Earnings Call Transcript - CLB Q2 2022

Operator, Operator

Good morning, and welcome to the Core Lab Second Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. 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.

Larry Bruno, Chairman and CEO

Thanks, Kate. 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 shareholders, analysts, and most importantly, our employees to Core Laboratories' second quarter 2022 earnings call. This morning, I'm joined by Chris Hill, Core's Chief Financial Officer; and Gwen Gresham, Core's Senior Vice President and Head of Investor Relations. The call will be divided into six segments. Gwen will start by making remarks regarding forward-looking statements. We'll then have some opening comments, including a high-level review of important factors in Core's Q2 performance. In addition, we'll review Core's strategies and the three 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 two operating segments, detailing our progress and discussing the continued successful introduction and deployment of Core Lab's 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.

Gwen Gresham, Senior Vice President and Head of Investor Relations

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 that could cause actual results to materially differ from our forward-looking statements. These risks and uncertainties are discussed 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. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events, or otherwise. Our comments also include non-GAAP financial measures. Reconciliation to the most directly comparable GAAP financial measures is included in the press release announcing our second quarter results. Those non-GAAP measures can also be found on our website. With that said, I'll pass the discussion back to Larry.

Larry Bruno, Chairman and CEO

Thanks, Gwen. In the second quarter of 2022, Core Lab's year-over-year revenue increased by 2% and sequentially revenue increased by 5%. For the remainder of 2022, we expect continued improvement in both business segments across most international arenas and in the U.S., although the conflict in Ukraine and the collateral impact into Core's European and Russian operations pose headwinds to year-over-year growth prospects in those regions. Full company sequential margins for Q2 were 43%, nicely reflecting the operational leverage available to Core Lab as global activity improves. During the second quarter of 2022, I visited with our major clients across the Middle East region. Key takeaways from those visits include: one, all of our clients have significant production growth plans over the next several years; two, project work for Core Lab has started to pick up and the growth in work volume is expected to accelerate as we move into the second half of 2022 and beyond; three, in addition to Core's traditional involvement with conventional reservoirs in the Middle East, there is a broad focus across the Middle East region on leveraging Core's expertise in unconventional reservoirs with opportunities in both Reservoir Description, as well as for completion products and completion diagnostics. And finally, multiple Middle East NOCs have begun engaging with Core Lab on their carbon capture and sequestration initiatives where Core Lab has established itself as an industry leader in subsurface evaluation of prospective CO2 sequestration sites. Another important factor in Q2 was the military conflict in Ukraine that has impacted both of Core Lab's business segments. In Reservoir Description, the conflict and associated sanctions slowed demand for liquid hydrocarbon assay work in Ukraine, Russia, and across parts of Europe. While sanctions will likely continue to impact Russian exports to Europe and the United States, we still anticipate a gradual return of client demand for these services as supply patterns realign during the rest of 2022 and into 2023. Production enhancement delivery of completion projects into Ukraine have slowly resumed. Core continues to execute on its key strategic objectives by: one, introducing new product and service offerings in key geographic markets; two, maintaining a lean and focused organization; and three, maintaining its focus on deleveraging the company. Now to review Core's strategies and the financial tenets that Core uses to build shareholder value over our 26 plus year history as a publicly traded company. The interests of our shareholders, clients and employees will always be well served by Core Lab's resilient culture, which relies on innovation, leveraging technology to solve problems and dedicated customer service. I'll talk more about some of our latest innovations in the operational review section of this call. While we navigate through the current challenges and pursue growth opportunities, the company will remain focused on its three longstanding long-term financial tenets; those being to maximize free cash flow, maximize return on invested capital, and returning excess free cash to our shareholders. Before moving on, I want to thank our employees for their dedication, loyalty, and adaptability in meeting all of our clients' needs and for the commitment that many have shown as we navigate the moment and prepare for a more active market. I'll now turn it over to Chris for the detailed financial review.

