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Core Laboratories NVÂ (CLB)
Q1Â 2020 Earnings Call
Apr 23, 2020, 8:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning, and welcome to the Core Laboratories Q1 2020 Earnings Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]
I would now like to turn the conference over to David Demshur, CEO and Chairman of the Board. Please go ahead.
David M. Demshur -- Chairman of the Board and Chief Executive Officer
Thank you, Grant. I'd like to say good morning in North America, good afternoon in Europe, and good evening in Asia Pacific. We'd like to welcome all of our shareholders, analysts, and most importantly, our employees to Core Laboratories' first quarter 2020 earnings conference call.
This morning, I'm 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. Then I'll return and review Core's three financial tenets, which the company employs to build long-term shareholder value. Chris will then follow with a detailed financial overview and additional comments regarding building shareholder value, Gwen will also add comments. And 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. Then we'll open the phones for a Q&A session.
I'll turn it back to Gwen for remarks regarding forward-looking statements. Gwen?
Gwendolyn Y. Schreffler -- Senior Vice President, Corporate Development and Investor Relations
Before we start the conference call this morning, I'll mention that some of the statements that we make during this call may include projections, estimates and other forward-looking information. This would include any discussion of the company's business outlook. These types of forward-looking statements are subject to a number of risks and uncertainties relating to the oil and gas industry, business conditions, international markets, international political climate and other factors, including those discussed in our 34 Act filings that may affect our outcome. Should one or more of these risks or uncertainties materialize or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. For a more detailed discussion of some of the foregoing risks and uncertainties, see Item 1A Risk Factors in our most recent Annual Report on Form 10-K as well as other reports and registration statements filed by us with the SEC and the AFM.
Our comments include non-GAAP financial measures. Reconciliation to the most directly comparable GAAP financial measures is included in the press release announcing our first 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 M. Demshur -- Chairman of the Board and Chief Executive Officer
Well, thanks, Gwen. I'd like to review the three financial tenets of which Core has used to build shareholder value over the 25-year history of being a publicly traded company. During the first quarter of 2020, Core generated over $18.5 million in free cash flow, marking the 74th consecutive quarter of generating free cash. The company's free cash flow remains lucid. Also in the first quarter, Core once again produced oil field industry-leading return on invested capital for the 42nd consecutive quarter with an ROIC exceeding 12%. And Core's third financial tenet, Core returned over $12 million back to our shareholders via our quarterly dividend and repurchasing a modest amount of stock while reducing debt in the quarter.
I'll now turn it back over to Chris, for a detailed financial review. Chris?
Christopher S. Hill -- Senior Vice President and Chief Financial Officer
Thanks, David. One of the focal points in many of our discussions that began in early March has been around our corporate debt structure and the associated financial covenants. So we changed the format of today's financial overview to include some comments to address these points of interest. I'll first summarize the company's current liquidity position, our two primary debt instruments and the associated financial covenants. Then I will provide the overview of our operational performance for the first quarter, material items in the balance sheet and cash flow.
I would like to start off by saying, we understand some of the differences between prior downturns in the industry and what has been caused today about the global COVID-19 pandemic. However, it is still important to understand that Core Lab was one of the few oil field service companies, which was able to remain profitable and generate free cash flow throughout the last downturn, which was also pretty severe. It is this history our light asset business model and company culture that provides our organization with the confidence and we will continue to generate positive free cash flow and maintain our profitability through the current challenges.
Core continues to utilize its $300 million revolving credit facility, under which we had $154 million outstanding as of March 31, 2020, and the ability to draw an additional $131 million if needed. However, we are not projecting the need to borrow again additional funds against our credit facility. In fact, with the challenges -- with the changes to our future dividend policy, reduced capital needs, and the cost reduction initiatives announced and implemented, our projections indicate a reduction of outstanding debt.
For clarity, I'm going to repeat the cost reductions plans that we have quantified in the earnings release have been approved, are within management's control, and are near completion as we are speaking today. Core Lab has two primary debt instruments: the revolving credit facility, just described and the private placement notes that were issued back in 2011. Both of these unsecured debt instruments carry some financial covenants, which are a restriction of the company's leverage ratio and the company must maintain a minimum interest coverage ratio.
The minimum interest coverage ratio permitted is three times and it's consistent across both debt instruments. The leverage ratio calculations are different for each instrument. The notes is a traditional net debt-to-EBITDA calculation, which is restricted to a ratio of 3.5. The revolving credit facility uses a modified calculation for adjusted EBITDA, which adds back non-cash charges and expenses such as the impairment of goodwill and stock compensation. The leverage ratio under the credit facility agreement is restricted to a ratio of 2.5. And historically has been the most restrictive financial debt covenant for Core Lab. For the first quarter of 2020, Core Lab was able to reduce net debt by $6 million and also maintained its leverage ratio as calculated under the revolving credit agreement to 1.93 as of March 31, 2020.
The company also continues to have a good relationship with our bank group and an open line of communication. The factors described above, the cost reduction initiatives implemented by the organization and the company's ability to remain profitable and continue generating positive free cash flow are all positive indicators that Core Lab is and will continue to be in a much stronger financial position than many other companies within the energy sector.
