in case at that time any of the
Rights Certificates shall not have been countersigned, any successor Rights
Agent may countersign such Rights Certificates either in the name of the
predecessor or in the name of the successor Rights Agent; and in all such cases
such Rights Certificates shall have the full force provided in the Rights
Certificates and in this Agreement.

(b) In case at any time the name of the Rights Agent
shall be changed and at such time any of the Rights Certificates shall have
been countersigned but not delivered, the Rights Agent may adopt the
countersignature under its prior name and deliver Rights Certificates so
countersigned; and in case at that time any of the Rights Certificates shall
not have been countersigned, the Rights Agent may countersign such Rights
Certificates either in its prior name or in its changed name; and in all such
cases such Rights Certificates shall have the full force provided in the Rights
Certificates and in this Agreement.

Section 20. Duties of Rights Agent. The Rights Agent undertakes the
duties and obligations imposed by this Agreement upon the following terms and
conditions, by all of which the Company and the holders of Rights Certificates,
by their acceptance thereof, shall be bound:

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<PAGE> 26
(a) The Rights Agent may consult with legal counsel (who may
be legal counsel for the Company), and the opinion of such counsel shall be
full and complete authorization and protection to the Rights Agent as to any
action taken or omitted by it in good faith and in accordance with such
opinion.

(b) Whenever in the performance of its duties under this
Agreement the Rights Agent shall deem it necessary or desirable that any fact
or matter (including, without limitation, the identity of any Acquiring Person
and the determination of "current market price") be proved or established by
the Company prior to taking or suffering any action hereunder, such fact or
matter (unless other evidence in respect thereof be herein specifically
prescribed) may be deemed to be conclusively proved and established by a
certificate signed by the Chairman of the Board, the President, any Vice
President, the Treasurer, any Assistant Treasurer, the Secretary or any
Assistant Secretary of the Company and delivered to the Rights Agent; and such
certificate shall be full authorization to the Rights Agent for any action
taken or suffered in good faith by it under the provisions of this Agreement in
reliance upon such certificate.

(d) The Rights Agent shall not be liable for or by reason of
any of the statements of fact or recitals contained in this Agreement or in the
Rights Certificates or be required to verify the same (except as to its
countersignature on such Rights Certificates), but all such statements and
recitals are and shall be deemed to have been made by the Company only.

(e) The Rights Agent shall not be under any responsibility in
respect of the validity of this Agreement or the execution and delivery hereof
(except the due execution hereof by the Rights Agent) or in respect of the
validity or execution of any Rights Certificate (except its countersignature
thereof); nor shall it be responsible for any breach by the Company of any
covenant or condition contained in this Agreement or in any Rights Certificate;
nor shall it be responsible for any adjustment required under the provisions of
Section 11 or Section 13 hereof or responsible for the manner, method or amount
of any such adjustment or the ascertaining of the existence of facts that would
require any such adjustment (except with respect to the exercise of Rights
evidenced by Rights Certificates after actual notice of any such adjustment);
nor shall it by any act hereunder be deemed to make any representation or
warranty as to the authorization or reservation of any shares of Common Stock
or Preferred Stock to be issued pursuant to this Agreement or any Rights
Certificate or as to whether any shares of Common Stock or Preferred Stock
will, when so issued, be validly authorized and issued, fully paid and
nonassessable.

(f) The Company agrees that it will perform, execute,
acknowledge and deliver or cause to be performed, executed, acknowledged and
delivered all such further and other acts, instruments and assurances as may
reasonably be required by the Rights Agent for the carrying out or performing
by the Rights Agent of the provisions of this Agreement.

(g) The Rights Agent is hereby authorized and directed to
accept instructions with respect to the performance of its duties hereunder
from the Chairman of the Board, the President, any Vice President, the
Secretary, any Assistant Secretary, the Treasurer or any Assistant Treasurer of
the Company, and to apply to such officers for advice or instructions in
connection with its duties, and it shall not be liable for any action taken or
suffered to be taken by it in good faith in accordance with instructions of any
such officer.

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<PAGE> 27
(h) The Rights Agent and any stockholder, director, officer or
employee of the Rights Agent may buy, sell or deal in any of the Rights or
other securities of the Company or become pecuniarily interested in any
transaction in which the Company may be interested, or contract with or lend
money to the Company or otherwise act as fully and freely as though it were not
Rights Agent under this Agreement. Nothing herein shall preclude the Rights
Agent from acting in any other capacity for the Company or for any other legal
entity.

(i) The Rights Agent may execute and exercise any of the
rights or powers hereby vested in it or perform any duty hereunder either
itself or by or through its attorneys or agents, and the Rights Agent shall not
be answerable or accountable for any act, default, neglect or misconduct of any
such attorneys or agents or for any loss to the Company resulting from any such
act, default, neglect or misconduct; provided, however, reasonable care was
exercised in the selection and continued employment thereof.

(j) No provision of this Agreement shall require the Rights
Agent to expend or risk its own funds or otherwise incur any financial
liability in the performance of any of its duties hereunder or in the exercise
of its rights if there shall be reasonable grounds for believing that repayment
of such funds or adequate indemnification against such risk or liability is not
reasonably assured to it.

(k) If, with respect to any Right Certificate surrendered to
the Rights Agent for exercise or transfer, the certificate attached to the form
of assignment or form of election to purchase, as the case may be, has either
not been completed or indicates an affirmative response to clause 1 and/or 2
thereof, the Rights Agent shall not take any further action with respect to
such requested exercise or transfer without first consulting with the Company.