Chris Hill, Chief Financial Officer

Thanks, Larry. 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 second quarter of 2022 include a non-cash adjustment of $3.3 million to reverse previously recognized stock compensation expense associated with performance shares, which are no longer expected to vest. This benefit from reversing the stock compensation has also been excluded from the discussion of our financial results. So now looking at the income statement, revenue from continuing operations was $120.9 million in the second quarter, up approximately 5% from $115.3 million in the prior quarter, and up almost 2% year-over-year. The sequential increase in revenue was driven by growth in both the U.S. and international markets. However, nice growth in the underlying operations in multiple international regions have been partially offset by the devaluation of the Euro and British Pound and continued disruptions as a result of the Ukraine-Russia conflict, which I'll expand on later in the discussion. So of this revenue, service revenue, which is more international, was $85.4 million for the quarter, up 1% sequentially from $84.7 million last quarter. While underlying activity has improved in multiple international regions, there are two primary factors impeding the overall service revenue growth; first, the conflict between Russia and Ukraine; and secondly, the devaluation of the Euro and British Pound. Revenue from our operation in Russia during the second quarter decreased approximately $800,000 sequentially and $2.3 million year-over-year. When looking at the first half of 2022, revenue from our operation in Russia has declined about $3.2 million when compared to 2021. Additionally, the sharp devaluation of both the Euro and British Pound during 2022 has lowered revenue built in these currencies when translated into U.S. dollars by about $1 million in the second quarter of 2022, when compared to the first quarter and is lower by about $2.6 million when compared to the second quarter of last year. Our revenue associated with services in the U.S. market, however, continue to grow in line with improving activity levels and have shown steady growth for the last three consecutive quarters. Product sales, which is more equally tied to the U.S. and international activity, were $35.5 million for the quarter, up 16% sequentially and up over 9% from last year. International product sales experienced a strong rebound of 26% sequentially and 15% year-over-year. Our international product sales are typically larger bulk orders and can vary from one quarter to another. We delivered several large international orders during the second quarter. Product sales in the U.S. increased approximately 5% sequentially and were led by the sales of our energetic products, which increased over 11% sequentially. Moving on to cost of services ex-items for the quarter, it was a little below 80% of service revenue and improved slightly from 81% last quarter. With forecasted growth and employee compensation more fully restored, as we progress through the remainder of the year, we would expect incremental margins to improve and trend toward historical levels. Cost of sales ex-items in the second quarter was 84% of revenue, a nice improvement compared to 92% last quarter. The improvement this quarter was primarily driven by gains in manufacturing efficiencies and a higher mix of international sales. We anticipate improvement in the manufacturing absorption rate in future quarters in line with our projected growth in product sales. G&A ex-items for the quarter was $10.4 million, an increase of $1.5 million from $8.9 million last quarter. G&A for the second quarter of 2022 includes a non-cash $600,000 loss associated with a fair market value adjustment tied to our company-owned life insurance policies that are held by the company to fund certain employee retirement plans. G&A expenses have also increased due to increases in travel, outside service providers, and investments in cybersecurity resources. G&A ex-items is anticipated to be approximately $40 million for the full year of 2022. Depreciation and amortization for the quarter was $4.4 million, down slightly from $4.6 million last quarter. EBIT ex-items for the quarter was $9.6 million, up from $7.2 million last quarter yielding an EBIT margin of 8% or up about 170 basis points sequentially. On a GAAP basis, EBIT was $11.7 million for the quarter, which includes the reversal previously recognized stock compensation expense mentioned earlier. Interest expense was $2.7 million, relatively flat from last quarter. Income tax expense ex-items at an effective tax rate of 20% was $1.4 million for the quarter and on a GAAP basis was $1.8 million for the quarter. The effective tax rate will continue to be somewhat sensitive to the geographic mix