Core Laboratories N.V.
Q1 2014 Earnings Call Transcript

Published: 24 Apr 2014

[Operator:]

Good morning, my name is Tasha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Core Lab Q1 2014 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. Mr. Demshur, you may begin your conference.

[David Demshur:]

Well, thank you, Tasha. I would like to say good morning to everybody in North America, good afternoon to all those in Europe, and good evening to the listeners in Asia Pacific. We’d like to welcome all of our shareholders, analysts, and most importantly our employees, to Core Laboratories’ First Quarter 2014 Earnings Conference Call. This morning I am joined by Dick Bergmark, Core’s Executive Vice President and CFO; and Core’s COO, Monty Davis, who will present the detailed operational review. Also this morning, I have the pleasure once again of introducing Chris Hill to the new participants. He will be helping Dick and me with our investor relations efforts. Chris has been with Core Labs for over seven years, most recently as our Global Corporate Controller, located in the Netherlands. Prior to joining Core Lab, he worked at E&Y for eight years and Halliburton for six. Many of you have already met Chris at our investor conferences, and I know he looks forward to working with you and meeting more of you in the future. The call will be divided into five segments. Chris will start by making remarks regarding forward-looking statements. Then we’ll come back and give a brief investor update and highlight the three financial tenets by which Core’s Executive Management team executes the company’s growth strategies. We believe these three tenets have produced industry-leading shareholder returns and returns on invested capital. We will also discuss Core’s long-held philosophy of returning excess capital back to our shareholders. Then Dick will follow with a detailed financial overview, and additional comments regarding building shareholder value, Core’s second quarter 2014 outlook, and a general industry outlook as it pertains to Core’s continued growth prospects in 2014. This outlook confirms our confidence in the trends of increasing activities internationally, and deepwater and projects tied to large complex crude oil developments, also unconventional tight-oil reservoirs in North America and emerging plays in Russia, North Africa, Australia amongst others. Core also sees exceptional opportunities in the deepwater Gulf of Mexico developments including the potentially prolific but technologically challenging lower tertiary fields. Then Monty will go over Core’s three operating segments, detailing our progress and discussing the continued successful introduction of new Core Lab technologies that we believe will be descriptive, and are tied to completing, stimulating, and producing horizontal wells, and then highlighting some of Core’s operations and major projects worldwide. Then we’ll open the phones for a Q&A session. I’ll turn it over to Chris for remarks regarding forward-looking statements. Chris?

[Chris Hill:]

Thanks Dave. Before we start the conference this morning, I’ll mention that some of the statements that we make during this call include projections, estimates, and other forward-looking information. This would include any discussion of the company’s business outlook. These types of forward-looking statements are subject to a number of risks and uncertainties related to the oil and gas industry, business conditions, international markets, international political climate, and other factors, including those discussed in our ‘34 Act filings that may affect our outcome. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. For more detailed discussion of some of our foregoing risks and uncertainties, see item 1A, Risk Factors, in our Annual Report on form 10-K for the fiscal year ended December 31, 2013, as well as other reports and registration statements filed by us with the SEC and the AFM. Our comments include non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures is included in the press release announcing our first quarter results. Those non-GAAP measures can also be found on our website. With that said, I’ll pass the discussion back to Dave.

[David Demshur:]

Okay, thanks Chris. I’d like to give a brief investor update. Core’s operations produced the company’s most profitable first quarter ever in the history of the company. We continued to benefit from our continued focus on international and deepwater activities and unconventional oil plays in response to seemingly high oil prices and dwindling global spare capacity. The focus on crude oil related projects continued to build as Core’s revenue mix now is more than 80% oil related and less than 20% natural gas related. Moreover, most of the natural gas related projects emanate from the international theater and are LNG-related, with major projects in the Eastern Mediterranean, East Africa and Western Australia. Core is also deeply involved with several natural gas projects in the Middle East with these countries looking to replace the use of crude oil with natural gas for power generation and to run their desalination plants. Reviewing the company’s first quarter results reveals Core’s growth strategy of progressively working in more established and new field developments, while continue to offer new technologies and services will lead revenue growth of 200 to 400 basis points higher than the increase in worldwide activity levels. Year-over-year quarterly revenue and operating profit growth for the first quarter of 2014, in spite of weather disruptions, is testament to the validity and robustness of the company’s growth strategy and are underpinned by operational excellence. We believe these trends to outperform market activity levels to hold and we are optimistic for North America and international growth trends for the remainder of 2014. Therefore, our growth strategy and the execution by our operating units continue to serve our clients, our employees and our shareholders well. Core’s continued focus on high return international crude oil-related developments, especially those in deepwater environments, unconventional oil resource plays, and the continued internal development of new technologies and services has led to multiple years of sustained growth and increased profitability. We are not complacent on technological innovation as indicated by Core’s recent introduction of our FLOWPROFILER technologies. These technologies are being applied to increase daily hydrocarbon production rates and increase the estimated ultimate recovery rates, not only in tight-oil reservoirs but conventional reservoirs worldwide. Turning to Core Lab’s performance. Core has always followed and will continue to follow three key investment tenets that has led to industry leading returns. These three important tenets, which now starting to receive attention from the other companies and analysts in our oilfield services sector are

