Core Laboratories Inc (CLB) 2012 Q2 法說會逐字稿

Good morning. My name is Kimberly and I will be your conference operator today. At this time, I would like to welcome everyone to the Core Labs Q2 2012 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)

I would now like to turn the call over to David Demshur. Please go ahead, sir.

Thanks, Kimberly. I would like to say good morning to everybody in North America, good afternoon in Europe, and good evening to all of the listeners in Asia-Pacific. We'd like to welcome all of our shareholders, analysts, and most importantly, our employees, to Core Laboratories second-quarter 2012 earnings conference call.

This morning, I am joined by Dick Bergmark, Core's Executive Vice President and CFO. Also, again this morning, we are joined by Core's COO, Monty Davis, who will present the 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 strategies. We believe these three tenets have produced industry-leading shareholder returns, and returns on invested capital. We will also discuss Core's long-held philosophy of returning excess capital back to our shareholders.

Then Dick will come in and follow up with a detailed financial overview, and additional comments regarding building shareholder value and Core's industry outlook for the third quarter of 2012, which confirm our confidence in the trends of increasing activities in unconventional oil reservoirs in North and South America, and North Africa, and especially the international deepwater activities tied to crude oil and large LNG developments. 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 highlighting some of Core's operations and major projects. Then we will open the phones to a Q&A session.

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

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 or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or 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, 2011, as well as the other reports and registration statements filed by us with the SEC or 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 second-quarter results. Those non-GAAP measures can also be found on our website.

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

Thanks, Dick. I would like to give a quick investor update. Core's operations produced another solid quarter as the Company continued to benefit from our continued focus on and the increase in international and deepwater offshore activities and unconventional oil plays in response to relatively high oil prices and dwindling global spare oil producing capacity. The focus on crude oil related projects continued to build in 2012 as we discussed the projected decrease in natural gas drilling activities in North America on our last four previous conference calls.

Therefore, Core's revenue mix now is closer to 80% oil and 20% natural gas, a shift from the previous 70-30 mix earlier. Moreover, most of the natural gas related projects emanate from the international theaters and these LNG projects are related to major developments in the eastern Mediterranean, East Africa and western Australia.

Turning to our Ops, Core's Reservoir Description results reflected the focus away from natural gas and the positive increases in both international and deepwater activities which continued into 2012. Core Lab dominates this deepwater core analysis and reservoir fluid markets capturing virtually all outsourced projects from offshore Brazil, West Africa, East Africa that includes thousands and thousands of feet of core that have been cut in East Africa, the eastern Mediterranean and the deepwater markets throughout Asia-Pacific. Looking at Reservoir Management, they posted another strong quarter reflecting additional oil Company support for its worldwide joint industry projects in oil shales and international areas of interest like the deepwater areas offshore western Brazil where Core Lab currently ops six joint industry projects and Petrobras continues to be Core Laboratories' largest and most important national oil company client.

Also driving our second-quarter results, they were bolstered by North American activity in oil shale reservoirs and increased activities in the Permian Basin of west Texas and this drove our incremental margins for production enhancement. Our growth strategies and the execution by our operating units continued to serve our clients, our employees, and our shareholders well. Core's continued focus on higher return international crude oil related projects, especially those in deepwater environments, the unconventional oil resource plays and the continued internal development of new technologies and services has led to a multi-year sustained growth and increased profitability for the Company.

Core has always and will continue to follow three key investment tenets that led to our industry-leading returns. These three important tenets, which usually receive only scant attention in our oilfield service sector are, number one, maximizing free cash flow through fiscal discipline. Core follows a strict discipline for allocating capital for investment in growing our business. Unless a certain return on invested capital standards are met or exceeded, the capital expenditure is disallowed.

Potential acquisition opportunities must pass the same high standards. This discipline has produced free cash flow for the first half of 2012 of $86 million. In fact, Core converted about $1 of every $5 revenue in the free cash during the first six months of 2012. Core will continue to demonstrate strict financial discipline in 2012 and beyond.

The second financial tenet is to maximize our return on invested capital. Core's Board has initiated an incentive compensation program for Core's executive and senior management teams based on the Company producing a return on invested capital in the top decile for the oilfield service industry. 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 the highest of any company in Bloomberg's oilfield services comp group recently listed by Bloomberg Financial. Also, Core's weighted average cost of capital was the lowest for the group.

Our third financial tenet, which is to return excess capital to shareholders has seen that, during the first half of 2012, Core has returned over $76 million to our shareholders in forms of quarterly dividends and repurchase of shares. Since October of 2002, Core has returned about $1.3 billion or $26 per diluted share to our owners. We will continue to follow these three investment tenets into 2012 which should enable Core to continue to produce industry-leading returns for all of our shareholders.

Now I'll turn it back over to Dick for a detailed financial review. Dick?

