CARBO Ceramics' CEO Presents at Capital One Securities 8th Annual Energy Conference (Transcript)

| About: CARBO Ceramics (CRR)

CARBO Ceramics Inc. (NYSE:CRR)

Capital One Securities 8th Annual Energy Conference

December 12, 2013, 11:20 AM ET

Executives

Gary Kolstad - President and Chief Executive Officer

Ernesto Bautista - Vice President and Chief Financial Officer

Analysts

Unidentified Analyst

Well, we'll get started. Next presentation, very fortunate to have CARBO Ceramics. CARBO Ceramics is the largest manufacturer of ceramic proppants, expanding their ceramic manufacturing capacity as we speak, and recently launched some of the high-strength product that they've ever produced, KRYPTOSPHERE. And I am always impressed with the names that Gary and his team come up with for their products.

Fortunate to have the Chief Executive Officer, Gary Kolstad, and as well have I believe with Gary is [ph] traveling is Ernesto Bautista, the Chief Financial Officer. And we'll spend about 20 minutes in here, and I think hopefully they'll be available for some questions in the breakout. And Gary, very pleased to have you.

Gary Kolstad

Thank you, [ph] Pierre. And thank you for all of you for showing up today to watch. There is forward-looking statement.

CARBO is a global oilfield services technology company and we supply products and services to design, build and optimize frac. Our business and technology strategy is to be the leader in improving production and recovery in frac through stimulated wells. We also have a growing environmental business called Falcon Technologies, which I'll cover later in the presentation.

So we have come a tremendously long way, so we used to be thought of as a ceramic proppant company, today we are a production enhancement company. And here is the portfolio of technologies that we have in that design build optimize process. We sell them under the three brand names listed there, and we'll either sell them as discreet offerings or multiple offerings, depending upon client need.

We've been adding a lot of intellectual property or IP, especially on the build side of the equation. And we're adding a lot of intellectual capital all around there. In another words, very talented, experienced people. And we are number one in the world on the design side and a clear number one on the build side.

So I'm going to talk about each one of those just a little bit. First of all, on design side, Fracpro is the industries most widely used hydraulic fracturing design software. Our clients are E&P operators, service companies and universities. Provides frac design economic optimization to reservoir performance and post-job analysis, and it's really the tool that ties all these things together. And it's incredibly successful business for us.

Moving over to the build side, which is branded under CARBO Ceramics, and I must spend more time on this, because of all the intellectual property we're developing there. So we have proppant deliver technology platforms here. As I mentioned before, we have up to this point been thought of as a ceramics proppant company and we're 34 years old and you can see some of the products we developed as time went on there, with the breakthrough product being KRYPTOSPHERE, which will change everything for us.

We also spend a lot of time with physics and chemistry over the last few years to develop the three platforms, and those platforms of technology will all be delivered via the proppant. So we are figuring out a better way to deliver chemicals detection, all these things, to the reservoir rather than pump it in the frac fluid or something like that.

And so we have production assurance, flow enhancement and production intelligence, and all of those will have multiple products released as the years unfold. And I'll talk about KRYPTOSPHERE, and I'll give an example of production assurance here in the coming slides, but they're all delivered via the proppant.

We also got in the resin coating business, originally a resin coating ceramics business, and then subsequently in the resin-coated sand business. And we like coating, because it will have something to play in the technology platforms. Ultimately, once again, we increased production in EURs and wells.

So KRYPTOSPHERE, and we just recently launched this, it's ultra-conductive, ultra-high strength proppant technology. It was a request me, to us, about four-and-a-half years ago by a super major, was the birth of this. They wanted us to develop a proppant that had twice the conductivity of the strongest proppant available, which is bauxite, have 20,000 psi closure. And this was to give them the ability to fracture the lower tertiary wells in the Gulf of Mexico.

So we spent four-and-a-half years on it and what we learned about it was just incredible. And so this slide, some of you have seen this and built this few years ago, just so the industry could start to understand that we don't just use water and sand to frac wells, right. There is three tiers of proppant in the industry.

Tier one is high-conductivity ceramic, tier two is medium-conductivity resin-coated sand and tier three is low-conductivity sand. So the higher the conductivity, the higher the production, EURs and rate of return. The science behind that is that sand is a naturally occurring product, irregular in size and shape and low strength.