Now with regards to our financial performance this 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 first quarter of 2020 include charges of $122 million for impairment of goodwill and intangible assets associated with our Production Enhancement segment. $6.8 million for the acceleration of stock compensation expense associated with employees who have reached their eligible retirement age, and an additional $1.2 million as we expanded our cost reduction plans in the first quarter. These items have been excluded from financial results to provide a more clear understanding of the performance from the underlying operations.
Now looking at the income statement. Revenue from continuing operations was $152.4 million in the first quarter, down about 3% from the $156.8 million in the fourth quarter of 2019. Our international business remained steady. However, as commodity prices weakened early in the quarter and fell sharply in March, the onshore activity was weaker than originally forecast. Revenue was also impacted by the disruptions associated and caused by the global COVID-19 pandemic. And absent these events, revenue would have challenged our original forecast for the first quarter. Of this revenue, service revenue, which is more international was $110 million for the quarter, down from $115.2 million or about 4.5% sequentially.
Our international revenue grew 1.5% sequentially. However, this was offset by a 9% decline in revenue source from the US. The decline in the US was primarily associated with the drop in US onshore activities. However, some delays on international project and an international facilities were also experienced as a result of the global COVID-19 pandemic, which have continued into the second quarter.
Product sales, which are tied more to North American activity, were $42.4 million for the quarter, an increase of 2% from $41.6 million last quarter. International product sales increased over the last quarter, which was partially offset by the decline in product sales to the US onshore market, where completion activity levels levels were down significantly from last quarter. Some product sales to our international customers were delayed due to disruptions with air freight carriers caused by the COVID-19 pandemic.
Moving on to cost of services for the quarter are 74% of service revenue, up just slightly from 72% last quarter, as service revenue declined slightly during the first quarter. When considering cost of services and the company's ability to generate very strong incremental margins, we have historically highlighted that incremental cost to perform additional tests in our laboratories is very low or approximately 25%. These costs would be considered direct variable costs of performing services for our clients through our laboratory network. This level of direct variable costs would also be fairly consistent for our field-based services. We are not including our employee costs in these direct variable costs. So changes in our workforce would be considered structural changes.
Cost of sales in the fourth quarter was 81% of revenue, a slight improvement from 83% last quarter, as product sales increased slightly and we were able to improve the absorption of our fixed cost. Product sales carry a higher direct variable cost component and generally would average 50% to 55% of sales, which is also important to understand when projecting future financial results for product sales across both our operating segments.
G&A ex-items for the quarter was $13.1 million, which is up from $10 million from last quarter. The increase in G&A for the quarter was primarily due to non-cash expenses associated with employee compensation plans. With the cost reductions announced this quarter, we anticipate G&A expense will be approximately $4 million lower than previous projections.
Depreciation and amortization for the quarter was $5.4 million, which is comparable to the last several quarters. In 2020, we would expect depreciation expense to be slightly lower when compared to prior year levels. And our capital expenditures are projected to be around $11 million. EBIT ex-items for the quarter was $20.6 million and continues to represent best -in-class EBIT margins of 14%. Our operating loss for the quarter on a GAAP basis was $109 million, which includes the non-cash charge of $122 million for the impairment of goodwill and intangible assets and the other charges previously discussed.
Income tax expense ex-items and using an effective tax rate of 20% for the quarter was $3.4 million. On a GAAP basis, the company recorded an income tax benefit of $4 million for the quarter. The income tax benefit is associated with the goodwill impairment charge. For the remainder of 2020, 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.
Income from continuing operations ex-items for the quarter was $13.7 million, down 20% sequentially from $17.1 million. GAAP operating loss from continuing operations was about $108 million for the first quarter.
Earnings per diluted share from continuing operations ex-items was $0.31 for the quarter. The GAAP loss per share from continuing operations for the first quarter was $2.44.
Now we'll move on to the balance sheet. Receivables was $126.9 million and decreased $4.7 million from last quarter-end. Our DSOs at 72 days for the quarter improved slightly from last quarter. We believe organizations across the globe were impacted, including ourselves, clients and the global banks, as plans to work remotely were implemented and tested during March. We will continue to monitor our collections closely as we are currently not anticipating any significant changes in payment practices or behaviors from our client base.
Inventory was $52.3 million, up a little over $2 million from year-end, primarily due to the receipt of bulk raw materials during the quarter as planned and some delayed international shipments that were anticipated in March. Additionally, there were some unanticipated build in finished goods as activity dropped sharply in the US onshore market as we exited the quarter. Our organization is working diligently to evaluate and assess the reduction of inventory balances throughout the remainder of 2020. This will take cooperation and coordination with some of our key vendors and suppliers.
And now on to the liability side of the balance sheet. Our long-term debt at quarter end was $304 million and we reduced net debt by $6 million. As discussed earlier, our debt is comprised of our senior notes at $150 million as well as $154 million outstanding under our bank revolving credit facility. As stated earlier, management's focus for the foreseeable future is to direct excess free cash toward reducing debt.
Looking at cash flow. In the first quarter, cash flow from operating activities was $22 million, and after paying our $3.3 million in capex, our free cash flow in Q1 was $18.7 million, an increase of almost 13% sequentially. For 2020, the company anticipates that its capex will be down approximately 50% as compared to 2019.