Section 21. Change of Rights Agent. The Rights Agent or any successor
Rights Agent may resign and be discharged from its duties under this Agreement
upon thirty (30) days' notice in writing mailed to the Company, and to each
transfer agent of the Common Stock and Preferred Stock, by registered or
certified mail, and to the holders of the Rights Certificates by first-class
mail. The Company may remove the Rights Agent or any successor Rights Agent upon
thirty (30) days' notice in writing, mailed to the Rights Agent or successor
Rights Agent, as the case may be, and to each transfer agent of the Common Stock
and Preferred Stock, by registered or certified mail, and to the holders of the
Rights Certificates by first-class mail. If the Rights Agent shall resign or be
removed or shall otherwise become incapable of acting, the Company shall appoint
a successor to the Rights Agent. If the Company shall fail to make such
appointment within a period of thirty (30) days after giving notice of such
removal or after it has been notified in writing of such resignation or
incapacity by the resigning or incapacitated Rights Agent or by the holder of a
Rights Certificate (who shall, with such notice, submit his Rights Certificate
for inspection by the Company), then any registered holder of any Rights
Certificate may apply to any court of competent jurisdiction for the appointment
of a new Rights Agent. Any successor Rights Agent, whether appointed by the
Company or by such a court, shall be a corporation organized and doing business
under the laws of the United States or of the State of New York (or of any other
state of the United States so long as such corporation is authorized to do
business as a banking institution in the State of New York), in good standing,
having a principal office in the State of New York, which is authorized under
such laws to exercise corporate trust powers and is subject to supervision or
examination by federal or state authority and which has at the time of its
appointment as Rights Agent a combined capital and surplus of at least
$100,000,000. After appointment, the successor Rights Agent shall be vested
with the same powers, rights, duties and responsibilities as if it had been
originally named as Rights Agent without further act or deed; but the
predecessor Rights Agent shall deliver and transfer to the successor Rights
Agent any property at the time held by it hereunder, and execute and deliver any
further assurance, conveyance, act or deed necessary for the purpose. Not later
than the effective date of any such appointment, the Company shall file notice
thereof in

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<PAGE> 28
writing with the predecessor Rights Agent and each transfer agent of the Common
Stock and the Preferred Stock, and mail a notice thereof in writing to the
registered holders of the Rights Certificates. Failure to give any notice
provided for in this Section 21, however, or any defect therein, shall not
affect the legality or validity of the resignation or removal of the Rights
Agent or the appointment of the successor Rights Agent, as the case may be.

Section 22. Issuance of New Rights Certificates. Notwithstanding
any of the provisions of this Agreement or of the Rights to the contrary, the
Company may, at its option, issue new Rights Certificates evidencing Rights in
such form as may be approved by its Board of Directors to reflect any
adjustment or change in the Purchase Price and the number or kind or class of
shares or other securities or property purchasable under the Rights
Certificates made in accordance with the provisions of this Agreement. In
addition, in connection with the issuance or sale of shares of Common Stock
following the Distribution Date and prior to the redemption or expiration of
the Rights, the Company (a) shall, with respect to shares of Common Stock so
issued or sold pursuant to the exercise of stock options or under any employee
plan or arrangement, granted or awarded as of the Distribution Date, or upon
the exercise, conversion or exchange of securities hereinafter issued by the
Company, and (b) may, in any other case, if deemed necessary or appropriate by
the Board of Directors of the Company, issue Rights Certificates representing
the appropriate number of Rights in connection with such issuance or sale;
provided, however, that (i) no such Rights Certificate shall be issued if, and
to the extent that, the Company shall be advised by counsel that such issuance
would create a significant risk of material adverse tax consequences to the
Company or the Person to whom such Rights Certificate would be issued, and (ii)
no such Rights Certificate shall be issued if, and to the extent that,
appropriate adjustment shall otherwise have been made in lieu of the issuance
thereof.

Section 23. Redemption and Termination.

(a) The Board of Directors of the Company may, at its
option, at any time prior to the earlier of (i) the Close of Business on the
tenth day following the Stock Acquisition Date (or, if the Stock Acquisition
Date shall have occurred prior to the Record Date, the Close of Business on the
tenth day following the Record Date), or (ii) the Final Expiration Date, redeem
all but not less than all the then outstanding Rights at a redemption price of
$.01 per Right, as such amount may be appropriately adjusted to reflect any
stock split, stock dividend or similar transaction occurring after the date
hereof (such redemption price being hereinafter referred to as the "Redemption
Price"); provided, however, that if the Board of Directors of the Company
authorizes redemption of the Rights in either of the circumstances set forth in
clauses (i) and (ii) below, then there must be Continuing Directors then in
office and such authorization shall require the concurrence of a majority of
such Continuing Directors: (i) such authorization occurs on or after the time a
Person becomes an Acquiring Person, or (ii) such authorization occurs on or
after the date of a change (resulting from a proxy or consent solicitation) in
a majority of the directors in office at the commencement of such solicitation
if any Person who is a participant in such solicitation has stated (or, if upon
the commencement of such solicitation, a majority of the Board of Directors of
the Company has determined in good faith) that such Person (or any of its
Affiliates or Associates) intends to take, or may consider taking, any action
which would result in such Person becoming an Acquiring Person or which would
cause the occurrence of a Triggering Event unless, concurrent with such
solicitation, such Person (or one or more of its Affiliates or Associates) is
making a Qualifying Offer. Notwithstanding anything contained in this Agreement
to the contrary, the Rights shall not be exercisable after the first occurrence
of a Section 11(a)(ii) Event until such time as the Company's right of
redemption hereunder has expired. The Company may, at its option, pay the
Redemption Price in cash, shares of Common Stock (based on the Current Market
Price, as defined in Section 11(d)(i) hereof, of the Common Stock at the time
of redemption) or any other form of consideration deemed appropriate by the
Board of Directors.

