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Edited Transcript of CLB earnings conference call or presentation 25-Apr-19 12:30pm GMT

Q1 2019 Core Laboratories NV Earnings Call

AMSTERDAM May 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Core Laboratories NV earnings conference call or presentation Thursday, April 25, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher Scott Hill

Core Laboratories N.V. - Senior VP & CFO

* David M. Demshur

Core Laboratories N.V. - CEO & Chairman of Supervisory Board

* Gwendolyn Y. Schreffler

Core Laboratories N.V. - SVP of Corporate Development & IR

* Lawrence V. Bruno

Core Laboratories N.V. - COO, President & Supervisory Director

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Conference Call Participants

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* Byron Keith Pope

Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research

* Chase Mulvehill

BofA Merrill Lynch, Research Division - Research Analyst

* Connor Joseph Lynagh

Morgan Stanley, Research Division - Equity Analyst

* Kurt Kevin Hallead

RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst

* Marc Gregory Bianchi

Cowen and Company, LLC, Research Division - MD

* Scott Andrew Gruber

Citigroup Inc, Research Division - Director and Senior Analyst

* Sean Christopher Meakim

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* Stephen David Gengaro

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst

* Vaibhav D. Vaishnav

Scotia Howard Weil, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Core Lab's Q1 2019 Earnings Call and Webcast. (Operator Instructions) Please note that this event is being recorded. I would now like to turn the conference over to Mr. David Demshur. Thank you, and over to you, sir.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [2]

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Okay. Thanks, Zed. Good morning in North America, good afternoon in Europe and good evening in Asia Pacific. I would like to welcome all of our shareholders, analysts, and most importantly our employees to Core Laboratories' First Quarter 2019 Earnings Conference Call. This morning I am joined by Chris Hill, Core's CFO, who will give a detailed financial review; Gwen Schreffler, Core's Head of IR, who will make comments on what Core projects for Q2 2019 after reading the forward-looking statements; and Larry Bruno, Core's President, who will present the detailed operational review.

The call will be divided into 5 segments. Gwen will start by making remarks regarding forward-looking statements. We will then come back and give a review on the current macro environment, updating industry trends pertaining to Core Lab's expected future performance, and then we will review Core's 3 financial tenets, which the company employs to build long-term shareholder value.

Chris will follow with a detailed financial overview and additional comments regarding building shareholder value, followed by Gwen discussing Core's second quarter 2019 outlook and a general industry outlook as it pertains to Core.

Then Larry will go over Core's 2 operating segments, detailing our progress and discussing the continued successful introduction of new Core Lab technologies and then highlighting some of Core's operations and major projects worldwide. Then we'll open the phones for a Q&A session.

I'll now turn it back to Gwen for remarks regarding forward-looking statements. Gwen?

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Gwendolyn Y. Schreffler, Core Laboratories N.V. - SVP of Corporate Development & IR [3]

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Before we start the conference call this morning, I'll mention that some of the statements that we make during the 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 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 filing that may affect our outcome. Should one or more of these risk or uncertainties materialize or should any of our assumptions prove incorrect, actual results may vary in material respect from those projected in the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise. For a more detailed discussion of some of the foregoing risks and uncertainties, 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 first quarter results. Those non-GAAP measures can also be found on our website. With that said, I'll pass the discussion back to Dave.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [4]

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Thanks, Gwen. Looking at some industry trends and comments on Core's 3 financial tenets. Core is encouraged that operating companies are buying into operating within free cash flow and emphasizing returns on invested capital as they are demanded by today's investors. This trend benefits Core, whose clients tend to be technologically sophisticated and are heavy users of technology over commodity-driven solutions offered by drillers, pressure pumpers and wireline providers.

During the first quarter, Core continued to host several conference calls and industry sessions for various industry groups and analysts to discuss optimal well spacing, rightsizing, upsizing, well positioning and parent-child well relationships. Upsizing is today's watchword.

In 2019, our technologically sophisticated clients will drill fewer wells but better wells. Most importantly, their returns will increase. Core is uniquely positioned to provide technology-driven data to determine optimal well spacing and upsizing to all but eliminate the deleterious effects of horizontal well interference. Detailed analysis of Core and fluid samples provide information to the operator on micro lithologies, rock competence, rock mechanics, crude oil types and qualities, all data necessary to determine optimal well spacing and well positioning.

As horizontal wells are drilled, completed and stimulated, Core's SpectraStim, SpectraScan and FLOWPROFILER EDS completion diagnostics technologies can verify that wells are not interfering with neighboring wells on the pad, eliminating loss production and maximizing producible reserve. This becomes more critical as well pads will soon see 24 or more wells being drilled from a single pad location. The combination of Core Lab reservoir technology related to Reservoir Description and Production Enhancement maximizes our clients' free cash flow and their returns. Their investment goals and ensures Core Lab revenue growth will be greater than activity levels again in 2019. Related to this, the industry will continue to add perforating charge clusters to each stage, yielding less but more complex stages, while lateral lengths are near maximum owing to frictional forces.

Perf clusters are increasing from 5 to 6 per stage to as many as 15, reducing the time and costs for well completion and stimulation programs, owing to the lower stage count. The reasons for more perf clusters and fewer stages are clients changing the way that reservoir rock is being stimulated to produce maximum amounts of stimulated reservoir volume in close proximity to the wellbore.

Long frac channels are to be avoided as they are the source of well interference. It is possible to realize more stimulated rock volume in the near wellbore region and avoid costly well interference program using more perf clusters.

