Core Laboratories Inc (CLB) 2010 Q2 法說會逐字稿

Good morning. My name is Brandy, and I will be your conference operator today. At this time I would like to welcome everyone to the Core Lab second quarter 2010 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (Operator Instructions). Thank you.

I would now like to turn the call over to David Demshur, Chairman, President, and CEO of Core Labs.

Good morning in North America. Good afternoon in Europe, and good evening in Asia Pacific. We would like to welcome all of our shareholders, analysts, and most importantly, our employees to Core Laboratories second quarter 2010 earnings conference call. This morning I am joined by Dick Bergmark, Core's Executive Vice President and CFO. Also this morning we are then joined by Core's COO, Monty Davis, who will present a detailed operational review.

The call will be divided into five segments. Dick will start by making remarks regarding forward-looking statements. Then we will come back and give a brief investor update, and highlight the three financial tenets by which Core's executive management executes the Company's growth management. We believe these three tenets have produced industry-leading shareholder returns, and returns on investor capital. We will discuss the long held philosophy of returning excess capital back to our shareholders. Dick will follow with a detailed financial overview and additional comments regarding building shareholder value, and then make some comments about our third quarter 2010 revenue and earnings guidance, and then Monty will go over Core's three operating segments, detailing our progress, and discussing the continued successful introduction of new Core Lab technologies and services, and then highlight some of Core's operations and major projects, and then we will open the phones for the Q&A session.

I will turn it back over to Dick for remarks regarding forward-looking statements. Dick?

Thanks David. Before we start the conference this morning, I will mention that some of the statements that we make during this call may include projections, estimates and other forward-looking information. This would include any discussion of the Company's business outlook. These types of forward-looking statements are subject to a number of risks and uncertainties relating to the oil and gas industry, business conditions, international markets, international political climate, and other factors including those discussed in our 34 Act filings that may affect our outcome.

Should one or more of these risks and uncertainties materialize or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. For a more detailed discussion of some of the foregoing risks and uncertainties, see item 1A Risk Factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, as well as the other reports and registration statements filed by us with the SEC.

With that said, I will pass the discussion back to David.

Thanks, Dick. I would like to give a brief investor update. The second quarter of 2010 marks Core Laboratories 60th quarter of being a public traded company, during which time Core Lab shares have advanced over 28-fold, from $2.86 per split-adjusted share on our IPO, to approximately $82 per share this morning.

Our growth strategies and the execution by our operating units have served our clients, our employees, and our shareholders well. Core's continued focus on international crude oil-related developments over North American natural gas markets, and the continued internal development of new technologies and services, have led to a sustained growth and increased profitability. Over the last decade Core's ten year, five year and three year total shareholder return has outpaced all major oil field services companies, as recently listed by Bloomberg Financial.

Core has followed and will continue to follow three key investment tenets that have lead to these industry-leading returns. These three tenets are,number one, maximizing free cash flow through fiscal discipline. Core follows a strict discipline for allocating capital for investment in our growing business, unless certain return on capital standards are met or exceeded, the capital expenditure is disallowed. On average over the past 30 years, the Company has determined that an appropriate capital allocation generally equals the amount of annual depreciation, currently at approximately $24 million to $25 million per year, or about $0.50 per diluted share.

Potential acquisition opportunities must pass these same high standards. This discipline produced a record high free cash flow of $2.08 per diluted share during the first half of 2010, which is one of the highest, if not the highest, for all oilfield service companies. Core will continue to demonstrate strict financial discipline in 2010 and beyond.

Our second tenet is maximize return on invested capital. Core's Board has initiated an incentive compensation program for its executive and senior management teams, based on the Company producing a return on invested capital in the top decile for oilfield service companies. Core's Board believes that stock price performance over time is directly related to return on invested capital. Based on the most recent calculations available from Bloomberg Financial, Core's return on invested capital was over 32% in the second quarter, and was more than 26 percentage points higher than the peer group average listed by Bloomberg Financial, and was more and this five times the peer group average.

Investors should also note that some oilfield service companies had returns below their weighted average cost of capital, a product of overinvestment in their company, or. overpayment for perceived growth via acquisition. Core strives to have industry-leading returns on invested capital, through continued execution of our growth strategies coupled with strict capital discipline. We believe that our commitment to both in 2010 will result in continued superior share price performance for Core's shareholders.

