Core Laboratories Inc (CLB) 2016 Q2 法說會逐字稿

Good morning and welcome to the Core Laboratories Q2 2016 earnings conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Mr. David Demshur, Chairman and President of Core Labs. Please go ahead.

Thanks, Harrison. I'd like to say good morning in North America, good afternoon in Europe, and good evening in Asia Pacific. Would like to welcome all of our shareholders, analysts and most importantly, our employees to Core Laboratories second-quarter 2016 earnings conference call.

This morning I am joined by Dick Bergmark, Core's Executive Vice President and CFO; Core's COO, Monty Davis who will present the detailed operation review; and Chris Hill, Core's Chief Accounting Officer. Also this morning, I have the pleasure of introducing Gwen Schreffler to new participants on this call.

Gwen will be helping Core with our Investor Relations efforts. Gwen has been with Core Lab for over 10 years, most recently as a Vice Present of Core's Human Resources based, in the last three years, in our Amsterdam Office. Her new role in Corporate Development and Investor Relations is a logical segue from her role leading our HR efforts as Core Lab is such a people focused, energy technology company.

Our most important assets are the skills, capabilities, and technologies delivered by our employees to our clients throughout the globe. Many of our European shareholders have already met Gwen over the past few years. As she has augmented our investor relations efforts in Europe while based in Amsterdam.

The call will be divided into five segments. Gwen will start by making remarks regarding forward-looking statements. Then we will come back and give a review on the current macro environment, updating US and worldwide crude oil supply [thoughts] as related to newly calculated net decline curve rates and then quickly comment on Core's three financial tenants, which the Company employs to build long-term shareholder value.

Chris will then follow with a detailed financial overview and additional comments regarding shareholder value. That will be followed by Dick Bergmark, commenting on Core's second-quarter and second-half 2016 outlook and a general industry outlook as it pertains to Core's prospects. Then Monty will go over Core's three operating segments, detailing our progress in discussing the continued successful introduction of new Core Lab technologies and then highlighting some of Core's operations in major projects worldwide. Then we will open the phones for a Q&A session.

I will turn this back over to Gwen for it remarks regarding forward-looking statements. Gwen.

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 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, 2015 as well as other reports and registration statements filed by us with the SEC and the AFM.

Our comments include non-GAAP financial measures. Reconciliation to the most directly comparable GAAP financial measures is included in the press release announcing our second-quarter results. Those non-GAAP measures can also be found on our website.

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

Thanks Gwen. We would like to look at the current macro view and then review our three financial tenants. Core believes that worldwide crude oil supply and demand markets are close to balancing and will balance the second half of 2016. On the crude oil supply side US unconventional production peaked at 5.5 million barrels of oil per day in March 2015. And has since fallen by over 1 million barrels a day owing to high decline curve rates, associated with these tight oil reservoirs.

Offsetting these sharp production declines have been additions of approximately 160,000 barrels a day from several Deepwater Gulf of Mexico legacy projects that were commissioned several years ago and started to bear fruit in late 2015, 2016. These additions no way will offset what is coming from the deductions that will occur on land throughout this year and into 2017.

The sharp declines from US land production are continuing in 2016 and Core believes these decreases could reach 1.1 million barrels of oil per day or more by year end. Lower levels of new wells and delayed production maintenance will exacerbate the fall in US land production going into 2017.

Remember, production decline curves are linear in time, but logarithmic in production declines. A year ago month over month US production declines were in the tens of thousands of barrels per day per month. Now, these month over month per day losses quite often reach 100,000 barrels of oil per day or more. So, look for that to expand and continue to expand into late 2016 and into 2017.

From these analysis, we would take the over on the drop of 1.1 million barrels per day by year end. We will recalculate these numbers for Q3 earnings release. Moreover, further net gains from legacy projects in the Deepwater Gulf of Mexico will be needed to offset significant increases in the existing Gulf of Mexico production base.

These legacy Gulf of Mexico projects could add a net 160,000 barrels a day in 2016, slightly offsetting the material onshore and shallow water declines that are taking place. Core estimates that the current net decline curve rate for US land production is approximately 10.1%, which will continue to expand into 2017. We are in the process of recalculating these parameters and we will re-up date Q3.

