WHQ W-H Energy Svcs

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2008

or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 001-31346

W-H Energy Services, Inc.

(Exact name of registrant as specified in its charter)

Texas		76-0281502
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)

2000 West Sam Houston Parkway South,
Suite 500
Houston, Texas 77042
(Address of principal executive offices and zip code)

(713) 974-9071
(Registrant’s telephone number, including area code)

     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, as amended during the past 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 þ No o

      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer   o (Do not check if a smaller reporting company)		Smaller Reporting Company o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     As of August 5, 2008 there were outstanding 31,014,016 shares of common stock, par value $0.0001 per share, of the registrant.

 

 

W-H ENERGY SERVICES, INC.

INDEX

				Page
PART I
FINANCIAL INFORMATION
Item 1.		Financial Statements			3
		Consolidated Balance Sheets (unaudited) — June 30, 2008 and December 31, 2007			3
		Consolidated Statements of Operations and Comprehensive Income (unaudited)— Three months and six months ended June 30, 2008 and 2007			4
		Consolidated Statements of Cash Flows (unaudited) — Six months ended June 30, 2008 and 2007			5
		Notes to Consolidated Financial Statements (unaudited)			6
Item 2.		Management’s Discussion and Analysis of Financial Condition And Results of Operations			14
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			21
Item 4.		Controls and Procedures			22
PART II
OTHER INFORMATION
Item 1.		Legal Proceedings			22
Item 1A.		Risk Factors			23
Item 4.		Submission of Matters to a Vote of Security Holders			23
Item 6.		Exhibits			23
		Signatures			24
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certification of CEO Pursuant to Section 1350
Certification of CFO Pursuant to Section 1350

PART I
FINANCIAL INFORMATION

Item 1. Financial Statements

W-H ENERGY SERVICES, INC.

CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)

		June 30,				December 31,
		2008				2007
Current Assets:
Cash and cash equivalents		$	30,943			$	23,076
Accounts receivable, net of allowance of $6,343 and $6,696, respectively			281,437				252,313
Inventories			119,232				102,584
Deferred income taxes			15,747				13,401
Prepaid expenses and other			15,309				15,479
Total current assets			462,668				406,853
Property and equipment, net			516,302				448,913
Goodwill, net			171,050				135,928
Other assets, net			28,553				15,336
Total assets		$	1,178,573			$	1,007,030
Current Liabilities:
Accrued liabilities		$	62,980			$	62,059
Accounts payable			64,705				54,756
Total current liabilities			127,685				116,815
Long-term debt			225,149				150,000
Deferred income taxes			74,833				73,526
Other long-term obligations			9,669				11,161
Commitments and Contingencies
Shareholders’ Equity:
Preferred stock, $0.01 par value, 10,000 shares authorized, none issued and outstanding			—				—
Common stock, $0.0001 par value, 100,000 shares authorized 30,977 and 30,699 shares issued and outstanding, respectively			3				3
Additional paid-in capital			301,929				293,424
Other comprehensive income			5,689				6,291
Retained earnings			433,616				355,810
Total shareholders’ equity			741,237				655,528
Total liabilities and shareholders’ equity		$	1,178,573			$	1,007,030

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

W-H ENERGY SERVICES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In thousands, except per share amounts)
(Unaudited)

		For the Three Months								For the Six Months
		Ended June 30,								Ended June 30,
		2008				2007				2008				2007
Revenues		$	346,937			$	277,752			$	647,905			$	550,639
Costs and expenses:
Cost of revenues			191,276				145,386				355,314				292,805
Selling, general and administrative			50,874				44,964				97,044				88,244
Transaction related costs (Note 1)			5,350				—				5,350				—
Research and development			6,849				5,485				12,943				10,201
Depreciation and amortization			24,671				19,162				47,988				36,714
Total costs and expenses			279,020				214,997				518,639				427,964
Operating income			67,917				62,755				129,266				122,675
Other (income) expense:
Interest expense, net			2,770				1,896				5,178				3,889
Other (income) expense, net			(4	)			(70	)			(12	)			(41	)
Income before income taxes			65,151				60,929				124,100				118,827
Provision for income taxes			24,405				21,855				46,294				43,929
Net income		$	40,746			$	39,074			$	77,806			$	74,898
Comprehensive income:
Net income		$	40,746			$	39,074			$	77,806			$	74,898
Increase (decrease) in interest rate swap valuations			2,126				989				(633	)			416
Foreign currency translation adjustment			333				16				31				194
Comprehensive income		$	43,205			$	40,079			$	77,204			$	75,508
Earnings per share:
Basic		$	1.33			$	1.29			$	2.54			$	2.48
Diluted		$	1.29			$	1.25			$	2.48			$	2.42
Number of shares used in calculation of earnings per share:
Basic			30,670				30,315				30,622				30,196
Diluted			31,480				31,140				31,389				31,008

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

W-H ENERGY SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

		For the Six Months
		Ended June 30,
		2008				2007
Cash Flows from Operating Activities:
Net income		$	77,806			$	74,898
Adjustments to reconcile net income to cash provided by operating activities —
Depreciation and amortization			47,988				36,714
Provision for doubtful accounts			(284	)			813
Gain on sales of equipment			(15,623	)			(10,689	)
Deferred tax provision			(1,428	)			(2,365	)
Share-based compensation			3,330				2,888
Amortization of deferred financing costs			262				287
Excess tax benefit from share-based compensation			(2,725	)			(3,434	)
Changes in operating assets and liabilities, excluding effects of acquisitions —
Accounts receivable, net			(26,161	)			(29,875	)
Inventories			(15,806	)			(15,112	)
Prepaid expenses and other			540				(6,917	)
Other assets, net			140				976
Accounts payable, accrued liabilities and other			9,101				(2,920	)
Net cash provided by operating activities			77,140				45,264
Cash Flows from Investing Activities:
Additions to property and equipment			(120,081	)			(97,776	)
Acquisition of businesses, net of cash acquired			(56,039	)			(12,583	)
Proceeds from sales of equipment			26,539				21,137
Net cash used in investing activities			(149,581	)			(89,222	)
Cash Flows from Financing Activities:
Proceeds from the issuance of debt			138,720				76,931
Payments on debt			(63,571	)			(56,856	)
Proceeds from the exercise of stock options			2,450				5,205
Excess tax benefit from share-based compensation			2,725				3,434
Net cash provided by financing activities			80,324				28,714
Effect of exchange rate changes on cash			(16	)			258
Net increase (decrease) in cash and cash equivalents			7,867				(14,986	)
Cash and cash equivalents, beginning of period			23,076				36,329
Cash and cash equivalents, end of period		$	30,943			$	21,343

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

W-H ENERGY SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Business Organization

Description of Company

     W-H Energy Services, Inc., a Texas corporation, and its subsidiaries (collectively, “W-H”) is a diversified oilfield service company that provides products and services used in connection with the drilling and completion of oil and natural gas wells and the production of oil and natural gas. W-H has the following primary lines of business: (1) drilling related products and services, which include logging-while-drilling, measurement-while-drilling, directional drilling, down-hole drilling motors, drilling fluids and rental tools; and (2) completion and workover related products and services, which include cased-hole wireline logging, perforating, tubing conveyed perforating and associated rental equipment, coiled tubing, completion fluids and rental tools.

Proposed Acquisition of W-H by Smith International, Inc.

