<PAGE>   1

                                  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, 2000

                                       OR

         (  )     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.)

 411 N. SAM HOUSTON PARKWAY, SUITE 600                    77060
             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 20, 2001 was $3,616,827,937 (48,548,026 shares at the closing price on the
New York Stock Exchange of $74.50). 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 50,559,053 shares of common stock outstanding on March 20,
2001.

                       DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the Proxy Statement related to the Registrant's 2001 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 petrochemical industry and other
industrial markets. 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 and diamond drill bits, fishing services, drilling tools,
underreamers, casing exit and multilateral systems, packers and liner hangers.
The Company also offers supply-chain management solutions through an extensive
branch network providing pipe, valves, fittings, mill, safety and other
maintenance products. 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 411N. Sam Houston Parkway, Suite 600,
Houston, Texas 77060 and its telephone number is (281) 443-3370.

        The Company's operations are aggregated into two reportable segments:
Oilfield Products and Services and Distribution. The Oilfield Products and
Services segment consists of: M-I, which provides drilling and completion fluid
systems and services, solids-control and separation equipment and
waste-management services; Smith Bits, which manufactures and sells three-cone
and diamond drill bits; and Smith Services, which manufactures and markets
products and services used for drilling, workover, well completion and well
re-entry operations. The Distribution segment consists of one business unit:
Wilson, which markets pipe, valves, fittings, mill, safety and other maintenance
products to energy and industrial markets.

        Financial information regarding reportable segments and international
operations appears in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and in Note 13 of the Notes to Consolidated
Financial Statements included elsewhere in this Form 10-K. Information related
to business combinations appear in Note 2 of the Notes to Consolidated Financial
Statements included elsewhere in this Form 10-K.

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. Drilling activity levels are
primarily influenced by energy prices but may also be affected by expectations
related to the worldwide supply of and demand for oil and natural gas, finding
and development costs, decline and depletion rates, 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 believes the long-term outlook for exploration and
production activity is favorable based upon the expected growth in worldwide
energy consumption. Higher commodity prices combined with historically low
inventory levels have resulted in operators announcing increases of 20 percent,
on average, for 2001 upstream capital spending programs. The majority of
worldwide drilling activity is concentrated in North America, where natural gas
drilling remains at record levels due to accelerating depletion rates and
continued growth in demand from natural gas-fired electric power plants. Barring
a global economic slowdown, which reduces consumption levels of oil and natural
gas, industry fundamentals should be favorable for continued growth in drilling
activity. From a geographic standpoint, increases in both North American and
Non-North American spending, on a percentage basis, are expected to be similar
in 2001.



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BUSINESS OPERATIONS

OILFIELD PRODUCTS AND SERVICES SEGMENT

M-I

M-I Fluids

        Products and Services. The Company is a leading worldwide provider of
drilling fluid systems, products and engineering 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. Engineering 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; monitoring drilling fluid properties;
recommending adjustments during the drilling phase; and analyzing/benchmarking
well results after completion of the project to improve the efficiencies of
future wells.

        M-I Fluids offers water-base, oil-base and synthetic-base drilling fluid
systems. Water-base drilling fluids are the world's most widely utilized
systems, having application in both land and offshore environments. Typically,
these systems comprise an engineered blend of weighting materials used to
contain formation pressures, and a broad range of chemical additives, designed
to yield the specific drilling performance characteristics required for a given
drilling project. Oil-base drilling fluids, which primarily are used to drill
water-sensitive shales, reduce torque and drag and are widely used in areas
where stuck pipe is likely to occur. In certain drilling areas of the world,
oil-base systems exhibit comparably higher penetration rates when compared to
water-base systems, significantly reducing time on location and overall drilling
costs. Synthetic-base drilling fluids are used in drilling environments where
oil-base fluids are environmentally prohibited and provide the performance
benefits of oil-base systems. Synthetic-base systems are particularly
advantageous in the deepwater environment. M-I also provides a comprehensive
line of reservoir drill-in fluids which combine the high performance properties
of a premium drilling fluid with minimal damaging characteristics of a brine
completion fluid.

        Completion fluids (clear brines) are solids-free, clear-salt solutions
with high specific gravities and are non-damaging to the producing formation.
Operators use these specially designed fluid systems in combination with a
comprehensive range of specialty chemicals to control bottom-hole pressures,
while meeting the specific corrosion inhibition, viscosity and fluid loss
requirements necessary during the completion and workover phase of a well. These
systems are specially engineered 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 low- and
high-density brines, specialty chemicals, filtration and chemical treatment
services, wellsite engineering, technical and laboratory support services.

        Competition. Within the oil service industry, M-I Fluids competes in a
variety of distinct segments with a number of different competitors. The major
competitors in the worldwide drilling fluids market, which approximated $2.5
billion in 2000, are Baroid Drilling Fluids (a division of Halliburton Company
("Halliburton")) and INTEQ (a division of Baker Hughes, Inc. ("Baker Hughes")).
While M-I and these companies supply a majority of the market, the drilling
fluids industry is highly competitive, with a significant number of smaller,
locally-based competitors. Differentiation within the competition is based upon
the engineering services provided at the wellsite, product quality and
availability, technical support, 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
Halliburton), Tetra Technologies, Inc., OSCA, Inc. and Ambar, Inc. This market
is highly competitive, and competition is based primarily on product
availability, technical service and price.



                                       2
<PAGE>   4


M-I SWACO

        Products and Services. M-I SWACO provides services, equipment and
engineering for solids control, pressure control and waste management to the
worldwide drilling market.

        Solids-control equipment is used to remove drill cuttings from the fluid
system, allowing the drilling fluid to be cleaned and recirculated. Solids are
normally separated from the drilling fluid using one or a combination of the
following: shale shakers, desanders, desilters, hydroclones, mud cleaners and
centrifuges. SWACO designs, sells and rents a comprehensive line of this
equipment for oil and gas drilling processes throughout the world. In addition,
it provides engineering and technical support to operators and drilling
contractors from the planning stages of their projects through waste removal and
site remediation. The SWACO-manufactured line of proprietary solids-control
shakers, MUD CLEANERS(TM), hydroclones and centrifuges allows operators to drill
in "dry locations", where waste must be minimized and handled in an
environmentally acceptable method. SWACO's acquisition of the Sweco Division of
Emerson ("Sweco') in late 2000 significantly expands its ability to design and
manufacture shakers and separation equipment for both the petroleum and
industrial markets. The Sweco acquisition also strengthens SWACO's screen
manufacturing capabilities.

        Operators employ SWACO-manufactured pressure control equipment to drill
safely and economically in sour-gas and high-pressure zones. Well killing and
high-pressure control drilling chokes, together with related operating consoles,
are used in the drilling process during well kicks and well clean-up and testing
operations. Degassers and mud gas separators are designed to remove and safely
vent entrained gases, including toxic gases such as hydrogen sulfide and
corrosive oxygen, from the drilling mud. This equipment reduces the risk of
dangerous and costly blowouts caused by recirculating mud that contains natural
gas. Key products in SWACO's pressure control product line include the MUD
D-GASSER(R) and SUPER CHOKE(R), both of which hold strong market positions, as
do the SUPER MUD GAS SEPARATOR(TM) and the SUPER AUTOCHOKE(TM). The latter
represent key advancements in hands-free well pressure control and underbalanced
drilling operations.

        With drilling operations expanding into more environmentally sensitive
areas, there has been increased focus on the effective collection, treatment and
disposal of waste produced during the drilling of a well. SWACO provides
value-added solutions to operators designed to minimize and treat drilling
waste. The Company provides a full suite of waste handling, minimization and
management services that includes rig vacuum systems for cuttings recovery,
high-gravity force drying for liquid/solid separation and cuttings slurification
and re-injection for reducing waste. In addition, through the THERMAL PHASE
SEPARATION(TM) process, SWACO provides operators a proven technology for
maximizing the recovery of drilling fluids, while minimizing wastes. SWACO's
waste treatment services encompass a wide range of activities, including site
assessment, drill cuttings injection, water treatment, pit closure, remediation,
bioremediation, dewatering and thermal processing. The Company has established
ENVIROCENTERS(TM) in Norway, Germany and the United States designed specifically
for recovering, treating and recycling solid and liquid drilling wastes.

        Competition. M-I SWACO competes with Brandt/Rigtech (a subsidiary of
Varco International, Inc.) and Derrick/Oil Tools. Additionally, there are a
number of regional suppliers that provide a limited range of equipment and
services tailored for local markets. Competition is based on product
availability, equipment performance, technical support and price.


Smith Bits

        Products and Services. Smith Bits is a worldwide leader in the design,
manufacture and marketing of drill bits used primarily in drilling oil and gas
wells and in mining applications. The Company's offering of petroleum drill bits
and services are designed principally for the premium market segments where
faster drilling rates and greater footage drilled provide significant economic
benefits in the total cost of a well.

        Most bits manufactured and sold by Smith Bits are three-cone drill bits
for the petroleum industry, ranging in size from 3 1/2 to 28 inches in diameter.
These three-cone bits comprise 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 recent years, there has been a significant increase in
demand for drill bits in which



                                       3
<PAGE>   5



the tungsten carbide insert is coated with polycrystalline diamond ("PDC"). In
certain formations, bits produced with diamond-enhanced inserts last longer and
increase penetration rates, which substantially decreases overall drilling
costs. Smith Bits is the leading provider of drill bits utilizing
diamond-enhanced insert technology.

        In addition, Smith Bits designs, manufactures and markets diamond, or
shear, drill bits featuring PDC or natural diamond cutters. The Company
manufactures ultra-hard PDC and cubic boron nitride materials that are used in
the Company's three-cone and diamond drill bits and other specialized cutting
tools. Smith Bits develops 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 provides 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. The Company believes that its ability
to develop specialized diamond inserts for specific applications has, and will
continue, to provide new business opportunities.

        Mining bits typically are used in shallow drilling to place explosives
for blasting in open pit mining operations. While the cutting structures in
mining bits are principally tungsten carbide insert, others, known as hammer
bits, employ both tungsten carbide and diamond-enhanced inserts and have been
designed for use with air percussion tools.

        Competition. Besides the Company, Hughes Christensen (a division of
Baker Hughes), Security DBS (a division of Halliburton) and Reed/Hycalog (a
division of Schlumberger Limited ("Schlumberger")) are the three major
competitors in the drill bit business. While Smith Bits and these companies
supply the majority of the worldwide drill bit market, they compete with more
than 20 companies. Generally, competition for sales of drill bits is based on a
number of factors, including performance, quality, reliability, service, price,
technological advances and breadth of products. The Company believes its
quality, reliability and technological advances, such as diamond-enhanced
inserts, provide its products with a competitive advantage.

Smith Services

        Products and Services. Smith Services is a global provider of premium
quality drilling, fishing, remedial, multilateral and completion products,
services and solutions to the upstream oil and gas drilling industry.

         Smith Services' Drilling Solutions business provides a broad range of
downhole impact tools for drilling applications as well as numerous other
specialized downhole drilling products and services. Smith Services sells and
rents impact drilling tools, such as the HYDRA-JAR(TM), which is used to free
stuck drill strings during the drilling process. Additionally, the
HYDRA-THRUST(TM) and HYDRA-TORAX(TM) impact tools are used in the drilling
process, designed to maintain constant weight on the drill bit and absorb drill
string vibrations. Smith Services also offers tubular drill string components,
such as drill collars, subs, stabilizers, kellys and HEVI-WATE(TM) drill pipe,
and provides related inspection services, including drill string repair and
rebuild services. These components and their placement in the drill string are
supported by engineering and field technical services in order to optimize
bottom hole management techniques. Through state-of-the-art software, Smith
Services aids the customer in maximizing the life of drill string components by
analyzing rotational hours and providing inspection and repair services for the
various drill string components. Rotating drilling heads for flow control in
underbalanced drilling applications and automatic connection torque monitoring
and control systems are also designed and manufactured by Smith Services.

         Smith Services' Fishing and Remedial Solutions business provides a
comprehensive package of fishing, remedial and thru-tubing services. Fishing
operations clear and remove obstructions from a wellbore that may arise during
drilling, completion or workover activities or during the well's production
phase. This operation requires a wide variety of specialty tools including
fishing jars, milling tools, casing cutters, overshots and grapples, all of
which are manufactured by Smith Services. These tools are operated by Company
service personnel, or sold or rented to third-party fishing companies. Smith
Services also manufactures and markets hole openers and underreamers which are
designed to create larger hole diameters in certain sections of the wellbore.
The Company's patented REAMASTER(TM) and UNDERREAMMING-WHILE-DRILLING SYSTEM(TM)
("UWD") are two examples of products that aid the customer in realizing lower
drilling costs through technology. Through the use of the UWD system above the
drill bit, the operator may drill the main bore with the bit and enlarge the
diameter of the hole above the drill bit in the same run.

         Smith Services provides Casing Exit and Multilateral Solutions through
the manufacture of proprietary casing exit tools which are installed by highly
trained technicians. These systems, which include the patented MILLMASTER
PERFORMANCE



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MILLING SYSTEM(TM), PACKSTOCK(TM), ANCHORSTOCK(TM), and TRACKMASTER(TM), allow
the operator to divert around obstructions in the main wellbore or reach
multiple production zones from the main wellbore (known as multilateral
completions). Smith Services has designed the patented DRILLAHEAD SYSTEM(TM)
that cuts the casing window and continues drilling beyond the window,
essentially creating a "no trip" system which saves the customer time and
reduces their overall drilling costs. The Company also provides mechanical,
hydraulic and explosive pipe cutting services to remove casing during well or
platform abandonment.

        Smith Services' Completion Solutions business specializes in providing
fit-for-purpose liner hanger, liner cementing equipment, isolation packers,
retrievable and permanent packers, packer products, and multilateral completion
equipment. Liner hangers allow strings of casing to be suspended within the
wellbore without having to extend the string all the way to the surface and are
also used to isolate production zones and formations. Most directional and
multilateral wells include one or more hangers due to the difficult casing
programs and need for zonal isolation. Packers are mechanically or hydraulically
actuated devices which lock into place at specified depths in the well and
provide a seal between zones through expanding element systems. The devices
therefore create isolated zones within the wellbore to permit either specific
formation production or allow for certain operations such as cementing and
acidizing to take place without damaging the reservoir.

        Competition. Smith Services major competitors in the drilling, remedial,
re-entry and fishing services markets are Weatherford International, Inc.
("Weatherford"), Baker Oil Tools (a division of Baker Hughes) and numerous small
local companies. The main competitors in the liner hanger and packer markets are
Baker Oil Tools, Weatherford and TIW. The main competitors in the drilling and
fishing jar market and the fishing product and service market are Weatherford
and National-Oilwell Inc. ("National-Oilwell"). Competition in the drilling and
completions sales, rental and services market is primarily based on performance,
quality, reliability, service, price and response time and, in some cases,
breadth of products. Smith Services 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

DISTRIBUTION SEGMENT

Wilson

        Products and Services. Wilson is a supply-chain management company which
provides products and services to the energy, refining, petrochemical, power
generation and mining industries. Wilson operates an extensive network of supply
branches, service centers and sales offices through which it markets pipe,
valves, fittings, mill, safety, janitorial and other maintenance products
throughout the world, predominately in the United States and Canada. In
addition, Wilson provides warehouse management, vendor integration and various
surplus and inventory management services. The majority of Wilson's operations
are focused on North American distribution of maintenance, repair and operating
supplies and equipment with the remainder associated with line pipe and
automated valve products (including valve, actuator and control packages).

