CARBO Ceramics Inc. (CRR) CEO Discusses Q2 2013 Results - Earnings Call Transcript

Jul.26.13 | About: CARBO Ceramics (CRR)

CARBO Ceramics Inc. (NYSE:CRR)

Q2 2013 Earnings Call

July 25, 2013 11:30 a.m. ET

Executives

Gary Kolstad – President and CEO

Ernesto Bautista – VP and CFO

Analysts

Brian Uhlmer – Global Hunter

Jeff Tillery – Tudor, Pickering, Holt & Co.

James West – Barclays Capital

Luke Lemoine – Capital One Southcoast

John Daniel – Simmons & Company

Trey Stolz – IBERIA Capital Partners

Brandon Dobell – William Blair & Company

Jon Hunter – Cowen and Company

Blake Hutchinson – Howard Weil

Stephen Gengaro – Sterne, Agee & Leach

Darren Gacicia – Guggenheim Securities

John Keller – Stephens

Michael Cerasoli – Goldman Sachs

Operator

Hello and welcome to today’s CARBO Ceramics Inc. Second Quarter 2013 Earnings Conference Call. At this time, all participants are in listen-only mode. After management’s remarks, we will conduct a question-and-answer session and instructions will follow at that time. Please be advised this call is being recorded today July 26, 2013 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 those projections. These statements reflect the company’s beliefs based on current conditions, but are subject to certain risks and uncertainties that are detailed in the company’s press release and public filings.

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 2013 earnings call. This morning we will provide you an overview of the second quarter results followed by an update on the outlook for the business and then we will open up the call for questions.

To start off, we are very pleased with the progress we made during the quarter in our production enhancement businesses which includes products and services branded under Fracpro, CARBO Ceramics and StrataGen. Our global ceramic proppant sales volumes were down 5% sequentially, largely a result of seasonality, including the Canadian spring breakup. However, we were very pleased that our ceramic proppant sales volumes grew 8% sequentially in the US. In the latter part of the quarter, demand for our ceramic proppant products increased and we exited the quarter on a positive trend with improving margins.

Ceramic proppant pricing was up 1% sequentially due to product mix. Few comments on the proppant market dynamics. Now the market conditions remain challenging during the second quarter of 2013. The E&P operators continue to focus on lowering completion costs at time sacrificing estimated ultimate recovery or EURs. Additionally there continues to be excess capacity of low quality Chinese ceramic proppant in the market. However we believe inventories of this low quality Chinese ceramic proppant appear to be shrinking. Based on that we analyzed it appears the inventory levels of proppant problem have been declining in 2012 and ’13 after building it excess inventory in 2011.

Through our aggressive technical marketing campaigns we continue to educate the industry on the negative aspects of lower quality Chinese ceramic proppant. Through imagery the campaign highlights the irregular size, traits, the rough surfaces and the internal defects of the pill. Long term conductivity data confirms the damaging effects these characteristics have on well production. We believe our technical marketing campaign has been well received by our clients. This excess supply of low quality Chinese ceramic proppant has pressured ceramic pricing for the last year and a half. Most of these producers cannot compete on quality or conductivity so they offer low prices. Most of the down movements in price for herbal during the second half of 2012, since then pricing has been fairly stable. There are several negative issues associated with Chinese ceramics which conversely offers support the Carbo’s value proposition over the long term.

More of our clients which include the E&P operators and service companies are becoming aware of the risk and drawbacks associated with using the low quality low conductivity Chinese ceramics. Our clients are also becoming more aware of the inventory cost of buying Chinese products, transferring across the world in bags and suffering inventory losses.

More of the service companies are becoming aware of the erosion damage the poorly shaped and rough surface Chinese pellets can cause their pressure treating iron and fluid ends on pumps. This is a very high cost. E&P operators can also see more erosion in their tubular and wellhead control equipment, the proof of this comes from erosion test. Our service companies and E&P operators are also becoming more aware of the service quality cost when bags of proppants are wafer frozen causing operational issues and jobs getting delayed or loss of products.

If you use CARBO ceramics as the post of this low quality Chinese ceramics you obviously will maximize production recovery, minimize stakeholders scrutiny or reputation damage, lower maintenance cost on pressure treating iron and pumps and wellhead control equipment will not have cash item proppant inventory and will not sacrifice service quality with onsite operational issues. We believe we will continue to see benefits our clients better understand the negative impacts of these Chinese ceramics.

