Core Laboratories N.V. (CLB) Q3 2022 Earnings Call Transcript

Operator

Thank you very much. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Stephen Gengaro from Stifel Financial Corporation. Please go ahead.

Gwen Gresham

Good morning, Stephen.

Stephen Gengaro

Thanks. Thanks good morning, everybody. I think two questions from me, if you don’t mind. And if we could start on the Reservoir Description side and I understand the FX issues and headwinds. When we — what we are kind of consistently hearing from other service companies and even large E&Ps is we’re on the cusp of kind of pretty strong international growth in 2023 and 2024 likely. How should we be thinking about the RD business in that environment? Should we start to see consistent double-digit year-over-year growth in that business. I’m just sort of trying to get a sense for how the growth rate should look. And I mean looking at history that would seem to be reasonable, but I’m trying to put together the puts and takes here.

Larry Bruno

Yeah, Stephen I think that’s right. It’s — we’re — we agree that we’re starting off for — heading into a multiyear up cycle that is going to really benefit Reservoir Description. As we’ve talked about with you and with other analysts and investors. Reservoir Description by its nature tends to lag directional trends. We’ve been saying that for a while. It held in very well when COVID hit and a lot of the — service companies that were more exposed to well construction and all really went down sharply. Reservoir Description held in very well. And now those leading indicators of an increased activity the international rig count being a very good bogey for that is gaining traction. We see that going forward. That aligns very well with our client discussions. And so Reservoir Description is going to start making headway there in terms of its margins which were what 11% or so for Q3. And we think it may not be as linear as any of us would like, but we think that it’s the beginning of a nice upcycle and getting back into some nice double-digit margins.

Stephen Gengaro

Great. Thanks. That’s helpful. And obviously the quarter was really strong on the margin side. When we look at the Energetics business in the US land market, it sort of seems to have evolved. And there seems to be a lot of offerings on sort of the integrated side, but you had a really good quarter there. Can you talk about some of the underlying positives that sort of drove the product sales in North America in the third quarter?

Larry Bruno

Sure. Gwen, why don’t you get into some of the details here.

Gwen Gresham

Yeah, Stephen. So in spite of the completion activity I mean increased a bit, but it was a little bit anemic compared to other quarters. With our energetic sales, though we outperformed the activity both completions and frac spreads kind of as our markers there. And so with our US sales we were up about 19% sequentially and 27% year-over-year. So that’s penetration into the market with our existing energetic products that we have. And then we also did pretty well internationally. And as you recall those are pretty — those can be bulky and they can move quarter-to-quarter. And so in Q3 we had some nice shipments there as well.

Stephen Gengaro

And just real quickly on that front, anything on the pricing front around the Energetics business right now in North America?

Gwen Gresham

Yes. Getting some pricing improvements. As you know that area of the market was hit pretty hard during COVID. And we’ve been working with operators wireline company since and we’ve seen some nice let’s say modest pricing improvements to date.

Stephen Gengaro

Great. Thanks for the color.

Larry Bruno

Okay. And Stephen I might add to that that we are seeing really nice penetration and demand for our premium energetic, which has always been sort of the bulwark of our products business.

Stephen Gengaro

Okay. No, that’s helpful.

Operator

Thank you. The next question comes from John Daniel from Daniel Energy Partners. Please proceed.

Gwen Gresham

Hey, John.

John Daniel

Hi, guys. Thanks for put me in. Just two questions for you this morning. You noted renewed interest in some of the studies. And I’m curious and you look back historically as you’ve seen interest rise for reviewing and study purchases, how long does that translate into more business whether for you or just for the industry at large?

Larry Bruno

Yeah. So interesting model that we have on those John. We collaborate on their international studies. We collaborate with national oil companies. And the — we deliver those to the original participants when we complete the analytical program. And then we retain a resale right on that data. So it was a cabin off-the-shelf sale, which yields some pretty high margins when we do that.

We’re usually sharing those with our collaborative partner with the national oil companies. But what we see on those is I would say after a quiet several years of interest in these offshore studies from the Africa — offshore Africa market all of a sudden that’s picked up pretty nicely in the last quarter or so. So we think we’re early in the reconnaissance phase where people are starting to reengage and look at opportunities that they might have had on the shelf during a period of turbulent activity in the industry.