        Competition. Wilson's competitors in the distribution business include
National-Oilwell, McJunkin Corporation and a significant number of smaller,
locally-based competitors. The oilfield equipment supply industry is highly
competitive. Generally, competition involves numerous factors including price,
experience, customer service and equipment availability. Wilson markets its
products and services to exploration and production companies as well as to
companies with operations in the refining, chemical and pipeline segments of the
petroleum industry and as a result is considered to be both an "upstream" and
"downstream" competitor. Fluctuations in the demand for products and services
from customers with operations in these segments tend to provide a diversified
revenue base.



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NON-U.S. OPERATIONS

        Sales to oil and gas exploration and production markets outside the
United States are a key strategic focus of Smith's 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. Approximately 51 percent of the Company's revenues in
2000 were derived from equipment or services sold or provided outside the United
States. The Company's Distribution operations are focused in North America and
serve to mask the Company's exposure to markets outside the United States.
Excluding the impact of the Distribution operations, 60 percent of the Company's
revenues were generated in non-U.S. markets.

        Historically, drilling activity outside the United States has been less
volatile than U.S. based activity as the high cost of exploration and production
programs outside the United States 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.

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 in and outside the United States, M-I
has the capability to produce a large portion of its requirements for barite and
bentonite. Barite reserves are mined in the United States, the United Kingdom
and Morocco. Bentonite is produced from ore deposits in the United States.
Mining exploration activities continue worldwide to locate and evaluate ore
bodies to ensure deposits are readily available 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 United States,
mainly the People's Republic of China, India and Morocco.

        The Company purchases a variety of raw materials for its Smith Bits and
Smith Services 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 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 producer with
substantial PDC manufacturing capabilities.



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<PAGE>   8



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 technologies to meet customer 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 Aberdeen, Scotland.

        The Company also maintains a drill bit database which records the
performance of substantially all drill bits used in the United States 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 are attributable to the Company's Oilfield
Products and Services segment and totaled $42.4 million in 2000, $39.0 million
in 1999 and $41.0 million in 1998. In 2000, research and engineering
expenditures approximated 2.3 percent of the Company's Oilfield Products and
Services segment 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 upon patent protection in general.

EMPLOYEES

        At December 31, 2000, the Company had 9,892 full time employees
throughout the world. Most of the Company's employees in the United States 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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<PAGE>   9



ITEM 2.  PROPERTIES

        The principal facilities and properties utilized by the Company at
December 31, 2000 are shown in the table below. Generally the facilities and
properties are owned by the Company.

<TABLE>
<CAPTION>
                                                                                                              Approx.
                                                    Principal Products Processed            Land            Bldg. Space
Location                                                   or Manufactured                  (Acres)          (sq. ft.)
--------                                                   ---------------                  -------          ---------

<S>                                      <C>                                                <C>            <C>
M-I:
  Florence, Kentucky.................      Separator units, mill units, parts, screens and
                                             motors                                               15         145,000
  Greybull, Wyoming..................      Bentonite mine and processing                       8,394         110,000
                                           Solids control, rig instrumentation and
  Oklahoma City, Oklahoma............        environmental remediation equipment                  13          99,000
  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
                                           Separator units, mill units, parts, screens and
  Nivellas, Belgium..................        motors                                                5          32,000
  Airdrie, Canada....................      Solids control equipment                                4          27,000
  Amelia, Louisiana..................      Barite processing                                      26          25,000
  Spruce Grove, Canada...............      Drilling fluid processing                               3          24,000
  Salzweld, Germany..................      Drilling fluid processing                               2          23,000
  Berra, Italy.......................      Solids control equipment                                2          24,000
  Galveston, Texas...................      Barite processing                                       6          21,000
  Macon, Georgia.....................      Separator units and screens                             1          18,000
  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 Bits and Smith Services:
  Houston, Texas.....................      Tubulars, surface and downhole
                                             tools, remedial products, liner
                                             hangers, diamond drill bits,
                                             drilling and fishing jars and fishing tool
                                             equipment                                            82         618,000
  Ponca City, Oklahoma...............      Three-cone drill bits                                  15         207,000
  Aberdeen, Scotland.................      Downhole tools and remedial products                   10         132,000
  Saline di Volterra, Italy..........      Three-cone drill bits                                  11          92,000
  Aberdeen, Scotland.................      Downhole tools and remedial products                   10          91,000
  Nisku, Canada......................      Tubulars and drill collars                             10          42,000
                                           Diamond drill bits and synthetic diamond
  Scurelle, Italy....................        materials                                             4          31,000
  Provo, Utah........................      Synthetic diamond materials                             4          30,000

Wilson:
  Houston, Texas.....................      Pipe, valves and fittings                              11         198,000
</TABLE>

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



                                       8
<PAGE>   10



ITEM 3.  LEGAL PROCEEDINGS

        Information relating to various commitments and contingencies, including
legal proceedings, is described in Note 14 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.

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.


<TABLE>
<CAPTION>

         NAME, AGE AND POSITIONS                           PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
         -----------------------                           -------------------------------------------
<S>                                      <C>
Douglas L. Rock (54)................      Chairman of the Board; Chief Executive Officer, President and Chief Operating
   Chairman of the Board, Chief            Officer.
   Executive Officer, President
   and Chief Operating Officer

Loren K. Carroll (57)...............      President and Chief Executive Officer of M-I since March 1994; Executive Vice
   Executive Vice President of the         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

Neal S. Sutton (55).................      Senior Vice President--Administration, General Counsel  and Secretary.
   Senior Vice President--
   Administration, General
   Counsel and Secretary

Margaret K. Dorman (37).............      Senior Vice President, Chief Financial Officer and Treasurer since June 1999; Vice
   Senior Vice President, Chief            President, Controller and Assistant Treasurer from February 1998 to May 1999;
   Financial Officer and Treasurer         Director of Financial Reporting and Planning from December 1995 to February
                                           1998.

Roger A. Brown (55).................      President, Smith Bits since July 1998; President, Smith Diamond Technology from
   President, Smith Bits                   April 1995 to July 1998.



John J. Kennedy (48)................      President and Chief Executive Officer, Wilson since June 1999; Senior Vice
   President and Chief Executive           President, Chief Financial Officer and Treasurer from April 1997 to May 1999;
   Officer, Wilson                         Vice President, Chief Accounting Officer and Treasurer from March 1994 to April
                                           1997.

Richard A. Werner (59)..............      President, Smith Services.
   President, Smith Services


Peter D. Nicholson (44).............      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.
</TABLE>



                                       9
<PAGE>   11


<TABLE>
<CAPTION>

         NAME, AGE AND POSITIONS                           PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
         -----------------------                           -------------------------------------------
<S>                                      <C>
Earl M. Springer (50)...............      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.

Brian E. Taylor (38)................      Vice President and Controller since September 1999; Various positions including
   Vice President and Controller            Controller for Camco International Inc., a division of Schlumberger Limited, from
                                            January 1998 to August 1999; Director of Central Financial Services for Drypers
                                            Corporation from October 1996 to December 1997; Arthur Andersen LLP, Audit Practice
                                            from December 1986 to September 1996.

Geri D. Wilde (50)..................      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 Payroll
   Assistant Treasurer                      of M-I 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.



                                       10
<PAGE>   12


                                     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.

<TABLE>
<CAPTION>

                                                                                                     COMMON STOCK
                                                                                                     ------------
                                                                                               HIGH                LOW
                                                                                               ----                ---
<S>                                                                                         <C>               <C>
         1999
           First Quarter................................................................    $  43 1/2          $ 23 9/16
           Second Quarter...............................................................       49 7/8             35 1/4
           Third Quarter................................................................      52 1/16            39 1/16
           Fourth Quarter...............................................................       50 1/8             31 5/8
         2000
           First Quarter................................................................    $  82 3/8         $       45
           Second Quarter...............................................................       88 1/2             65 1/4
           Third Quarter................................................................       87 1/8             65 7/8
           Fourth Quarter...............................................................       83 1/8             54 7/8
</TABLE>


        On March 20, 2001, the Company had 2,403 common stock holders of record
and the last reported closing price on the New York Stock Exchange Composite
Tape was $74.50.

        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.



                                       11
<PAGE>   13


ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                        FOR THE YEARS ENDED DECEMBER 31,
                                                 --------------------------------------------------------------------------------
                                                       2000           1999(a)        1998(b)(c)         1997           1996
                                                       ----           ----           ----               ----           ----

                                                                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<S>                                              <C>             <C>             <C>             <C>             <C>
STATEMENT OF OPERATIONS DATA:
Revenues.......................................  $    2,761,014  $    1,806,153  $    2,118,715  $    2,167,952  $     1,651,906

Gross profit...................................         745,169         467,940         629,059         652,599          472,728

Income before interest and taxes...............         199,026         149,532         125,309         248,946          148,785

Net income.....................................          72,800          56,724          34,069         121,329           73,297

Earnings per share - diluted basis.............            1.45            1.15            0.70            2.52             1.53

BALANCE SHEET DATA:
Total assets...................................  $    2,295,287  $    1,894,575  $    1,758,988  $    1,672,499  $     1,287,262

Long-term debt.................................         374,716         346,647         368,823         371,579          260,443

Total shareholders' equity.....................         817,481         720,220         634,034         572,045          454,269
</TABLE>

        In April 1998, the Company acquired Wilson Industries, Inc. in a
transaction accounted for as a pooling-of-interests. Accordingly, the financial
information gives effect to the acquisition for all periods presented. 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 business combinations
and unusual items which may affect the comparability of the information shown
above.

(a)     In May 1999, the Company acquired the distribution operations of
        ConEmsco, Inc. in exchange for 548,527 shares of common stock and a note
        payable (the "ConEmsco Transaction"). In July 1999, the Company
        completed a transaction with Schlumberger Limited related to the
        combination of certain M-I and Dowell drilling fluid operations under a
        joint venture arrangement. Schlumberger contributed its non-U.S.
        drilling fluid operations and paid cash consideration of $280 million to
        the Company in exchange for a 40 percent minority ownership interest in
        the combined operations (collectively, the "M-I Transaction"). The
        Company recognized a non-recurring gain of $81.4 million in connection
        with this transaction.
(b)     In August 1998, the Company acquired the remaining 36 percent interest
        in M-I in exchange for a $265.0 million non-interest bearing note.
(c)     In 1998, the Company recognized $82.5 million of charges related to
        restructuring efforts and costs associated with the acquisition and
        integration of Wilson Industries, Inc.



                                       12
<PAGE>   14



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.
This discussion 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 manufactures and markets premium products and services to
the oil and gas exploration and production and petrochemical industries and
other industrial markets. 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. Drilling activity
levels are primarily influenced by energy prices but may also be affected by
expectations related to the worldwide supply of and demand for oil and natural
gas, finding and development costs, decline and depletion rates, 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 believes the long-term outlook for exploration and production
activity is favorable based upon the expected growth in worldwide energy
consumption. Higher commodity prices combined with historically low inventory
levels have resulted in operators announcing increases of 20 percent, on
average, for 2001 upstream capital spending programs. The majority of worldwide
drilling activity is concentrated in North America, where natural gas drilling
remains at record levels due to accelerating depletion rates and continued
growth in demand from natural gas-fired electric power plants. Barring a global
economic slowdown, which reduces consumption levels of oil and natural gas,
industry fundamentals should be favorable for continued growth in drilling
activity. From a geographic standpoint, increases in both North American and
Non-North American spending, on a percentage basis, are expected to be similar
in 2001.

        Management also believes the increasing complexity of drilling programs
has resulted in a shift in exploration and production spending toward
value-added, technology-based products, which reduce operators' overall drilling
costs. 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 and reduced formation damage.
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.

FORWARD-LOOKING STATEMENTS

        This discussion contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995 concerning, among other
things, the Company's outlook, financial projections and business strategies,
all of which are subject to risks, uncertainties and assumptions. These
forward-looking statements are identified by their use of terms such as
"expect," "anticipate," "estimate," "project," "believe," and similar terms. The
statements are based on certain assumptions and analyses made by the Company
that it believes are appropriate under the circumstances. Such statements are
subject to general economic and business conditions, industry conditions,
changes in laws or regulations and other factors, many of which are beyond the
control of the Company. Should one or more of these risks or uncertainties
materialize, or should the assumptions prove incorrect, actual results may vary.



                                       13
<PAGE>   15



RESULTS OF OPERATIONS

Segment Discussion

        The Company markets its products and services throughout the world
through four business units which are aggregated into two reportable segments.
The Oilfield Products and Services segment consists of three business units:
M-I, Smith Bits and Smith Services. The Distribution segment includes the Wilson
business unit. The revenue discussion below has been summarized by business unit
in order to provide additional information in analyzing the Company's
operations. Dollars presented below are in thousands.

<TABLE>
<CAPTION>
                                                                      FOR THE YEARS ENDED DECEMBER 31,
                                                ------------------------------------------------------------------------------
                                                            2000                       1999                      1998
                                                   -----------------------    ----------------------    -----------------------
                                                     AMOUNT      PERCENT        AMOUNT     PERCENT        AMOUNT      PERCENT
                                                     ------      -------        ------     -------        ------      -------
Segment Revenues:
  Business Unit:

<S>                                               <C>              <C>    <C>              <C>        <C>               <C>
  M-I...........................................   $  1,236,999     45     $      842,214     47     $    1,014,449      48
  Smith Bits....................................        328,192     12            240,109     13            308,263      15
  Smith Services...............................         289,935     10            227,216     13            323,456      15
                                                   ------------     --        -----------     --     --------------      --
  Oilfield Products and Services................      1,855,126     67          1,309,539     73          1,646,168      78
  Wilson........................................        905,888     33            496,614     27            472,547      22
                                                   ------------     --        -----------     --     --------------      --

    Total.....................................     $  2,761,014    100     $    1,806,153     100    $    2,118,715     100
                                                   ============    ===     ==============     ===    ==============     ===
Revenues by Area:

  United States...............................     $  1,349,812     49     $      834,783     46     $    1,017,016      48
  Export......................................          115,330      4             83,594      5            140,398       7
  Non-United States...........................        1,295,872     47            887,776     49            961,301      45
                                                   ------------     --     --------------     --     --------------      --

    Total.....................................     $  2,761,014    100     $    1,806,153     100    $    2,118,715     100
                                                   ============    ===     ==============     ===    ==============     ===

Segment Income Before Interest and Taxes:

  Oilfield Products and Services..............     $    188,017     10     $       70,630      5     $      209,621     13
  Distribution................................           16,655      2                178      -              3,184      1
  General Corporate...........................           (5,646)     *             (5,275)     *             (4,996)     *

  Non-Recurring Items.........................                -      *             83,999      *            (82,500)     *
                                                   ------------     --     ---- ---------     --     --------------      --

    Total.....................................     $    199,026      7     $      149,532      8     $      125,309      6
                                                   ============    ===     ==============     ===    ==============     ===

</TABLE>
* not meaningful

 Oilfield Products and Services Segment

Revenues

        M-I provides drilling and completion fluid systems, engineering and
technical services to the oil and gas industry through its M-I Fluids division.
M-I's SWACO division manufactures and markets equipment and services for solids
control, separation, pressure control, rig instrumentation and waste management.
M-I's revenues increased $394.8 million, or 47 percent, from 1999 evidencing the
higher level of worldwide drilling activity. Approximately two-thirds of the
revenue improvement over 1999 was reported in the United States and
Europe/Africa, which was favorably impacted by increased customer spending in
the offshore markets. Offshore projects, which account for approximately
one-half of M-I's total sales, generate higher revenues than land-based projects
due to the complex nature of offshore drilling environments. The revenue
increase also related to inclusion of a full year of the Dowell drilling fluid
operations, which were acquired in connection with the formation of the drilling
fluids joint venture in July 1999. Excluding the impact of acquisitions,
revenues increased 41 percent over 1999 revenue levels. For the year ended
December 31, 1999, M-I reported revenues of $842.2 million which was 17 percent
below the 1998



                                       14
<PAGE>   16



amount. The revenue decline was attributable to a 24 percent reduction in
average worldwide drilling activity; however, the decrease was partially offset
by the addition of the Dowell drilling fluid operations. Excluding the impact of
the acquired operations, M-I's 1999 revenues were 23 percent below the prior
year amount with the majority of the decline reported in Latin America, the
United States and Europe/Africa.