     On June 3, 2008, W-H entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Smith International, Inc. (“Smith”) and an indirect wholly owned subsidiary of Smith, pursuant to which W-H is expected to become a wholly owned subsidiary of Smith (the “Acquisition”). In order to effectuate the Acquisition, and in accordance with the Merger Agreement, the Smith subsidiary has commenced an offer to exchange (the “Offer”) each outstanding share of W-H’s common stock validly tendered and not withdrawn in the exchange offer, at the election of the holder of such share, for:

	•		$56.10 in cash, without interest, and 0.48 shares of Smith’s common stock, par value $1.00 per share, including the associated
preferred share purchase rights (“Smith Common Stock”); or
	•		$93.55 in cash, without interest (the “All-Cash Consideration”); or
	•		1.1990 shares of Smith Common Stock (the “All-Stock Consideration”),

subject in each case to the election procedures and, in the case of elections of the All-Cash Consideration or the All-Stock Consideration, to the proration procedures described in Smith’s Prospectus/Offer to Exchange dated June 24, 2008, as amended, included in Smith’s Registration Statement on Form S-4 filed with the SEC on June 24, 2008, as amended, and which, together with the related letter of election and transmittal, as the same may be amended, constitute the “Offer.” The Offer will expire at 12:00 midnight, New York City time, at the end of August 18, 2008, unless further extended.

     Following consummation of the Offer, W-H will merge with a wholly owned subsidiary of Smith, with W-H surviving such merger. In the merger, any remaining shares of W-H’s common stock not tendered pursuant to the Offer will be cancelled and converted into the right to receive $56.10 in cash, without interest, and 0.48 shares of Smith Common Stock, subject to adjustment pursuant to the Merger Agreement. Following such merger, W-H, as the surviving corporation of such merger, will be a wholly-owned subsidiary of Smith and the former W-H shareholders will no longer have any direct ownership interest in W-H. Such merger will be followed by a second merger pursuant to which W-H will merge with and into a direct wholly owned subsidiary of Smith, with such subsidiary surviving such second merger.

     W-H expects that the Acquisition will be completed during the third quarter of 2008, but the closing is subject to customary closing conditions, including (i) there being validly tendered and not properly withdrawn before the expiration of the Offer at least 66 ² / ₃ % of W-H’s outstanding shares of common stock, (ii) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and (iii) Smith’s Registration Statement on Form S-4 having become effective.

     Through June 30, 2008, W-H had incurred approximately $5.4 million in expenses associated with the transactions contemplated by the Merger Agreement, including legal fees and fees payable to UBS Securities LLC (“UBS”) in respect of that firm’s fairness opinion provided to W-H’s Board of Directors in connection with the Acquisition transaction. Such costs have been reported as transaction related costs on the consolidated statement of operations for the three months and six months ended June 30, 2008. Pursuant to the engagement letter between W-H and UBS, W-H will be obligated to pay UBS an additional fee of approximately $22.0 million at the closing of the Acquisition in respect of the financial advisory services provided by UBS to W-H.

Basis of Presentation

     The unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Rule 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in W-H’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission (“SEC”). In the opinion of management, all necessary adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months and six months ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008.

Accounting Policies and Procedures

     Effective January 1, 2008, W-H adopted SFAS No. 157, Fair Value Measurements, (“SFAS No. 157”) as it relates to financial assets and financial liabilities. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which delayed the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on at least an annual basis, until January 1, 2009 for calendar year-end entities. Accordingly, W-H will defer the adoption of SFAS No. 157 for its nonfinancial assets and nonfinancial liabilities until January 1, 2009. The adoption of SFAS No. 157 did not cause a change in the method of calculating fair value of assets or liabilities. The primary impact from adoption was additional disclosures. See Note 6 for more information.

     Effective January 1, 2008, W-H adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115 , (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure most financial instruments and certain other items at fair value on an instrument-by-instrument basis (the fair value option) with changes in fair value reported in earnings. W-H adopted SFAS No. 159 on January 1, 2008. W-H already records its hedging activities at fair value in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , as amended. The adoption of SFAS No. 159 had no impact on W-H’s financial statements as W-H did not elect the fair value option for any other assets and liabilities.

     In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141R”) to change how an entity accounts for the acquisition of a business. SFAS No. 141R carries forward the existing requirements to account for all business combinations using the acquisition method (formerly called the purchase method). In general, SFAS No. 141R will require acquisition-date fair value measurement of identifiable assets acquired, liabilities assumed and non-controlling interests in the acquiree. SFAS No. 141R will eliminate the current cost-based purchase method under SFAS No. 141. The new measurement requirements will result in the recognition of the full amount of acquisition-date goodwill, which includes amounts attributable to non-controlling interests. The acquirer will recognize in income any gain or loss on the remeasurement to acquisition-date fair value of consideration transferred or of previously acquired equity interests in the acquiree. The direct costs incurred to effect a business combination and the costs the acquirer expects to incur under a plan to restructure an acquired business will be charged to expense when incurred. SFAS No. 141R will also change the accounting for contingent consideration, in process research and development, contingencies, and restructuring costs. In addition, changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination that occur after the measurement period will impact income taxes under SFAS No. 141R. SFAS No. 141R is effective for fiscal years beginning on or after December 15, 2008 and interim periods within those years. W-H intends to adopt SFAS No. 141R effective January 1, 2009 and apply its provisions prospectively. W-H currently does not believe that the adoption of SFAS No. 141R will have a significant effect on its financial statements;

however, the effect is dependent upon whether W-H makes any future acquisitions and the specific terms of those acquisitions.

     SFAS No. 141R amends the goodwill impairment test requirements in SFAS No. 142. For a goodwill impairment test as of a date after the effective date of SFAS No. 141R, the value of the reporting unit and the amount of implied goodwill, calculated in the second step of the test, will be determined in accordance with the measurement and recognition guidance on accounting for business combinations under SFAS No. 141R. This change could effect the determination of what amount, if any, should be recognized as an impairment loss for goodwill recorded before the effective date of SFAS No. 141R. W-H has not determined what effect, if any, SFAS No. 141R will have on the results of its goodwill impairment testing subsequent to December 31, 2008.

     Other than the adoptions of SFAS No. 157 and SFAS No. 159 as of January 1, 2008 described above, W-H has not added to or changed its accounting policies since December 31, 2007. For a description of these policies, refer to Note 2 of the Consolidated Financial Statements in W-H’s Annual Report on Form 10-K for the year ended December 31, 2007.

2. Acquisitions

     On February 22, 2008, W-H’s wholly-owned subsidiary, Sup-R-Jar, Inc. (“Sup-R-Jar”), acquired substantially all of the assets of a drilling jar company for cash consideration of approximately $49.9 million. Sup-R-Jar leases and sells these assets to participants in the oil and natural gas industry. The following table summarizes the preliminary purchase price allocation to the fair values of the net assets acquired in this acquisition (in thousands):

Net assets acquired:
Current assets		$	3,841
Property and equipment			4,929
Goodwill			30,384
Other intangibles and other assets			11,403
Current liabilities			(616	)
Net assets acquired		$	49,941

     On April 9, 2008, W-H’s wholly-owned subsidiary, PathFinder Energy Services, Inc. (“PathFinder”), acquired a directional drilling technology company and related technology for cash consideration of approximately $8.1 million. The technology included in this acquisition is expected to complement the directional drilling services provided by PathFinder.

     Unaudited proforma consolidated financial information for these acquisitions has not been included as the results were not material to current operations.