Globally, Core estimates that the net crude oil production decline curve rate has expanded to 3.3% net, up some 20 basis points from earlier year estimates. Applying the 3.3 net decline curve rate to a worldwide crude oil production base of approximately 85 million barrels per day means the planet will need to produce approximately 2.8 million new barrels by this date next year to maintain current worldwide productive capacity totals. With the long-term worldwide spare capacity nearing zero, Core believes worldwide producers will not be able to offset these declines, and the estimated 3.3 net production decline curve rate in 2016 will lead to falling global production in 2016. This is supported by some of the recent IEA data indicating decline of production on a global basis through Q2 2016.

Therefore, Core believes crude markets more than rationalize in the second half of 2016 and price stability, followed by price increases [sommer curry] as we speak return to the energy complex. Remember, the immutable laws of physics and thermodynamics mean that crude oil production curve always wins and it never sleeps.

On the demand side, if we look at the crude oil market, the IEA has increased demand in 2016 to approximately 1.4 million barrels of oil per day. The US is now using over 10 million barrels per day of gasoline. These are near record levels.

Recent Chinese export, coupled with strong demand out of India are at near all-time highs. Supply and demand will balance as they have in all past market disruptions.

Now to review the three financial tenets by which Core used to build shareholder value over our 20 year history of being a publicly traded company. Incidentally, Core is also celebrating its 80th year of innovation in 2016.

During the second quarter of 2016, Core generated free cash flow that exceeded net income for our eighth consecutive quarter. Free cash flow for the first half of 2016 more than doubled net income, clearly the best in all oil field services. Moreover, Core converted over $0.23 of every first half 2016 revenue dollar into free cash. Again, leading all oil field service companies.

Also, during the second quarter, Core once again produced the oil field's industry leading return on investment capital for the 28th consecutive quarter, topping an ROIC of 26%. Producing and industry-leading ROIC has not happened by chance.

A real concern for investors is exposure to the Venezuelan market. Core closed all operations in Venezuela in 2013, a discussion at which time, was highly questioned by our analysts, shareholders and potential shareholders. Departing Venezuela in 2013 led to lower short-term revenue and earnings growth rates, versus other oil field service companies for which we were criticized. This paralleled our discussion to depart Mexico operations over a decade ago.

Now, downsizing Latin and South American operations are very trendy in our industry. Core's internal risk assessment process determined that long-term risks clearly outweighed long-term values for the Venezuelan market. With hundreds of millions of past write-downs occurring, and with over $1 billion of write-downs to come, we believe Core made the correct decision, protecting long-term return investment goals by departing the Venezuelan market.

Finally, during the second quarter of 2016, Core returned over $23 million back to our shareholders via our quarterly dividend. Core will continue to return all excess capital back to it shareholders with hopes of additional share repurchases in the near future.

I will now turn the call back over to Chris for a detailed financial review.

Thank you David. Starting with the income statement, revenue for the second quarter was $148.1 million, so, down sequentially about 3.5%. But that it is in an environment where we have seen the average quarterly rig count in the US fall 24% this quarter and global average rig count is down from 19%. Of this revenue, service revenue is $118.2 million for the quarter, down almost 4% sequentially, but again, a favorable outcome considering the significant drop in global rig count this quarter and general spending levels from the oil and glass clients.

Product sales revenue, which is more tied to North America activity, was down only 3% sequentially to $29.9 million. When average horizontal rig count in the US decreased some 25% this quarter when compared to the first quarter this year.

Moving on to cost of services, for the quarter, they were at 70.5% of revenue and despite lower revenue stayed in line with Q1, which is about 69.5%. So you can see our cost reduction actions taken in the first half of this year are being realized, which help us to continue to generate some of the strongest margins among oil field service companies. Our cost of product sales was 89.1% of revenue, unchanged from the prior quarter. So, despite the sharp decrease in North American rig count and associated activities, again our cost reduction efforts being implemented throughout the first and second quarters helped the Company retain its margins.

G&A for the quarter was $11.1 million and is consistent with prior quarter. For the full-year we expect G&A to be approximately $45 million to $46 million. Depreciation and amortization for the quarter was $6.8 million unchanged sequentially but down a little year-over-year from $6.9 million, due to the reductions in our CapEx program starting last year.

Considering capital expenditures in 2015, and with our anticipated capital programs for this 2016, we would expect depreciation to continue on these approximate run rates and to be about $27 million for the full year. Other income and expense includes $400,000 of foreign exchange losses and as we have previously stated, our guidance excludes any gains or losses related to FX. The guidance we gave on our last call for this quarter, specifically included the impact of any FX gains or losses and was based on an effective of tax rate of 14%.