        Smith Bits manufactures and sells three-cone and diamond drill bits
primarily for use in the oil and gas industry. Smith Bits' 2000 revenues
increased $88.1 million, or 37 percent, from 1999. On a combined basis, sales of
three-cone and diamond bits grew 40 percent over the prior year levels, in
excess of the 30 percent improvement in worldwide drilling activity, benefiting
from increased market penetration and the impact of price increases implemented
throughout the year. Revenue increases were reported in all geographic regions,
with the majority of the growth concentrated in North America where demand for
drill bits has been favorably impacted by higher natural gas and crude oil
prices. For the year ended December 31, 1999, revenues approximated $240.1
million which was 22 percent below the 1998 amount. The significant reduction in
worldwide drilling activity resulted in lower demand for petroleum three-cone
bits and accounted for a substantial portion of the revenue decline.

        Smith Services manufactures and markets products and services used in
the oil and gas industry for drilling, workover, well completion and well
re-entry. Smith Services' revenues increased $62.7 million, or 28 percent, over
the amounts reported in 1999. Over three-quarters of the revenue improvement was
experienced in the United States and resulted from increased drilling and
remedial activity in the U.S. Gulf Coast area. On a product basis, increased
sales of tubular goods and improved demand for directional drilling services
accounted for the largest dollar and percentage increases period-to-period. The
Company's directional drilling operations, which generated revenues of $14.6
million during 2000, were sold in January 2001. In 1999, Smith Services'
revenues were $227.2 million, a 30 percent decline from the 1998 levels. Reduced
demand for tubular goods and remedial products and services due to lower
drilling and production activity accounted for the majority of the revenue
decrease from 1998.

Income before Interest and Taxes

        Income before interest and taxes for the Oilfield Products and Services
segment increased $117.4 million from 1999. For 2000, income before interest and
taxes was ten percent of revenues versus five percent in the prior year period.
The improvement in operating margins was equally split between increased gross
profit margins and lower operating expenses as a percentage of revenues. The
gross profit margins were impacted by higher sales and production volumes and,
to a lesser extent, price increases implemented during the year. Reflecting the
decline in worldwide exploration activity levels, income before interest and
taxes in 1999 declined to five percent of revenues from 13 percent of revenues
in 1998.

Distribution Segment

Revenues

        Wilson markets pipe, valves, fittings, mill, safety and other
maintenance products to energy and industrial markets, primarily through an
extensive network of supply branches in the United States and Canada. Wilson's
revenues increased $409.3 million, or 82 percent, from 1999 due to a combination
of internal growth and the impact of the ConEmsco and Texas Mill Supply
acquisitions. Excluding the impact of operations acquired and divested, revenues
grew 24 percent over the prior year period as the increase in U.S. exploration
and production activity had a favorable impact on energy sector revenues. In
1999, Wilson reported revenues of $496.6 million, a five percent improvement
over the prior year level. Incremental revenues generated by the operations
acquired in the May 1999 ConEmsco Transaction accounted for the revenue increase
over 1998. Lower base operation revenues in the United States, due to the
decline in U.S. drilling activity from 1998 levels, and the divestiture of
Wilson's Oil Country Tubular Goods ("OCTG") operations partially offset the
increase. Excluding the impact of operations acquired and divested during 1999,
Wilson's revenues were 22 percent below 1998 levels.

Interest before Interest and Taxes

        Wilson's income before interest and taxes increased $16.5 million from
1999. As a percentage of revenue, income before interest and taxes increased to
two percent in 2000 from a breakeven level in 1999. Higher revenues and a
favorable shift in product mix accounted for the majority of this favorable
variance. As a result of the decline from 1998 in exploration and production
levels, income before interest and taxes decreased $3.0 million in 1999.



                                       15
<PAGE>   17



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

<TABLE>
<CAPTION>
                                                                        FOR THE YEARS ENDED DECEMBER 31,
                                                 -------------------------------------------------------------------------------
                                                          2000                        1999                     1998
                                                          ----                        ----                     ----

                                                    AMOUNT      PERCENT        AMOUNT       PERCENT      AMOUNT      PERCENT
                                                    ------      -------        ------       -------      ------      -------
<S>                                               <C>           <C>          <C>            <C>       <C>           <C>
Revenues...................................        $ 2,761,014    100          $1,806,153    100       $2,118,715     100
                                                   -----------    ---          ----------    ---       ----------     ---

Gross profit...............................            745,169     27             467,940     26          629,059      30

Operating expenses.........................            546,143     20             402,407     22          421,250      20


Non-recurring items........................                 --     --             (83,999)    (4)          82,500       4
                                                   -----------    ---          ----------     --        ---------      --
Income before interest and taxes...........            199,026      7             149,532      8          125,309       6
Interest expense, net......................             34,895      1              38,773      2           43,371       2
                                                   -----------    ---          ----------     --        ---------      --
Income before income taxes and minority
   interests...............................            164,131      6             110,759      6           81,938       4
Income tax provision.......................             54,998      2              47,865      3           26,279       1
                                                   -----------    ---          ----------     --        ---------      --
Income before minority interests...........            109,133      4              62,894      3           55,659       3
Minority interests.........................             36,333      1               6,170      -           21,590       1
                                                   -----------    ---          ----------     --        ---------      --

Net income.................................        $    72,800      3          $   56,724      3          $34,069       2
                                                   ===========    ===          ==========     ==        =========      ==
</TABLE>

2000 versus 1999

        Total revenues for 2000 increased $954.8 million, or 53 percent, above
the prior year as higher commodity prices contributed to a 30 percent increase
in worldwide drilling activity. The year-over-year improvement was also
attributable to incremental revenues from acquired distribution operations and,
to a lesser extent, the impact of price increases implemented throughout the
year. Excluding the effect of acquired and divested operations, revenues grew 35
percent above the prior year levels with improvement reported across all
operating units and geographic areas. Approximately two-thirds of the base
business growth was generated in North America, resulting from a 46 percent
improvement in the average number of rigs drilling for oil and natural gas.
Revenues in 2001 are projected to exceed $3.5 billion due to a combination of
higher forecasted drilling activity levels and the effect of acquisitions
completed in late-2000 and 2001.

        Gross profit increased $277.2 million, or 59 percent, from the 1999
fiscal year. Period-to-period, gross profit margins improved one percentage
point reflecting the impact of higher sales volumes on fixed cost coverage,
increased absorption in the Company's manufacturing operations and price
increases implemented during the year. Gross profit margins increased in both
the oilfield and the distribution segments; however, the higher proportion of
distribution revenues, which traditionally generate lower profit margins than
the oilfield businesses, impacted the overall percentage. The Company's gross
profit in 2001 is expected to increase on a dollar and margin basis due to the
impact of higher activity levels and improved pricing on consolidated gross
margins, however, may not reach levels reported prior to 1999 due to the
increasing proportion of distribution revenues.

        Operating expenses, consisting of selling, general and administrative
expenses, increased $143.7 million from the amount reported in 1999. The
majority of the increase in operating expenses results from incremental costs of
the acquired operations and the impact of higher profitability levels, which
resulted in increased profit sharing and incentive accruals. Increased operating
expenses associated with higher volumes, primarily personnel additions and other
variable costs, also contributed to the period-to-period increase. Operating
expenses as a percentage of revenues declined two percentage points from the
prior year reflecting higher fixed cost coverage related to the overall sales
and administrative functions.

         Net interest expense, which represents interest expense less interest
income, decreased $3.9 million from the prior year. In 1999, the Company
utilized proceeds from the sale of an interest in M-I to repay outstanding
indebtedness, resulting in the reported decline. The reduction was partially
offset by increased borrowings in 2000 to finance acquisitions and general
working capital needs, which increased as a result of the revenue growth
experienced by the Company.



                                       16
<PAGE>   18



        The effective tax rate for 2000 approximated 34 percent, which was a
decrease from the 43 percent effective rate reported in 1999 and lower than the
U.S. statutory rate. The effective tax rate in 2000 is below the U.S. statutory
rate due to the impact of M-I's U.S. partnership earnings for which the minority
partner is directly responsible for their related income taxes. The effective
tax rate was below the prior year rate due primarily to the impact in 1999 of
non-deductible costs associated with the sale of a minority ownership interest
in M-I.

        Minority interests reflect the portion of the results of majority-owned
operations which are applicable to the minority interest partners. Minority
interests increased $30.2 million from the prior year due to the higher
profitability level of the M-I operations and, to a lesser extent, the period of
time the operations were owned jointly with a minority partner.

1999 Versus 1998

        Total revenues for 1999 decreased $312.6 million, or 15 percent, from
the prior year as high crude oil inventory levels resulted in reduced drilling
and completion activity levels in all geographic regions. The majority of the
revenue decline from 1998 levels was reported in the United States and Latin
America reflecting the decline in exploration and production activity. This
revenue decrease was partially offset by incremental revenues from the ConEmsco
Transaction and, to a lesser extent, increased sales associated with the
acquired drilling fluid operations. On a product basis, reductions in tubular
sales, due to the divestiture of Wilson's OCTG operations as well as the decline
in activity, accounted for over one-third of the revenue variance between
periods.

        Gross profit as a percentage of revenues decreased to 26 percent in 1999
from 30 percent in 1998. The decrease reflects the impact of lower revenues on
fixed cost coverage, with reduced manufacturing volumes and rental tool
utilization contributing to the majority of the overall margin decline. To a
lesser extent, competitive pricing pressures in certain markets in which the
Company participates and an increased proportion of distribution revenues, which
traditionally generate lower profit margins, have contributed to the decline in
gross profit margins.

        Operating expenses, consisting of selling, general and administrative
expenses, decreased $18.8 million from the prior fiscal year. Reductions in
costs associated with lower volumes, including reduced headcount levels and
other cost control measures implemented in response to activity level declines
experienced in 1998, were partially offset by incremental costs associated with
the acquired operations.

        During 1999, the Company recognized a non-recurring gain of $81.4
million associated with the M-I Transaction. The non-recurring gain is presented
net of transaction-related charges, including resulting profit-sharing and
incentive requirements, assessed fines, professional fees and other related
expenses. Additionally, the Company recorded a non-recurring net gain of $2.6
million in 1999 related to a gain on disposal of an industrial bentonite mining
operation which was partially offset by unrelated charges to write-off certain
assets and settle a customer receivable. During 1998, the Company recorded
charges related to restructuring efforts and costs associated with the
acquisition and integration of the Wilson operations. See Note 3, "Non-Recurring
Items," for further discussion of these items.

        Net interest expense, which represents interest expense less interest
income, decreased $4.6 million from 1998. Proceeds from the M-I Transaction and,
to a lesser extent, cash flow from operations were used to repay outstanding
indebtedness, resulting in the interest expense reduction. Incremental interest
expense associated with the August 1998 purchase of Halliburton Company's
minority ownership interest in M-I partially offset the decrease.

        The effective tax rate for 1999 approximated 43 percent, which was an
increase from the 32 percent effective rate reported in 1998 and higher than the
U.S. statutory rate. The rate exceeded the statutory rate due primarily to the
inclusion of non-deductible costs associated with the sale of a minority
ownership interest in M-I and the sale of one of the Company's international
mining operations. The variance from the 1998 effective rate reflects primarily
higher M-I U.S. partnership earnings in 1998 for which the Company's minority
interest partner was responsible for the respective portion of income taxes.

        Minority interests reflect the portion of the results of majority-owned
operations which are applicable to the minority interest partners. Minority
interests decreased $15.4 million from the prior year, primarily reflecting the
lower profitability of the M-I operations.



                                       17
<PAGE>   19



LIQUIDITY AND CAPITAL RESOURCES

  General

        At December 31, 2000, cash and cash equivalents equaled $36.5 million.
During 2000, the Company's operations generated $57.7 million of cash flows
which is $11.0 million below the amount reported in 1999. The significant
increase in revenues year-to-year required investments in working capital which,
for the most part, were offset by the higher profitability level of the
operations and the impact of prior year restructuring costs which did not recur.
Cash flows required to fund the Company's capital expenditure and acquisition
needs exceeded cash flows from operations, resulting in borrowings under new and
existing credit facilities. Cash flows provided by financing activities totaled
$178.2 million in 2000, with $138.6 million of such amount provided through
borrowings under credit facilities.

        In 2000, the Company invested $77.9 million in property, plant and
equipment net of cash proceeds arising from certain asset disposals. Projected
net capital expenditures for 2001 are expected to increase to approximately
$105.0 million due to the continued improvement in exploration and production
activity. Capital spending in 2001 is expected to primarily consist of spending
for routine additions of property and equipment used to support the Company's
operations and maintenance of the Company's capital equipment base.

        The Company funded $123.8 million of business acquisitions during 2000,
net of the minority partner's investment. Subsequent to December 31, 2000, the
Company acquired substantially all of the U.S. net assets of Van Leeuwen Pipe
and Tube Corporation, a provider of pipe, valves and fittings to the refining,
petrochemical and power generation industries, with borrowings under a
negotiated short-term loan facility. Management continues to evaluate
opportunities to acquire products or businesses complementary 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 United States for operating and financing needs.
The Company had approximately $41.7 million of funds available under its
long-term revolving line-of-credit facilities at December 31, 2000.
Additionally, the Company had $77.7 million of non-U.S. borrowing facilities
with various banks which had available borrowing capacity of $32.0 million at
year-end.

        Subsequent to year-end, the Company completed a public offering of
$250.0 million of 6.75 percent Senior Notes which mature in February 2011. The
Company received net proceeds of $246.7 million from the offering, which was
used to repay short-term borrowings and indebtedness under revolving credit
agreements. The Company believes funds generated from operations, amounts
available under existing credit facilities and external sources of liquidity
will be sufficient to finance capital expenditures and working capital needs of
the existing operations for the foreseeable future.