Resin-coated sand, we call it medium-strength, but that's only because we resin-coated. It's not -- sand isn't any stronger, but what it does do is contain the fine, when the sands crush, also minimizes the point loading. Ceramics on the other hand are an engineered product, very high strength, very uniform in size and shape and thermally resistance. So that's the industry for the first 34 years.

And now we're adding another level, KRYPTOSPHERE. And it is phenomenal how good this is. And so when we look at the ceramics level right below KRYPTOSPHERE, that really poor Chinese stuffs down to bottom, the Russians are down there, Brazilians. Then you have our more long-term competitor Saint Gobain, they're kind of the middle.

And then we have to sole existing product portfolio, we have which is at the top of the ceramics, and now we have KRYPTOSPHERE. So over the years, as they go on, we'll obviously, everything we ever did, and we're the industry leader.

KRYPTOSPHERE has more strength, durability, uniformly, sphericity, smoothness, all these characteristics that you need. More space to flow. We often say, the only reason we fracture well is to the create space to flow. That's what it's about. Unfortunately, we can't convince our clients to buy nothing, so we have to sell them proppant. But it's all about the space to flow.

It's more uniform flow path to geometrical structure of these proppants. They're rounder, more mono-size they are, the greater the ability for oil and gas and water to flow through there and the smoothness too. And here is the graph, for this is what the super major is looking for. We got over a 100% increase conductivity at 20,000 psi closure with KRYPTOSPHERE versus bauxite.

Now, the second part of that, I told you, I was going to give an example of a production assurance platform, and what we're trying do there is use proppants to maintain the baseline production, because often times as wells produce, they precipitate things out, solids and stuff like that. It could be due to scale, asphalting, paraffin et cetera.

So we are going to start infusing those chemicals into the proppant to prevent that. And our first product out is SCALEGUARD. And we prevent scaling from building up during the life of the well, that can be in the frac, that can be in the wellbore, that can be in surface equipment.

This is a great, much better delivery system than pumping in the fracturing fluids, where by a lot of it flows back initially. We engineer this so that the product elutes overtime. So to protect the well and release the chemicals we put in there overtime. And it only takes about 5% of the total frac volume to be SCALEGUARD. So if we had a 1 million pound job, only 50,000 pounds that would be SCALEGUARD, and it's put throughout the job and pumped as normal.

All these things lead us to a lot of confidence in the continued growth of our base of business. This chart shows our capacity in the bars and then the sales in the red line. So I am very proud that I joined in 2006, we've taken the company from 750 million pounds to 1.75 billion pounds capacity today.

But I'm even more happy about what's going to happen in the future. We currently are adding 500 million pounds. We have Millen Line 1, which will be online in mid 2014; where Millen Line 2, which will be online in mid 2015, and we've also have the environmental permits for Millen 3 and 4. So we'll be having 500 million pounds as we go along here within the next by mid 2015.

Finally, on optimize the frac, the StrataGen, the consulting services, and this is an incredible valuable business for us. Because we have field consultants, office consultants and then there is high-end 100,000 foot view called DANA, in which we take all the parameters, put it into a neural analysis and come back and tell the clients what is impacting your production recovery the most.

The field consultants are a fantastic tool for us, because we're at the cold phase. We're sitting on wells, completing wells for clients. We get to see the problems. We get to see what works better, plug and play, multiple stage, which proppant. We also get to see what's going wrong in the industry and help our clients do the right thing.

And fortunately, under our design build optimized process, we have the tools and products to make wells produce better. So we want to grow this business into where it's probably the leading consulting business in the U.S. We're also in Russia right now, but the U.S. is the main focus on building it.

In industry trend, I think the stakeholders, the E&P operators, the service companies, the royalty owners and the state agencies are becoming more aware of the losses to well production recovery that happens when you use this crappy, low conductivity Chinese proppant.

The question we ask, because if you're spending $4 million to $12 million on a well, how much are you sacrificing of production in EURs if you use this low quality stuff. And so we like to show inventory. So the top pictures there are pictures of the proppant grains, the bottom pictures are cross sections of proppant grains.