[Dick Bergmark:]

Thank you, David. Similar to other oil service companies with exposure to North America and Northern Europe who have reported this earnings season, we too experienced weather and project delays. And while ours was less than most, it nonetheless impacted our results. These issues understandably caused our revenue to fall below our prior guidance, which based on our analysis impacted our EPS this quarter by 5% or about $0.07 per share. We do believe that much of the work will be regained later this year rather than just being pushed out. Our increased quarterly guidance is reflective of that view. Please see our reconciliation tables at the end of our earnings release for our non-GAAP information. Within the first quarter by month, we saw the impact of the weather and project delays roll out during the quarter as one would expect, with February being our slowest month, as the weather had the greatest impact during that month. Further, that also seem to be the period of greatest introspection by the IOCs and NOCs regarding their deepwater and other international projects, all of which appears to have been short-lived in duration, as we saw a return to more normal activities in March, with this particular March being one of our best recorded. So we believe the transitory issues felt by the industry are truly temporary in nature, and are pleased with the return to more expected levels which we experienced in March. All that being said, we delivered solid execution in the quarter, which drove the expansion of not only our operating margins, but also our return on invested capital. And we expect to see this trend continue throughout the remainder of the year. Now, looking at the income statement, revenues were $262.9 million in the first quarter versus $260.9 million in the first quarter of last year. Revenues up about 1% year-over-year, in spite of the weather issues felt by the other oil service companies in the quarter. Notwithstanding that, our results reflect an all-time record revenue for first quarter. Of these revenues, services for the quarter, $188.7 million, up about 3% when compared to $182.5 million last year or an increase of about $6 million. Product sales for the quarter were $74.2 million, down primarily due to weather conditions when compared to $78.4 million in last year’s first quarter. Although revenues were depressed, our cost structure management enabled us to show improving margins. For example, our cost of services for the quarter were 58.6% of revenue, an improvement from the 60.4% in last year’s first quarter. And our cost of product sales were 68.9% of revenues, just slightly higher than the 68.2% reported in last year’s first quarter, due to the absorption of fixed costs on weather-related lower revenue in the current quarter. G&A for the quarter was $10.5 million, which runs about 4% of revenue and it’s down slightly from last year, primarily due to decreases in compensation costs. We expect G&A to be in the low $50 million in 2014. Depreciation and amortization for the quarter, $6.6 million, up slightly from $6 million in the last year’s first quarter as a result of growth in our client directed CapEx program. We expect depreciation in 2014 to total approximately $27 million. Other expense of $1.3 million this quarter included foreign exchange losses of $1.6 million. The guidance we gave on our last call for this quarter, specifically excluded the impact of any FX gains or losses. So accordingly, our discussion today excludes the impact of this FX translation. So excluding our FX losses to conform to our guidance, places EBIT for the quarter at $84.4 million, which is up $5.4 million or 6.8% year-over-year, which generated margins of 32.1%, an increase of 180 basis points over the 30.3% margins earned in last year’s first quarter. This increase in margin was greater than expected and should be positive to our business outlook. This EBIT represents a record for any first quarter. GAAP EBIT was $82.8 million, which is up $3.8 million or 4.8% year-over-year. Interest expense was $2.4 million for the quarter, similar to last year. Income tax expense for the quarter was $19 million based upon an effective tax rate of 24%. We continue to expect our full year 2014 annual effective tax rates to be approximately 24%. Net income ex-FX for the quarter was $62.3 million compared to $56.5 million in last year’s first quarter, so an increase of over 10%. Earnings per share for the quarter was $1.45 on the same basis that our guidance was given by excluding FX, but also weather and project delays. Our EPS is up year-over-year by $0.23 or almost 19% excluding those items. GAAP EPS was up by $0.13 or 11%. And this represents record EPS for any first quarter. Now going over to the balance sheet, cash was $23.3 million compared to the prior year-end balance of $25.1 million. Receivables stood at $209.2 million, up slightly from the year-end. And the inventory was also up slightly from the year-end at $50.9 million. Our inventory increased as weather conditions impacted our clients’ completion activities. Other current assets were $35.1 