25
<PAGE> 29
(b) Immediately upon the action of the Board of
Directors of the Company ordering the redemption of the Rights, evidence of
which shall have been filed with the Rights Agent and without any further
action and without any notice, the right to exercise the Rights will terminate
and the only right thereafter of the holders of Rights shall be to receive the
Redemption Price for each Right so held. Promptly after the action of the Board
of Directors ordering the redemption of the Rights, the Company shall give
notice of such redemption to the Rights Agent and the holders of the then
outstanding Rights by mailing such notice to all such holders at each holder's
last address as it appears upon the registry books of the Rights Agent or,
prior to the Distribution Date, on the registry books of the Transfer Agent for
the Common Stock. Any notice which is mailed in the manner herein provided
shall be deemed given, whether or not the holder receives the notice. Each such
notice of redemption will state the method by which the payment of the
Redemption Price will be made.

Section 24. Notice of Certain Events.

(a) In case the Company shall propose, at any time after
the Distribution Date, (i) to pay any dividend payable in stock of any class to
the holders of Preferred Stock or to make any other distribution to the holders
of Preferred Stock (other than a regular quarterly cash dividend out of earnings
or retained earnings of the Company), or (ii) to offer to the holders of
Preferred Stock rights or warrants to subscribe for or to purchase any
additional shares of Preferred Stock or shares of stock of any class or any
other securities, rights or options, or (iii) to effect any reclassification of
its Preferred Stock (other than a reclassification involving only the
subdivision of outstanding shares of Preferred Stock), or (iv) to effect any
consolidation or merger into or with any other Person (other than a Subsidiary
of the Company in a transaction which complies with Section 11(o) hereof), or to
effect any sale or other transfer (or to permit one or more of its Subsidiaries
to effect any sale or other transfer), in one transaction or a series of related
transactions, of more than 50% of the assets or earning power of the Company and
its Subsidiaries (taken as a whole) to any other Person or Persons (other than
the Company and/or any of its Subsidiaries in one or more transactions each of
which complies with Section 11(o) hereof), or (v) to effect the liquidation,
dissolution or winding up of the Company, then, in each such case, the Company
shall give to each holder of a Rights Certificate, to the extent feasible and in
accordance with Section 25 hereof, a notice of such proposed action, which shall
specify the record date for the purposes of such stock dividend, distribution of
rights or warrants, or the date on which such reclassification, consolidation,
merger, sale, transfer, liquidation, dissolution, or winding up is to take place
and the date of participation therein by the holders of the shares of Preferred
Stock, if any such date is to be fixed, and such notice shall be so given in the
case of any action covered by clause (i) or (ii) above at least twenty (20) days
prior to the record date for determining holders of the shares of Preferred
Stock for purposes of such action, and in the case of any such other action, at
least twenty (20) days prior to the date of the taking of such proposed action
or the date of participation therein by the holders of the shares of Preferred
Stock whichever shall be the earlier.

(b) In case a Section 11(a)(ii) Event shall occur, then,
in any such case, (i) the Company shall as soon as practicable thereafter give
to each holder of a Rights Certificate, to the extent feasible and in accordance
with Section 25 hereof, a notice of the occurrence of such event, which shall
specify the event and the consequences of the event to holders of Rights under
Section 11(a)(ii) hereof, and (ii) all references in the preceding paragraph to
Preferred Stock shall be deemed thereafter to refer to Common Stock and/or, if
appropriate, other securities.

Section 25. Notices. Notices or demands authorized by this
Agreement to be given or made by the Rights Agent or by the holder of any
Rights Certificate to or on the Company shall be sufficiently given or made if
sent by first-class mail, postage prepaid, addressed (until another address is
filed in writing with the Rights Agent) as follows:

26
<PAGE> 30
Smith International, Inc.
16740 Hardy Street
Houston, Texas 77032
Attention: Corporate Secretary

Subject to the provisions of Section 21, any notice or demand authorized by
this Agreement to be given or made by the Company or by the holder of any
Rights Certificate to or on the Rights Agent shall be sufficiently given or
made if sent by first-class mail, postage prepaid, addressed (until another
address is filed in writing with the Company) as follows:

___________________________________________
___________________________________________
___________________________________________

Attention: Corporate Trust Department

Notices or demands authorized by this Agreement to be given or made by the
Company or the Rights Agent to the holder of any Rights Certificate (or, if
prior to the Distribution Date, to the holder of certificates representing
shares of Common Stock) shall be sufficiently given or made if sent by
first-class mail, postage prepaid, addressed to such holder at the address of
such holder as shown on the registry books of the Company.