Addressing a new and growing market, the recent acquisition of Guardian Global Technologies has been a technological windfall for Core Laboratories. We have received positive client feedback on our industry-leading, preassembled energetic system via the company's GoGun. The GoGun is an open architecture, allowing all perforating guns to be used. Therefore, each perforating program can be specifically designed based on the reservoir properties and the reservoir type. Our new adjustable Select Fire Switch can fire multiple downhole elements and requires no electrical ramping. Remember, the most critical component of any preassembled gun are the energetics or perforating charges in the gun, and Core's charges are still industry-leading technology. Currently, the market for preassembled guns is small. However, Core projects that the market -- this market will grow to approximately $300 million in 3 years or less. Core is targeting sales of $100 million at the end of that 3-year program, as that is the case of our natural market share in energetics.

The last and most important trend for Core is that client discussions have continued to increase for international and deepwater longer cycle projects that will be needed to meet future production demands. The foreshadow of the increase in activity has been evident in the 20 FIDs approved in 2017, another 30 announced in 2018 when 30 or more queued up in 2019. Revenue from these longer-cycle projects is mainly been absent from Core's reservoir description revenue streams dating back to 2015 and should start to bolster revenue -- description revenue in 2019. Remember that the client curve still always wins and never sleeps.

Now a review of the 3 financial tenets of which Core is used to build shareholder value over the 24-plus year history of being a publicly traded company. During the first quarter of 2019, Core generated $20 million in free cash flow, which equaled 102% of net income, one of the highest percentages in all oilfield services. The first quarter of 2019 marked the 70th consecutive quarter in which Core generated positive free cash flow. In 2019, Core sets a target of converting 90% of all net income into free cash. Core has no plans to cut the dividend. For the past 2 quarters, Core's free cash flow has more than fully funded its dividend. Once again, in the quarter, Core produced the oilfield industry-leading return on invested capital for the 38th consecutive quarter with an ROIC of 20.1%.

Also, during the first quarter of 2019, Core returned approximately $25 million back to our shareholders via our quarterly dividend. In 2019, Core will continue to return all excess capital back to its shareholders via quarterly dividends and expand its share repurchases as free cash flow levels continue to increase.

I'll now turn the call over to Chris for a detailed financial review. Chris?

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Christopher Scott Hill, Core Laboratories N.V. - Senior VP & CFO [5]

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Thanks, David. 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 15%. So accordingly, our discussion today excludes any foreign exchange gain or loss for current and prior periods. Additionally, we have excluded $10.4 million of noncash charges recognized in the first quarter for stock compensation expense and other employment-related charges recognized in the first quarter of 2019. Although these performance share awards continue to be subject to future vesting schedules and company financial performance metrics, recognition of this expense is required by FASB ASC 718 for employees when they attain their eligible retirement age.

Now looking at the income statement. Revenue from continuing operations was $169.2 million in the first quarter comparable to the same quarter in 2018 and slightly above the guidance we gave during last quarter's earnings call. Of this revenue, service revenue, which is more international, was $120.3 million for the quarter, up just slightly year-over-year. Activity from international source projects is anticipated to increase throughout 2019. However, this activity is impacted from typical season -- seasonal patterns in the first quarter. Product sales, which are more tied to North American activity, were $48.9 million for the quarter, down 3% year-over-year and are in line with well completion activity for the U.S. onshore market.

Moving on to cost of services for the quarter are 77% of service revenue, up from 70% in the first quarter of last year. The increase from prior year is primarily associated with increased personnel-related costs and also some loss revenue opportunities as a result of the transitory closures in the Houston ship channel. Cost of sales in the first quarter was 72% of revenue, equivalent to the same quarter of last year and down from 77% in the previous quarter due to operational efficiencies and Core's planned adoption of higher end perforating system energetics.

G&A ex-items for the quarter was $10.2 million. For 2019, we expect G&A ex-items to be around $45 million to $46 million for the year. Depreciation and amortization for the quarter was $5.6 million, which is comparable to the last several quarters. In 2019, we would expect depreciation expense to remain at similar levels and our capital expenditures to also be in line with our operations. EBIT ex-items for the quarter was $26.9 million and continues to represent best-in-class EBIT margin of 16%. GAAP EBIT for the quarter was $16.4 million. Income tax expense for the quarter was $3.5 million using the effective tax rate of 15%. As discussed on our last earnings call, the company's ongoing corporate restructuring has resulted in a tax benefit, lowering the effective tax rate for 2019. On a GAAP basis, this tax benefit has been recognized in the first quarter and resulted in a net income tax benefit of $27.6 million. In the earnings release, a 15% effective tax rate was used for the second quarter guidance to allow for a better comparison of quarter-over-quarter operational performance. For second quarter 2019, we now expect our effective tax rate to be approaching 20%. Additionally, as discussed in prior earnings calls, 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. Income from continuing operations, ex-items for the quarter, was $19.7 million, down from $25.2 million in the same quarter last year. GAAP income from continuing operation, which includes the net tax benefit mentioned earlier, was $40.3 million for the first quarter. Earnings per diluted share from continuing operations ex-items was $0.44 for the quarter. GAAP EPS from continuing operations for the first quarter was $0.90.

Now we'll move on to significant aspects of the balance sheet. Receivables stood at $132.9 million, up a little from year-end but our DSOs have remained consistent at 67 days for the quarter. Inventory stood at $50.1 million, up about $4.5 million from year-end due to some bulk purchases of raw materials and introduction of new product offerings, like the new preassembled GoGun.

