Q2 2022 Core Laboratories NV Earnings Call
One introducing new product and service offerings in key geographic markets to maintaining a lean and focused organization and three maintaining its focus on delevering the company.
Now to review course core lab strategies and the financial tenants that core is used to build shareholder value over our 26 plus year history as a publicly traded company the.
In the interest 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 I will talk more about some of our latest innovations in the operational review section of this call.
While we navigate through the current challenges and pursue growth opportunities. The company 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 returning excess free cash to our shareholders.
Before moving on I want to thank our employees for their dedication loyalty and adaptability and meeting all of our clients' needs and for the commitment that many have shown as we navigate the moment and prepare for 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 current and prior periods.
Additionally, the financial results for the second quarter of 2022 include a noncash adjustment of $3 3 million to reverse previously recognized stock compensation expense.
Associated with performance shares, which are no longer expect to divest.
This benefit from reversing the stock compensation has also been excluded from the discussion of our financial results.
So now looking at the income statement revenue from continuing operations was $128 9 million in the second quarter up approximately 5% from $115 3 million in the prior quarter and up almost 2% year over year.
The sequential increase in revenue was driven by growth in both the U S and international markets.
However, nice growth in the underlying operations and multiple international regions has been partially offset by the devaluation of the euro and British pound and continued disruptions as a result of the <unk>.
Ukraine, Russia conflict, which I'll expand on later in the discussion.
So all of this revenue service revenue, which is more international was $85 4 million for the quarter up 1% sequentially from $84 7 million last quarter.
While underlying activity has improved in multiple international regions. There are two primary factors impeding the overall service revenue growth.
First the conflict between Russia, and Ukraine, and secondly, the devaluation of the Euro and British pound.
Revenue from our operation in Russia during the second quarter decreased approximately 800000 sequentially and $2 $3 million year over year.
When looking at the first half of 2022 revenue from our operation in Russia declined about $3 2 million when compared to 2.2 thousand 21.
Additionally, the sharp devaluation of both the euro and British pound during 2022 has lowered revenue build in these currencies when translated into U S dollars by about $1 million in the second quarter of 2022, when compared to the first quarter.
And is lower by about $2 6 million when compared to the second quarter of last year.
Our revenue associated with services in the U S market. However continue to grow in line with improving activity levels and have shown steady growth for the last three consecutive quarters.
Product sales, which is more equally tied to the U S and international activity were $35 5 million for the quarter up 16% sequentially and up over 9% from last year.
International product sales experienced a strong rebound of 26% sequentially and 15% year over year.
Our international product sales are typically larger bulk orders and can vary from one quarter to another.
We delivered several large international orders during the second quarter.
Product sales in the U S increased approximately 5% sequentially and was led by the sales of our energetic products, which increased over 11% sequentially.
Moving on to cost of services ex items for the quarter was a little below 80% of service revenue.
And improved slightly from 81% last quarter.
With forecasted growth in employee compensation more fully restored as we progress through the remainder of the year, we would expect incremental margins to improve and trend towards historical levels.
Cost of sales ex items in the second quarter was 84% of revenue a nice improvement compared to 92% last quarter the.
The improvement this quarter was primarily driven by gains in manufacturing efficiencies and a higher mix of international sales.
We anticipate improvement in the manufacturing absorption rate in future quarters in line with our projected growth in product sales.
G&A ex items for the quarter was $10 4 million, an increase of $1 5 million from $8 9 million last quarter.
G&A for the second quarter of 2022 includes a noncash $600000 loss associated with a fair market value adjustment just tied to our company owned life insurance policies that are held by the company to fund certain employee retirement plan.
G&A expenses also increased due to an increase in travel outside service providers and investments in cyber security resources.
G&A ex items is anticipated to be approximately $40 million for the full year of 2022.
Depreciation and amortization for the quarter was $4 4 million and down from down a little from $4 6 million last quarter.
EBIT ex items for the quarter was $9 6 million.
Up from $7 2 million last quarter, yielding an EBIT margin of 8% or up about seven to 170 basis points sequentially.
On a GAAP basis, EBIT was $11 7 million for the quarter, which includes the reversal of <unk>.
Previously recognized stock compensation expense mentioned earlier.
Interest expense was $2 7 million relatively flat from last quarter.
