Core Laboratories Inc (CLB) 2020 Q4 法說會逐字稿

Good morning, and welcome to the Core Laboratories Fourth Quarter 2020 Earnings Conference Call. (Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Larry Bruno, Chairman and CEO. Please go ahead.

Thanks, Islee. Good morning in the Americas. Good afternoon in Europe, Africa and the Middle East, and good evening in Asia Pacific. We'd like to welcome all of our employees, analysts, and most importantly, our employees to Core Laboratories' fourth quarter 2020 earnings call.

This morning, I'm joined by Chris Hill, Chief Financial Officer; and Gwen Schreffler, Core's Senior Vice President and Head of Investor Relations. The call will be divided into 6 segments. Gwen will start by making remarks regarding forward-looking statements. We'll then have some opening comments, including a high-level review of Core's 2020 performance. In addition, we'll review Core's strategies and the 3 financial tenets that the company employs to build long-term shareholder value.

Chris will then give a detailed financial overview and have additional comments regarding shareholder value.

Following Chris, Gwen will provide some comments on the company's outlook and guidance. I'll then review Core's 2 operating segments, detailing our progress and discussing the continued successful introduction and deployment of Core Labs technologies as well as highlighting some of Core's operations and major projects worldwide. Then we'll open the phones for a Q&A session.

I'll now turn the call over to Gwen for remarks on forward-looking statements.

Thank you, Larry. Before we start the conference this morning, I'll 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 most recent annual report on Form 10-K as well as other reports and registration statements filed by us with the SEC and the AFM. Our comments include non-GAAP financial measures. Reconciliation to the most directly comparable GAAP financial measures is included in the press release announcing our fourth quarter results. Those non-GAAP measures can also be found on our website.

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

Okay. Thanks, Gwen. First, our thoughts remain with all of those that have been directly affected by COVID-19, particularly among our dedicated employees, and their families as well as our industry colleagues and the medical professionals that are -- and others serving on the front lines. While we can all see the virus-related challenges that still lie ahead of us, there is certainly reason for optimism as the vaccines become more widely distributed throughout 2021.

Headwinds across the entire oil and gas industry due to a combination of reduced oil demand and oilfield operational disruptions tied to COVID-19 persisted during the fourth quarter, but there was improvement in operational activity in some regions. Unpredictable schedules in our clients' activities, along with logistic hurdles for field services and product shipments remain, particularly in those international regions that saw an increase in COVID-19 cases beginning in the early to middle part of the fourth quarter as a number of countries enacted or expanded precautionary measures and even lockdowns during the fourth quarter.

On a more positive note, U.S. land activity improved sequentially from Q3 to Q4 and Core Lab benefited from an uptick in well completions. Very importantly, Core Lab's dedicated staff continues to safely and efficiently provide all the vital services and products required to meet the needs of our global client base, and we are very well positioned to continue to do so.

As we look back over 2020, this is a year which posed unprecedented challenges across the oilfields. Due to effective and rapidly implemented adjustments to our cost and operational structures, Core Lab is one of the select group of oilfield service companies that posted positive full year free cash flow and when adjusting for noncash write downs for goodwill and other impairments posted four consecutive quarters of positive earnings and a positive return on invested capital for the year.

The leadership of Core's management team and the adaptability of Core's dedicated staff resulted in full year share price performance that comfortably exceeded the OSX Index, fourteenth time in the last 18 years that Core has outperformed the index. In addition, aligned with Core's stated goal to delever the company, Core reduced net debt by $49 million dollars from the end of 2019 to the end of 2020.

These financial performance metrics reflect both our disciplined approach to running the business and managing capital as well as the underlying durability of Core's global model.

Now to review Core's strategies for any financial tenets that Core has used to build shareholder value over our 25-plus year history as a publicly traded company.

The interest of our shareholders, clients and employees will always be served by Core Lab's resilient culture, which relies on innovation, leveraging technology to solve problems and dedicated customer service.

While we navigate through the current challenges, core will remain focused on its 3 long-standing, long-term financial tenets, those being to maximize free cash flow, maximize return on invested capital and return excess free cash to our shareholders.

Core generated $46 million in free cash in 2020, marking the 19th consecutive year of generating positive free cash. Core's asset-light business model will continue to focus on maximizing return on invested capital, which excluding onetime adjustment for asset impairments, remains among the best in the industry.

Core's management team remains sharply focused on ensuring that our cost structure is aligned with client activity levels, and we have exceeded the $61 million in annualized structural cost reductions outlined in the second quarter of 2020. This was accomplished while still maintaining the workplace safety of our employees. Moreover, we will continue to meet all of our client project needs and very importantly, we remain well positioned for the recovery in client activity that we anticipate in 2021 and beyond.

Central to our long-term growth strategy is the continued introduction of new technologies. Core Lab's internal pipeline for new technologic offerings in both Reservoir Description and Production Enhancement remains very strong. And the unique collaborative relationship that Core maintains with its technologically sophisticated client base has always allowed Core scientists to provide innovative solutions to address industry needs.

New collaborative efforts to develop problem-solving technologies are currently and always underway, and I'll touch on some of these in the operational review section of this call.