of earnings across the globe and the impact of items discrete to each quarter. However, we continue to project the company's effective tax rate to be approximately 20%. Income from continuing operations ex-items for the quarter was $5.5 million, up from $3.6 million last quarter. On a GAAP basis, we recorded income from continuing operations of $7.2 million for the quarter. Earnings per diluted share from continuing operations ex-items was $0.12 for the quarter, up from $0.08 last quarter, and GAAP earnings per diluted share from continuing operations was $0.15 for the quarter. Turning to the balance sheet, receivables was $99.2 million and remained flat from the prior quarter. Our DSOs for the second quarter were at 69 days, which improved from the 72 days last quarter. Inventory at June 30 was $52.6 million, up approximately $4.3 million from last quarter end. Inventory turns for the quarter remain consistent at 2.4, which is comparable to the last couple of quarters. As previously highlighted, the company continues to experience an increase in the cost of raw materials, labor, packaging, and transportation costs, which are increasing the cost of inventory. Additionally, challenges in the supply chain persist, which will continue to require carrying a larger amount of inventory to help mitigate disruptions. We continue to anticipate inventory turns will remain at current levels with some improvement as we progress through 2022. And now to the liability side of the balance sheet. Our long-term debt was $188 million at the end of the second quarter of 2022. Considering cash of $16 million, net debt was $172 million, a slight increase from the last quarter. As previously announced on July 25, we renewed and extended the company's revolving credit facility. The renewed credit facility has an aggregate borrowing commitment of $135 million with an accordion feature to expand the facility an additional $50 million. Additionally, the maximum leverage ratio permitted was increased to 2.75 through September 30, 2022, and will return to 2.5 thereafter. At June 30, our leverage ratio was 2.47 compared to 2.23 at last quarter end. We are projecting our leverage ratio to decrease slightly next quarter and continue improving through year-end. Our debt is currently comprised of our senior notes at $135 million as well as $53 million outstanding under our bank revolving credit facility. Looking at cash flow, for the second quarter of 2022, cash from operating activities was $600,000 and after paying for $3.2 million of CapEx for the quarter, our free cash flow for the quarter was a negative $2.6 million. Cash from operations was down in the second quarter of 2022, primarily due to the following factors. The company's profitability was significantly impacted during the first quarter as the company experienced a very elevated level of COVID cases and the Ukraine-Russia conflict began, while we also restored employee compensation on January 1. The Ukraine-Russia conflict negatively impacted our revenue as the company exited the first quarter and began the second quarter. As a result, cash collections on accounts receivable were at a lower level during the second quarter. Additionally, cash from operations was also used to fund working capital requirements as product sales continued to increase, supply chains remained challenged and inflationary factors are contributing to higher levels of inventory. Lastly, unfunded liabilities from certain employee retirement plans were paid with cash from operations during the quarter. Cost reduction plans and associated severance obligations accrued in the first quarter have also been partially executed in the second quarter. We expect the growth in working capital associated with higher levels of inventory to moderate, cash from operations to strengthen, and for the company to generate positive free cash flow in future quarters. We will continue managing capital expenditures to be aligned with activity levels for the remainder of 2022. For the full year 2022, we expect capital expenditures to be in the range of $12 million to $13 million. Core will continue its strict capital discipline and asset-light business model with capital expenditures, primarily targeted at growth opportunities and initiatives. Core Lab has historically had the ability to grow revenue and profitability with minimum capital requirements. Capital expenditures have historically ranged from 3% to 4% of revenue, even during periods of significant growth. That same level of laboratory infrastructure, intellectual property, and leverage exists in the business today. We believe evaluating a company's ability to generate free cash flow and free cash flow yield is an important metric for shareholders when comparing the 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.