Thanks, David. I would like to start by mentioning that we are excluding non-operational items from our operational earnings that occurred in the quarter; three of which were expenses while the other was a gain. We are excluding them from operational earnings for these discussion purposes because they were either a one-off item or an item that was specifically excluded from our prior guidance, like the losses caused by changes in foreign exchange rates or benefit from a more favorable tax rate than expected. We are also removing from our operational results the fees that we incurred in listing our shares on the NYSE Euronext Amsterdam Stock Exchange, as well as the fees incurred in a restructuring of certain of our legal entities that will improve administration efficiencies, which should reduce our fixed cost structure.

Now looking at the income statement, revenues were $247 million in the second quarter versus $225.8 million in the second quarter of last year. Revenues were up 9.4% year over year. Of these revenues, services for the quarter, $175.7 million, up 12.1% when compared to $156.8 million last year; an increase of $18.9 million. Product sales for the quarter were $71.3 million; up about 4% when compared to $68.9 million in last year's second quarter. Moving onto cost of services for the quarter, they were 59.1% of revenues; an improvement when compared to 65.4% in last year's second quarter, and 63.6% for all of 2011. In the second quarter, our cost of product sales increased slightly to 73.6% of revenues, compared to 69.3% for all of last year as our inventory costs were impacted by the cost of replacement steel as a result of the fire at our steel supplier.

G&A for the quarter, $10.2 million, and the same as last quarter, which was 4% of revenue, as was our G&A expense in last year's second quarter. So we expect G&A to be around $43 million to $44 million in 2012. Depreciation and amortization for the quarter, [$5.1 million], down slightly due to asset [lies] but expect Q3 to be back at $5.8 million level. We expect depreciation in 2012 to total approximately $24 million. Other expense this quarter is $3.2 million. This amount is comprised of, among other things, the FX loss of $1.4 million; the $700,000 expense for the NYSE Euronext listing, and a $1.9 million expense for the corporate restructuring.

EBIT for the quarter, excluding items, was $76 million, which was up $13.8 million or 22% year over year. Our second-quarter EBIT represents EBIT margins of 30.8%, well above the 27.5% margins earned in last year's second quarter. In a moment, Monty will discuss the operational basis for this improvement in margins.

Interest expense was $2.2 million for the quarter compared to $2.5 million in last year's second quarter. Income tax expense in the quarter was $17 million based upon an effective tax rate for the quarter of 24.3%. This compares favorably to our earlier guidance of 25% for the second quarter. Consequently, we pro-forma'd out the unanticipated benefit from this lower tax rate. We expect our full year 2012 annual effective tax rate to be approximately 25%.

Net income for the quarter, excluding items, was $55.4 million, compared to $43.9 million in last year's second quarter. So net income for the second quarter increased 26% on a year-over-year basis. GAAP net income for the second quarter was $52.9 million, compared to $40.5 million last year; an increase of more than 30%. Earnings per share for the quarter, adjusted for the items which were not included in prior guidance discussions, was $1.16, which rose above the Main Street estimate posted at the time of our Q1 earnings call by a $0.01. Recall that the Street was at $1.15 at that time.

During the quarter, our Main Street went up a $0.01 while all of the members of the OSX had their numbers reduced, in many cases significantly while our numbers went up. On average, the members of the OSX had their estimates reduced by more than 13% over the course of the last three months, while ours were actually raised almost 1%. Our adjusted EPS is up year over year by 26% -- excuse me, $0.26, or 28.9%. GAAP EPS stood at $1.11 for the quarter.

Now on the balance sheet, cash was $23.4 million, compared to the prior year end balance of $29.3 million. Cash balances and our free cash flow during the quarter we used primarily to repurchase stock and to pay our dividends. Receivables stood at $170.7 million, the same as at year end. Our DSOs improved in the quarter though to 62 days, an improvement from the 68 days experienced in 2011 and 70 days in 2010. So congratulations to our operating guys for looking after our working capital.

Inventory -- while inventory increased from $53.2 million at year end to $58.2 million at the end of Q2, inventory was flat sequentially from Q1. We expect inventory to fall as the year progresses while turns will also improve. Other current assets were $39.1 million, up from the year end balance of $33.2 million for the most part as a result of increases in current deferred tax asset of $2.5 million and income tax receivable of $1.8 million. There are no material changes in PP&E, intangibles, goodwill or other long term assets.

Now on the liability side of the balance sheet, accounts payable were $51.3 million, down from the prior year end balance of $57.6 million, primarily as a result of timing of vendor payments. Other current liabilities of $74.9 million are down $10.7 million from the prior year end balance of $85.6 million, due to a variety of reasons including a decrease of $2.7 million for income taxes accrued but not yet fully paid in various jurisdictions, and a decrease of $7.8 million in personnel related expenses.