Income tax expense ex items at an effective tax rate of 20% was $1 4 million for the quarter and on a GAAP basis was $1 8 million for the 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, we continue to project the company's effective tax rate to be approximately 20%.
Income from continuing operations ex items for the quarter was $5 5 million up from $3 6 million last quarter.
On a GAAP basis, we recorded income from continuing operations of $7 2 million for the quarter.
Earnings per diluted share from continuing operations ex items was <unk> 12 for the quarter up from eight last quarter and GAAP earnings per diluted share from continuing operations was <unk> 15 for the quarter.
Turning to the balance sheet receivables was $99 2 million and remained flat from the prior quarter, our dsos for the second quarter. We're at 69 days, which improved from the 72 days last quarter.
Inventory at June 30 was $52 6 million up approximately $4 3 million from last quarter end.
Inventory turns for the quarter remained consistent at $2 four.
Which is comparable to the last couple of quarters.
As previously highlighted the company continues to experience an increase in cost of raw materials labor packaging and transportation costs, which are increasing the cost of inventory.
Additionally challenges in the supply chain persist, which will continue to require carrying a larger amount of inventory to help mitigate disruptions.
We continue to anticipate inventory turns will remain at current levels with some improvement as we progress through 2022.
And now to the liability side of the balance sheet.
Our long term debt was $188 million at the end of the second quarter of 2022, considering cash of $16 million net debt was $172 million or slight increase from the last quarter.
As previously announced on July 25th rewritten, we renewed and extended the companys revolving credit facility.
The renewed credit facility has an aggregate borrowing commitment of $135 million with an accordion feature to expand the facility and additional $50 million.
Additionally, the maximum leverage ratio permitted was increased to 75% through September 32022, and will return to two five thereafter.
At June 30, our leverage ratio was 247% compared to $2 three two to three at last quarter end.
We are projecting our leverage ratio to decrease slightly next quarter and continue improving through year end.
Our debt is currently comprised of our senior notes at $135 million as well as $53 million outstanding under our bank revolving credit facility.
Yes.
Looking at cash flow for the second quarter of 2020 to cash from operating activities was 600000 and after paying for $3 2 million of Capex for the quarter, our free cash flow for the quarter was a negative $2 6 million.
Cash from operations was down in the second quarter of 2022, primarily due to the following factors.
The company's profitability was significantly impacted during the first quarter as the company experienced a very elevated level of Covid cases, and the Ukraine, Russia conflict began while we also restored employee compensation on January one.
The Ukraine, Russia conflict negatively impacted our revenue as the company exited the first quarter and began the second quarter as.
As a result cash collections on accounts receivable were at a lower level during the second quarter.
Additionally, cash from operations was also use it used to fund working capital requirements as product sales continue to increase supply chains remain challenged and inflationary factors are contributing to higher levels of inventory.
And lastly, unfunded liabilities from certain employee retirement plans were paid with cash from operations during the quarter.
Cost reduction plans and associated severance obligations accrued in the first quarter have also been partially executed in the second quarter.
We expect the growth in working capital associated with higher levels of inventory to moderate cash from operations to strengthen and for the company to generate positive free cash flow in future quarters.
We will continue managing capital expenditures to be aligned with activity levels for the remainder of 2022 for the full year 2022, we expect capital expenditures to be in the range of $12 million to $13 million.
We will continue its strict capital discipline and asset light business model with capital expenditures, primarily targeted at growth opportunities and initiatives.
Core lab has historically had the ability to grow revenue and profitability with minimum capital requirements capital expenditures have historically ranged from 3% to 4% of revenue even during periods of significant growth.
That same level of laboratory infrastructure intellectual property and leverage exists in the business today.
We believe evaluating our company's ability to generate free cash flow and free cash flow yield is an important metric for shareholders when comparing companies' 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.
We look forward to the second half of 2020 and into 2023, we anticipate that.
Great oil commodity price will remain elevated but to be more moderately body volatile as crude oil supply and demand may be impacted by uncertainties related to slowing global economic growth.
Crude oil supply is projected to Titan as production growth limitation data pro long underinvestment in many regions around the globe.
The crude oil market fundamentals are reflected in the year over year increase in international onshore and offshore rig count with oilfield drilling programs being executed and capital spending plan expanding our 2020 team 23 and beyond we see these as leading indicators of growing into.
National multi year cycle.
We're having more than 70% of our revenue exposure to international activity third business segment to remain active on international projects the company.