Before we move on, I want to thank Core's management team and employees for their hard work during the unprecedented challenges over the past year.

I also want to thank them for the dedication, loyalty and adaptability in meeting all of our client needs and for the personal sacrifices that many have endured as we both navigate the moment and prepare for a more active market for the upcoming year.

I'll now turn it over to Chris for the detailed financial review.

Thanks, Larry. And as Larry previously stated, the company announced that for 2020, we would focus on strengthening our balance sheet by reducing debt and working towards improving our liquidity position.

Excess free cash has been focused towards reducing debt. And for 2020, the company reduced net debt by approximately $49 million. Additionally, the company took steps in refinancing a portion of our long-term debt, and on January 12, 2021, issued $60 million in new senior notes through a private placement. These new senior notes have a 5- to 7-year maturity and the proceeds were used exclusively to reduce outstanding debt on our credit facility.

As a reminder, our bank credit facility is sized at $225 million and after reducing the outstanding balance with proceeds from issuing the new senior notes in January, the company has over $150 million of available borrowing capacity under the facility. At this time, I'll also provide an update on our debt leverage ratio as this is one of the more restrictive financial covenants tied to our corporate debt.

The maximum leverage ratio is currently limited to 3x of our trailing 12-month EBITDA. At December 31, the company's leverage ratio was a little over 2.8 as we continue to manage our debt levels down to remain compliant with our covenants. As the company has forecast financial performance over the past several quarters, we'd always forecast our leverage ratio to reach its peak in the fourth quarter of 2020 and first quarter of 2021.

We continue to forecast the company will remain compliant with our financial covenants and with current expectations for 2021. And as we continue applying excess free cash towards reducing debt, we are forecasting our leverage ratio to begin decreasing in the second quarter of 2021.

Before we review the financial performance for the quarter, the guidance we gave on our last call and past calls specifically excluded the impact of any FX gains or losses and assumed an effective tax rate of 20%.

So accordingly, our discussion today excludes any foreign exchange gain or loss for current and prior periods. Additionally, the financial results for the fourth quarter of 2020 include a noncash adjustment of $11.9 million to reverse previously recognized stock compensation expense that was associated with revalued performance share awards that did not fully vest and were revalued.

Additionally, ex items include a charge of $700,000 associated with additional inventory write-downs and facility exit costs. These additional credits and charges have also been excluded from the discussion of our financial results.

Now looking at the income statement. Revenue from continuing operations was $113.7 million in the fourth quarter, up approximately 8% from $105.4 million in the prior quarter. The U.S. land market continued to gain momentum through the fourth quarter, and we did not see the pronounced decrease that was experienced in the fourth quarter for the previous 2 years. Although COVID-19 disruptions continue to persist, activities did resume on longer cycle international projects which also had some revenue growth in the fourth quarter.

For the full year of 2020, revenue was $487.3 million, a decrease of 27% from 2019 revenue of $668.2 million.

Of this revenue, service revenue, which is more international, was $89.2 million for the quarter, up over 3% sequentially from $86.3 million last quarter. As stated earlier, we had some improvement in activity levels on international projects but also saw an improvement in U.S. markets for fluids analysis and well diagnostic services.

Our network of laboratories across the globe have remained operational throughout the fourth quarter. And although there's been a resurgence of the virus and additional restrictions in some countries, we continue to operate as activities return to project well sites and our clients' facilities.

Product sales, which is equally tied to North America and international activity, was $24.6 million for the quarter, an increase of over 28% from $19.1 million last quarter.

Product sales to the U.S. market were up 44% sequentially, while international product sales were up over 16% compared to the prior quarter.

Moving on to cost of services, ex items for the quarter are just below 76% of service revenue. And considering the operational challenges created by COVID-19 have held in pretty nicely when compared to 74% last quarter. These operational challenges, which often result in additional costs and operational inefficiencies for both us and our clients are expected to continue until the disruptions and restrictions associated with COVID begin to abate.

Cost of services averaged 74% for the year, which is comparable to 2019. The significant cost reductions were implemented in 2020 to align with the more efficient and appropriately sized cost structure.

Cost of sales ex items in the fourth quarter was 86% of revenue and has improved for 2 consecutive quarters from 90% during those earlier quarters. Our announced cost reduction initiatives were completed in the third quarter and fully realized this quarter. And as revenue levels improve, we would expect our margins to expand.

G&A ex items for the quarter was $7.6 million and $38.6 million for the full year, down from $8.9 million last quarter and down from $40.8 million for the full year of 2019. The decrease in G&A costs also reflects the cost reductions implemented by the company in 2020. Depreciation and amortization for the quarter was $4.8 million, down from $5.2 million last quarter, reflecting lower capital expenditures in 2020.

For the full year of 2020, capital expenditures were $11.9 million, down almost 50% from 2019 levels. For the full year, depreciation and amortization expense was $20.9 million, down about 7.5% from the $22.6 million last year. EBIT ex items for the quarter was $13 million, up from $12.3 million last quarter. And given the current circumstances, continues to represent best-in-class EBIT margin of over 11%.

Our operating income for the quarter on a GAAP basis was $23.4 million. Full year 2020 EBIT ex items was $56.6 million and generated margins of 11.6%.