3. Earnings per Share

     Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding for the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding for the period as adjusted for the dilutive effect of stock options and restricted shares. For the three months and six months June 30, 2008 and 2007, there were no anti-dilutive stock options; therefore, the effect of all stock options were included in the diluted earnings per share calculation.

     The following reconciles basic and diluted weighted average shares outstanding (in thousands):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
Basic weighted average shares outstanding			30,670				30,315				30,622				30,196
Dilutive effect of stock options and restricted shares			810				825				767				812
Diluted weighted average shares outstanding			31,480				31,140				31,389				31,008

4. Inventories

     The components of inventories as of June 30, 2008 and December 31, 2007 are as follows (in thousands):

		June 30, 2008				December 31, 2007
Finished goods		$	85,250			$	73,999
Work-in-process			12,261				10,937
Raw materials and supplies			32,022				27,227
Inventory reserve			(10,301	)			(9,579	)
Inventories		$	119,232			$	102,584

5. Credit Facility

     W-H maintains a revolving credit facility with certain lenders to provide for its cash, liquidity and other borrowing needs. The credit facility provides for aggregate borrowings of up to $375.0 million and matures on May 5, 2010. As of June 30, 2008, W-H had an outstanding loan balance of $225.1 million and approximately $10.5 million in letters of credit issued under its credit facility, resulting in an available borrowing capacity on such date of approximately $139.4 million.

     Amounts borrowed under the credit facility bear interest, at W-H’s election, at either a variable rate equal to LIBOR, plus a margin ranging from 1.0% to 2.0%, depending upon W-H’s leverage ratio, or an alternate base rate equal to the higher of (1) the prime rate or (2) the federal funds rate plus 0.5%, plus a margin ranging from zero to 1.0%, depending upon W-H’s leverage ratio.

     In May 2005, W-H entered into interest rate swap agreements with a total notional amount of $150.0 million related to its credit facility. Under these agreements, W-H receives interest at a floating rate equal to the three-month LIBOR rate and pays interest at a fixed rate of 4.24%. Including the effect of the interest rate swap agreements, W-H was incurring interest at a weighted average rate of approximately 4.9% on its total outstanding borrowings as of June 30, 2008.

     The credit facility is secured by a lien on substantially all of W-H’s property and assets, a pledge of all the capital stock of W-H’s domestic subsidiaries and a pledge of not greater than 65% of the capital stock of each of W-H’s top tier foreign subsidiaries. In addition, the credit facility is guaranteed by all of W-H’s domestic subsidiaries. The credit facility requires, among other things, that W-H maintain certain financial ratios, including a leverage ratio and an interest coverage ratio, and a specified net worth. The credit facility limits the amount of capital expenditures W-H may make, the amount of debt W-H may incur outside of the credit facility, the amount of future investments W-H may make, the ability of W-H to pay dividends and the ability of W-H to engage in certain business combination transactions.

     Although the consummation of the Offer would result in an event of default under W-H’s revolving credit facility, giving the lenders thereunder the right to accelerate all indebtedness outstanding thereunder, W-H and Smith intend to repay amounts outstanding and terminate the credit facility contemporaneously with the closing of the Offer.

6. Fair Value Disclosures

     SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principals and expands disclosures about fair value measurements. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements. The adoption of SFAS No. 157, as it relates to financial assets, had no impact on W-H’s consolidated financial position, results of operations and cash flows. W-H is currently evaluating the potential impact of SFAS No. 157, as it relates to nonfinancial assets and nonfinancial liabilities, on its consolidated financial position, results of operations and cash flows.

     SFAS No. 157 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy categorizes assets and liabilities measured at fair value into one of three different levels depending on the observability of the inputs employed in the measurement. The three levels are defined as follows:

     Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

     Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

     Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value measurement.

     A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. W-H’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. The following table presents information about W-H’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2008, and indicates the fair value hierarchy of the valuation techniques utilized by W-H to determine such fair value (in thousands):

		Level 1				Level 2				Level 3				Total
Assets:		$	—			$	—			$	—			$	—
Liabilities:
Interest rate swaps		$	—			$	2,425			$	—			$	2,425

     The following methods and assumptions were used to estimate the fair values of the assets and liabilities in the table above:

      Interest Rate Swaps — W-H’s interest rate swaps are valued using the counterparty’s marked-to-market statement, which can be validated using modeling techniques that include market inputs such as publicly available interest rate yield curves, and is designated as Level 2 within the valuation hierarchy.

     The Company has no assets or liabilities measured at fair value on a recurring basis that meet the definition of Level 3, which is significant unobservable inputs.

7. Litigation

     W-H is from time to time a party or otherwise subject to legal proceedings, claims, investigations and other proceedings in the ordinary course of its business. These matters typically involve tort, workers compensation, commercial, employment and infringement and other intellectual property claims. Where appropriate, W-H makes provision for a liability with respect to these claims in its financial statements in accordance with generally accepted accounting principles. These provisions are reviewed periodically and adjusted to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and events pertaining to a particular case. Litigation is inherently unpredictable. Based upon information currently available, management believes that the ultimate liability with respect to these proceedings and claims will not materially affect W-H’s consolidated results of operations or financial position.

8. Shareholders’ Equity

Stock options

     A summary of W-H’s stock options from December 31, 2007 to June 30, 2008 is as follows:

										Weighted Average
		Number of				Weighted Average				Remaining				Aggregate
		Options				Price per Share				Contractual Term				Intrinsic Value
										(Years)				(Amounts in thousands)
Outstanding at December 31, 2007			1,565,138			$	16.76
Granted			—				—
Exercised			(137,300	)			19.65							$	7,525
Expired/canceled			(36,250	)			19.44
Outstanding at June 30, 2008			1,391,588				16.41				4.1				100,393
Exercisable at June 30, 2008			1,205,713				15.50				3.7				96,746

Restricted Stock

     During the six months ended June 30, 2008, W-H awarded a total of 154,500 shares of restricted stock under its 2006 Stock Awards Plan to certain employees. The fair value of the restricted stock issued was approximately $8.8 million and will be recognized as compensation expense over the vesting period of 48 months.

     A summary of W-H’s restricted stock from December 31, 2007 to June 30, 2008 is as follows:

						Weighted
						Average
		Number of				Fair Value
		Shares				Per Share
Nonvested balance at December 31, 2007			148,084			$	53.05
Granted			154,500				55.17
Vested			(41,000	)			52.53
Forfeited			(1,500	)			56.36
Nonvested balance at June 30, 2008			260,084			$	52.74

9. Operating Segments

     Management has elected to aggregate W-H’s business unit segments based on the differences in each segment’s customers, the products and services offered and other economic characteristics. Based on these criteria, management has identified the following reportable segments: (1) drilling related products and services and (2) completion and workover related products and services. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies in W-H’s Annual Report on Form 10-K for the year ended December 31, 2007.

Drilling Related Products and Services

     The drilling segment provides products and services used by oil and natural gas companies, drilling contractors and other oilfield service companies for the drilling of oil and natural gas wells. These products and services are used primarily throughout North America and in select international areas. This segment includes the following business lines: (1) logging-while-drilling; (2) measurement-while-drilling; (3) directional drilling; (4) down-hole drilling motors; (5) drilling fluids and (6) rental tools.

Completion and Workover Related Products and Services

     The completion and workover segment provides products and services primarily to customers onshore in the United States and offshore in the Gulf of Mexico. These products and services include: (1) cased-hole wireline logging, perforating, tubing conveyed perforating and associated rental equipment; (2) coiled tubing; (3) completion fluids and (4) rental tools.

