Core Laboratories N.V. (NYSE:CLB) Q2 2019 Earnings Conference Call July 25, 2019 8:30 AM ET

Company Participants

David Demshur - Chairman & CEO
Gwendolyn Schreffler - Head, IR
Christopher Hill - CFO
Lawrence Bruno - President

Conference Call Participants

Chase Mulvehill - Bank of America Merrill Lynch
Byron Pope - Tudor Pickering Holt
Sean Meakim - JP Morgan
Ian MacPherson - Simmons
Scott Gruber - Citigroup
Connor Lynagh - Morgan Stanley
Stephen Gengaro - Stifel

Operator

Good day, ladies and gentlemen, and welcome to the Core Laboratories Q2 2019 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions]

I would now like to turn the conference over to David Demshur. Please go ahead.

David Demshur

Thank you, Chris. Good morning in North America, good afternoon in Europe, and good evening in Asia-Pacific. We would like to welcome all of our shareholders, analysts and most importantly, our employees to Core Laboratories second quarter 2019 earnings conference call. This morning, I am joined by Chris Hill, Core's CFO; Gwen Schreffler, Core's Head of IR; and Larry Bruno, Core's President and COO.

The call will be divided into five segments. Gwen will start by making remarks regarding forward-looking statements. And then we'll review some of the current macro environment, updating industry trends pertaining to Core Lab's expected future performance. And then some current thoughts on worldwide crude oil supply trends. We will then review Core's three financial tenets, which the company employs to build long-term shareholder value.

Chris will follow with a detailed financial overview and additional comments regarding building shareholder value, followed by Gwen discussing Core's third quarter 2019 outlook and a general industry outlook as it pertains to Core's prospects. Then Larry will go over Core's two operating segments, detailing our progress and discussing the continued successful introduction of new Core Lab technologies, and then highlighting some of Core's operations and major projects worldwide. And then, we will open the phones for a Q&A session.

I'll turn it over to Gwen for remarks regarding forward-looking statements. Gwen?

Gwendolyn Schreffler

Thank you, David. Before we start of the conference this morning, I'll mention that some of the statements that we make during the 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 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 second quarter results. Those non-GAAP measures can also be found on our website.

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

David Demshur

Thanks, Gwen. Now some industry trends and then onto our three financial tenets. Core is encouraged that operating companies are furthering their commitments to operating within their own free cash flow and emphasizing returns on invested capital as demanded by today's investors. This trend benefits Core, whose clients tend to be technologically sophisticated and are heavy users of technology over commodity-driven solutions. During the second quarter, Core continued to host several conference calls, industry sessions and industry groups and analysts to discuss optimal well spacing, rightsizing, upsizing, well positioning and parent-child well relationships.

Proper upsizing and well spacing are two of the most discussed topics within Core's clients today. Also improving perforating efficiencies and effectiveness rank a close second. Larry Bruno will have a detailed discussion of Core's recent commissioning of the industry's most advanced Reservoir Optimized Completions laboratory or ROC Lab. To that end, the industry will continue to add perf clusters per stage, yielding less but more complex stages, while lateral lengths or nearing their maximum length owing to frictional forces.

Perf clusters are now increasing to as many as 15 to 20 per stage reducing the cost and time for well completion and stimulation programs owing to the lower stage count. The reasons for more perf clusters and fewer stages are our clients are changing the way reservoir rock is being stimulated to produce the maximum amount of stimulated reservoir volume within close proximity to the wellbore. Long frac channels are to be avoided as they are the source of well interference. It is possible to rebelize more stimulated reservoir volume in the near wellbore region and avoid costly well interference problems using more perf clusters. We see this trend continuing. Adding a new and growing -- addressing a new and growing market, the recent acquisition of Guardian Global Technologies continues to be a technological win for Core Laboratories. We have received positive client feedback, market acceptance and market share on our industry-leading preassembled energetic systems via the company's GoGun.

Core's current biggest challenge is scaling up to meet gun demand as automated systems are currently being added. Core recently had to turn down a single order for over 13,000 guns, an order valued at $7 million. The most critical components of any preassembled energetic system remain the perforating charges and their interaction with the reservoir ROC. Core's industry-leading ballistics team continues to innovate the best perforating systems, including Core's most recently introduced refrac system that significantly improves the results and economics of refaced wells. Note, watch the refaced [ph] well space over the next several quarters and next several years.

The last and most important trend for Core is that client activities have continued to increase for international and deep water long cycle projects that will be needed to meet future production demand. The foreshadow of this increase in activity has been evident in the 20 FIDs approved in 2017, another 30 in 2018 and 30 or more queued up here in 2019. Revenue from these longer cycle projects has mainly been absent from Core's reservoir description revenue streams dating back to 2015. The increased international activity did bolster reservoir description revenue in the second quarter of 2019, more than offsetting lower activity in North America. Remember, the decline curves still always wins and never sleeps.