Gwen Gresham, Senior Vice President and Head of Investor Relations

Thank you, Chris. As we look forward to the second half of 2022, and into 2023, we anticipate that crude oil commodity prices will remain elevated, but to be more moderately volatile as crude oil supply and demand may be impacted by uncertainties related to slowing global economic growth. Crude oil supply is projected to tighten as production growth faces limitations due to prolonged underinvestment in many regions around the globe. These crude oil market fundamentals are reflected in the year-over-year increase in international onshore and offshore rig counts with drilling programs being executed and capital spending plans expanding for 2022, 2023, and beyond. We see these as leading indicators of a growing international multi-year cycle. With more than 70% of our revenue exposed to international activity, both business segments remain active on international projects. The company will have revenue opportunities when wells are completed, stimulated, and once reservoir rock or fluid samples have been collected. We continue to see modest improvement in client activity across many international regions, including the South Atlantic margin, Latin America, and the Middle East. However, our Russia, Ukraine, and Western Europe laboratory networks present some uncertainty as the Russia-Ukraine geopolitical conflict continues and sanctions on Russia expand. We expect Reservoir Description revenue to improve by low to mid single digits in the third quarter of 2022. Year-to-date, the international rig count has been flat. When the international rig count sustains improvement and our clients drill and sample their reservoirs, Reservoir Description is expected to outperform the changes in industry activity levels. Now turning to Production Enhancement, which is more exposed to U.S. onshore activity and typically correlates with well stimulation and completion programs. We expect the third quarter 2022 U.S. rig count to increase sequentially. However, the rate of growth for completion may potentially be limited by the availability of third-party frac equipment and crews. Consequently, Production Enhancement revenue is projected to increase sequentially by mid to high single digits. In summary, we project continued improvement in U.S. activity and moderate improvement in international offshore and deepwater markets. The realignment of crude oil supply lines is projected to continue into the third quarter of 2022 having a sequential positive impact on Reservoir Description's assay laboratory testing in the affected region. As a result, we project company revenue to range from $123 million to $129 million, operating income $10.1 million to $13.3 million, yielding operating margins of approximately 9%. EPS for the quarter is expected to be $0.13 to $0.18. Our third quarter 2022 guidance is based on projections for underlying operations and excludes gains and losses in foreign exchange. Third quarter 2022 guidance also assumes an effective tax rate of 20%. With that said, I'll pass the discussion back to Larry.