Income tax expense ex items and using an effective tax rate of 20% for the quarter was $2 million. On a GAAP basis, the company recorded income tax expense of $6.5 million. The unusual events of 2020, which included adjustments recorded for impairment of goodwill that was substantially nondeductible, have also skewed the company's effective tax rate for 2020.

But now looking forward to 2020, '21, we project the company's effective tax rate to be approximately 20%. The effective tax rate will continue to be somewhat sensitive to geographic mix of earnings across the globe and the impact of items that are discrete to each quarter.

Income from continuing operations, ex items for the quarter was $8.1 million, up 10% sequentially from $7.3 million last quarter.

For the full year 2020, ex items, it was $35.3 million. GAAP income from continuing operations was $13.9 million for the fourth quarter of 2020, and a loss of $97.1 million for the full year.

Earnings per diluted share from continuing operations ex items was $0.18 for the quarter and $0.78 for the full year. GAAP earnings per share -- per diluted share from continuing operations was $0.31 for the quarter and a loss of $2.18 per share for the full year.

Now we'll move on to the balance sheet. Receivables were $83.2 million and decreased a little over $2 million from prior quarter. Our DSOs for the fourth quarter were exceptional at 62 days, a substantial improvement from the 68 days last quarter and the lowest we have achieved in a quarter in the last 6 years.

For the full year, DSOs were 69 days and comparable with 2019. Core Lab has always maintained great focus on managing our working capital, and we will continue this tradition in maintaining one of the lowest DSOs for an international oilfield service company. We currently do not anticipate any significant changes in payment practices from our client base.

Inventory finished the year at $38.1 million, down approximately $4.7 million from last quarter. The decrease is primarily due to improved completion activity in the U.S. land market as well as our team's efforts in 2020 to work with our suppliers. Inventory turns were at 2.2x for the year, and we anticipate inventory turns will continue to improve throughout 2021, in line with improved activity levels for the U.S. land.

And now on to the liability side of the balance sheet. Our long-term debt was $261 million at the end of 2020. And considering cash of $14 million, net debt was reduced to $247 million or a decrease of $4 million in the fourth quarter. Over the course of 2020, we reduced our net debt by $49 million from last year-end. Our debt is comprised of our senior notes at $150 million as well as $111 million outstanding under our bank revolving credit facility at December 31.

As stated earlier, the company issued $60 million in new senior notes in January 2021. These new notes were issued with the purpose of refinancing a portion of $75 million of senior notes maturing in September of 2021. The company will continue with our longer-term strategy towards reducing debt and Core Lab's debt leverage ratio.

Now looking at cash flow. For the full year of 2020, cash flow from operating activities was $57.9 million and after paying for $11.9 million of CapEx for the year, our free cash flow in 2020 was $49 million, marking the 19th consecutive year in which the company has generated positive free cash flow.

In the fourth quarter, cash flow from operating activities included $21 million of cash payments that are unique to this quarter. Included in the $21 million is a onetime employee post-retirement payment of $16 million that was associated with a distribution from the company's employee deferred compensation plan and the employees employment agreement.

Additionally, the fourth quarter includes a $5 million payment for our 2021 annual corporate insurance programs, which is prepaid to lower the annual premium cost. For many years, Core Lab has invested in company-owned life insurance policies as an investment vehicle to fund our employees deferred compensation plan. This is not an uncommon practice, and these policies are often referred to as COLI. As intended, the cash surrender value of these COLI policies was accessed to help fund these payments. And in the fourth quarter, the company converted $11.5 million of the cash surrender value to cash, which was used towards funding these payments.

However, the cash received from the COLI policies is treated as an investing activity and therefore, is not included in our cash from operations or free cash flow. As a result, for the fourth quarter, cash flow used in operating activities was $2.9 million. And after paying for $3.3 million in CapEx, our free cash flow in Q4 was a negative $6.2 million. A couple of more important points on this topic.

As of December 31, 2020, our employee deferred compensation plan is fully funded through our investments in company-owned life insurance policies. Additionally, our forecast of future employee distributions from this plan are expected to be immaterial for any one calendar year or quarter.

Now on to CapEx. For 2021, the company anticipates that its CapEx for the next couple of quarters will be at similar levels to recent quarters. However, as 2021 is expected to improve in the second half, we would also expect our capital expenditures to increase but stay in line with historical levels, while in a growth period.

Core will continue our strict capital discipline and asset-light business model with capital expenditures, primarily targeted at growth opportunities and initiatives. This also marks the 19th consecutive year Core Lab has generated positive free cash flow and we are projecting to continue generating positive free cash flow as we look ahead to 2021 and beyond.

We believe evaluating a company's ability to generate free cash and free cash flow yield is an important metric for shareholders when comparing company's financial results, particularly for those shareholders who utilize discounted cash flow models to assess valuations.

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

Thank you, Chris. And as Chris mentioned, for 2021, Core will continue to focus on executing our strategic plan of generating free cash and reducing our net debt while maximizing return on invested capital. Additionally, as part of the company's 2021 strategic focus, we will continue to invest in targeted client-driven technologies that aim to solve both client problems and capitalize on Core's growth opportunities. We are optimistic about the company's international growth opportunities as the second half of 2021 unfolds and COVID-19 disruptions are expected to abate.