Now some comments on worldwide crude supply. An indication of the effects of the decline curve comes from the fact that non-US and non-OPEC production totals have fallen for their seventh consecutive year more than offsetting production gains in Russia. Also notable, Russian gains over the last several years have been slowing. Moreover, the Eagle Ford play is in permanent decline as Bakken production will near its projected peak over the next year or so. We remain bullish on crude oil.

Now to review the three financial tenets by which Core is used to build shareholder value over the 24 year history of being a publicly traded company. During the second quarter of 2019, Core generated over $10 million in free cash flow, marking the 71 consecutive quarter of generating positive free cash. Core has no plans on cutting our dividend as we view it's important to our investor base, especially our European investor base as being sacrosanct. With the emergence of international markets pushing Core Lab revenue and operating margins, core is confident that the company's asset light model will allow Core's future cash flow to more than cover our dividend. And to add further to bolster free cash, the company has embarked on a North American cost cutting plan. We are continuing to streamline businesses, the increased automation and continues to review operating structures to right-size costs for current market conditions.

In addition, as was the case in the second quarter, the company will continue to review divestment opportunities of non-core non-strategic low margin businesses. Also in the second quarter, Core once again produced the oil field industry-leading return on invested capital for the 39 consecutive quarter with an ROIC of 21.3%. We appreciate all the analysts pointing that out and then notes that they've recently put out. Also during the second quarter of 2019, Core returned approximately $25 million back to our shareholders via our quarterly dividend. Core will continue to return capital back to its shareholder via quarterly dividends and share repurchases as free cash flow levels increase.

I'll turn it back to Chris for a detailed financial overview. Chris?

Christopher Hill

Thanks, David. 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, we have excluded the gain of $1.2 million on the divestiture of a non-strategic business and a $3 million charge associated with the company's efforts to streamline our operating structures and business reporting lines as part of a company-wide cost reduction program.

Now, looking at the income statement. Revenue from continuing operations was $169 million in the second quarter, comparable to last quarter, but below the same quarter last year. Of this revenue, service revenue was $117.9 million for the quarter, down 2% sequentially. This quarter's activity was impacted by lower than projected service revenue in North America and with the reduction of almost $2 million in revenue associated with the divestiture of a non-strategic business in Asia-Pacific. However, the impact from these items was partially offset by increased activity from international and offshore projects, which is anticipated to continue improving into the second half of 2019.

Product sales, which are tied to North American activity were $51.2 million for the quarter, nicely up 5 % from last quarter. The growth in product sales for the quarter was led by our US energetic product sales, which grew 18% this quarter.

Moving on to cost of services for the quarter are 73 % of service revenue, down from 75% in the previous quarter, due to improved operational efficiencies. Cost of sales in the second quarter were 75% of revenue, down slightly from 76% in the previous quarter due to improved absorption of fixed costs. G&A ex-items for the quarter was approximately $10 million, which is down slightly from last quarter. For 2019, we now expect G&A ex-items to be between $42 million and $44 million for the year. Depreciation and amortization for the quarter was $5.8 million, which is comparable to the last several quarters. In 2019, we would expect depreciation expense to remain at similar levels and our capital expenditures to also be in line with our operations. EBIT ex-items for the quarter was $29.6 million and continues to represent best-in-class EBIT margins of 17.5%.

GAAP EBIT for the quarter was $28 million. Income tax expense for the quarter was $5.2 million using an effective tax rate of 20%. GAAP income tax expense for the second quarter was slightly lower at $4.8 million. We continue to project our effective tax rate to be approximately 20%. Additionally, as discussed in prior earnings calls, 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. Income from continuing operations ex-items for the quarter was $20.7 million, up $1 million or a little over 5% from $19.7 million last quarter. GAAP income from continuing operations was $19.5 million for the second quarter. Earnings per diluted share from continuing operations ex-items was $0.46 for the quarter and also up almost 5% from last quarter. GAAP EPS from continuing operations for the second quarter was $0.43.

Now, we'll move on to significant aspects of the balance sheet. Receivable stood at $134.9 million, up a little for the quarter and up $5.7 million from year end. However, our DSOs have remained consistent at 67 days for the quarter. Inventory stood at $49.3 million, up about $3.6 million from year end, but down about $800,000 from last quarter, as we continue to work through some bulk purchases of raw materials that were purchased in Q1. Inventory turns were 3.2 for the second quarter, and we anticipate inventory turns will improve for the second half of 2019.