The third tenet is return excess capital to our shareholders. Since 2002, Core Laboratories has returned excess capital to our shareholders in the forms of share repurchases, dividends, and special dividends. Since 2002, Core has returned over $800 million, or over $17 per diluted share to our owners, when including the dividends and special dividends that will be paid in a few weeks. With year-over-year cash balances continuing to grow, Core shareholders can expect more capital return in 2010 via dividends and possibly more share repurchases. We will continue to follow these three key investment tenets throughout 2010 and into 2011, and this should enable Core to continue to produce industry-leading returns for all of our shareholders.

So now I will turn it back over to Dick for the detailed financial review.

Okay. Thank you, David. If we go to the financial statements on the press release, revenues were $198.9 million in the second quarter versus $167.3 million in the second quarter of last year, and $188.3 million last quarter. So revenues were up 18.9% year-over-year, andsequentially they were up almost 6%. Of these revenues services for the quarter were $153 million, up year-over-year when compared to $134.7 million in last year's second quarter,an increase of $18 million, or 13.6%.

Product sales for the quarter were $45.9 million, up over 40% when compared to $32.6 million in last year's second quarter. So improving activity levels in the US along with strong international sales created the majority of this positive variance.

Moving on to cost of services for the quarter, 63% an improvement sequentially from 66.5% or 63.6% for all of last year. Cost of sales in the second quarter they were 70.8% of revenues, versus 75.5% in last year's second quarter, and 74.6% for all of 2009. This improvement in cost of sales is reflective of higher product sales being run through our manufacturing cost structure.

G&A was $9.2 million, up from $6.7 million in the prior year. This quarter we incurred unexpected building maintenance costs and additional compensation expenses. But our year-to-date G&A at $15.6 million is slightly below last year's year-to-date $16 million, and is on track with our prior guidance for the full year of $32 million.

Depreciation and amortization for the quarter was $5.8 million, virtually unchanged from last year's second quarter. We expect depreciation in 2010 to total approximately $23 million. Other expense in this quarter was $1.3 million, which compares to a gain of $800,000 last quarter, the majority of the difference relating to foreign currency translation. EBIT for the quarter adjusted for foreign exchange was $55.4 million, which was $2 million higher than our initial guidance for the quarter, and better than our second quarter adjusted earnings in 2009 of $46.3 million. GAAP EBIT in the quarter was $53.7 million versus $51.7 million last year.

Now let's talk about margins. Second quarter EBIT represents operating margins of 28% excluding foreign exchange, matching our highest-ever reported operating margins. Interest expense was $4.1 million for the quarter, with $3.9 million of that being noncash. We expect interest expense in 2010 to be approximately $16.5 million, with $15.6 million of that, or $0.22 per share being noncash.

Income tax expense was $15.2 million, which is a slight increase over last quarter's tax expense. Our tax rate in the quarter was just under 31%, and we expect our effective tax rate for the remainder of 2010 to be in the 31% to 32% range.

Net income for the quarter $34.2 million, ahead of last year's second quarter's net income of $29.8 million. Earnings per share were $0.75, compared to the $0.62 earned in the second quarter of last year, and $0.69 earned in the first quarter. Earnings were up 20% year-over-year. And these EPS numbers do reflect our two-for-one stock split which was effective July 8, and exclude FX and other one-time charges. GAAP EPS for the quarter was $0.71.

If we go over to the balance sheet, year-over-year quarter cash balances increased by over $70 million to $173.6 million,compared to the prior year end balance, cash was down $7.4 million, as we used $106 million of our cash year-to-date for continuing our stock repurchase program, paying cash dividends to our shareholders, and acquiring a small technology business.

Receivables stood at $137.6 million, up from $133.8 million at year end, primarily due to improving revenues this quarter. DSOs in the quarter though did improve again to 62 days, as compared to 66 days for the fourth quarter of 2009. Inventory despite the significant increase in product sales, inventory levels are up only slightly to $33.8 million from our year end balance, as a result of our $3 million opportunistic bulk purchase of raw materials. Otherwise inventory levels would have improved. Inventory turns have increased more than 23%, now at 4.2 turns, versus 3.4 in Q4 of last year.

Other current assets decreased from year end balances by $14.6 million,primarily due to the realization of income tax receivables. There are no material changes in PP&E. Intangibles, goodwill and other long-term assets are unchanged from last quarter, but year-to-date they are up $9.2 million, as a result of a small acquisition we made in the Production Enhancements segment.

On the liability side of the balance sheet, our Accounts Payables were $39.5 million up from prior year end balance of $33 million, primarily due to the increase in business activity, and that bulk inventory purchase of raw materials in June. Other current liabilities increased $7.7 million from $73.4 million at year end, due to an increase in income tax payable.