Accordingly, our discussion today in pro forma EBIT and EPS excludes this foreign exchange loss and assumes a tax rate of 14%. Excluding those FX losses, and to conform to our guidance, pro forma EBIT for the quarter was $20.7 million, compared to the pro forma EBIT of $23.7 million reported last quarter.

GAAP EBIT for the second quarter was a little over $20.2 million. Interest expense in the quarter was $3 million, a decrease of about 12% from $3.4 million in the first quarter. We expect interest expense in future quarters to continue to be materially lower than previous quarters as the proceeds from our equity offering are used to reduce our outstanding debt by almost 50%. As a result of the reduction in debt and interest expense, the equity offering will be accretive to EPS for the Company.

We expect interest expense at current debt levels to be approximately $2.6 million to $2.7 million per quarter going forward. I will provide further details related to the equity offering later in my discussion on the balance sheet.

Income tax expense in the quarter, using an effective tax rate of 14%, would have been $2.4 million. Our GAAP income tax expense for the quarter was about $650,000 and was lower than our guidance due to slightly lower earnings in the US, and adjustments like [FIN] 48 and other discrete items that were recognized during the second quarter. We believe our effective tax rate for the third quarter will approximate 11% and this excludes any discrete items that may be recognized in the quarter.

Net income for the quarter, [ex] items was $15.3 million compared to $15.7 million for the first quarter of 2016, ex items. GAAP net income was [at] $16.6 million for the quarter. Earnings per share for the quarter was $0.35 on the same basis that our guidance was given.

Our GAAP EPS was $0.38 per share, which includes those foreign exchange losses, and uses the GAAP effective tax rate. These items are reconciled in a table, which is included in our earnings release.

Now, as we move on to the balance sheet and in the interest of time, I will only highlight the items we feel are of interest to the audience or have materially changed from previously reported balances. Cash is $14.8 million, down from $22.5 million at prior year-end. Receivables stand at $112.8 million, down from $145.7 million at prior year-end.

Our DSOs for the quarter were 64 days, a nice improvement from the 67 days last quarter, and he 66 days for all of 2015. Our management team and personnel continue to focus on important aspects of running a business during this difficult environment. Inventory at $39.8 million is down slightly from the year-end balance and down approximately $1.9 million from March 31. We continue to expect inventory levels to trend down as we move through the remainder of 2016. There were no material changes on other current assets. [PP&E] and tangible good wills or other long term assets.

Now on to the liability side of the balance sheet. Accounts Payable is $29.4 million, down from the balance of about $33.5 million at prior year-end. Other current liabilities are down about $7 million during the quarter to $66.8 million and down from the year-end balance of $87.3 million, primarily due to the timing of accruals and payment for severance tax and other various liabilities. Our long-term debt stands at $208 million, which is reduced approximately $200 million or almost 50% this quarter, primarily from the proceeds received for the equity offering.

On May 26, we completed a successful equity offering, issuing about $1.7 million new common shares for net proceeds of approximately $197 million. So, for issuing less than 4% of our outstanding shares, we used those proceeds to pay down a substantial portion of the outstanding balance on the revolving credit facility and reduce our total debt by almost 50%. Our outstanding debt of $208 million is comprised of $100 million in senior unsecured notes, $60 million drawn on our bank revolving credit facilities, which is net against $2 million of debt issuance costs.

This reduction of debt this quarter has strength in the balance sheet and position the Company well as we manage through this difficult year to prepare for the recovering energy market. Shareholders equity ended the quarter at a $167.5 million, up primarily due to the equity offering just mentioned and net income offset by our dividend payment.

Capital expenditures for the quarter were $2.4 million, down from the $2.9 million in first quarter of 2016. The Company continue to expect its 2016 capital expenditure program will be less than 2015, perhaps in the $15 million range. However, if oil field activities pick up Core has the ability to increase its investment in support of these strengthening activities.

Now looking at cash flow. Cash flow from operating activities in the first half of 2016 was $73.8 million and after paying for our $5.3 million in CapEx, our free cash flow is $68.5 million. Once again, our free cash flow exceeded net income this quarter. During the first half of 2016, we used our excess free cash flow to pay $46.6 million in dividends and further reduced our long-term debt.