Our free cash flow conversion ratio, which is free cash flow divided by income from continuing operations excluding non-cash charges and using a normalized 20% effective tax rate was over 136% for the first quarter of 2020. This also marks the 74th consecutive quarter Core Lab has generated positive free cash flow and we are projecting to continue generating positive free cash as we manage the organization through the challenging market ahead. We believe this is an important metric for shareholders when comparing company's financial results particularly for those shareholders who utilize discounted cash flow models to assess valuations.
I will now turn it over to Gwen for an update on our outlook.
Gwendolyn Y. Schreffler -- Senior Vice President, Corporate Development and Investor Relations
Thank you, Chris. Core Lab expects crude oil prices to remain low for the near to mid-term given the decline in global crude oil demand seen in the first quarter of 2020. Global consumption fell as transportation, daily community movement and other mandated restrictions around the globe were implemented to mitigate the outbreak of COVID-19. As uncertainty around the longevity of the imbalance between supply and demand continues to down -- place downward pressure on the crude oil -- the price of crude oil for clients' focus on managing their balance sheet has never been greater. In addition, they will evaluate the breakeven crude oil price needed to support capital spending for both short and long-term cycle project.
During the first quarter of 2020, crude oil prices declined 55%, which resulted in E&P companies, significantly reducing their 2020 capital expenditure plans, especially in the US as witnessed by a 12.5% fall in the average frac spread index and a 24% decline in completion activity. In addition, as a result of the overall decline in demand and COVID-19 related disruptions associated with transportation and supply chain, international activity is experiencing negative impacts as well.
On April 12, the OPEC and non-members, OPEC Plus announced an unprecedented 3-phase plan to reduce crude oil production by 9.7 million, 7.7 million and 5.8 million barrels of oil per day through April of 2022. As the remainder of 2020 unfolds the OPEC Plus agreement and the COVID-19 demand disruptions abate, the price of crude oil and consequently the E&P industry activity may modestly improve. Core believes the actions taken by the E&P companies during the first quarter of 2020 in response to the decrease in crude oil price indicate lower overall activity in 2020 versus 2019. Core project activity declines to continue internationally and in North America during the second quarter of 2020. The company's clients are prioritizing operating plans for conducting their activities in this unprecedented environment. International activity is expected to decrease. However, not as sharply as the anticipated decline in US onshore activity year-over-year. This continues to be a high level of uncertainty with regard to the level of -- level and timing of Core's clients activity. Consequently, Core is not in a position to provide quantitative guidance for the upcoming quarter at this time.
From a qualitative perspective, the company anticipates that delays in project work and international shipment of products may improve during the second half of 2020. For reservoir description, we would expect reservoir fluid analysis, which accounts for more than 65% of this segment's revenue to be more resilient given the work is not solely tied to drilling and completion activity. Additionally, production enhancement has a wide range of innovative product offerings, some of which are not tied to drilling and completion activity such as large international plug-and-abandonment and well remediation programs.
So when projecting the future financial performance of Core Lab, it is also important to consider the following: service revenue has historically had lower direct variable cost approximately 25%, while product sales in general carry a higher direct variable costs, which averages 50% to 55%. Additionally, and as described by Chris earlier, Core has implemented significant structural reduction plans, which will benefit the financial performance by both business segments. The cost reductions will benefit reservoir description's future financial results by over $7 million per quarter and $21.6 million for the remainder of 2020. And for production enhancement, cost reductions will benefit future results by over $4 million per quarter and over $12 million for the remainder of 2020.
Now, I'll pass the discussion over to Larry.
Lawrence V. Bruno -- President and Chief Operating Officer
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. Before turning to the detailed operational review, I also want to especially thank all of Core Lab's dedicated staff for their commitment and for the personal sacrifices they have made during this unsettled period in the energy industry. This dedication and adaptability to recent challenges has allowed Core Lab to safely conduct our business to remain largely operational across our global network, and very importantly, allowed Core to continue to service our clients on their schedules. Those of us that have weathered previous difficult periods in the industry understand both the cyclical nature of the business as well as the critical role Core Lab plays and providing best-in-class technologies and service to the industry for more than 84 years.
Turning first to reservoir description, the Northern South Atlantic margin continues to be a very attractive area for exploration, appraisal development and production projects. It is currently among the most active international regions for Core Lab. In the first quarter of 2020, Core Lab under the direction of BHP was engaged to provide laboratory analysis for BHP's deepwater Northern licenses project, offshore Trinidad and Tobago. This multi-well analytical program is employing Core's proprietary and patented laboratory technologies to assess reservoir rock properties from the Bele-1 ST-1, Bele-1 ST-2, Boom-1, Hi Hat-1, and Tuk-1 wells.
High quality, conventional core was recovered from unconsolidated strata in the target reservoir intervals. Once the cores reach the rig floor upon recovery from the subsurface, the cores were stabilized at the well site using proprietary Core Lab techniques. These methods ensure that the natural fabric of the rock and the pore fluids are retained during handling and transportation to the laboratory.
Upon arrival at the lab, these cores were immediately scanned using Core's proprietary non-invasive technologies for reservoir optimization, branded as NITRO. This package of proprietary technologies, including dual-energy CT and High Frequency Spectral Gamma surface logging provided BHP's experts with little logic information as well as a wide variety of critical petrophysical parameters for pay assessment. These NITRO deliverables were provided well in advance of the results derived from time-honored laboratory analyses. NITRO also provided the BHP team with a digital archive of the core intervals in a web-enabled 3D format with millimeter scale bed resolution. These conventional cores are now progressing through the traditional laboratory program of physical measurements following consultation between BHP's and Core Lab's technical teams. Core Lab is very pleased to be assisting BHP and their evaluation of the significant discovery.