Our long term debt stood at $206.1 million, up slightly from last quarter end and is comprised of $150 million in senior unsecured notes due in 2021 and 2023 with a blended fixed interest rate of 4.06%, while the remaining $56.1 million was drawn on our bank revolving credit facility. Other long-term liabilities ended at $66.3 million, an increase of $3.3 million over the previous year end balance, due mostly to increases in deferred comp of $2.3 million. Shareholders' equity ended the quarter at $224.2 million, up from the prior year end balance of $181.7 million, primarily due to additions from earnings offset by share repurchases and dividends. Using annualized net income for the second quarter, our return on equity was over 94%. This is certainly one of the highest returns earned in the industry.

Capital expenditures for the quarter were $7.6 million, unchanged from the first quarter. Year to date, our CapEx is 24% higher than the prior year as we continue to address opportunities created by the strong growth we experienced in our business. We expect our CapEx program in 2012 to be approximately $33 million as a result of an expected continued improvement in industry activity, particularly internationally and in the deepwater environment. Our CapEx growth is client directed for the most part, meaning that we will increase our capacity for locations or for increases in technology on the basis of discussions with clients about their specific needs, which is one reason why we have been able to generate our high returns on invested capital. So when our CapEx increases in positive business cycles, it usually reflects upon upcoming demand for our products and services.

Looking at cash flow, cash flow from operating activities in the quarter was $47.1 million and, after paying our $7.6 million in CapEx, our free cash flow was $39.5 million. In the second quarter, we turned almost 16% of our revenues into free cash flow, clearly one of the highest cash conversion rates in our industry. During the quarter, we used our free cash flow and cash balances to pay $13.3 million in quarterly dividends and to repurchase 299,104 shares for $37.3 million.

Now, if we look for guidance and at our outlook for 2012, we expect to see increasing international growth, especially in deepwater projects supported by the scheduled arrivals of additional deepwater rigs. Deepwater pre-salt activities in several international basins, including in the South Atlantic margin, should increase for the remainder of 2012. In addition, we should benefit from increasing activities in the deepwater Gulf of Mexico, which is projected to approach and surpass early 2008 highs by the third quarter of 2012. We believe we will also benefit from increasing activities in unconventional oil shale reservoirs, not only in North America, but also South America and North Africa. We expect to generate about $200 million in revenue from primarily oil shale reservoirs in 2012.

As a result of that outlook for the third quarter of 2012, we expect revenue of approximately $250 million to $260 million, with EPS between $1.17 and $1.25 where the midpoints of guidance represent a revenue increase of approximately 10%, and EPS growth of 21% for the third quarter 2011 totals, excluding year ago non-operational gains and charges. Third quarter 2012 operating margins are projected to be approximately 31%, which is about 100 basis points higher than the prior year and it also assumes an effective tax rate of approximately 25%.

Now we will turn the discussion over to Monty for our operational review.

Thanks, Dick. The second quarter of 2012 revenue of $247 million represents revenue growth year-over-year of 9%. Operating earnings excluding the benefit from a lower effective tax rate, losses from foreign currency translations and non-operational expense items increased to $76 million with operating margins of 31%. Operating margins improved 300 basis points over Q2 2011. We commend our nearly 5,000 employees around the globe for another excellent performance.

Reservoir Description revenue grew 6% over Q2 2011 and operating earnings grew 28% over Q2 2011 with operating margins improving by 500 basis points to a record 31%. Reservoir Description operations continue to work on large core analysis and crude oil testing programs, in addition to reservoir fluids-phase behavior studies from deepwater offshore West and East Africa, the eastern Mediterranean region, the Middle East and Asia-Pacific areas. Thousands of feet of cores from Cretaceous and Tertiary-aged sedimentary fan reservoirs from both coasts of Africa are being analyzed to describe these complex petroleum systems. Hundreds of reservoir fluid samples consisting of crude oils, condensates, natural gases, and waters are being characterized for composition and phase behavior relationships. The data sets are being used to plan the full scale developments of these recent discoveries. Large Middle Eastern projects include the use of advanced rock properties and reservoir fluid characterizations to increase the productive capacity of existing fields, some of which [have] already been in production for decades.

The Asia-Pacific work continues offshore Malaysia, India, Indonesia and Australia. In deepwater Gulf of Mexico, Core worked on its largest project ever in the lower Tertiary section, while providing integrated reservoir conditions, reservoir rock and fluids data sets. Core also expanded the number of clients and the number of projects from deepwater to an all-time high. The Company expects industry activity levels to equal or surpass pre-moratorium levels during the third quarter of 2012.

Core is expanding our US laboratory capacity to handle the increasing demand for reservoir conditions laboratory testing of Core's. This includes a partnership with a major oil company to expand our industry-leading overburdened reservoir conditions centrifuge capacity. In addition, we have expanded the Houston facility and are in the process of adding four X-ray diffraction units, a field emission scanning electron microscope, a multi-slice high resolution CT scanner, and an industry-leading ultra high pressure rock mechanics load frame and expanding our analytical capacity in organic chemistry and doubling our core extraction capacity. We are also expanding our high pressure and high temperature reservoir fluids testing for deepwater reservoirs of the Gulf of Mexico with five new state-of-the-art automated mercury-free high pressure PVT cells.