Section 26. Supplements and Amendments. Prior to the
Distribution Date and subject to the penultimate sentence of this Section 26,
the Company and the Rights Agent shall, if the Company so directs, supplement or
amend any provision of this Agreement without the approval of any holders of
certificates representing shares of Common Stock. From and after the
Distribution Date and subject to the penultimate sentence of this Section 26,
the Company and the Rights Agent shall, if the Company so directs, supplement or
amend this Agreement without the approval of any holders of Rights Certificates
in order (i) to cure any ambiguity, (ii) to correct or supplement any provision
contained herein which may be defective or inconsistent with any other
provisions herein, (iii) to shorten or lengthen any time period hereunder (which
lengthening or shortening, following the first occurrence of an event set forth
in clauses (i) and (ii) of the first proviso to Section 23(a) hereof, shall be
effective only if there are Continuing Directors and shall require the
concurrence of a majority of such Continuing Directors), or (iv) to change or
supplement the provisions hereunder in any manner which the Company may deem
necessary or desirable and which shall not adversely affect the interests of the
holders of Rights Certificates (other than an Acquiring Person or an Affiliate
or Associate of an Acquiring Person); provided, this Agreement may not be
supplemented or amended to lengthen, pursuant to clause (iii) of this sentence,
(A) a time period relating to when the Rights may be redeemed at such time as
the Rights are not then redeemable, or (B) any other time period unless such
lengthening is for the purpose of protecting, enhancing or clarifying the rights
of, and/or the benefits to, the holders of Rights. Upon the delivery of a
certificate from an appropriate officer of the Company which states that the
proposed supplement or amendment is in compliance with the terms of this Section
26, the Rights Agent shall execute such supplement or amendment. Notwithstanding
anything contained in this Agreement to the contrary, no supplement or amendment
shall be made which changes the Redemption Price, the Final Expiration Date, the
Purchase Price or the number of one one-hundredths of a share of Preferred Stock
for which a Right is exercisable. Prior to the Distribution Date, the interests
of the holders of Rights shall be deemed coincident with the interests of the
holders of Common Stock.

Section 27. Successors. All the covenants and provisions of
this Agreement by or for the benefit of the Company or the Rights Agent shall
bind and inure to the benefit of their respective successors and assigns
hereunder.

27
<PAGE> 31
Section 28. Determinations and Actions by the Board of Directors,
etc. For all purposes of this Agreement, any calculation of the number of
shares of Common Stock outstanding at any particular time, including for
purposes of determining the particular percentage of such outstanding shares of
Common Stock of which any Person is the Beneficial Owner, shall be made in
accordance with the last sentence of Rule 13d-3(d)(1)(i) of the General Rules
and Regulations under the Exchange Act. The Board of Directors of the Company
(with, where specifically provided for herein, the concurrence of the
Continuing Directors) shall have the exclusive power and authority to
administer this Agreement and to exercise all rights and powers specifically
granted to the Board (with, where specifically provided for herein, the
concurrence of the Continuing Directors) or to the Company, or as may be
necessary or advisable in the administration of this Agreement, including,
without limitation, the right and power to (i) interpret the provisions of this
Agreement, and (ii) make all determinations deemed necessary or advisable for
the administration of this Agreement (including a determination to redeem or
not redeem the Rights or to amend the Agreement). All such actions,
calculations, interpretations and determinations (including, for purposes of
clause (y) below, all omissions with respect to the foregoing) which are done
or made by the Board (with, where specifically provided for herein, the
concurrence of the Continuing Directors) in good faith, shall (x) be final,
conclusive and binding on the Company, the Rights Agent, the holders of the
Rights and all other parties, and (y) not subject the Board or the Continuing
Directors to any liability to the holders of the Rights.

Section 29. Benefits of this Agreement. Nothing in this Agreement
shall be construed to give to any Person other than the Company, the Rights
Agent and the registered holders of the Rights Certificates (and, prior to the
Distribution Date, registered holders of the Common Stock) any legal or
equitable right, remedy or claim under this Agreement; but this Agreement shall
be for the sole and exclusive benefit of the Company, the Rights Agent and the
registered holders of the Rights Certificates (and, prior to the Distribution
Date, registered holders of the Common Stock).

Section 30. Severability. If any term, provision, covenant or
restriction of this Agreement is held by a court of competent jurisdiction or
other authority to be invalid, void or unenforceable, the remainder of the
terms, provisions, covenants and restrictions of this Agreement shall remain in
full force and effect and shall in no way be affected, impaired or invalidated;
provided, however, that notwithstanding anything in this Agreement to the
contrary, if any such term, provision, covenant or restriction is held by such
court or authority to be invalid, void or unenforceable and the Board of
Directors of the Company determines in its good faith judgment that severing
the invalid language from this Agreement would adversely affect the purpose or
effect of this Agreement, the right of redemption set forth in Section 23
hereof shall be reinstated and shall not expire until the Close of Business on
the tenth day following the date of such determination by the Board of
Director,

Section 31. Governing Law. This Agreement, each Right and each
Rights Certificate issued hereunder shall be deemed to be a contract made under
the laws of the State of Delaware and for all purposes shall be governed by and
construed in accordance with the laws of such State applicable to contracts
made and to be performed entirely within such State.

Section 32. Counterparts. This Agreement may be executed in any
number of counterparts and each of such counterparts shall for all purposes be
deemed to be an original, and all such counterparts shall together constitute
but one and the same instrument.

Section 33. Descriptive Headings. Descriptive headings of the
several Sections of this Agreement are inserted for convenience only and shall
not control or affect the meaning or construction of any of the provisions
hereof.

28
<PAGE> 32
IN WITNESS WHEREOF, the parties hereto have caused this Agreement
to be duly executed and their respective corporate seals to be hereunto affixed
and attested, all as of the day and year first above written.

Attest: SMITH INTERNATIONAL, INC.