Inventory turns were 3.3 for the first quarter, and we anticipate inventory turns will improve as we progress into 2019. The adoption of the new lease accounting guidance resulted in the company recording $77.5 million of lease assets, which have traditionally been reported as operating leases. These lease assets are now referred to as right-to-use assets and represent the underlying asset of the lease. The new guidance also required us to record an equivalent liability on the balance sheet, which represents the present value of the future minimum lease payments.

Moving on to other long-term assets was $121 million, up from prior year-end balance of $62.5 million, which is primarily due to recording the deferred tax benefit as a result of our corporate restructuring mentioned earlier.

And now onto the liability side of the balance sheet. Our long-term debt at quarter end was $297 million, up from $292 million at year-end. Our debt is comprised of our senior notes at $150 million as well as $147 million under our bank revolving credit facility.

Now looking at cash flow. In the first quarter, cash flow from operating activities was $25.2 million. And after paying for $5.2 million in CapEx, our free cash flow in Q1 was $20 million, which is the 70th consecutive quarter Core Lab has generated positive free cash flow. For 2019, the company anticipates that its CapEx will be at similar levels to 2018 as we continue evaluating capital expenditure opportunities like we currently have associated with automating our laboratory facilities and expanding production capabilities for new technologies like the AFS Select Firing Switch and the GoGun.

Our free cash flow conversion ratio, which is free cash flow divided by income from continuing operations, continues to be one of the highest in the industry at almost 102% for the first quarter ex-items. We believe this is an important metric for shareholders when comparing company's financial results, particularly for those shareholders who utilize discounted cash flow models to assess valuations. In the first quarter of 2019, our free cash flow was higher than our net income, as it has been in 13 of the last 17 years.

I will now turn it over to Gwen for an update on our guidance and outlook.

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Gwendolyn Y. Schreffler, Core Laboratories N.V. - SVP of Corporate Development & IR [6]

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Thank you, Chris. During the first quarter of 2019, the worldwide crude oil market shifted into a supply correction, which increased crude oil prices more than 30% sequentially. Additionally, global crude oil inventories exited the first quarter of 2019 at approximately 39 days of consumption, consistent with a multiyear trend of declining global crude oil inventories relative to demand. The International Energy Agency's most recent estimated worldwide demand projections for 2019 remain strong, with demand anticipated to increase 1.4 million barrels of oil per day. The recent rebound in the crude oil prices is underpinned by the rebalancing of crude oil supply and demand and continues to support a broad-based international oil field recovery. The emergence of this trend is reflected in the actions taken by operators to have announced the final investment decisions in 2017. These projects are in the beginning phase of development as indicated by the increase in rigs and other heavy oilfield equipment now coming under contract, particularly in the Middle East, Asia Pacific, the North Sea and Russia regions. Additionally, the international rig count continues to improve since bottoming in the fourth quarter of 2016 and showing sluggish behavior during 2017 and '18. Core believes 2019 international growth is expected to reach mid- to high-single-digit levels.

As has been the case in past industry recoveries of worldwide operating activities, Core's worldwide revenue growth and margin expansion is not immediately correlated to increasing rig counts but to subsequent completion and stimulation events and large-scale reservoir rock and reservoir fluid characterization projects. Wells need to be drilled, rock and reservoir fluids sampled and wells completed before Core realizes a revenue opportunity. The company projects the average second quarter 2019 U.S. rig count to be down but U.S. completion activity is expected to be flat sequentially.

Capital conservatism by operators may limit growth activity in the second quarter of 2019. Therefore, we expect consolidated second quarter 2019 revenue of approximately $172 million to $175 million, and operating income of approximately $28.5 million to $30 million, yielding operating margins of 17%, with incremental margins, ex-items, exceeding 50%. Using a comparable sequential effective tax rate of 15%, EPS for the second quarter 2019 is expected to be approximately $0.47 to $0.50. The company's second quarter 2019 guidance is based on projections for the underlying operations and excludes gains and losses in foreign exchange.

Now I'll hand it over to Larry for an operational review.

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [7]

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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 is the foundation of Core Lab's success. Turning first to Reservoir Description, 1 year ago, during Core Lab's 2018 Q1 earnings release, Core announced that it had expanded laboratory capabilities at its Anchorage office to include dual-energy computed tomography or CT scanning as well as other proprietary laboratory technologies.

In Q1 of 2019, the North Slope region of Alaska was again very active for reservoir description. Extensive reservoir rock and reservoir fluid studies were undertaken on multiple wells from conventional reservoirs. The data derived from these studies are key components of the operators' efforts to refine this stratigraphic models, obtain rock property's data for downhole log calibration, determine permeability parameters that are critical for predicting reservoir performance and understand the in situ phase behavior characteristics of the hydrocarbons.

In-house CT capabilities in Anchorage allow Core's clients to assess the recovered hole core intervals within just a few days of the Core's arrival at the laboratory. Moreover, Core can provide its clients with parameters such as porosity, lithology and rock strength that are based on models validated by Core's proprietary worldwide database of physically measured rock properties. Following the CT and other initial lab work, the rock and reservoir fluid samples are now moving through the traditional laboratory program where direct physical measurements will be used to define pay zones, build reserve estimates and predict reservoir performance. PVT testing and compositional analysis of the hydrocarbons are vital inputs in determining other crude oil and natural gas properties will change throughout the life of the field.

