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Core Lab Third Quarter 2020 Results

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   |    Thursday,October 22,2020

Core Laboratories reported its Q3 2020 results.

Core's revenue vs international rig count

Continuing operations resulted in third quarter 2020 revenue of $105,400,000. Core's operating income was $11,300,000, with earnings per diluted share ("EPS") of $0.07, all in accordance with U.S. generally accepted accounting principles ("GAAP"). Operating income, ex-items, a non-GAAP financial measure, was $12,300,000, yielding operating margins of 12% and EPS, ex-items, of $0.16. A full reconciliation of non-GAAP financial measures is included in the attached financial tables.

The sequential decline in revenue was attributable to continued global industry disruptions associated with COVID-19, as well as four tropical weather systems impacting the Gulf of Mexico during the third quarter of 2020. Geographically, the sequential revenue decline was primarily associated with a decrease in both international product sales, as well as lower activity on international projects. Improved revenue from the U.S. land market was offset by Gulf Coast storm-related disruptions.

Previously announced Cost Reduction Plans (Phase 1 and Phase 2), totaling $61,000,000 of annualized cost savings, have now been fully implemented and were completed in the third quarter of 2020, in line with Core's previously stated expectations. Core's management will continue to evaluate further options to align the Company's cost structure with anticipated client activity as necessary.

Core's CEO, Larry Bruno stated, "Core's third quarter results display both the durability and adaptability of the business model, along with the benefit of our cost reduction plans, as Core continued to generate free cash flow despite the aforementioned industry disruptions. Core's global exposure, talented and dedicated staff, along with our expanding line of proprietary and patented products and services, have us well positioned to navigate today's market and capitalize on future opportunities".

Liquidity, Free Cash Flow, Private Placement Notes and Dividend

During the third quarter of 2020, Core continued to generate free cash flow ("FCF"), with cash from operations of $20,700,000 and incurred capital expenditures of $2,200,000, yielding FCF of $18,500,000. The third quarter of 2020 marks the 76^th consecutive quarter that the Company generated positive FCF, despite challenging market and industry conditions. Free cash was almost entirely focused towards reducing the Company's debt, with net debt reduced by $16,200,000 during the third quarter of 2020. Core will continue applying its excess free cash flow towards debt reduction for the foreseeable future.

As previously announced on 16 October 2020, Core Lab entered into an agreement to issue $60,000,000 of new fixed-rate long-term senior notes ("Notes") through a private placement to extend the maturity for a portion of the Company's long-term debt. The Note Purchase Agreement was signed on 16 October 2020, with funding to occur 12 January 2021.

The following table summarizes the terms of the new Notes:

The net proceeds from the new Notes are intended to be used exclusively to reduce outstanding debt on the Company's revolving credit facility ("Credit Facility"), thus increasing the available borrowing capacity by $60,000,000. The Company's Credit Facility has an aggregate borrowing capacity of $225,000,000, of which $116,000,000 was outstanding as of 30 September 2020. The Company's CFO, Chris Hill, had the following statement, "This transaction accomplishes two goals as we manage the Company's corporate debt structure through the disruptions associated with the COVID-19 pandemic. First, it provides additional liquidity under the Company's Credit Facility to address the outstanding $75 million senior notes maturing 30 September 2021, and second, issuing $60 million in new Notes and retiring $75 million of existing notes next year is an additional step toward our long-term strategy of reducing debt and Core Lab's debt leverage ratio". The new Notes include certain financial covenants that align with the financial covenants under the Company's Credit Facility, limiting total Company net debt to a maximum leverage ratio and requiring a minimum interest coverage ratio.

Quarter Ending 2020 2021 Jun. 30 Sept. 30 Dec. 31 Mar. 31 Jun. 30 Sept. 30 Dec. 31 Maximum Leverage Ratio 3.00 2.75 2.50 2.00 1.50 1.00 Core Lab's leverage ratio of 2.21 at 30 June 2020

As of 30 September 2020, the Company's leverage ratio was 2.49 to 1, with $96,000,000 of excess capacity under the Credit Facility. As stated earlier, the proceeds from the new Notes on 12 January 2021 are intended to reduce outstanding debt on the Company's Credit Facility and provide an additional $60,000,000 of borrowing capacity and liquidity. The Company anticipates it will continue to generate positive cash flow and reduce net debt, while maintaining ample liquidity.