And now onto the liability side of the balance sheet. Our long-term debt at quarter end was $292 million, down $5 million from last quarter end. The company completed the sale of the business that was held as discontinued operations and non-strategic business in Asia-Pacific region for net proceeds of approximately $19.6 million. The surplus proceeds from the sale of these businesses were used to reduce our debt under our revolving credit facility. Our debt is comprised of our senior notes at $150 million, as well as $142 million under our bank revolving credit facility.

Looking at cash flow in the second quarter, cash flow from operating activities with $17.1 million and after paying for our $7 million in CapEx our free cash flow in Q2 was $10.1 million, which is the 71 consecutive quarter, Core Lab was generated positive free cash flow. Our free cash flow for the second quarter was impacted by an increase in working capital and increased capital investment associated with technological innovations and automation programs. These capital investments add additional operational efficiencies and expand our capabilities and service offerings for new technologies like the integrated GoGun system and our ROC Lab.

For 2019, the company anticipates that its CapEx will be between $22 million to $24 million. As Dave previously mentioned, the emergence of the international market is important for Core Lab and we'll continue to fuel the expansion of our operating margins and future cash flow. We remain confident that our incremental margins will continue to be strong. Operating margins will continue to improve and a future generation of free cash flow will grow to more than cover our dividend. Our free cash flow conversion ratio, which is free cash flow divided by income from continuing operations using a normalized 20% effective tax rate, continues to be one of the highest in the industry at just over 100% for the first half of 2019. We believe this is an important metric for shareholders when comparing company's financial results, particularly for those shareholders who utilize discounted cash flow model to assess valuations.

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

Gwendolyn Schreffler

Thank you, Chris. During the first half of 2019, the global crude oil market stabilized with the continuation of OPEC production cuts and a modest decline in global crude oil inventories, supporting a balance between supply and demand. The most recent International Energy Agency report estimates demand growth for 2019 will be 1.1 million barrels per day, slightly down from the first quarter of 2019. Also during the second quarter, the international offshore rig count increased by 26% year-over-year and the overall international rig count increase by 14.5% year-over-year. While market concerns exist regarding the balance of future crude oil supply and demand, crude oil production additions are limited on a global basis.

The decline curve is prevailing in the mature crude oil fields internationally, heading towards a supply GAAP over time. These crude oil fundamentals drive Core's clients' international activity levels, which are expected to continue to improve in the third quarter of 2019. The balancing of crude oil supply and demand supports the crude oil price which underpins the Final Investment Decisions and emerging international crude oil field reinvestments. These international investments are critical, as the decline in production from mature fields continues and new field development is required for supply replacement.

Consequently, Core's accepts the Reservoir Description segment to benefit from increased client spending in the international crude oil markets. The average third quarter 2019 US rig count is projected to be down. While operators continue to focus on generating free cash flow and returns on investment, optimizing well completions remains a significant lever in growing field investment returns while managing their capital budgets. As a result, Core projects US onshore completion activity to be flat sequentially. Core would expect US energetic sales to exceed the rate of completion activity, as they did in the second quarter of 2019.

Therefore, we expect consolidated third quarter 2019 revenue of approximately $171 million to $175 million and operating income of approximately $30.6 million to $32.6 million, yielding operating margins of 18%, with incremental margins, ex-items, exceeding 50%. The Company's EPS for the third quarter of 2019, using an effective tax rate of 20%, is projected to be $0.48 to $0.52. Core Lab's third quarter 2019 guidance is based on projections for the underlying operations and excludes gains and losses in foreign exchange.

To summarize, the following assumptions were used to provide third quarter 2019 company guidance. The international recovery is expected to continue benefiting the international revenue generated by Reservoir Description. Third quarter 2019 US rig count is projected to be down. However, Core projects US onshore completion activity to be flat sequentially. And we would expect US energetic sales to exceed the rate of completion activity as they did in the second quarter of 2019. And lastly, the potential North American market challenges that may affect both business segments.

With that said, I'll turn the call over to Larry.

Lawrence Bruno

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 success. Turning first to Reservoir Description. During Core's 2019 Q1 conference call on April 25, Core announced that it was engaged in the analysis of over 700 feet of conventional Core from the Talos Energy Zama-2 Well located in Block 7 of the Sureste Basin, in the Gulf of Mexico. In the second quarter of 2019, Core Laboratories under the continued direction of Talos Energy provided similar services, unconventional core from a second well, in this offshore Mexico project, the Zama-3 delineation well. Over 700 feet of conventional core was captured from the Zama-3 well with 99% recovery breaking Talos' own record for the longest conventional core from a single well in the history of offshore Mexico.