Larry Bruno, Chairman and CEO

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 has been very visible during the current challenges and is the foundation of Core Lab's success. Turning first to Reservoir Description. For the second quarter, revenue came in at $75.8 million, up slightly compared to Q1. As Chris mentioned, when looking at the sequential growth in revenue, it is important to consider the sharp devaluation of the Euro and the British Pound during Q2. These currency devaluations lowered CLB revenue when translated into U.S. dollars by $1.1 million as compared to Q1. Comparing the first half of 2022 to the first half of 2021, the currency devaluation in the Euro and the British Pound lowered revenue when translated into U.S. dollars by $4.8 million. The Reservoir Description business segment absorbed most of this currency exchange impact to the top line. Operating income for Reservoir Description ex-items was $5 million and operating margins were 7%. Even with the challenges posed by the Russia-Ukraine conflict, sequential incremental margins for Reservoir Description were just over 100% as revenue improved and costs were reduced. After accounting for the currency devaluations just discussed, sequential incremental margins were still approximately 100%. As we look ahead, while still well below pre-COVID levels, we see the growing international rig count as a harbinger of an improving landscape for Reservoir Description. The trend that we project will play out throughout 2022 and for the next several years, particularly in the Middle East and North and South America regions. Now, for some operational highlights from the second quarter. Energy transition opportunities that leverage Core's expertise in Reservoir Description continue to emerge. During the second quarter of 2022, Core Lab, under the direction of 3PL Operating, Inc., commenced work on a multi-well core project to evaluate lithium production opportunities from Railroad Valley in Central Nevada. 3PL Operating has targeted a Pliocene continental evaporite sequence with extensive metalliferous deposits that include sodium, phosphorus, tungsten, boron, lithium, and other metals, potentially making the Railroad Valley deposit one of the most promising in the world of this type. Multiple core intervals from the 3PL Operating Li 10-28 and Li 11-18 wells were recovered from the subsurface and stabilized at the well site with Core Lab's proprietary CoreSta Technology. CoreSta is superior preservation technology, specifically invented for friable and unconsolidated formations. Upon arrival at the laboratory, these cores are immediately scanned using Core Lab's proprietary Non-Invasive Testing and Reservoir Optimization Technologies, including Dual Energy Computed Tomography. Core's proprietary deliverables from the CAT scanner quickly provided the experts at 3PL Operating with lithologic information and a wide range of geological and petrophysical parameters, as well as millimeter-scale 3D digital images of the recovered cores. The cores are now progressing through the laboratory analytical program. The geologic insights and petrophysical parameters obtained from this analytical program will provide a robust dataset of physical measurements that 3PL Operating will use for both the economic assessment of the strata and to establish optimized development strategies. All of the data for this important project are being hosted in Core Lab's secure RAPID database, which 3PL Operating will use as a shared digital workspace. Moving now to Production Enhancement where Core Lab's strengths in both energetic systems and completion diagnostics helped clients optimize their well completions. Revenue for Production Enhancement came in at $45.1 million, up 11% both sequentially and year-over-year. Operating income ex-items was $3.9 million. Operating margins were 9% for the second quarter of 2022 and sequential incremental margins were 18%. During the second quarter of 2022, working with a client in the North Sea, Core Lab successfully launched its innovative energetic perforating system, Helios, aimed at improving the efficiency of plug-and-abandonment programs. The Helios technology's unique engineering and design generates a high-density perforation matrix that provides access to the cement between the outermost layer of casing and the geologic formation. The Helios perforation matrix creates an optimized design that allows for greater circulation and more efficient debris removal in the annular space during perf and wash operations. The operator first perforated the casing with the Helios technology, then utilizing a specialized jet wash tool, circulated fluid between the perforated casing and the geologic formation to create a clean annulus. Subsequently, cement plugs were set to secure the well for abandonment. Core's Helios perforating technology provides the opportunity to significantly reduce plug-and-abandonment expenses by reducing the number of rig days, saving the operator up to $4 million per abandoned well versus the traditional section milling approach. Helios also demonstrates how Core's production enhancement engineers are able to adapt downhole technological advances to diverse industry needs. Also, during the second quarter of 2022, Core's SpectraStim, SpectraScan and PackScan downhole imaging technologies were utilized in a client's deepwater Gulf of Mexico well to evaluate a frac pack completion. A successful frac pack requires an effective proppant pack. This includes uniform proppant placement across the annulus between the casing and the sand control screen, as well as ample proppant reserve above the top of the screen. When a successful frac pack is placed, the well is protected from the influx of formation fines that can cut the screen, damage surface facilities, and fill the wellbore with produced solids, thus restricting production. Based upon traditional volumetric measurements during the frac pack treatment, a successful frac pack was initially interpreted to have been placed on the well. However, when Core's Production Enhancement engineering team analyzed the diagnostic data retrieved from its SpectraScan and PackScan logging tools, the results revealed a major void in the annular pack, as well as inadequate proppant reserve at the top of the screen. Core's experts recommended a top-off proppant treatment to ensure complete screen coverage. The top-off procedure was successfully pumped and a relog of the completion using Core's PackScan logging tool confirmed the successful proppant infilling on the annular void along with adequate proppant reserve placement above the top of the screen. This avoided a multi-million dollar remedial completion intervention. That concludes our operational review. We appreciate your participation. And Kate, we will now open the call for questions.

Operator, Operator

We will now begin the question-and-answer session. Our first question is from John Daniel of Daniel Energy Partners. Please go ahead.

John Daniel, Analyst

Thank you for having me. I have two questions. The first one, Larry, pertains to your comments on lithium extraction.

Larry Bruno, Chairman and CEO

Yes.

John Daniel, Analyst

Can you help me understand what the market potential for that is?

Larry Bruno, Chairman and CEO

Lithium will significantly contribute to the production of efficient batteries. Historically, a large portion of the world's lithium has originated from remote locations, particularly from the lithium triangle in the high Andes and the Atacama Desert, which are challenging to access due to their altitude and logistical demands. Consequently, there has been an increasing interest in sourcing lithium closer to battery manufacturing sites and markets. The Great Basin presents a valuable geological opportunity, with several lithium assessment projects currently underway and at least one active mining operation. This project is still in the initial evaluation phase. It's crucial for us to understand the geology and the behavior of brines in rock formations, similar to how oil and gas reservoirs are assessed, as this will impact the economic viability of production. I foresee this growing to represent over 5% of Core Lab's revenue. Looking at our energy transition opportunities, including carbon capture and storage, I anticipate that could eventually grow to around 10% of Core Lab's revenue, although predicting the timeline is challenging.

John Daniel, Analyst

Okay. Great. That's helpful. And then the last one for me, it's just on the Helios product that you referenced.