Our focus on managing a business during this challenging environment continues to be on maximizing free cash flow and return on invested capital. Our free cash flow conversion ratio, which is free cash flow divided by revenue, continues to be one of the highest in the industry at 23% year-to-date. We believe this is an important metric for shareholders when comparing companies' financial results, particularly those shareholders who utilize discounted cash flow models to assess valuations. In 2015 and year-to-date 2016, our free cash flow was higher than our net income as a has been in 10 of the last 14 years.

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

Thank you Chris. Dave has already set the foundation for our broad view of the crude oil markets coming into balance, and how that should provide a positive backdrop for Core Labs, particularly in 2017 when our clients are expected to begin to increase their activity levels. Until then, based on typical seasonalities, we do project third quarter result will increase on a sequential basis from the second quarter.

Revenues should range between approximately $148 million to $151 million, yielding operating margins increasing sequentially to approximately 15%. Our effective tax rate is expected to be approximately 11% in the third quarter, as a result of lower profitability and higher tax rate jurisdictions. Third-quarter EPS is expected to be in the $0.39 to $0.41 range, with free cash flow exceeding net income for the ninth consecutive quarter.

On an equivalent currency basis, Core expects third-quarter 2016 revenue and operating income and margins to increase from second-quarter 2016 levels. Therefore, our second quarter 2016 results should mark the bottom of our anticipated [V-shape] worldwide commodity recovery followed by increased crude oil prices and expanded industry activity levels worldwide.

That guidance discussion over I will now turn it over to Monty for an operational review.

Thanks, Dick. Second quarter revenues of $148 million were down $3.6 million sequentially from the first quarter, compared to a 19% decline in the global [rake] down. Operating earnings, excluding foreign exchange losses were $20.7 million, yielding an operating margin of 14%. We extend our appreciation to our dedicated employees worldwide for their continued delivery of best in class services and products to add value for our clients every day in a difficult market.

Reservoir [description] revenues for the second quarter of $103 million grew 1.4% from Q1. Operating earnings of $19.2 million yielded operating margins of 19%.

In the second quarter, Core Lab expanded work on several laboratory-based programs aimed at evaluating enhanced oil recovery opportunities in unconventional reservoirs. [Fracture] stimulated unconventional reservoirs often yield only a very small portion, an average of 9% of the original oil in place. Testing and validating methods to improve recovery factors in these types rocks can substantially change [plate] economics, possibly increasing recovery rates to 13% to 15%.

Core is on the cutting edge of developing EOR techniques in pipe oil reservoirs. Scientists in Core Labs' Aberdeen Advanced Technology Center have been working on a multi-well evaluation project to describe, characterize and evaluate the potential of what our client describes as a world-class deep water asset off shore West Africa. A key deliverable of the multi-well program is to delineate the physical properties and architecture of the asset. Information and data sets from Core will help the client to develop their long-term exploitation plan, focusing on maximizing production from this complex reservoir structure.

Course geoscientists are utilizing proprietary techniques, high-resolution digital imaging technologies, and other state-of-the-art laboratory equipment to characterize the geological and petrophysical attributes of the rock. Our reservoir condition measurements will be used to calibrate third party wire line [logs] yielding a much more detailed reservoir model.

At the same time, Core's reservoir fluids laboratory in Aberdeen has been tasked with characterizing the key chemical and physical properties of the hydrocarbons in this discovery. State of the art high-pressure full visual PVT sales manufactured by Core Lab are bringing [use] to understand the variations in fluid properties across this reservoir. The results of these tests will provide critical inputs into flow assurance models.

During this quarter, our live data systems delivered tangible savings to one of our customer which we worked on with on a pilot project. In this particular project, we used our dashboard technology to measure the efficiency for loading and discharge operations at a number of their facilities in Europe. By using this technology, (inaudible) in the logistical chain became visible, such as, unnecessary waiting time and congestion that led to superfluous lay time. As a result thereof, process have been redesigned and optimized. More importantly, continuous monitoring assignments have been put in place to secure permanent improvement.

This concrete result created further leverage to our strategy of adding value to the logistical change of our customers. A number of other pilot projects with different customers and/or partners in the distribution chain are being put in motion.

We expect reservoir description will recover later in the spending upturn, as new wells must be drilled and [cores] reservoir fluids taken before they can be analyzed. As mentioned in the Q1 call, we are still targeting 20% margin or reservoir description for Q3.