Previously established workflows, including proprietary, core preservation and stabilization techniques developed by Core Lab for a wide range of sandstone reservoirs in the US portion of the Gulf of Mexico were again successfully applied. Upon arrival in the laboratory, the Zama-3 conventional core was immediately scanned using Core's proprietary non-invasive dual energy CAT Scanning and high-resolution spectral gamma ray detectors. These surface logging technologies provide Talos Energy with lithological data and a wide range of critical parameters for pay assessment well in advance of time-honored laboratory analytical methods.

Advanced laboratory analysis is ongoing. Talos will use the data sets provided by Core Laboratories on the Zama-2 and Zama-3 wells to calibrate models that will ultimately provide reliable calculations of recoverable resources on what Timothy Duncan, Talos, President and CEO, had described as a globally recognized asset. Core Lab continues to be pleased to be part of this unprecedented exploration achievement and looks forward to completing the detailed geoscience and engineering studies. Also, during the second quarter of 2019, Core completed a fully integrated study of Brazil's North Eastern Offshore Basin. This multicompany interpretive study incorporates stratigraphy, geochemistry, reservoir geology and seal rock analysis across several Atlantic Margin Basins offshore Brazil. This study provides the participating companies access to a rock based subsurface data set to evaluate new opportunities, including deepwater, Late Cretaceous turbidity that are attracting considerable attention from operators.

In addition, in Q2, Core continue to make progress on its two multicompany EOR projects in the Eagle Ford and in the Permian Basin. Core's clients are using the detailed reservoir fluid analysis and laboratory based engineered gas injection tests results to evaluate opportunities for field scale deployment. Some of Core's clients are already in fields scale testing and additional companies are looking at the opportunity through proprietary work with Core Lab.

Moving now to production enhancement; during the second quarter of 2019, Core's production enhancement segment commissioned its new cutting edge reservoir optimized completions or ROC Lab in Godley, Texas. The ROC Lab is designed to determine the best energetic solutions for a specific ROC type, so as to maximize productivity of an operators reservoir. The ROC Lab features an industry-leading test vessel capable of matching the temperatures and pressures encountered in the most challenging oil and gas reservoirs on the planet. The perforation test vessel is paired with a Core Lab proprietary flow system that uses highly specialized, internally developed and manufactured pumps and flow controllers.

Combined, these technologies create a proprietary flow loop capable of dynamically displacing oil, brine, and gas through the rock samples that have been perforated with preselected energetics. Core relied on its many decades of experience in conducting multi-phase fluid flow tests through porous medium to optimize this technological investment. In addition, the ROC Lab has a high resolution, industrial grade 3D-CT scanner. This onsite scanner gives client the ability to look inside the test samples, see depth of penetration, determine tunnel volume and geometry, and assess completion to damage to the formation, all with industry leading imaging resolution.

The ROC Lab is a collaborative development between the ballistics engineering experts and production enhancement and the scientists in Cores, Reservoir Description, rock, fluid and laboratory instrumentation segments. This collaboration for which Core Lab is uniquely positioned presents clients with the opportunity to obtain measured data on the interrelationships among rocks, pore fluids and various energetic options, all at reservoir stress conditions. Combined with Core's proprietary geological analysis techniques. Cores clients can now select energetics that will optimize performance for specific stratigraphic targets.

Core's ballistic delivery system and its addressable fire switch are key differentiators of Core's pre-assembled GoGun adaptive perforating system. During the second quarter of 2019, client adoption of these technologies continued to grow as they convert from legacy devices to Core's advanced delivery system and downhole communication offerings.

Also in the second quarter, Core saw a substantial increase in demand for its proprietary refrac perforating technology. Refrac works as part of a mechanical [ph] isolation approach to recompletions in existing wells. Mechanical isolation involves placing and cementing a smaller diameter casing inside the existing well casing, completely closing off communication between the reservoir and the original wellbore. This approach avoids the reliability issues that can be encountered when diverter technologies are attempted for recompletions.

The challenge with mechanical isolation is to reestablish effective communication through two layers of casing strength while generating consistent perforation hole size. Without uniform hole size, the recompletion attempt would produce uneven stimulation effects. Core's refrac perforating solution, the first offering of its kind provides optimal and consistent hole sizes through both strings of tubular. This allows for new zones in the lateral to be effectively pumped and stimulated, breathing life into older under stimulated wells. Advances such as Core Labs proprietary refrac technology are key to successfully expanding recompletion opportunities across mature, unconventional plays.

Core continues to assist its clients in understanding parent-child relationships between frac wells. Core's fracture diagnostic services, utilize technology to determine optimum well spacing and [indiscernible] usage, while minimizing well interference. During the second quarter of 2019, Core designed a large scale field program with a Permian Basin operator to profile production and communication across 19 total wells on multiple pads. Critical to evaluating such a large complex program for Core's extensive portfolio of proprietary FLOWPROFILER EDS hydrocarbon tracers which were deployed in both 100-mesh and 40-70 mesh sizes, [ph] as well as the expertise of Core's engineers to design diagnostic programs around the operator specific objectives. Core was able to identify which portions of the frac treatment were overlapping with offset fracture networks, as well as the impact on well performance. Work is ongoing on this project.