Moving now to production enhancement. For the first quarter of 2020, Core launched its participation in an extensive multi-well multi-year comprehensive water shutoff and plug and abandonment program for a large international operating company operating in the Asia-Pacific region. The program utilizes Core's innovative X-SPAN system as well as other Core Lab downhole plug and abandonment product technologies. Efficient and effective zonal isolation is a critical step in well plugging and abandonment procedures. X-SPAN utilizes the proprietary energetic based 3-dimensional metal to metal technology to provide a permanent seal over existing perforations. X-SPAN is a highly reliable, cost-effective solution for eliminated unwanted water production from the depleted reservoir. These proprietary and patented lab Core Lab technologies result in efficient plug and abandonment operations and are being deployed across a wide range of well configurations. Core's ability to provide an integrated package of well site services along with superior product performance have helped to reduce the time to execute an individual abandonment job by more than 2 days per well. This provides the IOC with significant savings and improved cash flow. Core's expertise, service ethic and superior technological product offerings were instrumental in the IOC's decision to use Core Lab for this extensive 2,900 well program.
Before we move to the Q&A session, I want to take a moment to acknowledge that this will be Dave Demshur's 99th Core Lab quarterly earnings call. That's an extraordinary accomplishment in both the history of our industry and among publicly traded companies in general. Since Core Lab went public 25 years ago, Dave's leadership vision and drive have been both pillars of Core Lab's success and a great source of inspiration and motivation for all of those fortunate enough to have worked alongside them. I've had that privilege for more than 20 years, and I want to personally thank Dave for the support, the confidence and the mentorship he has always provided to me and the rest of the Core Lab leadership team. While the industry clearly will face challenges from time to time, the high spirits and dedication to Core Lab that Dave brought with him to work every day will always permeate through the leadership team and the entire company.
That concludes our operational review. We appreciate your participation. Grant, we'll now open the call for questions.
Questions and Answers:
Operator
Thank you, Larry. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Sean Meakim with JPMorgan. Please go ahead.
Gwendolyn Y. Schreffler -- Senior Vice President, Corporate Development and Investor Relations
Good morning, Sean.
Operator
Well, it looks like we are instead going to take George O'Leary with TPH & Company. Please go ahead.
Gwendolyn Y. Schreffler -- Senior Vice President, Corporate Development and Investor Relations
Hi, George.
George O'Leary -- TPH & Company -- Analyst
Good morning, Gwen. How are you?
Gwendolyn Y. Schreffler -- Senior Vice President, Corporate Development and Investor Relations
Doing well.
David M. Demshur -- Chairman of the Board and Chief Executive Officer
Hi, George.
George O'Leary -- TPH & Company -- Analyst
Good morning, guys. I just wanted to kick off with customer dialog-oriented question. Just curious I realize you guys aren't providing quantitative color, but just from a qualitative perspective, could you describe how the dialog is progressing with international customers versus North American or domestic customers. And then maybe also IOC versus NOC behavior. Any differences in tone, discussion, outlook, rate of change? Just anything high level even if it has to be qualitative would be helpful framing?
David M. Demshur -- Chairman of the Board and Chief Executive Officer
Yeah, George, a few comments along that. So on our international projects, none of those have been canceled. The disruptions have largely been, quite frankly, the operations have been shut down, say, on our offshore project, say, offshore South America for the time being, and that's largely transportation related. They're not sending their staff to the location. And so we're not sending our staff to location at their request. So those are all projects that the -- I think very reasonable anticipation is they're going to move forward with. That's what they've told us. And some of them have told you publicly, told the investment community publicly. They're not stopping these projects, they're moving forward with them. These are big development, long cycle projects. Those are all going to be moving forward from the information that we've received and from what they've said publicly. And so once they get back to normal ability to move people and equipment around the planet, those will move forward. So I think those will be a very nice stabilizing influence for us.
Clearly on the international front, the stability of the projects appears to be much greater. I think in North America, there has been very clear statements by some companies about laying down rigs and cutting back on frac crews. So I think everything that we've heard is in line with what's been talked about publicly. There'll be a steeper drop-off in the North America region, then there will be outside the US. In terms of IOC and NOC, really no change there. I would say, just told us hang in there, we'll call you when we're ready for you.
George O'Leary -- TPH & Company -- Analyst
Okay. Great. That's helpful color. And then on the -- you guys have a large portion of your reservoir business on the fluid side now, which you highlighted in the release and have highlighted through time that, that percentage of your revenue stream is increasing. How do you shut-ins in the North American market. And I realize that business has a lot of international exposure, but shut-ins in the North American market, we've heard rumblings that maybe Norway is mulling over shut-ins, clearly there is going to be some of those emanating from OPEC to a pretty stout degree. How does shut-ins impact that business? And what are you guys seeing on a leading edge basis in North America have folks already started to do some shut-ins here?