Production enhancement second-quarter revenues declined 11% to $39.1 million. Operating margins of 2.5% yielded operating earnings of $1 million. Noble Energy and Core Laboratories co-author A Society of Petroleum Engineers technical paper in Q2 to be presented at the fall 2016 SPE annual technology conference. This paper describes 13 [frac pac] treatments performed over the past six years on Noble Energy wells in deep water Mississippi Canyon, in which Core Laboratories proprietary diagnostic technologies Spec Trastem and Spec Trascan/Pac Scan were employed to improve offshore operations, ensure complete annular packs, evaluate frac pack efficiencies and provide decision-making data to be used in the development of best practices for Noble Energy going forward.

According to one of the Noble engineers without Core's diagnostic data identifying the need for, and the top of design and Core's follow-up diagnostics confirming the success of the top off, this well most likely would have been an infancy (inaudible) control failure, which would have resulted in an expensive work over. Ultimately the well was successfully put on production and has been producing sand free for six years with a low skin factor and has cumulatively produced 11 million barrel oil equivalent and is still producing 2000 barrel oil equivalent per day.

As the new well drilling market continue to fall to its lowest levels in Q2 2016, Core Lab's ballistic and mechanical engineers have been having significant success in developing economical solutions for customer problems that exist with older wells that need to fix [facing] leaks or shut off on unwanted water for increased hydrocarbon production. As a result, Core's product enhancement group is realizing significant growth in the remedial market with unique solutions. The production enhancement team successfully adapted and tested five patented X [band] casing pack systems to meet Russian [gulf] standards, equivalent to API casing standards used in most oil field regions.

During the second quarter, our first significant order was shipped to Russia to be utilized for repairing casing leaks and shutting off water in older wells. Core's X [band] technology was previously tested in a Russian oil field and proven as a more reliable and economic method for repairing casing leaks and shutting off unwanted water in old wells versus the conventional method of cement squeezing. Cement squeezes are often more expensive and ineffective in repairing casing leaks and shutting off water producing zones.

Core's X band system utilizes a patented multidimensional metal to metal technology to provide a permanent seal over the damaged casing and existing perforations for zonal isolation. In addition to the projects in Russia the X band system has been successfully deployed in North Africa, where a water shut off program that is expected to continue over the next three quarters. We expect production enhancement to be an early beneficiary of increased client spending as duct wells will be one of the first areas to see increased activity.

Reservoir management revenues for the second quarter of $6 million were down 25% sequentially. Operating margins increased to 8% yielding operating earnings of $0.5 million.

Early in the quarter, most client interest was in the Permian basin studies. Near the end of Q2 interest increase in plays that are predominantly gas prone, the Marcellus in the Haynesville, indicating the industry is becoming more bullish on the potential for increasing domestic natural gas demand.

Many of the US customers continue to be new companies that are entering the arena with good financing and little or no debt. The key to their success is identifying the best place with the lowest risk. A process that requires good geological and engineering data. Two debt value data sets that Core Lab can supply.

We anticipate an increase in [steady] sales as the acquisition and divestiture markets become more active. Outside of North America, reservoir management has been leveraging our expertise in non-conventional [ways] to gain a foothold in some of the emerging markets. A concentrated effort in the Middle East is paying off with a recent reward of another unconventional reservoir evaluation contract.

On the conventional side, Surinam, Guyana, Angola, and the east coast of Canada are the focus of our ongoing offshore work. The announcement of the overwhelming success of Exxon Mobil in and Hess' exploration program in Guyana bodes well for future sales of Core Lab's regional study.

Harrington, we will now open the call for questions.

(Operator Instructions)

At this time we will pause momentarily to assemble a roster. Rob MacKenzie of Iberia capital

Good morning guys.

Good morning Rob.

Dave or maybe Monty. I guess my first question is, coming back to what you talked about on [enhancing] recovery in tight reservoirs. And some you have talked about for awhile. I'm curious where that stands in the development process? What hurdles or what milestones you need to achieve before that becomes a more material commercially?

Yes. Good question Rob. We first mentioned this at the end of the first quarter of last year. We have a number of projects that continue to grow and we are still currently in the experimental stage for specific reservoirs and specific crude oils on what is the proper cocktail, at what pressures and temperatures to inject that into the reservoir to recycle.