Larry Bruno, Chairman and CEO

Yes.

John Daniel, Analyst

Is this a silly question, so I apologize. Is this specifically intended for just the North Sea, or can it be applied to all offshore well projects? Any insight on that?

Larry Bruno, Chairman and CEO

Yes. So good question. The Helios will work in any, I would say, offshore well plug-and-abandonment program. A couple of comments there on that. One is Core Lab use its move or expansion into more plug-and-abandonment work as a derivative of an energy transition play. Even if oil and gas starts to decline in demand over the next number of decades, it's going to be many, many decades of plug-and-abandonment work on producing wells. We see that as a nice position for us. I would say the technology is probably not greatly applicable to sort of onshore unconventional wells in North America, but anywhere you have a complex well, like an offshore well or deepwater well, Helios has a role to play and a substantial economic opportunity for cost savings from the operator. So we have a nice arc for that going forward. And some more P&A innovations coming out of Core Lab. Stay tuned.

John Daniel, Analyst

Okay. Thank you for including me. That's all I had.

Larry Bruno, Chairman and CEO

Okay. Thanks, John.

Operator, Operator

The next question is from Chase Mulvehill of Bank of America. Please go ahead.

Gwen Gresham, Senior Vice President and Head of Investor Relations

Good morning, Chase.

Chase Mulvehill, Analyst

Good morning. We've participated in many calls this earnings season and have heard a lot of positive feedback regarding the offshore market. I would like to delve deeper into your offshore business. This primarily relates to Reservoir Description. I believe the recent increase in offshore activity and your approvals of new projects, especially after discussions with FTI regarding their significant subsea orders, would likely lead to improved revenue growth in your rock analysis segment. Could you elaborate on what you are observing behind the scenes in the offshore sector and how that might impact your Reservoir Description business?

Larry Bruno, Chairman and CEO

Yes, really good question, Chase. And you're right. We will lag, I'll call it the metal-intensive operators or metal-intensive service companies as they access an improving market. A couple of things on the offshore international rig count that kind of flattened out a little bit in the first half of this year, after I'd say a pretty nice growth arc year-over-year. What we're seeing now is more activity lined up; the South Atlantic margin looks real nice. The Gulf of Mexico looks very promising for us. In the Middle East, both onshore and offshore look promising for us. Asia-Pacific, I'd say there’s a little bit of opportunity there. But right now, the bigger opportunities are the South Atlantic margin, Gulf of Mexico, and some offshore work in Asia-Pac. The North Sea also has opportunities where we've got projects with rock and fluid awards made to us from the North Sea. That will show up over the next couple of quarters.

Chase Mulvehill, Analyst

Okay. If I could just kind of follow up on that real quick and thinking about Reservoir Description, I guess kind of depending on what happens in the back half, I mean we'll call it kind of flattish revenues this year. But if we get into 2023 and you're seeing kind of this momentum you just mentioned, what kind of growth should we expect on the R&D side? Could you get double-digit growth or should we still think single-digit growth for Reservoir Description? I'm sorry, I know that's a bit away, but just trying to get some color as we look to 2023.

Larry Bruno, Chairman and CEO

Yes. I think double-digit growth on the international side, in particular, and the offshore side, in particular, is well within grasp. The spool-up time of project engagement that we see lining up for us would indicate that getting to double digits is achievable. Just a little refinement on your premise there, what we're seeing is Reservoir Description across most of our global reach is seeing growing business opportunities that we think will start showing up toward the back half of 2022 and into 2023. That's going to be offset a bit by, let's call it, uncertainties in Russia-Ukraine and Europe related to that crude assay work – a little bit of a counterbalance there as that sorts out. Longer term, we see the realignment of global supply lines, and we think that Russian crude oil is finding a home and will continue to find a home in other places. And Europe will be backfilling sources of oil from places where they hadn't been necessarily supplying before. That realignment is going on right now, and it’s having an impact on our business. But we think that’s going to settle down between the rest of this year and into next year, making it a different but more normalized world in terms of demand for that portion of our Reservoir Description business.