Summary Information

     W-H recognizes revenues, operating income, depreciation and amortization expense, total assets and capital expenditures by segment. Interest expense and other income (expense) are not monitored by segment. Summarized information for W-H’s reportable segments is contained in the following tables (in thousands):

     As of and for the three months ended June 30, 2008:

		Drilling				Completion				Corporate				Total
Revenues		$	222,984			$	123,953			$	—			$	346,937
Operating income			43,242				34,842				(10,167	)			67,917
Depreciation and amortization			14,899				9,709				63				24,671
Total assets			765,202				375,212				38,159				1,178,573
Capital expenditures			43,840				18,113				35				61,988

     As of and for the three months ended June 30, 2007:

		Drilling				Completion				Corporate				Total
Revenues		$	179,141			$	98,611			$	—			$	277,752
Operating income			41,307				26,032				(4,584	)			62,755
Depreciation and amortization			11,600				7,493				69				19,162
Total assets			578,163				320,623				39,087				937,873
Capital expenditures			28,681				21,428				426				50,535

     As of and for the six months ended June 30, 2008:

		Drilling				Completion				Corporate				Total
Revenues		$	417,237			$	230,668			$	—			$	647,905
Operating income			80,835				63,289				(14,858	)			129,266
Depreciation and amortization			28,962				18,899				127				47,988
Total assets			765,202				375,212				38,159				1,178,573
Capital expenditures			75,843				44,185				53				120,081

     As of and for the six months ended June 30, 2007:

		Drilling				Completion				Corporate				Total
Revenues		$	358,402			$	192,237			$	—			$	550,639
Operating income			80,289				51,884				(9,498	)			122,675
Depreciation and amortization			22,173				14,426				115				36,714
Total assets			578,163				320,623				39,087				937,873
Capital expenditures			54,593				42,530				653				97,776

     W-H operates in the United States, the North Sea and other select geographic regions. The following is summary information by geographic region (in thousands):

Revenues

		For the Three Months								For the Six Months
		Ended June 30,								Ended June 30,
		2008				2007				2008				2007
United States		$	315,597			$	249,898			$	585,537			$	487,185
North Sea			10,875				12,923				24,577				28,723
Other			20,465				14,931				37,791				34,731
Total		$	346,937			$	277,752			$	647,905			$	550,639

Operating Income

		For the Three Months								For the Six Months
		Ended June 30,								Ended June 30,
		2008				2007				2008				2007
United States		$	62,422			$	57,304			$	117,223			$	111,035
North Sea			1,090				2,864				3,997				4,616
Other			4,405				2,587				8,046				7,024
Total		$	67,917			$	62,755			$	129,266			$	122,675

Property and equipment, net

		June 30,				December 31,
		2008				2007
United States		$	469,470			$	404,111
North Sea			13,088				13,588
Other			33,744				31,214
Total		$	516,302			$	448,913

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

     In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that involve risks, uncertainties and assumptions. The words “believe,” “expect,” “plan,” “intend,” “estimate,” “project,” “will,” “could,” “may,” and similar expressions are intended to identify forward-looking statements. Actual results may differ materially from the results discussed in the forward-looking statements as a result of important risk factors including, but not limited to, trends in oil and natural gas prices, capital expenditures by customers, oil and natural gas industry activity, difficulty in continuing to develop, produce and commercialize technologically advanced products and services, weather conditions in offshore and land markets, risks associated with events that result in personal injuries, loss of life, damage to or destruction of property, equipment or the environment and suspension of operations, unavailability of or costs associated with insurance, our ability to attract and retain skilled workers, the loss of key members of management, competition in our industry, compliance with and developments in environmental and other governmental regulations, loss of use of certain technologies, the concentration of customers in the energy industry, our ability to successfully integrate future acquisitions, political and economic risks including changes in tax laws, an impairment of goodwill, as well as restrictions on our ability to raise additional funds. For additional discussion of these risks, please see the discussion set forth under the heading “Item 1A — Risk Factors” contained in our most recent Annual Report filed on Form 10-K with the SEC.

Proposed Acquisition of W-H by Smith International, Inc.

     As more fully described in Note 1 to our Consolidated Financial Statements, on June 3, 2008, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Smith International, Inc. (“Smith”) and an indirect wholly owned subsidiary of Smith, pursuant to which we are expected to become a wholly owned subsidiary of Smith (the “Acquisition”). In order to effectuate the Acquisition, and in accordance with the Merger Agreement, the Smith subsidiary has commenced an offer to exchange (the “Offer”) each outstanding share of our common stock validly tendered and not withdrawn in the exchange offer, at the election of the holder of such share, for:

	•		$56.10 in cash, without interest, and 0.48 shares of Smith’s common stock, par value $1.00 per share, including the associated
preferred share purchase rights (“Smith Common Stock”); or
	•		$93.55 in cash, without interest (the “All-Cash Consideration”); or
	•		1.1990 shares of Smith Common Stock (the “All-Stock Consideration”),

     subject in each case to the election procedures and, in the case of elections of the All-Cash Consideration or the All-Stock Consideration, to the proration procedures described in Smith’s Prospectus/Offer to Exchange dated June 24, 2008, as amended, included in Smith’s Registration Statement on Form S-4 filed with the SEC on June 24, 2008, as amended, and which, together with the related letter of election and transmittal, as the same may be amended, constitute the “Offer.” The Offer will expire at 12:00 midnight, New York City time, at the end of August 18, 2008, unless further extended.

     Following consummation of the Offer, we will merge with a wholly owned subsidiary of Smith, with our company surviving such merger. In the merger, any remaining shares of our common stock not tendered pursuant to the Offer will be cancelled and converted into the right to receive $56.10 in cash, without interest, and 0.48 shares of Smith Common Stock, subject to adjustment pursuant to the Merger Agreement. Following such merger, we, as the surviving corporation of such merger, will be a wholly-owned subsidiary of Smith and our former shareholders will no longer have any direct ownership interest in us. Such merger will be followed by a second merger pursuant to which we will merge with and into a direct wholly owned subsidiary of Smith, with such subsidiary surviving such second merger.

     We expect that the Acquisition will be completed during the third quarter of 2008, but the closing is subject to customary closing conditions, including (i) there being validly tendered and not properly withdrawn before the expiration of the Offer at least 66 ² / ₃ % of our outstanding shares of common stock, (ii) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and (iii) Smith’s Registration Statement on Form S-4 having become effective.

Overview of Our Products and Services

     We provide drilling related products and services and completion and workover related products and services to major and independent oil and natural gas companies, drilling contractors and other oilfield service companies. The majority of our revenues are generated from charging our customers day rates, based on the number of days our products and services are used. We also sell certain products used in the exploration for and production of oil and natural gas and receive revenues from our customers in connection with these sales. Our primary expenses are salaries for our personnel and the costs associated with expendable parts and supplies, research and development, repair and maintenance of rental equipment and costs of products sold as well as general operational costs. As a result of increased demand and competition for skilled personnel, compensation costs to attract and retain employees have continued to rise.

     Prices for oil and natural gas are subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and natural gas, market uncertainty, expectations and a variety of other factors. Any prolonged increase or decrease in oil and natural gas prices affects the levels of exploration, development and production activity as well as the entire health of the oil and natural gas industry. Demand for our drilling related products and services is directly affected by the level of exploration, development and production activity of, and the corresponding capital spending by, oil and natural gas companies. Demand for our completion and workover related products and services also depends on oil and natural gas production activity, which may be less immediately affected by changes in oil and natural gas prices.

