Core Laboratories N.V. (CLB) Q3 2021 Earnings Report, Transcript and Summary

Good morning, and welcome to the Core Laboratories' Third Quarter 2021 Earnings Conference Call. [Operator instructions] Please note this event is being recorded. I would now like to turn the conference over to Larry Bruno, Chairman and CEO. Please go ahead.

Thanks Debbie. Good morning in the Americas. Good afternoon in Europe, Africa, and the Middle East, and good evening in Asia Pacific. We'd like to welcome all of our shareholders, analysts and most importantly, our employees to Core Laboratories third quarter 2021 earnings call. This morning, I'm joined by Chris Hill, Core's Chief Financial Officer; and Gwen Schreffler, Core's Senior Vice President and Head of Investor Relations. The call will be divided into six segments. Gwen will start by making remarks regarding forward-looking statements. We'll then have some opening comments, including a high-level review of important factors in Core's Q3 performance. In addition, we'll review Core's strategies and the three financial tenets that the company employs to build long-term shareholder value. Chris will then give a detailed financial overview and have additional comments regarding shareholder value. Following Chris, Gwen will provide some comments on the company's outlook and guidance. I'll then review Core's two operating segments, detailing our progress and discussing the continued successful introduction and deployment of Core Lab technologies as well as highlighting some of Core's operations and major projects worldwide. We'll then open the phone for a Q&A section. I'll now turn the call over to Gwen for remarks on forward-looking statements.

Thank you, Larry. Before we start the conference this morning, I'll mention that some of the statements that we make during this call may 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 relating 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 other rules. For a more detailed discussion of some of the foregoing risks and uncertainties, please see Item 1A-Risk Factors in our most recent annual report on Form 10-K as well as other reports and registration statements filed by us with the SEC and the AFM. Our comments include non-GAAP financial measures. Reconciliation to the most directly comparable GAAP financial measures is included in the press release announcing our Q3 quarter results. Those non-GAAP measures can also be found on our website. With that said, I'll pass the discussion back to Larry.

Thanks Gwen. Our thoughts remain with all those that continue to be affected by the global pandemic. During the third quarter, global caseloads rose and approach the highest levels recorded over the course of the pandemic. This negatively and unevenly impacted global commerce and continue to pose headwinds to oilfield activities. Still, global demand for hydrocarbons continues to rise and inventories continue to decline, signaling positive trends for future oilfield activity. Virus related issues are still complex, still causing unpredictable schedules in our clients' activities, travel complications and logistical hurdles for field services and product shipments. A number of countries across our global operating network saw increasing COVID case counts and many countries maintained, enacted, reenacted or expanded precautionary measures during Q3. Despite these hurdles, Core remains ready to fully service our clients' needs. And we see a gradually improving landscape for client activity. During the third quarter, tropical weather systems resulted in disruptions in and along the Gulf of Mexico, significantly reducing client activity for several weeks. Multiple Core Lab offices along the Gulf Coast were affected by storm related closures and subsequent power outages many lasted for weeks. I'm happy to report that all of our employees are safe, and that there was only minor temporary impact on the company's physical infrastructure. We appreciate the hard work of our employees along the Gulf Coast to both mitigate damage and spool of operations as quickly as possible. Looking at Core Lab's performance in the third quarter of 2021, the company saw increased cash from operations and increased free cash flow. In addition, operating margins expanded in both segments during the quarter. At the same time, Core continued to execute on its strategic financial objectives by strengthening its balance sheet, reducing net debt and improving its leverage ratio compared to the second quarter. Reservoir description having greater international exposure continues to deal with the uneven progression of already committed project work, as some clients are only now beginning to return to normal work schedules due to COVID 19 accommodations. Now to review Core Lab strategies and the financial tenets that Core is used to build shareholder value over our 26 plus year history as a publicly traded company. The interests of our shareholders, clients and employees will always be well served by Core Lab's resilient culture, which relies on innovation, leveraging technology to solve problems, and dedicated customer service. While we navigate through the current challenges, Core will remain focused on its three long standing long-term financial tenants. Those being to maximize free cash flow, maximize return on invested capital, and return excess free cash to our shareholders. Before we move on, I want to thank Core's management team and employees for their hard work during the unprecedented challenges of the past 18 months. I also want to thank them for their dedication, loyalty and adaptability in meeting all of our customers' needs and for the personal sacrifices that many have endured as we navigate the moment and prepare for a more active market. I'll now turn it over to Chris for the detailed financial review.