With Core Lab having more than 70% of its revenue exposed to international activity, the company remains active on international projects already underway. Additionally, as Core sees early signs of growth in international markets trending higher in 2022 and beyond. Combined with the international opportunities as well as the continued momentum of U.S. land for the company in the second half of 2021 and beyond, we believe the strength of the company's technology portfolio, dedicated and talented workforce and strong operating model is a nice backdrop to the emerging cycle.

Some of the emerging international growth areas are Brazil, Mexico, Qatar and various areas of the Middle East.

For the first quarter of 2021 and consistent with historical trends, we expect lower client activity due to seasonality. This seasonal pattern typically results in a decline in first quarter revenue by mid-single digits.

We anticipate typical seasonal effects and COVID-19 restrictions to impact the first quarter of 2021, with the first quarter revenue projected to be flat to down low-single digits, sequentially. And the projected decline in first quarter revenue is slightly less pronounced compared to historical trends as expected momentum in U.S. land activity continues.

With Reservoir Description, we expect reservoir fluid analysis, which accounts for more than 65% of the segment's revenue to remain resilient as this work is diversified across the life of the reservoir and less reliant on drilling and completion of new wells.

However, given Reservoir Description's strong international exposure, COVID-19 disruptions present uncertainties or near to midterm client activity levels as travel restrictions fluctuate due to virus trends. The company sees sequential improvement in U.S. land activity into 2021.

As a result, we project Production Enhancement's first quarter 2021 revenue to increase sequentially. Additionally, we expect Production Enhancement to continue to track or outperform activity levels in U.S. land completions.

In summary, despite the near-term international challenges related to COVID-19 restrictions, we see activity levels improving in 2021 as 2021 unfolds with higher incremental margins emerging in the second half of the year. Our growth opportunities are directly related to expanding client activity and new market penetration, particularly internationally.

Within that context, we remain focused on the ongoing development of new client-driven technologies and market penetration as well as the continued focus on digitization and automation throughout Core's business. The company's first quarter 2021 guidance is based on projections for the underlying operations and excludes gains and losses in foreign exchange. This initial first quarter 2021 guidance also assumes an effective tax rate of 20%.

And with that, I'll turn it back to Larry.

All right. Thanks, Gwen. First, I'd like to thank our global team of employees for providing innovative solutions, integrity and superior service to our clients. The team's collective dedication to servicing our clients is the foundation of Core Lab's success and is shining through during the current challenges.

Turning first to Reservoir Description. During the fourth quarter of 2020, Core continued to perform highly specialized core and reservoir fluid analytical programs on samples originating from the offshore South Atlantic margin, a region that Core sees as a growth opportunity in 2021 and beyond. Several international operating companies have obtained licenses for pre-solved exploration and appraisal in Brazil, signaling that this region will be a focus of near, mid and long-term capital deployment.

To support current and future programs, Core is in the final stages of commissioning a new laboratory facility in Rio de Janeiro. This lab will offer a wide range of rock and fluid testing capabilities, including Core's proprietary, full visualization, pressure volume temperature or PVT cell instrumentation, and Core's dual energy CT rock evaluation technologies.

This new lab secures Core's position as the leading provider of advanced Reservoir Description services in the region and satisfies the growing demand for Core's patented and proprietary laboratory technologies in the growing Brazilian market. Also in the fourth quarter of 2020, Core conducted analytical programs on a variety of CO2 injection projects for both carbon capture and sequestration as well as for enhanced oil recovery efforts.

Under the direction of the carbon net project, Core continued its laboratory analysis of conventional Core from the Gular-1 appraisal well offshore Southeast Australia, helping in the evaluation of this large-scale carbon capture and sequestration project.

Data generated by Core is providing insight into seal capacity, storage capacity, geomechanical properties and the portions and properties of the rocks in the targeted injection zone. Also in the fourth quarter of 2020, Core was engaged by a national oil company in the Asia Pacific region to evaluate CO2 injection opportunities as part of an enhanced oil recovery program in tight-oil reservoirs. Core Lab combined its proprietary, high-frequency nuclear magnetic resonance technology with physical laboratory, Core flooding experiments to determine in situ hydrocarbon saturations during and after CO2 injection.

This data set is providing the operator with a detailed understanding of fluid displacement and fluid interactions throughout the CO2 flooding process. The 2 projects I've described here are representative of some of the various CO2 subsurface injection opportunities that exist for Core and its clients.

Moving now to Production Enhancement, where Core Lab's strengths in both energetic systems and completion diagnostics were again on display. Core's clients are always looking to improve their completion techniques. In response, Core's Production Enhancement segment continues to expand and penetrate the market with its technologically advanced completions product line. Recently, several of Core's technologically sophisticated clients in the North America region have pursued opportunities to precisely align the perforation channels in the direction of maximum principle stress.

To meet this objective, core's Production Enhancement engineering team developed a patent pending oriented GoGun. By providing both very high alignment accuracy and well site efficiency, this technological advancement is designed to allow the frac energy to be focused in a manner that maximizes the frac while minimizing tortuosity. The innovative design of the oriented GoGun also eliminates the need for orientation subassemblies. This is a big advantage at the well site as it minimizes the number of required connections and saves time as the operator does not have to recapture and redress operating subs.