We will have revenue opportunities when wells are completed stimulated and once.
Reservoir rock or fluid samples have been collected.
Continue to see modest improvement in client activity across many international regions.
The South Atlantic margin.
In America, and then Italy, However, our Russia, Ukraine in Western Europe Laboratory network.
Uncertainty and from Russia, Ukraine, geopolitical conflict continues and sanctions on Russia expand.
We expect reservoir description revenue to increase by low to mid single digits in the third quarter of 2020 team.
To date, the international rig count has been flat.
In the international rig count sustained improvement in our clients' drill and sample their reservoirs reservoir description is expected to outperform the changes in industry activity levels.
Now turning to production enhancement, which is more exposed to U S onshore activity and typically correlate with well stimulation and completion program.
We expect the third quarter 2022 U S rig count to increase sequentially.
However, the rate of growth for completion may potentially be limited by the availability of third party frac equipment and credit.
Consequently production enhancement revenue is projected to increase sequentially by mid to high single digits.
In summary, we project continued improvement in U S activity and moderate improvement in international offshore and deepwater market.
Realignment of crude oil supply lines, it's projected to continue into the third quarter of 2000 2018, having a sequential positive impact on reservoir description assay laboratory testing and the affected region. As a result, we project company revenue to range from $1 20.
123 million to $129 million operating income 10.
$10 1 million to $13 3 million, yielding operating margins of approximately 9%.
EPS for the quarter is expected to be 13 <unk>.
Sir.
Our third quarter 2022 guidance is based on projections for underlying operations.
And losses and foreign exchange third quarter 2020 guidance also assumes an effective tax rate at 20%.
With that said I'll pass the discussion back to Larry.
Thanks Glenn.
First I would 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 is the foundation of core lab's success.
Turning first to reservoir description for the second quarter revenue came in at $75 $8 million up slightly compared to Q1.
As Chris mentioned when looking at the sequential growth in revenue. It is important to consider the sharp devaluation of the euro and the British pound during Q2.
These currency devaluations lowered <unk> revenue when translated into U S dollars by $1 1 million as compared to Q1.
Comparing the first half of 2022 to the first half of 2021, the currency devaluation in the euro and the British pound lowered revenue when translated into U S dollars by $4 8 million.
Our reservoir description business segment absorbed most of this currency exchange impact to the top line.
Operating income for reservoir description ex items was $5 million and operating margins were 7%.
Even with the challenges posed by the Russia, Ukraine conflict sequential incremental margins for reservoir description, where just over 100% as revenue approved and costs were reduced.
After accounting for the currency devaluation as just discussed sequential incremental margins were still approximately 100%.
As we look ahead, while still well below pre COVID-19 levels, we see the growing international rig count as a harbinger of an improving landscape for reservoir description a trend that we project will play out throughout 2022 and for the next several years, particularly in the middle East and North and South America regions.
Now for some operational highlights for the second quarter.
Energy transition opportunities that leverage <unk> expertise in reservoir description continued to emerge during the second quarter of 2022 core lab under the direction of <unk> operating Inc. Commenced work on a multi well core project to evaluate lithium production opportunities from railroad valley and Central Navarre.
<unk>.
<unk> operating has targeted a pliocene continental evaporite sequence with extensive metalliferous deposits that include sodium phosphorus tungsten boron lithium and other metals potentially making the railroad valley deposit what are the most promising in the world of this type.
Multiple cord intervals from the <unk> operating loss of $10 28, and <unk> 18 wells were recovered from the subsurface and stabilized at the well site with core lab's proprietary core state technology.
Core stay as a superior preservation technology, specifically that differ friable, an unconsolidated formations.
Out of arrival at the laboratory. These cores were immediately scanned using core lab's proprietary noninvasive testing in reservoir optimization technologies, including dual energy computed tomography.
Core's proprietary deliverables from the Cat scanner quickly provided the experts at <unk> operating with little logic information in a wide range of geological and Petro physical parameters as well as millimeter scale <unk> digital images of the recovered cores.
Cores are now progressing through the laboratory analytical program, the geologic insights and Petro physical parameters obtained from this analytical program will provide a robust data set of physical measurements that <unk> operating we'll use for both economic assessment of the strata and to establish optimized development strategies.
All of the data for this important project are being hosted in core lab secure rapid database, which <unk> operating we will use as a shared digital workspace.