On 17 July 2020, the Board announced a quarterly cash dividend of $0.01 per share of common stock, which was paid on 10 August 2020 to shareholders of record on 27 July 2020. Dutch withholding tax was deducted from the dividend at a rate of 15%.

On 15 October 2020, the Board announced a quarterly cash dividend of $0.01 per share of common stock, payable on 17 November 2020 to shareholders of record on 26 October 2020. Dutch withholding tax will be deducted from the dividend at a rate of 15%.

Reservoir Description

Reservoir Description revenue in the third quarter of 2020 was $80,100,000, down 9% sequentially. Operating income for the third quarter of 2020 on a GAAP basis was $11,000,000, while operating income, ex-items, was $11,700,000, yielding operating margins, ex-items, of 15%, down slightly more than 200 BPS sequentially. Revenue, operating income, and margins were all affected by both continued COVID-19 project disruptions and weather events in the Gulf of Mexico during the third quarter of 2020. Implemented cost controls in the segment helped mitigate the impact to operating margins.

Core's clients continue to be heavily focused on digital transformation technologies to pursue operational excellence. Core Lab has been at the forefront of this movement for more than two decades. Core's extensive, proprietary databases and analog technologies, coupled with artificial intelligence ("AI") and machine learning, help the Company's clients improve efficiencies and lower operating costs throughout the upstream value chain. In the third quarter of 2020, Core Lab's Digital Innovation Group worked collaboratively with multiple international and national oil companies on projects that utilize several of Core's proprietary digital technologies and services. Core's proprietary Advanced Rock Typing technology combines Core's vast, comprehensive database of physical measurements, and Rock Catalogs^TM with its proprietary image acquisition technology and the latest in AI image recognition. These technologies provide clients with analog data sets in situations where acquisition of new conventional core may not be possible. High-resolution images of wellbore cuttings and sidewall cores are quickly and efficiently matched with analogs from Core's proprietary database of samples from around the world. Physically measured data sets from the matching analogs are delivered to Core's clients in time to make appraisal and development decisions.

During the third quarter of 2020, Core Laboratories, under the direction of The CarbonNet Project ("CarbonNet") engaged in laboratory analysis of 300 feet of conventional core from the Gular-1 appraisal well in the offshore Gippsland Basin, in the Bass Strait, off the southeast coast of Australia. CarbonNet is funded by the Victorian and Commonwealth governments of Australia. In a recent press release the CarbonNet team mentioned, "The CarbonNet Project is advancing the science and viability for establishing a commercial-scale carbon capture and storage ("CCS") network. The network would bring together multiple carbon dioxide ("CO₂") capture projects in Victoria's Latrobe Valley, transporting CO₂ via a shared pipeline and injecting it into deep, underground, offshore storage sites in the Bass Strait. CCS is being investigated as part of a suite of solutions with the potential to mitigate greenhouse gas emissions." The cores are progressing through physical laboratory measurements, in an iterative analytical program. The data generated by Core Lab will provide insight into seal capacity, storage capacity, geomechanical properties and the pore system properties of the rock. Core Laboratories is pleased to be playing a role in evaluating this important CCS project, which is among the most promising CO₂ storage opportunities in the region.

Production Enhancement

Production Enhancement operations, which are focused on complex completions in unconventional, tight-oil reservoirs in the U.S., as well as conventional offshore projects across the globe, posted third quarter 2020 revenue of $25,300,000, declining 7% sequentially. The revenue decline was primarily associated with decreased international product shipments due to COVID-19 disruptions and weather events in the Gulf of Mexico. More positively, U.S. land revenue increased 23% sequentially, partially mitigating the sequential decline in international sales, and correlating favorably with the improved U.S. land well completion activity during the quarter. Operating loss on a GAAP basis was $300,000, and approximately break-even, ex-items. Although revenue sequentially declined in the third quarter as compared to the second quarter of 2020, the operating loss was minimized, and improved significantly, as a result of cost-control measures completed during the second and third quarters of 2020.