John Daniel

Okay. Fair enough. And then you also noted the success of the PAC system. And as I read the commentary on that, it sounds like it’s more of a system design for offshore wells in the P&A process?

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Larry Bruno

Primarily that’s correct. Yes we do have some offerings that we would use in land business. But the big market and what we focus our efforts on the sort of the big upside for us on the well abandonment and plug and abandonment programs is on the complex offshore wells, but there’s multiple casing strings. And I referred to this at times is there’s an energy transition aspect to this. It’s going to take decades to plug and abandon all of the offshore wells that are — that have been drilled. And so we’re still adding new ones. The rig count is going up new wells are being added. It’s going to be a very nice long horizon. And so we focused some efforts on to making sure that we are well represented there with our innovative technologies.

John Daniel

Okay. The reason I ask about it is when I — a lot of times since you drive around the field and talk to folks they’ll say in the onshore market the E&P company typically just goes low bid when it’s time to P&A well. And I’m curious just kind of given the emphasis these days on ESG and doing things right. If you see somehow greater adoption of technology or sophistication when it comes to onshore P&A moving forward. That’s a big picture question. What’s your thoughts?

Larry Bruno

Yes. I think that’s still going to have to evolve a bit on the design of the onshore wells and I hate to use the word simple, because there’s certainly not. But compared to a very complicated offshore well with multiple strings of casing and multiple completion zones. It’s a much more complicated task. I don’t disagree with your assessment that there is a highly priced approach to doing these costs effectively. And that’s what we focused our efforts on the — like on the PAC system and our other plug and abandonment offerings.

We saved the client substantial dollars and rig time from going in and trying to mill out some very hard steel and all those casing strings and then having the pull the casing by using our energetic systems to create those communication pathways to allow those cement plug to be set. So yes you’re right, cost is a priority and we’re using our technologies to help lower costs and save time.

John Daniel

Okay. Awesome. Thanks, Larry. Thanks, Gwen.

Larry Bruno

Yes. You’re welcome, John.

Operator

Thank you. Next question comes from Don Crist from Johnson Rice. Please proceed.

Larry Bruno

Hey, Don.

Don Crist

Good morning. How are you?

Larry Bruno

Good.

Don Crist

I wanted to ask about just the geographic leverage. I mean, obviously, we’re seeing activity pick up in Brazil, West Africa, Middle East, et cetera. Is there one area that you have more geographic leverage to than another? And should we monitor where rigs are going into Brazil might be better for you all versus West Africa, et cetera?

Larry Bruno

Not particularly, John. I mean I think we have a really broad international footprint. And so we have operations in Brazil. We have operations in multiple countries throughout the Middle East. We have operations in Asia Pacific. And so — and in Africa. So we are well positioned.

Now during tough times that works against you. You’ve got that kind of sprawling infrastructure. But during good times that’s when you really harvest the benefit of holding in there during turbulent times in the industry. And so I would say to give you a little more color, I would say the Middle East is at the forefront of what we’re seeing as a pickup in activity.

Now we are in four different countries. I don’t get into too much detail about those because in some of those countries, I only have one client. And so you can do a little geographic assessment and figure out where those are. But I’d say, the Middle East is an earlier mover and a bigger mover than we’re seeing in other places.

Certainly the South Atlantic margin has been very good for Core Lab for the last number of years and it looks like it’s improving. We actually expanded operations in Brazil. I would also maybe also keep an eye on both sides of the Gulf of Mexico. I think there is some opportunity there.

And as I mentioned in the call earlier West Africa has been kind of quiet for us for a while. And I think renewed interest as people start to reevaluate opportunities, particularly, offshore but also some onshore Africa plays.

Chris Hill

Yes. The only other thing I would keep in mind is that the rocks and fluids are mobile. So it’s pretty often that they’ll come to one of our advanced technology centers for the more advanced testing.

Larry Bruno

The hub and spoke structure has served us very well. So we want to be close to where the activity is. And then to maximize our utilization of our technologies we’ll ship those samples around to the our major centers.

Don Crist

I appreciate all that detail. And just one final one for me. Obviously, there’s still a lot of tension in Europe with the Russia situation. And we’re coming up on a decision point here on December 5. But the assay work on Russian crude is that completely out of your model today i.e. if Russia quits exporting crude that will not hurt you going forward? Is that a correct statement?

