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CARBO Ceramics (CRR) CEO Gary Kolstad on Q2 2017 Results – Earnings Call Transcript

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CARBO Ceramics Inc (NYSE:CRR)

Q2 2017 Earnings Conference Call

July 27, 2017 11:30 AM ET

Executives

Gary Kolstad – Chief Executive Officer

Ernesto Bautista – Chief Financial Officer

Analysts

Blake Hutchinson – Howard Weil

Stephen Gengaro – Loop Capital

John Watson – Simmons & Company

Bill Dezellem – Tieton Capital Management

Harold Weber – Aegis Capital

Operator

Hello, and welcome to today’s CARBO Ceramics Inc. 2017 Second Quarter Earnings Conference Call. [Operator Instructions] Please be advised, this call is being recorded today, July 27, 2017, and your participation implies consent to our recording this call. If you do not agree to these terms, simply disconnect.

I would like to remind all participants that during the course of this conference call, the company will make statements that provide information other than historical information, and will include projections concerning the company’s future prospects, revenues, expenses or profits.

These statements are considered forward-looking statements under the safe harbor provision of the Private Securities Litigation Reform Act of 1995, and are subject to risks and uncertainties that could cause actual results to differ materially from these projections. These statements reflect the company’s beliefs based on current conditions that are subject to certain risks and uncertainties that are detailed in the company’s press release and public filings.

During today’s call, management may discuss financial measures that are not determined in accordance with U.S. generally accepted accounting principles. These non-GAAP measures, including EBITDA and adjusted EBITDA, such measures are not a substitute for GAAP measures and may not be comparable to similar measures of other companies. A reconciliation of net loss to EBITDA and adjusted EBITDA as discussed on this call is presented in the company’s earnings release, which is available on its website. Your host for today’s call is Mr. Gary Kolstad, President and Chief Executive Officer of CARBO Ceramics Inc. Mr. Kolstad, please begin your call.

Gary Kolstad

Thank you, and welcome everyone to our second quarter 2017 earnings call. This morning, I’ll review our business in the second quarter followed by a review of our financials, and then an update on the outlook for our businesses before turning it over to questions. Revenue continues to rebound and is now up 115% off the trough we witnessed in the third quarter of 2016. We are pleased with the 111% revenue growth year-on-year and 26% sequential growth. We made progress during the second quarter in expanding our opportunities in technology products and services, and in our industrial products and services. Our efforts to reduce fixed structural costs resulted in increased fall-through on revenue growth. These are the key parts of our strategy to strengthen and build upon the foundation that we believe will make CARBO a stronger company in the future. We are very pleased with the transformation strategy that we are executing on. This year, we will grow our overall revenue by greater than 60%. This growth is almost exclusively driven by businesses other than base ceramic and has contributed to our improved EBITDA. Although the oil and industry remains challenging, we are pleased with our technology product sales during the quarter. We continue to find opportunities for our value-added, production enhancement technologies in a low commodity price environment that leaves many operators focused primarily on upfront costs. In addition, we saw revenue growth in the Fracpro software, StrataGen consulting and base ceramic businesses.

Frac sand continues to see strong demand as operators push the limits on the volume of sand being pumped into today’s wells. Given this demand, we are now at full utilization at our sand plant in Marshfield, Wisconsin. Our strategy to grow the industrial products and services business is proceeding. We gained several new clients, initiated several product tests with other potential new clients, laid the groundwork to expand our sales channels and introduced 2 new products for testing during the second quarter.

As we mentioned last quarter, we started plant trials at our facilities to produce products other than base ceramic proppant. Those mineral processing plant trials have proved successful and have led to increased revenue generation in the second quarter of 2017. We continue to develop additional opportunities within the industrial, agricultural and oil and gas industries to return our idle assets back to work. AssetGuard, our environmental business, improved on the back of increased oil and gas industry activity.