David M. Demshur -- Chairman of the Board and Chief Executive Officer
Yeah. So I think I need to frame the question a little bit. There is some long cycle waves in where our -- on the laboratory side of the business and the reservoir description side of the business and how -- which is the bigger revenue generator, rocks or fluids. That goes in cycles. And so from, say from, 2010 to 2014, rock business was more than 50%. And then -- since then fluids business has been more than 50%. And so what I would anticipate is as we get into the next round of global development exploration somewhat, but for us, for Core Lab, more development and appraisal of those projects come on into play. We'll see the rock business come back and be sub equal with the fluids business.
That being said, the fluids business is less tied to rig count, for example, in that people need to continue to monitor their fluid properties. Now, when they shut in a well, one of the first things that's going to have to happen is that they will have to go back and check the properties of the oil. Because pressure might have drifted in the reservoir at the near well-bore is probably a better way to say it rather than the reservoir. And so they'll have to go back and check that. So there might be a period where some shut-ins would impact the immediate fluids testing, but then there might be a concomitant rebound in that as people bring production back on. And so with the -- and I would say with the -- back to your earlier question about work in different areas, we'll make an adjustment in our workforce. The largest adjustments that we've made to our labor pool has been in the US and internationally there is some that's going on and anticipate there'll be some more of those as we move forward and we see plans develop. But I think all that comes together to say, we'll have a period of transition in front of us, but a lot of the heavy lifting has been done to get our fixed cost in line with what we see today as the market demand for our services.
George O'Leary -- TPH & Company -- Analyst
Great. Thank you very much for the color. I'll turn it back over.
Operator
Our next question will come from Sean Meakim with JP Morgan. Please go ahead.
Gwendolyn Y. Schreffler -- Senior Vice President, Corporate Development and Investor Relations
Good morning, Sean.
Sean Meakim -- JP Morgan -- Analyst
Yeah, good morning. Thank you. So I was hoping to start off with a question on reservoir description. There is a number of factors that make this downturn more challenging than the last one. You've been able to sustain that $100 million a quarter revenue for quite a long time now. The fluid analysis business is so helpful just given that opex orientation, and that's maybe two-thirds of the mix today. So given the challenges are unfolding here, oil price pressure on customer budgets, COVID disruptions etc. Do we see risk of breaching that $100 million a quarter mark? How do we think about the puts and takes there going forward?
Lawrence V. Bruno -- President and Chief Operating Officer
Yeah, the way we've always looked at that, Sean, was, say, over the last cycle, is that $100 million a quarter was Core Lab's participation in keeping that roughly 100 million barrels of oil moving around the planet being produced and transported and tested in the laboratory. And so, yeah, there is an impact that could happen as we see that production drop for some period of time. And so I don't think that floor is a fixed dollar amount that's insensitive to the amount of oil being produced and put into consumption. So I do think that's something that we will likely see that we will face, and that will be revenue in that segment below $100 million. But again, not ready to give specific guidance on that. We'll have to see.
Sean Meakim -- JP Morgan -- Analyst
Understood. And I appreciate that feedback, Larry. And so then on production enhancement, pretty high decremental in the first quarter. It's naturally a pretty high decremental or incremental business, but particularly in 1Q. Can you maybe put some parameters around downside to margins in the second quarter just given or how to think about the operating leverage given the acute pressure that the whole industry is going to face? And what can be done to mitigate in future quarters the impact that I was just trying to think about what happened in the first quarter and how it should frame what we think about 2Q and beyond?
Lawrence V. Bruno -- President and Chief Operating Officer
Yeah, I'll take the first part of that question and I'll let Chris fill in a little bit about going forward there. So, Sean, if you think about where we were coming out of Q4, we had a sharp slowdown in US completions. We had a lot of constructive conversations going on with clients. Yeah, we're getting back to business in the early part of the New Year. So we had furloughs in place in response to the Q4 slow down, we turn those off. We start responding to client demands that brings cost back into play, add materials in. And we're starting to build for what we saw as a pretty nice rebound into 2020. Well, that clearly didn't pan out after the virus and the events of the OPEC Plus meeting not going the way any of us would have liked to seeing that happen. And so we had a very sharp reversal in that. So we had some cost come on early in the quarter to respond to the rebound that we were seeing and being advised of by our clients. And so we brought some cost back into the system and then we had a very steep drop off. So that -- we've turned the knobs very quickly on getting those cost under control. Following -- by the time we made our March 16 release, we had made some -- started making adjustments at that point. And so we had to unwind some of those costs that we brought back in the first quarter.
And with respect to decrementals going forward, Chris?
Christopher S. Hill -- Senior Vice President and Chief Financial Officer
Yeah, I mean -- so just like Larry was saying, I think some of the costs that were taken out on a temporary basis in Q4 kind of came back in Q1. And with the, really, the sharp drop off at the end of the quarter, the structural changes that we're talking about. So the reduction in workforce that really didn't have any impact in Q1, that was done very late in the quarter and a lot of it done, honestly, in the beginning of Q2. So those savings will flow through in Q2 and it will definitely soften the decrementals going forward. So we are not expecting a projecting decrementals for Q2 like you saw in Q1.
Sean Meakim -- JP Morgan -- Analyst
Thank you. That's really helpful. But just with 2Q and with respect to downside to where revenue could go where completions activity could go? Anything that drove that component of the decremental?