During most years, drilling activity in Alaska largely comes to an end at the conclusion of the winter drilling season on the North Slope. Part of Core Lab's strategic plan to expand capabilities at its Anchorage laboratory was the recognition of emerging onshore Alaska plays, where drilling and sampling of reservoirs will occur during the summer months. Core has been awarded projects onshore Alaska where both conventional and unconventional reservoir targets will be assessed.

During Core's 2018 Q4 conference call back on January 31, 2019, Core announced that it had expanded its laboratory facility in Ciudad del Carmen in Mexico, including the introduction of patented and proprietary wellsite side Core handling technologies required for upcoming offshore Mexico projects. In line with this, in the first quarter of 2019, Core Lab, under the direction of Talos Energy, was engaged in wellsite processing, core stabilization and the initial stages of laboratory analysis on over 700 feet of conventional core recovered from the Talos Energy Zama-2 ST1 delineation well located in Block 7 of the Sureste basin, Gulf of Mexico.

High-quality hole cores recovered from the shallow oil bearing sands for comprehensive laboratory evaluation. Several proprietary core preservation and stabilization techniques that were developed by Core Laboratories for sandstone reservoirs on the U.S. side of Gulf of Mexico have been successfully applied to these new cores from offshore Mexico. These wellsite technologies are critical for preserving intrinsic rock properties, thus eliminating damage during handling and transportation to the laboratory. Upon arrival at the laboratory, these cores were immediately scanned using Core's proprietary, noninvasive, dual-energy CT and high-resolution spectral gamma-ray detectors. These surface logging tools provided Talos Energy with lithologic data as well as a wide range of critical parameters for pay assessment, well in advance of the results derived from time-honored laboratory analytical methods. The combined efforts of U.S. and Mexico-based Talos Energy and Core Lab employees were leveraged in fast-tracking results to evaluate this significant oil reservoir. Core is pleased to have been part of this unprecedented wellsite achievement and looks forward to completing the detailed geoscience and engineering studies.

Moving now to Production Enhancement, offshore Gulf of Mexico operators, primarily in the Deepwater, have been employing Core -- Core Lab's SpectraStim technology to trace the leading edge of cement jobs on intermediate casing strength. This technology allows the operator to identify the top of the cemented interval and confirm adequate cement coverage over the zone of interest. The results of this service satisfied Bureau of Safety and Environmental Enforcement regulations. The SpectraStim service eliminates the traditional need and cost of a cement bond log, saving approximately 24 hours of costly offshore rig time. Recently, an operator on the outer continental shelf that had employed the SpectraStim technology observed that the top of the cement was only halfway through the intended coverage interval. The operator identified a potential well-control problem, remediated the situation and ultimately satisfied the Bureau of Safety and Environmental Enforcement.

Also, in the first quarter, Core's production enhancement energetic engineers partnered with a major operator in the Eagle Ford to develop a perforating solution for their mechanically isolated recompletion program. Plush joint tubulars were running the hole and cemented inside the well's previously perforated casing. Core's proprietary refrac perforating solution, the first offering of its kind, was then placed in the well and triggered, providing optimal and consistent holes through both strings of tubulars. This allowed for new zones in the lateral to be effectively pumped and stimulated. The refrac system also allowed the operator to double the number of stages that could be perforated in a single day when compared to conventional perforating techniques, thus substantially reducing operating costs for Core's client. Advances such as Core Lab's proprietary refrac technology are key to successfully expanding recompletion opportunities across mature, conventional plays.

That concludes our operational review. We appreciate your participation, and Zed will now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) First question is from Byron Pope from Tudor, Pickering, Holt.

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Byron Keith Pope, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [2]

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Just wanted to start with international. I appreciate the color on the mid- to high-single digit expected international revenue growth. And I realize that the geographies where the core and fluid samples are taken don't always match up with where -- the labs where the analysis is done. But could you just provide some color on which international countries or regions are most likely to drive your international top line growth this year?

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [3]

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Yes, Byron. I think the Middle East stands out as one area that is, I would say, kind of ahead of the pack in international recovery. Of course, we're going to continue to see robust activity offshore of the northern part of South America for quite some time. So that's already kind of running at a high clip. But I think the Middle East is when you compare sort of year-over-year or the -- from the bottom of the cycle to where we are today, I think the Middle East is ahead of the curve in recovery. And I think looking a little further down the line, I think Brazil is posing some new opportunities for us.

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Byron Keith Pope, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [4]

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Okay, appreciate that. And then I was really struck by the potential size of the preassembled perf systems' market the way you framed it, Dave, and I realize you said it's a fairly small market today. But anyway to ballpark how you think the size of that market today versus the $300 million market you expect it to be within the next 3 years?

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [5]

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Yes. Probably somewhere in the order of $50 million to $60 million size market today. We see that rapidly expanding because more and more of the clients that we talk with, they're interested in this preassembled gun but very interested to the preassembled gun using our energetics. So we think we're going to have some rapid market share gain in that area. And the expense is going to be the conventional perforating where I think, naturally, this will take market share from the conventional into the preassembled.

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Operator [6]

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The next question is from the line of Chase Mulvehill from Bank of America.

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Chase Mulvehill, BofA Merrill Lynch, Research Division - Research Analyst [7]

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So I guess just a follow up on Byron's question here, a lot of positive commentary on the international and offshore side. So maybe if you can just kind of lay out the roadmap about the reservoir description given this positive backdrop, maybe by -- when we think about sequential growth throughout the year, when we think about 2019, are you comfortable kind of being in the mid-single digits? Should we kind of be more in the high single-digit growth for Reservoir Description?