In addition, we started to capitalize on efforts to generate revenue from industrial opportunities during the second quarter. We continue to rightsize our fixed costs to better align with activity levels. During the second quarter of 2017, we made strategic decisions to reduce our distribution footprint through facility closures and subleasing of facilities, yet remain flexible enough to serve our client base. We are also finding additional opportunities to sublease idled railcars and generate revenue from railcars dedicated to the frac sand business.

Subsequent to quarter end, we met remaining post-closing conditions under our $65 million credit facility and received the remaining $12.3 million. On a pro forma basis, our cash balance at quarter end, including this $12.3 million, stands at $62.9 million.

In addition, subsequent to quarter end, we signed a share purchase agreement to sell our Russian proppant business for $22 million, and subject to local regulatory approval, expect the closing of this transaction to occur in the third quarter of 2017. This additional liquidity, coupled with our expectation for reduced cash burn in the second half of 2017, keeps our balance sheet strong.

Now turning to the quarter’s financial results. The revenues for the second quarter increased 111% compared to the same period in 2016. This increase is primarily attributable to increase in technology product sales, frac sand sales and environmental product sales.

Operating loss for the second quarter was reduced to $23.7 million, primarily due to the increased sales combined with a reduction in certain fixed structural costs, and a decrease in slowing and idling expenses. On the outlook, we continue to execute on our strategy to drive both revenue growth and profitability improvement. The second quarter resulted in a 26% sequential revenue increase and strong sequential incremental operating margins.

We anticipate technology products, industrial ceramic products and mineral processing opportunities to lead our revenue growth and return to profitability, and now believe our revenue growth in 2017 will be at least a 60% increase over 2016. Although the commodity price environment remains tenuous in the oil and gas industry, we are optimistic about our oilfield business for the second half. Technology product sales are tracking as expected and existing orders for the second half are strong compared to the first half. KRYPTOSPHERE HD continues to see success in deep wells, specifically the Lower Tertiary Gulf of Mexico, where all super majors have now selected the product for use. Currently, there are several wells slated for completion with KRYPTOSPHERE HD in the second half. Additional technologies, such as SCALEGUARD, continue to grow as well.

We expect the base ceramic business to see higher volumes in the second half as compared to the first half. We are focused on improving the pricing. We have had modest price increases in base ceramic over the last couple of quarters, and we expect this trend to continue as the industry should move from an inventory liquidation mode, into a mode of increased pricing to produce profit on manufactured proppant. We believe the negative returns throughout the base ceramic industry should lead to increased industry pricing moving forward, given the basic logic that companies want to provide a positive economic return on business.

The frac sand business has grown substantially this year and is part of delivering a complete suite of product offerings to our oil and gas clients. Given the strong demand for frac sand, we ramped to full utilization at our Marshfield, Wisconsin sand plant during the second quarter. We anticipate similar levels of sand sales in the third quarter as compared to the second quarter. In addition to increased sand volumes, we are also benefiting from railcar revenue generated from the leased railcars we have dedicated to this business. This is having a very positive effect on reducing the cash burn associated with idle railcars.

We believe the work completed in the second quarter, to solidify our industrial product offering and increase our sales channels, will allow us to continue to grow industrial products and services in the second half. Our current product suite, including new products we are introducing to the industrial arena, should allow us to grow this business over the long term. We believe AssetGuard, our environmental business, will generally follow industry activity in the second half. Industrial product sales continue to be identified as we focus resources on growing this business. Given the sequential improvement in EBITDA in the second quarter of 2017, our expected revenue increases and benefits from fixed cost reductions, we believe our second half cash burn and EBITDA should improve. We are focused on returning CARBO to profitability, and believe our strategy to reduce reliance on any single business line will make us a stronger company. Before I turn it over for questions, I want to talk a little bit more about our industrial business. Overall, we’re very excited and committed to grow our industrial business. We expect the growth to be of a material nature as the quarters progress and one of the unique profitable benefits of these businesses is that they can grow without having to spend any significant CapEx. They may not need any CapEx.