million, up from the year-end balance of $30.6 million, for the most part as a result of an increase in income tax pre-payments of $3.7 million reflecting the timing difference between when statutory tax payments are required to be made to the various tax offices and a corresponding current tax provision recorded under GAAP rules for our financial statements. PP&E was $141.8 million, up from the year-end balance of $138.8 million, due to continuing investments on our part on our business assets. There were no material changes in intangibles, goodwill and other long-term assets. On the liability side of the balance sheet, accounts payable for the quarter were $53.7 million, up slightly from last quarter end and other current liabilities for the quarter were $94.7 million, up from $84.9 million, primarily due to an increase in unearned revenue of $6.6 million, relating to some reservoir management consortium studies, where we have received cash from the clients but have not yet recognized revenue. Our long-term debt stood at $279 million compared to $267 million last quarter. And this comprised of $150 million in senior notes and a $129 million drawn on our bank revolving credit facility. As of today, those drawings under the credit facility are $130 million. Other long-term liabilities ended at $86 million, a decrease of $2.9 million over the previous year and due in part due to decrease in deferred tax liability. Shareholders’ equity ended the quarter at $166.9 million and its down slightly from the year-end, primarily due to additions from earnings being offset by share repurchases and dividends. Using annualized net income for the first quarter, our return on equity was over 155%, making it one of the highest returns earned in the industry. Capital expenditures for the quarter were $7.7 million, and we expect our CapEx program in 2014 to be approximately $37 million, as a result of an expected continued improvement in industry activity, particularly in the markets where we operate. Our CapEx growth is client directed for the most part, meaning that we will increase our capacity for locations or for increases in technology on the basis of discussions with clients about their specific needs. And that’s one of the reasons why we’ve been able to generate our high returns on invested capital. Looking at cash flow. Cash from operating activities in the quarter was $65.6 million. And after paying for our $7.7 million in CapEx, our free cash flow was $58 million. In the first three months of 2014, as David mentioned, we turned 22% of our revenues into free cash flow and that’s one of the highest cash conversion rates in our industry. During the quarter, we used our free cash flow and cash balances to pay $22.5 million in quarterly cash dividends and repurchased 254,340 shares for $46.8 million, which had a VWAP of $184.40 per share. Our use of cash continues to be designed to enhance shareholder value. Free cash flow generation such as this gives companies like Core Lab significant optionality to enhance shareholder value. An recent example of that is the dividend increase of 56% for the dividend paid in the first quarter of this year compared to our dividends last year. Now let’s review our second quarter and full year 2014 guidance. We anticipate a continuation of the improving trend experienced in the later part of the first quarter which began in March. Since that time, North American activity and that in the international arena have increased as well. We believe that second quarter 2014 North America activity levels will continue to ramp up from the weather affected first quarter levels, which will drive our expected earnings higher than previous implied guidance based on our prior full year 2014 outlook. Therefore, we expect second quarter revenue to range between $280 million and $286 million, which would be up about 8% year-over-year. Using the range of revenue guidance and applying approximately 35% to 40% sequential incremental margins, second quarter 2014 EPS guidance would range from $1.48 to $1.53, which would be up over 14% year-over-year. Free cash flow in the quarter is expected to be approximately $70 million, once again exceeding net income for the period. This operational guidance excludes foreign currency translations or any shares that maybe repurchased in the second quarter. A 24% effective tax rate is assumed for the quarter. Based on the anticipated increases in worldwide activity levels, we believe that full year 2014 revenue will range between approximately $1,155,000,000 and $1,175,000,000, up 8% year-over-year, with full year EPS ranging from approximately $6 to $6.25, up 15% year-over-year. Operating income margins are expected to expand to 33%, increasing approximately 200 basis points over 2013 levels. We expect free cash flow to exceed $300 million in 2014 with our client directed CapEx program to be slightly greater than in 2013 and to be more than offset by improvements in working capital efficiencies. Now with the guidance taken care of, let’s turn the discussion over to Monty, who will have a more detailed operational review.