Regarding individual products, our first product in our production assurance technology platform scale art was pumped in wells for a large operator in the Bakken. Scale Art is a ceramic proppant infused with scale inhibiting chemicals that place throughout the fracture as part of the standard fracturing process. It provides sufficient long term protection against steel formation in a single treatment while maintaining maximum fracture conductivity. We made a lot of process in bringing our new proppant technology initially aimed at ultra-deep wells closer to commercialization. I will comment more on this product in the outlook section.

Also it progresses in our sales of resin coated sand products as volumes increased compared to the first quarter of 2013. Margins in the RCS product line remain challenged as the market is over supplied and we have been operating the low plant utilization levels. We are focused on reducing cost and increasing the utilization in this product line.

With respect to distribution costs, we continue to work on driving our inefficiencies in the system. This includes reducing our costs through rationalizing our rail fleet, increasing proppant storage and reducing transportation cost. Regarding our other two production enhancement businesses, our Fracpro fractured design software continues to expand its client base globally while Strategem consulting remains focused on client expansion in the main US shale basins with South Texas and the Rockies leading the regional growth. Both of these businesses are key elements of our production enhancement strategy and offerings.

Our environmental prevention containment business, Falcon Technologies experienced revenue growth both year over year and sequentially primarily due to an increase in its client base and geographic market expansion. Our client truck continues to grow with Falcon due to remarkable 100% environmental success achieved in the thousands of well sites containment that is built.

Now for a brief overview of our financial performance in the second quarter. Revenues in the second quarter of 2013 decreased 13% compared to the second quarter of 2012. This decrease mainly attributed to two factors, first ceramic proppant sales volumes were lower as a result of lower drilling activity, second, CARBO experienced decrease in the average proppant selling price for all province. North America which we define as Canada and US proppant sales volumes increased 3% while international proppant sales volumes decreased 13% compared to same period last year.

Operating profit in the second quarter of 2013 decreased 49% compared to the second quarter of 2012. This decrease was primarily the result of decreased average selling price, higher ceramic proppant unit costs resulting from lower plant utilization and the change in the products mix resulting from volume gains as the company sand based products. In addition, spending to bring the new proppant technology to a commercial state continued which reduced second quarter earnings per share by approximately $0.08.

Net income for the second quarter decreased 49% compared to Q2 ’12. Carbo repurchased 45,000 shares of its common stock at an average price of $70 a share in the second quarter pursuant to the previously announced stock repurchase program. Since September 2008 1.95 million shares have been repurchased at an average price of $43.09. In addition to the share repurchase board of directors recently approved an 11% increase in the quarterly dividend. This marks the 13th consecutive year we have increased the dividend and is a testament to the board’s continued confidence in our long term cash flow outlook.

With that update on the second quarter, I would like to turn to our outlook for the business. While the first half of 2013 was difficult we believe the second half is potential to be better. Coming out of second quarter 2013 we witnessed improving trends in volumes and margins. Pricing pressures are still evident in today’s market though. If improving trends continue throughout the third quarter we expect to see increased ceramic volumes in the third quarter of 2013. Both these increased volumes and successful execution on cost reduction initiatives could lead to improved sequential margins.

Increased proppant sales volumes are the primary objective as we enter the second half of 2013. Field trials have been ongoing for several quarters to demonstrate the benefits of a high quality high conductivity ceramic proppant can have on production in the EUR and our clients wells. The production data we gather from these liquids rich shale field trials has been positive and indicates need for higher quality, higher conductivity proppants especially wells that experienced multi-phase non-darky flow (ph). These positive results appear to be lower ceramic proppant import levels should work in our favor. We are addressing the distribution costs head on with a number of ongoing initiatives, a critical initiative is rationalizing our rail fleet has reduced our reliance on the fleet as a form of storage. Other initiatives include reducing transportation costs. We anticipate completing majority of these initiatives in the second half of 2013 with resulting benefits seeing in 2014.

With regard to our RCS products unlikely we will see large near term price increases on these products given the low natural gas activity and the industry over supply. We are focused on improving margins through the efficient plant utilization and lowering the certain manufacturing costs. We remain excited about our new proppant technology and growing our production enhancement solutions business. The commercial launch of this new is scheduled for the annual society petroleum engineers meeting in September of this year.

This product represents a new class of proppant with greater conductivity that will increase the production and EURs in ultra-deep reservoir completions. Initial efforts will focus on the deep oils in the Gulf of Mexico where depths can reach greater than 30,000 feet. We are confident through our initial product test that this technology provides the solution that will enhance the production results that no other product can match today. Spending will continue in the third quarter to bring this proppant technology to a full commercial state.