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [8]

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I think we should track along with the improvements with 80% of Reservoir Description's business being in the international market, we ought to track along with that plus a bit more. Historically, Core Lab will do a little bit better than the overall trend. So the high-single digits maybe with a little bit added on top of that for Reservoir Description.

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Chase Mulvehill, BofA Merrill Lynch, Research Division - Research Analyst [9]

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Okay. Right, that's very helpful. And then I know that you guys have kind of been under absorbed in reservoir description, so what about incrementals, just as we step through each quarter, what kind of sequential incrementals should we think about as revenue continues to show positive progression in 2019?

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [10]

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Yes. I think we see that as exceeding 50%.

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Chase Mulvehill, BofA Merrill Lynch, Research Division - Research Analyst [11]

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Okay. All righty. Last one, just any updates that you have on unconventional EORs in the adoption rate that you're seeing from your customers.

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [12]

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Yes. So it continues to be a very nice story. Some companies are becoming more vocal about their participation and their progress in the field with this. And one that has publicly talked about it is OXY. I'll refer you to the good folks at OXY and their great IR team and management team for details of what they're finding. But they've expressed some optimism that they see this moving into a commercial practice I would say in the near term. A lot of upside there for a lot of clients.

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Operator [13]

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The next question is from the line of Stephen Gengaro from Stifel.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [14]

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Dave, a couple of things. I just wanted to hit on -- on -- back to the integrated perf gun system, I'm just curious about how you're thinking about the market. And I think you mentioned the market like $50 million going to $300 million. And I'm just trying to figure out, what are including kind of in that market? And do you think the data that the overall perf market right now is kind of in the $1.3 billion range and the integrated gun portion is that small a piece right now? I'm just struggling to sort of triangulate what I've heard with those data points.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [15]

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Yes. We'll stick by our data points. We're mainly looking at the part that or the elements that we want to control. And that's going to be the hardware, the energetics and the det cord. And so we're comfortable with where we see that market today and where it's going to in 3 years or less.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [16]

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And so when you define the integrated gun, you're just -- you're talking about those components of it or you're talking about the overall revenue opportunity when you sell an integrated system, all the pieces that go with that into the hole for the energetics and the detonating cords and the switches, that overall market is only $50 million or $60 million right now?

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [17]

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For the clients that we're going to address, that is correct.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [18]

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Okay. How do you see, on the Production Enhancement side, how do you see the revenue playing out there as we go forward and kind of what are you thinking about just from an overall U.S. land completion market growth over the next several quarters? And how do you think your Production Enhancement division reacts within that framework?

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Gwendolyn Y. Schreffler, Core Laboratories N.V. - SVP of Corporate Development & IR [19]

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So Stephen, we saw completions were up about 4% year-over-year while our energetics sales were up about 9% year-over-year. We think moving into Q2, completions, while they may be flat, potentially slightly up. We think the intensity of those completions is going to be greater. So greater penetration into our customer base and then additional penetration with this preassembled gun into that market. So we see that -- well, we continue to see that to ramp as the year continues to play out.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [20]

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Okay. Great. And as far as the incremental margins looking, and I think you referenced like 50% plus sequential incrementals in RD in response, I think, to Chase's question. How does that look on the Production Enhancement side?

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [21]

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About the same.

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Operator [22]

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Next question is from the line of Sean Meakim from JPMorgan.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [23]

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So just to come back to the growth rate for international and Reservoir Description. So if we're thinking about 2019 high-single-digit growth year-on-year, if you're generating lower single-digit growth in the first half, does that -- that seems to require a steeper second half '19 ramp year-on-year to achieve the overall. Is double-digit year-over-year growth in the back half plausible? Do you have visibility on projects ramping with that type of cadence?

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [24]

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It's a little -- we don't want to get ahead and -- we're not ready to give full year guidance or quarterly guidance for Q3 and 4 right now. But we do see the trend improving, and I do think you're right, we will see it build through the year, and we'll stick with our overall assessment, mid- to high-single digits improvement and with our typical expectation of Core Lab will be a little bit better than the overall trend.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [25]

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Okay. That's fair. And I guess thinking about the margin progression that goes along with that, one is the -- just to clarify, the 100 basis point ding that you had in the first quarter, is that basically factored back in -- added back into the second quarter? And I'm just thinking about what's the plausible expectation for RD margin to exit the year? Is there -- another way of putting that, what's the margin potential for that business near term without the return of deepwater core work?

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [26]

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Yes. I think we head towards high teens for an exit margin on reservoir description. I think that's attainable. The 100 bps impairment that we saw in the first quarter tied to the ship channel interruption, that's less than 1% of revenue for Reservoir Description on the quarter, but 100% decremental. So as that gets -- comes back online and there's a little bit of seasonality in that business as well, as that gets back online, we think that comes back and supports sequential growth over what you saw in Q1.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [27]

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Yes, Sean. If you look at the coring programs laid out by our clients here over the last couple of quarters, it gives us confidence in getting those margins back in the mid- to high teens on exit for the year.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [28]

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Got it. Thank you for that. I think that's helpful. And then just one last point of clarification around that same piece. What would you say is the split today in your offshore business for RD between shallow water and deepwater?

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [29]

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Yes. We tend to slice it a bit just onshore and offshore.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [30]

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I would say, still, the majority would be deepwater offshore if you're looking to split shallow water and deepwater.