By: /s/Vivian Cline By: /s/Douglas L. Rock
---------------------------------- --------------------------------
Name: Vivian Cline Name: Douglas L. Rock
Title: Acting Secretary Title: President

Attest: FIRST CHICAGO TRUST COMPANY
OF NEW YORK

By: /s/Joanne Gorostiola By: /s/John C. Bambach
---------------------------------- --------------------------------
Name: JOANNE GOROSTIOLA Name: JOHN C. BAMBACH
Title: CUSTOMER SERVICE OFFICER Title: VICE PRESIDENT

<PAGE> 1
EXHIBIT 10.27

AMENDMENT TO LOAN AGREEMENT AND
INTEREST RATE AND FOREIGN CURRENCY AGREEMENT
AND MODIFICATION OF NOTES EVIDENCING TERM LOANS

THIS AMENDMENT TO LOAN AGREEMENT AND INTEREST RATE AND FOREIGN
CURRENCY AGREEMENT AND MODIFICATION OF NOTES EVIDENCING TERM LOANS
("Amendment") dated as of December 23, 1997 (the "Amendment Effective Date") is
made and entered into by and among SMITH INTERNATIONAL, INC. (the "Borrower"),
a Delaware corporation, the banking institutions (each, together with its
successors and assigns, a "Bank" and collectively, the "Banks") from time to
time a party to the Loan Agreement (as hereinafter defined), as amended by this
Amendment, ABN AMRO BANK N.V., HOUSTON AGENCY and DEN NORSKE BANK AS, as
Co-Agents (in such capacity, together with their successors in such capacity,
collectively called the "Co- Agents") and TEXAS COMMERCE BANK NATIONAL
ASSOCIATION ("TCB"), a national banking association, as agent for the Banks (in
such capacity, together with its successors in such capacity, the "Agent").

RECITALS:

WHEREAS, the Borrower, the Banks, the Co-Agents, and the Agent are
parties to a Loan Agreement dated as of April 4, 1996, as amended by instrument
dated April 8, 1997 (the "Loan Agreement"); and

WHEREAS, certain provisions regarding interest rates and foreign
currency matters in respect of the obligations of the Borrower under the Loan
Agreement have been gathered in that certain Interest Rate and Foreign Currency
Agreement (the "Interest Rate and Foreign Currency Agreement") attached as
Schedule 1 to the Loan Agreement; and

WHEREAS, the Borrower, the Banks, the Co-Agents, and the Agent have
agreed, on the terms and conditions herein set forth, that the Loan Agreement
and Interest Rate and Foreign Currency Agreement be amended in certain
respects;

NOW, THEREFORE, IT IS AGREED:

Section 1. Definitions. Terms used herein which are defined in the
Loan Agreement shall have the same meanings when used herein unless otherwise
provided herein.

Section 2. Amendments to the Loan Agreement. On and after the
Amendment Effective Date, the Loan Agreement shall be amended as follows:

<PAGE> 2

(a) The definition of "Commitment Fee Percentage" contained in
Section 1. 1 of the Loan Agreement is hereby amended to read in its entirety as
follows:

Commitment Fee Percentage shall mean, on any day, the
applicable per annum percentage set forth at the appropriate intersection
in the table shown below, based on the. Rating (as defined in the Interest
Rate and Foreign Currency Agreement) as of the close of business on the
preceding Business Day:

<TABLE>
<CAPTION>
Commitment Fee
Rating Percentage
------ ----------
<S> <C>
A-/A3 or higher 0.090%

BBB+/Baa1 0.100%

BBB/Baa2 0.150%

BBB-/Baa3 0.175%

BB+/Bal or lower 0.200%
</TABLE>

(b) The definition of "Maturity Date" contained in Section 1. 1
of the Loan Agreement is hereby amended to read in its entirety as follows:

Maturity Date shall mean the maturity of the Notes evidencing
the Revolving Loans, December 31, 2002, as the same may hereafter be
accelerated pursuant to the provisions of any of the Loan Documents.

(c) A new definition of "Net Worth" is hereby added to Section 1.1
of the Loan Agreement, such new definition to read in its entirety as follows:

Net Worth shall mean all items classified as assets (valued at
cost less normal depreciation) in the financial statements of the
applicable Person delivered in accordance with this Agreement, less all
items classified as liabilities in the financial statements of such
Person delivered in accordance with this Agreement (including contingent
and indirect liabilities to the extent included on the balance sheet of
the applicable Person), all determined in accordance with GAAP. The term
"liabilities" shall include, without limitation, (1) Indebtedness secured
by Liens on Property of the Person with respect to which Net Worth is
being computed, whether or not such Person is liable for the payment
thereof; (2) deferred liabilities, and (3) Capital Lease Obligations. The
term "Net Worth" shall include any direct or indirect minority interest
in M-I.

2
<PAGE> 3

(d) A new definition of "Term Loan Maturity Date" is hereby
added to Section 1.1 of the Loan Agreement, such new definition to read in its
entirety as follows:

Term Loan Maturity Date shall mean the maturity of the Notes
evidencing the Term Loans, March 31, 2001, as the same may hereafter
be accelerated pursuant to the provisions of any of the Loan Documents.

(e) Section 3.2(d) of the Loan Agreement is hereby amended to
read in its entirety as follows:

(d) Term Loan Amortization. The principal of each Note
evidencing Term Loans shall be due and payable in semiannual
installments due on each six month anniversary of the making of the
Term Loans equal to the applicable Term Loan Lender's pro rata share
of the Term Loans times 32,000,000 Krone. On the Term Loan Maturity
Date, the entire unpaid principal balance of each Note evidencing
Term Loans and all accrued and unpaid interest on the unpaid
principal balance of each such Note shall be finally due and payable.

(f) Section 7.3(a) of the Loan Agreement is hereby amended to
read in its entirety as follows:

(a) Debt to Total Capitalization Ratio - a Debt to Total
Capitalization Ratio of not greater than 45%.

(g) Section 7.3(c) of the Loan Agreement is hereby amended to read
in its entirety as follows:

(c) Net Worth - Net Worth of not less than (1) for the
period commencing on December ____, 1997 through and including December
31, 1997, $490,000,000 and (2) for each fiscal quarter thereafter, the
minimum Net Worth required during the immediately preceding fiscal
quarter plus 50% of the Net Income (if positive) of the Borrower for
the immediately preceding fiscal quarter plus 100% of any increase in
Net Worth during such fiscal quarter resulting from any merger, sale or
issuance of equity.