The next opportunity for this technology would be a broader application to our existing proppant product lines. Construction on the first line at a mill in Georgia location is progressing with planned completion anticipated near the end of the second quarter of 2014. Upon completion our total annual ceramic manufacturing capacity will increase from 1.75 billion pounds to 2 billion pounds. Falcon technologies continues to leverage this engineer to product suite providing environmental solutions for clients in oil and gas industry. For 2013 we anticipate Falcon’s revenues to grow approximately 15% compared to 2012.

At CARBO, we integrate technologies and intellectual capital to design build and optimize the tracks. We believe our foundational focus on production enhancement technologies continues to build an enduring company. And with that we will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Brian Uhlmer of Global Hunter.

Brian Uhlmer – Global Hunter

Thanks for the expanded guidance. I really appreciate the extra commentary this quarter. I had a couple of quick questions for you. I was, number one, curious about call it, the $0.08, which I guess is a little bit over $2 million pretax that you're spending. What happens to that spend over time? How does it ramp down? And, does it entirely go away even if you have this new product, or is there still going to be some ongoing residual incremental costs?

Ernesto Bautista

That $0.08 we wouldn’t anticipate that that’s going to materially change as we look in the third quarter, obviously bringing the new product to a commercial state. We will continue to have an expense may comparable to that even into the fourth quarter as we are completing that process, we do anticipate that we will get into ’14 with that particular cost went down. However it’s not going to go to zero. As Gary mentioned in his commentary the next step in the process is to apply the technology to our broader platform, most of the learning curve is being addressed in this particular spend, we are experiencing today. So that number should be lower but it will at least carry forward at some level into 2014.

Brian Uhlmer – Global Hunter

Also, another quick easy one -- on the G&A, you had a nice, sequential drop. Is this a decent run rate for the back half of the year and into next year?

Ernesto Bautista

No, actually part of the drop maybe two major components associated with the drop would be – we slowed up discretionary spend as you would anticipate given the current situation, in addition, another component is lower accrual and incentives, as things may change and get better looking into the second half, that rate of incentive accrual will increase. So I would say looking out for the balance of the year, SG&A somewhere in the 9.5 to 10% of revenue range and maybe from an absolute dollar standpoint something approximating what the total spend was in 2012.

Brian Uhlmer – Global Hunter

And finally, on ceramic pricing, you stated you're up 1% due to mix. On a product-by-product-line basis, how did pricing look? Was it essentially flat or flat, down, or up?

Ernesto Bautista

Pretty flat than most of the products.

Brian Uhlmer – Global Hunter

Were any of them up?

Ernesto Bautista

We had minor movements in some, I think we cautioned in the past that a lot of our pricing depends on how we get up to the clients, so we can either ship direct to the clients DC, we can ship to large DC, they can pick it up. All three of those will have different pricing components. So there would be a little bit of movement around that but for the most part I would say we have a flat and in some cases slightly up.

Brian Uhlmer – Global Hunter

And then one final one before I'll turn it over to some other guys. You guys did not blame the Bakken weather, which I guess has become the cool thing to do this quarter. On a year-over-year basis, or just from your viewpoint, did that have a negative effect on you? And, how much capacity could you have shipped if not for the slowdown in pumping up there?

Gary Kolstad

I am going to make my comment in mid from 2011 when we shifted from gas to oil. I said we are absolutely going to have more cyclicality in the business moving forward and thereby needs the model towards that rate, because other than the third quarter it seems like there is going to be some in the other three quarters in the various parts of the US or Canada. Seasonality we still mentioned Canada but that’s just more a reminder but the weather patterns are going to get us North Dakota every year and Montana. So we don’t like to talk about that too much, I think I would look at it Brian from the standpoint of more how good could we have done and I think one of the reasons why we are implying at the second half or the third quarter it could be better is just that I think we will see more activity by some of our clients as they are capable of doing it and then we also had several clients wins as well. So the combination of that probably implies the third quarter will be better.

Operator

The next question comes from Jeff Tillery of Tudor, Pickering, Holt & Co.

Jeff Tillery – Tudor, Pickering, Holt & Co.

On margins with the decline this quarter -- obviously, there is a lot of moving parts. How much of the -- excluding the commercialization costs if I look at either EBITDA or operating margin decline, how much of that is from the significant increase quarter on quarter in the resin-coated sand volumes versus any erosion in the core ceramics business?

Ernesto Bautista

Jeff from a volume standpoint the decline in ceramic volume quarter on quarter is probably close to half as far as impact to margin whereas increase in our RCS makes up the other.

Jeff Tillery – Tudor, Pickering, Holt & Co.

As we think about realized price for you in the second half of the year, should we expect any tailwind from reduced customer field trials, as we get to the latter part of the year, or are you expecting relatively consistent impact from the field trials going forward?