The proppant grains you can see are irregular in size and shape that means that they compact, when they're placed in a frac and reduces the space to flow. They are very rough surfaces, which of course creates resistance and friction in the frac, reducing flow. That internal structure is full of porosity, so it crushes easier, which then collapses frac, which reduces space to flow.

These are three samples of what's being pumped in North Dakota today from three different Chinese suppliers. They are all three Chinese intermediate density ceramics. How does that compare to CARBOLITE. And bottom picture there, the CARBOLITE actually is a cross section. So you can see the incredible difference between these.

Here is another three more examples of sample four, five and six. Three other suppliers, this is all from North Dakota too. So we all have a responsibility to drive to the industry for clients to know what they're putting in their wells. There is two samples of the Brazilian light weight and one sample of the Russian light weights. It looks like the Brazilian's actually may take the first prize for the worse proppant.

These three samples are coincidentally taken of North Dakota. People have to know this. You have to know what's going in there, right. Is it worth a penny a pound or two penny a pound savings, if you don't get the production recovery out of wells.

Now, let's take a look at how that's stacks up against KRYPTOSPHERE. So that's a cross section of KRYPTOSPHERE, no internal porosity. We better go back on that one and there is the Chinese intermediate, which one do you want to put in your well? Another industry trend is that, in these resource plays if you want to have economic success, there is really things you have to do.

One is make sure you have a lot of reservoir contact area because of low permeability of the rock. So you want to expose as much of the reservoir as you can to the frac. And secondly, you need a very highly conductive, highly durable frac that will last till life of the well. Because another thing we're trying to do a fracture right is to create a flow channel for oil and gas to get to the wellbore, space to flow.

Most of the fracs today are very complex. They're non-planar and they are absolutely conductivity-limited and you keep seeing this through well test, through infill drilling, where an operator lowers the spacing, and says, wow, I got virgin reservoir pressure. What we say is that if you effectively stimulated your wells, you might be able to lower your F&D costs by drilling less infill wells. And we have the technology to increase the recovery factor in those wells.

Here is an example of most common mistake made in the industry today, using sand where you shouldn't. So on the Y axis we have the conductivity. On the X axis we have the closure stress. Some ranges there, some three resource plays. White sand is the best sand. Brown sand gets really bad, and then the rest of it shouldn't be pumped in a well, but white sand itself starts to break at 6,000 psi and that it's basically completely gone at 10,000 psi.

And I've only reduced the book conductivities here by 60% due to non-Darcy flow, multi-phase flow and all the other things, gel damage. And in reality it can sometimes get reduced to 70%, 80%, 90%.

So let's just take a closer look at that, just you have the visual. So there is white sand at 6,000 psi. That's when it starts to break, and white sand is the best sand in the industry, northern white. At 12,000, it's mush. And because it collapsed as you have less frac width, and so you can just visually see it's going to be difficult to get the oil and gas out of there.

What happens when people do it right, then they used the right amount of conductivity in the industry. Here is just some example. And we did one comparison, the operator didn't want his name mentioned, but we did six wells with CARBOECONOPROP and four wells for Chinese intermediate density, compared the two, 24-stage wells, 3 million pounds per well. In this case, the 30-day cumulative oil is 20% higher using our ECONOPROP. The EUR estimate from the operators had to get an extra 120,000 barrels out of it.

Here is the one that really set the Bakken on fire. This was Brigham, which of course if bought by Statoil. And we wrote an SPE paper, and did a test with them. Seven wells with our lightweight ceramics, 12 with sand, and they saw 100% increase in production on this time period. 125,000 barrel increase in recovery, equated to $8.7 million at $70 dollar barrel oil. It also delays when the pumping units need to be installed. And they were absolute leader in the industry, right. They kept taking the stages farther in pumping more and more. So they really set the stage for the Bakken.

Here is SM Energy. It's an older paper, but broader base 23 ceramic, 91 sand, 40% higher IP that expands over time to 90% higher production rates as time goes on, that's because sand fails overtime. And at this time you can see, as a while back, because they sit at $40 barrel oil and a $150,000 additional investment. It took only 10 barrels a day to payout in one year. The reality is it pays out in less than a month.