[Monty Davis:]

Thanks, Dick. Quarter one 2014 was our most profitable first quarter in company’s history. I want to thank our employees for their contributions to setting into the record. First quarter revenue of $263 million shows growth of 1% over Q1 2013 despite the setbacks in North America and North Sea due to severe weather. Operating earnings excluding FX losses grew 6.8% and generated margins of 32.1%, up 180 basis points over Q1 2013. Reservoir description revenues were only slightly improved over Q1 2013 due to weather impacts, but we were able to grow operational earnings excluding FX by 2% to yield margins of 28.2%, up 40 basis points over Q1 2013. Our reservoir description labs in the Middle East are currently performing a large sampling and compositional analysis project in Kuwait. Project is being performed as part of a large scale pilot project, monitoring the effect on reservoir fluids during steam injection. The project includes compositional analysis of pressurized gases and liquids, and includes trace contaminant analysis. In addition, we are performing simulated distillation and detailed hydrocarbon analysis on liquid samples to determine optimum refining methods and economic values of the production. Continuing with the Middle East, we are working with oil companies in Abu Dhabi to assess undeveloped, unconventional reservoirs conducing geochemical analysis, X-ray diffraction, mineralogy, and thin section analysis to determine the potential of these fields and the best exploitation methods. Our reservoir description fluids labs in the U.S. are conducting several high pressure enhanced or recovery analysis for ultra deepwater Gulf of Mexico projects in pressures up to 21,500 psi, which includes the determination of minimum miscibility pressures, physical measurements of fluids after they are contacted with injection gases and thermodynamic testing for reservoir simulation models. These fluids are also tested to ensure production deposition and formation damage does not occur using Core Lab’s proprietary pressurized fluid imaging system, providing complete high pressure EOR and flow assurance testing in our labs. EOR work is also ongoing in the Continental U.S. where secondary and tertiary recovery in liquid rich shale basins and more mature oilfields will be necessarily for these basins to reach their full production potential. Work is currently ongoing in the Eagle Ford, Permian and parodies basins. Core Lab’s mobile laboratories are providing essential real-time sample quality and key fluid property parameters for the deepwater and ultra deepwater drilling programs to our clients. Data is provided within hours instead of days. Properties that can be determined onsite by mobile laboratory analysis include, gas oil ratio, hydrocarbon sulfide content, oil base, drilling contamination – mud contaminations, fluid compositions and pressurized viscosities which allow operators to make decisions as to the commercial viability of their reservoirs. In our Midland Texas lab, recently received compliment from a key client. And I quote, on behalf of my company, I just wanted to thank you and the Core Lab Midland staff for an outstanding job on our Woodford core. I know you and others paid considerable amount of time of your time working on our core and we greatly appreciate your efforts. It is people like you that keep Core Lab the premium core analysis company it is. And that’s the end of that quote. Production enhancement revenues for Q1 grew 2.7% despite the series of severe weather setbacks. As has been reported, that Bakken well completions were down 50% in January and February compared to 2013. Operating earnings excluding FX grew 11.4%, and margins improved to 34.6%, an increase of some 270 basis points over Q1 2013. Our patented FLOWPROFILER service continued its growth trend in the first quarter. First quarter growth was predominantly from increased activity in the Permian basin. Adoption of this new service continues to be strong. Full value has yet to be recognized, and new applications are still in development. We are field testing new tracers and expect them to add to our offerings sometime in the second quarter. Our recently introduced PT 3D software is making it easier for our clients to evaluate the FLOWPROFILER data which makes it easier for them to determine optimal well placement and stimulation design. PT 3D, our new three-dimensional software was unveiled in the first quarter to help our clients interpret inner well communication using our Spectrochem and FLOWPROFILER data. This has been utilized in the Bakken, Niobrara and West Texas fields. It is still in development but is being very well received. In two separate offshore completions for two different customers, our SPECTRASTIM and PACKSCAN services identified serious problems with the gravel pack sand control completions. Our diagnostic services allowed both customers to remediate the problems prior to bringing the wells on production, saving potentially hundreds of millions of dollars in damages. Reservoir management operating earnings excluding FX grew 7.2% over Q1 2013, and generated margins of 38.6%, an improvement of 370 basis points over Q1 2013. In Q1, reservoir management initiated two new joint-industry unconventional projects. The first, Eaglebine Play Reservoir Characterization and Production Properties is an extension of our highly successful South Texas Eagle Ford project and is focused on the Eagle Ford shale extension into East Texas and the overlying Woodbine sandstones. Most of the operators in that play have joined the project. Second project is focused on the liquids window of the Woodford Shale in the Permian basin and Oklahoma. This project is designed to evaluate prospectivity of the Woodford in areas not currently being exploited by operators. In the quarter, we also added members to our Permian Basin projects, bringing the total number of participating companies to 66. Internationally, reservoir management has continued to focus on West and East Africa exploration projects. We completed the second phase of our Tanzania project and Uganda Study, culminating in workshops and seminars for the member companies. We also initiated new projects in Mozambique and Senegal. These studies are directed at providing data sets consisting of biostratigraphy, geology, reservoir quality, petrophysical properties and seal evaluations with ties to seismic data for companies exploiting the deepwater. We recently completed the successful deployment of 110 of our patented CT-MORE monitoring systems for the Husky’s Sunrise Thermal Project. Located near Fort McMurray, Alberta, Sunrise is considered a world class reservoir with estimated reserves of 3.7 billion barrels of bitumen and production is anticipated over a 40-plus year lifespan. Sunrise will use in-situ steam-assisted gravity drainage technology to recovery the bitumen with minimal surface land disturbance. Steam injection into the reservoir heats the bitumen so it moves more easily allowing it to be pumped to the surface. Our high temperate ERD pressure and temperature sensors will provide the data required to assist engineers to optimize injection rates and maximize the production. Despite the severe weather setbacks in the first quarter, we remain optimistic for 2014. Activities in the major U.S. unconventional plays will be robust. In addition, we expect to see very strong activity in deepwater Gulf of Mexico and off both coast of Africa, throughout the Middle East and in most markets in Asia Pacific for the remainder of 2014. Tasha, we will now open the call for questions.