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

Christopher Hill

We will take questions now.

Question-and-Answer Session

Operator

Thank you very much. [Operator Instructions] Our first question is from Chase Mulvehill with Bank of America Merrill Lynch.

Chase Mulvehill

Good morning. I guess first question, if you could just talk about the 3Q outlook, in particular on the production enhancement. It sounds like, there do you all think that completions will be flat and energetics will outperform that? So if we think about revenues for production enhancement in 3Q, should we be thinking about those revenues being up or kind of flattish?

Gwendolyn Schreffler

Think those are going to -- Chase, this is Gwen. I think those are going to be somewhat flattish. And on the energetics, we would owe that to penetration with existing customers as well as adoption with new customers and the new technology. That's having a flat completion activity sequentially and then more energetic sale.

Chase Mulvehill

Okay. And on the energetics and the GoGun in particular, because you kind of quantify if you could maybe the penetration that you've gotten so far, maybe kind of -- what kind of market share that you think you have on the preassembled guns and really, what differentiates your GoGun versus everyone else's?

David Demshur

So yes, Chase. It's still very early innings of the introduction to GoGun into the market. And I think, so it's a -- we're still in a ramp up phase on that. I think the important point is the differentiator is ultimately the energetics. We can deliver -- and other companies can deliver a convenient package to the well site in terms of the preassembled gun, but ultimately, it's the efficiency and effectiveness of the energetics that are the determining factor. That's what drives people to Core Lab's offerings.

Chase Mulvehill

Okay. Right. That's helpful. The quick follow-up here on Reservoir Description, obviously a good quarter and nice rebound in margins. Could you maybe just talk about the back half of the year and, FIDs that seemed them [indiscernible] possibly be kind of coming through in the back half of the year. So what kind of year-over-year growth? When do we hit that 10% mark on year-over-year growth for Reservoir Description and what about that 20% EBIT margins? Do you think that's plausible by the end of the year for Reservoir Description?

Christopher Hill

Okay. Not quite ready to give full year guidance here, but our view right now is that, we'll see improving margins in the third quarter and further penetration of this rebound in the international market?

David Demshur

Yes. We have to caution though Chase because we do generate some Reservoir Description revenue in North America, so that's kind of offset some of the international impact. Right now, we do see international growth at 8% or some of that was offset by some decrease in North America. So I think that's the watchword. If you can hold North America flat in Reservoir Description, I think we get to that 10%, certainly high-single digits, maybe as early as next quarter.

Chase Mulvehill

Okay. All right. That's helpful. I'll turn it back over.

David Demshur

And on margins, Chase, I think we're looking at 18% next quarter, so we could be knocking on that door fourth quarter.

Chase Mulvehill

All right. Good to hear. Thanks, Dave. Thanks.

David Demshur

Thank you, Chase.

Operator

Thank you. The next question is from Byron Pope of Tudor Pickering Holt. Please go ahead.

Byron Pope

Good morning, everyone. For -- within the production enhancement, so clearly the energetics demand continues to trend in the right direction. I was just wondering if you could give some color on the discretionary services where there were some headwinds in Q2. And just trying to understand that dynamic as you think about the back half of the year because again, realized energetics demand will continue to trend in the right direction.

Gwendolyn Schreffler

Byron, so on the services part that is a fairly discretionary service that is diagnostic services that represents about a third of the production enhancement segment. So we did see somewhat of a decline in the North America part of that business.

Byron Pope

Okay. That's helpful.

Lawrence Bruno

I'll add to that. Byron, I'll add to that, there's some very nice opportunities for our completion diagnostics in offshore field development programs. And so, as those improve both offshore US and internationally, we see that providing some support for completion diagnostics going forward.

Byron Pope

Okay. That's helpful. And then that's a good segue to my next question. Just thinking about international across both business segments realize it's more skewed toward Reservoir Description, but I recall correctly that Europe, Africa, Middle East region is your largest international region. And could you just frame the growth prospects that you see there over the next 12 months?

Lawrence Bruno

Yes. I think the Middle East is, I think I mentioned last quarter, I still hasn't changed views on. I still see the Middle East as a sort of a -- on the forefront of the international recovery. We've seen some nice things developing -- continuing and developing in South America for us offshore primarily and so maybe, I think, still think the Brazil opportunities for us are largely a 2020 event. But for the back half of this year, I think the Middle East is leading. We've got a very nice project going on in Australia as well. I say, Asia-PAC not quite as mature than recovery as the Middle East and South America ongoing work continuing in a very nice clip and some new opportunities emerging for us into 2020.