Here is WPX Energy from the Bakken. The reason I'm talking about the Bakken is that the Bakken, the classic thing where the E&P companies now get it right and the Bakken continues to use more and more and more ceramics. It's getting established.

We still have a lot of work to do in Eagle Ford and Permian, but the Bakken has got a lot of good hit case histories. I love it when the clients talk about ceramics. In this case they talk about be in the production, later on the reservation up there. And show what their 180 days cums are, your EURs and who is using sand and what they are using.

Liberty Resources, their assets got bought by somebody recently, but they did a tremendous job, there is an slickwater, plug and perf in ceramics and you can see the 90 day bubble-plots there from Williams County to where they produced just a heck of a lot more than others.

One example from the Eagle Ford, Rosetta Resources, who is a leader in production in South Texas there, and what they saw is a 15 million, they admitted on Mcf equivalent, but 15 million increase per stage at 12 months. So that's $1.5 million revenue increase in a payout of eight to nine months.

Moving on to Falcon. At Falcon, we provide wellsite containment, tank lining, tank bases, water storage, wellsite liners and they are the industry technology leader as well. It's all based on proprietary polyurea technology. And the value to the E&P is that it lowers their LOE costs and also reduces their environment risk and their business risk in general.

So what we see happening is that E&P are moving away from high-risk wellsite containments like this where you have un-lined tanks that are corroding on the outside and inside. You have tank sitting on pea gravel, which corrodes the basis and then you have it sitting on un-lined dirt berm. I truly believe this is going to go way in our industry. It's hard to believe that the regulatory agencies will allow this to be in place in future years.

And a lot of them are moving to the Falcon containments and here is the picture one, I think this is from Colorado. We've done more than 6,000 of them and they've all had a 100% success. Lined tanks prevent corrosion, tank bases prevent corrosion and lined containment is impermeable. We've also recently been asked to do some water impoundments and we hope that that gets to be a growing business for us as well.

On the finance side, we've been pretty fortunate there. We kind of came out, the industry kind of went into a tough 18-month downturn. We kind of bottomed in Q2 of this year and then we had a pretty decent Q3, but it's nice. We've been able to basically triple the revenue since '05. We've tripled the cash from operations. We've invested a lot by increasing our capacity so much. We took it from, just looking at the ceramic side, 750 million to 1.75 billion, and did that all without incurring any debt.

So I think we've got a pretty good business model when we can build a company that fast and not incur any debt. And because we've been investing so much, of course, the cash from operations tensed out around the net income due to depreciation. Then it is on our per share basis, we fully expect 2014 to be better.

And so besides, what we do with the cash. Organic growth, next year it will be a big year for us because of the KRYPTOSPHERE invention, building 500 million pounds of capacity, all these things. The second thing we'd like to do is we believe in dividend. So we tripled the dividends since '05 as well.

And the third thing is we kind of like to get the share count constant, so we buyback the shares that we issue every year or have been anyway. In '09, you see a dropdown there, because the industry is once again coming to an end like it always does during cycles. So we bought back 7.5% of the shares at that time.

Industry factors. We will be impacted by the weather issues in Q4, just like everybody else. We had a lot of weather in Texas, rains in South Texas in October and November, slowed down some completion activity, of course West Texas, everybody is talking about freeze outs there.

And then we've had pretty decently cold weather in North Dakota, Montana and Canada this year, but that to me is not that surprising coming from there. Long-term, however, and that's why we keep building and growing and adding people. And more importantly, add technology.

The wells are under-stimulated in the U.S. and Canada for that matter. And so we see the drive for conductivity. The wells are getting deeper and more complex. And so we're very comfortable with the technology we're building. And we think the demand for our products will only grow overtime.

And in summary, we're going to continue to differentiate our company from everybody else through technology. We want our clients to gain knowledge, that we are the production leader and it's based upon improving production and recovery in fracture stimulated wells.

And we stress to each E&P, the investment benefits of looking at it from a design, build, optimized approach, where you balance EUR and AFE, trying to get the best return on to that. We'll grow Falcon Technologies through product development and geographical expansion. And finally most importantly, does continue to grow cash flow and build an enduring company.

And with that I thank you, will see you in the breakout.

Question-and-Answer Session

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