From onshore in North America, thousands of feet of core from unconventional reservoirs are being characterized for their potential to produce oil and natural gas liquids. Sequences from the Permian Basin, Bakken and the Eagle Ford plays are undergoing extensive rock properties and advanced rock properties testing to determine production and stimulation programs to maximize daily production and ultimate hydrocarbon recovery rates. Bakken cores are being tested for susceptibility and potential effectiveness of the use of light hydrocarbon gases and water flooding to enhance ultimate recovery rates. Production enhancement revenue grew 12% over Q2 2011 and operating margins improved 200 basis points over Q2 2011 to 30%. Production enhancements continues to benefit from increasing market penetration and evolution of its patented and proprietary technologies and services.

Core's HTD-Blast technology which originally delivered up to eight perforating guns to the toe portion of an extended reach horizontal well has been significantly improved and the Company is now offering HTD-Blast XL. The HTD-Blast XL for extended length system has delivered up to 27 perforating guns in vertical well bores that penetrate sedimentary sequences that contain multiple unconventional reservoirs, similar to sequences present in the Permian Basin. In addition, the gun firing sequence can be changed to ensure a more effective perforating event. The HTD-Blast XL system decreases an operator's cost while increasing the potential of the well bore to produce at higher daily rates and improving ultimate hydrocarbon recoveries from the reservoir. With further technology development, the HTD-Blast XL will be deployable on coiled tubing to extended reach horizontal wells. Our HTD-Blast and HTD-Blast XL revenues were increased 27% for the first half of 2012, compared to the same period of 2011.

The Company's patented and proprietary diagnostics technology was used to determine the effectiveness of a large and complex stacked frac pack in the Tertiary-aged reservoirs in the deepwater Gulf of Mexico. The well required that four frac packs be performed in sequence. The customer utilized Core's patented PackScan logging tools and SpectraScan tracers to assure effectiveness of the gravel pack and the optimum production method. Diagnostic data sets were used by the operator to ensure the maximum production rates could be achieved for extended periods of time without interruption and well shut-in time.

Reservoir Management revenue grew 15% over Q2 2011 and produced operating margins of 34%. The importance of Core's granite wash regional study was cited by an industry expert in a featured article in the July issue of the AAPG Explorer Magazine. Our study allowed them to high-grade the best intervals to complete using our core-based petrophysical model. This also revealed many bypass pay intervals. We helped them optimize their stimulation of intervals for maximum well performance. Study results helped the operator understand the complexities of the multiple stacked reservoirs prevalent in the granite wash sequence, unlocking the potential of trillions of cubic feet of natural gas and natural gas equivalents.

International Reservoir Management, in its continuing cooperation with Petrobras, now has six studies detailing the petroleum geology and reservoir potential of onshore and offshore Brazil. Core's newest study, Equatorial Basins of Western South America, contains cores and cutting samples from the multiple sedimentary basins in shallow and deepwater areas. In addition, Core's Deepwater Campos Basin, Santos Basin, Cretaceous Carbonates of the Southeast Margin and Pre-Salt Phase II Brazil studies now have over 30 industry participants. The combination of these studies contain the most comprehensive data sets of Cretaceous-aged carbonate sequences which make up the reservoir complex of offshore, deepwater pre-salt giant and super-giant field developments. Petrobras remains Core's largest and most important national oil company client.

We will now open the call for questions.

Kimberly, you can go ahead and open the call.

(Operator Instructions) James West from Barclays.

Monty, great color on the expansion programs you have underway on the international side of the core analysis side. But I was curious on your production enhancement, which is a little more levered to North America with NGL pricing coming down, liquids pricing overall pressuring E&P company cash flows. Are you considering resizing that business or has the international become enough of a growth component that there is no need to do that?

James, the rig count has been pretty flat in that area. The production enhancement revenue actually grew 12% Q2 -- over Q2 2011. We are still seeing a pretty good growth rate. You will notice that our HTD-Blast and HTD-Blast XL, that family of systems grew 27%. So we are continuing to apply the technology. Where we keep the operation at a right size, and I'll say that all along which in this period and in the coming periods to us means a growth mode.

A couple of points, James, we look -- our outlook for the third quarter is a flattish rig count in North America with a gain of some rig counts looking for liquids and a continued drop of the rig count associated with natural gas. Most of the expansion that Monty talked about in the reservoir condition core analysis and the reservoir fluids areas are actually right here because we are capturing more and more work from the deepwater Gulf of Mexico and our clients have come to us and told us we need expansion in both rocks and fluids. So in response to that, it really is the largest expansion that we have had in capital aimed at the deepwater Gulf of Mexico market ever. So, very positive there. But in saying that, when we look at the North American market, we think we can still grow that market in that flat rig count environment 2 points. Number one, additional stages done on some of these oil resource plays, and then additionally, more deepwater rocks and deepwater fluids from the deepwater Gulf of Mexico.