        The Company has been named as a potentially responsible party in
connection with two sites on the U.S. Environmental Protection Agency's National
Priorities List. The Company has recorded liabilities for estimated future
clean-up costs for these as well as other environmental sites. 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
Note 14, "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. Additionally,
inflation has not had a material effect on the Company in recent years, and is
expected to have a modest impact on the operations in the foreseeable future.
The Company has generally been able to offset most of the effects of inflation
through productivity gains, cost reductions and price increases.



                                       18
<PAGE>   20



NEW ACCOUNTING AND REGULATORY PRONOUNCEMENTS

        The Securities and Exchange Commission staff issued Staff Accounting
Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition," to provide guidance on
the recognition, presentation and disclosure of revenue in financial statements.
SAB No. 101 reflects the basic principles of revenue recognition in existing
generally accepted accounting principles, does not supercede any existing
authoritative literature and was effective for the Company as of October 1,
2000. Management believes that its revenue recognition policies are consistent
with those described in SAB No. 101. The adoption of SAB No. 101 did not have a
material impact on the Company's financial position or results of operations.

        The Financial Accounting Standards Board has issued Statement of
Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for
Derivative Instruments and Hedging Activities," which, as amended, was effective
for the Company as of January 1, 2001. SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded and
measured at its fair value. SFAS No. 133 requires that changes in fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. The adoption of SFAS No. 133 on January 1, 2001 did not have a material
impact on the Company's financial position or results of operations.

QUALITATIVE AND QUANTITATIVE MARKET RISK DISCLOSURES

        The Company is exposed to market risks from changes in interest rates
and foreign exchange rates and enters into various hedging transactions to
mitigate these risks. The Company does not use financial instruments for trading
or speculative purposes. See Note 7, "Financial Instruments," for additional
discussion of hedging instruments.

        The Company's exposure to interest rate changes is managed through the
use of a combination of fixed and floating rate debt and by entering into
interest rate swaps on a portion of its long-term borrowings. The fair value of
interest rate swaps as of December 31, 2000 and 1999 was not material. At
December 31, 2000, after considering the effect of interest rate swaps, 10
percent of the Company's long-term debt carried a variable interest rate.
Management believes that significant interest rate changes will not have a
material near-term impact on the Company's future earnings or cash flows.

        The Company's exposure to changes in foreign exchange rates is managed
primarily through the use of forward exchange contracts. These contracts
increase or decrease in value as foreign exchange rates change, to protect the
value of the underlying transactions denominated in foreign currencies. All
currency contracts are components of the Company's hedging program and are
entered into for the sole purpose of hedging an existing or anticipated currency
exposure. The gains and losses on these contracts offset changes in the value of
the related exposures. In some areas, where hedging is not cost effective, the
Company addresses foreign currency exposure utilizing working capital
management.

        The Company utilizes a "Value-at-Risk" ("VAR") model to determine the
maximum potential one-day loss in the fair value of its foreign exchange
sensitive financial instruments. The VAR model estimates were made assuming
normal market conditions and a 95 percent confidence level. The Company's VAR
computations are based on the interrelationships between movements in various
currencies (a "variance/co-variance" technique) during the year. The model
includes all of the Company's foreign exchange derivative contracts. Anticipated
transactions, firm commitments and assets and liabilities denominated in foreign
currencies, which certain of these instruments are intended to hedge, were
excluded from the model. The VAR model is a risk analysis tool and does not
purport to represent actual losses in fair value that will be incurred by the
Company, nor does it consider the potential effect of favorable changes in
market factors. The estimated maximum potential one-day loss in fair value of
currency sensitive instruments, calculated using the VAR model, is not material
to the Company's financial position or results of operations.



                                       19
<PAGE>   21



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,
2000 and 1999, and the related consolidated statements of operations,
shareholders' equity and comprehensive income and cash flows for each of the
three years in the period ended December 31, 2000. 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 auditing standards generally
accepted in the United States. 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, 2000 and 1999, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States.



ARTHUR ANDERSEN LLP

Houston, Texas
January 28, 2001



                                       20
<PAGE>   22


                            SMITH INTERNATIONAL, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                                FOR THE YEARS ENDED DECEMBER 31,
                                                                      ----------------------------------------------------
                                                                       2000                  1999                  1998
                                                                       ----                  ----                  ----

                                                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)

<S>                                                                   <C>                  <C>                  <C>
Revenues..................................................            $2,761,014           $1,806,153           $2,118,715

Costs and expenses:
  Costs of revenues.......................................             2,015,845            1,338,213            1,489,656
  Selling expenses........................................               415,448              310,818              339,097
  General and administrative expenses.....................               119,579               82,886               75,353
  Goodwill amortization...................................                11,116                8,703                6,800
  Non-recurring items.....................................                    --              (83,999)              82,500
                                                                      ----------          -----------          -----------
     Total costs and expenses.............................             2,561,988            1,656,621            1,993,406
                                                                      ----------          -----------          -----------

Income before interest and taxes..........................               199,026              149,532              125,309

Interest expense..........................................                36,756               40,823               45,986
Interest income...........................................                (1,861)              (2,050)              (2,615)
                                                                      ----------          -----------          -----------

Income before income taxes and minority interests.........               164,131              110,759               81,938
Income tax provision......................................                54,998               47,865               26,279
                                                                      ----------          -----------          -----------

Income before minority interests..........................               109,133               62,894               55,659

Minority interests........................................                36,333                6,170               21,590
                                                                      ----------          -----------          -----------

Net income................................................            $   72,800          $    56,724          $    34,069
                                                                      ==========          ===========          ===========

Earnings per share:
  Basic...................................................            $     1.47               $ 1.17          $      0.71
                                                                      ==========          ===========          ===========
  Diluted.................................................            $     1.45               $ 1.15          $      0.70
                                                                      ==========          ===========          ===========

Weighted average shares outstanding:
  Basic...................................................                49,603               48,586               47,909
                                                                      ==========          ===========          ===========
  Diluted.................................................                50,302               49,190               48,341
                                                                      ==========          ===========          ===========

</TABLE>
The accompanying notes are an integral part of these financial statements.



                                       21
<PAGE>   23



                            SMITH INTERNATIONAL, INC.

                           CONSOLIDATED BALANCE SHEETS

                                     ASSETS

<TABLE>
<CAPTION>
                                                                                                 DECEMBER 31,
                                                                                  ----------------------------------------
                                                                                           2000                   1999
                                                                                           ----                   ----

                                                                                                 (IN THOUSANDS)

CURRENT ASSETS:
<S>                                                                                   <C>                     <C>
     Cash and cash equivalents................................................        $     36,544            $     24,127
     Receivables, less allowance for doubtful accounts of $10,211 and
      $9,636 in 2000 and 1999, respectively...................................             654,420                 474,114
     Inventories..............................................................             560,027                 497,414
     Deferred tax assets, net.................................................              29,462                  38,954
     Prepaid expenses and other...............................................              29,550                  20,171
                                                                                      ------------            ------------

       Total current assets...................................................           1,310,003               1,054,780
                                                                                      ------------            ------------

PROPERTY, PLANT AND EQUIPMENT:

     Land.....................................................................              24,683                  25,119
     Buildings................................................................              91,432                  87,024
     Machinery and equipment..................................................             401,624                 365,360
     Rental tools.............................................................             225,962                 219,118
                                                                                      ------------            ------------

                                                                                           743,701                 696,621

     Less - Accumulated depreciation..........................................             334,653                 315,539
                                                                                      ------------            ------------

     Net property, plant and equipment........................................             409,048                 381,082
                                                                                      ------------            ------------

  GOODWILL, net of accumulated amortization of $38,101 and $26,985
   in 2000 and 1999, respectively.............................................             453,947                 349,773

  OTHER ASSETS................................................................             122,289                 108,940
                                                                                      ------------            ------------

  TOTAL ASSETS................................................................        $  2,295,287            $  1,894,575
                                                                                      ============            ============
</TABLE>

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



                                       22
<PAGE>   24



                            SMITH INTERNATIONAL, INC.

                           CONSOLIDATED BALANCE SHEETS

                      LIABILITIES AND SHAREHOLDERS' EQUITY


<TABLE>
<CAPTION>
                                                                                                       DECEMBER 31,
                                                                                      ------------------------------------------
                                                                                              2000                        1999
                                                                                              ----                        ----

                                                                                        (IN THOUSANDS, EXCEPT PAR VALUE DATA)

CURRENT LIABILITIES:

<S>                                                                                   <C>                        <C>
  Short-term borrowings and current portion of long-term debt....................       $    165,951               $     50,784
  Accounts payable...............................................................            280,820                    218,551
  Accrued payroll costs..........................................................             62,934                     62,729
  Income taxes payable...........................................................             23,747                     17,468
  Other..........................................................................            109,352                    107,786
                                                                                        ------------               ------------

    Total current liabilities....................................................            642,804                    457,318
                                                                                        ------------               ------------

LONG-TERM DEBT...................................................................            374,716                    346,647

DEFERRED TAX LIABILITIES.........................................................             44,659                     37,098

OTHER LONG-TERM LIABILITIES......................................................             37,945                     15,037

MINORITY INTERESTS...............................................................            377,682                    318,255

COMMITMENTS AND CONTINGENCIES (Note 14)

SHAREHOLDERS' EQUITY:

  Preferred stock, $1 par value; 5,000 shares authorized; no shares issued
    or outstanding in 2000 or 1999...............................................                 --                         --
  Common stock, $1 par value; 60,000 shares authorized; 50,419 shares
    issued in 2000 (49,586 in 1999)..............................................             50,419                     49,586
  Additional paid-in capital.....................................................            382,248                    351,397
  Retained earnings..............................................................            410,309                    337,509
  Cumulative translation adjustments.............................................            (17,793)                   (10,570)
  Less - treasury securities, at cost; 656 common shares in 2000 and 1999........             (7,702)                    (7,702)
                                                                                       -------------              -------------

    Total shareholders' equity...................................................            817,481                    720,220
                                                                                       -------------              -------------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.......................................         $2,295,287                 $1,894,575
                                                                                       =============              =============
</TABLE>

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



                                       23
<PAGE>   25

                            SMITH INTERNATIONAL, INC.

    CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
              FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
                        (IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                      COMMON STOCK
                                               ----------------------------     ADDITIONAL                    CUMMULATIVE
                                                  NUMBER                          PAID-IN       RETAINED      TRANSLATION
                                                 OF SHARES       AMOUNT           CAPITAL       EARNINGS      ADJUSTMENTS
                                               --------------  ------------    ------------- --------------  --------------
<S>                                            <C>             <C>             <C>           <C>             <C>
Balance, December 31, 1997 ..................     48,215,599      $ 48,216        $ 296,222      $ 246,809       $ (11,500)
Comprehensive income:
   Net income ...............................             --            --               --         34,069              --
   Currency translation adjustments .........             --            --               --             --             602
                                               --------------  ------------    ------------- --------------  --------------
Comprehensive income ........................             --            --               --         34,069             602
                                               --------------  ------------    ------------- --------------  --------------
Shares issued in connection with business
   combination ..............................        542,198           542           25,958             --              --
Exercise of stock options and stock grants ..         35,186            35              876             --              --
Cash dividends to Wilson shareholders .......             --            --               --            (93)             --
                                               --------------  ------------    ------------- --------------  --------------
Balance, December 31, 1998 ..................     48,792,983        48,793          323,056        280,785         (10,898)
Comprehensive income:
   Net income ...............................             --            --               --         56,724              --
   Currency translation adjustments .........             --            --               --             --             328
                                               --------------  ------------    ------------- --------------  --------------
Comprehensive income ........................             --            --               --         56,724             328
                                               --------------  ------------    ------------- --------------  --------------
Shares issued in connection with business
   combination ..............................        548,527           549           23,176             --              --
Exercise of stock options and stock grants ..        244,401           244            5,165             --              --
                                               --------------  ------------    ------------- --------------  --------------
Balance, December 31, 1999 ..................     49,585,911        49,586          351,397        337,509         (10,570)
Comprehensive income:
   Net income ...............................             --            --               --         72,800              --
   Currency translation adjustments .........             --            --               --             --          (7,223)
                                               --------------  ------------    ------------- --------------  --------------
Comprehensive income ........................             --            --               --         72,800          (7,223)
                                               --------------  ------------    ------------- --------------  --------------
Exercise of stock options and stock grants ..        833,019           833           30,851             --              --
                                               --------------  ------------    ------------- --------------  --------------
Balance, December 31, 2000 ..................     50,418,930      $ 50,419        $ 382,248      $ 410,309       $ (17,793)
                                               ==============  ============    ============= ==============  ==============

<CAPTION>

                                                    TREASURY SECURITIES
                                               ------------------------------
                                                      COMMON STOCK
                                               ----------------------------          TOTAL
                                                 NUMBER OF                      SHAREHOLDERS'
                                                  SHARES          AMOUNT            EQUITY
                                               --------------  ------------    -----------------
<S>                                            <C>             <C>             <C>
Balance, December 31, 1997 ..................       (655,854)     $ (7,702)           $ 572,045
Comprehensive income:
   Net income ...............................             --            --               34,069
   Currency translation adjustments .........             --            --                  602
                                               --------------  ------------    -----------------
Comprehensive income ........................             --            --               34,671
                                               --------------  ------------    -----------------
Shares issued in connection with business
   combination ..............................             --            --               26,500
Exercise of stock options and stock grants ..             --            --                  911
Cash dividends to Wilson shareholders .......             --            --                  (93)
                                               --------------  ------------    -----------------
Balance, December 31, 1998 ..................       (655,854)       (7,702)             634,034
Comprehensive income:
   Net income ...............................             --            --               56,724
   Currency translation adjustments .........             --            --                  328
                                               --------------  ------------    -----------------
Comprehensive income ........................             --            --               57,052
                                               --------------  ------------    -----------------
Shares issued in connection with business
   combination ..............................             --            --               23,725
Exercise of stock options and stock grants ..             --            --                5,409
                                               --------------  ------------    -----------------
Balance, December 31, 1999 ..................       (655,854)       (7,702)             720,220
Comprehensive income:
   Net income ...............................             --            --               72,800
   Currency translation adjustments .........             --            --               (7,223)
                                               --------------  ------------    -----------------
Comprehensive income ........................             --            --               65,577
                                               --------------  ------------    -----------------
Exercise of stock options and stock grants ..             --            --               31,684
                                               --------------  ------------    -----------------
Balance, December 31, 2000 ..................       (655,854)     $ (7,702)           $ 817,481
                                               ==============  ============    =================
</TABLE>

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

                                       24
<PAGE>   26




                            SMITH INTERNATIONAL, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                         FOR THE YEARS ENDED DECEMBER 31,
                                                                                ---------------------------------------------------
                                                                                     2000             1999              1998
                                                                                     ----             ----              ----

                                                                                                  (IN THOUSANDS)