Gary Kolstad

I think that will be relatively consistent to where – we are very pleased that we have a couple that we are executing on now which is a very positive thing, and I think you should model forward volume gains with minimalistic pricing gains and on the resin side of course, we will have some efficiency gains in some things like that but I would model volume gains.

Jeff Tillery – Tudor, Pickering, Holt & Co.

And then, for the third quarter, we do get some Canadian recovery -- the exit rate from the US would imply better -- should we think about, if that exit rate sustains high single-digit ceramic volume growth as being potential this quarter?

Ernesto Bautista

We would categorize the gains whether it’s margin or volume as being modest, so take that for what it is.

Gary Kolstad

The visibility as everybody tells you right, you get out there Q4 gets tougher, our visibility on Q3 is what’s giving us encouragement today, the latter part of Q2 and what we see in front of us in Q3 is what most of our comments are based upon about the second half looks better. Q4 I think everybody would say we all need more visibility, we need to get closer to it.

Operator

The next question comes from James West of Barclays Capital.

James West – Barclays Capital

Just want to dig in to follow up on that earlier margin question. I know you talked about modest improvements sequentially. It sounds like you have a good amount of confidence there. Is modest -- should we think about that as getting back to 1Q levels, or is that -- or, am I being too aggressive with that?

Ernesto Bautista

Might be a little too aggressive there James.

James West – Barclays Capital

So, somewhere in between now and the first quarter, realized margin is probably fair?

Ernesto Bautista

One, we will work on the volume side of things, that will help margin, but the gains are also going to be tied to cost, cost efficiencies, they don’t necessary jut flip, they happen over the course of time. So I wouldn’t jump too far ahead there.

James West – Barclays Capital

And then, unrelated question -- another question for me. The new proppant that you have coming out in September, I know it's originally targeted for deepwater Gulf of Mexico, but there's applicability on land in the US. How quickly can you convert your operations to be selling that proppant on land? And in fact, are you doing so, now, in field trials or with targeted customers?

Gary Kolstad

So it’s deep wells wherever they are out in the world, but we just focus on the Gulf of Mexico because they have such a huge amount of deep wells coming up. Secondarily it’s part of what Ernesto said about the cost or the R&D pilot plants, we are – engineering side for the other products and we are also simultaneously trying to establish capital costs for conversion of the plants. So it’s a little bit early days for us, we need to wait – we are very comfortable on the engineering side, we are not where we want to be yet on the CapEx determination side.

Operator

The next question comes from Luke Lemoine of Capital One Southcoast.

Luke Lemoine – Capital One Southcoast

Gary, I guess you're almost done with your 2 million share repurchase program, have a little bit left there. How are you and the Board thinking about that, and has your attitude towards debt changed any, as far as share repurchases?

Gary Kolstad

We haven’t discussed it yet but it’s little mid – like you said we see probably more today than in the past few years we see more opportunity looking forward for ceramic business than we ever have because of the technology platforms we are putting on it. So very similar to James question we need to know – just capacity right now but also we are developing several technology platforms that will execute on starting last quarter and moving forward for next couple years, and that will take certain amount of money, so that’s going to be priority one for us. The second one is our consistent – we have tripled the dividends and so things like that, and then whatever we do on share repurchases, we are fairly financially conservative. But we will see when we finish what we have left, we will talk to the board then, see what think but we are – I got to tell you we are more excited about what we know we are going to do and that’s going to have a priority.

Operator

The next question comes from John Daniel of Simmons & Company.

John Daniel – Simmons & Company

Gary, first question is -- late 2012, early '13, we had a herd of customers shifting away from ceramic, just for cost reasons, not necessarily because it was better. Are you seeing signs that they are coming back?

Gary Kolstad

One of the reasons why we are confident we recently had a larger client that experimented with sands in the Bakken and now switch back to ceramic. We have had a couple of others up there that have been trying to poor quality Chinese or imported proppants to – and then they have switched back, we got some field trials in Eagle Ford, other places where we are showing the benefits. So I think it’s getting better to kind answer your question there and I don’t know about others but we are certainly seeing some positive movements, but that’s a long journey for us. We will always spite this over the cycle, it doesn’t really bother us too much… and probably more importantly apply technology to what is the best ceramic proppant today.

John Daniel – Simmons & Company

Earlier this year, I believe you guys had expressed an expectation of potentially getting back in the second half of this year, selling volumes at the stated manufacturing capacity levels, even where you were exiting Q2, the run rate, if that were to hold, would we get back to those levels?

Gary Kolstad

We are very pleased with how we think Q3 looks and everything is possible.