Chase Mulvehill, Analyst

Okay. Just one follow-up, and I'll turn it back over. I'm sorry for asking all the follow-ups, but thanks, Chris. Thanks, Larry.

Chris Hill, Chief Financial Officer

Yes.

Larry Bruno, Chairman and CEO

Yes. You're welcome. Thanks, Chase.

Operator, Operator

The next question is from Don Crist, Johnson Rice. Please go ahead.

Gwen Gresham, Senior Vice President and Head of Investor Relations

Good morning, Don.

Larry Bruno, Chairman and CEO

Hey Don, good morning.

Don Crist, Analyst

Good morning. I wanted to ask a follow-up to John's question on the Helios product that's new. Does that work on shallow water Gulf of Mexico? I know that shallow water Gulf of Mexico P&A work is really ramping up now. A lot of wells were put back to original operators through bankruptcies, and it looks like there's probably going to be a $700 million or $800 million market going forward. Does the Helios product have any impact there?

Larry Bruno, Chairman and CEO

Yes, it sure does. I would probably draw the line at relatively simple onshore or U.S. land wells; probably not going to be a target for us there. But offshore wells, whether it's on the shelf or in deep water globally are target environments for us for Helios. A better way of plugging and abandoning these complex wells, especially where there are multiple wells off of a production platform and they're going to abandon one of those wells. They can execute it much more quickly and efficiently with the Helios product. We see a nice arc ahead of us for that.

Don Crist, Analyst

Great. And just one on the international operations. Obviously, you're talking about a multi-year cycle starting up there. Can you just walk through the indicators that you’re seeing right now? Is it so broad-based that it probably doesn't stop anytime soon with a recession or any other kind of pullback in oil, or is it more impacted by oil moving around, if you will?

Larry Bruno, Chairman and CEO

Yes. Don, I draw a difference. I think the potential to be impacted by shorter-term economic volatility probably poses more risk to onshore land projects, mostly in North America. You have to look at the backdrop of underinvestment that's now been going on for more than half a decade in international arenas. What we've said for a long time, and I'll admit very candidly that it's been slower evolving, is that the next cycle of investment was going to come into the industry, going to be international, and was going to be conventional reservoirs and offshore primarily. That's right in Core Lab's wheelhouse. The conversations that we're seeing are picking up globally, and we like those types of projects. They tend to be a little more lucrative for us because the risk profile for our clients is higher. They need to reduce that geologic risk, if you will. That means more robust datasets, and that feeds right into more coring and more sampling. We will lag a bit; Reservoir Description always lags directional changes in industry activity. That may be a little frustrating for folks who say, hey, we're hearing about the drillers that are picking up. Where’s Core Lab's role in this? We're going to be a little later in the cycle. But the flip side to that is you look how Reservoir Description held in as COVID hit. There was a deep downturn; you saw Reservoir Description hold in there very well. You can't lag on the way down and then lag on the way up. That's a pretty lucrative business model if you can find one. So we’ll lag a bit, but it’s building up and will be across many sectors.

Gwen Gresham, Senior Vice President and Head of Investor Relations

We are watching the international offshore rig counts as a leading indicator. Additionally, we are tracking information from Wood Mackenzie concerning final investment decisions and projects currently being discussed with our clients. These activities are taking place in several major regions around the globe.

Don Crist, Analyst

Great. I appreciate the color. I'll turn it back.

Larry Bruno, Chairman and CEO

Thanks, Don.

Gwen Gresham, Senior Vice President and Head of Investor Relations

Thanks, Don.

Operator, Operator

The next question comes from Stephen Gengaro of Stifel. Please go ahead.

Stephen Gengaro, Analyst

Thanks. Good morning. Thank you for taking the questions. So two things, if you don't mind. The first is around the RD discussion and just sort of from a bigger picture perspective, when we think about that business over the last, I don't know, five, six years, the growth rates haven't been what we've expected. Part of that is just international activity. If we compare that business to prior upturns, is anything structurally different in that business, either what the competitors are doing or what you're doing, who you're working for, etc.? Or is it simply related to just underlying activity trends?