[Operator:]

(Operator Instructions) One moment for the first question. And it comes from the line of Rob MacKenzie.

[Rob MacKenzie:]

Good morning guys.

[David Demshur:]

Hi Rob.

[Rob MacKenzie:]

Dick or David I guess, I wonder if you could give us a feeling for how the disruptions in terms of weather and project delays came upon you in the quarter, and also if you will, the relative size? I guess I am a bit surprised that when you gave guidance in January that they weren’t apparent at that time given most people said January was the worst month in the quarter.

[Dick Bergmark:]

Hi Rob, when we looked at our business activities, it did begin to show evidence in February. And you’re right. We gave guidance I think on January 30. Actually go to your temperature chart, you’ll see that February was the worst month. So we saw the lowest activity levels in February having dropped from January, but importantly, we see that recovery in March. And as I mentioned in my prepared comments, that was one of our best March as recorded ever. So unfortunately the impact was after our guidance, but now we see the recovery and view as transitory as we had mentioned.

[Rob MacKenzie:]

Great. Thanks. And I guess as part of that, the margin performance was quite positive in the quarter given the revenue shortfall. Can you give us some more color in terms of how that was delivered?

[Dick Bergmark:]

Yes, I think when you look at our incremental cost to deliver services, particularly if we have our staff fully employed and onsite, our costs are fixed, so we did not experienced incremental margins as a result of the lower revenue. So I think the operating guys did a super job of containing our costs during that downtown period.

[Rob MacKenzie:]

Great. Thank you. That’s my two questions.

[Operator:]

Your next question comes from the line of Kurt Hallead.

[Kurt Hallead:]

Hi good morning.

[David Demshur:]

Good morning, Kurt.

[Kurt Hallead:]

I was wondering if you could give us a little more color on what’s happening out there with these deepwater project delays, and is there some light at the end of the tunnel that these projects are going to start to move forward perhaps this year.

[David Demshur:]

Yes, Kurt. We have mentioned this over the last several quarters that we were disappointed in the amount of delay to some of these projects owing to redesign of some of the production facilities. You can point to West Africa, deepwater Gulf of Mexico as classic areas. We saw the good news from Total and the Kaombo on the Block 32 ultra deepwater, Angola. We think we will see the initiation of more of those start to take place. If you look at the redesign of some of these surface facilities and development cost, one project in the Gulf of Mexico in the deepwater tertiary area, the development costs have been lowered by over $5 billion. So with these plans now in place, we ought to see a number of projects get initiated later this year that we would have thought would have been going or are actually starting up at the end of the first quarter and certainly be robust in the first quarter. So as we look at the deepwater, it is still significant to Core Lab. These developments will occur. We look at just the redesign of some of these making these projects back into the very economical for the major companies developing those.

[Kurt Hallead:]

Thanks, Dave. So just as a follow-up to that, I guess a two-parter on my question number two. But the dynamic here, is there now a template set before these major oil companies that they can push forward on these projects without additional delays on other projects? And the second part of that dynamic is, can you help – at least help me understand how Core Labs is impacted, because my understanding on most of these project delays, they are capital costs related and the services that you provide help them understand where they can ultimately get out of the reservoir. So before they can go through their whole cost analysis, they need to kind of utilize what you guys have. So what am I missing?

[David Demshur:]

Yes, on the part A, I believe that all these offshore developments are going to be regional in nature and so if a template could be put in place, one would be put in place let’s say for the deepwater tertiary developments in the Gulf of Mexico. The template would be different in West Africa. But yes indeed, those are going in the place, and I think the design programs and specifications will be actually sped up. With respect to how delay in these projects affect us. We figured by now we would have very robust deepwater reservoir fluid projects going on. Monty referred to a couple of those. We referred to one or a couple of them in the release. If you looked at the amount of fluids work we did from the deepwater, we expected much more to occur in Q1. We expect to see that now starting in Q2 and in Q3. So when these projects are rolling out, there is always incremental rock to look, at but more importantly more and more deepwater fluids when they’re trying to determine what’s the best way, to not only maximize daily rates, but their ultimate recovery from those reservoirs. So it’s just ongoing work that would have been pushed out.

[Kurt Hallead:]

Okay. Thanks for that color. Appreciate it.

[David Demshur:]

All right, Kurt.