Our senior notes continue to be classified as current, and are available for early exchange in the third quarter. This early exchange option and current classification occur in any quarter when our share price exceeds the conversion premium by 30% over 20 of the last 30 trading days of the prior quarter. This reclassification does not impact any of our banking covenants. This means that the notes are exchangeable in the third quarter. So noteholders if they choose can send their notes to the trustee, and we will exchange their notes. We have received six requests to exchange 28 notes as a result of the early exchange option. Long-term debt continued to be zero, as a result of the senior notes being classified as current.

Other long-term liabilities ended at $59 million, similar to the year end balance. And you will now see a new line item entitled equity component of senior exchangeable notes just above the equity section. The classification of this $21.9 million out of equity to this mezzanine section on the balance sheet is associated with the equity conversion option of the notes, and represents the cash settlement amount that when combined with the short-term debt amount of $216.8 million, equals the $238.7 million face value of the notes. This classification is required while the early conversion condition of the notes is in effect.

Shareholders equity ended the quarter at $234.4 million, down from the prior year end balance of $281.8 million. The decrease is the result of share repurchases, cash dividends paid, and the reclassification of the equity component of our senior exchangeable notes. All of that which was partially offset by net income generated year-to-date. Using annualized year-to-date net income, our return on equity is approximately 58%, and this is certainly one of the highest returns earned in the industry. This compares with 50% for the same time period in 2009, and 41% for the full year 2009.

Capital expenditures for the quarter were $6.5 million, up from $2.7 million in the prior year's second quarter, reflecting the increase in industry activity. We expect CapEx in 2010 to be approximately $24 million. Looking at cash flow, cash from operating activities in the quarter was $49 million. And after paying for our $6.5 million in CapEx, our free cash flow was $42.5 million, which is up 27% from $33.5 million in free cash in the prior year's second quarter. On a per share basis our free cash flow in the quarter equaled $0.89 per share, up from $0.72 per share in the second quarter of 2009. The annualized per share yield at quarter end on this quarterly cash flow was 4.8%.

For the first half we used our free cash flow to acquire a technology business for $9 million, paid $5.4 million in dividends to our shareholders, and repurchase $91.7 million of our shares. And we are getting ready to pay a $29 million special dividend in August. And we thought we would touch on total shareholder return for a moment. and our views on the steps that we take to maximize that return.

And by total shareholder return we mean the combination of the appreciation in the stock along with dividends that we pay. Both the regular quarterly dividends and our special dividends. Our view is that a variety of factors are at play to create this total return to our owners. One of the most important drivers to total shareholder returns has been the increase in our share price, as the Company has continued to grow revenues and earnings, while at the same time employing capital wisely, which we have created industry-leading returns on our own invested capital. We then take the free cash flow that is ultimately generated by that employed capital and return it to you. And we have been able to do this on a very consistent basis over the last decade or so.

And it was pointed out to us recently that our five year share price compounded annual growth rate alone was over 40%, more than four times that of the industry's bell cow, and the other members of our industry's big four. We have managed the financial side of our business from the participant of building shareholder value, and we don't mean that from a sound bite perspective, but from actually taking measured steps to ensure that our shareholders are rewarded by holding CLB. We are guided by our research that demonstrates that shareholder returns have the highest correlation to a company's return on equity or invested capital, and that correlation holds for our industry sector. No other performance metric has as close an R-squared correlation, not price to earnings, and not price to EBITDA.

In other words, those companies who continually have high returns on equity or invested capital, also provide the highest total shareholder returns. In fact, performance metrics like price to earnings and price to EBITDA have very low correlation. So if the decision to buy a stock was based on returns, then the owner probably did fairly well. If the decision was based on buying a stock with lower PEs or price to EBITDA because it wasn't viewed as too expensive, then the returns were probably sub-standard, or at least the correlation would not have been that good.

What is interesting about rewards to shareholders being highly correlated to returns on equity or invested capital, is that it means that a company should invest for its own internal growth, and give the excess cash back to their owners. Interestingly the correlations to shareholder return do not differentiate whether the cash payout is returned via share buybacks or dividends. Rather the correlation is that you return it to your owners.

In fact, on the correlations which we ran, buybacks and dividends had the same outcome. And there has been much recent academic literature written than supports that thesis, while literature from 50 or 60 60 years ago may have shown bias for one over the other. As you know, we have done both buybacks and dividends, our view is that share buybacks are preferable, provided that they are accretive to value, but dividends do have their role to play as well. Based on historical results we believe our capital discipline with focusing on creating high returns on invested capital have created greater shareholder return for our owners versus the rewards to owners of our peers.