<S>                                                                               <C>                 <C>               <C>
Cash flows from operating activities:
  Net income..................................................................     $.72,800           $ 56,724          $ 34,069
  Adjustments to reconcile net income to net cash
    provided by operating activities, excluding the
    net effects of purchase acquisitions:
      Depreciation and amortization...........................................       80,688             76,037            70,316
      Minority interests......................................................       36,333              6,170            21,590
      Non-recurring items, net of tax.........................................           --            (45,233)           65,777
      Provision for losses on receivables.....................................        3,277              2,029             3,016
      Increase (decrease) in LIFO inventory reserves..........................        1,339              1,571            (1,013)
      Gain on disposal of property, plant and equipment.......................       (5,755)            (7,052)           (9,380)
      Foreign currency translation losses.....................................          487                879             1,207
  Changes in operating assets and liabilities:
    Receivables...............................................................     (156,792)           (12,915)           82,576
    Inventories...............................................................      (38,345)            48,777            (9,513)
    Accounts payable..........................................................       31,943             19,695           (62,324)
    Accrued merger and restructuring costs....................................           --            (33,337)          (35,396)
    Other current assets and liabilities......................................       38,739            (37,611)          (21,741)
    Other non-current assets and liabilities..................................       (6,994)            (7,025)          (15,129)
                                                                                 ----------        -----------         ---------
        Net cash provided by operating activities.............................       57,720             68,709           124,055
                                                                                 ----------        -----------         ---------

Cash flows from investing activities:
  Acquisition of businesses, net of cash acquired.............................     (145,371)          (305,297)          (34,685)
  Proceeds from M-I Transaction...............................................           --            314,652                --
  Proceeds from disposal of operations........................................           --             44,218                --
  Purchases of property, plant and equipment..................................      (94,581)           (57,174)         (119,204)
  Proceeds from disposal of property, plant and equipment.....................       16,705             18,322            16,443
                                                                                 ----------        -----------         ---------
        Net cash provided by (used in) investing activities...................     (223,247)            14,721          (137,446)
                                                                                 ----------        -----------         ---------

Cash flows from financing activities:
  Proceeds from issuance of long-term debt....................................      128,195             76,485            25,843
  Principal payments of long-term debt........................................      (33,918)          (125,678)          (29,380)
  Net change in short-term borrowings.........................................       44,290            (34,719)           (1,044)
  Proceeds from exercise of stock options.....................................       18,059              2,975               548
  Contributions from (distribution to) minority interest partners.............       21,600             (1,440)            2,712
  Cash dividends to Wilson shareholders.......................................           --                 --               (93)
                                                                                 ----------        -----------         ---------
        Net cash provided by (used in) financing activities...................      178,226            (82,377)           (1,414)
                                                                                 ----------        -----------         ---------
Effect of exchange rate on cash...............................................         (282)               357               413
                                                                                 ----------        -----------         ---------
Increase (decrease) in cash and cash equivalents..............................       12,417              1,410           (14,392)
Cash and cash equivalents at beginning of year................................       24,127             22,717            37,109
                                                                                 ----------        -----------            ------
Cash and cash equivalents at end of year......................................   $   36,544           $ 24,127         $  22,717
                                                                                 ==========        ===========         =========
</TABLE>

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



                                       25
<PAGE>   27




                            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") provides premium products and
services to the oil and gas exploration and production industry, the
petrochemical industry and other industrial markets. 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.

  Use of Estimates

        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, three
to 25 years for machinery and equipment, and five to seven 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.

        Costs 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.

        Management reviews fixed assets for impairment whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable. If an evaluation is required, the estimated future cash flows
associated with the asset will be compared to the asset's carrying amount to
determine if an impairment exists.

  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 the majority of the
Company's inventories. The remaining inventories are costed under the first-in,
first-out ("FIFO") or average cost methods. Inventory costs consist of
materials, labor and factory overhead.

  Goodwill

        Goodwill, which represents the excess of costs over the fair value of
net assets acquired, is amortized on a straight-line basis over 20 to 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. If an
evaluation is required, the estimated future cash flows associated with the net
assets acquired will be compared to the carrying amount to determine if an
impairment exists. 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.



                                       26
<PAGE>   28


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)



  Foreign Currency Translation and Transactions

        Gains and losses resulting from balance sheet translation of operations
outside the United States 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 United States 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 instruments are
classified as for "purposes other than trading" under the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 119, "Disclosure about
Derivative Financial Instruments and Fair Value of Financial Instruments."

        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 currently in the
Consolidated Statements of Operations.

        The Company enters into foreign exchange contracts to hedge certain
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 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, 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.

  Minority Interests

        The Company records minority interest expense which reflects the portion
of the earnings of majority-owned operations which are applicable to the
minority interest partners. The minority interest amount primarily represents
the share of the M-I profits associated with the minority partners' interests in
those operations. To a lesser extent, minority interests include the portion of
CE Franklin Ltd. earnings applicable to the minority shareholders.



                                       27
<PAGE>   29


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)


  Reclassifications

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

  Recent Accounting Pronouncements

        The Securities and Exchange Commission staff issued Staff Accounting
Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition," to provide guidance on
the recognition, presentation and disclosure of revenue in financial statements.
SAB No. 101 reflects the basic principles of revenue recognition in existing
generally accepted accounting principles, does not supercede any existing
authoritative literature and was effective for the Company as of October 1,
2000. Management believes that its revenue recognition policies are consistent
with those described in SAB No. 101. The adoption of SAB No. 101 did not have a
material impact on the Company's financial position or results of operations.

        The Financial Accounting Standards Board has issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which, as
amended, was effective for the Company as of January 1, 2001. SFAS No. 133
establishes accounting and reporting standards requiring that every derivative
instrument be recorded and measured at its fair value. SFAS No. 133 requires
that changes in fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. The adoption of SFAS No. 133 on January 1,
2001 did not have a material impact on the Company's financial position or
results of operations.

2.  BUSINESS COMBINATIONS

  Acquisition of Safeguard Disposal Systems, Inc.

        On May 27, 1998, the Company acquired all of the outstanding shares of
Safeguard Disposal Systems, Inc. ("Safeguard"), a company engaged in the rental
of vacuum and collection systems used in the oil and gas industry. The Company
issued stock and cash consideration totaling $42.7 million in exchange for the
equity interests of Safeguard and M-I acquired other Safeguard-related assets
for $4.8 million. Subsequent to the acquisition date, the Company contributed
the Safeguard assets to M-I partly in exchange for a $16.6 million contribution
from the former minority interest partner.

  Acquisition of Minority Interest in M-I

        On August 31, 1998, the Company acquired the remaining 36 percent
interest in M-I previously held by Halliburton Company ("Halliburton"). The
Company issued a $265.0 million promissory note, which matured and was repaid on
April 28, 1999, to Halliburton in exchange for its minority ownership interest.

  Acquisition of ConEmsco, Inc. and CE Franklin Ltd.

        On May 28, 1999, the Company acquired certain operations of ConEmsco,
Inc. ("CE"), and CE's majority ownership interest in CE Franklin Ltd.,
businesses primarily engaged in oilfield supply and distribution in the United
States and Canada. In connection with the acquisition, the Company issued
548,527 shares of common stock and a $30.0 million note payable to the seller
which was subsequently repaid.

  Formation of Drilling Fluids Venture

        On July 25, 1999, the Company completed a transaction with Schlumberger
Limited ("Schlumberger") related to the combination of certain M-I and Dowell
drilling fluid operations under a joint venture arrangement. Schlumberger
contributed its non-U.S. Dowell drilling fluid operations, including an asset
equalization payment of $34.7 million, and paid cash consideration of $280
million to the Company in exchange for a 40 percent minority ownership interest
in the combined operations (collectively, the "M-I Transaction"). Proceeds from
the transaction were used to reduce outstanding borrowings of the Company. See
Note 3 for a discussion of the gain recognized in connection with the M-I
Transaction.



                                       28
<PAGE>   30


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)


  Acquisition of Texas Mill Supply and Manufacturing, Inc.

        On January 15, 2000, the Company acquired all of the outstanding shares
of Texas Mill Supply and Manufacturing, Inc. ("Texas Mill"), in exchange for
cash consideration of $30.0 million. Texas Mill is a Houston, Texas
based-provider of industrial mill and safety products and management services
primarily to the refining, power generation and petrochemical markets.

Acquisition of Drilling Fluids and Solids-Control Operations of Bolland & Cia.
S.A.

        On November 30, 2000, M-I acquired the drilling fluids and
solids-control assets of Bolland & Cia. S.A. for cash consideration of $25.5
million. Bolland & Cia. S.A. is a privately-held company based in Buenos Aires,
Argentina. During 1999, the acquired operations generated revenues of
approximately $25.0 million.

  Acquisition of Sweco

        On December 15, 2000, M-I acquired the Sweco Division of Emerson
("Sweco") for cash consideration of $75.0 million. Sweco manufactures, markets
and services specialty separation equipment for oilfield applications and a
broad range of industrial markets. The minority partner contributed $21.6
million in cash to the joint venture in connection with the transaction. During
1999, Sweco reported revenues of approximately $55.0 million.

  Other Acquisitions

        In 2000, the Company completed the purchase of three other operations.
These operations were acquired in exchange for cash of $14.9 million which was
financed with borrowings against available lines of credit. Additionally,
several other acquisitions were completed in 1999 and 1998 in exchange for
consideration of $8.8 million and $20.5 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
$111.9 million in 2000 and $68.6 million in 1999, 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 detailed above had occurred on January 1, 1999 (in thousands,
except per share amounts):

<TABLE>
<CAPTION>
                                                                                    2000                      1999
                                                                                    ----                      ----

<S>                                                                             <C>                        <C>
Revenues................................................................        $ 2,854,004                $ 2,271,579
Net income..............................................................             74,463                      2,067
Earnings per share:
      Basic.............................................................        $      1.50                $      0.04
      Diluted...........................................................               1.48                       0.04
</TABLE>

        As discussed in Note 3, the Company recognized an after-tax,
non-recurring gain of $45.0 million, or $0.91 per diluted share, in connection
with the M-I Transaction in 1999 which is excluded from the unaudited pro forma
supplemental information. 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.



                                       29
<PAGE>   31


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)


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

<TABLE>
<CAPTION>
<S>                                                                                           <C>
           Fair value of assets, net of cash acquired...............................             $91,167
           Goodwill recorded........................................................             111,892
           Total liabilities assumed................................................             (57,688)
                                                                                                --------
           Cash paid for acquisition of businesses, net of cash acquired............            $145,371
                                                                                                ========
</TABLE>

  Acquisition of Wilson Industries, Inc.

        On April 30, 1998, the Company merged with Wilson Industries, Inc.
("Wilson"), a Houston, Texas based provider of products and services to the
worldwide petroleum and petrochemical industries. In connection with the merger,
the Company issued a total of 7.9 million of its shares in exchange for all of
the outstanding shares of common stock of Wilson. The transaction has been
accounted for as a pooling-of-interests.

         The separate Smith and Wilson revenue and net income amounts included
in the 1998 Consolidated Statements of Operations for the four-month period
prior to the merger are summarized below:

<TABLE>
<CAPTION>

                                      Revenues        Net Income
                                   -----------        ----------
<S>                                <C>                <C>
             Smith...........      $ 1,913,438        $   28,414
             Wilson..........          205,277             5,655
                                   -----------        ----------
             Combined........      $ 2,118,715        $   34,069
                                   ===========        ==========
</TABLE>

3. NON-RECURRING ITEMS

        During 1999, the Company recognized a non-recurring gain of $81.4
million, or $45.0 million on an after-tax basis, associated with the M-I
Transaction in accordance with the provisions of Staff Accounting Bulletin No.
51. The non-recurring gain is presented net of transaction-related charges of
$25.4 million, including resulting profit-sharing and incentive requirements,
assessed fines, professional fees and other related costs. The Company also
recorded a non-recurring net gain of $2.6 million ($0.2 million after-tax)
associated with disposal of an industrial bentonite mining operation which was
partially offset by unrelated charges to write-off certain assets and settle a
customer receivable.

        During 1998, the Company recognized special charges totaling $97.4
million, or $65.8 million on an after-tax basis. Of that amount $82.5 million
was recorded as merger and restructuring costs in the accompanying financial
statements and relates to restructuring efforts undertaken in response to
activity-level declines and costs required to consolidate and integrate the
Wilson operations. The remaining $14.9 million of the charge consists of amounts
required to reflect inventories at net realizable value and was recorded in
costs of revenues.

        In order to reduce costs and improve productivity, the Company initiated
various restructuring efforts to streamline the organizational structure,
consolidate manufacturing operations and exit certain product line offerings.
These actions resulted in the recognition of $52.5 million of restructuring
charges as reflected below. The restructuring efforts included the termination
of approximately 2,100 individuals across all business operations and job
functions, including manufacturing, sales and administrative positions. Although
certain of the employee reductions related to the combination of two separate
business units and the elimination of duplicate cost structures, the majority of
the reductions were in response to the activity-level declines associated with
the industry downturn. The restructuring charge also included amounts to close
manufacturing facilities and exit certain business operations. These amounts
included costs related to the closure and relocation of one of the Company's
European manufacturing operations along with the exit costs for a manufacturing
operation and certain product line offerings which were discontinued due to
economic considerations in Latin America. The remainder of the restructuring
charge related to asset write-offs necessitated by the prevailing economic
environment, including non-recoverable assets recorded in Indonesia and certain
assets located in the United States which had no future value. The restructuring
efforts were substantially completed by the first quarter of 1999.



                                       30
<PAGE>   32

                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)



        In connection with the Wilson transaction, the Company recorded merger
costs of approximately $30.0 million which consisted of transaction costs,
including accounting, legal and investment banking costs and amounts to
consolidate and integrate the existing Wilson operations. The remaining portion
of the charge relates to severance costs, including payments required under
"change of control" agreements, amounts incurred to relocate and consolidate two
separate manufacturing operations located in the United States and write-off
certain assets which were determined to have no future value.

         The significant components of the charges recorded during 1998 are
included below:

<TABLE>
<CAPTION>
<S>        <C>                                                                     <C>
           Employee terminations and related costs                                   $23,719
           Facility closure costs and exit costs for certain business operations      15,500
           Write-off of certain assets and other miscellaneous costs                  13,281
                Total restructuring costs                                           --------
                                                                                      52,500
           Merger costs related to the Wilson transaction                             30,000
                                                                                    --------
               Total merger and restructuring costs                                   82,500
           Write-down of certain inventories                                          14,900
                                                                                    --------
                                                                                    $ 97,400
                                                                                    ========
</TABLE>


        All expenditures for this provision, which was used as intended, were
made as of December 31, 1999.

4.  EARNINGS PER COMMON SHARE

        Basic and diluted earnings per share ("EPS") are presented in accordance
with the provisions of SFAS No. 128, "Earnings Per Share." 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. For purposes of the EPS computation, the 7.9
million shares issued in connection with the Wilson transaction have been
treated as if they had been issued and outstanding for all of 1998.