     In July 2001, exploration and development activity levels in the United States peaked and subsequently began to decline primarily as a result of lower natural gas prices. This decline continued through April 2002, at which point the United States drilling rig count reached a low of 738, which consisted of 110 offshore rigs and 628 land rigs. As natural gas prices climbed and remained relatively strong, rig count levels began to recover in 2003, and this trend has continued through the first quarter of 2008. This increase, however, resulted from an increase in land-based rigs. According to statistics published by Baker Hughes, the average number of rotary rigs operating in the United States was 1,649, 1,768 and 1,817 for 2006, 2007 and for the six months ended June 30, 2008, respectively. Of these figures, land rigs comprised 1,559, 1,695 and 1,754, respectively, and offshore rigs comprised 90, 73 and 63, respectively, for the same periods. For the week ended July 25, 2008, an average of 67 rotary rigs were operating offshore in the United States.

     The search for natural gas has been the primary focus of domestic drilling for the last several years as approximately 80% of the domestic drilling rig count has been natural gas drilling. We believe that the outlook for domestic natural gas exploration and development activity remains positive. First, due to significantly higher natural gas production decline rates, more wells must be drilled to maintain or increase natural gas production. As reported by RigData, the number of wells drilled annually has increased approximately 57% from 27,252 in 2003 to an estimated 42,695 for the twelve months ended June 30, 2008. Second, our supply of natural gas continues to be provided primarily by domestic drilling. We believe these factors should keep upward pressure on long-term natural gas prices and domestic drilling. As a result, we are focusing our capital expenditure investments in locations which are attracting long-term investment in oil and natural gas exploration and development.

Drilling Related Products and Services

     Revenue from our drilling related products and services segment constituted approximately 64% of our consolidated revenue for the six months ended June 30, 2008. Approximately 85% of our drilling segment revenue for the six months ended June 30, 2008 was generated in the United States, including the Gulf of Mexico. The remaining 15% was generated in various international locations.

     We have sought to increase the content of our land-based services as onshore drilling activity in the United States has improved. As a result of growth in the domestic non-vertical rig count, we have successfully leveraged our directional drilling business to effect an increase in the utilization of our measurement-while-drilling and logging-while-drilling tools and down-hole drilling motor fleet. The increased utilization of our measurement-while-drilling and logging-while-drilling tools and down-hole drilling motor fleet has helped to offset the slowdown in domestic offshore activity.

     Outside of the United States, the North Sea remains our largest market segment. For the remainder of 2008, we expect to see increasing drilling activity in the Middle East and a modest increase in activity levels in our other foreign markets.

     A key challenge that our drilling related products and services segment faces is the demand by our customers for more efficient and technologically advanced services and tools. We have invested substantial time and capital into developing and commercializing technologies that are of value to our customers and that enable us to compete effectively with the major integrated oilfield service companies. During 2004, we began to market our PathMaker ^® 3-Dimensional Rotary Steerable line of tools with the introduction of our PathMaker ^® tool in the 12 ¹ / 4 -inch hole size. The PathMaker ^® tool in the 8 ¹ / 2 -inch hole size became available on a commercial basis during the first quarter of 2007. Other sizes of the PathMaker ^® tool are currently in development. We expect commercialization of the 3-Dimensional Rotary Steerable technology to further improve the utilization of our logging-while-drilling, measurement-while-drilling and directional drilling services, as our customers are increasingly requiring this type of technology as a prerequisite for submitting bids on a drilling project or contract.

     In 2004, our subsidiary, PathFinder Energy Services, Inc. (“PathFinder”), introduced the first of the Survivor ^tm tools designed for use in high pressure and high temperature conditions (up to 25,000 psi and 350°F) with the commercialization of its dual frequency Array Wave Resistivity tool. That tool is now available in 4 ³ / 4 , 6 ³ / 4 , 8 and 9 ¹ / 2 -inch outside diameter sizes. The Survivor ^tm tool series currently also includes Survivor ^tm HDS-1 ^tm (a high precision directional survey tool), Survivor ^tm DPM ^tm (Dynamic Pressure Module) and Survivor ^tm SDNSC ^tm (4 ³ / 4 -inch outside diameter Slim Density Neutron Standoff Caliper tool).

Completion and Workover Related Products and Services

     Our completion and workover related products and services segment provided approximately 36% of our total consolidated revenue for the six months ended June 30, 2008. Revenues provided by this segment are almost entirely derived from the United States and the Gulf of Mexico. Demand for this segment’s products and services has historically been less immediately affected by changing oil and natural gas prices and, thus, has tended to be less directly impacted by these changes than is our drilling related products and services segment. However, the onshore content of our business line has increased over the past few years and has resulted in a proportionately greater amount of completion services which are associated with exploration and development activity, rather than workover services which are associated with production activity.

     We have increased our revenue capacity in this segment through capital spending which, when combined with our acquisitions and strategic land-based expansion efforts, has strengthened and further diversified our operations. Continued growth in this segment will be dependent upon, among other factors, industry activity levels, prices of oil and natural gas, our capital expenditure program and our ability to attract and retain qualified service personnel and field engineers required to operate the specialized equipment used in this business. Increased competition in certain markets within this segment has adversely impacted utilization and pricing and increased the demand for qualified personnel.

Results of Operations

     The following information should be read in conjunction with our Consolidated Financial Statements and the accompanying notes presented elsewhere in this Form 10-Q.

Three Months Ended June 30, 2008 Compared to the Three Months Ended June 30, 2007

      Revenues. Revenues increased by $69.2 million, or approximately 25%, to $346.9 million for the three months ended June 30, 2008 from $277.7 million for the three months ended June 30, 2007. This increase was primarily attributable to higher levels of activity, increased demand for certain of our products and services and additional revenue capacity from our capital expenditure investments.

     Revenues from our drilling related products and services increased by $43.9 million, or approximately 25%, to $223.0 million for the three months ended June 30, 2008 from $179.1 million for the three months ended June 30, 2007. We attribute the increase in revenues in this segment to:

	•		a 6% higher average number of rotary rigs operating in the United States resulting in an increase in demand for our drilling fluids products, directional drilling services and technologically advanced services and tools and rental tools;
	•		our larger asset base resulting from our capital expenditure investments;
	•		our onshore geographic expansion;
	•		increases in pricing, particularly for certain drilling fluids products; and
	•		a full quarter of results from Sup-R-Jar which was acquired during the first quarter of 2008.

     Revenues from our completion and workover related products and services increased by $25.4 million, or approximately 26%, to $124.0 million for the three months ended June 30, 2008 from $98.6 million for the three months ended June 30, 2007. We attribute the increase in revenues in this segment to:

	•		higher demand for our cased-hole wireline services, completion fluid products and coiled tubing services as a result of an overall increase in activity levels;
	•		an increase in our coiled tubing and cased-hole wireline fleets and other capital expenditure investments; and
	•		our onshore geographic expansion.