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [31]

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Among the marine activity, yes, I would say, since the projects are so much more lucrative and high caloric for us on the deepwater, I think our revenue opportunity would lean toward -- the bulk of the revenue opportunity being more on the deepwater side.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [32]

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Yes. If I had to venture a guess just on the back of the envelope, I would say, today, just on looking at maintenance operations, deepwater, probably 70% of our offshore revenue is deep and 30% shallow.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [33]

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And that's more -- that would be more fluids driven, you're indicating because that's...

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [34]

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And that is correct right now. That, of course, will shift as the year progresses and some of the coring programs kick in.

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Operator [35]

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The next question is from the line of Vaib Vaishnav from Scotia Howard Weil.

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Vaibhav D. Vaishnav, Scotia Howard Weil, Research Division - Analyst [36]

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I guess, can you just help us with some magnitude of revenues view on, on an exploration well versus a production well? And how different is it, if you can expand on that, for the shallow water versus deepwater.

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [37]

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Yes. I think, Vaib, there is no one-size-fits-all answer to a deepwater project. It really comes down to the complexity of the reservoir. Unfortunately, for our clients, the easy reservoirs have largely been tapped. The most complex reservoirs are what's having to be addressed going forward. And that's good for Core Lab. The more complicated they are, the more data that they'll need to unravel the performance of the project.

Overall, historically, deepwater projects tend to be of greater value or greater opportunity for Core Lab because the risks are so high for the operator in making a mistake. They make an error of a porosity unit or 2 in their model it has huge implications for the overall economic viability of the field. So they'll take much more intense, much more densely-packed data sets on these deepwater projects. And so we see -- we're very optimistic as those start to filter back into Core Lab's Reservoir Description portfolio, those are pretty nice projects for us.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [38]

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Yes, Vaib, in less than 15% of our revenue generated out of Reservoir Description is exploration related. So we tend to be there on appraisal and development wells. They see -- the operator sees the risk too high to take core samples in that first or second exploration well.

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Vaibhav D. Vaishnav, Scotia Howard Weil, Research Division - Analyst [39]

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Got it. And can you help us just think about -- if I think about international revenues for you, specifically for Reservoir Description, is it all offshore or is there is some onshore split as well?

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [40]

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It's onshore as well.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [41]

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Yes. If you look at Reservoir Description, about 30% of all oil is produced offshore. 40% of our revenue, mostly reservoir description, is from the offshore. That tends to have higher margins for what Larry said. And so 60% onshore around the globe.

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Vaibhav D. Vaishnav, Scotia Howard Weil, Research Division - Analyst [42]

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Got it. And last question for me, can you help us just reconcile? So you think the activity out of U.S. completions would be flat sequentially into 2Q. But the other companies who are focused on, you may call it pressure pumping or completions, I'm talking about higher completions activity. Is there a way you can help us reconcile the 2 comps, the different comps.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [43]

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Yes. And -- yes, Vaib, if you look at, as Gwen said, we project rig count to be down slightly here in the near term, completions to be flat. Owing to my comments on our technologically sophisticated clients will drill less wells. So that subset will have less completions on the intensity side where we're going to have more perf clusters per stage and less stages will offset that. So our total revenue opportunity probably will be up even if completions, as we see it in our eyes, for our technologically sophisticated companies, will be flat. The intensity of those completions will be up, giving us a revenue opportunity. You've already seen some of our best clients dropping -- plan to drop rigs like Pioneer, and so this is not going to be a surprise to us.

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Operator [44]

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The next question is from the line of Connor Lynagh from Morgan Stanley.

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Connor Joseph Lynagh, Morgan Stanley, Research Division - Equity Analyst [45]

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I'm wondering if we could go back to the integrated gun opportunities, so the $300 million potential. It sounds like some of that is gaining share from nonintegrated solutions, but I guess I'm wondering if we could talk to the broader energetics market, just what sort of growth you see with the cluster increases.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [46]

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Yes. With the increase in the number of clusters per stage, certainly, we see continued growth over what the market would suggest because you're just packing more complex systems into that. So as we go now, we're seeing the number of clusters per stage from 5 to 6. We've had them 20-plus. So again, we see further growth and not the number of stages but the complexity per stage.

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Connor Joseph Lynagh, Morgan Stanley, Research Division - Equity Analyst [47]

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And any sort of magnitude you can give us on where -- if the market average is at 5 to 6, I think you said, how much growth in that market can you see above and beyond just stage count.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [48]

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Yes. Sequentially, as Gwen had mentioned...

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Gwendolyn Y. Schreffler, Core Laboratories N.V. - SVP of Corporate Development & IR [49]

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We would see that the energetic sales would be up because of that intensity. And I think, overall, what has typically happened is we've kept pace or outpaced the completion activity.

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Connor Joseph Lynagh, Morgan Stanley, Research Division - Equity Analyst [50]

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Yes. I appreciate that. I guess I mean more longer term what's the potential opportunity here, I mean? Is everybody going to go to this extremely high intensity or what do you feel the ultimate growth potential is?

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [51]

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Well, certainly, that's going to be a bifurcation of clients. Those that are looking to increase returns and maximize production and recovery will do that. So what we refer to as our technologically sophisticated clients because they have to spend more money. There will be operators that will choose not to do that, and hence their returns are going to be substandard as they are today. They choose not to use Core Lab. So it's hard giving you a number and knowing that we're just dealing with a subset of companies that are out there.

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Operator [52]

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The next question is from the line of Scott Gruber from Citigroup.