Ernesto Bautista

I would say one of the other earlier comments Gary made is that obviously Q3 we feel relatively comfortable from a visibility standpoint, as we look into Q4, we have historically seen some slowdown. So from a volume standpoint there may still be some volatility there during the second half.

John Daniel – Simmons & Company

Let's throw out the whole Q4 idea for a second and focus on Q3. The Q2 run rate, does that seem reasonable for Q3? -- suggested earlier in the year, that's all, if there's a difference.

Ernesto Bautista

It is possible.

John Daniel – Simmons & Company

The last question for me, and I don't know -- I don't want to jeopardize the relationship with clients referenced in the press release, but you talk about some successes in the Bone Springs, and then also the Pearsall, and I'm curious, broadly speaking, what the typical ceramic volumes are per well you're seeing in those areas?

Ernesto Bautista

We would see one to two million bounce.

Operator

The next question comes from Trey Stolz of IBERIA Capital Partners.

Trey Stolz – IBERIA Capital Partners

I guess first thing I'd like to ask, or maybe clarify, the volumes and the redefinition of ceramic in the press release. If we look at 1Q, we saw 389 million pounds on the ceramic line, and that excluded outsourced ceramic and in 2Q, we see 378 million pounds, including the outsourced. So, if we're looking at apple to apples on CARBO-produced ceramic, how can we put that in perspective? Also, the other line changed, I guess, quite a bit, any clarification on that as well?

Gary Kolstad

The amount of third party manufacturer is got to be such a minimalistic amount that we decided to actually bring more clarity, it’s a suggestion of some people and just put everything under ceramic, we stopped purchasing that back in December 2011, so it’s miniscule amount and so when we talked about ceramic it’s all in, and so when I said earlier – we increased 8% sequentially from Q1 to Q2 you can logically think that is nearly all our own produced ceramic proppant.

Regarding the other line, that’s just sand when we make resin coated sand dependent upon what’s in demand whether it’s 40, 70, 20, 40, 30, 50 whatever, they are sand that we don’t use right and so we try and move that off, it’s not really a business we are focused on, it’s a business that we manage based upon the resin coated sand business. So that’s the other one that one can go up or down in a given quarter, I wouldn’t get too worried or concerned about that one, one way or the other.

Trey Stolz – IBERIA Capital Partners

On the inventories of the third-party ceramic, where do you stand with that? And, was it enough to influence average pricing at all, or effect margins?

Gary Kolstad

We have always said that the margins aren’t as good, but the amount we sell is pretty miniscule right, you are talking less than 5% right. So it’s very small and that’s why we made the decision to just put ceramic up there and so not much of an impact.

Ernesto Bautista

Trey, I think easy to say that it’s not the same impact that we have seen in 2012 because we were selling at a much higher rate, we made it a business decision to do that to monetize that inventory.

Trey Stolz – IBERIA Capital Partners

Looking at the Bakken and the weather there -- understand that might have delayed some completions. You talked about uptick or exit rate in the month of June or 2Q. Do you think or is it possible that the weather and the timing completions could be behind that, or is there a genuine surge? How would you define that?

Gary Kolstad

I think the industry will – you are just seeing the pattern that the industry takes and that’s that weather always happens and so there would always be a backlog, we should move into the summer months. We have road vans up there and everything like that, it’s a miniature of Canada in some respects, flooding whatever comes and goes, snow comes and goes but you are always going to have the road vans. So I think it’s just going to be a normal cycle and in the summer months you will see more activity when the industry get back to work full force.

It is a combination as I think I said at the outset what we see is both client gains for us as well as activity increases is why we have confidence in the Q3.

Operator

The next question comes from Brandon Dobell of William Blair & Company.

Brandon Dobell – William Blair & Company

Any sense -- or I guess for us of the magnitude of the ongoing field trials, in terms of volumes or what that -- maybe Q3 field trial volumes versus Q2 field trial volumes might look like?

Gary Kolstad

Yeah I would say pretty similar, the places we try this, high volume wells, so you are talking millions of pounds per well. So I don’t think you will see much difference between the previous quarter and once again we kind of give a general guidance, on modeling think of it as volume growth and don’t base – increase is based on pricing let’s say.

Brandon Dobell – William Blair & Company

I think you mentioned a little bit about -- rationalizing the rail and transportation logistics stuff -- what's the thought process behind deciding to either increase or decrease your in-basin presence? And is that in response to what customers are saying, or based on what you think is going to be the better way to get your products out there?