      Cost of Revenues. Cost of revenues increased by $45.9 million, or approximately 32%, to $191.3 million for the three months ended June 30, 2008 from $145.4 million for the three months ended June 30, 2007. As a percentage of revenues, cost of revenues were 55% and 52% for the three months ended June 30, 2008 and 2007, respectively. The increase in cost of revenues as a percentage of revenues for the three months ended June 30, 2008 as compared to the three months ended June 30, 2007 was due primarily to the decline in domestic offshore utilization of our measurement-while-drilling and logging-while-drilling tools and down-hole drilling motor fleet which has historically earned higher operating margins than our domestic onshore activity. This trend was partially offset for the period by higher profit margins on certain of our drilling fluids products. The margins on certain of these drilling fluids products may decrease as a result of an increase in our product cost.

      Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $5.9 million, or approximately 13%, to $50.9 million for the three months ended June 30, 2008 from $45.0 million for the three months ended June 30, 2007. The increase was primarily attributable to increased selling costs related to our revenue growth and other personnel compensation costs related to expansion efforts within all of our business lines. As a percentage of revenues, selling, general and administrative expenses decreased to 15% for the three months ended June 30, 2008 from 16% for the three months ended June 30, 2007.

      Transaction Related Costs. Through June 30, 2008, we had incurred approximately $5.4 million in expenses associated with the transactions contemplated by the Merger Agreement, including legal fees and fees payable to UBS Securities LLC (“UBS”) in respect of that firm’s fairness opinion provided to our Board of Directors in connection with the Acquisition transaction. Pursuant to the engagement letter between us and UBS, we will be obligated to pay UBS an additional fee of approximately $22.0 million at the closing of the Acquisition in respect of the financial advisory services provided by UBS to us.

      Research and Development Expenses. Research and development expenses increased by $1.3 million, or approximately 24%, to $6.8 million for the three months ended June 30, 2008 from $5.5 million for the three months ended June 30, 2007. This increase was the result of a higher rate of research and development spending in the 2008 period on PathFinder technologies, including our PathMaker ^® 3-Dimensional Rotary Steerable technology.

      Depreciation and Amortization. Depreciation and amortization increased by $5.5 million, or approximately 29%, to $24.7 million for the three months ended June 30, 2008 from $19.2 million for the three months ended June 30, 2007. This increase was principally the result of a larger depreciable asset base resulting from our capital expenditure investments.

      Interest and Other Expense. Interest and other expense for the three months ended June 30, 2008 was $2.8 million, an increase of $1.0 million, or approximately 56%, from $1.8 million for the three months ended June 30, 2007. This increase was primarily due to higher outstanding borrowings under our credit facility resulting from our acquisitions, capital expenditures and working capital requirements.

      Provision for Income Taxes. Our effective income tax rate for the three months ended June 30, 2008 was approximately 37% as compared to 36% for the three months ended June 30, 2007. The increase in the 2008 effective rate compared to the 2007 period was due primarily to the non-deductibility of a majority of the costs associated with the transactions contemplated by the Merger Agreement recognized during the period. Generally, our effective rate varies due to several factors including, but not limited to, fluctuations in income across international tax jurisdictions with varying tax rates.

Six Months Ended June 30, 2008 Compared to the Six Months Ended June 30, 2007

      Revenues. Revenues increased by $97.3 million, or approximately 18%, to $647.9 million for the six months ended June 30, 2008 from $550.6 million for the six months ended June 30, 2007. This increase was primarily attributable to higher levels of activity, increased demand for certain of our products and services and additional revenue capacity from our capital expenditure investments.

     Revenues from our drilling related products and services increased by $58.8 million, or approximately 16%, to $417.2 million for the six months ended June 30, 2008 from $358.4 million for the three months ended June 30, 2007. We attribute the increase in revenues in this segment to:

	•		a 4% higher average number of rotary rigs operating in the United States resulting in an increase in demand for our drilling fluids products, directional drilling services and technologically advanced services and tools and rental tools;
	•		our larger asset base resulting from our capital expenditure investments;
	•		our onshore geographic expansion;
	•		increases in pricing, particularly for certain drilling fluids products; and
	•		results from Sup-R-Jar which was acquired during the first quarter of 2008.

     Revenues from our completion and workover related products and services increased by $38.5 million, or approximately 20%, to $230.7 million for the six months ended June 30, 2008 from $192.2 million for the six months ended June 30, 2007. We attribute the increase in revenues in this segment to:

	•		higher demand for our cased-hole wireline services, completion fluid products and coiled tubing services as a result of an overall increase in activity levels;
	•		an increase in our coiled tubing and cased-hole wireline fleets and other capital expenditure investments; and
	•		our onshore geographic expansion.

      Cost of Revenues. Cost of revenues increased by $62.5 million, or approximately 21%, to $355.3 million for the six months ended June 30, 2008 from $292.8 million for the six months ended June 30, 2007. As a percentage of revenues, cost of revenues were 55% and 53% for the six months ended June 30, 2008 and 2007, respectively. The increase in cost of revenues as a percentage of revenues for the six months ended June 30, 2008 as compared to the six months ended June 30, 2007 was due primarily to the decline in domestic offshore utilization of our measurement-while-drilling and logging-while-drilling tools and down-hole drilling motor fleet which has historically earned higher operating margins than our domestic onshore activity. This trend was partially offset for the period by higher profit margins on certain of our drilling fluids products. The margins on certain of these drilling fluids products may decrease as a result of an increase in our product cost.

      Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $8.8 million, or approximately 10%, to $97.0 million for the six months ended June 30, 2008 from $88.2 million for

the six months ended June 30, 2007. The increase was primarily attributable to increased selling costs related to our revenue growth and other personnel compensation costs related to expansion efforts within all of our business lines. As a percentage of revenues, selling, general and administrative expenses decreased to 15% for the six months ended June 30, 2008 from 16% for the six months ended June 30, 2007.

      Transaction Related Costs. Through June 30, 2008, we had incurred approximately $5.4 million in expenses associated with the transactions contemplated by the Merger Agreement, including legal fees and fees payable to UBS Securities LLC (“UBS”) in respect of that firm’s fairness opinion provided to our Board of Directors in connection with the Acquisition transaction. Pursuant to the engagement letter between us and UBS, we will be obligated to pay UBS an additional fee of approximately $22.0 million at the closing of the Acquisition in respect of the financial advisory services provided by UBS to us.

      Research and Development Expenses. Research and development expenses increased by $2.7 million, or approximately 26%, to $12.9 million for the six months ended June 30, 2008 from $10.2 million for the six months ended June 30, 2007. This increase was the result of a higher rate of research and development spending in the 2008 period on PathFinder technologies, including our PathMaker ^® 3-Dimensional Rotary Steerable technology.

      Depreciation and Amortization. Depreciation and amortization increased by $11.3 million, or approximately 31%, to $48.0 million for the six months ended June 30, 2008 from $36.7 million for the six months ended June 30, 2007. This increase was principally the result of a larger depreciable asset base resulting from our capital expenditure investments.

      Interest and Other Expense. Interest and other expense for the six months ended June 30, 2008 was $5.2 million, an increase of $1.4 million, or approximately 37%, from $3.8 million for the six months ended June 30, 2007. This increase was primarily due to higher outstanding borrowings under our credit facility resulting from our acquisitions, capital expenditures and working capital requirements.

      Provision for Income Taxes. Our effective income tax rate for the six months ended June 30, 2008 and 2007 was approximately 37%. Generally, our effective rate varies due to several factors including, but not limited to, fluctuations in income across international tax jurisdictions with varying tax rates.

