Smith International, Inc. ( ) – a major oilfield services provider – reported financial results for the second quarter 2009 on Jul y27, 2009. Earnings per share, excluding one-time items, came in at $0.15, below our estimate of $0.21 and the Street’s estimate of $0.22. On a year-over-year basis, Smith’s adjusted earnings per share plunged 83.5%, while revenue declined 22.1% to $1.9 billion.

The Houston-based company’s weaker-than-expected results were due to the collapse in North American natural gas drilling activity that has led to lower volumes and a very competitive pricing environment.

Geographic Performance

On a geographic basis, revenue in North America decreased 29.9% year-over-year to $906.1 million. Outside North America, revenue in the Latin American market fell 7.0% to $227.5 million, Europe/Africa revenue was down 21.0% to $510.7 million, while sales in the Middle East/Asia region decreased 3.5% to $300.0 million. Overall, North American sales accounted for 46.6% of the total quarterly revenue, while the other three geographic regions accounted for the rest.

Segment Performance

M-I SWACO

M-I SWACO accounted for 52.1% of total quarterly revenue. The segment’s quarterly revenue totaled $1.0 billion, down 21.2% year-over-year, while operating income, at $121.3 million, decreased 42.9%.

A slowdown in the number of land-based drilling programs operating in the U.S. and a decline in U.S. offshore business levels, which resulted in lower demand for base fluid and environmental product offerings, contributed to the revenue and income decline. The segment results were also adversely impacted by the timing of offshore projects in West Africa and the decline in offshore drilling activity in Mexico.

Smith Oilfield

The Smith Oilfield segment reported second-quarter revenue of $520.5 million (26.8% of total quarterly revenue), down 12.2% year-over-year. Operating income was $47.6 million, down 70.8% over the prior-year period.

The decline was due to lower activity levels in the North American market that impacted demand for tubular products as well as high-margin drill bits, directional services and other drilling-related product offerings. Outside of North America, the segment performance suffered from lower sales volumes in the Middle East and West African markets.

Distribution

The Distribution segment revenue during the quarter totaled $410.8 million (approximately 21.1% of total quarterly revenue), down 33.3% year-over-year. The segment generated an operating loss of $9.8 million, as against an income of $36.5 million in the previous-year quarter.

The decreases were mainly due to lower customer demand and pricing weakness in the U.S. market. The segment’s reported dismal results also reflect the effect of the reduction in U.S. land-based drilling projects.

Balance Sheet

Smith International ended the quarter with cash on hand of $224.2 million and total debt of $2.5 billion (including short-term borrowings of $404.9 billion). The quarter-end total debt-to-capitalization ratio stood at 28.9% (31.3% at the end of last quarter).

Despite the weak operational results, we are maintaining our Buy recommendation on Smith International shares, reflecting the company’s strong cash flow, low capital needs and diverse product portfolio with a growing international presence.

Looking forward, we believe that the likelihood of economic recovery in 2010 is strong, which will improve demand for Smith’s products and services.