*Cash flow per share consists of earnings before interest, taxes, depreciation and amortization earned by the company after reduction for minority interests.

At Smith, 1996 was a good year. Our financial performance was solid and we strengthened our worldwide operations through internal growth and acquisitions. Each business unit and region reported higher revenues and earnings compared to 1995. We completed three acquisitions and announced a new joint venture, broadening and strengthening our presence in the markets we serve. Most importantly, our rate of product and service innovation is increasing as evidenced by the number of world performance records achieved in 1996.

IMPROVED FINANCIAL PERFORMANCE
For the year ended December 31, 1996, Smith International, Inc., reported revenues of $1,156.7 million, an increase of 32 percent from $874.5 million in 1995. Excluding revenues from the acquisitions completed during the year, Smith revenues rose more than 24 percent from the prior year.

Net income for 1996 totaled $64.4 million, or $1.62 per share, which compared to $45.6 million, or $1.16 per share, in the previous year. Operating income before interest and taxes rose to $132.5 million, up 54 percent from 1995.

Company-wide, our focus on containing operating costs enhanced profitability. As we benefited from increased demand and improved pricing, the Company's selling, general and administrative costs declined as a percent of revenues and resulted in an incremental operating margin of 16.4 percent year to year.

Our return on average shareholders' equity again improved, standing at 19.5 percent for the year, up from 16.5 percent in 1995. Economic Value Added (EVA^®) also improved as our return on total capital increased over 1995 generating a positive spread of over 4 percent.

In 1996, operations outside the U.S. produced 61 percent of the Company's revenues, an increase from the 59 percent reported in the prior year. Growth in our operations in Europe/Africa and the Middle East benefited from successful acquisitions as well as increased activity levels. The acquisitions of Anchor Drilling Fluids AS, headquartered in Stavanger, Norway, and the Red Baron Ltd., of Aberdeen, Scotland, have expanded our product offerings and service capabilities in Europe, the Middle East and the Far East. Additionally, the purchase of SupraDiamant S.p.A. in Scurelle, Italy, has increased our capacity for manufacturing ultrahard materials which are used in both three-cone and diamond drill bits and also in our downhole tools.

Our recent acquisitions are operating successfully and we're pleased to report they have been fully integrated into our operating units. We've also benefited from the addition of the people in these businesses, several of which have assumed senior management positions within other Smith operating units.

In addition to the growth experienced outside the U.S., results from the domestic operations remained strong during the year, aided by increased Gulf Coast activity. Demand for our premium products and services continues to grow as we reduce the overall cost of our customer's drilling programs.

A FAVORABLE OUTLOOK FOR 1997
The momentum we saw entering 1996 continued throughout the year as our reported revenues increased nearly 500 percent over the revenues of five years ago. Investment in technology by Smith produced new products and services which improve drilling efficiency. These advances enabled our customers to explore for and develop fields previously considered unfeasible from an economic or technical standpoint. The pace of activity in such areas as the Gulf of Mexico is expected to increase in 1997 and beyond.

New polycrystalline diamond drill bits, the Magnum™ line of three-cone drill bits, the NOVAPLUS™ synthetic fluids, the FLO-PRO™ drill-in fluids and the Trackmaster™ one-trip sidetracking systems are all examples of our emphasis on improved performance. Enhancement of our products and services will continue in 1997 as we continue to make significant investments in research and engineering.

Other factors in addition to the above are expected to contribute in 1997. Our new joint venture with Sonatrach, the Algerian National Oil and Gas Company, positions M-I to participate in the growth in Algeria. Also, Smith Drilling & Completions is expected to benefit from the increased level of re-entry activity.

SMITH PEOPLE DESERVE THE CREDIT
Smith International is people. Our customers drill, develop and produce their oil and gas assets more rapidly, reducing costs and improving returns. Our employees assist them in the achievement of these objectives by designing, manufacturing and delivering technologically advanced products and services. Our success is measured by the success of our customers.

We thank our people for last year's work and look forward to 1997, Smith International is evidence that people of many nations, cultures and religions can work together to provide the world with affordable energy.

Doug Rock
Chairman of the Board and Chief Executive Officer

Loren K. Carroll
Executive Vice President and Chief Financial Officer