Now let's touch on our targets. We believe that in our third quarter 2010 we should expect revenues of approximately $205 million, with EPS between $0.76 and $0.78, up approximately 34% over year earlier totals. The mid-point of this guidance would result in operating margins of approximately 28%, again equaling our highest ever reported by Core, with year-over-year quarterly incremental margins of up to approximately 35%.

This third quarter guidance excludes any gains or losses that may originate from the repurchase of outstanding debt, any effects of foreign currency translation, and assumes an effective tax rate of 31%. In addition, third quarter EPS guidance does not consider shares that may be repurchased by the company, or shares that may be added to the share count relating to our senior exchangeable notes and the warrants. We are unable at this time to provide full year 2010 guidance with a high degree of confidence.

With that, I will turn the call over to Monty, who will go into further detail on our strong operational results.

Thank you, Dick. In the second quarter of 2010 revenue grew 19% over Q2 2009, and 6% over the first quarter of 2010. Our employees are doing a great job of keeping the services and products at Core Lab best in the industry. We have the best people in the business, and once again I commend them for making Core Lab a great company. Our reservoir description revenues grew 3% over Q2 2009. This compares favorably to the international rig count that was up only 2%. Operating earnings excluding FX losses of $25 million yielded 24% operating margin. This is down compared to Q2 2009 with the largest effects coming from salary increases, which were deferred until October in 2009, and the effects of FX changes. In the current environment these increases could not be passed on to the clients, but were important to reward and retain our employees.

Our strongest areas of activity were in Asia Pacific, the Middle East, and South Atlantic margins. In Indonesia we are helping VICO, an independent oil and gas company, progress toward their goal of being the first to provide coalbed methane for conversion to LNG. We are providing well site, methane gas desorption services operated from our Balikpapan facility, and associated laboratory studies providing data critical to the economic evaluation of this unconventional gas source. Following the desorption process we determine residual gas content, adsorption isotherm analysis of maximum capacity, approximate and ultimate measurements to determine gas in place and gas saturation, to assist VICO in the development of their existing processing plant in [Bintan] to process this gas.

Core Laboratories Wellsite and Rock Property Services are being utilized to confirm the reservoir quality and natural gas content of Noble Energy's Tamar structure in the eastern Mediterranean. This field was the world's largest gas discovery in 2009, and the largest in Noble Energy's history. Core Laboratories Field Services personnel preserved the core at the well site, and our Rock Property's laboratory personnel conducted the analysis in our Houston Advanced Technology Center.

The core analysis evaluation measured porosity and permeability, confirmed that the shale content was lower than previously estimated from log data, thereby increasing the net sand encountered within the reservoir. Reservoir quality was further investigated by a detailed geological evaluation using X-ray defraction and thin section photography, which supported excellent reservoir quality, high porosity, and low clay content. The correlation of this core analysis with the corresponding log data, led to a 33% increase in calculated recoverable resources to the current level of 8.4 TCF.

Production Enhancement revenues grew 53% over Q2 of 2009,and over 16% over Q1 2010, and yielded operating margins of 33%. Revenue is the quarterly record for Production Enhancement. While our HERO family of perforating system continues to lead the segment, we also had a significant sale of perforating systems for the Iraq market. These systems are for through tubing perforating to workover existing wells and boost production for the Iraq South Oil Company. Our Patent pending coal tubing transfer system has been widely accepted as the best conveyance of perforating systems for horizontal wells, and is critical in many horizontal wells to efficiently perforate the critical toe section of the well,perforating as many as 8 intervals in one run in the well.

Reservoir Management revenue grew 8% over Q2 2009, and operating margins were 28%. Our gas shale studies continued to be very strong, with new additions to the Eagle Ford now with 30 members, and Global Gas Shales Study, now with 15 members. Proprietary studies also continued to be productive with reservoir studies in the Ivory Coast, Nigeria, and the United States, along with a gas shale reconnaissance project in Asia Pacific.

We will now open the call for questions.

(Operator Instructions). Your first question comes from the line of Rob MacKenzie with FBR Capital Markets.

Good morning, guys.

Good morning, Rob.

I guess the first question for you, Dick, in your comments you mentioned that you were unable to have confidence in giving full year 2010 guidance. The year is half over now. What are you seeing out there that gives you pause in terms of guidance of the full year?

I will, Rob, this is Dave. We still do not have an accurate assessment of what is going to happen in the North American natural gas market. Even though that market is shifting from some of the gas-related shales to the oil-related shales, it is difficult to determine with the gas price in the $4.50 to $4.60 range, whether we will have sustainable rig counts at that level through the fourth quarter. So that basically is the reason why we are hesitant to give that full-year guidance.