Byron Pope

Great. Thanks.

David Demshur

Byron, just to add to that, looking at, we would rank growth prospects Middle East the number one, and Latin South America number two at this point and Asia-PAC third.

Operator

Thank you. The next question is from Sean Meakim of JP Morgan.

Sean Meakim

Thank you. Good morning. I was hoping, we could unpack the mix in production enhancement in the second quarter, maybe gives a little more of a read into your guidance for the third quarter. So was the -- so I guess if US energetics were up 18%, can you give us a sense of what percentage growth for -- sorry, what percentage of products would constitute energetics and what the growth rate was for products overall? So just given that, that's approximate two-thirds of the segment services are third and it's the third that drove the decline. Just trying to get a sense of the magnitude?

Lawrence Bruno

So we typically don't give the sales by product lines, but energetics is a significant part of the product sales. We also sell some instrumentation. So if you're just looking at total product sales, there's also instrumentation in there from our Reservoir Description group as well.

Christopher Hill

But energetic are the bulwark of our product sales, and especially more so in production enhancement.

Sean Meakim

Right. And about two-thirds of the business is in the US and one-third roughly is international offshore. So I'm still trying to figure out [indiscernible] often, give a lot of detail, but he gave some of the detail. And so I'm just trying to understand, if the bulk of the products business was up 18%. How much of a drop off we had to see in the services and diagnostics to get to that, to get that down 4% quarter-over-quarter? Just seems like it's hard to bridge the one data point to the other. So I'm just trying to conceptually understand it better because I've not heard that much volatility in the services previously.

Gwendolyn Schreffler

Yes, Sean. That equated to about $4 million during the quarter down in service.

Sean Meakim

Okay. And [indiscernible] up more off-line, but just trying to understand that the bridge came to the one data point to the other. So maybe just another question on Reservoir Description. I mean, Dave already kind of gave a little bit of around where I'm trying to go in terms of what the exit rate could look like. So it sounds like confidence that you have been knocking on that 20% door and directionally that seems to make sense. Are there any other factors driving the step up in profitability in the second quarter besides mix, is it just job mix coming through?

David Demshur

Yes, it's international and offshore and Core's challenged by North America. So Sean, we've seen these trends take place in recoveries in 2010 through 2014. We think -- we're seeing the beginning of those stages actually currently happening right now.

Gwendolyn Schreffler

And Sean, as a reminder, the step up is directly tied to more activity and that's coming through a fixed cost structure. That's the reason you see the nice incremental's and the nice EBIT margin.

David Demshur

Right. So some of these FIDs that were announced back in 2017 and 2018 are finally coming to fruition for us, generating revenue from those.

Sean Meakim

Right. So the higher margin projects and then you get the fixed cost operating leverage on top, and that's why you see that big step up?

David Demshur

Correct.

Sean Meakim

Makes sense. Okay, thank you for that detail.

David Demshur

All right, Sean.

Operator

Thank you. The next question is from Ian MacPherson of Simmons. Please go ahead.

Ian MacPherson

Good morning, everybody. Hi David, my question is on the operational side had been pretty well covered. Thanks for all that. I wanted to ask Chris or whomever on the free cash flow side, just because operating cash flow has fallen short of dividend coverage in the first half, I think by about 40%. And I know that you have a target to bridge that. But I wanted to see what that looks like in the second half. What your expectations are for dividend coverage from operating cash flow and what leverage you have to pull to get there?

Christopher Hill

Sure. So I think it's important to remember that, the fundamentals of what have sort of generated free cash flow for Core Lab historically are still all there. It was down slightly this quarter and I highlighted some of the factors that impacted that. But as we go into the second half of the year, we continue to talk about and believe that free cash flow is going to improve and it's driven by this international activity and the growth from our Reservoir Description group and the expansion of those margins. So we do, I'm going to reiterate what I said in my notes that or my speaking notes, that we are confident that as we get deeper into this international recovery, that's going to be reflected in our free cash flow generation. So we're pulling the levers that we would normally pull. I think we'd like to see inventory turns improve a little bit, but like we talked about, we're expanding our product lines there. So there's a little bit of build and inventory with some new product offerings. But then also we did have some bulk purchases there. So as we work through that, you'll see some improvements there as well.

Ian MacPherson

So as I understand it, it's essentially the low capital intensity associated with the expected uplift in already earnings in the second half.

Christopher Hill

Yes, exactly.

David Demshur

No, no additional [indiscernible] required. And so that's a fixed cost structures -- a real theme here that we will be deploying it Core Lab.

Ian MacPherson

Got it, thanks. And then for the follow up, it will be any lingering or continuing restructuring charges beyond the $3 million that you took in Q2 that we should see again?