(h) The reference in Section 11.5 of the Loan Agreement to the
phrase "Maturity Date" is hereby amended to read "Maturity Date or Term Loan
Maturity Date".

Section 3. Amendments to the Interest Rate and Foreign Currency
Agreement. On and after the Amendment Effective Date, the Interest Rate and
Foreign Currency Agreement shall be amended as follows:

(a) The definition of "Eurocurrency Margin Percentage" contained
in Section 1 of the Interest Rate and Foreign Currency Agreement is hereby
amended to read in its entirety as follows:

<PAGE> 4

Eurocurrency Margin Percentage means, on any day and with respect to
any Loan, the applicable per annum percentage set forth at the appropriate
intersection in the table shown below, based on the Rating as of the close of
business on the preceding Business Day:

<TABLE>
<CAPTION>
Eurocurrency Margin Eurocurrency Margin
Percentage for Euro- Percentage for Euro-
Rating dollar Rate Borrowings krone Rate Borrowings
------ ---------------------- ---------------------
<S> <C> <C>
A-/A3 or higher 0.250% 0.375%
BBB+/Baal 0.300% 0.425%
BBB/Baa2 0.350% 0.475%
BBB-/Baa3 0.400% 0.525%
BB+/Bal or lower 0.625% 0.750%
</TABLE>

(b) Each reference in the Interest Rate and Foreign Currency
Agreement to the phrase "Maturity Date" is hereby amended to read "Maturity
Date or Term Loan Maturity Date, as the case may be".

(c) A new definition of "Rating" is hereby added to Section 1 of
the Interest Rate and Foreign Currency Agreement, such new definition to read
in its entirety as follows:

Rating shall mean the senior debt rating for Borrower publicly
announced by Standard & Poor's Ratings Group or Moody's Investors Service,
Inc. In the event the ratings are not equivalent, the higher rating shall
be treated as the "Rating"' hereunder; provided, that if such ratings
differ by more than one (1) level, the Rating shall be the average,
rounded upwards, of the two ratings.

Section 4. Modification of the Notes Evidencing Term Loans. On
and after the Amendment Effective Date, each reference in the Notes evidencing
the Term Loans to the phrase "Maturity Date" is hereby amended to read "Term
Loan Maturity Date".

Section 5. Limitations. The amendments set forth herein are
limited precisely as written and shall not be deemed to (a) be a consent to, or
waiver or modification of, any other term or condition of the Loan Agreement or
any of the other Loan Documents, or (b) except as expressly set forth herein,
prejudice any right or rights which the Banks may now have or may have in the
future under or in connection with the Loan Agreement, the Loan Documents or
any of the other documents referred to therein. Except as expressly modified
hereby or by express written amendments thereof, the terms and provisions of
the Loan Agreement, the Notes, and any other Loan Documents or any other
documents or instruments executed in connection with any of the foregoing are
and shall remain in full force and effect. In the event of a conflict between
this Amendment and any of the foregoing documents, the terms of this Amendment
shall be controlling.

Section 6. Payment of Expenses. The Borrower agrees, whether or
not the transactions hereby contemplated shall be consummated, to reimburse and
save the Co-Agents, the Agent and the Bank(s) harmless from and against
liability for the payment of all reasonable

<PAGE> 5

substantiated out-of-pocket costs and expenses arising in connection with the
preparation, execution, delivery and enforcement of, or the preservation of any
rights under this Amendment, including, without limitation, the reasonable fees
and expenses of any local or other counsel for the Agent, and all stamp taxes
(including interest and penalties, if any), recording taxes and fees, filing
taxes and fees, and other similar charges which may be payable in respect of,
or in respect of any modification of, the Loan Agreement and the other Loan
Documents. The provisions of this Section shall survive the termination of the
Loan Agreement and the repayment of the Loans.

Section 7. Governing Law. This Amendment and the rights and
obligations of the parties hereunder and under the Loan Agreement shall be
construed in accordance with and be governed by the laws of the State of Texas
and the United States of America.

Section 8. Descriptive Headings, etc. The descriptive headings
of the several Sections of this Amendment are inserted for convenience only and
shall not be deemed to affect the meaning or construction of any of the
provisions hereof.

Section 9. Entire Agreement. This Amendment and the documents
referred to herein represent the entire understanding of the parties hereto
regarding the subject matter hereof and supersede all prior and contemporaneous
oral and written agreements of the parties hereto with respect to the subject
matter hereof, including, without limitation, any commitment letters regarding
the transactions contemplated by this Amendment.

Section 10. Counterparts. This Amendment may be executed in any
number of counterparts and by different parties on separate counterparts and
all of such counterparts shall together constitute one and the same instrument.
Complete sets of counterparts shall be lodged with the Borrower and the Agent.

Section 11. Amended Definitions. As used in the Loan Agreement
(including all Exhibits thereto) and all other instruments and documents
executed in connection therewith, on and subsequent to the Amendment Effective
Date the term (i) "Agreement" shall mean the Loan Agreement as amended by this
Amendment, and (ii) references to any and all other Loan Documents shall mean
such documents as amended as contemplated hereby.

<PAGE> 6
NOTICE PURSUANT TO TEX BUS. & COMM. CODE SECTION 26.02

THIS AMENDMENT AND ALL OTHER LOAN DOCUMENTS EXECUTED BY ANY OF THE PARTIES
BEFORE OR SUBSTANTIALLY CONTEMPORANEOUSLY WITH THE EXECUTION HEREOF TOGETHER
CONSTITUTE A WRITTEN LOAN AGREEMENT AND REPRESENT THE FINAL AGREEMENT BETWEEN
THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS
OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL
AGREEMENTS BETWEEN THE PARTIES.