Larry Bruno

No, I don’t think that’s correct. I mean, we still have clients that European clients included in that that want us to be part of their activity. That includes Russian crude. I guess, I’d take a perspective that the — I think both sides the Russians need to keep their crude flowing and the rest of the globe needs that oil that’s going to come out of Russia. If not we’re going to see a spike in oil prices.

And so I think the — I think what will happen is there’ll be some accommodation there to keep things flowing. But we are — we’ve tried to risk assess some of the uncertainties that we see that potentially could impact us. But it’s a crystal ball question for what’s going to happen in the kind of the near to mid-term, but I think we’re kind of optimistic that the realities of supply and demand for crude oil don’t allow for Russian oil to be excluded from that for very long.

Don Crist

Okay. I appreciate the color. I will turn it back. Thank you.

Larry Bruno

Okay.

Operator

Thank you. The next question comes from Simon Galligani from Awilco. Please proceed

Gwen Gresham

Hi, Simon.

Simon Galligani

Good morning. Hi. Just a brief question. You announced the ATM in early June and then later you announced the debt refinancing. Can you guys elaborate on your current thoughts on the ATM? Thank you.

Chris Hill

Sure. This is Chris. We have not sold any shares under the ATM. I would say we’re not planning to sell any shares unless we need to. So that was put out there with what happened I think during the first quarter and you see how that impacted us the conflict and whatnot but we’ve recovered partially from that. But keep in mind we do have $75 million of notes that are come in due next year. And we’re working to improve the liquidity in the company and how we’re going to retire that or sort of refinance those. So we’re keeping multiple options open, but we’re going to try to do it without utilizing the ATM.

Larry Bruno

And just to expand on one point that $75 million note that comes due next September was a 12-year note. So set up in a different time, but it just happens to be coming due now. And so I wanted to have options and if we needed to, but as Chris mentioned we have not sold the shares under the ATM.

Simon Galligani

Okay Thanks very much.

Larry Bruno

You’re welcome.

Operator

Thank you. The next question comes from Dan Kutz from Morgan Stanley. Please proceed.

A – Gwen Gresham

Good morning, Dan,

Dan Kutz

Good morning, Gwen. So I just wanted to kind of follow up on the kind of capital allocation a lot of questioning. I guess, considering that you have the maturity next year, if you put the leverage target out there of 1.5 times. So appreciating that those two are factors. I was just wondering, if you could help us think through your calculus and thoughts around potential increases in shareholder returns, what you would need to see to feel comfortable starting to consider that? And what would kind of be your presence, between raising the normal dividend or buybacks or some kind of special dividend? Just generally, your thoughts around shareholder returns would be great.

Chris Hill

Sure. I don’t think that has really changed. We’ve tried to message that consistently. So I think when we think about raising the dividend, we want to do that in a way where we think it’s sustainable. So I think as we get into a recovery what — the way we would return cash to shareholders, is through our buyback program. Initially, it does provide a little bit more flexibility if you will, versus committing to a dividend. But I think once we get the leverage ratio down and that’s sort of not consideration with respect to that, and we’re comfortable with the forecast you would see us start to consider to raise the dividend.

Dan Kutz

Great. That’s, really helpful color. And then, I saw in the press release that you guys making progress in the CCS Consortium added two members I think. Just wondering, if you could give us an update in terms of the opportunities that you’re seeing in the CCS space for Core Lab. And if you could remind us anything you’ve said kind of on, the — what the medium- or longer-term prospects could be in that market? Thank you.

Larry Bruno

Yes. I think it’s very early in the process. I think Core Lab focused on maybe, not getting out over our skis in this. We wanted to wait until, we were actually generating revenue profitably on this activity. And so we took a multipronged approach. If you go back and look at the earnings release from a little while ago, you’ll see we signed a strategic alliance with Talos. I think Talos is well positioned to be a leader in CCS projects going forward and we had a great relationship with them through our activity on their upstream production, oil and gas production side. And so that was a natural fit for us.

And then we put together this consortium, in collaboration with the University of Houston to really focus on where Core Lab has its applicable expertise and that is an understanding, what happens when we — when people try to put for 30, 40, 50 years or longer try to put large volumes of CO2 in the ground, it’s going to react with the poor fluids, it’s going to react with the rocks. If you bubble CO2 through water, the water gets more acidic and that’s going to create rock-fluid and fluid-fluid compatibility issues.