Okay. That's very helpful. Thanks, David and Monty. Just one last follow-up for me. The fracturing companies that Dick alluded to, consensus numbers coming down; a lot of that is due to your problems in stimulation in North America. Are the fracturing companies that you tend to sell to, your perforating guns and charges, are they pressuring you now on pricing? Are you having to give anything on pricing so we expect any margin erosion or is it because you are at the high end that, that is not really the case?

Yes, a couple of points, James, just to be clear. Our sales point, our marketing point are to the oil companies, not to frac companies. So we really don't sell into that fracking process because you remember, the perforation event occurs prior to fracking. So what we have found is we are able to sell based on value that we've created. Particularly with the HERO line of charges giving superior performance seems to be the way for us to continue to expand margins. Remember in this last quarter, margins reached 31%.

Sure.

That group is doing very, very well. Have we seen requests? We have heard about requests from some operators looking to reduce costs. Remember, we are talking about adding value. So, we don't really try to get in the middle of that chain, I guess, if you will, of operators who focus on costs. We prefer to deal with operators who focus on returns on their investments.

Got it. Thanks, guys.

Jim Crandell with Dahlman Rose.

This is the first time I remember reading your release and seeing you specifically say core analysis at the well site. Do you see this segment of the market growing very rapidly in today's market?

Yes, Jim, in my 30 years here at Core Laboratories, we have attempted to offer these services three times. They have all turned out not well. We look at the data quality that can be generated at the well site and what those data sets are used for and we find this really a low margin, low return market. We choose not to address that. So, for us going forward, we are concentrating more on reservoir condition. So, temperature and pressure measurements of rocks and fluids as opposed to the lower tech ambient condition measurements associated with maybe mud logging operations. So for us, there probably is a market for that but it would never reach what our hurdle rate is for a return on invested capital for us to invest money for equipment to do that at the well site.

Do you see the oil companies that do use that, are they using it mainly as a correlation tool so they are getting their electric wireline, [LWD] or mud logging estimates and they want to correlate it with Core's and that is being offered as another add-on service to other [FEE] techniques.

I think most of the work being done at the well site is actually not on core; it's actually on cuttings. Yes, you are exactly right. They are using low level correlations at the well site that can be used to help calibrate at a lower degree, some Wireline logs or some other data points that might be generated from a suite of logs. So again, really on the exploration side, really on the mud logging side, not really our [bailiwick]. Dick?

I was just going to reinforce that, Dave. Just thinking about how the data sets are used, it's not where we approach the market. That information is valuable to the oil companies to help them decide, should I complete that well bore or not? Our data sets are all about, how do I best produce from a reservoir? As David said, that is more of an exploration tool, do I complete the well bore or not. Our data sets are used to develop producing fields.

Moreover, Jim, you remember Core Lab in the early '80s used to be the largest international mud logger in the world. This is when we attempted at one time to go ahead and provide some of these services at the well site. We sold -- well, actually I personally was charged with selling that business in the mid-80s to Baker Hughes. So, we once visited that area. I don't think we would visit there again.

David, I think I know the answer to this but I want to ask it anyway. So you can't see a scenario based on the measurements being offered where, let's just say a big formation evaluation company, one of the big three, that there was demand for core analysis from the oil and gas companies as one tool in their toolbox to have a better picture of the well at their well site. Could you envision if that was the case, you possibly forming some strategic alliance with another major service company where you would provide them core analysis tools they needed and probably be able to make your return on capital requirements?

Yes, interesting question, Jim. We view the addition of mud logging and some of these lower tech availability of data sets for correlation primarily revolving around the need to offer a full package for these IPM projects. Core has chosen not to participate in these integrated project management type projects because we just have found them over the years is to -- the operators trying to get bundled services for the lowest possible price ever. We don't believe we have ever lost a job because we have not had a cooperative agreement with any of the big three. So, we will continue to go our own way.

Okay. David was that you I saw at a Pirates game in the front row leading the cheering for the [Bucks] the other night?

That was me.

You must be delighted.

First time in 20 years.

Kurt Hallead with RBC Capital.

Got a couple of quick follow-ups for you. I know you indicated a number of times here in your prepared commentary about your capital discipline and your return on invested capital and so on and so forth. Can you just give us a quick reference point on where your current hurdle rates are for investment? The rate of those hurdle rates -- I know when I talked to a number of companies here recently have given me a fact that cost of capital has come down pretty significantly. Some of those have dropped their hurdle rates a tad. So I just wanted to get a general sense whether or not you've maintained your hurdle rates, what those hurdle rates are and are you pushing the envelope even harder now than ever before?