Thanks Larry. Before we review the financial performance for the quarter, the guidance we gave on our last call and past calls specifically excluded the impact of any FX gains or losses and assumed an effective tax rate of 20%. So accordingly, our discussion today excludes any foreign exchange gain or loss for the current and prior periods. Additionally, the financial results for the third quarter of 2021 include a charge of $6.5 million for non cash stock compensation expense associated with the future vesting of performance shares for certain employees who have reached their eligible retirement age. Although, these performance shares, share awards continue to be subjected to future vesting schedules and company financial performance metrics; full recognition of the expenses required by US GAAP for employees when they attain their eligible retirement age. Now, let's review the income statement. Revenue from continuing operations was $118 million in the third quarter, comparable to $118.7 million in the prior quarter and up 12% year-over-year. Geographically, the US market continued to grow. This was offset by a sequential decrease in international revenue. Year-over-year international revenue for the quarter is up 9% and the US is up almost 20%. As Larry mentioned earlier, there continues to be challenges with supply chains and workflow disruptions associated with the pandemic have also continued to have an impact on progression of projects in our international operations and on international shipment of products. The third quarter results were also adversely impacted by the severe weather events in the Gulf of Mexico. Of this revenue service revenue, which is more international was $84.8 million for the quarter down slightly from $86.3 million last quarter. The decrease in service revenue is primarily associated with the ongoing disruptions and delays caused by the pandemic in many regions outside the US, but were also adversely impacted by the storms in the Gulf this quarter. Products sales, which is more equally tied to the US and international activity were $33.2 million for the quarter, up 2% sequentially, coming off very strong growth in the second quarter. Our perforating and energetic products remain in high demand. However, the growth in the sales to the US market in the third quarter was partially offset by a decrease in international sales. The second quarter included some large international orders, which can vary from quarter to quarter. It's also worth mentioning that challenges with supply chains for materials continue and did impede some growth opportunities during the quarter for both the US and international markets. Longer lead times and short supply for certain raw materials limited the growth in our manufacturing and production capabilities during the quarter. Moving on to cost of services, ex-items for the quarter was 79% of service revenue, and fairly consistent to prior quarter. As discussed during our second quarter earnings call, cost of services are expected to increase as we restore some temporary cost reduction measures previously put in place during the pandemic. As we progress further into the recovery, with operational activity and our laboratory utilization improving, and then when employee costs are fully restored, our incremental margins on services will improve and trend towards historical norms. Cost of Sales x items in the second quarter was just below 78% of revenue, and is improved from 82% last quarter and for the last five consecutive quarters. As product sales continue to grow, manufacturing efficiencies and absorption of fixed costs will also continue to improve. G&A ex-items for the quarter were $8.6 million compared to last quarter of $9.7 million. Year-to-date G&A is $26 million compared to $31 million for the same period last year. As we progress through 2021, the timing and extent to which we have restored and continued to restore employee compensation levels could also impact our G&A expense for the next few quarters. G&A ex-items for the full year of 2021 are expected to be between $35 million to 37 million, which is about a decrease of 10% from last year. Depreciation and Amortization for the quarter at $4.5 million was slightly lower compared to $4.8 million last quarter. EBIT ex-items for the quarter were $13 million comparable to last quarter and representing an EBIT margin of over 11%. Our operating income for the quarter on a GAAP basis was $6.6 million, which was impacted by the accelerated accounting recognition of the non cash stock compensation expense. Interest expense was $2.7 million comparable