Smith International, Inc. Reports Third Quarter Results

Smith International, Inc. (NYSE: SII) today announced third quarter income from continuing operations of $14.8 million, or $0.07 per diluted share, excluding $7.8 million of after-tax charges related to employee severance. Reported net income in the third quarter of 2009 totaled $7.0 million, or $0.03 cents per diluted share, on revenue of $1.88 billion. In the comparable prior-year period, earnings from continuing operations, net of charges, were $211.9 million on revenue of $2.85 billion, while second quarter 2009 earnings from continuing operations, net of charges, were $32.1 million on revenue of $1.94 billion.

The Company’s third quarter results were primarily influenced by unfavorable economic fundamentals in the North American natural gas market that contributed to continued pricing pressure within the U.S. operations of the Distribution and Smith Oilfield segments. Line pipe, drilling-related tubular offerings, as well as fishing and remedial services were particularly affected during the quarter. The modest seasonal recovery of drilling activity in Canada, sequential quarter revenue growth in Latin America and the solid performance of M-I SWACO were not sufficient to mitigate the revenue and margin deterioration experienced during the third quarter of 2009.

Consolidated revenue declined $65.3 million, or three percent, from the second quarter of 2009. Approximately 90 percent of the sequential revenue decline was concentrated in the United States influenced in large part by lower pricing, decreased customer spending and significantly reduced offshore activity. Outside the U.S. market, revenue levels were essentially flat as compared to the June 2009 quarter, with the impact of lower offshore drilling activity levels in the Eastern Hemisphere partially offset by the seasonal improvement in Canadian drilling following the spring breakup.

Commenting on the results, Chief Executive Officer, John Yearwood stated, “Our operating results for the third quarter reflected a challenging U.S. environment but displayed signs of stabilization towards the end of the quarter. M-I SWACO continued its remarkable success in deepwater contract awards, winning approximately 75 percent of the total fluids contract values awarded over the first three quarters of 2009. Due to strong customer demand and excellent drilling results, our PathFinder business continued to execute on its planned international expansion. Directional drilling, measurement-while-drilling and logging-while-drilling service revenue grew at a double digit percentage, exceeding the growth rate of the U.S. non-vertical rig count.

We continued our actions during the past quarter to control costs and improve longer-term profitability, including personnel reductions of five percent in the United States, increased focus on improving supply chain and manufacturing efficiencies, and expansion of our business outside of North America. Moreover, we kept our manufacturing facilities operating below full capacity in line with our inventory reduction goals. We believe all of these actions will benefit our financial performance in 2010 and beyond.

We anticipate a more favorable industry environment during 2010 with increased activity as compared to current levels. We expect M-I SWACO revenue to grow, both domestically and internationally, driven by an increase in deepwater rigs and commercialization of new technologies. The Smith Oilfield segment should benefit as PathFinder continues to gain ground, with expected higher growth rates than what we achieved during the third quarter of 2009. The success of our Drilling Optimization offering should help us pull through incremental revenue for the other drilling-related business lines. Distribution’s revenue performance in 2010 will depend on demand for infrastructure and economic recovery in the United States. Even at current activity levels, we anticipate significant improvement in our Distribution segment results starting next year.”

William Restrepo, Chief Financial Officer, added, “The weak U.S. market continued to drive sequential declines in operating income. Our oilfield-related margins for the quarter fell sequentially by 100 basis points, resulting in decremental margins of 55 percent. While the profitability of our M-I SWACO operations provided stability to our operating income, unfavorable mix and falling prices in the United States negatively impacted our overall oilfield-related margins. Within the Distribution segment, operating income was influenced by the bulk line pipe activity, which accounted for approximately 10 percent of the segment’s revenue, but 65 percent of the operating loss during the current quarter. Our sustained efforts to reduce working capital contributed approximately $130 million to free cash generation, mainly through consumption of inventory. A portion of our excess cash was used to repay $84 million in outstanding debt, reducing our leverage ratio to 28.1 percent at the end of the quarter and our net leverage ratio to 25.6 percent. Our net debt as of September 30, 2009 was $2.1 billion.”

Segment Results:

M-I SWACO’s third quarter 2009 revenue totaled $994.6 million, down two percent on a sequential basis and 27 percent below the prior year period. The sequential quarter revenue decline was primarily driven by a six percent reduction in the global offshore rig count and reduced customer activity levels in the Eastern Hemisphere. Revenue in the Western Hemisphere rose five percent sequentially, reflecting the effect of the land-based seasonal recovery in Canada and higher activity in Latin America.