[Operator:]

Your next question comes from the line of Byron Pope.

[Byron Pope:]

Good morning guys.

[David Demshur:]

Good morning, Byron.

[Byron Pope:]

Had a question on your development of mobile offshore reservoir fluids labs. It’s intriguing. So I guess my question related to that is, are you seeing an industry trend or customer preference towards more real-time analysis of the reservoir fluids in the deepwater and ultra deepwater applications?

[David Demshur:]

Yes, Byron we look at – for instance the deepwater Gulf of Mexico. If you remember back a number of years ago, we were looking at building cylinders that could withstand pressures up to 30,000 psi. At that time, I think a lot of people thought maybe we were off our rockers, but indeed we are now approaching those pressures. If we can measure some of those properties offshore and real-time decisions can be made about a well-bore or treatment for a well-bore, that is going to save spread cost of several days. If you look at the spread cost, it’s somewhere between $1 million and $1.2 million per day. So we’ve had demands for more and more, well-site fluid analysis, especially those at ultra high pressures and temperatures.

[Byron Pope:]

Okay. And it sounds like some of these mobile labs have already been deployment, and if so, I’m assuming you are focusing on the deepwater Golden Triangle?

[David Demshur:]

That is correct. Most of them right now are in the deepwater Gulf of Mexico, but we will see that technology exported to the other two points of the Triangle over the couple of years.

[Byron Pope:]

Okay. And then just a second question for me. Your production enhancement services revenue, you said had phenomenal growth over the past couple of years, kind of 25% to 30% annual growth. And given that your C&P [ph] effort, you seem to be migrating towards what you’ll have been recommending which is kind of closer well clusters and what not. I guess my question is what have been the drivers of that robust growth on the production enhancement services side? And it would seem as though you guys would be setting up for fairly robust growth again in 2014 just given North America activity levels?

[David Demshur:]

Yes, very good points there, Byron. Essentially this FLOWPROFILER service has enabled us to see how each individual stage is actually flowing or not flowing. That coupled with rock analysis, we can determine how much of the reservoir that we’re effectively draining with these stages. We now know that we need additional stages to drain that reservoir. So we’re going to ask for again longer laterals and stages that are even closer together to effectively drain that reservoir. Also the technology we mentioned in the release owing to deepwater developments, when we look at some of these lower tertiary reservoirs, they are friable in nature. And so when we flow from these reservoirs, we know that we are mobilizing sand grains that are braces [ph]. And the combination of these technologies in this deepwater is enabling us to ensure that the operators have robust gravel packs in place when they begin their multiyear production. So the combination of all of those you’re right on, that is setting up for robust growth. With respect to this quarter, being that they are more closely tied to the development of unconventional reservoirs, they were indeed – their revenue stream was affected the most. Essentially as Monty talked about, if you look at the number of well completions in the Bakken during the first part of this year, they were down 50% year-over-year. A well has to be completed and stimulated for our production enhancement group to realize revenue. So as we get back to normality and even more stages, it should set up for robust growth going forward.

[Byron Pope:]

Great. Very helpful. Thanks guys.

[David Demshur:]

Okay, Byron.

[Operator:]

Your next question comes from the line of Jim Crandell.

[Jim Crandell:]

Good morning.

[David Demshur:]

Good morning, Jim.

[Jim Crandell:]

Dave what – you’ve had such success with your new products and your production enhancement business. And it’s been such a flow of them. It’s almost difficult to keep track of. But what percentage of that business would you say is coming from new products introduced in the past, let’s just say three years?

[David Demshur:]

I would say 70% of the revenue is coming from new products over the last three years. And Jim, I would say over the last five years, probably closer to 90%.

[Dick Bergmark:]

Particularly when you think that most of these – not most, many of them are evolutions of existing ones, no improvements. So as an example in the product line, our HERO line of charges which you know is our load of recharge that we’ve improved multiple times, it now represents two-thirds of all charges that we make. So it’s really done a superb job of just the supplanting old lower margin technology.

[Jim Crandell:]

And in that business guys, what percentage roughly of that business would you say is shale-related of the entire production enhancement business?

[David Demshur:]

Related to the development of shales?

[Jim Crandell:]

Yes. Used in horizontal drilling in the shale versus deepwater or versus other applications?

[David Demshur:]

Yes, unconventional reservoir is probably about 70%.

[Jim Crandell:]

About 70% from unconventional. Okay. And once you get up to the margin territory that you’re in there, it becomes extremely difficult to increase margins, but I assume that as you – that all of these new products that are coming out really contain margins that are higher than the group average? So as they make up a higher percentage of the total, it just has the natural effect of enhancing margins. Is that a way of looking at it?

[David Demshur:]

Yes, correct Jim. We always price for incremental margins that are going to be in the range that we talk, about 35% to 45%. Of course some of these new products because they are such a value-add have been at the higher end of that range or in some cases above that range.