Christopher S. Hill -- Senior Vice President and Chief Financial Officer
Yeah, I would tell you that we have internally done a pretty robust two year forecast and we've come up with sort of a base case and a worst case, which is pretty much in line with the consensus out there. And I can tell you, we probably got additional cost cuts coming our way. So don't be surprised if you see some additional cost reduction initiatives coming through in Q2. So I would tell you we're trying to be very thoughtful about that. We're talking about our employee base, our workforce. So we're monitoring that very closely, but we're also doing it in a thoughtful way. So you will see that continue as we move through and monitor where exactly the activity is going to be. And is that going to be more short-term or long-term.
Sean Meakim -- JP Morgan -- Analyst
I appreciate that. Thanks, Chris. Thanks, Larry.
Lawrence V. Bruno -- President and Chief Operating Officer
Welcome.
Operator
Our next question will come from Scott Gruber with Citigroup. Please go ahead.
Gwendolyn Y. Schreffler -- Senior Vice President, Corporate Development and Investor Relations
Good morning, Scott.
Scott Gruber -- Citigroup -- Analyst
Good morning, everybody. Good morning, Gwen.
David M. Demshur -- Chairman of the Board and Chief Executive Officer
Good morning, Scott.
Scott Gruber -- Citigroup -- Analyst
Good morning. So following on the question around reservoir description. I understand that the COVID activity disruptions and the shut-ins interject a great deal of uncertainty near term. But if we look out to, say, the middle of '21, and we're back 100 million-ish barrels or so in oil demand. But international E&P spending is down 20%, 25%. Is reservoir description back to 100 million [Phonetic] or so of revenues? Or how much is it down, just given the low leverage to customer capex?
Lawrence V. Bruno -- President and Chief Operating Officer
Yeah, I think the important thing to remember there is that the reservoir description revenue is largely tied to opex spending. So that ties in with Sean's question from a bit earlier. As opex maybe has a pause here or decline, we're going to feel that. But as the effects of the COVID-19 disruptions change and world demand starts to come back later in the year and we made reference to that that we saw some opportunity for some improved activity in the second half of this year as demand starts to come back up, then we'll start to see that filter through and reservoir description will benefit as those opex budgets turn back on. So that tends to be a pretty opex heavy segment of our business with some obvious capex sprinkled in for these large projects like we've talked about in the last several quarters, the BHP one we just referenced here, the Guyana work that we've talked about, offshore Australia, things like that.
Scott Gruber -- Citigroup -- Analyst
Got it, got it. And just turning to the balance sheet and you guys are now focused on turning that debt with excess cash. Just some color on how long you think about debt pay down being the priority for excess cash. Is there a medium-term leverage target you want to get to before you start balancing debt data with other uses of cash? How should we think about that?
Christopher S. Hill -- Senior Vice President and Chief Financial Officer
Yeah, this is Chris. So, again, we've done a 2-year forecast, what I would tell you is, even in that sort of worst-case scenario, we've tried to stress test that and see how close we get to our debt covenants. And right now, we look to be OK. So that's good news. Longer term, I think, I've historically or in the past I've said, hey, maybe a leverage ratio of 1.5 times is an appropriate target. What I would say about that is when we are comfortable that we've reduced the debt and we've got room under that leverage ratio and there is more less uncertainty I'll say in the forecast for the energy sector, then you might start to see us change our sort of focus. But for the time being, so for the foreseeable future, we're going to focus excess cash flow or free cash flow on reducing the debt.
Scott Gruber -- Citigroup -- Analyst
Got it. I appreciate it. Thank you.
Operator
Our next question will come from Chase Mulvehill with Bank of America. Please go ahead.
Gwendolyn Y. Schreffler -- Senior Vice President, Corporate Development and Investor Relations
Good morning, Chase.
Chase Mulvehill -- Bank of America Merrill Lynch -- Analyst
Hi, good morning, Gwen. I hope everybody is safe and healthy. Thank you. I guess I kind of wanted to come back to reservoir description a little bit. And maybe if you could frame reservoir -- the fluids business and how it reacted during the 2015 and 2016 downturn. I mean, obviously, it's not going to be down as much as drilling and completion spending. But maybe just kind of talk to that and how it performed during the last downturn and you talked about it maybe being a little bit more impacted in the near term. But as you start these wells up, you're going to see a rebound in fluid. So it would be good just to have the '15, '16 context to work off of.
Lawrence V. Bruno -- President and Chief Operating Officer
Yeah. I think if you go back and look at the financial performance of reservoir description, you see our sort of base revenue, there was about 100 million [Phonetic], and that tied pretty closely to the 100 million barrels. I would say maybe somewhat coincidentally, but trend-wise, it tied pretty much to that roughly 100 million barrels of oil that we were consuming across the planet every day. So I think what you saw in that was resilience. Even though the rig counts came down, you saw a resilience in there, tied to pretty much the amount of oil being produced and consumed across the globe. And so that -- I think that ties very well into what we're seeing today, which is there is going to be a hiccup here while the world is producing and consuming less oil. But as those things unwind, and we think the back half of this year, we start to feel some of those effects will -- no one can really predict how quickly the recovery is going to be in demand. But we think that plays out and the fluid side of the business will respond pretty quickly to that. I think the core side of the business, the rock side of the business, will respond a little more slowly to that. That being said, I think it's always important to reemphasize here that some of our major IOC clients and NOC clients have talked specifically about that they are making changes, say, into onshore land North America plans, but they are not derailing large capex projects the offshore ones that are very lucrative to our business.