We haven't really adjusted them downward. We're still in the 30% to 40% range and while that may seem high to what you hear from others, that's where we think it's an effective use of our capital and to be able to continue to service our clients and generate our internal growth. It seems to be a nice balance of having industry-leading revenue growth and industry-leading margins. So, we like that 30% to 40% range.

Okay, great. And then second thing I had for you was, can you give us an update on how you may be thinking about redeploying that cash to shareholders? I know you've indicated that you have, I think in recent times, been more favoring dividends over share repurchase. Can you give us an update on whether or not that is shifting at all?

If you go back in history, we started the program back in 2002. It was principally share buybacks. Then we did begin a regular quarterly dividend and kicked it off with some special dividends. We did those for three years. We found over time that some of our discounted cash flow model type investors could not put that special dividend in their model to create value for it. So that's when we rolled in, I believe it was a year ago, our special dividend into our regular quarterly. In this last year, we increased that by 12%. So, we have taken a view that probably not going to do special dividends because they are hard to value but we are cognizant that good companies do increase their dividends over time. Other than that, I think it would be predominant share buyback for use of capital because of our view going forward on the value of the Company is clearly in front of us.

Okay. In the context -- I appreciate that answer and that color. In the context of a dividend increases, is this something that you are thinking about perhaps being able to do on an annual basis or is this the business still too volatile and your opportunity is more fluid than that, that you wouldn't necessarily go out to guarantee an annual dividend increase but something that's a little bit more dependent on the dynamics of business?

The year that we combined our special with our regular, the payout ratio was about 30%. That was about the highest in the group. I think Schlumberger's payout ratio was also 30% at that time. We have chosen not to target a payout ratio but that just shows you the, I'll use the vernacular, spare capacity that we have in the free cash flow to be able to continue to raise that dividend. Will it be done annually? I don't think we're going to commit to that but we will say that quality companies do increase their dividends over time.

Great. That is fantastic. Just the last thing, you guys, the last time you brought a full-year guidance number was back in January or February after your fourth quarter earnings. I know you provided the third quarter. Do you want to take a stab at how do you see the full year now that we've got three quarters in?

The reason why we didn't put in the full year, Kurt, is we still do have some concern with some of the softness in North America and if we still can see economic softness certainly in Europe and maybe Asia-Pacific, maybe we get a little softening. Our crystal ball can't view the fourth quarter but if we don't have any big disruption, those numbers should be fairly accurate on the way we should roll out for the year.

I think you said here that you expect North America activity to be flat but you would improve your business on top of that. So, that would give at least an indication that on the surface, right, we can assume that fourth quarter could be higher than the third quarter at a very minimum if the activity levels remain flat. Is that fair?

Correct, because as Monty said, in looking at the deployment of some of the newer technologies, like HTD-Blast XL and the increased number of completion stages and the complexity of those, we should be able in a flat rig environment -- but we got a little bit up in oil, a little bit down in natural gas continue to grow production enhancement even though 66% of that business is still US and now 34% is outside the US.

Rob MacKenzie with FBR.

A question for you. One of the regions I didn't hear you guys talk about for international and unconventional that others have is unconventional gas in Saudi Arabia. Is that because you are not as bullish on it as some or are you not involved there or what is the rational?

No, Rob, good question on your behalf, an oversight for us. We have done extensive work there on oil shales and natural gas shales and actually have an internal project on a proprietary basis done for Saudi Aramco looking at some of the deeper [prove] of related natural gas there. So an oversight on our behalf and you are absolutely correct. We are fully engaged in gas shales, oil shales and some of the deeper gas deposits there.

Okay, fair enough. Then along those lines, how would you say your outlook for development of international unconventionals has changed in terms of the pace and magnitude of that development now versus, say, six months ago?

About the same with the caveat that we probably see a slowing now in Argentina due to a nationalization of YPF. That could be offset because I read with interest this morning that Shell and Exxon and Mobil have signed agreements with Sonatrach for the development of unconventional resources there. You remember over the last several years that we talked about that (inaudible) shale there to have great potential, not only from a natural gas standpoint but also from a liquids standpoint. Those two might offset so I would say that we would still be equal.

Let me also add Australia is an area that's going to be developing in this. I left that off of the second quarter talk. We will talk about that more in the third quarter but That's an area that where we're going to see a big expansion in unconventional.

Okay. Thanks, Monty. Switching to the deepwater a bit, one of the things that you guys have talked a lot about in the past and to a little bit here are South Atlantic margins and the potential off of West Africa for substantial pre-salt in addition to conventional reserves. How much growth do you think is left there for future studies, for analysis work and the like? It seems like it's quite early.