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
duly executed and delivered by their respective duly authorized offices as of
the date first above written.

SMITH INTERNATIONAL, INC.

By:
-------------------------------

Name:
-----------------------------

Title:
----------------------------

<PAGE> 1
EXHIBIT 10.28

AMENDMENT TO LOAN AGREEMENT
AND INTEREST RATE AGREEMENT

THIS AMENDMENT TO LOAN AGREEMENT AND INTEREST RATE AGREEMENT
("Amendment") dated as of December 23, 1997 (the "Amendment Effective Date") is
made and entered into by and among M-I DRILLING FLUIDS, L.L.C. (the
"Borrower"), a Delaware limited liability company, the banking institutions
(each, together with its successors and assigns, a "Bank" and collectively, the
"Banks") from time to time a party to the Loan Agreement (as hereinafter
defined), as amended by this Amendment ABN AMRO BANK N.V., HOUSTON AGENCY and
DEN NORSKE BANK AS, as Co-Agents (in such capacity, together with their
successors in such capacity, collectively called the "Co-Agents") and TEXAS
COMMERCE BANK NATIONAL ASSOCIATION ("TCB"), a national banking association, as
agent for the Banks (in such capacity, together with its successors in such
capacity, the "Agent").

RECITALS:

WHEREAS, the Borrower, the Banks, the Co-Agents, and the Agent are
parties to a Loan Agreement dated as of April 4, 1996, as amended by instrument
dated April 8. 1997 (the "Loan Agreement"); and

WHEREAS, certain provisions regarding interest rates in respect of
the obligations of the Borrower under the Loan Agreement have been gathered in
that certain Interest Rate Agreement (the "Interest Rate Agreement") attached
as Schedule 1 to the Loan Agreement; and

WHEREAS, the Borrower, the Banks, the Co-Agents, and the Agent have
agreed, on the terms and conditions herein set forth, that the Loan Agreement
and Interest Rate Agreement be amended in certain respects;

NOW, THEREFORE, IT IS AGREED:

Section 1. Definitions. Terms used herein which are defined in
the Loan Agreement shall have the same meanings when used herein unless
otherwise provided herein.

Section 2. Amendments to the Loan Agreement. On and after the
Amendment Effective Date, the Loan Agreement shall be amended as follows:

(a) The definition of "Maturity Date" contained in Section 1.1
of the Loan Agreement is hereby amended to read in its entirety as follows:

1
<PAGE> 2

Maturity Date shall mean the maturity of the Notes, December 31,
2002, as the same may hereafter be accelerated pursuant to the
provisions of any of the Loan Documents.

(b) A new definition of "Net Worth" is hereby added to Section
1.1 of the Loan Agreement, such new definition to read in its entirety as
follows:

Net Worth shall mean all item classified as assets (valued at
cost less normal depreciation) in the financial statements of the applicable
Person delivered in accordance with this Agreement, less all items classified
as liabilities in the financial statements of such Person delivered in
accordance with this Agreement (including contingent and indirect liabilities
to the extent included on the balance sheet of the applicable Person), all
determined in accordance with GAAP. The term "liabilities" shall include,
without limitation., (1) Indebtedness secured by Liens on Property of the
Person with respect to which Net Worth is being computed, whether or not such
Person is liable for the payment thereof; (2) deferred liabilities, and (3)
Capital Lease Obligations.

(a) The Borrower shall pay to the Agent for the account
of each Bank commitment fees for the period from the Effective Date to
and including the Termination Date at a rate per annum equal to
0.100%. Such fees shall be computed (on the basis of the actual
number of days elapsed in a year composed of 360 days) on each day and
shall be based on the excess of (x) the aggregate amount of each
Bank's Loan Commitment for such day over (y) the aggregate unpaid
principal balance of such Bank's Note on such day. Accrued commitment
fees through each Quarterly Date prior to the Termination Date shall
be payable on the third (3rd) Business Day after such Quarterly Date.
Any accrued and unpaid commitment fees shall be due and payable on the
Termination Date.

(d) Section 7.3(b) of the Loan Agreement is hereby amended to read
in its entirety as follows:

(b) Net Worth - Net Worth of not less than (1)
for the period commencing on December ___, 1997 through and
including December 31,1997, $270,000,000 and (2) for each
fiscal quarter thereafter, the minimum Net Worth required
during the immediately preceding fiscal quarter plus 50% of
the Net Income (if positive) of the Borrower for the
immediately preceding fiscal quarter plus 100% of any increase
in Net Worth during such fiscal quarter resulting from any
merger, sale or issuance of equity.

2
<PAGE> 3

Section 3. Amendments to the Interest Rate Agreement. On and
after the Amendment Effective Date, the Interest Rate Agreement shall be
amended as follows:

(a) The definition of "Eurodollar Rate" contained in Section 1 of
the interest Rate Agreement is hereby amended to read in its entirety as
follows:

Eurodollar Rate means for any day a rate per annum equal to
the lesser of (a) the sum of (1) the Eurodollar Interbank Rate in
effect on the first day of the Interest Period for the applicable
Eurodollar Rate Borrowing plus (2) 0.300% and (b) the Ceiling Rate.
Each Eurodollar Rate is subject to adjustments for reserves, insurance
assessments and other matters as provided for in Section 2.3 hereof.