It leverages our existing assets, technology and people. I’ll talk a little bit about the 3 components. On industrial ceramics, we saw year-on-year revenue growth in industrial ceramics product sales, we gained several new clients in the first half and expect the same in the second half, and we introduced 2 new products to the portfolio. In AssetGuard, we added sales resources to the business in Q1 and started to see sales in Q2.

We expect the sales growth to accelerate as we define what markets we want to address. Currently, we’re focused on selling our top-selling oilfield-developed products, TANKGUARD and GROUNDGUARD, to nonoilfield companies. This provides leverage as it utilizes existing equipment. Finally, mineral processing. We saw progress in a couple of fronts in the development of our mineral processing business. As a reminder, we are aggressively engaging in efforts to put our plant assets back to work, producing products other than base ceramic proppant. In the second quarter, we had 2 successful product production tests which should positively impact the second half revenue, and could lead to a longer term business relationship with the clients. A third product is currently under production test for another company. In addition, we are also in production testing for a product for an oilfield application. With that, I will turn it over to questions.

Question-and-Answer Session

Operator

We will now begin the question and answer session [Operator Instructions] The first question will come from Blake Hutchinson of Howard Weil. Please go ahead

Blake Hutchinson

Good morning. Realizing it may be difficult to extract a hard number here, I was looking for kind of some more color on your last comment there, Gary, around industrial becoming more material as the quarters progress and how you go about in terms of the evolution of defining what should material and what is the material hurdle to us or to you? Is it simply, are you measuring it in sequential improvement?

Or is it something where at the end of the year, we can – you have targets for percentage of perhaps overall volumes on the ceramic side? Or however – whatever you’re thinking internally about the progress of that business would be really helpful.

Gary Kolstad

Yes. What we’re looking at is the percent of the total company’s business. And we’ve kind of internally laid out a 3-year plan for our growth expectations. And I think we’re well on the path to that. It doesn’t necessarily have to relate to ceramic production, remember. So we have industrial ceramics, of course, which we really like the path that’s on and the margins of that business. The mineral processing will be incredibly important for us and we really like what’s happening there. We’ve set a team in place that does nothing but that every day.

And everybody, including myself, is in conversations with clients about that. That will be something that will impact us, I believe, a lot in the future. So it’s – we don’t want to tell you yet what percentages of our total company revenue we expect it to be, but we do expect it to be material. We’re not talking hundreds of thousands of dollars here, we’re talking millions of dollars. I think it’s a little bit too early to lay out a game plan. And then obviously for competitive reasons, we’re not going to tell everybody what we’re doing, but we do have very high expectations for the growth.

Blake Hutchinson

And you mentioned little or no CapEx as you go through kind of these trials and early runs. I mean, assume that OpEx costs are fairly minimal as well in terms of restart. And maybe, in fact, you’re actually covering some of your idling costs.

Gary Kolstad

Well, you just hit the nail on the head there. It’s not only the idling costs – well, I guess, if you include natural gas in on the idling costs, that covers it all. But yes, absolutely, it helps us in so many ways.

Blake Hutchinson

And then, I guess, continuing on the cost side. As we think about making – continuing to make strides going forward, I mean, should we center in on the idle railcar coverage as the main – a major bucket or the major bucket to look at? Or would having higher base ceramic runs in the second half help you there? I mean, what should we be thinking about as the levers that continue to help you to close the cash burn gap?

Gary Kolstad

Well, I’m going to just say a little bit there and turn to Ernesto. We will always keep pushing to have base ceramic sales, right? And we always expect to produce products that are better than the industry and be a leader in that. But we expect more impact, quite honestly, from the fixed costs. We did a real good job in Q2 on that, and we have some plans for Q3 on that. And maybe I’ll let Ernesto quantify that a little bit in Q2

Ernesto Bautista

Yes, so Blake, obviously, we focused on reducing fixed cost for quite some time now. But as an example goes, in second quarter alone, as it relates to distribution, we were able to reduce cost on a combined basis. Gary mentioned earlier some subleasing of facilities, reducing our footprint in certain distribution areas geographically and then in subleasing railcars. The aggregate savings was about $1 million quarter- on-quarter or maybe $4 million annualized. That’s going to continue. That effort or initiative will continue as we look out, sort of rationalizing geography and then also looking at subleasing additional railcars.