Absolutely right, Rob. If you look, we are doing work from some of the more recent discoveries there. Cobalt had a pre-salt test that's been positive. Maersk has had a pre-salt test that is positive. We have wells being drilled now by Petrobras and BP Coalition and then also there's a Cobalt test that will be done in just a bit. So I think early days for that. In a past call, we had mentioned our Reservoir Management group has initiated a study further south of there in the Orange Basin where we are looking at a post-salt reservoirs now but as wells start to go pre-salt, no doubt we will have industry interest in those. So I think you are right, very early days for joint industry projects there.

Okay. I guess my last question comes back to the US. There is some worry among investors that prices and differentials into the Bakken may hamper or reduce activity there. Are you seeing any signs of reduced spending on your frac diagnostics work there at all?

We have not. As a matter of fact, I think we are seeing clients more interested in employing that technology because of some of the complexities there of those completions.

Great, thank you. I will turn it back.

John Daniel with Simmons.

Just a couple for me. Within the production enhancement business, have you seen any customer shift from your higher technology products to lower technology products in North America in order to save money and is that something that you would expect to see?

Not really. The value proposition is still very great towards the higher technology products and for the cost differential compared to the well cost and the value that's generated by using the higher technology products, it's usually a slam dunk if we can get them into the higher products. They love the high-technology and the value it brings.

Okay. Then, Monty, you listed all expansion opportunities. It was so exciting I wasn't able to write them all down but obviously, it sounds like a lot. Can you help us translate what all of that means into incremental revenue opportunities?

The things I listed are expansions of laboratories here in the US. That's only part of our expansion opportunity. As far as revenue dollars, it will be generated. I haven't added those up. But it's -- each of those projects meets those hurdles we talked about. That is a compilation of only the major items we are doing. We expect to see continued growth going incrementally just like we have seen in the past going into the future. Obviously with the deepwater Gulf of Mexico, as it continues to build some steam, we will see more incremental growth in that area.

John, I think you are seeing the effects of the expansion of this higher technology level of products and services that we're offering. As you've seen in Reservoir Description, the highest margins that we've ever had in Reservoir Description and that relates directly to us doing more and more work from these deepwater cores not only in the deepwater Gulf of Mexico but also worldwide.

Right. I guess the one that I was able to catch was the first one Monty listed, which was the, for example, Core X-ray detection units. I didn't know if -- is that on a base of 40, 10, 100? I'm trying to understand the magnitude of this, that's all.

That increases that particular capacity in our US lab by about one-third.

Generally speaking, the capacity expansion would be in that 25% to 50% range?

Yes, that is correct. It varies to each area but, yes.

Sounds pretty good. Okay, guys, good quarter.

Blake Hutchison with Howard Weil.

I just wanted to hone in on the Reservoir Description margins, obviously really stand out performance-wise for the quarter. David, you just mentioned that a good portion of that performance is driven by certainly by mix. But I guess maybe more specifically, is there a portion of that, that is driven simply by absorption so you keep that higher margin level as long as you have this level of throughput and then the -- how much is the qualitative versus just the pure level of business at this point?

Remember, it's two things that drive that for us. It's incremental revenues but it's also managing that fixed cost structure. So, you know each quarter we talk about each of those components. I think what you saw is the benefit of some restructuring efforts we did last year in Reservoir Description to improve that cost structure and then throw on top of that the higher tech services that both David and Monty have talked about and your incrementals are going to cause the absolute margins to expand. That's exactly what happened this quarter.

Let me add to that, we stick real strongly in operational management to a discipline of going where we make the money. We work on these margins all the time. We don't enter into areas where we cannot make a margin that helps us out here. So, we try to avoid those areas and as Dick mentioned, last year we had some underperforming areas internationally and we addressed them pretty strongly. That's the way we get there and that's the way we stay there.

I guess qualitatively, we wouldn't expect to take any steps backward in terms of where this positive mix influence has been going?

No, I think As Monty commented, we don't go there.

Right. Right. And again, I think historically you guys have pointed to the fixed cost structure and the ability as a franchise in its entirety to handle with a maybe upwards of $1.2 billion in revenue with a similar fixed cost structure. Does that change as we get more business specific here in Reservoir Description? Is there a level of revenue that you feel like you'd have to start making more major investment or is what we outline today representative of a more major investment at this point?

What you are seeing is our year end and year out approach to our growth capital, not maintenance but growth. Every year we spend about two-thirds of our capital program on that growth to drive our revenues. So, you are just seeing the expansion of capacity based on that $33 million that we're going to spend this year. So, we would expect that $1.2 billion in capacity is going to go up. So it's not a step function that we need to now do something significantly larger. That's not the case. This is what we have done for the last decade, every year spending about two-thirds of our capital program on growth.

Great. Then just a couple of quick ones on the [division's] production enhancement. I think you mentioned that you are still dealing with some higher cost inventory. Is there a point where that rolls off and we see a little bit of a margin benefit?