to last quarter, but down from $3.1 million in Q3 of 2020 as we continue to reduce long-term debt. Income tax expense ex-items and using a 20% effective tax rate was approximately $2.1 million for the quarter. On a GAAP basis income tax expense was $3 million for the third quarter. As mentioned earlier, that third quarter includes a $6.5 million of non-cash stock compensation expense that was recognized for accounting purposes, and is not deductible for tax purposes. The recognition of this expense in the quarter also increases the effective tax rate for the third quarter. The effective tax rate will continue to be somewhat sensitive to the geographic mix of earnings across the globe and the impact of items discrete to each quarter. However, for the fourth quarter of 2021, we continue to project the company's effective tax rate to be approximately 20%. Income from continuing operations ex-items for the quarter was $8.3 million down slightly from $8.5 million last quarter. GAAP income from continuing operations was $1 million for the third quarter and includes the $6.5 million of stock compensation expense mentioned earlier. Earnings per diluted share from continuing operations ex-items were $0.18 for the quarter comparable the last quarter. GAAP earnings per diluted share from continuing ops were $0.02 for the core. Moving on to the balance sheet; receivables were $95.3 million and increased approximately $2 million from prior quarter. Our DSOs for the third quarter were 68 days, up from 64 days last quarter. Inventory ended the quarter at $44.1 million, up a little over $5 million from $38.9 million last quarter. Inventory turns for the quarter were 2.5 compared to 2.7 in the last quarter. As previously highlighted last quarter, the company continues to experience longer lead times in the supply chain, an increase in cost of raw material materials and supplies, and in some instances short supply. The majority of the increase in inventory this quarter is associated with carrying larger quantities of raw materials in an effort to help mitigate the challenges in the supply chain. Additionally, some larger international product sales anticipated to ship this quarter were delayed at some of the challenges with international shipments continued. On the liability side, our long-term debt was $190 million at the end of the third quarter of 2021. And considering cash of $19 million, net debt was reduced to $171 million or decrease of $5.4 million from June 30. Our leverage ratio was 2.1 as of September 30, which is down from 2.18 last quarter and continues to improve as we work to delever the company. At September 30, $75 million of 10 year private placement now notes which were issued back in 2011 matured and were retired. These notes were settled using a combination of $20 million from cash on hand and $55 million drawn from our credit facility. Our debt is now comprised of $135 million in senior notes, and $55 million outstanding on our credit facility. Our credit facility remains fully available with over $159 million in borrowing capacity. Looking at cash flow for the third quarter of 2021, cash flow from operating activities was $11.9 million, and after paying for $3.1 million of CapEx for the quarter, our free cash flow was $8.8 million, which is up from $6.6 million in the second quarter. Excess free cash was primarily used to reduce long-term debt and $2.6 million in repurchasing shares associated with our long-term share based incentive programs. CapEx for 2021 will continue to be aligned with activity levels and growth opportunities. The company continues to anticipate activity levels will build for the rest of the year and beyond. And we would also expect our capital expenditures to modestly increase but remain in line with historical levels while in a period of growth. For the full 2021 year, we expect capital expenditures to be in a range of $12 million to $14 million. Core will continue its strict capital discipline and asset light business model with capital expenditures primarily targeted at growth opportunities and initiatives. This also marks another quarter where Core Lab generated positive free cash and we are projecting free cash to grow as we look ahead to the remainder of this year and beyond. We believe value evaluating a company's ability to generate free cash flow and free cash flow yield are important metrics for shareholders when comparing company's financial results, particularly for those shareholders who utilize discounted cash flow models to assess valuations. I will now turn it over to Gwen for an update on our guidance and outlook.