I think for us, though, as we look at the various levers, distribution is one of several areas that we’re focused on. But I think it’s a little bit challenging just to focus on any one item simply because there’s a lot of different things going on in one time, including product mix from a top line standpoint, geographical mix from a top line standpoint. So instead, really would direct folks to really focus on EBITDA. And if you think about the sequential EBITDA gain that we had quarter-on-quarter, we’re confident that based on what we’re doing, based from a cost-reduction standpoint and also on what we’re seeing from a revenue expectation for the second half, that we should be able to see incremental EBITDA of 40% for the second half when compared to the first half.

Blake Hutchinson

Actually that’s very helpful.

Operator

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

Stephen Gengaro

Before I ask my question, just to clarify that, Ernesto, you said 40% incremental EBITDA margins in the back half of the year?

Ernesto Bautista

That’s right, comparing first half to second.

Stephen Gengaro

Okay great, thank you. As we think about the balance sheet and the cash needs/kind of cash burn as you look at the second half of the year, I know you noted lower. Can you give us a sense for how to think about that? Maybe quantify it a bit. And then how does that look as we get out to 2018?

Ernesto Bautista

Yes, I’ll tell you, Stephen, I think it’s – unfortunately, it’s going to be – it’s going to vary a little bit based on our working capital needs, right? So with the focus on sort of the positive trajectory on EBITDA, with what we’re seeing from a demand standpoint across all the businesses, it’s – there’s going to be some working capital draw. As we look at it in aggregate, first half to second half, we do believe that the burn is going to get better and likely substantially better.

But we’re also making strategic decisions in order to address the sort of favorable market conditions that we’re seeing in certain areas. I think as we look out, our focus remains to be in a position where 2018, for the full year, is a positive EBITDA for CARBO.

Stephen Gengaro

That actually answers my next question. I was going to ask you when you would expect to turn EBITDA positive based on what you see in the market now and kind of what you see on the industrial side, but it sounds like some time in 2018.

Ernesto Bautista

That’s right. And I think for – as we see things right now based on what we’re seeing in the market and the variety of projects that we have in the pipeline, we’re pretty confident about a full year’s positive EBITDA for 2018.

Stephen Gengaro

And then just one final question. As we think about the manufacturing process for products that are not directed towards the energy industry on the industrial side, is there – what’s the – I’m sorry, I think I had asked this, but do you have to isolate a facility for that or can you go – is there sort of a switchability between the oil and gas product and the industrial product? Or you have to dedicate a facility kind of longer term to that product?

Gary Kolstad

Well, for the industrial ceramics, we don’t really have to do anything because that’s – we’ve been in that business for a while, so it’s the same assets. On the other ones there, because we have multiple lines at our plants, you can isolate and just produce. So it’s just a matter of getting through the test, finding out what needs to be done. And it’s not really – we’re pretty good at executing on this, and I think that’s shown up so far, especially in the second quarter. I think the guys did a really good job of adapting to that. And so it’s not too difficult for us.

Operator

[Operator Instructions] The next question comes from John Watson of Simmons & Company. Please go ahead.

John Watson

Good morning guys. Gary, this morning, I saw that there’s an operator in Appalachia that’s suspending its Utica test program, where I think they might have been using ceramic. Has the suspension of that program been incorporated in your guidance?

Gary Kolstad

Yes. I would – we don’t really want to comment too much on individual clients, but I would probably just characterize. It depends on the assets they have, the rocks they have, the drilling they’ve done. Because if you say one operator is doing that, we may see or 1 or 2 or 3 others that are going the other way. So yes, we are aware of that and – but we certainly have thought that about going forth in the second half. It’s really dependent upon the assets that they own.