        The following schedule reconciles the income and shares used in the
basic and diluted EPS computations (in thousands, except per share data):


<TABLE>
<CAPTION>

                                                         2000             1999             1998
                                                         ----             ----             -----
<S>                                                    <C>               <C>              <C>
        BASIC EPS:
        Net income................................     $72,800           $56,724          $34,069
                                                       =======           =======          =======

        Weighted average number of common
          shares outstanding......................      49,603            48,586           47,909
                                                        ------           -------          -------

        Basic EPS.................................      $ 1.47           $  1.17          $  0.71
                                                        ======           =======          =======


        DILUTED EPS:

        Net income................................     $72,800           $56,724          $34,069
                                                       =======           =======          =======

        Weighted average number of common
          shares outstanding......................      49,603            48,586           47,909
        Dilutive effect of stock options..........         699               604              432
                                                      --------          --------          -------
                                                        50,302            49,190           48,341
                                                      --------          --------          -------

        Diluted EPS...............................    $   1.45          $   1.15          $  0.70
                                                      ========          ========          =======
</TABLE>



                                       31
<PAGE>   33


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)


5.  INVENTORIES

         Inventories consist of the following at December 31:
<TABLE>
<CAPTION>
                                                              2000         1999
                                                         ---------    ---------
<S>                                                      <C>          <C>
Raw materials...........................................   $46,923      $41,508
Work-in-process.........................................    57,167       43,498
Products purchased for resale...........................   139,591      118,786
Finished goods..........................................   341,117      317,054
                                                         ---------    ---------
                                                           584,798      520,846
Reserves to state certain U.S. inventories
 ($273,811 and $227,622 in 2000 and 1999, respectively)
 on a LIFO basis                                           (24,771)     (23,432)
                                                         ---------    ---------
                                                          $560,027     $497,414
                                                         =========    =========
</TABLE>



                                       32
<PAGE>   34

                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)



6. DEBT

         The following summarizes the Company's outstanding debt at December 31:

<TABLE>
<CAPTION>
                                                                                          2000             1999
                                                                                          ----             ----
     CURRENT:
<S>                                                                                    <C>             <C>
       Short-term borrowings..................................................         $  75,394       $  28,317
       Current portion of long-term debt......................................            90,557          22,467
                                                                                       ---------       ----------
         Short-term borrowings and current portion of long-term debt..........         $ 165,951       $  50,784
                                                                                       =========       =========

     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 $693 and $797 in 2000 and 1999,
       respectively)..........................................................         $ 149,307       $ 149,203

       Notes payable to insurance companies maturing between 2001 and 2006.
       Interest payable semi-annually at rates ranging from 7.24% to 9.83%....            60,222          70,444

       7.7% Senior Secured Notes maturing July 2007. Principal due in equal
       annual installments of $7.1 million beginning July 2001. Interest payable
       semi-annually..........................................................            50,000          50,000

       Bank revolvers payable:
       $120.0 million revolving note expiring December 2002. Interest payable
       quarterly at base rate (9.50% at December 31, 2000) or adjusted
       Eurodollar interbank rate, as defined (6.93% at December
       31, 2000) and described below..........................................           103,300          30,300

       M-I $80.0 million revolving note expiring December 2002. Interest payable
       quarterly at base rate (9.50% at December 31, 2000) or adjusted
       Eurodollar interbank rate, as defined (6.93%
       at December 31, 2000) and described below..............................            55,000          11,900

       CE Franklin Ltd. Canadian dollar secured revolving facilities.
       Interest payable monthly at prime rate (7.50% at December 31, 2000)....            32,086          25,289

       Term loans and other...................................................            15,358          31,978
                                                                                       ---------       ---------
                                                                                         465,273         369,114
       Less current portion of long-term debt.................................           (90,557)        (22,467)
                                                                                      ---------        ---------
         Long-term debt.......................................................         $ 374,716       $ 346,647
                                                                                       =========       =========
</TABLE>

         Principal payments of long-term debt for years subsequent to 2001 are
as follows:

<TABLE>
<CAPTION>
<S>                                                                               <C>
       2002.................................................................           $176,362
       2003.................................................................             10,476
       2004.................................................................             10,476
       2005.................................................................             10,476
       Thereafter...........................................................            166,926
                                                                                       --------
                                                                                       $374,716
                                                                                       ========
</TABLE>




                                       33
<PAGE>   35


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)


        The Company's short-term borrowings consist of amounts outstanding under
lines of credit and short-term loans. Certain subsidiaries of the Company have
unsecured line-of-credit facilities with banks aggregating $77.7 million. At
December 31, 2000, $32.0 million of additional borrowing capacity was available
under these facilities. At December 31, 2000, the Company had $35.0 million of
borrowings outstanding under a note payable to a bank. These borrowings had a
weighted average interest rate of 11 percent at both December 31,2000 and 1999.

        At December 31, 2000, the Company had $200 million of unsecured
revolving credit agreements in addition to the facilities discussed above. These
agreements provide for the election of interest at a base rate or a Eurodollar
rate of LIBOR plus 30 basis points and require the payment of a quarterly
commitment fee of one-tenth of one 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, 2000, the borrowing
capacity under these lines of credit approximated $41.7 million.

        In connection with a 1997 public debt offering, the Company issued $150
million of unsecured 7 percent 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 its loan covenants under the various
loan indentures at December 31, 2000. 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, 2000, 1999 and 1998,
amounted to $35.4 million, $34.0 million and $40.8 million, respectively.

7.  FINANCIAL INSTRUMENTS

  Interest Rate Contracts

        From time to time, the Company enters into interest rate swaps with the
intent of managing its 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, 2000 and 1999, the Company had notional principal
amounts of interest rate swaps on outstanding debt of $78.6 million and $54.1
million, respectively. These agreements, which are hedges against certain
obligations, terminate between March 2001and October 2001. Gains and losses from
interest rate swaps are recognized currently in the Consolidated Statements of
Operations.

        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 collected.

  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. The terms of these contracts generally do not exceed one year.
Market value gains and losses 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, 2000 and 1999, foreign exchange contracts
outstanding totaled $42.9 million and $52.3 million, respectively.

        The Company has purchased foreign exchange option contracts, with terms
which generally did not exceed one year, to hedge certain operating exposures.
Premiums paid under these contracts were expensed over the life of the option
contract. Gains arising on these options are recognized at the time the options
were exercised. The Company had $6.7 million of foreign exchange option
contracts outstanding at December 31, 1999.



                                       34
<PAGE>   36

                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)



  Fair Value

<TABLE>
<CAPTION>
                                                                          2000                           1999
                                                                ------------------------    ---------------------------
                                                                  Recorded       Fair           Recorded        Fair
                                                                    Value        Value           Value          Value
                                                                ------------------------    ------------- --------------
<S>                                                              <C>         <C>              <C>          <C>
  Long-term debt............................................       $465,273    $465,351         $369,114     $369,670
  Interest rate swaps.......................................             --         496               --         (21)
</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.

8.  INCOME TAXES

        The geographical sources of income before income taxes and minority
interests for the three years ended December 31, 2000 were as follows:

<TABLE>
<CAPTION>
                                                                      2000              1999             1998
                                                                      ----             -----             ----

<S>                                                                 <C>              <C>               <C>
   Income before income taxes and minority interests:
     United States............................................      $ 74,681         $ 70,463          $19,919
     Non-United States........................................        89,450           40,296           62,019
                                                                    --------         --------          -------
     Total....................................................      $164,131         $110,759          $81,938
                                                                    ========         ========          =======

</TABLE>

         The income tax provision is summarized as follows:

<TABLE>
<CAPTION>
                                                                       2000             1999              1998
                                                                       ----             -----             ----
<S>                                                                 <C>                <C>               <C>
     Current:
       United States..........................................         $12,111          $16,266           $ 9,117
       Non-United States......................................          23,138            9,723            27,955
       State..................................................             146            1,675             2,706
                                                                      --------         --------           -------
                                                                        35,395           27,664            39,778
                                                                      --------         --------           -------
     Deferred:
       United States.........................................           11,601           18,015           (10,301)
       Non-United States......................................           8,002            2,186            (3,198)
                                                                      --------         --------           -------
                                                                        19,603           20,201           (13,499)
                                                                      --------         --------           -------
     Income tax provision.....................................        $ 54,998          $47,865           $26,279
                                                                      ========         ========           =======
</TABLE>

        Deferred taxes are principally attributable to timing differences
related to depreciation expense, restructuring reserves, inventories and net
operating loss and tax credit carryforwards. The Company reported the tax
benefit of operating loss carryforwards utilized in 1998 as a reduction in the
provision for income taxes in accordance with SFAS No. 109.



                                       35
<PAGE>   37
                           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
tax rate as follows:

<TABLE>
<CAPTION>
                                                                                  2000              1999          1998
                                                                                  ----              ----          ----
<S>                                                                            <C>               <C>            <C>
   U.S. federal statutory tax rate...............................                 35.0%             35.0%          35.0%
   Utilization of U.S. net operating
     loss and tax credit carryforwards...........................                   --                --           (5.6)
   Minority partner's share of U.S. partnership earnings.........                 (4.3)             (1.6)          (6.9)
   Non-deductible expenses.......................................                  3.9               5.0            9.0
   Benefit of foreign sales corporation..........................                 (0.6)             (0.6)          (3.9)
   State taxes, net..............................................                  0.1               1.5            3.3
   Non-U.S. tax provisions which vary from the
     U.S. rate/non-U.S. losses with no
     tax benefit realized........................................                 (0.6)              4.2            2.5
   Other items, net..............................................                   --              (0.3)          (1.3)
                                                                                  ----              ----           ----
   Effective tax rate............................................                 33.5%             43.2%          32.1%
                                                                                  ====              ====           ====
</TABLE>

         The components of deferred taxes at December 31 are as follows:
<TABLE>
<CAPTION>

                                                                                   2000             1999
                                                                                   ----             ----
<S>                                                                            <C>               <C>
Deferred tax liabilities attributed to the excess of net book
  basis over remaining tax basis (principally depreciation):
    United States................................................              $(35,883)         $(32,964)
    Non-United States............................................               (21,036)          (18,208)
                                                                                --------         ---------
  Total deferred tax liabilities.................................               (56,919)          (51,172)
                                                                                --------         ---------

Deferred tax assets attributed to net operating loss and tax
  credit carryforwards:
    United States................................................                 3,952            10,813
    Non-United States............................................                33,090            36,624

Other deferred tax assets (principally accrued liabilities not
  deductible until paid):
    United States................................................                44,879            48,061
    Non-United States............................................                 4,396             5,317
                                                                               --------         ---------
      Subtotal...................................................                86,317           100,815

Valuation allowance..............................................               (32,250)          (33,646)
                                                                               ---------         ---------

  Total deferred tax assets......................................                54,067            67,169
                                                                               --------          --------

     Net deferred tax (liabilities) assets.......................              $ (2,852)          $15,997
                                                                               ========           =======

Balance sheet presentation:

  Deferred tax assets, net.......................................               $29,462           $38,954
  Other assets...................................................                12,345            16,174
  Other current liabilities......................................                    --            (2,033)
  Deferred tax liabilities.......................................               (44,659)          (37,098)
                                                                                --------          -------
     Net deferred tax (liabilities) assets.......................               $(2,852)          $15,997
                                                                                ========          =======
</TABLE>



                                       36
<PAGE>   38


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)


        At December 31, 2000, various tax credits and net operating loss
carryforwards totaling $4.0 million are available to reduce future U.S. income
taxes. Total foreign operating loss carryforwards at December 31, 2000, are
approximately $33.1 million, of which $26.6 million have been offset by
recording a valuation reserve. These losses are available to reduce the future
tax liabilities of their respective foreign entities. Approximately $8.3 million
of these losses will carryforward indefinitely, while the remaining losses
expire at various dates.

        Income taxes paid during the years ended December 31, 2000, 1999 and
1998, amounted to $23.0 million, $33.7 million and $40.7 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 $37.7 million at December 31, 2000, 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.

9.  STOCKHOLDERS' RIGHTS PLAN

        On June 8, 2000, the Company adopted a Stockholder Rights Plan (the
"Rights Plan") to replace a similar plan which expired on June 19, 2000. 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 20, 2000. The Board also authorized the issuance of
one such Right for each share of the Company's common stock issued after June
20, 2000 until the occurrence of certain events.

        Each Right entitles the holder thereof (except an Acquiring Person) to
purchase, at an exercise price of $350, shares of the Company's common stock
having a market value of twice the Rights exercise price subject to adjustment.
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 acquiring person will not
be entitled to exercise these Rights. 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 8, 2010.

10.  EMPLOYEE STOCK OPTIONS

        As of December 31, 2000, the Company had outstanding stock options
granted under the 1989 Long-Term Incentive Compensation Plan ("1989 Plan").
Options are generally granted at the fair market value 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
2010, are conditioned upon continued employment.

        The Company has adopted the reporting standards of SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 123 established financial
accounting and reporting standards for stock-based employee compensation and for
transactions in which equity instruments are issued to non-employees for the
acquisition of goods and services. This standard requires, 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 consolidated financial statements.



                                       37
<PAGE>   39


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)

        The Company continues to apply APB Opinion 25 and related
interpretations in accounting for the 1989 Plan and, accordingly, no
compensation cost has been recognized in the accompanying consolidated financial
statements. Had the Company elected to apply the accounting standards of SFAS
No. 123, the Company's net income and earnings per share would have approximated
the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                                    2000                     1999                    1998
                                                                    ----                     ----                    ----
<S>                               <C>                            <C>                      <C>                     <C>
         Net income                 As reported                  $72,800                  $56,724                 $34,069
                                    Pro forma                     68,457                   53,575                  31,517

         Earnings per share         As reported:
                                        Basic                     $ 1.47                   $ 1.17                  $ 0.71
                                        Diluted                     1.45                     1.15                    0.70

                                    Pro forma:
                                        Basic                     $ 1.38                   $ 1.10                  $ 0.66
                                        Diluted                     1.36                     1.09                    0.65
</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 $30.66, $15.08 and $10.87 for grants made during the years
ended December 31, 2000, 1999 and 1998, respectively. The following assumptions
were used for option grants in 2000, 1999 and 1998, respectively; dividend yield
of 0.0 percent, 1.7 percent and 1.7 percent; expected volatility of 43.0
percent, 34.0 percent and 39.0 percent; risk-free interest rates of 5.4 percent,
6.8 percent and 5.3 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 adopting SFAS No. 123 was not determined.