Thank you, Chris. The global crude oil market continues to tighten as demand for crude oil approaches pre COVID levels, resulting in noticeable increases in the crude oil commodity prices. Current crude oil commodity prices should also support a higher level and more accelerated pace of investment and international offshore crude oil development projects for 2022 and beyond. These crude oil market fundamentals are reflected in the gradual increase in the international rig count with more oilfield equipment coming under contract as the cycle strengthens in IOCs, NOCs and independent expand their investments in maintenance of existing fields, and development of new fields or field extensions. We anticipate operators to increase capital spending by 15% to 20% for North America, and double digits for international in 2022. Core is well positioned to capitalize on this growth opportunity given our global presence and proprietary technologies. With Core Lab having more than 70% of its revenue exposed international activity, both business segments remain active on international projects. As additional field developments emerge, wells need to be drilled and reservoir rock and fluid samples before reservoir description more fully participate in the cycle. As disruptions from the pandemic abate, the expansion of international development provides growth opportunities for both segments into 2022 and beyond, with a particular focus on the South Atlantic margin, Latin America and the Middle East. As Chris mentioned, international revenue was up 9% year-over-year for the third quarter. For the fourth quarter 2021, Core expects continued growth and year-over-year international revenue. Additionally, growth in US activity is projected to moderately progress 2021 comes to a close. Core projects fourth quarter revenue to range from $121 million to $124 million and operating income of $13 million to $15.5 million yielding operating margins of approximately 12%. As previously discussed in Core's prior earnings calls, financial performance and incremental margins will be temporarily impacted as some cost reduction measures announced in 2020 continue to be rolled back. Once these costs are fully restored, Core expects its historical incremental margin performance to return as client activity expands. EPS for the fourth quarter of 2021 is expected to be approximately $0.18 cents to $0.22. In summary, Core remains committed to its strategic plan of expanding market penetration by introducing new technologies and targeting new market opportunities. Core remains focused on generating free cash flow and reducing net debt while maximizing return on invested capital. As part of Core's 2021 strategic focus, the company will continue to invest in targeted client driven technologies that aim to both solve problems and capitalize on Core's growth opportunity. The company remains well positioned to meet the needs of its clients as the energy industry cycle unfolds. The company's fourth quarter 2021 guidance is based on projections for underlying operations, and excludes gains and losses in foreign exchange. Fourth quarter 2021 guidance also assumes an effective tax rate of 20%. Now I'll turn it back over to Larry.