So that’s kind of the technical side of what we’re focusing our engagement on, evaluating the seal rock and the containment and formation sensitivity to injecting the CO2. So from a dollar perspective, we’re still saying that as this matures we see that this could become 5% to 10% of Core Lab’s business over time, not there yet. But I think we are in a more concrete position than some companies that are talking about future engagement there. We’re actually doing projects and see more projects building. We’ve got more projects on our board now, than we’ve done to this point, let’s put it that way.

Dan Kutz

Great. Thank you, Chris and Larry. Thanks. Gwen, I’ll turn it back.

Larry Bruno

Okay. You’re welcome. Thanks, Dan.

Gwen Gresham

Thanks, Dan.

Operator

Thank you. The next question comes from David Smith from Pickering Energy Advisors. Please proceed.

Gwen Gresham

Hi, David.

David Smith

Good morning. Thank you for taking my question. So apologies I jumped on the call a little late. Sorry if I missed this. Did I hear that US Production Enhancement revenue was up 19% sequentially, or was that just a reference for Energetics?

Gwen Gresham

That was a reference for Energetics.

Chris Hill

The US product sales were up 20-plus percent sequentially.

Gwen Gresham

Yes.

David Smith

Yes. I was just wondering if you gave any details on the total US growth sequentially because that – even that level of product growth would kind of suggest a decline in total international for the segment. And I was just wondering if that maybe lines up with just the FX impact.

Chris Hill

Yes. So this is Chris. So US was up over 20% sequentially. But international product sales out of PE were down this quarter. And when we talk about that those are larger bulk orders and they can be a little lumpy from quarter-to-quarter. So – and those are not as subject to the FX impact like our service revenues that are coming through Europe and whatnot. Those are usually billed in dollars. So they don’t – there’s not as much currency impact in our Production Enhancement segment. Just to put that in perspective the international product sales were up 16% year-over-year. They’re just down and can be a little lumpy quarter-to-quarter when you’re looking sequentially.

David Smith

Got it. Makes perfect sense. And the follow-up question is solid incremental margins for production enhancement this quarter. Is that a function of a better mix with the Energetics growth? Is that just the segment getting to the kind of incremental margins you would normally expect?

Chris Hill

Well, I think we had a really nice pickup in the US, which is the primary market for the manufacturing so some nice manufacturing efficiencies, and we have had some pricing traction. I would say the pricing isn’t keeping up with inflation but it’s a combination of manufacturing efficiencies as product manufacturing expands but then also some benefits from some pricing picking up. We don’t model that kind of incremental margin going forward. But when we have a nice quarter it can get up to those levels.

Larry Bruno

I think more consistently we would look at margins on the manufacturing side. On the product side of the company, which is almost entirely in PE, look at that for 25% to 35% incremental margins.

Chris Hill

Right. And our services side of that segment also had some nice growth too. So when they start to pick up, we talk about on the service side the incremental margins can be stronger so it can actually improve the sequential incremental margins for the segment as well.

Larry Bruno

Right. So to be clear on production enhancement the incremental margin is a blend of the manufacturing margins and the service margins.

David Smith

Got it. Thank you. If I could sneak one more in?

Larry Bruno

Sure.

David Smith

Did you provide any characterization of the SA work in Q3 relative to Q2? I mean I saw the modest improvement referenced in the press release. But just wanted to ask if you could provide any rough numbers on the revenue improvement.

Larry Bruno

Yes up mid-single digits.

Chris Hill

Right.

David Smith

Thank you so much.

Chris Hill

Yes, sure.

Operator

Thank you. The next question comes from Samantha Hoh from Evercore ISI. Please proceed.

Samantha Hoh

Hey, guys. Just a quick for the housekeeping. The CapEx guide, I mean it seems like kind of just work this way down from the initial $15 million to $18 million guide for the year. Can you maybe talk to what is driving that? Is it a timing issue? And just some of it roll into next year? And just also where your CapEx is going towards these days?

Larry Bruno

Yes. So I don’t think any major change there. It’s maybe a little bit lighter. We are trying to – we – I think at Core Lab we are extremely thrifty when it comes to capital investment. We have to see a very rational reason and appropriate returns to make us move forward. But that being said, having sort of grown up through the lab network in Core Lab is my sort of my responsibilities approved no good idea never goes — no good idea goes unfunded.