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Scott Andrew Gruber, Citigroup Inc, Research Division - Director and Senior Analyst [53]

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I wanted to stay on the topic of the day, the preloaded guns. If you could provide some color on how you think about how much of the $100 million opportunity for Core is incremental? So if we keep the frac market just flat for the next 3 years and you see that market share pick up for the preloaded systems and you realize $100 million, how much benefit do we see on your production enhancement revenue run rate?

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [54]

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It would be the incremental margins associated with that switch; from a conventional gun system to a preassembled system because that is going to be a more expensive system. So your incrementals will be very high on those sales. And so you might not see significant shift in us picking up $100 million in revenue in the third year of that development. But the amount of revenue we do pick up will have a -- be very high incremental margins. So that's what I think you need to watch there.

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [55]

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I think it's important at the end of the day to come back to reinforcement, as Dave said earlier. At the end of the day, the preassembled guns are a very nice technology that's been brought to the market. It's derisked a lot of wellsite activities. But the driver ultimately is the quality of the energetics and how effectively, efficiently and cleanly they make preparations into the casing and into the formation. And that's where Core Lab has really has had an advantage in large measure because of our deep understanding of the rocks and how these energetics interact with the rocks. We have some unique perspectives on that. There's been a -- there was a early entrance into the preassembled gun system. They deserve some credit for seeing that path. But that moat, if you will, has been pierced. And at the end of the day, it's the quality of the energetics that are going to drive penetration into the market.

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Scott Andrew Gruber, Citigroup Inc, Research Division - Director and Senior Analyst [56]

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Got it. Understood. And maybe just a bit more color on the profitability because it sounds like it's going to be a margin enhancer for Production Enhancement. Can you either provide the potential margin on the de-integrated system or maybe if you don't want to go there, how about...

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [57]

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We'll just say that the incrementals could be north of 60%, and ultimately Production Enhancement at the end of those -- at the end of that time period could see their margins back with a 3 in front of it. Peak margins there in '14 were 36%. So we see ourselves working back towards that. We knew that this market was under development. And 3 years ago we tried to build our addressable Select Fire Switch. Our ballistic engineers turned out to be much more superior than our mechanical engineers. And so we went out and acquired Guardian Technologies after working with them for about a year, 1.5 years.

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Scott Andrew Gruber, Citigroup Inc, Research Division - Director and Senior Analyst [58]

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Got it. And just so much as at the end of the day, how do we think about this opportunity manifesting? How do we think about that $100 million kind of opportunity? What's the cadence? Is it -- do we just think about it linearly? Is it going to be a little faster than linear? Just kind of how do we think about that...

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [59]

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It won't be linear. It won't be linear because once you have some acceptance from the industry, you get a herding mentality where you have everybody wants that variety of gun system. So it will be -- I don't want to say exponential, but it will not be linear.

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Scott Andrew Gruber, Citigroup Inc, Research Division - Director and Senior Analyst [60]

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Do you think you'll hit that inflection on the S-curve for the next 12 months?

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [61]

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Probably not. I would guess between 12 and 24.

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Operator [62]

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The next question is from the line of Marc Bianchi from Cowen.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [63]

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I wanted to ask about the ship channel disruption, and I know it's a transitory thing, but I think it's important to kind of go through it as we think about normalized results beyond second quarter. If I do the math and give you the benefit of that not impacting your results in the first quarter, it seems like the second quarter guide kind of implies incrementals overall in the 30% range. If that's kind of the underlying, and I think Larry you made the comment of sort of longer-term thinking about over 50%, what's the change in the business? Is there maybe more Core description that's happening -- beyond the second quarter? Is there more pricing happening? Just curious if you could comment on that progression.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [64]

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Yes. Marc, I think we see a lot more deepwater offshore work scheduled for our 2H. And that's what prompts us to say we're comfortable with incrementals in the greater than 50% range and approaching 60% range.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [65]

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Great. Okay. Thank you, Dave. And then, Chris, just a point of clarification, you made a comment about the tax rate for second quarter and I didn't quite catch what you were saying there. I think you said you expect it to be towards 20% but you're guiding to 15%. Is that the right description or maybe you could just clear that up?

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Christopher Scott Hill, Core Laboratories N.V. - Senior VP & CFO [66]

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Yes. We wanted to make sure it was clear when you try to compare operational performance from first quarter to second quarter that you're not getting the tax rate mixed up with that. So we've guided using a 15% tax rate, so you can see what EPS is based on operational performance. But as we're working through these corporate restructuring events that we've had where we are projecting a more normalized rate to kind of approach -- approaching 20% as we move through the rest of the year. The benefit from that had to be recognized all in the first quarter. So that's what we're talking about.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [67]

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So when we think about the business longer term, is the implication that we should be thinking about something closer to 20%?

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Christopher Scott Hill, Core Laboratories N.V. - Senior VP & CFO [68]

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Yes.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [69]

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And Marc, that's why we offered up the range of what we felt the second quarter would be in operating income. You see it declines nicely from that, which was performed in Q1.

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Operator [70]

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The next question is from the line of Kurt Hallead from RBC.

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Kurt Kevin Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [71]

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Sorry, just a couple, might as well take the follow-up and the opportunity that kind of Marc mentioned on the tax rate, just to make sure that I'm clear on it. So when we do calculate our earnings per share estimates starting in the second quarter, we should be using a tax rate that is close to 20%, not a 15% tax rate. Is that the right way to look at it?

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Christopher Scott Hill, Core Laboratories N.V. - Senior VP & CFO [72]

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Yes, that's correct.