        A summary of the Company's stock option plans as of December 31, 2000,
1999 and 1998, and changes during those years is presented below:

<TABLE>
<CAPTION>
                                                                                     Weighted Average
                                                                  Shares                 Exercise
                                                               Under Option                Price
                                                           ----------------------  ----------------------
<S>                                                           <C>                      <C>
Outstanding at December 31, 1997.....................            1,369,162                $ 29.79

Options granted......................................              876,000                  23.56
Options forfeited....................................               (9,220)                 51.03
Options exercised....................................              (33,186)                 14.05
                                                                 ----------               -------

Outstanding at December 31, 1998.....................            2,202,756                  27.47

Options granted......................................              546,110                  39.19
Options forfeited....................................              (22,175)                 32.65
Options exercised....................................             (237,401)                 13.05
                                                                 ---------                ------

Outstanding at December 31, 1999.....................            2,489,290                  31.37

Options granted......................................              531,910                  61.36
Options forfeited....................................              (36,490)                 43.95
Options exercised....................................             (833,019)                 21.18
                                                                 ---------                -------

Outstanding at December 31, 2000.....................            2,151,691                $ 42.62
                                                                 =========                =======
</TABLE>



                                       38
<PAGE>   40

                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)



        The number of outstanding fixed stock options exercisable at December
31, 1999 and 1998 was 1,100,841 and 942,994, respectively. These options had a
weighted average exercise price of $26.84 and $20.74 at December 31, 1999 and
1998, respectively. The following summarizes information about fixed stock
options outstanding at December 31, 2000:

<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
--------------------  ------------   -------------------  -------------   --------------  -------------
<S>                   <C>            <C>                  <C>              <C>           <C>
$ 8.38 - $10.31              7,287          2.8                  $8.86            7,287         $ 8.86
$13.13 - $17.88             47,335          4.4                  15.33           47,335          15.33
$23.56 - $41.13          1,330,399          8.1                  31.62          594,615          30.94
$55.63 - $69.06            766,670          9.0                  63.72          176,070          69.06
                         ---------          ---                 ------          -------        -------
                         2,151,691          8.3                 $42.62          825,307        $ 37.98
                         =========          ===                 ======          =======        =======
</TABLE>

        At December 31, 2000, there were 608,724 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.

11.  EMPLOYEE BENEFITS

Pension Plans

        The Company has pension plans in the United States and the United
Kingdom ("U.K."). In 1987, Smith and Wilson amended their defined benefit plans
to freeze all future benefit accruals and prohibit the addition of any new
participants. At that time, the plans covered substantially all full-time U.S.
employees of the respective companies. Due to the freezing of the plans, no
material contributions were made to the plans for any period presented. Although
M-I sponsors certain defined benefit plans, most of the M-I employees are not
covered by a pension plan. During 1997, a decision was made to terminate the
U.K. pension plan and benefit accruals were frozen in 1998. All obligations to
plan participants in the Wilson and U.K. pension plans were settled in 2000.

        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, benefit obligations and the fair value of plan assets for these plans
were not material at or for the periods ended December 31, 2000, 1999 or 1998.

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 (the "cap") on the dollar
amount of the Company's portion of the cost of benefits incurred by retirees
under the Smith Medical 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 four percent.

         M-I provides 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
benefits under this plan; however, these costs are reviewed annually for
inflation, and limited to a maximum five percent increase in M-I's contribution
per year. Any costs in excess of M-I's maximum contribution are the
responsibility of the retirees or their dependents.



                                       39
<PAGE>   41

                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)



        Although Wilson provides postretirement medical coverage to eligible
retirees and their spouses, new employees have not been eligible for inclusion
under this program since February 1987. Eligible individuals are able to
continue primary medical coverage under Wilson's group insurance programs until
reaching the age of 65 at which time such coverage becomes secondary for
participants electing to remain in the program. Participating retirees are
required to contribute a portion of the insurance premiums under the program
with Wilson responsible for any costs in excess of those contributions.

        The following tables disclose the changes in benefit obligations and
plan assets during the periods presented and reconcile the funded status of the
plans to the amounts included in the accompanying Consolidated Balance Sheets.

<TABLE>
<CAPTION>
                                                                 PENSION PLANS            POSTRETIREMENT BENEFIT PLANS
                                                           --------------------------    --------------------------------
                                                              2000          1999              2000             1999
                                                              ----          ----              ----             ----
<S>                                                         <C>          <C>                <C>             <C>
Changes in benefit obligations:
  Benefit obligations at beginning of year...........         $24,981      $26,402            $ 14,595      $ 18,519
  Service cost.......................................             --            --                 248           274
  Interest cost......................................             917        1,604               1,066         1,057
  Plan participants contributions....................             --            --                 521           380
  Actuarial loss (gain)..............................             653       (2,045)             (1,412)       (2,603)
  Plan amendments....................................             --            --                  --        (1,826)
  Plan settlements...................................         (13,663)          --                  --            --
  Benefits paid......................................            (568)        (980)             (1,361)       (1,206)
                                                              --------     -------            --------      --------
  Benefit obligations at end of year.................         $12,320      $24,981            $ 13,657      $ 14,595
                                                              =======      =======            ========      ========

Changes in plan assets:
  Fair value of plan assets at beginning of year.....         $26,295      $26,797            $     --      $     --
  Actual return on plan assets.......................           1,134          478                  --            --
  Employer contributions.............................              --           --                 840           826
  Plan participants contribution.....................              --           --                 521           380
  Transfer to other employee benefit plan............          (1,319)          --                  --            --
  Plan settlements...................................         (13,663)          --                  --            --
  Benefits paid......................................            (568)        (980)             (1,361)       (1,206)
                                                              -------      -------            --------      --------
  Fair value of plan assets at end of year...........         $11,879      $26,295            $     --      $     --
                                                              =======      =======            ========      ========

  Funded status......................................         $  (441)     $ 1,314            $(13,657)     $(14,595)
  Unrecognized net actuarial loss (gain).............           1,411         (775)             (2,755)       (3,407)

  Unrecognized prior service cost....................              --           --              (1,323)       (1,716)
                                                              -------      -------            ---------     ---------
  Prepaid benefit (accrued liability)................         $   970      $   539            $(17,735)     $(19,718)
                                                              =======      =======            =========     =========
</TABLE>

         Assumptions used for financial reporting purposes to compute net
benefit expense and its components are as follows:

<TABLE>
<CAPTION>
                                                                     PENSION PLANS                 POSTRETIREMENT BENEFIT PLANS
                                                           ----------------------------------    ----------------------------------
                                                                2000              1999                 2000             1999
                                                                ----              ----                 ----             ----
<S>                                                        <C>             <C>                  <C>                <C>
Weighted average assumptions:
  Discount rate.......................................           7.40%        6.35%-7.40%           7.26%-7.40%       7.40%-7.70%
  Expected return on plan assets......................           8.50%        6.00%-8.50%               N/A               N/A

Components of net periodic benefit expense:
  Service cost.......................................        $     --           $   --                 $ 248            $ 274
  Interest cost.......................................            898            1,604                 1,066            1,057
  Return on plan assets..............................            (742)          (1,782)                   --               --
  Amortization of prior service cost.................              --                --                 (234)          (1,185)
  Amortization of loss (gain)........................          (1,319)             (44)                 (125)              56
                                                             ---------          -------                -----            -----
  Net periodic benefit expense (credit)..............        $ (1,163)          $ (222)                $ 955            $ 202
                                                             =========          =======                =====            =====

</TABLE>



                                       40
<PAGE>   42


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)


        The health care cost trend rate assumption can have a significant effect
on the amounts reported. 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 $1.9 million and $0.2 million, respectively.
A decrease of one percentage point in the health care cost trend rate would
decrease the accumulated postretirement benefit obligation and the aggregate of
the service and interest cost components of the postretirement benefits expense
by $1.5 million and $0.1 million, respectively.

12.  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 two percent to
six percent of their qualified compensation. In addition, the Board of Directors
may provide discretionary matching contributions based upon financial
performance to participants who are employed by the Company on December 31.

        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
three percent of qualified compensation, and a full match of the first 1 1/2
percent of their contributions. In addition, the Board of Directors may provide
discretionary profit-sharing contributions based upon financial performance to
participants who are employed by M-I on December 31.

        The Company recognized expense totaling $20.7 million, $12.4 million and
$9.1 million in 2000, 1999 and 1998, respectively, related to Company
contributions to the plans.

        Certain of the Company's subsidiaries sponsor various defined
contribution plans. The Company's contributions under these plans for each of
the three years in the period ended December 31, 2000, were immaterial.

13.  INDUSTRY SEGMENTS AND INTERNATIONAL OPERATIONS

        The Company manufactures and markets premium products and services to
the oil and gas exploration and production industry, the petrochemical industry
and other industrial markets. The Company aggregates its operations into two
reportable segments: Oilfield Products and Services and Distribution. The
Oilfield Products and Services segment consists of three business units: M-I,
which provides drilling and completion fluid systems and services,
solids-control and separation equipment and waste-management services; Smith
Bits, which manufactures and sells three-cone and diamond drill bits; and Smith
Services, which manufactures and markets products and services used for
drilling, workover, well completion and well re-entry operations. The
Distribution segment consists of one business unit: Wilson, which markets pipe,
valves, fittings, mill, safety and other maintenance products to energy and
industrial markets.

        The principal markets for these segments include all major oil and gas
producing regions of the world including North America, Latin America,
Europe/Africa, the Middle East and the Far East. The Company's customers include
major multi-national, independent and national, or state-owned, oil companies.



                                       41
<PAGE>   43


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)


        The following table presents financial information for each reportable
segment:

<TABLE>
<CAPTION>
                                                                                    2000        1999          1998
                                                                                 -----------  ----------   ----------
<S>                                                                             <C>          <C>          <C>
Revenues:
  Oilfield Products and Services.................................                $1,855,126   $1,309,539   $1,646,168
  Distribution...................................................                   905,888      496,614      472,547
                                                                                 ----------   ----------   ----------
                                                                                 $2,761,014   $1,806,153   $2,118,715
                                                                                 ==========   ==========   ==========

Income Before Interest and Taxes:
  Oilfield Products and Services.................................                $  188,017      $70,630     $209,621
  Distribution...................................................                    16,655          178        3,184
  General corporate..............................................                    (5,646)      (5,275)      (4,996)
  Non-recurring items............................................                        --       83,999      (82,500)
                                                                                 ----------   ----------   ----------
                                                                                   $199,026     $149,532     $125,309
                                                                                 ==========   ==========   ==========

Non-Recurring Items (See Note 3):
  Oilfield Products and Services.................................                $       --   $   83,999   $  (52,500)
  Distribution...................................................                        --           --      (30,000)
                                                                                 ----------   ----------   ----------
                                                                                 $       --   $   83,999   $  (82,500)
                                                                                 ==========   ==========   ==========

Capital Expenditures:
  Oilfield Products and Services.................................                $   85,225   $   52,013   $  111,811
  Distribution...................................................                     7,219        4,776        4,008
  General corporate..............................................                     2,137          385        3,385
                                                                                 ----------   ----------   ----------
                                                                                 $   94,581   $   57,174   $  119,204
                                                                                 ==========   ==========   ==========

Depreciation and Amortization:
  Oilfield Products and Services.................................                $   72,379   $   70,583   $   66,329
  Distribution...................................................                     7,588        4,953        3,496
  General corporate..............................................                       721          501          491
                                                                                 ----------   ----------   ----------
                                                                                    $80,688      $76,037      $70,316
                                                                                 ==========   ==========   ==========

Total Assets:
  Oilfield Products and Services.................................                $1,829,908   $1,499,735   $1,523,023
  Distribution...................................................                   367,220      281,970      142,252
  General corporate..............................................                    98,159      112,870       93,713
                                                                                 ----------   ----------   ----------
                                                                                 $2,295,287   $1,894,575   $1,758,988
                                                                                 ==========   ==========   ==========
</TABLE>

The following table presents consolidated revenues by country:

<TABLE>
<CAPTION>
                                                                                    2000         1999            1998
                                                                                 ----------   ----------     ------------
<S>                                                                            <C>            <C>            <C>
United States....................................................               $ 1,349,812   $   834,783    $  1,017,016
United Kingdom...................................................                    84,102        84,115         119,865
Canada...........................................................                   380,316       204,956         101,264
Norway...........................................................                   133,068        86,784          88,316
Venezuela........................................................                    92,294        60,383          89,113
Other............................................................                   721,422       535,132         703,141
                                                                                -----------   -----------    ------------
                                                                                $ 2,761,014   $ 1,806,153    $  2,118,715
                                                                                ===========   ===========    ============
</TABLE>



                                       42
<PAGE>   44
                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)


The following table presents the net long-lived assets by country:

<TABLE>
<CAPTION>
                                                                      2000              1999              1998
                                                                   ------------     -------------     -------------
<S>                                                                <C>              <C>               <C>
  United States........................................            $   226,693      $    210,783      $    219,819
  United Kingdom.......................................                 12,265            14,434            13,410
  Canada...............................................                 33,974            36,679            18,569
  Norway...............................................                 11,565            11,292            12,152
  Venezuela............................................                 16,336            16,665            20,600
  Other................................................                108,215            91,229            90,686
                                                                   ------------     -------------     -------------
                                                                   $   409,048      $    381,082      $     375,236
                                                                   ============     =============     =============
</TABLE>

        The Company's revenues are derived principally from uncollateralized
sales to customers in the oil and gas industry, the petrochemical industry and
other industrial markets. 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.

14.      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 $39.4
million, $30.6 million and $24.9 million in 2000, 1999 and 1998, 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>
              2001..............................................    $  26,891
              2002..............................................       15,514
              2003..............................................       11,326
              2004..............................................        9,053
              2005..............................................        7,076
              Thereafter........................................       37,484
                                                                    ---------
                                                                    $ 107,344
                                                                    ---------


</TABLE>

  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.

  Environmental

        Although the Company believes it is in substantial compliance with
environmental protection laws, estimating the costs of compliance with these
regulations is difficult considering the continual changes in environmental
legislation.

        The Company is involved in several actions relating to alleged liability
in connection with the U.S. Environmental Protection Agency's National
Priorities List ("NPL") sites. The Company has been named as a potentially
responsible party in two NPL sites. Federal law generally imposes joint and
several liability for site clean-up costs investigated under the Comprehensive
Environmental Response, Compensation and Liability Act of 1980 without regard to
fault or site ownership considerations.



                                       43
<PAGE>   45


                            SMITH INTERNATIONAL, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)



        The Company has recorded liabilities for estimated future clean-up costs
for these sites as well as properties currently or previously owned or leased by
the Company. 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.

15.     EVENTS SUBSEQUENT TO DATE OF AUDITOR'S REPORT (UNAUDITED)

        On January 31, 2001, the Company acquired substantially all of the U.S.
net assets of Van Leeuwen Pipe and Tube Corporation ("Van Leeuwen") in exchange
for cash consideration of $41.1 million borrowed under a short-term loan
facility. Van Leeuwen is a leading provider of pipe, valves and fittings to the
refining, petrochemical and power generation industries. In connection with the
transaction, Wilson also acquired certain inventories to be liquidated in
exchange for a non-interest bearing note to be issued to the seller for
approximately $11.0 million.

         On February 16, 2001, the Company completed a public offering of $250.0
million principal amount of 6.75 percent Senior Notes which mature in February
2011. The Company received net proceeds of $246.7 million from the offering,
which was used to repay short-term borrowing and indebtedness under revolving
credit agreements.