So, we do have a number of projects that are ongoing. You do have one field implementation of admissible flood out in the Eagle Ford Channel. Rob, we are still probably several quarters away before we see the field-wide implementation of these projects. But, sure enough, they are coming down the pike.

Okay. So, it sounds like, from my prior notes, you guys were talking recovery rates up to 12% to 14% and now you are saying 13% to 15%. Is there something you are seeing that is making you more optimistic about what you are able to achieve here?

Yes. As we study the cocktails of which we are injecting, including miscible hydrocarbon gases. We have upped those 100 basis points on either end. We still believe that is doable in the field.

However, taking a laboratory scale to a field scale is a big step. It is always happened before in experimental projects that we have worked. We have no reason to believe that will not occur at that level. So the more that we study these phenomena and the cycling of these various fluids through these rocks the more we learn.

Got it. Then, A, how would billing for a service like this work? And B, how would you protect the intellectual property and all of the work that has gone into designing these cocktails and prevent others from simply copying you?

From the aspect of billing, these are really book price analysis that we perform and many of which are performed at reservoir temperature and pressure. So, Rob, we are looking at relative permeability testing across using water and multiple gases. So that is a very common analysis for us that it runs to the price book.

On protecting the proprietary side, we are using trade secrets for individuals in our facilities. Of course, once paid for by the client they own the technology, and the secrets associated with that, they are free to share that with whomever. However, we must say, that the variety of cocktails of gases needed to be effective are going to vary greatly even within single plays.

So, when you look at it from a standpoint of being able to share what these cocktails are, what could be very effectual in one area of the play, might not be all that effectual in a county or two over. Moreover, on proprietary side, some of these pressures and temperatures at which we are injecting, we are the only guys on the planet that have this equipment. And so that also provides a proprietary note on others being able to simulate these in their laboratories, whether they be in major oil companies or pseudo-competitors in North America or the global space.

Great. Thanks. One final if I may. How do you think about the ultimate size of this? Because on the surface, it sounds like this could be a very material contributor to earnings over time. Trying to see if we can put some benchmarks around that.

It is hard to say right now. But I think you are right, Rob. In two or three years this will be a mainstay of reservoir description in North America.

All right. Thanks. I will turn it back.

Thanks Rob.

Next question Sean Meakim, JPMorgan.

Good morning, Sean.

Thinking about North America and given the continued ramp and volumes per stage we keep hearing about from the EMPs, how are you thinking about that trend helping your results and production enhancement relative to recounts? You have talked about a V-shaped recovery. How do you see the performance of that business relative to broader activity in the [recall] specifically?

If we look at production enhancement, clearly outperforming by a long stretch [with] the decline in the North American, especially the US land rig count has been more of that to come. Again, the mantra for continued success are longer laterals, more stages, closer clusters, more profit.

If you look at our 2013 annual report, on the cover we have what was then called the well of the future, it contained 256 stages. We have just worked on a well that had over 160 stages. So, the well of the future will be here before we know it. So, that being said, you can look at and model the recovery in the growth rate in production enhancement to clearly outstrip the [gain] back in the rigs that we have added, the 70 rigs or so that we have added from the bottom in May.

Then how do we translate that into incremental margins this cycle do you think?

I will let Dick answer that one because he has been working on these incrementals.

Sean, if you think about the cost that we would need to take out to the field as the number of stages increase, and the lateral [length] increases it really does not change our cost structure. It is just an incremental cost of additional stages. So some additional chemicals, for example are pretty much nil, so we're thinking incrementals will be 60% plus. Just as they have been on any recovery in a cycle. Moreover, as these new services are added though, irrespective of our you on a cycle, you will see the incremental nature of the revenue it will generate the high incremental margins through cycles.

Right. It makes sense. Switching gears, and coming back to EOR. I am just curious, as we are at a bit of an inflection point here in terms of activity for North America. How do you expect EMP interests, and (inaudible) products to evolve in a recovery? EMPs are getting more cash flow, but they are also getting more interested in incremental drilling programs. Any in a shift in those conversations?

Yes. It is interesting Sean, we've got clients now that are talking about return on their invested capital. And certainly, if you could just apply these numbers to their past returns, which, in many cases have not been to the level that they need to be to even recapture their cost of capital, these programs will be needed to ensure that their return on invested capital is a positive, with respect to their cost of capital. So, even as we drill additional wells and exploiting more of these major tight oil plays, you will see the more sophisticated clients using these technologies, clients like Pioneer Natural Resources.