During the field trials, one of the operators deployed downhole cameras to compare various preassembled gun offerings and assess their ability to be preferentially oriented. Core Lab's oriented GoGun proved to have the highest level of alignment accuracy, both from perforation to perforation and from stage to stage.

As a result of the superior performance of Core's technology, the operator has adopted the oriented GoGun as their preferred perforating system.

Now moving on to the service side of Production Enhancement. Core's proprietary completion diagnostic services are most often used to evaluate well completions, producing oil and gas wells.

In the fourth quarter of 2020, these services were used for an untraditional application as part of a natural gas storage project being developed along the U.S. Gulf Coast. Core Lab was engaged by the operator to deploy its completion diagnostic services and assess the effectiveness of frac pack completions performed on a number of wells in this large gas storage field.

Core utilized its PackScan density logging technology to determine the competency of the annular packs that were placed in these wells.

In one of these wells, Core's PackScan density log revealed insufficient coverage of the perforated interval and a completely uncovered sand control screen. Core's engineers identified these potential failure points and recommended a proppant top-off treatment to remediate these areas of concern. The operator agreed and within a week, a successful top-off treatment was performed resulting in optimum proppant coverage above the top of the sand control screen.

It is critical that these gas storage wells be effectively fracked and the annulus completely packed in order to ensure their long-term functionality for both injecting and withdrawing natural gas over the life of the storage field. Core Lab's PackScan technology and the resulting top off-treatment avoided a costly completion remediation program. This is a new market for this proprietary Core Lab technology and has applications for both natural gas storage and carbon sequestration projects as in both applications, well bore stability must be both maintained and assured for many years.

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

(Operator Instructions) Our first question today will come from George O'Leary with TPH & Company.

The 65% increase in energetic sales quarter-on-quarter was particularly striking. Completions activity was clearly up big. But was this an example of a case where your wireline customers were kind of cut short inventory and had to both service projects plus restock that inventory? Or is this more of a market share shift type of dynamic? Just curious what drove the super strong bounce there?

Yes. I think -- well, that might be a better question for some of the wireline companies to give you a definitive answer on. There may be a bit of both going on there. But I think as we look over the longer period of time, what we see is our energetic sales tracking in almost every case, exceeding the trends in completion. So we see completions that were probably up, a little bit fuzzy still on some of the numbers seems that most people are thinking that number is around 40% or so. And so we think we nicely exceeded that. And we attribute a substantial part of that to penetration of new products and offerings.

Okay. Great. That's helpful. And then just on the Q1 seasonality that you mentioned, apologies if you hear my kid in the background, we're in a virtual learning, as I'm asking these questions. The Q1 seasonality that you mentioned, just went back and looked at the last 10 years, and it kind of jumps around the Q-over-Q sequential change in revenue. And I realize there's different drivers across different years. But could you frame maybe what drives the seasonality, whether that's something from a regional perspective on the international side or year-end sales that you might get in the fourth quarter kind of abating as we progress into that first quarter? Any color there would be helpful.

Yes. I think we look at maybe even a longer view than that 15, 20 years go back, and it's a pattern that we see play out pretty consistently. That jumping around, you see on occasion is usually attributed to a sharp upward move in the commodity price late in the year like coming out of a steep frac holiday. And then you'll see things that will buck that trend. But very frequently, we've got clients that are trying to wrap up budgets or projects in the year. Historically, the fourth quarter of the year is our busiest year and our highest revenue year, and we see that new projects take a little time to spool up.

Some companies are still refining budgets and plans. So a little bit of a drag sort of out of the gate in the first quarter is what we've come to expect for Core Lab and in particular, in Reservoir Description. And so we see that is playing out this year. And then we throw a little bit of uncertainty about COVID-19 disruptions, how those are going to unfold or at the pace at which those will abate. And that leads us to think that the first quarter will be flat to down slightly.

Now we normally would see that seasonal rollover in the mid-single digits. Let's say, when we -- even when we include some of those sort of aberrant years, but we think that will be mitigated or lessened in the first quarter of 2021. And as far as locations and all and some underlying reasons. So often, it's northern hemisphere areas that we see some of the seasonality related to planning for weather conditions that might impair activity. Some clients just say, hey, no point in getting those started and fighting predictably bad weather patterns. So they push those out a little bit, and that slows things down.

That's very helpful, Larry.

Russia, the North Sea, Europe, Canada, those can all be influenced in the first quarter.

Got it. That makes sense. And then I'll just sneak in one more, if I could. You talked a decent bit in the prepared remarks about free cash flow generation and deleveraging, clearly primary goals for you guys as we move forward. How do you think about -- is there a year-end target or a 2022 or 2023 target on the deleveraging front? And then could you maybe frame the moving pieces for free cash flow? And 2021 coming on the heels of a pretty powerful free cash flow generation here in 2020?