And a follow-up to that is how would you characterize the relative service intensity of the more liquids rich shales versus the dryer gas shales?

It certainly is higher, and we saw some benefit from that in Q2. When we look at the number of stages in a typical Bakken frac, or what we believe will be developed in the Eagle Ford fracs, the service intensity will be higher. I think on our last call we talked about the potential for a dual lateral being drilled up in the Sanish and middle Bakken. 10,000-foot laterals with as many as 60 stages in each lateral, and we continue to believe that that will happen before the end of the year. Service intensity, Rob, is much higher.

Okay. Thanks. Coming back to Monty's question about margins, and not being able to pass through wage hikes to our customers and reservoir description. I guess that led to the year-over-year decline in margins. When do you expect to be able to start seeing some operating leverage again in that segment?

Rob, I would think that we will see that later in this year. Things are going to start improving, so the second half of this year we will start seeing an improvement and a pickup in that sector,particularly compared to the previous year.

Rob, if we see that pickup that Monty talks about, and that is why we mentioned it in the release, you get greater absorption there, and we will see upward movement on those margins, so we are pretty comfortable with that right now.

Thanks. I guess my question for Dick here on the exchangeable note, can you guys give us any color or feel for when, where, how, and what it might look like when you restructure that security?

Rob, they are due in October, at the end of October of next year, and our view over time we are very comfortable with a 35% or so debt to cap, so at any point in time that is where we target our debt to cap ratios to be. At any particular point in time though, as we deal with these notes, it may be a little bit different. I would expect we are going to use our cash in a substantial amount to repay that note. That is one of the reasons why we have retained cash on the balance sheet, just from a conservative nature on where the capital markets might be when these things come due. We want to be able to pay them off in cash, but ultimately you will see some debt on that balance sheet, probably more in the form of a plain vanilla-type transaction that has straightforward accounting.

Thanks. One more follow-up question for Monty. Monty, you mentioned a couple of projects which both may have encompassed gas desorption. Can you give us a better handle on what that means, and how big that is for Core?

It is a small part of our business at this time. It is something we are doing in Indonesia, which is a big coalbed methane market developing, and in the United States and Canada. So, it is a niche service that we are growing. It is a relatively new service for Core Lab that we see a lot of hope for.

Thank you.

Your next question comes from the line of Neal Dingmann with Wunderlich Securities.

Good morning, guys.

Good morning, Neal.

Obviously activity continues to be very brisk, I was just wondering especially international, as you see clients continue to come in, are you seeing I guess maybe you want to call it bidding activity go out on a further basis, meaning are clients now lining up things for next year yet, or be it for a wider part of next year, what are you seeing on that front?

That is a good point, Neal. Actually, if you look at the queue going into 2011 we think we will see a robust movement upwards in international activity. This year I think our guidance was low double digits in that, and we will see the majority of that take place or start to ramp up here in the second half, and looking 2011 with jobs that we already know are in the queue for 2011, it certainly will be a more robust environment.

Is that new, I mean you have always had a great track record of entering most of the major oil regions worldwide. Are you continuing to enter a few new regions, or I am just kind of wondering region-wise and customer-wise, are you seeing some expansion, or is it just a broadening of the current customer base?

No, really just the level of activity, Neal, with the same client base. We going to start to have developments insome of these central west African basins, that will be certainly of interest. And then also as Monty mentioned in the eastern part of the Mediterranean Sea, the Tamar development, certainly again will be growth areas for us, as well as activity levels in southern Iraq.

Okay. And then my last question maybe for Dick, if I could. Dick, obviously the inventory turns continues to be phenomenal as far as what you are doing with that. I am wondering maybe in detail what you are doing to get those turns that way, and can that continue to improve?

I think I can speak broadly to our working capital effort to include, say, receivables. Our guys are incentivized on working capital, they are incentivized on return on invested capital, and that is just a component. We are continually impressed with the way our operating guys are able to improve DSOs and turns. I think we have proper incentives in place, but we also have proper systems. We have had an ERP system based on Oracle now for several years, and they are able to fine-tune the functionality of that, to help us better manage our working capital. Will it improve dramatically from this point? It will be hard to think so, but I think you will see incremental gains as we go along.

Great to hear it. Thanks, guys.

Your next question from the line of Veny Aleksandrov with Pritchard Capital Partners.

Good morning, guys.

Hello, Veny.