John Watson

Right. Okay. Great. And then on the sand side, can you help me understand the reasoning behind volumes remaining flat quarter-over-quarter in Q3 despite Marshfield now running at full utilization. And might volume start to move higher in Q4?

Gary Kolstad

Well, we kind of augment Marshfield with some third party marketing and distribution. I’d probably characterize Q3 as a conservative number and leave it at that.

John Watson

Okay. Fair enough. And then following up on Blake’s question, is there a way to quantify where the slowing and idling costs might go in the second half now that some of those facilities are producing industrial products?

Ernesto Bautista

Yes, John, I would say, for the time being, it’s probably appropriate to leave them sort of at the run rate that we’ve seen. I think while we’re going to continue to see improvements, say, in mineral process or even in industrial product, I think we won’t see a substantial change in those numbers until probably sometime 2018.

John Watson

Okay. And then one last one for me. On KRYPTOSPHERE HD, am I right in thinking that there was one well in Q2 and another release says several, but how should we think about maybe the number of wells in Q3 or Q4. Does the run rate go over one per quarter? Or is that the right way to think about the back half of the year?

Gary Kolstad

Yes. I think we had put in the press release, we said several wells in the second half, I believe. So that second half will be larger than the first half for sure. And that’s when we said we have existing orders that gives us a lot of confidence. I might add too just on your initial question there that we also are looking at asset values and everything like that. So as you go into 2018, that could be affected a little bit there if we adjust asset valuations.

Operator

The next question comes from Bill Dezellem from Tieton Capital Management. Please go ahead.

Bill Dezellem

I’m actually going to follow up on a prior question relative to the KRYPTOSPHERE HD wells and just give you an opportunity to call out that number. How many wells are currently planned for the second half?

Gary Kolstad

Yes. We don’t give individual ones. And one of the reasons we don’t is that we’ve seen cases on these really, really deep, complex wells where they may move anything from 1 month to 1 year. And I know that seems surprising to people, but that actually has happened. There will be – several is a good number to use. That obviously means more than 2, and we’d probably leave it at that because we do know it’s going to be better in the second half. We know that something could spill over into 2018. So we just – we kind of leave it that broad.

Bill Dezellem

And Gary, taking that a step further, do you have operators that are already discussing KRYPTOSPHERE HD wells in 2018? Or do the discussions seem to be more focused on the second half right now?

Gary Kolstad

Well, each and every operator has different drilling programs, of course. And so you’re going to see some that will continue on into 2018. Some have said, we’re going to pause here for a little bit. So it’s very individual, and we really try and stay away from commenting on knowledge they may have told us because they’re all, for the most part, it’s super majors. So they don’t – it isn’t really something that they express publicly.

And I think one of the other good things too is that the marketing and sales team have done a good job to where we now have other operators using KRYPTOSPHERE LD in the Gulf, too. So we really like the acceptance. And so much of it is just the, of course, the superconductivity of both of them, but then also the smoothness of that product and the fact that it doesn’t wear out the downhole tools or jewelry and the pumping equipment of service companies really takes a lot of risk out of the business for them as well as reduces rig rates and all that.

Bill Dezellem

And have you find the – found the pressure pumping companies are trying to encourage their customers to use the KRYPTOSPHERE line because of that lower wear and tear?

Gary Kolstad

Yes. Yes, we have. On offshore, offshore.

Bill Dezellem

Great. And then circling back to the comments, Ernesto, that you made relative to positive EBITDA in full year 2018. Does that lead to net income, late in 2018?

Ernesto Bautista

Yes, I don’t know that I would comment specific to quarters or halves at this point. I think we’re looking at it at a little bit higher level overall. As things sort of come together over the next couple of quarters, I think we might be able to give better visibility on how that might shape up. But as I said, with confidence today, we go – as we look out, we feel that 2018 for the full year will be positive.