Moving now to production enhancement for core lab strengths in both energetic systems and completion diagnostics help clients optimize their well completions.
Revenue for production enhancement came in at $45 $1 million.
Up 11%, both sequentially and year over year.
Operating income ex items was $3 $9 million.
Operating margins were 9% for the second quarter of 2022 and sequential Incrementals incremental margins were 18%.
During the second quarter of 2020 to working with the client and the North Sea core lab successfully launched its innovative energetic perforating system Helios aimed at improving the efficiency of plug and abandonment programs. The Helios technologies unique engineering and design generates a high density perforation matrix that.
<unk> access to the cement between the outermost layer of casing and the geologic formation.
The Helios perforation matrix creates an optimized design that allows for greater circulation and more efficient debris removal and the annulus space during perfect wash operations.
The operator first perforated casing with the Helios technology than utilizing a specialized jet wash tool circulated fluid between the perforated casing and the geologic formation to create a clean annulus subsequently cement plugs, we're set to secure the well for abandonment.
Coors Helios Perforating technology provides the opportunity to significantly reduce plug and abandonment expenses by reducing the number of rig days saving the operator up to $4 million per abandoned well versus the traditional section milling approach here.
<unk> also demonstrates how core's production enhancement engineers are able to adapt downhole technologic advances to diverse industry needs.
Also during the second quarter of 2022 core spectra Stim spectra scan and tax scanned downhole imaging technologies were utilized in our clients' deepwater Gulf of Mexico, well to evaluate a frac pack completion.
A successful Frac pack requires an effective proppant pack. This includes uniform profit placement across the annulus between the casing and the sand control screen as well as ample profit reserve above the top of the screen.
When a successful Frac pack has placed the well is protected from the influx of formation fines that can cut the screen damage surface facilities and filled the wellbore with produced solids, thus restricting production.
Based upon traditional volumetric measurements during the Frac pack treatments are successful Frac pack was initially interpreted to have been placed in the well however.
However, when Core's production enhancement engineering team analyzed the diagnostic data retrieved from its spectral scan and tax gain logging tools. The results revealed a major void in the annual or pack as well as inadequate proppant reserve at the top of the screen.
Of course experts recommended a top off profit treatment to ensure complete screen coverage the top or procedure was successfully pumped and are re logged the completion using core's pack scan logging tool confirm the successful profit in filling of the annual avoid along with an adequate profit reserve replacement above the top of the screen this avoided or <unk>.
<unk> million dollars remedial completion intervention.
That concludes our operational review, we appreciate your participation and Kate we'll now open the call for questions.
We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.
You are using a speakerphone please pick up your handset before pressing the keys to withdraw from your question can you. Please press Star then two.
Okay.
Our first question is from John Daniel of Daniel Energy Partners. Please go ahead.
Good morning, John .
Good morning, Thank you for including me I've got two.
Two questions the first one Larry.
Related to your comments on the lithium extraction.
Yes of course that you took can you just help me understand what.
What's the market potential for that.
So.
Clearly with CMS.
He is going to play a big role in creating efficient batteries and so historically most of the lithium on the planet or a good percentage of it has come from really hard to reach areas in.
Big one being in that what's called a lithium triangle and the high Andes <unk>.
At a common desert.
So a hard place to get too hard place to work at given the altitude and the logistics of that so folks started looking for.
Sources lithium.
Closer to where those batteries are can be made and closer to the market will have to be deployed and so.
A great geologic opportunity exists in the great basin.
And so there are a number of lithium.
Evaluation projects going on and some active at least one active mind. So I think it's a nice project.
In the early stages of evaluation. The key here for US is just like with an oil and gas reservoir understanding the geology understanding the ability of brine to flow through rock in this case, rather than oil and gas are going to be important to making an economic assessment and understanding how to produce these wells. So.
I'd say over time, I could see that growing to maybe 5% plus of core lab revenue.
I think if we look over our energy transition opportunities, including Ccs I can see that over time.
Hard to predict the time and I would say, but I can see that growing to maybe 10% of core labs revenue.
Okay great.
That's helpful. And then the last one from me is just on the Helios product that you referenced.
Yes.
This is a dumb questions I apologize is that specifically designed for just the north sea or is there an application across all.
Yes.
Offshore well projects just any color there.
Yes so.
Good question, the Helios will work.