During the third quarter of 2020, Core Lab introduced its next generation, best-in-class, HERO^®PerFRAC energetic technology, which is now available in combination with the new, patent pending Oriented GoGun™. This new technology provides Core's clients with a technological solution for achieving: 1) extreme limited entry perforating capability, 2) precisely aligned perforations, and 3) minimized connections and completion string length. Casing erosion around perforations can occur when stimulating unconventional reservoirs. Larger perforating holes preferentially increase in size and take more frac fluid, robbing stimulation from smaller perforating holes, which results in inconsistent breakdown of the formation. The consistent-sized holes generated by the latest HERO^®PerFRAC charges reduce this problem. Core Lab partnered with major U.S. operators to design custom, consistent-hole-size charges that can be aligned in a specific orientation in order to achieve uniform breakdown across each stage. Core Lab's Production Enhancement development team designed a patent pending method to orient the GoGun™, with both very high accuracy and wellsite efficiency. By eliminating the need for reusable orientation subassemblies, the Oriented GoGun™ minimizes the number of connections and saves time at the wellsite by not having to recapture and redress the orienting subs.

Also during the third quarter of 2020, Core Lab's Production Enhancement engineers developed and introduced a new application for its proprietary SpectraChem^® chemical frac water tracer to determine whether horizontal wells are unobstructed and flowing through the entire length of the lateral. Leveraged by operators in the Permian, Eagle Ford, and Haynesville, this technology can identify wellbore obstructions, often caused by inter-well communication or dissolvable plug remnants. By applying this technology, Core's clients can identify and remediate well obstructions that can negatively impact well performance, reserve calculations and reserve-based lending.

Return On Invested Capital

Core's Board of Supervisory Directors ("Board") and the Company's Executive Management continue to focus on strategies that maximize return on invested capital ("ROIC") and FCF, a non-GAAP financial measure defined as cash from operations less capital expenditures, factors that have high correlation to total shareholder return. Core's commitment to an asset-light business model and disciplined capital stewardship promote capital efficiency and are designed to produce more predictable and superior long-term ROIC.

Events associated with the COVID-19 pandemic have caused significant disruptions in global markets and economies, with adverse effects throughout the energy sector. These adverse effects have triggered significant asset impairments for goodwill, intangible assets, inventory and other fixed assets, which further distort underlying financial performance and performance metrics, such as ROIC.

The Board has established an internal performance metric of demonstrating superior ROIC performance relative to the oilfield service companies listed as Core's Comp Group by Bloomberg. In the first half of 2020, Core Lab recorded $133 million in non-cash charges associated with the impairments and inventory write-down. Excluding these non-cash asset impairments and write-down, Bloomberg's calculation of Core's ROIC was 4.3%. Under the current circumstances, and considering the magnitude of the asset and goodwill impairment charges incurred across the energy industry, it is difficult to appropriately determine the underlying relative performance across the Bloomberg Comp Group as compared with Core Lab.

Industry and Core Lab Outlook

Conversations with Core's clients broadly reaffirm the Company's expectation that international projects already underway will continue; however, the pace and breadth of recovery from COVID-19 restrictions remains uncertain, making it difficult to forecast both the level and timing of such activity. Core Lab projects international activity in the fourth quarter of 2020 may slightly to modestly improve sequentially for both operating segments, if COVID-19 travel restrictions and supply chain disruptions begin to ease.

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

U.S. land activity improved from the lows experienced during the middle of the second quarter as the third quarter of 2020 unfolded. This trend of gradual improvement in U.S. land activity is expected to continue into the fourth quarter of 2020. As a result, Core Lab projects overall fourth quarter 2020 U.S. land activity to modestly improve sequentially, and expects Production Enhancement to continue to track or outperform activity levels in U.S. land completions.

Collectively, these trends point toward slightly to modestly improved sequential operational performance for Core Lab, barring any COVID-19-related retrenchments in client activity. Additionally, Core expects to generate positive FCF in the fourth quarter of 2020 as Core's aggressive adjustments to its cost structure further align with client activity, with continued focus on free cash generation and strategic debt reduction.