Yes. I'll get started on that. So directionally, we are aiming to try to get that leverage ratio below 1.5. We think that's a more comfortable position, maybe go lower than that, depending on market conditions. But certainly get it down to what I would call it, a cooler balance sheet. And now that will be helped as well. Obviously, as activity picks up and our EBITDA grows, that will -- there will be a virtuous cycle on that leverage ratio. But we will and we are committed to as we work throughout 2019 and continued -- I'm sorry, as we continue into 2021 and as we were in 2020, we're committed to, for the time being, applying free cash to reducing our net debt. And so Chris, with relation to the forecast and timing on those?

Yes. I think Larry did a great job summarizing that. Longer term, that's kind of the target. Whether we get there by the end of this year or next year seems to be very achievable to get to those levels by the end of 2022.

But this year, it will really depend on how it unfolds and kind of how much time it takes to get sort of this COVID in the rearview mirror and really the global economy kind of moving back towards where we were pre COVID.

Our next question comes from Mike Sabella with Bank of America.

I was wondering if you kind of try to help frame the magnitude of how you're thinking about the second half recovery in international. Some of the larger guys have been pointing to kind of double digits second half '21 over second half '20. How do you see your all opportunities that kind of playing out in the second half?

Yes. I mean, I think there's maybe a little bit of built-in caution as we look and some of the unpredictability, but we wouldn't necessarily disagree with some of the forecasts that I've put out there. We see that trend developing. And particularly as you look at it on a year-over-year basis.

Perfect. And then if we're kind of thinking about Reservoir Description and thinking about the segment in the context of how it performs as OPEC starts kind of bringing production back online. Can you talk about what the opportunities for the fluids business are sort of earlier in that process kind of versus maybe later, once kind of the lowest hanging fruits been picked?

Yes. I think there's a little bit of a potential bump upward there, particularly where there's been wells shut in and people want to assess what current gas oil ratios are, what the pressures are doing, how it's affecting the fluids in the borehole. So there could be a little bit of a flurry unfold on that. I don't think it's going to be a big needle mover, but we're well positioned to handle that.

We are also expanding our fluids laboratory capability right now in the Middle East as well as the Brazil market that I talked about earlier, so I think the fluid side of the business, we are -- let's maybe frame this in a bigger context here. We're in a fluids heavy phase of -- for Core Laboratories, go back and contrast, say, Core Laboratories 2010 to 2015, when there was a lot of new rock having to be evaluated in unconventionals, that was a rock heavy cycle. We're in now more of a harvesting mode. And so we're more of a fluid heavy cycle.

And I'd say, historically, if you look back over Core Lab as we look back over it, it kind of swings between about 1/3, 2/3, it's blend of one or the other, the services over time. And so we're kind of at the -- tilted heavily toward the fluid side of the business at the moment. That's -- those cycles inevitably wind down and as new fields have to be developed and appraisal has to go on. It swings back toward the rock side of the business.

So I think fluids are real anchor for our business through what's a down cycle like we've been through and are experiencing right now. And I think it will stay that way, although what we see as we look out longer over several years is a new cycle of appraisal to bring new fields on and new zones and fields on will have to unfold, and that will swing the pendulum back a bit toward the rock side of the business.

Our next question comes from Scott Gruber with Citigroup.

So just a little bit more color on 1Q. When we think about the split on segment revenue trajectory, you guys thinking about R&D potentially down kind of mid-singles and PE up 10%, 15%. Is that fair or a little bit different?

I think that's broadly framed. I think the short-term upside for us is a continuation of improving conditions in U.S. land, and that will certainly lean toward Production Enhancement. That's a substantial part of that business. And then on the Reservoir Description side, for the first quarter, that seasonality is going to play into a regular pattern that we anticipate there. And then we've got just, I guess, what everybody is dealing with the lack of clarity on what country is going to be next in putting a lockdown or imposing a restriction on business activities that might impact us. And so I think broadly, you're correct there. I don't know that I'd extend the downside and Reservoir Description quite that much, but it's not out of the realm of what we might expect.

Got you. And then just some color on incrementals for both. Costs are coming back into the system for everybody as things start to turn the corner here. So any color on incrementals in 1Q? And then as we think about 2Q, obviously, you guys mentioned stronger incrementals in the second half. Sounds like getting back to those normal healthy incrementals for Core Labs in the second half. But in 2Q, do you still have costs coming back into the system? Or is there just a lack of clarity on growth in 2Q right now or maybe the incrementals just aren't that relevant? How do you think about both 1Q and 2Q before we get to better incrementals in the second half?

Sure. This is Chris. So it's a -- I think you have to look at it segment-by-segment that we are projecting costs to kind of come back in a little bit in Q2 and maybe even more so, I mean, in Q1 and a little bit maybe more so into Q2. But -- so it is going to soften the incrementals. For the company as a whole, you start to get into also a different mix of this segment. So Production Enhancement is kind of more in a growth mode and that is carrying lower margins. So company overall, it is going to impact the incrementals and kind of how the 2 segments sort of play out. Anything you want to add to that?