Gary Kolstad

We all understand that railways figured out how to bring up the price – so they can charge for everything under the roof very well, right. So when the US got into trouble from logistical standpoint, whether it’s south Texas or North Dakota, Montana whatever they just start charging for everything. And so what we are doing and I think we probably said up there some place that we are rationalizing our rail fleet and putting more storage out of the consumption and reducing the amount of rail cars and that’s a process. So we know fields and where they would be, and how many years and all those things. So we know the investments we want to make out of the consumption and so we are working through this and very proud of the team that’s done a really good job of identifying ways to get rid of costs and we started to execute on those. And so it will be a process and we will be in numerous spots with storage and you just can’t rely on the rail industry because of all the stuff that goes to switching everything like that. That combined with the fact that we have had drilling with multiple wells, huge volumes, we have weather swings, we have all these things that make it a tough situation for the industry that we are at to. So I am pleased with where we are going, pleased with the team and I am pretty sure we will get to where we want to be.

Brandon Dobell – William Blair & Company

And then, final one for me. The momentum you are currently seeing exiting Q2 into Q3 on the ceramics side -- is that coming from a particular weight or density – i.e., is the light end of the product suite showing more momentum than the heavy end? Or is there anything specific about the types of products that you're seeing more demand for?

Gary Kolstad

It’s absolutely the light ends, it’s what the US needs, it’s what the reservoirs needs and we get 20% more volume when you buy the light weights and intermediates and most of the poor quality Chinese is intermediate. So yeah the demand is absolutely on the lights.

Operator

The next question is from Jim Crandell of Cowen.

Jon Hunter – Cowen and Company

This is Jon Hunter filling in for Jim. For the first one, here, I know you mentioned some modest -- or the possibility for some modest margin improvement in the third quarter. Do you think that the second quarter marks an inflection point for margins? In other words, do you think is the bottom for margins?

Gary Kolstad

It will be the bottom for 2013.

Jon Hunter – Cowen and Company

Okay. For my second one, here, the change in mix you mentioned in the release seemed to have generated $6 million in incremental revenue and decreased gross profit by about $3 million sequentially -- do you see the change in mix continuing to generate decremental gross profit?

Gary Kolstad

I think we see an increase in ceramic proppant volumes, which tends to get rid a lot of those issues.

Operator

Next question comes from Blake Hutchinson of Howard Weil.

Blake Hutchinson – Howard Weil

I hate to dwell on something that's ultimately a small portion of the revenue stream, but just to help us understand as we've recompartmentalized the model here. When we talk about challenged margins during the ramp up of the RCS throughput here, are we talking something at the operating line that's near breakeven? And if so, from here, do you have to have some pretty significant benefits of higher utilization and some cost savings to even -- really put anything through the business, let alone, higher volumes.

Gary Kolstad

We are not going to talk about individual product profitability other than we will say the same thing we did about the third party ceramic, it’s got lower margins than our owned produced ceramic. But we are actually fairly pleased with what the team did as the planned, both plants Marcellus and new Iberia, they have done a great job on the manufacturing side and efficiency side and we actually – as the quarter rolled on, we saw very, very modest pricing improvement there. So we are happy with what’s the efforts have been and we think it will get better.

Blake Hutchinson – Howard Weil

So, with some of your exit-rate margin commentary specific to RCS as well, not just the ceramic product coming through at higher volumes?

Gary Kolstad

Yeah but it’s dominated by ceramics.

Blake Hutchinson – Howard Weil

And then, as we go through the rationalization process of the rail fleet, I guess, is there a timing specific to that? Are we talking about a significant magnitude of lower railcars, and so when we hit a duration of contracts where you can start getting out of leases, that's when we see the benefit, but for now we're carrying a bit of a dual cost structure?

Gary Kolstad

I am okay with that. We are probably – like the second inning of this. We started to reduce down the rail fleet, we are in the process which takes little while to build storage. We’ve had other opportunities in some places like the Bakken where as some of these things have leveled off as you well know it’s like the gold rush in sand, it’s over and things like that. You see these things level off, it always happens. So we are seeing better economic opportunities for ourselves, so we would be little bit patient there but yeah we are in second inning and pretty darn excited about how the game finishes given the plan we got out there.

Blake Hutchinson – Howard Weil

But in terms of the rationalization, it's more a game of inches. There's not one stepping-off period where you release the burden of a major number of leased railcars?

Ernesto Bautista

That’s right, Blake. It’s a benefit experienced over time, it will bleed into 2014 and as Gary mentioned we started the process, we have seen some reductions even now and we will continue to do that from a practical standpoint, these costs are going to be all over the country. So even though perhaps we have an opportunity in front of us, we have to organize that in order to make it happen. So unfortunately it isn’t just a flip or switch.