I have a question on margins if you can talk a little bit about that. You are guiding to sustainable operating margins in Q3, but at the same time you beat your own guidance in the last two quarters, so what is the perfect storm that you need so that margins can improve from here, or are you just saying that margins above 28% are not realistic?

No, we believe they are, Veny. It is all a function of what that incremental margin is, and as we continue to put additional work through our fixed cost system worldwide, whenever we can get that incremental margin back up into the mid-30s, we know it will feed our operating margin. Bottom line, we believe operating margins can get into the low -30s over the next several quarters, and of course that will be driven by the incremental margins.

Okay. Thank you. And I know that Monty gave us the total members for the Eagle Ford and the [Guabo] study, but can you give us the number of new members for the quarter that you have added?

Actually Veny, I don't have that on hand. The Eagle Ford, I think that is six or seven new members. That has been our most active one as far as growth. Global shale, I think we had 11 last quarter, and we are at 15 this quarter.

Thank you so much. Those were my questions, thanks.

Your next question comes from the line of Stephen Gengaro with Jefferies.

Thank you. Good morning, gentlemen.

Good morning, Stephen.

A couple of things. I guess the first is when we look at the sort of revenue breakdown between Reservoir Description and Production Enhancement, obviously Production Enhancement has been a big growth driver here for the last several quarters, and I assume as you look at the fourth quarter, that is an area where you are more reluctant to give guidance. What can you tell us on the Reservoir Description side, how to think about, even if not in dollar terms, but how to think about the growth in the back half of this year and in 2011? You are making progress, I know you laid out a long-term plan I think of adding fields. How should we think about that growth rate vis-a-vis the last five years?

I think if you look at, Stephen, if you just look at the activity rate internationally we are going to, we still believe that we will grow 200 to 300 to 400 basis points higher than that. If you get international year-over-year up 10% in the fourth quarter, we would expect reservoir description revenues to be up 12, 13, 14% in the fourth quarter. There is no reason for us to believe that that relationship has changed. Depending on what your views are for activity levels internationally in the third and fourth quarter, I think that can help you with your modeling.

Okay. That is helpful. Then I guess the other question I had just back to sort of the Production Enhancement side, how in North America particularly, is it being, is it volume and price that is driving this currently, or is it more one or the other? And if it is less price, do you think you start to get better, additional or better pricing traction going forward there?

The North American market has seen a real resurgence in volume. We have done a number of things over the last year particularly when the market was down in 2009, down pretty severely, to position ourselves we talked about those in previous calls, partnering with our major customers, working on a few new technologies, those are coming to bear now as the volume has increased substantially. We see that a 33% margin for that group, we feel like we are getting a pretty good margin out of there. We have squeezed a lot of manufacturing efficiency because we have been able to increase volume. I feel very comfortable, we have gained significant market share because of positioning that we have done during the downturn actually of last year, to position ourselves for a resurgence in volume.

Yes, David and certainly the HERO line technology has really captured market share for us, especially in these ultra-difficult completions in these gas shales, and even moreso in the oil related shales of the Eagle Ford and the Bakken, certainly to come in the Niobrara.

Thank you. Just one final, there are obviously just a lot of positives just in general here. What do you worry about, I mean outside of the obvious, which is commodity prices and economic conditions and activity, what do you worry about competitively? Is there anything, what are your biggest concerns there as we think about this going forward?

We really don't have any concerns on that level right now, Stephen. We believe our technology is superior that can be offered by anybody else, and several of our product lines, most of our product lines, certainly in Production Enhancement really have no offsetting competitors. We invented the science, we employ the science, we distribute the science.

Okay, thanks.

Okay, Stephen.

Your next question comes from the line of John Daniel with Simmons and Company.

Hi, guys, good morning.

Good morning, John.

I just got two questions for you. The first one should be pretty simple. Given that the service intensity in liquids rich plays is greater than dry gas, should we continue to expect production enhancement revenue growth to outperform the rig count?

Absolutely.

Fair enough. Monty you highlighted the coal tubing transfer system. Can you give me a little bit more information on just the technology and application of it?

Sure, it is an important technology when you are particularly in the shale gas, which is the sweet part of this market. When you are drilling and then you go in to complete, you have to perforate starting at the toe, the far end of the well and move back. That is a very delicate area to be perforating. Perforating is a powerful explosive event. They have had problems in the past with some reservoir integrity problems, well integrity problems after a perforating event particularly in the toe of the well.