Any I would say offshore.
Well plug and abandonment program a couple of comments there on that one as core lab views.
<unk> move or expansion into more plug and abandonment work as a derivative of an energy transition play, even if oil and gas.
It starts to decline in demand over the next number of decades, it's going to be many many decades, a plug and abandonment work on producing well. So we see that as a nice position for us and so I would say the technology is probably not.
Greatly applicable to sort of onshore unconventional wells in North America, but anywhere you have a complex.
<unk> like an offshore well or a deepwater well Helios has a role to play and a substantial economic opportunity for cost savings from the operators. So we see C&I arc for that going forward and some more P&A.
Innovations coming out of core lab stay tuned.
Okay.
Thank you for including me, that's all I had okay. Thanks John .
The next question is from Chase Mulvehill of Bank of America. Please go ahead.
Good morning, Jay.
Hey, good morning I.
I guess.
We've been on a lot of the calls so far this earning season and obviously you heard a lot of positive commentary around.
Offshore.
Our market. So just wanted to kind of dig in and kind of try to understand what's going on with.
Your offshore business and obviously this is heavily kind of reservoir description.
But but I would think that this.
Tick in offshore activity in Europe .
More sanctioning of projects I mean, we just talked to STI and obviously that had really big orders when the subsea side. We think that this would start kind of driving some some better revenue growth. When we think about your rock analysis business in reservoir description. So if you could just step back and kind of tell us what youre seeing kind of behind the scenes I know theres, a little bit of a lag.
So kind of what you're seeing behind the scenes on the offshore side and what it could mean for the reservoir description business.
Yes, really good question Chase and Youre right, we will lag I'll call it the.
Metal intensive.
Operators are a metal intensive service companies.
Access to an improving market a couple of things on the on the offshore international.
Rig count that kind of flattened out a little bit in the first half of this year after I'd say.
A pretty nice.
Arc.
Call it from year over year.
And so what we're seeing now forming up is more activity lining up south Atlantic margin it looks real nice.
The Gulf of Mexico looks very promising for us.
And then I would say.
In the middle East onshore and offshore both look promising.
For us.
Asia Pacific I would say theres, a little bit of opportunity there.
But I'd say right now the bigger opportunities South Atlantic margin Gulf of Mexico, and some offshore stuff in.
In Asia Pac and the North sea as well there is opportunities there. We just talked about one on the completion side or plug and abandonment side, but there's also we've got projects, where rock and fluid awards have been made to us from the North Sea and that will show up over the next couple of quarters.
Okay. If I could just kind of follow up on that real quick and thinking about reservoir description I.
I guess kind of depending on what happens in the back half I mean, I will call it kind of flattish revenues this year.
But if we kind of get into 2023 and Youre seeing kind of this momentum that you just mentioned about like how what kind of growth should we expect on the R&D side could you get double digit growth. There should we still kind of think single digit growth for reservoir description in sorry, I know.
That's a bit of ways, but just trying to get some some color as we as we looked at 2023.
Yes, I think double digit growth on the on the international side in particular in the offshore side in particular is as well within grasp I think the spool up time of project engagement that we see.
Lining up for us would indicate that getting to double digits.
Well achievable.
And just a little bit of refinement on your on your premise there what we're seeing is reservoir description across most of our global.
Reach we're seeing growing business opportunities that we think we will start showing up 2020.
Back half of 2022 and into 2023, that's going to be offset a bit by let's call. It uncertainties in.
Russia, Ukraine, and Europe related to that crude assay works, so a little bit of a counterbalance there as that sorts out longer term, what we see going to happen with sort of the global supply lines. Those are going to realign and we think that Russian crude oil is finding a home and we will continue to find homes and other places.
<unk> in Europe will be back filling with with sources of oil.
From places, where they hadn't been necessarily.
Sort of filling the fill in the wagon with crude oil and so that realignment is going on right now.
Having an impact on that aspect of our business.
But we think thats going to settle down.
Between the rest of this year and into next year and then it starts to become a a different but sort of more normalized world.
Demand for that part of our reservoir description business.
Okay, just one follow up and I'll turn it back over I'm sorry.
Related here.
When we think about the Russia levered crude assay work.
Can you talk about pre Russia conflicts, where it was where it is today.
Just so we kind of understand how much could kind of further bleed out and if that business were to actually come back like what like what.