Blake Hutchinson – Howard Weil

I'm sorry if there was specific commentary made, but the year-over-year declines internationally, was that mainly specific to Mexico? And, where should we expect that to go from here?

Ernesto Bautista

There are – of course some of that, all others have talked about Latin America, Mexico, so we didn’t feel a need to do that. There are some there, there is a little bit in other countries, we kind of expect the couple of the countries that we are down a little dip, will come back in Q3. Russia seems to be getting a little more active. China is getting there but of course it’s very, very slow, and I think that’s probably the ones we would just shout out.

Blake Hutchinson – Howard Weil

But sequential comparison, then maybe a little bit better internationally as well?

Ernesto Bautista

I think sequentially it will be better.

Operator

The next question comes from Stephen Gengaro of Sterne, Agee.

Stephen Gengaro – Sterne, Agee & Leach

Just one real follow up, any updates on what's coming out of Brazil? I know you mentioned it last quarter as a bit of a headwind from a pricing perspective. It seems like that isn't as bad. Can you give us your thoughts there?

Gary Kolstad

What we probably should have done last quarter was just quantify or qualify the quantify, it’s still less than 5% of the business per se. So it’s not a big number, we probably just more commenting that some of the other fellows that have lowered their price too and so that’s not a big deal, some of these guys have to lower their price right up their quality. So I think they are just acting like some of the other importers and it’s not that big of a quantity issue for us.

Stephen Gengaro – Sterne, Agee & Leach

And then, the other quick question I had pertains to the new product development -- and I realize there's not a lot of details that you're willing to talk about yet. If you're talking about ultra-deep wells, on a relative basis to your overall market right now, is this fairly small at the beginning? How should we think about the overall potential impact in '14 and '15 just in general terms?

Gary Kolstad

Small volume, much higher revenue. Yes there is only a limited amount of these wells and once again we are focused on Gulf of Mexico but it can be any places in the world. But this product will be – because it costs more and because of the value it brings that there is nothing else that you should be completing these wells with, it will have a higher revenue of course. So we will – when we kind of introduce the product I think people will get probably little bit more familiar with that and everything. But we sure like the interest that these big E&P players and couple service companies have in the product, because once again there is many things like that, it’s basically two X, the strengthened conductivity of the best products that are out there today.

Stephen Gengaro – Sterne, Agee & Leach

And is it a product which will be manufactured in existing facilities?

Gary Kolstad

Yes.

Operator

Question comes from Darren Gacicia of Guggenheim.

Darren Gacicia – Guggenheim Securities

Few things, the first one is, you made a mention of lower imports of ceramic as a tailwind. Can you expand on that a little bit? Is that basically talking just the Brazil? Is it talking to what you've seen coming in from China? Can you expand on that a little bit?

Gary Kolstad

The majority of it comes from China, Brazil is much, much less and the Russians have kind of – very, very small too if not non-existent let’s say. And so when we look at it and the things we look at it export data, import data all those things and client communication. 2011 it went way over board and there was surplus of inventory moved in. As we went into 2012 that dropped down by about 35% as we moved into 2013, it’s running at a run rate less than 2012. So we try not to act like we know precisely what’s happened on the quarterly basis but we do take a look at it over the long term and the trends appear to be positive. And a lot of that’s due to our clients making the right decisions and putting the right things in their wells. It’s very expensive and I think we have done a good job of explaining just how bad the stuff is and the risk associated with that. But I think they are doing a better job of gaining knowledge on that. So that’s kind of where we sit, we don’t know what the future holds but we certainly know that historical history here.

Darren Gacicia – Guggenheim Securities

Switching gears a little bit, when you look at the new product you're about to introduce and thinking about it in terms of offshore wells versus onshore wells -- and just generally the adoption thought process from clients, is there like an approval, a testing phase you're going to have to go through? What is the process there? Where do you think you could be -- how do you think that goes along on a timeline, in terms of being an approved product for use? And then, how that should affect adoption?

Gary Kolstad

I am not going to give the dates on release or anything like that, (inaudible) up to the end of September there. But what I will say is in answer to your first question testing yes, and so the big players we are in communication with them, and yes they do require testing. And we have to remember that one of the biggest layers were the ones that actually asked us to develop it and we spent several years on this. So there is a certain amount of confidence out there already but we will go through a certain amount of testing and that’s taking place. So I think everything is rolling up real well to our product information release at the end of September.

Darren Gacicia – Guggenheim Securities

Yes, just to be a little more -- if I could, just to be a little more specific on that, is the testing period measured in months, is it in years? It seems like you've already started with a number of clients. Is that a delay to any material ramp in the economics here I guess is what I'm trying to drive at and understand.