This system that we developed is coiled tubing convey, and allows them in one run to sequentially perforate, and we have done eight intervals, eight different spots in the well as they are pulling the coiled tubing back. This does two things. One, it is obviously economically advantageous to do it in one run. The other thing is it helps you with your structural integrity of the well, if there is a problem you are already in the perforating mode as you are coming out of the well. And that has been, the acceptance has been tremendous for that product. So that is a new technology that our guys, our people invented, and has been widely accepted and is being widely used. That helps us with our market position.

Is the technology, I mean obviously everybody is talking about coil ed tubing and the strength of it, is that displacing the traditional method of perforating via wire line?

What it is doing actually is allowing the portion of the well that is normally done with coiled tubing, to be done much more efficiently and with a lot less risk. Then they are coming in to the later sections often still with wire line, but coiled tubing in gas shale wells because they are all horizontal wells is critical.

And John, on one note on these horizontal wells when Monty mentioned the applications in some of these unconventional reservoirs here in the United States for natural gas, and now seeing more and more for crude oil production, don't be surprised if we see long laterals with multistages being used in Iraq in the redevelopment of some of these fields. That probably is going to be a very efficient and effective way for boosting production there. So, our eyes are already thinking about how we can employ some of this technology in some of those field developments over the next decade or so.

And in gas shale around the globe. That is an area that is gaining steam.

Okay.

So these same technologies will be very useful going around the globe.

Okay. And when did you guys develop it, can you say?

It has been developed over the last year and a bit, yes.

Okay. Thanks a lot, guys.

Your next question comes from the line of Terese Fabian with Sidoti & Company.

Thank you. I have another question to follow-up on the Production Enhancement segment. I don't know whether you said, what is the percentage of international sales this last quarter?

About 33%. So Terese, it is still in that between 30% and 35%.

And are you getting any work in either production enhancement or the reservoir description in eastern Europe at this time?

That is not a huge market. It is a market that is potentially going to grow. You have seen maybe some announcements from companies on gas shale prospects, prospecting in eastern Europe. It is not a significant market for us at this time, but it is one that has some potential for the future. And we do have rocks in house we are working on, primarily from gas shale in eastern Europe.

Okay. And just one last question. The composition of the Production Enhancement segment in terms of products and services, can you talk a little bit, the coiled tubing is a new venture for you, is that significant yet? And in terms of diagnostic tools and perforating charges and guns, what has the proportion of revenue coming in?

Let me be real clear. We are not in the coiled tubing business, okay. We have not entered that. We have entered perforating technology that is run on coiled tubing. So it is very important. Our product business is about two-thirds of it, service is about one-third of Production Enhancement, and it varies a little time to time but that is about the split.

Okay. Thank you.

(Operator Instructions). Your next question comes from the line of Victor Marchon with RBC Capital Markets.

Thank you. Good morning, guys.

Good morning, Victor.

First on the Gulf of Mexico, realizing that deepwater is not a significant piece in the Gulf for you guys, but just wanted to ask about the impact on the quarter, apologize if you had mentioned this. And the second part to the question are you seeing any change in behavior from your customers in other areas of the world in the deepwater because of what is going on in the gulf?

Yes, two points Victor. Number one on the deepwater Gulf of Mexico, we believe that is somewhere around $0.02 per share, and certainly it is going to have as long as the moratorium stays involved probably $0.02 a share is the way we draw that out for the second, third and fourth quarter, and hopefully it won't expand above that and hopefully it will be shortened. And then change of attitude or activity worldwide in other deepwater markets, absolutely none.

And the second one I just and I missed this when you guys had mentioned the margin impact on reservoir description because of the wage increases, and just has that been typical historically the inability to pass that through to your customer base, or is it somewhat of an unusual event?

Well, I think because we have had limited growth internationally because that is where it usually is focused that that is the reason why it might be a little bit different this time. I think we pick up robust international activity, those salary increases are always absorbed by the expanding activity. We only saw 3% revenue growth year-over-year, so some of the absorption wasn't as obvious as it would have been if sales were up 10%, 12%, 15%.

Understood. And the last is just a follow-up to what you had mentioned regarding margins in the low 30% range. Was that on an absolute basis or on year-to-year incrementals when I think you had mentioned that over the next couple of quarters looking out that you thought you guys could get up to the low 30% range?

That is looking forward over let's say the next six quarters to the next year and a half. That would take incremental margins somewhere in the mid to high 30s to low 40s, and we have been there before. So that would be the answer is absolute margins.

Got you. Okay. Great. That's all I had. Thank you, guys.

All right, Victor.

Your next question comes from the line of Thad Vayda with Stifel Nicolaus.

Good morning, just to follow-up on Victor's questions, what gave rise to the $0.02 impact specifically? Is it fewer cores?