We are going to see that roll off this year for the most part. Each quarter you should expect to see that come down, say $4 million each quarter through the end of the year.

Great. Is there a timeframe set for the deployment of the HTD XL where we will start going from coil deployment and into the horizontal well bores?

Working on that now. Blake, we will just give quarterly updates on that.

Okay, great. Then just finally, I wanted to gauge the Reservoir Management business at this point. It has become so, I think and rightfully so, focused on the consortium studies and other portions of that business. As we try to model that business, at this point, is that 70% or 80% dominated by consortium studies versus the other offerings within that group?

Yes. I would say yes. We don't talk about the proprietary studies we do in general because they are proprietary. There is not a whole lot we can say about those that is not of a very general nature. That's why we focus on the consortium. But at this time, the consortium studies are the huge share of that business.

So we should start seeing less variability around the numbers in the quarters if that takes over the mass of the segment.

It still has a variability depending on the progress in those studies and new members joining those studies. We are constantly working on new areas of studies to keep that pipeline growing but it is somewhat still up and down, just the size of that business, can make -- big transactions have a big difference in the quarter.

Okay. Thanks for the color, guys.

Stephen Gengaro with Sterne, Agee.

Two things. One, you did say in the release that you expect to generate over $200 million in free cash. That is the same thing you said when you provided the initial guidance range?

I think -- no, Stephen, there was one word changed. It was over to approximately.

Okay.

If you look in the original release on that, the Company expects to generate over $200 million. That has been changed now to approximately $200 million. It still might be over but we did downgrade that commitment.

Okay, that's helpful. You commented on the last call, I think about the consensus being reasonable, the [$4.80] consensus that we currently see now. Do you have any comments on it?

Well, the reason why we didn't put a paragraph in there about yearly consensus is, again, our crystal ball not being as clear in the fourth quarter. So, again, we didn't want to commit to that until we looked at activity levels, especially here in North America. If we have a continuing economic weakness in Europe and in Asia-Pacific, you might have a disruption in crude oil prices which would affect the operational activities of our clients and certainly in these unconventional oil plays. That is really our hedge that we removed that paragraph.

Okay, that's fair. Just as one follow-up, and you have given a lot of color, when we think about the three segments and maybe you can either give a general or segment by segment response, but when we think about that, is there any reason to think your incrementals should not continue to be in that 30% plus range in a different segment as we go forward here? I think about that on a year over year basis.

And we do as well. It is a year over year comparison when we disclose that information. We agree prior guidance has been mid-30%s to 40%. We don't know of any reason why that would not be the case going forward.

Kim, we will take one additional question.

John Lawrence with Tudor Pickering.

Just one quick one. Deepwater as a percentage of revenue, what is that number? How would you expect that to change over the next two or three years?

Okay, when we look at all offshore, 30% of all oils produced offshore, 40% of our revenue comes from offshore, about 50% of that is deepwater.

Okay.

We look for that percentage to go up actually significantly as we find, as Dick had made mention of additional floaters and ultra deepwater drill ships coming on. So, we think that demographic works for us nicely. Moreover, we like that work because it is very data intensive and it generates higher incremental margins. So, we like the whole deepwater demographic because we think that works very nicely for us. If we look at some of these markets, virtually every foot of core that has come out of East Africa, and these are thousands and thousands of meters of core, Core Lab has been able to capture and ditto for reservoirs off of West Africa. So these deepwater plays are incredibly important to us because they do generate higher incremental margins and push our margins. And then Monty has already detailed our expansion plans for the amount of work that we think we are going to be capturing from a deepwater Gulf of Mexico which we just saw our most successful quarter there and certainly we have been told by our clients to expect a lot more of that work. So, all in all, when you look at the rocks and fluids environment in deepwater worldwide, that works very nicely for us.

Great. That's helpful. Thanks a lot, Dave.

Okay, John. I would like to thank everybody for participating this morning. In summary, Core's operations posted another solid quarter. We have never been better operationally or technologically positioned to help our clients expand their existing production base. We remain uniquely focused and the most technologically advanced reservoir optimization Company in the oilfield service sector. This positions Core well for the challenges that lie ahead in 2012 and into 2013. For 2012, we continue to be encouraged by the recent activity trends in international and especially deepwater activities, the growing activity in the deepwater Gulf of Mexico and remain confident in activity levels associated with unconventional oil plays, especially in North America and also worldwide.

The Company remains committed to industry leading levels of free cash flow 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. As Monty Davis has already pointed out, the executive management and Board of Core Laboratories gives a special thanks to our 5,000 worldwide employees that have made all of these outstanding results possible. We are proud to be associated with their continuing achievements. Thanks for spending your time with us this morning. We look forward to our next update. Good-bye for now.

Thank you. That does conclude today's Core Lab Q2 2012 earnings conference call. You may now disconnect.