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Kurt Kevin Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [73]

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Okay. So Dave or Larry, whoever wants to kind of take this, so talking about the -- kind of an emerging growth opportunity in the preassembled perforating gun market, and I was just kind of curious, you've had -- there's been some market noise out there from some of the competition, some concerns on the investor base regarding that increased competition, meaning, Core Lab is going to lose market share potentially and maybe even the market may undergo some pricing pressure and margin degradation. So I was wondering if you can kind of help us out and give us some insight as to what the competitive advantage is for Core Labs and what the value proposition is that you're offering up for the E&Ps that maybe some of your competitors don't have or can offer?

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [74]

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Yes. Kurt, I think I would go back to what I said before. Remember that the preassembled gun is a delivery platform. The driver of any perforating hardware is how well it creates communication between the formation and the borehole. And you'll be hearing more from Core Lab over the next few quarters here about some advances we're making, closely tying energetic performance to a wide range of rock properties. Think of this as geologic formation-specific energetics. We can do that and we've put a fair amount of intellectual horsepower behind this already, working to tune the energetics to be effective in specific types of rock. With our reservoir description knowledge and foundation, we're in really in rather unique position to amplify on that expertise. And we think that's where the leverage comes in going forward.

Another aspect of the preassembled gun, we've worked toward an open architecture design, which will allow people to buy, if they should choose, preassembled guns and use a wide range of energetics that we or potentially other people might provide. Others in this space have gone to closed architecture, which means you buy their preassembled gun and you get their energetics. One of the things that that does is if you buy a certain configuration and get it out to the wellsite and then you decide it's not working the way I thought, you can't change on the fly. With our open architecture system, we can send out a different set of energetics and change the completion program in relatively quick order.

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [75]

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Yes. Kurt, think about it this way, and this has always been the case. The money is always and the profitability has always been in the energetics. The gun is just the delivery system. Conventional guns we rarely make anymore. We can buy them cheaper than we can make them. And the preassembled gun, given the piercement of that moat by us and no doubt others to come, you will see less emphasis put on the preassembled gun. And again, more and more emphasis on the formation-specific perforating charges that we are going to be developing here over the next year.

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [76]

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There was some industry conversations recently where -- and it's kind of hard to get hard numbers on this, but estimates that maybe 15% of the gun market in the U.S. were preassembled guns. Well, that's an area that previously we hadn't been participating in. Today, we are participating in a sort of an entryway, but we'll be penetrating that market more going forward. So here we come.

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Kurt Kevin Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [77]

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Okay. And that's awesome. And at the end of the day, who makes the ultimate, say, purchase decision with respect to what you're offering? Is it the E&P company, or is it kind of a wireline service company?

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [78]

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Well, for us, it's a lot of the E&P company. For instance, we had a conference call on this 1.5 week ago. Our first call was from a technologically sophisticated client from West Texas, from the Permian Basin area, wanting to know what our offering was. So ultimately, because our charges tend to be the most expensive in the industry, we're not going to let a wireline company decide that. We're going to let the operating company or the E&P company decide to choose our charges.

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Lawrence V. Bruno, Core Laboratories N.V. - COO, President & Supervisory Director [79]

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And it's important to recognize that the wireline companies play a critical role in this. They have a license to possess these energetics just like we do. The operating companies do not. So we have to -- we do and we will maintain great relationships with the wireline companies because at the end of the day that's who we transfer ownership of these energetics to.

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Kurt Kevin Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [80]

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That's great color. If I may wrap up with this. So on Reservoir Description, I know, Dave, you guys have been highlighting the FID component, and as you've mentioned, it's really -- the revenue opportunity comes once the well has been drilled and fluids and rocks have been collected and then made their way through your lab, right? So looking at the bigger hues, international offshore rig count looks like it's up 28% in the first quarter of '19 versus the first quarter of '18, you guys...

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [81]

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We're excited about that.

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Kurt Kevin Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [82]

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Yes. I was going to say, so now looks finally there's some momentum building. You gave some good reference points. So in the context of the outlook for high single-digit percentage, can we expect that growth rate, given the rig count growth rate year-on-year, that revenue momentum building throughout the course of the year and then maybe even being higher in 2020? I mean, any general thoughts around that dynamic?

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David M. Demshur, Core Laboratories N.V. - CEO & Chairman of Supervisory Board [83]

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Yes. If we can keep crude oil prices where they're at right now, we think we would see that.

All right, Kurt, so we're going to go ahead and wrap up Zed. So in summary, Core's operations continue to position the company for activity levels in the second quarter of 2019, and we know significant challenges await. However, we have never been better operationally or technologically positioned to help our clients to maintain and expand their existing production base. We remain uniquely focused and are the most technologically advanced reservoir optimization company in the oil field services sector. This positions Core well for the challenges ahead. The company remains committed to industry-leading levels of free cash generation and returns on that invested capital, with capital being returned to our shareholders via dividends and future opportunistic share repurchases. So in closing our 95th quarterly earnings release, we'd like to thank all of our shareholders and the analysts that follow Core. And as already noted by Larry Bruno, the Executive Management and Board of Core Laboratories gives a special thanks to our worldwide employees that have made these results possible. We are proud to be associated with their continuing achievements. So thanks for spending time with us this morning, and we look forward to our next update. Goodbye for now.

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Operator [84]

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Thank you, sir. Ladies and gentlemen, the conference call has now concluded. Thank you for attending today's presentation. You may now disconnect.