Chase Mulvehill -- Bank of America Merrill Lynch -- Analyst
Yeah. That sounds good. That makes sense. And then if we were to think about the cost cuts, nice bump up to the cost cuts, the $46 million annualized, it looks like you maybe got some more in your pocket that you'll kind of look at and consider for 2Q as well. But could you talk about the segment split of that $46 million and where you think you're able to kind of pull some more cost out as we kind of look into 2Q and 3Q. And then wrap into that kind of how we should think about the downside risk the reservoir description margins, and if you think we can kind of hold 10% -- hold above 10% for reservoir description.
Christopher S. Hill -- Senior Vice President and Chief Financial Officer
Hi, Chase. This is Chris. So I know Gwen gave some additional guidance on that $46 million and the sort of split across the segments. What I would tell you is, if you look at production enhancement relative to its size, the cost reductions, the reduction in workforce there is actually deeper on a relative basis. So the bulk of our employees are really in the reservoir description group. So the cuts are actually deeper from that perspective for production enhancement, but like I mentioned earlier, there are additional cost reduction plans that are being formulated as we speak. So the ones that we've announced are the only -- are the ones that have been finalized, approved and kind of put in place. So there will be additional cost cuts what -- for long-term, I think that business is going to be more challenged because it is more directly tied to North America onshore activity. But we're committed to keeping that business at a minimum breakeven going forward. So the sort of the benchmark that you laid out there for reservoir description with 10% EBIT margins or operating margins, we think that's on the low end of where our projections could be even in a worst-case scenario. We are dedicated to making the appropriate amount of structural cost reductions, if necessary, to keep that at those kind of margins are higher, I would say.
Lawrence V. Bruno -- President and Chief Operating Officer
And I'd just amplify a little bit on the cost cuts. So what we put in the table in our release, I'm sure most of you look those over there. We consider those to be structural and in large matter, fixed costs. Those are reductions in workforce, furloughs, pay cuts. In other words, we say that they're going to be -- you're not going to see those come back until the work demands it. So things like non-essential travel and stuff like that, all been cut. And that's all we included in that table. We did not include variable cost like supplies and materials and the cuts that we talked about in that table in our release.
Chase Mulvehill -- Bank of America Merrill Lynch -- Analyst
Okay. Larry, I appreciate the color. I will turn it back over.
Lawrence V. Bruno -- President and Chief Operating Officer
Thanks, Chase.
Operator
Our next question will come from Blake Gendron with Wolfe Research. Please go ahead.
Gwendolyn Y. Schreffler -- Senior Vice President, Corporate Development and Investor Relations
Good morning, Blake.
Blake Gendron -- Wolfe Research -- Analyst
Hey, good morning, everybody. So pretty encouraging commentary from some of your larger customers on the international projects that might bridge the activity here over the near term as things kind of dip down. We also know, though, that there has been a lot of changing of asset -- assets changing of hands. So some of the larger providers selling assets to smaller providers. I'm wondering, what you're hearing from the smaller operator group internationally, I would imagine, maybe more of a conservative response here in the near term, but maybe a more aggressive response as things start to normalize. Is that kind of what they're communicating, just in terms of having to restimulate production of free cash flow in the back end of this downturn?
Lawrence V. Bruno -- President and Chief Operating Officer
Yeah, I think the biggest voice in the room have been from our big IOC clients who've talked about, they're not taking the foot off -- or the plans. They're not changing any of their plans. They're pausing on some of these large projects. But they're going to continue with these large capex projects. I think as a general rule, as we look over time here, when assets change hands, that's a good thing for Core Lab, because there is always questions that come up, they need to be answered, because different companies look at different aspects of reservoir performance to try to model the value of that asset. So when things change hands, that tends to be good for us.
Blake Gendron -- Wolfe Research -- Analyst
That makes sense. The conversation has also gravitated away from oil to natural gas as of late, particularly in the long-term outlook for global gas. Wondering if Core has done anything to get into that market in a bigger way. I know it's been somewhat of a subscale part of your reservoir description business. But wondering specifically in the Middle East, if there are any opportunities for you to potentially get in on that secular tailwind.
Lawrence V. Bruno -- President and Chief Operating Officer
Actually, a couple of things here. If you look at our release, we talked about opening up a new fluids lab in the Middle East. We commissioned that. That was tied to a country that's got a lot of gas in play. And the projects that I referenced earlier today in the call, offshore Trinidad and Tobago from BHP, that's a big gas project. There are some others that we are anticipating will spool up here over the next couple of quarters. So I guess the short answer there is, we've always been involved gas projects, oil projects tend to be a little more lucrative for us. When there is three phases of fluids present in the core structure, or it's crude oil, natural gas and water, it's much more complex for the clients to understand the behavior of those -- that multiphase flow. So they will tend to be a little more lucrative. But we participate in gas projects everywhere from Pennsylvania to pick your place or hemisphere on the planet, and we'll likely have some involvement.
Blake Gendron -- Wolfe Research -- Analyst
That's helpful. If I could squeeze one more in, in terms of working capital. It was a pretty big source of cash for you in the last downturn. And working capital appears to have been built up relative to 2014 levels, fairly appreciably here. I know you made some comments in the prepared remarks, but wondering if you could just go through the major components of working capital and what we should expect from a cash contribution perspective, at least here in 2020.