Recent Accounting Pronouncements

     Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, (“SFAS No. 157”) as it relates to financial assets and financial liabilities. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which delayed the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on at least an annual basis, until January 1, 2009 for calendar year-end entities. Accordingly, we will defer the adoption of SFAS No. 157 for our nonfinancial assets and nonfinancial liabilities until January 1, 2009. The adoption of SFAS No. 157 did not cause a change in the method of calculating fair value of assets or liabilities. The primary impact from adoption was additional disclosures. See Note 6 to Consolidated Financial Statements for more information.

     Effective January 1, 2008, we adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115 , (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure most financial instruments and certain other items at fair value on an instrument-by-instrument basis (the fair value option) with changes in fair value reported in earnings. We adopted SFAS No. 159 on January 1, 2008. We already record our hedging activities at fair value in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , as amended. The adoption of SFAS No. 159 had no impact on our financial statements as we did not elect the fair value option for any other assets and liabilities.

     In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141R”) to change how an entity accounts for the acquisition of a business. SFAS No. 141R carries forward the existing requirements to account for all business combinations using the acquisition method (formerly called the purchase method). In general, SFAS No. 141R will require acquisition-date fair value measurement of identifiable assets acquired, liabilities assumed and non-controlling interests in the acquiree. SFAS No. 141R will eliminate the current cost-based purchase method under SFAS No. 141. The new measurement requirements will result in the recognition of the full amount of acquisition-date goodwill, which includes amounts attributable to non-

controlling interests. The acquirer will recognize in income any gain or loss on the remeasurement to acquisition-date fair value of consideration transferred or of previously acquired equity interests in the acquiree. The direct costs incurred to effect a business combination and the costs the acquirer expects to incur under a plan to restructure an acquired business will be charged to expense when incurred. SFAS No. 141R will also change the accounting for contingent consideration, in process research and development, contingencies, and restructuring costs. In addition, changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination that occur after the measurement period will impact income taxes under SFAS No. 141R. SFAS No. 141R is effective for fiscal years beginning on or after December 15, 2008 and interim periods within those years. We intend to adopt SFAS No. 141R effective January 1, 2009 and apply its provisions prospectively. We currently do not believe that the adoption of SFAS No. 141R will have a significant effect on our financial statements; however, the effect is dependent upon whether we make any future acquisitions and the specific terms of those acquisitions.

     SFAS No. 141R amends the goodwill impairment test requirements in SFAS No. 142. For a goodwill impairment test as of a date after the effective date of SFAS No. 141R, the value of the reporting unit and the amount of implied goodwill, calculated in the second step of the test, will be determined in accordance with the measurement and recognition guidance on accounting for business combinations under SFAS No. 141R. This change could effect the determination of what amount, if any, should be recognized as an impairment loss for goodwill recorded before the effective date of SFAS No. 141R. We have not determined what effect, if any, SFAS No. 141R will have on the results of our goodwill impairment testing subsequent to December 31, 2008.

Liquidity and Capital Resources

     Our primary uses for cash are capital expenditures, working capital, research and development expenditures, and principal and interest payments on indebtedness. Historically, we have also used cash to consummate acquisitions transactions, but we do not expect to complete any such transactions during the pendency of the Acquisition transaction. Our primary sources of liquidity are cash reserves, cash generated by operations and amounts available to be drawn under our revolving credit facility. To the extent our cash requirements exceed our sources of liquidity, we will be required to fund our cash requirements through other means, such as through debt and equity financing activities (although, as discussed under “Part II, Item 1A. Risk Factors”, we are subject to contractual restrictions on our ability to engage in such financing activities) or we will be required to curtail our expenditures.

Cash flow

     Working capital was $335.0 million as of June 30, 2008 and $290.0 million as of December 31, 2007. Net cash provided by operating activities was $77.1 million for the six months ended June 30, 2008 and $45.3 million for the six months ended June 30, 2007. Increased cash provided by operating activities is attributable to higher operating income levels and a decrease in accounts receivable days outstanding for the 2008 period as compared to the 2007 period.

     Net cash used in investing activities was $150.0 million for the six months ended June 30, 2008 and $89.2 million for the six months ended June 30, 2007. The increase in net cash used in investing activities was principally the result of the Sup-R-Jar transaction and increased capital expenditures.

     Net cash provided by financing activities was $80.3 million for the six months ended June 30, 2008 and $28.7 million for the six months ended June 30, 2007. Changes in net cash related to financing activities were principally the result of net borrowings under our credit facility in 2008 to fund the Sup-R-Jar transaction and capital expenditures.

     For the six months ended June 30, 2008, we made capital expenditures, primarily for rental equipment, of $120.0 million, which included expenditures for the replacement of rental equipment damaged or lost down-hole. In addition, we incurred $12.9 million in research and development expenses for the six months ended June 30, 2008.

      Capital resources

      Credit Agreement

     As more fully described in Note 5 to our Consolidated Financial Statements, we maintain a revolving credit facility to provide for our cash, liquidity and other borrowing needs. Such credit facility provides for aggregate borrowings of up to $375.0 million and matures on May 5, 2010. As of June 30, 2008, we had an outstanding loan balance of $225.1 million and approximately $10.5 million in letters of credit issued under our credit facility, resulting in an available borrowing capacity on such date of approximately $139.4 million. We have entered into interest rate swap agreements with a total notional amount of $150.0 million related to our credit facility. Including the effect of the interest rate swap agreements, we were incurring interest at a weighted average rate of approximately 4.9% on our total outstanding borrowings as of June 30, 2008.

     Although the consummation of the Offer would result in an event of default under our revolving credit facility, giving the lenders thereunder the right to accelerate all indebtedness outstanding thereunder, we and Smith intend to repay amounts outstanding and terminate the credit facility contemporaneously with the closing of the Offer.

Future capital requirements

     During the pendency of the Acquisition, we will continue to need to make capital expenditures for tools and rental equipment and make research and development expenditures to maintain and improve the quality of our products and services. We currently estimate that we will make capital expenditures of approximately $190 million during 2008 and will make research and development expenditures of approximately $26.0 million to $27.0 million during 2008. We believe that our internally generated cash flow, combined with access to our credit facility, will be sufficient to meet the liquidity requirements necessary to fund our operations, capital expenditures, research and development and debt service requirements for at least the next 12 months. However, our ability to maintain our credit facility and the sufficiency of our internally generated cash flow can be impacted by economic conditions outside of our control.

      Off balance sheet arrangements

     With the exception of operating leases on real property and automobile leases, we have no off-balance sheet debt or other off-balance sheet financing arrangements.

Item 3.   Quantitative and Qualitative Disclosures about Market Risk

     We are exposed to market risks. Market risk is the potential loss arising from adverse changes in market prices and rates. We have not entered into derivative or other financial instruments for trading or speculative purposes. Our market risk could arise from changes in interest rates and foreign currency exchange rates.

      Interest Rate Risk.   We are subject to market risk exposure related to changes in interest rates. To manage this risk, we have entered into interest rate swap agreements with a total notional amount of $150.0 million related to our credit facility. Under these agreements, we receive interest at a floating rate equal to three-month LIBOR plus the applicable spread under our credit facility and pay interest at a fixed rate of 4.24% plus the applicable spread under our credit facility. Assuming our current level of borrowings and considering the effect of the interest rate swap agreements, a 100 basis point increase in the interest rate we pay under our credit facility would not have had a material impact on our interest expense for the six months ended June 30, 2008.

      Foreign Currency Exchange Risk.   Our earnings and financial position are affected by foreign exchange rate fluctuations. We currently do not hedge against foreign currency translation risks and we believe that foreign currency exchange risk is unlikely to be significant to our operations.