What kind of magnitude that would <unk>.
<unk> to your P&L.
Sure and Chase this is Chris so when you when you look at last year, we did about a little over $28 million and our Russia operation there locally.
So it was right around 7 million, maybe a little bit per quarter.
And that came in just under $5 million this quarter.
But what I would say there is that the impact to that group was was harder earlier in the conflict and what we've seen more recently is that's actually turning and picking back up.
So it is difficult to say, where it might be for this next quarter or beyond but theres about $5 million of revenue I would say their profitability has been impaired, but we've put some action plans in place they have been partially executed to minimize that but we're trying to be thoughtful.
As we do this because it is so fluid both on the Europe side and inside of Russia, and Ukraine for that matter. It's a lot smaller in the Ukraine, but we've continued to hold our employees and trying to watch it and monitor and our guys on the ground are sort of looking at that before they execute any plans.
Okay, Alright, I appreciate the color and sorry, but asking follow ups. Thanks, guys. Thanks, Larry.
Yes.
Thanks, Jason.
The next question is from Don Chris Johnson Rice. Please go ahead.
Good morning, Don Don Good morning.
Good morning.
Wanted to ask a follow up to John's question on the Helios.
Product.
New.
Does that work on shallow water Gulf of Mexico, because I know that shallow water Gulf of Mexico.
P&A work is really ramping up now is a lot of wells were put back to original operators through bankruptcies and it looks like there is probably going to be at 7% or $800 million.
Market going forward as does the Helios product.
Any impact there.
Yes sure does.
I would probably draw the line at relatively simple onshore.
U S land wells, probably not going to be a target for us there, but offshore wells, whether it's on the shelf or in deepwater globally, our target environments for us for Helios, It's just a better way of plugging and abandoning these complex wells, especially where there's multiple wells off of.
Say, a production platform and they're going to abandon one of those wells.
They can execute it much more quickly and efficiently with the Helios products. So we see a nice Ark ahead of us for that.
Great and just one on the international Ops, obviously, youre talking about a multi year cycle.
Starting up there can you just kind of walk through the indicators that you're seeing right. Now is that is it so broad based.
Probably doesn't stop anytime soon with them.
The recession or any other kind of pullback in oil or <unk>.
Or is it more.
More impacted by.
Oil moving around if you will.
Yes, Don I draw I draw a difference I think the potential to be impacted by shorter term economic sort of volatility probably.
<unk> is more risk to onshore land projects.
Mostly in North America, I think you have to look at the at the backdrop of Underinvestment. That's now been going on for more than half a decade in international arenas, what we've said for a long time and I will let I'll admit.
Candidly that it's been slower evolving and of course, the uncertainties of Covid is that the next cycle of investment that was going to come into the industry was going to be international it was going to be conventional reservoirs and it was going to be offshore primarily that's right in core lab's wheelhouse and so the conversations.
That we're seeing are picking up.
Globally on that and we like those types of projects they tend to be a little more lucrative for us because the risk profile for our clients are higher.
Have to reduce that geologic risk if you will and that means more robust datasets and that feeds right into more core and more sampling at all and so we're not going to be a leading indicator of their reservoir description always lags directional changes in industry activity.
<unk>.
That may be a little frustrating for folks that are saying, hey, we're hearing about the drillers that are picking up core lab's role in this we're going to be a little bit later in the cycle, but the flip side to that is you look at reservoir description held in say as Covid hit and there was a deep downturn you saw reservoir description holding theyre very well you cant lag on.
On the way down and then lag and then proceed on the way up that's that's a pretty lucrative business model. If you can find one so we will lag a bit but it's.
It's building up and it's going to be across many many sectors of geographic sectors.
The leading indicators there one Larry you mentioned the international offshore rig count and we're also monitoring.
Data like from Wood Mackenzie regarding <unk> and then those projects that we know are under discussion with our clients and those are happening.
Pretty much in a lot of the major pockets around the world.
Great I appreciate the color I'll turn it back.
Thanks, Doug.
Again, if you have a question. Please press Star then one.
The next question comes from Steven Zingaro Stifel. Please go ahead.
Thanks. Good morning, good morning, everybody. Thank you for taking my questions.
So two things if you don't mind.
First centers around the R&D discussion than just sort of from a bigger picture perspective, when we think about that business over the last I don't know five years six years.
Growth rates haven't been what we've expected.