Christopher S. Hill -- Senior Vice President and Chief Financial Officer
Right, sure. This is Chris. So I think if you look at our DSOs, we've actually maintained those pretty well throughout the whole cycle. They crept up on us a little bit the last couple of quarters so -- but an actual improvement from this quarter versus last quarter. So I think we are expecting those to stay around those letters -- levels. I'd like to see improvement in the DSOs. So that would be -- I think the biggest build in working capital has been around inventory. And if you kind of go back a couple of years even with the acquisition of Guardian in our Production Enhancement segment, we started building inventory to service that pre-assembled gun market. So we understand the dynamics have changed for that. So our organization that's focused on that will be working diligently to reduce inventory. I think that's going to take a little bit of time, but as we progress through the year we've got some aggressive goals to reduce that. So it's going to take some help from our key suppliers and vendors to work with us, because a lot of those raw materials are sort of long lead time bulk purchase type items. So we're going to have to adjust those plans and kind of push those things out.
Blake Gendron -- Wolfe Research -- Analyst
Got it. That's helpful color. Thanks.
Operator
Our next question will come from Kurt Hallead with RBC. Please go ahead.
David M. Demshur -- Chairman of the Board and Chief Executive Officer
Hi, Kurt.
Kurt Hallead -- RBC Capital Markets -- Analyst
Good morning, everybody. I hope everybody is doing well.
David M. Demshur -- Chairman of the Board and Chief Executive Officer
Thank you. Hope you are too.
Kurt Hallead -- RBC Capital Markets -- Analyst
Yeah, hanging in. So I guess, for Chris, focus on free cash flow and your leverage ratios, I heard commentary a little bit earlier. But I'm not sure if you mentioned this on a free cash flow dynamic as you look forward through this is 2-year period, where you kind of did the stress testings. What's kind of range of free cash flow that you came up with under that stress test?
Christopher S. Hill -- Senior Vice President and Chief Financial Officer
Well, we're not giving guidance in that respect. I'm not going to be able to give you numbers. There is still a lot of uncertainty about the timing of some of this stuff, especially with the COVID-19 factor in there. But you can take the last few quarters and you can come up with your projections across the company. We've tried to outline and give you enough what our variable costs are, the changes to our structural costs. So that you can kind of model what free cash flow might look like under different scenarios. I can tell you, we haven't -- we haven't tried to model anything that would be excessively different than what we've experienced in the past through the last downturns. We really didn't experience any significant write-offs of customers bad debt. I can tell you, we've tried to make that a lot higher just to sort of stress test it. But DSOs should remain about the same. I think inventory will be a challenging area for us, but we are working, we're going to be working to reduce that. I'm not going to say our inventory turns are going to improve. But I'm telling you our inventory balances are going to go down for the remainder of the year. So that is a multi-variable equation you're talking about there. But I think if you use the last few quarters as a model, you can kind of model what that looks like going forward.
Kurt Hallead -- RBC Capital Markets -- Analyst
Okay. And then maybe just -- what would be a reasonable assumption in the context of debt reduction as we work through, if not 2020, as we get out in 2021 as well?
Christopher S. Hill -- Senior Vice President and Chief Financial Officer
Yeah, I think what I would do there is just try to model what you think cash flow from operations is, OK? Subtract out what we've given you guidance for on capex, take the dividend out and then use that excess free cash flow above the dividend, assume that's going to be 100% for reducing debt.
Kurt Hallead -- RBC Capital Markets -- Analyst
Got it. Thank you so much.
David M. Demshur -- Chairman of the Board and Chief Executive Officer
Okay. Grant. We are at our hour. So in summary, Core's operations continue to position the company for activity levels in the second quarter of 2020 and we know significant challenges away. However, we've never been better operationally or technologically positioned to help our clients to maintain and expand their production base. We remain uniquely focused and are the most technologically advanced reservoir optimization company in all of oilfield services. This positions Core well for the challenges and long-term ahead. The company remains committed to industry-leading levels of free cash generation, return on invested capital, with capital being returned to our shareholders via dividends and future optimistic -- opportunistic share repurchases. So in closing, we'd like to thank all of our shareholders and the analysts to follow Core. And as already noted by Larry Bruno, the executive management and Board of Core Laboratories give a special thanks to our worldwide employees that have made these results possible. We are proud to be associating with our continuing achievements. So thanks for spending time with us this morning and we look forward to our new update -- our next update. Goodbye for now.
Operator
[Operator Closing Remarks]
Duration: 61 minutes
Call participants:
David M. Demshur -- Chairman of the Board and Chief Executive Officer
Gwendolyn Y. Schreffler -- Senior Vice President, Corporate Development and Investor Relations
Christopher S. Hill -- Senior Vice President and Chief Financial Officer
Lawrence V. Bruno -- President and Chief Operating Officer
George O'Leary -- TPH & Company -- Analyst
Sean Meakim -- JP Morgan -- Analyst
Scott Gruber -- Citigroup -- Analyst
Chase Mulvehill -- Bank of America Merrill Lynch -- Analyst
Blake Gendron -- Wolfe Research -- Analyst
Kurt Hallead -- RBC Capital Markets -- Analyst