Larry Bruno, Chairman and CEO

Yes. I'd say nothing's changed structurally in the business. It's simply a reflection of activity levels. I do think that the IOCs, the International Operating Companies have been extraordinarily measured in their reengagement on projects. However, the NOCs are emerging as being more aggressive or they’re much closer to engaging at a higher level. There’s a little bit of that going on. The economics of these bigger projects gave some pause when people were focused on repairing balance sheets and doing what they needed to recover after COVID. The commodity prices; WTI this morning was around $100, Brent around a little over $110, I think. That economic model supporting these longer-cycle projects has emerged. The rationale view of global demand for oil and natural gas for the next several decades is going to support investment in these types of projects. It’s just been slow to get started.

Stephen Gengaro, Analyst

Great. No, that's helpful color. Thank you. And in general here, when we think going forward, and this is a question I think on both segments, when we think about historical incremental margin performance, I know there's a lot of moving pieces in the very short term. But as we think about 2023, assuming things normalize a bit, where do you think those year-over-year incrementals should play out, given what you see and what the cost structures look like?

Larry Bruno, Chairman and CEO

Yes, I'll begin and then Chris can add more. In Reservoir Description, we notice significant operational leverage. However, it's important to note that we won't see consistent incremental gains every quarter from this group. Instead, we should analyze performance over several quarters. I believe the operational leverage is most pronounced in Reservoir Description, as it involves more rock and fluids passing through our current infrastructure. This will likely lead to incremental gains of 50% and above, which we've achieved in the past. I think there's potential for even better results moving forward due to our streamlined organization. In manufacturing, we are currently facing some challenges related to higher supply costs and inflation, which may limit our product margins compared to those in Reservoir Description. Nonetheless, I still anticipate incremental margins in the range of 25% to 35%. Chris, do you have anything to add?

Chris Hill, Chief Financial Officer

Well, I just want to remind folks that definitely as we went through COVID and we had these temporary cost reductions in place, they kind of artificially lowered the cost base for Reservoir Description. As we were working through last year, we started to restore some of that. I think mainly in employee compensation costs. Our largest group of employees is in the Reservoir Description group. So it's more impactful for that group. As we started this year, we completed that almost. We had these costs coming in Q1 and then these other events happen in Q1. Now we’ve kind of reset the baseline for the cost structures in Reservoir Description. As you see top-line growth in that group, you will see those incremental margins as we've seen historically. That's really what we’ve had to work through over the last several quarters. But now we feel like we've got a pretty good baseline. There are some inflationary costs, and we expect labor costs to increase. We have to give our employees merit to be in line with where inflation has been. So that’ll be a bit of a headwind. As that group picks up momentum, like Larry was talking about, as we get deeper into the recovery, absolutely, we would expect incrementals to be where they historically were.

Stephen Gengaro, Analyst

Great. No, thank you. That's great color. Thank you, gentlemen.

Larry Bruno, Chairman and CEO

Hey, Stephen, if I could, just one point I failed to make in your first question about the landscape here. If anything, we saw a continuation over the last couple of years of downsizing internal laboratories within our IOC client base, where fewer projects can be handled internally, as they've downsized their internal infrastructure to accommodate the cost. This has happened through every previous downturn cycle. Every time there's a downturn, IOCs have looked at their internal lab structures and said, let's go buy this when we need it; let's not have it internally. The same thing happened during this cycle. We’re even better positioned going forward, in that there are fewer internal opportunities to do work within the company's laboratory structures, those that still have them.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Larry for now for closing remarks.

Larry Bruno, Chairman and CEO

We'll wrap up here. In summary, Core's operational leadership continues to position the company for improved client activity levels in both U.S. and international markets in 2022 and beyond. We have never been better operationally or technologically positioned to help our global client base, optimize their reservoirs 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 maximizing free cash 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 strengthen its balance sheet while always investing in growth opportunities. So in closing, we thank and appreciate all of our shareholders and the analysts that cover Core Lab. The executive management team and the board of Core Laboratories give a special thanks to our worldwide employees who have made these results possible. We're proud to be associated with their continuing achievements. So thanks for spending time with us. We look forward to our next update. Goodbye for now.

Operator, Operator

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