Bill Dezellem

And then I have 2 additional questions. One, with the recent bumpiness of oil prices, has that altered discussions at all with your customers relative to their use of technology and ceramics? And then secondarily, would you talk a little bit more detail just on an inventory update of what you’re seeing out there.

Gary Kolstad

I’ll take that first part. Some of the technologies that doesn’t have a lot of impact, if we’re talking about deep wells in the Gulf of Mexico, commodity price, and this is very long-term planning that they do, right? So that probably wouldn’t be affected. Conversely, you could probably go onshore where, let’s say, SCALEGUARD is being used by a small, private independent that may drop the 1 or 2 rigs. I think everybody’s kind of seen that, and I think there’s been some comments by people about – that small independents that have to live within cash flow or doing something. So it’s a little bit of a mixed bag. The big macro high dollar technology will not be impacted as much, but we might see some other things on the lower end of onshore type of business. Ernesto, you want to answer the question?

Ernesto Bautista

Bill, can you clarify the second part of your question inventory?

Bill Dezellem

Sure. Just the industry level of inventories. You have often commented in the past where you saw them, where we’re at in that drawdown process.

Gary Kolstad

Okay. Sorry. Yes, on base ceramics, yes, it continues to go down. We don’t see it being imported. The low-quality Chinese expletive isn’t still coming in. And I think we kind of know the balance point of what the pricing would be for it to come in. And so it’s all being reduced. Globally, the utilization is so low globally for base ceramic production that you would hope people would start to focus on the pricing side of it to try and get these businesses profitable versus market share. I think the dumping of inventory by the Chinese in this past 18 months has or maybe 2 years would impact us all, but we see that slowing.

Bill Dezellem

Do you believe it’s at the end or is there still a little bit left?

Gary Kolstad

Well, we know there’s a little bit left, but I don’t think it impacts us today because where we’re working, the clients actually need some quality and it’s real high pressure work. So I think there’s – you’re probably going to stay away from the low-quality Chinese.

Unidentified Analyst

Thank you boss.

Unidentified Company Representative

Thank you.

Operator

The next question comes from Harold Weber of Aegis Capital. Please go ahead.

Harold Weber

My question is with regard to the new products that you’re developing. What’s the market size potential on those products?

Gary Kolstad

Are you talking about the industrial products? I’m not sure.

Harold Weber

Yes. Yes. Yes. Industrial products. Yes. Yes.

Gary Kolstad

Okay. The only thing we did do is when we had our last quarter call, we identified at that time that the addressable market for us was around $300 million. And that was with kind of the portfolio we had at that time. I think it’s a little bit early for us to describe what we see as the next step in that because we have products we’re developing still that we’ll have to have market penetration. But just from a macro viewpoint, that’s kind of the size of the market that we would address.

Harold Weber

That includes all 3 of those products you were referring to?

Gary Kolstad

Perhaps

Harold Weber

Okay. And with regard to some of the other stuff that’s being developed, when might that come out?

Gary Kolstad

Well, it will come out as the year rolls on. Probably within a year, I think we will have gotten most of the plans that we have in process right now. And I hate to give too much information on that because it doesn’t do us any good from a competitive standpoint.

Harold Weber

Okay.

Gary Kolstad

Okay thanks.

Operator

At this time, I will turn the call over to Mr. Kolstad for closing remarks.

Gary Kolstad

Well, thanks, everybody, for joining us this morning. I want to summarize a few key points for you. We expect a better half in 2017 – the second half of 2017 than the first half. We expect a revenue increase of at least 60% this year compared to last year. We continue to work on areas within our control and expect further cost reductions. And our expectation for revenue increases to show margin improvement in the quarters ahead. We’re very pleased with the transformation strategy that we are executing on. This year, we will grow our overall revenue by greater than 60%. This growth is almost exclusively driven by businesses other than base ceramic and has contributed to our improved EBITDA are focused on returning CARBO to profitability, and believe our strategy to reduce reliance on any single business line will make us a stronger company. Thank you very much.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines. Have a great day.

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