On the CO2 front, you have a company like Occidental, that has been very good in applying this technology out in West Texas. You will continue to see that occur and actually expand over this the next rebound in the cycle, keeping in mind that our most sophisticated and technical logically adept clients know that they need to increase their returns on their invested capital.

Fair enough. It makes sense. Thanks a lot gentlemen.

Next question, Blake Hutchinson of Howard Weil.

Good morning. First question. Just a point of clarification from some of the numbers that were thrown out there relating to segment outlook. I think Monty said that the goal of attaining 21% margins and reservoir description for the coming quarter was still intact. As we look at the overall numbers that would entail that production enhancement margins were flat to perhaps down.

Is there some mix working against Gulf of Mexico or an international mix? Is that correct? And is there a positive mix working against production enhancement that may mask some of the increments from the US land market? From the quarter to quarter basis if that's what (inaudible)?

Blake, first let me be really clear on this, we said 20% margins for reservoir description for Q3. That is the same number we gave out at the end of Q1. We thought by Q3 our reservoir description margins would be up to 20%.

We have been dealing with our cost structure for the last year and a half and as the bottom of the [Bee] went deeper than most people expected, we have continued to deal with our cost structure, including into the second quarter and right up to the end of the second quarter, we have been making adjustments. So, the full effect of those won't be in play, the later ones, of course, until the third quarter. So that is where we get our feeling of what is going to happen for us.

We do see some pickup in the production enhancement revenues as I mentioned the duct wells. We think that there will be a reduction in the number of duct wells in excess of normal process over the second half of the year. And, we have got pretty good reason, talking to customers, to know that is the plans of many of our customers. So that is opportunity for us in production enhancement that we're pretty confident is going to happen in the second half of the year and into 2017.

So, Blake if you use 20% margins and reservoir description, you still have room to grow production enhancement margins slightly in Q3 as well.

Yes. That jives more with what we were talking about in this conversation. I'm sorry I misheard that 21%. Absolutely. I got it.

Then, David or Monty. Because we're in the starting box here, and you mentioned all the costs that you have worked out of the system on reservoir description, specifically, as we think about cycle to cycle margins. I am not asking to get granular and I understand pricing has not necessarily impacted the whole portfolio of projects within reservoir description. But if we look over the last 12 to 18 months, what type of price impact, and maybe on a weighted average basis have you felt? So that we can understand what has come out from that perspective and apply that to our margin understanding going forward.

I think you do not make a large amount of correction for pricing. Most of this is volume related, Blake and we have tried to reduce costs to offset the lack of volume coming out of this. Reservoir description should model no differently than it did through 2008, 2009, 2010, 2011. So if you use the model base, you see that you can get your reservoir description operating margins back into the low [30%] area.

Great. That is extremely helpful. Let me sneak one more in here, and I will hang up and listen. You mentioned that the reservoir management section is actually seeing an uptick in some demand for US basins. Is that a continuation of your private equity comments from the last quarter? Or are you starting to see some operators come back and take a look at these data sets?

It is both, Blake. You have had a lot of small operating companies that are getting infusions of equity as they [go] through the process. And this is where we are seeing people that have new interest. We're also seeing people come in and acquire management from our previous operators that have plans of their own and they are looking at these same plays that we mentioned. So, it is a mix of companies that have gotten an infusion and companies that are being formulated with some expertise from the prior (inaudible).

Thank you for that guys.

Okay Blake.

(Operator Instructions)

It appears that we have no further questions at this time.

Okay Harrington, thank you. In summary, Core's operations continue to position the Company for an uptick in activity levels in the second half of 2016 and we know the significant challenges await. However, we have never been better operationally and technologically positioned to help our clients to maintain and expand their existing production base. We remain uniquely focused, and are the most technologically advanced reservoir optimization company in all of the oil field services. This positions Core well for the challenges ahead.

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 shareholder via dividends and future opportunistic share repurchases. So, in closing, we would like to thank all of our shareholders and the analysts that follow Core and as Monty Davis has already said, the Executive Management and Board of Core Laboratories give a special thanks to our worldwide employee base that have made these results possible. We are proud to be associated with their continuing achievements.

So, thanks for joining us this morning and we look forward to updating you at the end of the third quarter. Goodbye for now.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.