Yes. I would just say that it's a bit choppy right now, and it's going to be remaining that way with incrementals. We're still in this with -- if you go back and refer back to our calls over the last few quarters, we're still seeing this stop, go, stop, go effect. It's just unpredictable where it's going to happen or if product delivery shipment or a wellsite job is just going to get shut down because of virus activities. We're not letting those people go. Those costs remain in the system. We've got to be ready to go when the client says go. And so it's a somewhat inefficient phase here. I'll take it over the strict steep downward trend that we had in activity, but it's still a bit chaotic in terms of how activity is going to roll out. And so we're carrying a cost structure that we think we've got broadly aligned with what we need to, to execute the program, but it's still a little choppy in terms of how the work project is going to enroll.

As we look further out, I think the traditional incrementals that you've come to expect at a Core Lab, 50%, 60% are very achievable. And I'll go on to say that if you look at the structural costs that we've taken out of the company from G&A all the way through operations, we are set up to be very well positioned to convert $1 of revenue into $0.50 or much better in terms of EBIT.

Got it. I appreciate all that silver lining as that -- there seems to be light at the end of the tunnel now. Maybe just if I could sneak one more in, Chris, on CapEx. And maybe you guys haven't made a decision on the second half. So should we think about maybe $6 million in the first half and at a starting -- for a starting point, maybe $10 million in the second? Or can you provide some clarity on how you guys are thinking about second half CapEx, maybe relative to revenues?

Yes. The numbers that you threw out there, those are definitely in the range that we're kind of looking at. There is some flexibility there. So we have the ability to flex some things. If we need to accelerate some things, we'll do that. So anything that looks like a good investment with good returns, we're going to go ahead and move forward with that. And if needed, there are some levers we can pull to do that. So -- but those are kind of close to what we're thinking. It could be a little higher. If things don't take off in the second half as quickly as we're projecting, then we have the ability to dial that back a little bit.

And I think the only thing I'd add to that, I think Chris covered it very well, is expect Core Lab to stay within its traditional percentage of capital to revenue ratios, it's normally around 3%, 3.5% during down cycles. It will be below 3% during normal cycles and sort of, hey, we've got to get after some say, lab build-outs or things like that to face client needs.

It might tick up, but we're talking about fractions of a percentage up, but we're going to stay very close to our asset-light capital discipline business. We know that very well, how to run that. And we're pretty disciplined in how we evaluate opportunities and how we deploy that capital.

Got you. So it wouldn't go above 4%, say, in the second half? I know it had to just kind of restart spend.

Look, back over time, it would be a rare case when we were in a sort of hyper growth cycle where it might have gotten up in that range. But that's a good buoy.

Our next question comes from Connor Lynagh with Morgan Stanley.

I just wanted to talk a little bit more about the balance sheet and cash flows. I guess you don't notice that you guys have not chosen to do anything with the at the market equity program. In light of, Chris, your comments on having some pretty good confidence on delevering organically. How should we think about how you guys are planning to use this? Is it just an option out there for flexibility? I guess, how should we think about whether or not you guys will be utilizing that program or not?

Yes. I think we've talked a little bit about that. It is out there. We're always looking at opportunities, both internally and externally. So we are constantly evaluating that. I think we wanted to have the flexibility to make sure we're progressing on some of these internal growth initiatives, but also, in case something externally comes across that we want to execute on. We want to have that flexibility.

And although we're projecting to stay within our financial covenants, it is tighter than we would like it to be. And we just don't want to be restricted from doing something that we think is a good long-term decision for the company because we got to manage a little tighter to the debt leverage ratio for the next quarter or 2. So it is there. And if we feel like we need to access it, that is what it's there for. There's still a lot of uncertainty over the next couple of quarters with respect to how we're going to plow through the virus and when we're really going to kind of have that behind us.

Understood. Understood. I guess if we sort of think about the world and where you sort of get to those target leverage ratios you were discussing earlier. It seems like you're talking about some internal and external growth opportunities. There's also the potential for incremental capital return. Can you just discuss your sort of framework around that? And specifically on the growth opportunities, where do you see, within your portfolio, the more interesting avenues right now?

Yes, we look across the landscape there. I would say Core Lab is -- because of our position and our global footprint, we are somewhere between regularly approached and bombarded with external opportunities. We take a very calculated look to how things might fit in. We're more interested in our internal pipeline growth opportunities. We think that, that's extraordinarily good. And some of those, and as we get through the year, we'll be talking about them more, some of those are concepts that individual clients that we have great relationships with, have come to us and said, "Hey, what about this, and we're working on it with them together, Core Lab will own the IP and will own the service, say, opportunity for us.

So we want to make sure that we have the ability to fund those. And as Chris said, I think, frames that very nicely. We don't want to have to manage the company and miss or delay growth opportunities because we're trying to navigate what I would call a transient tight point in the leverage ratio. It's just not good for the long-term to be handcuffed like that and miss or delay opportunities.

Our next question comes from Sean Meakim with JPMorgan.

Maybe just to continue back on the margin progression discussion. I think you indicated cost savings will help incrementals, at least on a year-on-year basis, even if it sounds like there's a bit of a headwind sequentially in the first half. It all sounds reasonable. As you think about potential peak margin for '21 versus the average, as I think about RD or high teens, a possible peak in '21, even if perhaps maybe we're going to average in the more like mid-teens. Could we just talk about that dispersion potential?