The Smith Oilfield segment reported revenue of $505.9 million, a decline of three percent from the June 2009 period and 30 percent below the comparable prior-year period. The sequential revenue decrease was concentrated in the U.S. market, influenced by a 26 percent reduction in tubular product revenue as well as lower demand for the segment’s fishing and remedial related product and service offerings. The sequential revenue comparison within the United States also reflects the effect of increased competitive pricing pressures. Smith Oilfield revenue outside the United States rose eight percent driven primarily by the Eastern Hemisphere and by the seasonal recovery in Canadian drilling activity.

Distribution segment revenue totaled $378.5 million in the third quarter of 2009, eight percent below the prior quarter and down 50 percent on the comparable prior-year quarter. The decline in revenue from the second quarter of 2009 came primarily from the energy sector, reflecting continued weakness in North American completion activity that resulted in reduced capital project spending for maintenance, repair and operating (“MRO”) supplies. The effect of market-driven pricing declines on line pipe sales were partially offset by higher volume levels.

Smith International, Inc. is one of the largest global providers of products and services used by operators during the drilling, completion and production phases of oil and natural gas development activities. The Company will host a conference call today beginning at 10:00 a.m. Central to review the quarterly results. Participants may join the conference call by dialing +1-800-233-1182 or +1-847-413-2447 for international calls, and requesting the Smith International, Inc. call hosted by John Yearwood. A replay of the conference call will also be available through Thursday, November 5, 2009, by dialing +1-888-843-8996 and entering conference call identification number “25526864”.

Certain comments contained in this news release and today’s scheduled conference call concerning among other things, our outlook, financial projections and business strategies of the Company constitute “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Whenever possible, the Company has identified these forward-looking statements by words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “project,” “should” and similar terms. The forward-looking statements are based upon management’s expectations and beliefs and, although these statements are based upon reasonable assumptions, actual results might differ materially from expected results due to a variety of factors including, but not limited to, overall demand for and pricing of the Company’s products and services, general economic and business conditions, the level of oil and natural gas exploration and development activities, global economic growth and activity, political stability of oil-producing countries, finding and development costs of operations, decline and depletion rates for oil and natural gas wells, seasonal weather conditions, industry conditions, and changes in laws or regulations, many of which are beyond the control of the Company. The Company assumes no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. For a discussion of additional risks and uncertainties that could impact the Company’s results, review the Smith International, Inc. Annual Report on Form 10-K for the year ended December 31, 2008 and other filings of the Company with the Securities and Exchange Commission.

Non-GAAP Financial Measures. The Company reports its financial results in accordance with generally accepted accounting principles (“GAAP”). However, management believes that certain non-GAAP performance measures and ratios utilized for internal analysis provide financial statement users meaningful comparisons between current and prior period results, as well as important information regarding performance trends. Certain information discussed in this press release and in the scheduled conference call could be considered non-GAAP measures. See the Supplementary Data – Schedule III in this release for the corresponding reconciliations to GAAP financial measures for the three-month periods ended September 30, 2009 and 2008 and June 30, 2009, and the nine-month periods ended September 30, 2009 and 2008. Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, the Company's reported results.

Financial highlights follow:

NOTE (a): Noncontrolling interests in consolidated subsidiaries (formerly referred to as minority interests) is now reflected as a component of stockholders’ equity.

NOTE (b): During 2008, the Company revised its segment reporting in connection with the inclusion of the W-H Energy Services operations to reflect three segments: M-I SWACO, Smith Oilfield and Distribution. In connection with this change, the Company no longer allocates corporate costs to the operating segments. All periods shown have been recast to conform to the current segment reporting structure.

NOTE (c): The Company derives a significant portion of its revenue and earnings from M-I SWACO and other majority-owned operations. Consolidated operating income, depreciation and amortization and capital spending amounts have been separated between the Company’s portion and the noncontrolling interests’ portion in order to aid in analyzing the Company’s financial results.

NOTE (d): Net capital spending reflects the impact of proceeds from lost-in-hole and fixed asset equipment sales.

NOTE: Management believes that it is important to highlight certain charges included within operating income to assist financial statement users with comparisons between current and prior period results. During the three-month periods ended September 30, 2009 and June 30, 2009, the Company incurred severance-related costs of approximately $13.0 million and $12.5 million, respectively, primarily reflecting reductions in North American personnel levels. The three-month period ended June 30, 2009 also included other charges of $0.5 million, associated with facility closures. For the three-month and nine-month periods ended September 30, 2008, the Company incurred hurricane-related charges of $4.0 million.