[Dick Bergmark:]

And Jim particularly on the service side where we are doing diagnostics, if we can add a service, maybe through an addition to our existing tool stream, we’re only adding slight amount of depreciation to conduct that job. So it’s the same number of engineers going out to the site to conduct that job which gives us incremental revenues with extremely high incremental margins. So those incremental margins are also going to drive the underlying EBIT margin. So that’s how we also get margin expansion too. So it’s not just trying to price the new technology with a highest possible margin, but it’s also being cognizant of how well you can integrate those services to drive the highest incrementals.

[Jim Crandell:]

Okay. That’s well said and very helpful. Thank you.

[David Demshur:]

Okay, Jim.

[Operator:]

Your next question comes from the line of Veny Aleksandrov.

[Veny Aleksandrov:]

Good morning guys.

[David Demshur:]

Good morning, Veny.

[Veny Aleksandrov:]

My first question is on the guidance for the year. So your revenue guidance is just slightly off of what you gave last time, but you kept EPS guidance. I mean how confidence are you about your margins? Is it because of the deepwater projects moving in Q2 and Q4, or improvement in all of your margins? And I’m sorry for the background noise.

[Dick Bergmark:]

That’s fine. It is improvement across the board, driven also by those incremental margins that we were talking about. So for our guidance for 2014, it’s in essence similar to what we gave last time, but keeping in mind that our Q1 turned out to be lower than our prior guidance. So what that means is, we’ve actually raised our guidance for Q2, Q3 and Q4 to come up with the same – virtually the same 2014 guidance.

[Veny Aleksandrov:]

Thank you. And my second question, and my question has already been asked on the mobile offshore [indiscernible], but can you give us a little bit more details. It’s very interesting. Do you send your people, your equipment, how big equipment is. So where this can go, like how many labs like that you can have in the next three years installed?

[Monty Davis:]

Veny, the labs are in a container-type setting. We do – it is our equipment the whole laboratory, all the equipment in it. The people are our people that go out and man the laboratories, take the samples and do the analysis. They are set on rigs or platforms. Not every rig can accommodate the room, but there are lots that do. And the savings to our clients is pretty phenomenal versus the price. So it’s a great value-add to the client when they can’t take these mobile laboratories to the rig or platform and place them on there to do the analysis they have upcoming. It lets them make much quicker decisions and change what they’re doing without losing any rig time, which as you know is very expensive. We expect to see that business growing, as we see the pick-up in the deepwater activity that we also alluded to early.

[David Demshur:]

Yes, and as Byron Pope spoke of earlier, we’ll see that migrate from mainly deepwater Gulf of Mexico to West Africa and also offshore Brazil.

[Veny Aleksandrov:]

Thank you so much.

[David Demshur:]

Okay, Veny.

[Operator:]

And your next question comes from the line of Blake Hutchinson.

[Blake Hutchinson:]

Good morning guys.

[David Demshur:]

Good morning, Blake.

[Blake Hutchinson:]

Just to kind of round out a lot of the pieces that have been put together here. You talked a bit about with regard to the guidance, with 1Q out there and 2Q pretty dialed in. I’ll look at the back half and all what we talked about here would leave me to believe that your guidance for the back half would entail incremental margins that are certainly at the higher end of the range, your historical prescribed range, if not, maybe beyond that. We’ve got some indication of scale and mix improvement. Is there also a shift in your top line more towards your North American businesses actually in that revenue number as well? And just to make sure we come right way with the right message, am I characterizing that correctly that the increment should be pretty outsized in the back half of the year?

[David Demshur:]

Yes, I think that’s right Blake. And just if you look at where we are generating our highest incremental margins and our highest margin, it happens to be in production enhancement. And of course that has greatest exposure to North American unconventionals. That growth rate has been higher, so we will see more of that revenue flow to production enhancement higher incrementals pushing the underlying margins. Moreover with the backend loaded with some deepwater work, we know those incrementals are also up at the top of that range. So what you’ve laid out is exactly what we expect to occur in Q3 and Q4 of this year.

[Blake Hutchinson:]

Okay, great. And I guess attached to that, you did point out maybe a little more sluggish receivable in inventory levels, but with your 2Q guidance as well, I suggest that you need to make up some ground on the working capital front with regard to achieving your free cash goals. Is that more or less just the continuation of greater efficiency over the year, or is there some kind of annual collection process that kicks in, or what gives you the confidence that we can still reach that $300 million plus goal for free cash?