16.      QUARTERLY INFORMATION (UNAUDITED)

<TABLE>
<CAPTION>
                                                  FIRST          SECOND         THIRD           FOURTH           YEAR
                                                  -----          ------         -----           ------           ----
                                                                 (in thousands, except per share data)
2000
<S>                                          <C>              <C>           <C>             <C>            <C>
Revenues.................................    $      625,432   $   657,229   $    718,470    $    759,883   $    2,761,014
Gross profit.............................           161,483       174,335        195,352         213,999          745,169
Net income...............................            11,323        14,974         20,474          26,029           72,800
Basic earnings per share.................              0.23          0.30           0.41            0.52             1.47
Diluted earnings per share...............              0.23          0.30           0.41            0.52             1.45
1999
Revenues.................................    $      397,022   $   389,695   $    481,541    $    537,895   $    1,806,153
Gross profit.............................           111,339        98,685        118,836         139,080          467,940
Net income (loss)........................             6,606        (3,021)        46,860           6,279           56,724
Basic earnings (loss) per share..........              0.14         (0.06)          0.96            0.13             1.17
Diluted earnings (loss) per share........              0.14         (0.06)          0.95            0.13             1.15
</TABLE>




                                       44
<PAGE>   46
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 "STOCK 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...........................................................       20
         Consolidated Statements of Operations for the years ended
           December 31, 2000, 1999 and 1998.................................................................       21
         Consolidated Balance Sheets at December 31, 2000 and 1999..........................................       22
         Consolidated Statements of Shareholders' Equity and Comprehensive Income
           for the years ended December 31, 2000, 1999 and 1998.............................................       24
         Consolidated Statements of Cash Flows for the years ended
           December 31, 2000, 1999 and 1998.................................................................       25
         Notes to Consolidated Financial Statements.........................................................       26

(2)      Financial Statement Schedule for the years ended December 31, 2000, 1999 and 1998:
         Report of Independent Public Accountants on Financial Statement Schedule...........................       50
         Schedule II-Valuation and Qualifying Accounts and Reserves.........................................       51
</TABLE>


        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.



                                       45
<PAGE>   47



(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 3.1 to the Company's report on
                                Form 8-K dated August 13, 1998 (and filed on
                                August 14, 1998) and incorporated herein by
                                reference.

                4.1     -       Rights Agreement, dated as of June 8, 2000,
                                between the Company and First Chicago Trust
                                Company of New York, as Rights Agent. Filed as
                                Exhibit 4.1 to the Company's report on Form 8-A,
                                dated June 15, 2000, and incorporated herein by
                                reference.

                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. 1989 Long Term
                                Incentive Compensation Plan, as amended to date.
                                Filed as Exhibit 10.2 to the Company's report on
                                Form 10-K for the year ended December 31, 1999
                                and incorporated herein by reference.

                10.3    -       Smith International, Inc. Stock Plan for
                                Outside Directors, as amended to date.

                10.4    -       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.

                10.5    -       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.

                10.6    -       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.

                10.7    -       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.

                10.8    -       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.



                                       46
<PAGE>   48



                10.9    -       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.

                10.10   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 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, 1999 and incorporated herein by reference.

                10.11   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and Neal S.
                                Sutton. Filed as Exhibit 10.12 to the Company's
                                report on Form 10-K for the year ended December
                                31, 1999 and incorporated herein by reference.

                10.12   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and Richard
                                A. Werner. Filed as Exhibit 10.13 to the
                                Company's report on Form 10-K for the year ended
                                December 31, 1999 and incorporated herein by
                                reference.

                10.13   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and Loren K.
                                Carroll. Filed as Exhibit 10.14 to the Company's
                                report on Form 10-K for the year ended December
                                31, 1999 and incorporated herein by reference.

                10.14   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and Margaret
                                K. Dorman. Filed as Exhibit 10.15 to the
                                Company's report on Form 10-K for the year ended
                                December 31, 1999 and incorporated herein by
                                reference.

                10.15   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and John J.
                                Kennedy. Filed as Exhibit 10.16 to the Company's
                                report on Form 10-K for the year ended December
                                31, 1999 and incorporated herein by reference.

                10.16   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and Roger A.
                                Brown. Filed as Exhibit 10.17 to the Company's
                                report on Form 10-K for the year ended December
                                31, 1999 and incorporated herein by reference.

                10.17   -       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.

                10.18   -       First Amendment and Waiver to Note Agreement,
                                dated as of May 5, 1997, 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 10.19 to the Company's report on Form
                                10-K for the year ended December 31, 1998 and
                                incorporated herein by reference.

                10.19   -       Second Amendment to Note Agreement, dated as
                                of July 31, 1998, 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 10.20 to the Company's report on Form
                                10-K for the year ended December 31, 1998 and
                                incorporated herein by reference.




                                       47
<PAGE>   49


                10.20   -       Third Amendment to Note Agreement, dated as of
                                April 27, 1999, between the Company and
                                Principal 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 10.21 to the
                                Company's report on Form 10-K for the year ended
                                December 31, 1999 and incorporated herein by
                                reference.

                10.21   -       Fourth Amendment to Note Agreement, dated as
                                of September 30, 1999, between the Company and
                                Principal 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 10.22 to the
                                Company's report on Form 10-K for the year ended
                                December 31, 1999 and incorporated herein by
                                reference.

                10.22   -       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.

                10.23   -       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.

                10.24   -       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.

                10.25   -       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.

                10.26   -       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. Filed as Exhibit 10.27 to the
                                Company's report on Form 10-K for the year ended
                                December 31, 1997 and incorporated herein by
                                reference.

                10.27   -       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. Filed as
                                Exhibit 10.28 to the Company's report on Form
                                10-K for the year ended December 31, 1997 and
                                incorporated herein by reference.

                10.28   -       Amendment to Loan Agreement and Interest Rate
                                Agreement dated August 31, 1998, by and among
                                M-I L.L.C. and Chase Bank of Texas, National
                                Association (formerly known as Texas Commerce
                                Bank National Association), a national banking
                                association, individually and as Agent, and the
                                other financial parties thereto. Filed as
                                Exhibit 10.1 to the Company's report on Form
                                10-Q for the quarter ended March 31, 1999 and
                                incorporated herein by reference.



                                       48
<PAGE>   50



                10.29   -       Amendment to Loan Agreement dated August 31,
                                1998, by and among the Company and Chase Bank of
                                Texas, National Association (formerly known as
                                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 March 31, 1999 and incorporated herein by
                                reference.

                10.30   -       Amendment to Loan Agreement dated December 31,
                                1998, by and among the Company and Chase Bank of
                                Texas, National Association (formerly known as
                                Texas Commerce Bank National Association), a
                                national banking association, individually and
                                as Agent, and the other financial institutions
                                parties hereto. Filed as Exhibit 10.3 to the
                                Company's report on Form 10-Q for the quarter
                                ended March 31, 1999 and incorporated herein by
                                reference.

                10.31   -       Amendment to Loan Agreement dated January 1,
                                2000, by and among M-I L.L.C. and Chase Bank of
                                Texas, National Association (formerly known as
                                Texas Commerce Bank National Association), a
                                national banking association, individually and
                                as Agent, and the other financial 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.


(B)     REPORTS ON FORM 8-K.

        The Registrant filed a Form 8-K dated October 19, 2000, reporting under
"Item 5. Other Events," related to a press release announcing the Registrant's
results for the three months ended September 30, 2000.




                                       49
<PAGE>   51



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
                         ON FINANCIAL STATEMENT SCHEDULE

To Smith International, Inc.:


        We have audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheets of Smith
International, Inc. and subsidiaries as of December 31, 2000 and 1999, and the
related consolidated statements of operations, shareholders' equity and
comprehensive income, and cash flows for each of the three years in the period
ended December 31, 2000, included in this Form 10-K, and have issued our report
thereon dated January 28, 2001. 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 28, 2001







                                       50
<PAGE>   52



                                                                     SCHEDULE II

                            SMITH INTERNATIONAL, INC.

                 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
                                 (IN THOUSANDS)



<TABLE>
<CAPTION>
                                                                         ADDITIONS            DEDUCTIONS
                                                                  ------------------------    ------------
                                                  BALANCE AT       CHARGED                     PAYMENTS           BALANCE
                                                   BEGINNING          TO                          AND             AT END
                                                    OF YEAR        EXPENSE         OTHER      WRITE-OFFS          OF YEAR
                                                  ------------    -----------     --------    ------------     --------------
<S>                                                <C>             <C>             <C>         <C>               <C>
Accrued merger and restructuring costs:
     Year ended December 31, 2000............        $ 9,636         $ 3,277       $  793       $ (3,495)         $ 10,211
     Year ended December 31, 1999............         10,437           2,029            -         (2,830)            9,636
     Year ended December 31, 1998............          8,730           3,016           58         (1,367)           10,437

</TABLE>

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

<TABLE>
<CAPTION>
                                                                         ADDITIONS            DEDUCTIONS
                                                                  ------------------------    ------------
                                                  BALANCE AT       CHARGED                     PAYMENTS           BALANCE
                                                   BEGINNING          TO                          AND             AT END
                                                    OF YEAR        EXPENSE         OTHER      WRITE-OFFS          OF YEAR
                                                  ------------    -----------     --------    ------------     --------------
<S>                                                    <C>             <C>            <C>          <C>               <C>
Accrued merger and restructuring costs:
     Year ended December 31, 2000............       $      -       $       -       $    -      $       -          $      -
     Year ended December 31, 1999............         36,299               -            -        (36,299)                -
     Year ended December 31, 1998............              -          82,500            -        (46,201)           36,299

</TABLE>





                                       51
<PAGE>   53
                                   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, 2001

         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, 2001


/s/ LOREN K. CARROLL                        Executive Vice President and Director                           March 23, 2001
--------------------------------------
(Loren K. Carroll)

/s/ MARGARET K. DORMAN                      Senior Vice President, Chief Financial
--------------------------------------        Officer and Treasurer
(Margaret K. Dorman)                                                                                        March 23, 2001

/s/ BENJAMIN F. BAILAR                      Director                                                        March 23, 2001
--------------------------------------
(Benjamin F. Bailar)

/s/ G. CLYDE BUCK                           Director                                                        March 23, 2001
--------------------------------------
(G.  Clyde Buck)

/s/ JAMES R. GIBBS                          Director                                                        March 23, 2001
--------------------------------------
(James R. Gibbs)

/s/ JERRY W. NEELY                          Director                                                        March 23, 2001
--------------------------------------
(Jerry W. Neely)

/s/ WALLACE S. WILSON                       Director                                                        March 23, 2001
--------------------------------------
(Wallace S. Wilson)
</TABLE>




                                       52
<PAGE>   54


                                                EXHIBIT INDEX

                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 3.1 to the Company's report on
                                Form 8-K dated August 13, 1998 (and filed on
                                August 14, 1998) and incorporated herein by
                                reference.

                4.1     -       Rights Agreement, dated as of June 8, 2000,
                                between the Company and First Chicago Trust
                                Company of New York, as Rights Agent. Filed as
                                Exhibit 4.1 to the Company's report on Form 8-A,
                                dated June 15, 2000, and incorporated herein by
                                reference.

                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. 1989 Long Term
                                Incentive Compensation Plan, as amended to date.
                                Filed as Exhibit 10.2 to the Company's report on
                                Form 10-K for the year ended December 31, 1999
                                and incorporated herein by reference.

                10.3    -       Smith International, Inc. Stock Plan for
                                Outside Directors, as amended to date.

                10.4    -       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.

                10.5    -       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.

                10.6    -       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.

                10.7    -       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.

                10.8    -       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.



<PAGE>   55



                10.9    -       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.

                10.10   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 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, 1999 and incorporated herein by reference.

                10.11   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and Neal S.
                                Sutton. Filed as Exhibit 10.12 to the Company's
                                report on Form 10-K for the year ended December
                                31, 1999 and incorporated herein by reference.

                10.12   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and Richard
                                A. Werner. Filed as Exhibit 10.13 to the
                                Company's report on Form 10-K for the year ended
                                December 31, 1999 and incorporated herein by
                                reference.

                10.13   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and Loren K.
                                Carroll. Filed as Exhibit 10.14 to the Company's
                                report on Form 10-K for the year ended December
                                31, 1999 and incorporated herein by reference.

                10.14   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and Margaret
                                K. Dorman. Filed as Exhibit 10.15 to the
                                Company's report on Form 10-K for the year ended
                                December 31, 1999 and incorporated herein by
                                reference.

                10.15   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and John J.
                                Kennedy. Filed as Exhibit 10.16 to the Company's
                                report on Form 10-K for the year ended December
                                31, 1999 and incorporated herein by reference.

                10.16   -       Change-of-Control Employment Agreement dated
                                January 4, 2000 between the Company and Roger A.
                                Brown. Filed as Exhibit 10.17 to the Company's
                                report on Form 10-K for the year ended December
                                31, 1999 and incorporated herein by reference.

                10.17   -       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.

                10.18   -       First Amendment and Waiver to Note Agreement,
                                dated as of May 5, 1997, 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 10.19 to the Company's report on Form
                                10-K for the year ended December 31, 1998 and
                                incorporated herein by reference.

                10.19   -       Second Amendment to Note Agreement, dated as
                                of July 31, 1998, 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 10.20 to the Company's report on Form
                                10-K for the year ended December 31, 1998 and
                                incorporated herein by reference.



<PAGE>   56


                10.20   -       Third Amendment to Note Agreement, dated as of
                                April 27, 1999, between the Company and
                                Principal 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 10.21 to the
                                Company's report on Form 10-K for the year ended
                                December 31, 1999 and incorporated herein by
                                reference.

                10.21   -       Fourth Amendment to Note Agreement, dated as
                                of September 30, 1999, between the Company and
                                Principal 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 10.22 to the
                                Company's report on Form 10-K for the year ended
                                December 31, 1999 and incorporated herein by
                                reference.

                10.22   -       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.

                10.23   -       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.

                10.24   -       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.

                10.25   -       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.

                10.26   -       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. Filed as Exhibit 10.27 to the
                                Company's report on Form 10-K for the year ended
                                December 31, 1997 and incorporated herein by
                                reference.

                10.27   -       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. Filed as
                                Exhibit 10.28 to the Company's report on Form
                                10-K for the year ended December 31, 1997 and
                                incorporated herein by reference.

                10.28   -       Amendment to Loan Agreement and Interest Rate
                                Agreement dated August 31, 1998, by and among
                                M-I L.L.C. and Chase Bank of Texas, National
                                Association (formerly known as Texas Commerce
                                Bank National Association), a national banking
                                association, individually and as Agent, and the
                                other financial parties thereto. Filed as
                                Exhibit 10.1 to the Company's report on Form
                                10-Q for the quarter ended March 31, 1999 and
                                incorporated herein by reference.



<PAGE>   57



                10.29   -       Amendment to Loan Agreement dated August 31,
                                1998, by and among the Company and Chase Bank of
                                Texas, National Association (formerly known as
                                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 March 31, 1999 and incorporated herein by
                                reference.

                10.30   -       Amendment to Loan Agreement dated December 31,
                                1998, by and among the Company and Chase Bank of
                                Texas, National Association (formerly known as
                                Texas Commerce Bank National Association), a
                                national banking association, individually and
                                as Agent, and the other financial institutions
                                parties hereto. Filed as Exhibit 10.3 to the
                                Company's report on Form 10-Q for the quarter
                                ended March 31, 1999 and incorporated herein by
                                reference.

                10.31   -       Amendment to Loan Agreement dated January 1,
                                2000, by and among M-I L.L.C. and Chase Bank of
                                Texas, National Association (formerly known as
                                Texas Commerce Bank National Association), a
                                national banking association, individually and
                                as Agent, and the other financial 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.