Christopher Hill

We [ph] don't have any plans at this time.

Ian MacPherson

And anything material remaining on that, you mentioned the potential for more non-core divestitures, anything as significant as what you sold last quarter totaling $20 million.

David Demshur

Yes, Ian. We're always going to review, we've got 70 locations in 50 countries, so we'll look through there and one of the diversities last year, we've continually run our laboratory operation in Singapore for the last 50 years. So when we put that lab in 1969, Singapore was the center of Asia-Pacific. But adding laboratories in Australia, Indonesia, Kuala Lumpur made that central location no longer viable it'd become a low margin operation. So we'll continue to look at things like that. We don't have any businesses that we're holding for sale. The promo [indiscernible] was kind of a one off. So as we stand, we'll look for just individual opportunities of maybe laboratories that aren't positioned in the right place.

Ian MacPherson

Okay. Thanks, Dave. Thanks, everyone.

Operator

Thank you. The next question is from Scott Gruber of Citigroup. Please go ahead.

Scott Gruber

Good morning. So just coming back to the domestic frac market, I realize visibility is low, but early indications from the frac companies, so that completion activity is going to be trending down in 3Q. What signs are you seeing in the marketplace that provide confidence that the mark will be more flattish in 3Q versus down?

Gwendolyn Schreffler

It's the intensity of the energetic utilization in the completion that we see Scott. So we saw that in Q2, we would expect that to continue into Q3 as well.

Scott Gruber

So the flattest comment is more on energetic sales versus overall wells fracs?

David Demshur

Yes. And so in some my commentary, I talked about the increasing complexity of the completion, especially associated with the energetics. Right now, we're seeing as many as 20 clusters per stage. You know, this feeds revenue into the production enhancement and there's no reason why that should not continue to increase. So from our standpoint, from our standpoint, total number of wells might be completed. It might be down a bit. But from our revenue opportunity, flattish.

Scott Gruber

Makes it interesting to hear about it from me and pays interest on the refract technology. It sounds interesting and data highlight that we should be watching the penetration rate here. Can you size the revenue opportunity for core of the mix for over 18 months?

David Demshur

Unknown at this point. This is a brand new product that we've just introduced. We've had some opportunities to use that in some of the older unconventional plays. We are now targeting certainly plays like the Eagle Ford, which is in decline. We will be targeting over the next couple of quarters. The Haynesville, which is a natural gas producer, but we'll go into decline. And also the Bakken, which we project, is nearing production peak here over the next year or year and a half. We think the adoption opportunities is very large for us. Just think about where we were completion wise several years ago. Not uncommon for wells to have three to five stages through the eight stages will lose. A lot of us stimulated rock between those stages. So that's the market that we're that we're looking at. We're working very closely with a couple of operators that it has had some very encouraging results.

We're in the process of beating the drum on that with other clients to look over there under stimulated wells. And so we think market penetration can be very nice. It's been improving at a pretty good clip for us, but a little early to put any hard metrics on where we see it going in the near-term.

Scott Gruber

Yes, I'd appreciate the color. Thank you.

Operator

Thank you. The next question is from Connor Lynagh of Morgan Stanley. Please go ahead.

Connor Lynagh

Good morning. Want to go back to Reservoir Description. Here I was wondering, if you could help us think about, is your revenue run rate or your earnings run rate right now, I mean, it seems like there's not a lot of the FID impact. So should we think about sort of the $400 million annual run rate is -- as a good baseline? And then beyond that, can you think about how we should layer in the impact of these FIDs we're seeing this year in terms of longer term revenue growth?

Lawrence Bruno

Yes, Connor. During the -- call the darker days of the downturn, Reservoir Description was running at about $100 million per quarter run rate, which largely reflected OpEx spending from clients. So what you've seen in the lift-off from that, getting us now into the $105 million, $106 million and moving in the right direction here is more of that capital spending coming into the revenue stream.

David Demshur

So if you look at 2014, you had revenues running in the $130 million a quarter. We would expect that once you start to pile up these FIDs over four or five years. We could again approach those levels in 2021, 2022.

Gwendolyn Schreffler

And that also shows that Connor in our operating income being up sequentially 30% and 23% year-over-year. So you see it expanding or see incremental's and then the expanding EBIT margin.

Connor Lynagh

Yes, makes sense. So, maybe just to follow-up there on the margin side. Is there any reason to think that the margin at which your bidding work for these incremental FIDs different than it had been historically in that 2014 time horizon?

Gwendolyn Schreffler

No, Connor.

David Demshur

No. The margins in 2014, which was kind of the peak, reached high 20s, 28. We like our products offerings better. We like our cost structure better. So no reason that, that can't happen.