Yes. I mean, I think if things unfold the way we expect them to and the virus abates, kind of with the idea that, hey, things will be improving into the second quarter and beyond. I think an exit rate for RD in the mid- to high teens is achievable. We just did 15 last quarter. And I think in the quarter before that, we had 2 consecutive quarters of that. And so I think from there, get past sort of the -- maybe a little bit of the seasonality issues in the first quarter, we should go up.

Okay. That sounds reasonable. So then just continuing that line of thinking…

Sean, I would add, I would just reinforce one thing on that is, that I said earlier, that when we look at the structural cost that we've taken out of the system, all the way up and down the organization, that will reinforce that what we can do with that extra dollar of revenue that will come with an increase in activity.

Fair enough. So then just continuing on that line of thinking, but now for PD, you had a nice bounce back on margins in 4Q. You had good volume growth. How do you think about the potential cadence of activity in U.S. onshore? So do we think we'll see a peak in volumes middle of the year, 2Q, 3Q, risk of budget exhaustion at year-end? Are you -- do you anticipate more of a level load? And then the read-through to margins would be interesting. So can we peak at a double digit margin? Or would you characterize maybe high single as the best we could hope for in '21?

Sean, this is Chris. So we're kind of projecting more of a gradual kind of build as we move throughout the year. And maybe that starts to kind of flatten out as you get towards the back half. But if you make assumptions around where commodity prices are going to be, unless they stay at current levels or strengthen throughout the year, that would be our expectation. And we're still not to sort of levels where we really have full efficiencies in our manufacturing facilities. So we would expect margins to continue to expand. They're a little bit -- incrementals can be a little bit lower for -- on the product side. So I wouldn't get too aggressive there, maybe in the -- historically, 25% to 30% range has been achievable for us. And then on the services side, they can be a little higher. So as you kind of blend that out and forecast that out, we would expect high-single digits to low-double digits to be achievable, if you projected continued growth through the rest of the year.

And so it sounds like you're not expecting much of a kind of midyear peak and a budget roll off, more of a plateau perhaps at some time towards the end of the year?

Yes, not at the current commodity prices.

Sean, just to reinforce something Chris was -- said earlier here, we do have some costs that are going to have to come back into the system, and that's going to impact our incrementals. We'll call it, the near-term until we get back to a sort of more normalized world.

We've still got employees that are on furlough. We're slowly winding those back in. We've got employees that have demonstrated great loyalty to us, taking pay cuts to navigate the difficult time.

It's a priority for us to, as soon as possible return people either in steps or in whole, get them back to where they were. And so we want to make sure that we do that and don't neglect the sacrifices that they've made to help navigate this difficult moment.

We've got time for one more call.

Our next question will come from Stephen Gengaro with Stifel.

Thanks for slipping me in here. Really, I think there's only one thing left I really wanted to ask you about. The -- we heard that there was a lot of sort of component inventory in the channel on the perforating side over the last couple of quarters, especially because of the massive drop-off in 2Q, and that has kind of impacted the pricing dynamics there.

Do you have any thoughts on that? And where the inventories stand, especially from some of these more probably commodity component manufacturers and how the pricing dynamic currently sits within the perforating business?

Yes. I kind of circle back to I think George's question earlier there, it might be a better question to ask some of the wireline companies where they stand on their -- on the inventories they're holding there. I imagine they're trying to run pretty lean inventories. And so I think they're trying to work on a just-in-time opportunity.

They don't want to have capital tied up sitting in inventory. And so for us, it's been a combination of system sales and component sales. And we've new offerings that are coming on to the market that we're having a nice reception to. And so I think it's a complicated world out there. I'm glad that Core Lab is in the business of selling both components and systems.

And then within that context, are you seeing any reacceleration or acceleration in the adoption of integrated systems versus components because I heard that, that kind of slowed down because of that phenomenon earlier in the year? Have you seen sort of, for example, the GoGun regain some traction?

Yes. I mean, I talked about one expression of that here with the oriented GoGun and so that's coming to market now. And so that was a desire on the part of the client that was using our preassembled system, but said, "Hey, our objective for the moment is to make sure that we get precise alignment of the perforating tunnels before we go in and frac this thing."

And so thanks to that relationship, they came to us and said, "Here's what we're trying to do. Can you help us get there?" And that led to the oriented go gun and stay tuned, more to come on that.

Okay. Thanks, Stephen.

Okay. I think we'll wrap up from there. In summary, Core's operational leadership continues to position the company for improving client activity levels in 2021. While there are still operational uncertainties in the near to midterm, there are many opportunities ahead. We have never been better operationally or technologically positioned to help our clients maintain and expand their production base and address their evolving needs.

We remain uniquely focused and are the most technologically advanced, client-focused reservoir optimization company in the oilfield service sector. The company will remain focused on free cash conversion and returns on invested capital. In addition to our quarterly dividends, we'll bring value to our shareholders via growth opportunities, driven by both the introduction of problem-solving technologies and new market penetration. In the near term, Core will continue to use free cash to reduce debt.

So in closing, we thank and appreciate all of our shareholders and the analysts that cover Core. The executive management team and the Board of Core Laboratories give a special thanks to our worldwide employees that have made these results possible.

We're proud to be associated with their continuing achievements. So thanks for spending time with us, and we look forward to our next update. Goodbye for now.