Section 4. Limitations. The amendments set forth herein are
limited precisely as written and shall not be deemed to (a) be a consent to, or
waiver or modification of, any other term or condition of the Loan Agreement or
any of the other Loan Documents, or (b) except as expressly set forth herein,
prejudice any right or rights which the Banks may now have or may have in the
future under or in connection with the Loan Agreement, the Loan Documents or
any of the other documents referred to therein. Except as expressly modified
hereby or by express written amendments thereof, the terms and provisions of
the Loan Agreement, the Notes, and any other Loan Documents or any other
documents or instruments executed in connection with any of the foregoing are
and shall remain in full force and effect. In the event of a conflict between
this Amendment and any of the foregoing documents, the terms of this Amendment
shall be controlling.

Section 5. Payment of Expenses. The Borrower agrees, whether or
not the transactions hereby contemplated shall be consummated, to reimburse and
save the Co-Agents, the Agent and the Bank(s) harmless from and against
liability for the payment of all reasonable substantiated out-of-pocket costs
and expenses arising in connection with the preparation, execution, delivery
and enforcement of, or the preservation of any rights under this Amendment,
including, without limitation, the reasonable fees and expenses of any local or
other counsel for the Agent, and all stamp taxes (including interest and
penalties, if any), recording taxes and fees, filing taxes and fees, and other
similar charges which may be payable in respect of, or in respect of any
modification of, the Loan Agreement and the other Loan Documents. The
provisions of this Section shall survive the termination of the Loan Agreement
and the repayment of the Loans.

Section 6. Governing Law. This Amendment and the rights and
obligations of the parties hereunder and under the Loan Agreement shall be
construed in accordance with and be governed by the laws of the State of Texas
and the United States of America.

Section 7. Descriptive Headings, etc. The descriptive headings
of the several Sections of this Amendment are inserted for convenience only and
shall not be deemed to affect the meaning or construction of any of the
provisions hereof.

3
<PAGE> 4

Section 8. Entire Agreement. This Amendment and the documents
referred to herein represent the entire understanding of the parties hereto
regarding the subject matter hereof and supersede all prior and contemporaneous
oral and written agreements of the parties hereto with respect to the subject
matter hereof, including, without limitation, any commitment letters regarding
the transactions contemplated by this Amendment.

Section 9. Counterparts. This Amendment may be executed in any
number of counterparts and by different parties on separate counterparts and
all of such counterparts shall together constitute one and the same instrument.
Complete sets of counterparts shall be lodged with the Borrower and the Agent.

Section 10. Amended Definitions. As used in the Loan Agreement
(including all Exhibits thereto) and all other instruments and documents
executed in connection therewith, on and subsequent to the Amendment Effective
Date the term (i) "Agreement" shall mean the Loan Agreement as amended by this
Amendment, and (ii) references to any and all other Loan Documents shall mean
such documents as amended as contemplated hereby.

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to
be duly executed and delivered by their respective duly authorized offices as
of the date first above written.

M-I DRILLING FLUIDS, L.L.C.

By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------

<PAGE> 1
EXHIBIT 21.1

SUBSIDIARIES OF THE COMPANY

The following table sets forth all subsidiaries of Smith
International, Inc., other than inactive and insignificant subsidiaries that,
considered in the aggregate, would not constitute a significant subsidiary,
indicating the percentage of issued and outstanding voting securities
beneficially owned by it:

% of Direct
Where and Indirect
Name of Subsidiary Incorporated Ownership
- ------------------ ------------ ------------

Smith Internacional,
S.A. de C.V. Mexico l00%
Omega II Insurance Ltd. Bermuda l00%
S.I. Nederland B.V. Netherlands l00%
Smith International
Acquisition Corp. Delaware 100%
Smith International
Australia (Pty) Ltd. Australia l00%
Smith International
Canada Ltd. Canada l00%
Smith International
do Brasil Ltda. Brazil l00%
Smith International
Deutschland GmbH Germany l00%
Smith International
Gulf Services Ltd.* U.A.E. 49%
Smith International
France, S.A.R.L. France l00%
Smith International
Italia, S.p.A. Italy l00%
Smith International
(North Sea) Ltd. Scotland l00%
Smith Internacional
de Venezuela, C.A. Venezuela l00%

</TABLE>

- -------------------------------------------------------------------

* Not consolidated; accounted for on the equity method of
accounting.

Except as indicated, all of the above subsidiaries are included in the
Company's consolidated financial statements.

<PAGE> 1
Exhibit 23.1

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation
of our report dated January 30, 1998 included in this Form 10-K into the
Company's previously filed Registration Statement File No. 33-31556, No.
33-69840, No. 33-56693, No. 333-34249 and No. 333-47729.

ARTHUR ANDERSEN LLP

Houston, Texas
March 23, 1998

<ARTICLE> 5
<MULTIPLIER> 1,000
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<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 28,971
<SECURITIES> 0
<RECEIVABLES> 415,569
<ALLOWANCES> 5,804
<INVENTORY> 358,361
<CURRENT-ASSETS> 850,971
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<CURRENT-LIABILITIES> 372,927
<BONDS> 306,279
0
0
<COMMON> 40,316
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<TOTAL-LIABILITY-AND-EQUITY> 1,396,033
<SALES> 1,563,144
<TOTAL-REVENUES> 1,563,144
<CGS> 1,014,612
<TOTAL-COSTS> 1,014,612
<OTHER-EXPENSES> 331,041
<LOSS-PROVISION> 1,612
<INTEREST-EXPENSE> 24,973
<INCOME-PRETAX> 192,518
<INCOME-TAX> 50,650
<INCOME-CONTINUING> 102,351
<DISCONTINUED> 0
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