Cores and reservoir fluids. Thad, and doing the PBT work which is pretty intensive on a lot of these deepwater wells. You have got fluids that range in reservoir pressure from 15,000 PSI all the way up to 25,000 PSI on many of these reservoir fluid combinations, whether they be light oils, condensate, or even critical fluids, we have a suite of technologies, and the pressure vessels to handle those, and in some cases we may be the only company able to do those.

Okay. And unrelated, you talked about or you mentioned a technology acquisition in the quarter. Can you just give us a little bit more color as to kind of what it is and how it fits? That is it, thanks.

That was a reference to year-to-date and that was an acquisition that was done in Q1, and it was technology, it was diagnostics oriented, it fit nicely in our Production Enhancement group. It was about $9 million in cash.

Thank you.

Your next question comes from the line of Paul Crovo with PNC Capital.

Yes, good morning, gentlemen. You have alluded a couple of times during the course of your comments to business in Iraq, and I was wondering if you could expound a little bit on the opportunity there over the next year or two or three years going forward, in terms of what the potential impact would be on your overall business?

Okay Paul, yes if we look at Iraq, we look at it and we bifurcate the country down through the middle, with the north we are look at the development of smaller reserves mainly by independents outside of Kirkuk. We have activity levels there. Probably not real needle movers. In the south we know that we have got 11 of these contracts that have been signed either by the IOCs or NOCs. We believe that is where the major impact will be. We worked on a number of those as Monty had made mention. We just made a fairly large shipment of completion and perforating guns into that market for the Southern Iraqi Oil Company. It will be an incremental market that we are adding. It will be a place that we will be for decades.

That being said, with respect to the ultimate potential for Iraq to produce vast amounts of oil, we have said from the first quarter of this year that when looking in the rear view mirror, Iraqi production peaked at 3.6 million-barrels a day in 1978, and we felt that in four years time that we would take the under on that number, so we still believe Iraqi production will be less than their peak in 1978 in four years. Read that as a little bit of caution, because there were some big numbers thrown out from the potential to produce in the country. We don't think those will be realized, owing to the amount of extensive formation damage that has happened to these major giant and super giant fields that are more prevalent in the south of the country.

Yes, a very good market for us. It will mean additional millions and millions of dollars of revenue. Additional fields for us. Will you see it as an ultimate mover in the revenue stream. Probably not. They will be incremental adds of revenue that will help drive incremental margins, that will help drive our underlying margins.

Thank you. And I just had one more question, if I may. Interested in finding out a little bit more about your R&D effort, and how much you decide to dedicate in terms of dollars that are spent on R&D, in order that your Company can maintain its advantage in terms of its leading edge technologies over whatever competition that you have in your markets?

Paul, the way we address R&D we think is the proper way. It is very customer-focused. We work with them wherever they may be located, because the technologies that you employ in one particular type of field may well be different than the characteristics of another field. So our view is take an idea, a technology that a client may be working on, and let's turn that into a commercial application that we can turn into revenues pretty quickly. Think of us as smaller R on the R&D but very large D, very large development of ideas into revenues, and that is what you have heard Monty talk about on this call and previous calls, about the development of new ideas turning into revenues.

We spend about 2% or 3% of our Petroleum Services revenues on generating new technologies, and our view is technology is fleeting, so you have to stay in front of it. You can't rest on what you already have. That is why we are always trying to evolve and create new iterations of existing technologies. So don't expect us to come out with some new technology that is going to replace 50% of our business, that is not the way we operate. We evolve our technologies.

Thank you, gentlemen.

Okay, Paul.

At this time, there are no further questions.

Okay, Brandy, I think we are going to wrap it up. In summary, Core's operations posted a solid quarter. We have never been better operationally or technologically positioned to help our clients expand their existing product based. We remain uniquely focused and are the most technologically advanced reservoir optimization company in the oilfield service sector. This positions Core well for the challenges that await in 2010 and 2011.

The Company remains committed to industry-leading levels of free cash generation and returns on invested capital, with all excess capital being returned to our shareholders. In closing, we would like to thank all of our shareholders and the analysts that follow Core, and as already noted by Monty Davis, the executive management and the supervisory Board of Directors of Core Laboratories would like to give special thanks to our 5,000 worldwide employees, that have made these outstanding Q2 and past results possible. We are proud to be associated with their continuing achievements. Thanks for spending your morning with us, and we look forward to our next update. Good bye for now.

This concludes today's Core Lab second quarter 2010 earnings conference call. You may now disconnect.