I think clearly part of that is just international activity, but if we compare that business too.
Prior Upturns is there anything structurally different in that business either what the competitors are doing or what youre doing who you're working for et cetera.
It simply related to just underlying activity trends.
Yes, I would say.
Nothing has changed structurally in the business, it's simply a reflection of activity levels I do think that the Ioc's international operating companies have been I'll call. It extraordinarily measured in their reengagement on projects. However, the nlcs are emerging as.
Being more aggressive or they're getting they're much closer to engaging at a higher level. So I think theres a little bit of that going on I think the economics.
Some of these bigger projects.
Gave some pause when people were focused on repairing balance sheets.
And doing what they needed to do to recover after COVID-19, but I do think that the commodity price at <unk>. This morning was around 100 Bucks.
<unk>.
Roundabout.
110, I think.
And so I think the economic model that will support these longer cycle projects has emerged.
<unk>.
I think the rational view of.
Global demand for oil and natural gas for the next several decades.
Is going to support investment in those types of projects just a little slow getting started on it.
Great no.
That's helpful color. Thank you.
In general here, when we when we think going forward.
A question I think on both segments.
We think about historical incremental margin performance and I know theres a lot of moving pieces in the very short term, but as we think about 2023.
Assuming things kind of normalize a bit where do you think those those year over year Incrementals should play out given what you see and what the cost structure look like.
Yes, I think.
I'll get started maybe let Chris fill in there I think.
Reservoir description, we see the the <unk>.
Great operational leverage that that group has.
Let's get it clear, we're not going to see 100% incremental every quarter for that group I think you have to look at it a little bit quarter over quarter over quarter or over multiple quarters, but I think that operational leverage is strongest in reservoir description, where it's just more rock and more fluids.
Through the existing infrastructure and thats going to translate into very nice incrementals, 50% and above.
We've achieved that historically I think it could be even a little bit better going forward because of how we've streamlined the organization.
On manufacturing I think a bit of a headwind early on there with supply costs raw material costs inflationary costs that we're that we're navigating right now.
And so they're not going to be on the product side, there won't be as high as we can see.
<unk> on reservoir description, but I still think.
We could see incremental margins, there, 25% to 35% probably not unreasonable Chris you want to add anything to that well I just want to remind folks that definitely as we went through and we had these temporary cost reductions in place it kind of artificially lowered the cost base for reservoir description and as we were working.
Through last year, we started to restore some of that I think of that mainly be in employee compensation costs in our largest group of employees is in the reservoir description group. So it's more impactful for that group and then it was we started this year, we completed that almost so we had these costs coming in in Q1 and then these other events happened in <unk>.
Q1.
But now we've kind of I would say reset the baseline if you will for the cost structures in reservoir description and now as you start to see topline growth in that group you will see those incremental margins that we've seen historically, so that's really what we kind of had to work through over the last several quarters, but now we feel like we've got a pretty good baseline there.
There are some inflationary costs and we're expecting labor cost increase we have to give our employees a merit to.
To kind of be in line with where inflation has been so that'll be a little bit of a headwind.
But as that group picks up momentum like Larry was talking about as we get deeper into the recovery absolutely. We would expect incrementals to be where they historically were.
Great. Thank you that's great color. Thank you gentlemen, hey.
Hey, Steve if I could just one point I fell to make on your first question about the landscape here if anything.
We saw a continuation over the last.
Couple of years of downsized.
Internal laboratories within our call it our IOC client base, where.
Fewer projects can be handled internally as they as they downsized their internal infrastructures.
Accommodate the cost. This is a this has happened through every previous downturn cycle over my.
I'm shaking my head as I'm, saying 37 years in the industry every time, there's a downturn.
<unk> have looked at their internal lab structures and said Hey, let's go buy this when we need it let's not have it internally the same thing happened during this cycle and so I think we're even better positioned going forward in that there are fewer internal opportunities to do work.
Within the company's laboratory straw.
Structures those that still have them.
Got you that makes sense. Thank you.
Okay.
This concludes our question and answer session I would like to turn the conference back over to Larry for closing remarks.
Okay, we'll wrap up here in summary, Core's operational leadership continues to position the company for improved client activity levels in both U S 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 maximizing free cash and returns on invested capital. In addition to our quarterly dividends will bring value to our shareholders via growth opportunities driven by both 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 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.