Thanks Gwen. First, I'd like to thank our global team of employees for providing innovative solutions, integrity, and superior service to our clients. The team's collective dedication to servicing our clients has been very visible during the current challenges, and it's the foundation of Core Lab success. Turning first to reservoir description. For the third quarter, revenue came in at $79 million, up slightly sequentially. Operating Income ex-items was $8.6 million, up 14% sequentially and operating margins ex-items improved to 11%. The segment improvements occurred despite disruptions caused by Gulf Coast storms and the global pandemic. By the nature of the business reservoir description's performance historically has lagged directional changes in client activity. As industry activity recovers, reservoir description will respond more slowly than say oilfield service companies with direct exposure to well construction and other early cycle client spending. As we look ahead, we see the growing international rig count is a harbinger of an improving landscape for reservoir description. A trend that we project will play out throughout 2022 and beyond. Now to some operational highlights. During the third quarter of 2021, Core's Advanced Technology Center in the United Kingdom launched an analytical program to provide both Core and Fluid Analysis on a client - for a client operating in the North Sea. Conventional core was recovered from sandstone strata in the targeted reservoir interval. Once the core reached the rig floor upon recovery from the subsurface, they were stabilized using proprietary Core Lab techniques that ensured that the natural rock fabric and pore fluids were retained during handling and transportation. Upon arrival at the laboratory, the core was scanned using Core's proprietary non-invasive testing and reservoir optimization technologies branded as NITRO, NITRO includes proprietary dual energy, computed tomography and high resolution spectral gamma logging. The results quickly provided Core's clients with lithologic information as well as a wide range of critical petrophysical parameters for pay delineation. NITRO deliverables are normally available within a week of receiving the core. These initial analyses are being utilized in conjunction with Core's recently expanded machine learning artificial intelligence algorithms to refine and accelerate sample selection for the traditional time honored physical measurement program. Single phase subsurface reservoir fluid samples from the same North Sea well were also brought to the Advanced Technology Center for testing. The analyses included detailed determination of contamination levels from the drilling mud, compositional profiling of the hydrocarbons, speciation of sulfur compounds, and measurement of physical properties including density, viscosity, gas oil ratio and bubble point. Quick turnaround on the resulting rock and fluid analytical data sets allowed Core's clients to make timely decisions supporting two upcoming sidetrack appraisal wells. In other international areas, Core's Laboratory in Rio de Janeiro is now offering an expanded range of testing capabilities, including many of Core's proprietary and patented technologies that are in high demand throughout Core's global client base. These proprietary offerings include Core's dual energy CT Rock Evaluation Technologies, and Core's Automated Digital Imaging System which robotically captures high resolution images of core material. The CT datasets and photographic images are being delivered to the clients via Core's proprietary web enabled data management system known as RAPID. These technologies and the RAPID data management system were utilized in the third quarter on Brazilian projects, including a fully integrated study of Brazil's Northeastern offshore basin. This multiclient study incorporates stratigraphy, geochemistry, reservoir geology, and seal rock analysis across several offshore depo centers. With the RAPID data management system, multidisciplinary teams located around the globe are efficiently accessing data and collaborating on analytical results. Moving now to production enhancement or Core Lab strengths in both energetic systems and completion diagnostics, help clients optimize their well completions. Revenue for production enhancement came in at $39.2 million, down 3% sequentially. That was driven by lower international sales compared to the second quarter, plus some supply change or hurdles and the suspension of rig operations tied to weather events in the Gulf of Mexico. Operating income ex-items was $5 million, up 29% sequentially; operating margins was 30% for the third quarter of 2021, up over 320 basis points sequentially. Now for some operational highlights, Oriented Perforating Technology is gaining widespread acceptance among US land operators as the preferred method to optimize frac stimulation. Testing shows that well performance is highly correlated to perforating gun alignment accuracy. Moreover, downhole images have shown suboptimal results from perforating systems that require manual alignment of guns in the gun string. During the third quarter, Core's production enhancement team was engaged by a Permian Basin operator to deploy Core's innovative patent pending Oriented GoGun. This next generation design provides a plug and play system that removes inaccuracies associated with the manual alignment of the guns, as is required with other gun system offerings. In addition, the Oriented GoGun eliminates the need for orientation sub-assemblies, greatly lowering assembly time. The innovative Oriented GoGun design results in the highest degree of alignment accuracy among externally Oriented Gun System offerings, both from gun to gun and from stage to stage. As a result of superior gun alignment and expedited string assembly, the operator adopted the system for all the wells in their multi well drilling pad. Also in the third quarter of 2021, Core's Completion Diagnostic Services were called upon by a Permian Basin client to assess a new approach to cementing operations for their horizontal unconventional wells. It's often difficult to maintain stage containment, when non uniform cement placement has occurred, resulting in channels behind pipe. Frac fluid can move along these channels and migrate between targeted intervals. As a consequence, channels behind pipe can result in sub targeted intervals being under stimulated. The client wanted to evaluate if casing rotation while cementing would eliminate channels behind pipe. Core utilizes its proprietary SPECTRASTIM tracers, and SPECTRASCAN logging technologies to compare the degree of frac fluid containment in a horizontal well, in which casing rotation was employed during the cementing operation. That well was then compared to adjacent wells, in which no casing rotation had been deployed. Core's Completion Diagnostics engineers were able to confirm more uniform cement placement and better containment of frac fluid when pipe rotation was employed. In comparing oil production between the rotated pipe well, and the wells in which no pipe rotation had been performed, the client observed an increase of 800 barrels of oil per 1000 feet of treated well, in just the first 80 days of production from the rotated pipe well. With these favorable results, the operator elected to implement pipe rotation in subsequent cementing operations. Core's Completion Diagnostic Technologies are an invaluable tool for assisting operators in their assessment of innovations and completion techniques. That concludes our operational review. We appreciate your participation, and Debbie will now open the call for questions.