Gary Kolstad

I mean these tests are standard industry tests other than the fact that nobody has ever found a product this good. So some tests have to be altered a little bit to try and measure the strengths and conductivity of this product. But at the end of the day it’s a material that industry is familiar with, there has been an absolute interesting thing that’s taken place too, this product is much, much less erosive. So the E&P operators that are developing and service companies that are designing jobs offshore they will now be able to put the correct amount of proppant into for emissions that is likely to, currently they are limited because certain proppant erodes tubulars and well heads and stuff like that. So that’s an exciting part too. Once again we are all about improving production and recovery and that’s what this product was designed for and it looks like we are there.

Darren Gacicia – Guggenheim Securities

If I could sneak one more small housekeeping one in -- when you look at other proppant volumes, can you give me a sense of what the mix was between RCS and sand?

Gary Kolstad

But other is strictly sand and it’s a little bit of a byproduct of whatever demand is for RCS of the several (inaudible) this right, 40:70, 20:40, 30:50, whatever is being in use because there is a natural mix that comes out of mines, we just move that and sell into sand. It’s not anything that should have much of any impact on CARBO at all.,

Operator

The next question comes from John Keller of Stephens.

John Keller – Stephens

Just one quick one, I guess, most everything has been answered. But just curious if you're seeing any of the domestic players show up in the marketplace? I know they have been speculatively adding capacity, I guess, as they move through the back half of this year and into early next year, potentially? And if so, what kind of pricing behavior has been?

Gary Kolstad

Not really yet, because one facility finished wells, it’s not producing and they have one – been completed yet. So not really too much of an impact, one of them started an earlier facility whatever 18 or 24 months ago or something like that, and – obviously with price lower just as for the reasons they all have to price lower but it hasn’t really impacted things yet and I think as you look long term let’s not forget, I think their focus will be just like ours and that’s to get rid of the really low conductivity Chinese out of the US. I would imagine that’s their strategy, it only makes sense.

Operator

The next question comes from Michael Cerasoli of Goldman Sachs.

Michael Cerasoli – Goldman Sachs

I'm trying to dig in a little more to the Q3 activity increase -- ex the pickup in Canada, is there an implied assumption of an increase in rig count? Or, would a pickup in rig count drive even more upside to your current outlook?

Gary Kolstad

Yeah I think we are probably thinking fairly flat on rigs, I mean you have seen the trick when you are up right, but I wouldn’t model anything to show which of an increase. Now ours is more or less pretty common throughout the industry, you are hearing more about pad drilling and the efficiency of rigs and things like that. But once again ours is a combination of some client gains as well as client activity gains. So no, we are not really modeling rig increases.

Michael Cerasoli – Goldman Sachs

And then just at a higher level, these client gains, can you affirm that it's mostly just education that's getting the operators to use more ceramic? Is there -- when you think about -- and then, secondarily, if you think about the potential for ceramics to start regaining market share back from sand, does it take something more direct like increase in natural gas prices or can it just be the education that gets you kind of the reverse that trend?

Gary Kolstad

No, gosh, it’s both of course, it’s not limited to natural gas, our drilling rigs picking up. We don’t ever say client’s names but we – give you an example without – we had a client – fairly large client of ours that finally took a look at these low quality products and had us tested, and so they found that it was even worse than what they thought it was. So you can’t underestimate people may be demanding quality for what they are paying for and so there will be a continuous education for ever for us but I think that one still has a lot of ground to gain.

Operator

That concludes our time for today. Mr. Kolstad, I will turn the call back to you for closing remarks.

Gary Kolstad

Thanks everyone for joining us again. A couple of summary points, we are very pleased with the progress in our product enhancement businesses and we continue to invest in developing technology that continues to improve well production and EURs. And we are really focused our businesses around the design, build and optimize the frac strategy. We are very focused on that. We have the highest quality and highest conductivity ceramic proppants in the world and we continue to develop technology platforms that we integrate into ceramics to drive future growth. So our story is not necessarily a manufacturing growth story, it’s manufacturing growth plus technology. These platforms will continue to expand our position as an production enhancement leader. We will continue to educate the industry on the damage that these poor quality Chinese proppants can do to a well production and EURs. And we need to communicate the risk that I outlined earlier today and the high cost operations of these things can cause. We are excited about our new technology developments and we will communicate a lot of that at the ASP meeting in September and while our Q4 visibility may be limited, we believe the second half of the year will see an improvement in the business compared to the first half.

With that, we thank you and we will see you next quarter.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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