And so, there are — we have also rationalized our geographic footprint and with that consolidated some locations so that’s helped to reduce some of the CapEx that we might have had to put into facilities.

And so I think no big change in that, as we — it’s one of the benefits of staying asset-light. We don’t have a lot of rusting metal to replace overtime, compared to some other types of oilfield service businesses.

And so I think it’s a combination of our natural thoughtfulness about capital expenditure trying to be cognizant of free cash that we’re trying to generate, as we focus on de-levering the company and also some operational efficiencies, that have come through reorganizing and restructuring and re-geographically balancing our footprint around the world.

Gwen Gresham

And Sam when you look at the numbers you could — in terms of modeling if you want in terms of where the dollars go to Larry’s point with no good idea going unfunded there’s about two-thirds of that that goes towards new technology and maybe about one-third that goes towards things that lose their life in the laboratory environment.

Samantha Hoh

Okay. That’s super helpful. And then, okay, maybe switching to some of the newer stuff that you’re doing, on the CCUS Consortium it’s really interesting to see that you’re adding private equity and midstream partners.

Curious if this is sort of like — if this is something that has happened in the past with some of your other studies where sort of non-upstream partners or members get involved early on, or do they tend to get involved later after a field starts to — projects start to mature and you’re actually bringing that project online there?

Larry Bruno

Yeah. So to be clear, this is the first non-upstream consortium project that we’ve done. Everything else that we’ve done the hundreds of multi-company studies that we’ve done over decades have all been focused on subsurface reservoir characterization seal evaluation.

Some have had implications on completion design say in the in the Permian Basin and all evaluating the rocks and fluids and how to get the most out of that. This is the first one that’s not focused on some upstream application. So, like for example, EOR in Unconventional that was a technology study but it was still focused on upstream oil and gas production. The CCS Consortium is not focused on upstream oil and gas production.

We’re very happy to see a I would call it a very nice blend of some very well-known and respected nameplates on the oil and gas operator side that are seeing CCS opportunities either for their own initiatives or to become a player in that arena, but also getting some private equity in midstream engagement here I think broadens the discourse for us on how companies are going to develop effective economic models for CCS projects.

Chris Hill

Yeah. The only thing I would add is that historically with our traditional projects there I don’t remember any midstream type companies buying in, but as assets were changing hands private equity firms have bought those studies in the past.

Larry Bruno

That’s correct.

Samantha Hoh

All right. And then one thing that I’m kind of surprised, I haven’t heard you guys mention is a geothermal. That just seems to be a trend that I would think would fit into your wheelhouse. Can you maybe elaborate? And is there work that — is there an opportunity there for you guys to get involved in that space?

Larry Bruno

Sure. So this could be a long conversation. We only have a few minutes left. But there’s, really two broad categories of geothermal. There’s what I would call the hot rock hot fluid ones and the warm rock warm fluid ones.

The most of the ones overtime say like the Geysers in California pretty long-term geothermal project. Those are very hot rock projects. So shallow areas where — that are relatively shallow and by this I mean hundreds to thousands of feet deep not tens of thousands of feet deep, and they provide hot fluids from the earth that allow for warming of water to create a steam environment and generate electricity.

We do on occasion get involved in those hot rock projects. They tend to — so we’ve done some for example in Indonesia. They tend to be in tectonically active areas where those hot rocks are close to the surface. One of the complications there is, it’s pretty tough to Core wells when you’re talking about 700 or 800 degrees temperature. And so not a whole lot of coring sometimes they’ll core on the flanks of those projects and we’ll evaluate the rocks. We do so — we do have some offerings in there looking at fluid and rock compatibility but not a big business for us.

Samantha Hoh

Okay, great. Thanks so much guys.

End of Q&A

Larry Bruno

Okay. I think we’ll wrap up there. In summary, Core’s operational leadership continues to position the company for improving client activity levels in both the US and international markets for the remainder of 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 maximizing free cash and returns on invested capital. In addition to our quarterly dividends, we’ll bring value to our shareholders via growth opportunities driven by the introduction of problem solving technologies and new market penetration. In the near-term, Core will continue to use free cash to strengthen its balance sheet while always investing in growth opportunities.

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 us 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.

Operator

Thank you. Ladies and gentlemen, the conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.