[Operator Instructions] The first question comes from Ian Macpherson with Piper Sandler.

Good morning, everyone. Larry, when we think about the upstream spending growth rates that you're contemplating for next year, which are in the fold of what others are saying, if not a little bit more conservative, we know that service pricing needs to increase pretty substantially to recover the inflation that you're experiencing. And so when you think about total spend minus OFS pricing, it doesn't seem to leave enough dollars left in the piggy bank for the requisite activity increase that we need to balance oil markets next year. So curious on your thoughts on how this unfolds with pricing recovery for Core Lab and how you think those spinning growth rates that you talked about should translate toward your revenue opportunity next year in this inflationary context?

Yes, okay. Good question, Ian. So first maybe frame where we think we're kind of what we're seeing today with our client conversations about our outlook come and going into next year for 2022. So we'd say US activity likely to grow 15% to 20%, still some conversations going on with both our domestic and international clients. But we think that's a reasonable growth rate that's going to occur in the US. And then on the international side, from what we see today, we're comfortable saying that it's going to grow double digits. And so I think we'll dial that in, I think one of the things that certainly, I think a need across the industry for improvement in pricing. I think that'll come. I think one of the unique situations with Core Lab is we've got a lot of operational leverage in our organization, in that with the automation that we put into the system, we can generate a substantial amount more revenue without having to grow our headcount proportionally. So while I do think prices will firm up as demand and activity levels pick up, I think the way we've structured the company coming out of this call it period of upheaval, has us well positioned to see incremental margins start to trend back toward our traditional levels, it won't happen overnight, and it won't happen in one or two quarters. But we'll see that start to rise back into the call it 50% for reservoir description, and call it 20% to 30% or a little bit more on the product side.

That's really helpful. Thanks Larry. Now that you've - the road is - obviously your margins need some time to normalize, but just from a total health of the market and demand growth respect of things normalized. So you've gotten your balance sheet on more solid footing than last year. How are you thinking about the opportunities strategically for the company with respect to M&A or other strategic opportunities for Core Lab in a market that's now positioned for growth rather than contraction?

Sure, I'd say first of all, our attention is always drawn toward our internal pipeline for technology development. It is a foundation for where we go we've got a number of very intriguing technologies, some including nuclear physics sort of revolutionary approach to how we'll address core analysis in the future. And then on a product side, a number of innovations both on diagnostics and an energetic systems. So first, our attention goes to growth opportunities, we have an investment opportunities we have there, we're always looking and always listening to opportunities on the M&A side, I can say that we go through a rather rigorous evaluation of the technical and financial consequences of M&A. As we look at things, we, as you mentioned, we now have called the balance sheet flexibility to act on those things. The one thing I would say in terms of M&A as we look over the landscape of opportunities that are out there, the Core Lab acts on an M&A opportunity. It'll be something that you look at and go, well, that makes sense that sticks close to Core Lab's wheelhouse of things we know. What you won't see us do is get adventurous into things that have you scratching your head is why is Core Lab think they know anything about that?

Great answer. Hey, thanks Larry. I'll pass it over.

Okay, sure. I think we've got a pretty full earnings release agenda this morning with other companies going so since there are no more questions we'll wrap up here. In summary, Core's operational leadership continues to position the company for improving client activity levels in both the US and international markets in 2022 and beyond. We have never been better operationally or technologically positioned to help our global client base, optimize their reservoirs, and to address their evolving needs. We remain uniquely focused and are the most technologically advanced, client focused reservoir optimization company in the oilfield service sector. The company will remain focused on generating free cash and returns on invested capital, in addition to our quarterly dividends will bring value to our shareholders. The growth opportunities driven by both the introduction of problem solving technologies and new part market penetration. In the near term, Core will continue to use free cash to strengthen its balance sheet. So in closing, we thank and appreciate all of our shareholders and the analysts that cover Core Lab. The executive management team and the board of Core Laboratories give a special thanks to our worldwide employees that have made these results possible. We're proud to be associated with their continuing achievements. So thanks for spending time with us. And we look forward to our next update. Goodbye for now.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.