      Stock Price Volatility.   The market price of our stock may be influenced by many factors including variations in our earnings, variations in oil and natural gas prices, the level of exploration, development and production activity of, and the corresponding capital spending by, our customers, investor perceptions of us and other oilfield service companies and the liquidity of the market for our common stock. We believe that the market price of our common stock is significantly impacted by changes in the market price of Smith’s common stock as a result of Smith’s common stock comprising a portion of the consideration in the Acquisition transaction, and we expect this impact to continue during the pendency of the Acquisition transaction.

Item 4.   Controls and Procedures

      Disclosure Controls and Procedures.   We maintain disclosure controls and procedures, which are controls and procedures designed to ensure that the information we are required to disclose in the reports we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based on an evaluation of our disclosure controls and procedures as of the end of the period covered by this report conducted by our management, with the participation of our Chief Executive Officer and Chief Financial Officer, our Chief Executive Officer and Chief Financial Officer believe that these controls and procedures are effective to provide reasonable assurance that we are able to collect, process and disclose the information we are required to disclose in the reports we file with the SEC within the required time periods.

      Internal Control over Financial Reporting.   During the period covered by this report, there were no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

     Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent and/or detect all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.

PART II
OTHER INFORMATION

Item 1. Legal Proceedings.

     On June 9, 2008, an action entitled The Booth Family Trust v. White, et al. , No. 2008-35207, was filed in the 269th Harris County Texas District Court. The plaintiff claims to be one of our shareholders and purports to sue us, the members of our Board of Directors and Smith on behalf of a class of all holders of our common stock other than the defendants and their affiliates. The petition alleges that our directors breached the fiduciary duties of care, loyalty, candor, good faith, independence and fair dealing owed to our shareholders in agreeing to the Offer and the merger described in Note 1 to our Consolidated Financial Statements, and that we and Smith aided and abetted these breaches of duty. The plaintiff claims that the consideration to be paid to our shareholders in connection with the Offer and the merger is unfair and grossly inadequate and did not result from an appropriate consideration of our value or the strategic alternatives available to us. The plaintiff alleges that, following the announcement of the Merger Agreement, our stock has traded over the value of the Offer consideration and that this suggests that the Offer and the merger does not reflect fair value of our common stock. The plaintiff asserts that our directors placed their own interests ahead of those of our shareholders in that the Offer and the merger offers an inadequate premium to the shareholders but will provide substantial personal benefits to the defendants. The plaintiff claims that the termination fee and “no shop” provisions of the Merger Agreement act as a disincentive to other potential bidders and preclude us from taking steps to maximize shareholder value. The plaintiff also alleges that our directors have failed to disclose all material information to our shareholders concerning the Offer and the merger. The petition seeks various forms of injunctive relief including an injunction against the consummation of the Offer and the merger, an order directing our directors to exercise their fiduciary duties to obtain a transaction that is in the best interests of us and our shareholders until the sale of our company is completed and the highest price is obtained, an order rescinding the Offer and the merger if already consummated, the imposition of a constructive trust upon any benefits improperly received by defendants, and an award of attorneys’ and experts’ fees and costs. On July 3, 2008, the plaintiff filed an amended petition further alleging that defendants had purportedly failed to disclose allegedly material information relating to the Offer and the merger.

     On July 10, 2008, the parties entered into a Memorandum of Understanding regarding the settlement of the lawsuit. Under the terms of the proposed settlement, the claims of the named plaintiff and the proposed class of public shareholders will be dismissed and released on behalf of the settlement class. Finalization of the proposed settlement remains subject to several conditions, including court approval and completion of the Offer and the merger. In connection with the proposed settlement, we and Smith have provided additional disclosures in Smith’s

Registration Statement on Form S-4 and our Solicitation/Recommendation Statement on Schedule 14D-9, respectively. The parties also contemplate that plaintiff’s counsel will petition the court for an award of attorneys’ fees and expenses to be paid by defendants, up to an agreed-upon limit.

Item 1A. Risk Factors

     For information regarding risks that may affect our business, see the risk factors included in our most recent Annual Report on Form 10-K under the heading “Risk Factors” and for information regarding the risks associated with Smith’s Offer and the Acquisition transaction, see the risk factors included in Smith’s Registration Statement on Form S-4 under the heading “Risk Factors.” The following are additional factors that could affect our results of operations, cash flows or financial position or could cause actual results to differ materially from estimates contained in our forward-looking statements. We may encounter risks in addition to those described below and in our Annual Report on Form 10-K for the year ended December 31, 2007. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, may also impair or adversely affect our results of operation, cash flows and financial condition.

We are subject to a variety of risks associated with the Acquisition transaction, including risks associated with contractual constraints on our operating flexibility, uncertainties surrounding the transaction, diversion of our management’s attention from our normal operations and similar risks.

     Until the Acquisition transaction has closed, we are subject to provisions of the Merger Agreement with Smith that require us to operate in the ordinary course consistent with our past practices and that prohibit us from taking certain actions, in each case, without the prior approval of Smith. These contractual provisions may prevent us from pursuing otherwise attractive business opportunities and making other changes to our business that may arise prior to completion of the Acquisition transaction. Additionally, uncertainty about the effect of the Acquisition transaction may result in difficulties in retaining and hiring employees and could result in the loss of customers and suppliers. Finally, our management has been required and is expected to continue to be required to devote substantial time and attention to the Acquisition transaction. This diversion of management’s attention from its normal operating responsibilities, the restrictions on our operating flexibility, the potential loss of employees, customers and suppliers and the transaction-related costs that we have incurred and expect to incur could have a material adverse effect on our results of operations, cash flows and financial position.

Item 4.   Submission of Matters to a Vote of Security Holders

     The 2008 annual meeting of the shareholders of the Company was held on May 21, 2007. The purpose of the meeting was to elect members of our Board of Directors.

     At the annual meeting, each of the directors nominated by our Board of Directors to serve a one-year term until the 2009 annual meeting of shareholders was re-elected (there were no broker non-votes):

		For				Withheld
Kenneth T. White, Jr.			26,331,361				813,048
John R. Brock			25,603,370				1,541,039
James D. Lightner			25,608,099				1,536,310
Christopher Mills			19,747,694				7,396,715
Milton L. Scott			24,422,308				2,722,101
Robert H. Whilden, Jr.			26,337,779				806,630

Item 6.   Exhibits

     The documents listed on the Exhibit Index following the signature pages hereto are filed with this Quarterly Report on Form 10-Q, and the contents of such Exhibit Index are hereby incorporated herein by reference.

SIGNATURES

     Pursuant to the requirements 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.

Date: August 8, 2008

Date: August 8, 2008

EXHIBIT INDEX

2.1				Agreement and Plan of Merger dated as of June 3, 2008 among W-H Energy Services, Inc., Smith International, Inc. and Whitehall Acquisition Corp. (incorporated by reference to W-H’s Current Report on Form 8-K filed with the Commission on June 5, 2008).
31.1*		—		Certification of Chief Executive Officer of W-H Energy Services, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*		—		Certification of Chief Financial Officer of W-H Energy Services, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*		—		Certification of Chief Executive Officer of W-H Energy Services, Inc. pursuant 18 U.S.C. Section 1350
32.2*		—		Certification of Chief Financial Officer of W-H Energy Services, Inc. pursuant 18 U.S.C. Section 1350

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