[Dick Bergmark:]

There is some seasonality on the receivables in the first quarter. That’s why we mentioned about the deferred revenues. So we billed the clients that have not recorded the revenues and we would expect those to be paid during this quarter. So naturally we begin to see a reduction in AR as the year progresses. Regarding inventory, that’s just a result of – we had the inventory to self. And as Monty mentioned, there are 50% less completions. So we believe as the activity levels begin to improve, those inventory levels will again recede, and be contributors to working capital that we believe will get us to that $300 million plus free cash flow.

[Blake Hutchinson:]

But nothing striking outside of the continued processes?

[Dick Bergmark:]

No.

[Blake Hutchinson:]

Right.

[Dick Bergmark:]

Remember that customer base that we work for, these are all extremely creditworthy clients. So we don’t have a collection credit issue.

[Blake Hutchinson:]

Okay. Well, I appreciate that guys. Thanks for the time.

[David Demshur:]

Okay, Blake.

[Operator:]

Your next question comes from the line of Rob MacKenzie.

[Rob MacKenzie:]

My follow-up question was asked and answered. Thank you.

[David Demshur:]

Okay, Rob. Tasha, we’ll take one more question.

[Operator:]

Yes sir. Your final question comes from the line of John Daniel.

[David Demshur:]

Good morning, John.

[John Daniel:]

Good morning. Just want to follow-up a little bit on the mobile labs if I may. Can you guys quantify how many labs you have right now and how many you expect to deploy over next 12 to 18 months?

[Monty Davis:]

Right now we have a few labs in the Gulf of Mexico, North Sea. We expect to deploy a few more. It’s not huge numbers. We don’t expect every rig to have one, but we will – they move to where they are needed. It’s not like equipment that is permanently on the rig.

[John Daniel:]

Okay.

[Monty Davis:]

These are mobile and they move rig to rig for the different testing programs that the different companies have lined out. It’s not a piece of equipment that’s firmly on a rig. So we don’t expect to have huge numbers, huge CapEx going into that. We expect to get utilization numbers out of it that yield us a good return.

[David Demshur:]

Yes, and with all the interest in these mobile labs, we’ll go ahead and give more color certainly next quarter onwards.

[John Daniel:]

Okay. Is it safe to assume that that is a higher margin, just by virtue, you’ve been out there?

[David Demshur:]

Yes, correct.

[Monty Davis:]

Yes, that’s correct. All our services throughout the company, we’re looking at the value-add and trying to give our customers a great value. The higher the value, the higher the margins we’re going to have as you might expect. So that’s our philosophy throughout. That’s why you see FLOWPROFILER with higher margins, mobile labs with higher margins, some of these EOR projects have higher margins. It’s the value-add we bring to our clients.

[John Daniel:]

Got it. And is it safe to say you guys are the first ones to have the mobile labs building this out?

[David Demshur:]

Yes, some of these pressures and temperatures that we’re running these fluids at, we’re really kind of the only company on the planet that can do that. So that gives us a real nice market niche.

[John Daniel:]

Fair enough. And just last one for me Dave, if you look at the volumes within the fluid studies business if you will, how do you characterize the growth rates in recent quarters, and how does that growth rate evolve over the next two to three years excluding of course the weather which is in Q1?

[David Demshur:]

Yes, I’d say that it is – when you look at the reservoir fluid market worldwide, it certain is expanding. When you analyze core samples, you analyze them once. Reservoir fluid samples are dynamic in nature. And we have one client in the North Sea, that we test his reservoir fluid samples every two weeks. And these used to be done maybe once a year. So we’re seeing more and more of this data be used to ensure that they are getting maximum flow rates but more importantly maximum recovery rates.

[John Daniel:]

Got it. And as I recall, I think you mentioned that part of business tends to carry higher margins in the core analysis. Is that correct?

[David Demshur:]

Yes, slightly higher. That’s correct.

[John Daniel:]

Okay. All right. That’s all I got. Thank you guys.

[David Demshur:]

Okay. Very good. So in summary, Core’s operations posted another solid quarter. But we know we can do better. We’ve never been better operationally or technologically positioned to help our clients expand their existing production base. We remain uniquely focused and are the most technologically advanced reservoir optimization company in the oilfield service sector. This positions Core well for the challenges ahead. For 2014, we continue to be encouraged by recent activity trends in the international, and especially deepwater arenas, and the growing activity levels in the deepwater Gulf of Mexico, especially in the lower tertiary sequences, and we remain confident that activity levels will return to unconventional plays in a robust nature. The company remains committed to industry-leading levels of free cash generation, and returns on invested capital, with excess capital being returned to our shareholders. So, in closing, we would like to thank all of our shareholders, and the analysts who follow Core. And as Monty Davis has already noted, the executive management and board of Core Laboratories gives special thanks to our 5,000 worldwide employees that have made these outstanding results possible. We are proud to be associated with their continuing achievements. So, thanks for spending your morning with us, and we look forward to our next update. Good bye for now.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.