Connor Lynagh

All right. Thank you.

Operator

Thank you. [Operator Instructions] Our next question is from [indiscernible]. Please go ahead.

Unidentified Analyst

This is Vaib [ph] in place of Emily's. Sorry to disappoint you.

Lawrence Bruno

A worthy pinch hitter there.

Unidentified Analyst

Okay. So I guess, just wanted to ask you more about the cost cutting effort that you took. How do you think about future cost savings the potential timing over what you would realize that? And then maybe taking a stab at what do you think U.S. activity could be next year?

David Demshur

Yes, in terms of the cost cutting, we're working to streamline businesses, improve operational structures. We've been on a long term path toward a laboratory and manufacturing automation that's been that's a big driver of our cost savings. And so it's we've got some things that we've started on that more that we'll be implementing in the near term. But it's think of it as a progression of or an evolution of building a more efficient structure. Yes, we're going to target them somewhere between 3% and 4%. We get to that level would be quite pleased.

Unidentified Analyst

Okay. So I guess implied it was what you're saying is if, if and if he was growing modestly, you are now properly, your business structure is properly sized for that kind of activity. Is that fair? Take away?

David Demshur

Correct, Well, not yet. Over the next couple of quarters, it will be there. And also with adding some automation, we can get to those levels.

Unidentified Analyst

And just one modeling question, if I may. So much on production enhancement is a it's about 40% international. And given that the revenues declined by 4%, my back of the envelope suggested the U.S. a share of the revenues for production, and ASMAN declined about 10%. Am I in the ballpark? Can you help me with that?

David Demshur

Yes. We're good with that.

Operator

Thank you. Next question is from Stephen Gengaro of Stifel. Please go ahead.

Stephen Gengaro

Thanks. Good morning, everybody. Two things if you don't mind. One, just think about R.D and to the international leverage there. A lot of your peers are talking about kind of high single digits growth this year, maybe 10%-ish in 2020. Do you think that's reasonable for the R.D. business as you go forward here?

David Demshur

Yes, we're at it right now, so we definitely can get there.

Gwendolyn Schreffler

Yes, RD International revenues up at 8% force year-over-year. And then we see that building. 80% or so of that of that segment, their revenues are sourced from that market. So think about that when you're trying to model or determine what kind of growth would be in reservoir description.

David Demshur

And you can see it nicely offsets a decrease in North America because we had margin expansion from that international growth.

Stephen Gengaro

So International is up. The total business was up round three. So that suggested that 20% piece was down dramatically?

David Demshur

Correct. You can do the math.

Stephen Gengaro

Okay, that makes sense. And then as you -- you talked about sort of the intensity on the energetic side. Would you be willing to hazard a guess if you had a sort of a flat environment? What percentage growth -- sort of what that -- sort of intensity measure looks like over the next 6 to 18 months?

David Demshur

I'd put it in the teens.

Stephen Gengaro

In the teens?

David Demshur

In the teens.

Stephen Gengaro

Wow. Okay, great.

Gwendolyn Schreffler

Well, I'm going to go get Steve an example of that. If you've got completions that were up 8% sequentially, our U.S. energetic sales were up 18% sequentially, so there is 10 percent worth there.

Stephen Gengaro

Okay, that's helpful. And then when you when you think about your -- the number you gave up 18% energetic sales, what does that number encompass? Is that everything? Is that just -- that's not just GoGun sales, obviously; that's all of your energetic product sales?

Gwendolyn Schreffler

That is correct.

David Demshur

Perf operating charges.

Stephen Gengaro

Charges and delivery systems?

David Demshur

Yes.

Stephen Gengaro

Okay, that's helpful color. Thank you.

David Demshur

Okay, Stephen. Chris, we're going to go ahead and wrap while we don't see any more questions. So in summary, Core's operations continue to position the company for activity levels in the third quarter of 2019. And we know significant challenges await. However, we have never been better operationally or technologically positioned to help our clients maintain and expand their existing production base. We remain uniquely focused and the most technologically advanced reservoir optimization company in the oil field services sector. This positions Core well with challenges ahead. The company remains committed to industry leading levels of free cash generation and returns on invested capital, with capital being returned to our shareholder via dividends and future opportunistic share repurchases as free cash flow levels expand.

So in closing, our 96 quarterly earnings release; we'd like to thank all of our shareholders, the analysts that follow Core, and as already noted by Larry Bruno, the executive management and Board of Core Laboratories gives a special thanks to our worldwide employee base that have made these results possible. We are proud to be associated with their continuing achievements.

So thanks for spending time with us this morning. And we look forward to our next update. Goodbye for now.

Operator

Thank you very much, ladies and gentlemen. That concludes this conference call and you may now disconnect your lines.