CARBO Ceramics' (CRR) CEO Gary Kolstad on Q2 2014 Results - Earnings Call Transcript

Aug. 1.14 | About: CARBO Ceramics (CRR)

CARBO Ceramics, Inc. (NYSE:CRR)

Q2 2014 Earnings Call

July 31, 2014 11:30 am ET

Executives

Gary Kolstad - President & CEO

Ernesto Bautista - VP & CFO

Analysts

Jeff Tillery - Tudor, Pickering, Holt

John Daniel - Simmons

Blake Hutchinson - Howard Weil

Stephen Gengaro - Sterne Agee

Darren Gacicia - Guggenheim

Trey Stolz - IBERIA Capital Partners

Marc Bianchi - Cowen and Company

Brandon Dobell - William Blair & Company

Avinash Kant - D.A. Davidson & Co.

Luke Lemoine - Capital One Southcoast

Neil Gore - Private Investor

Operator

Hello and welcome to today's CARBO Ceramics Second Quarter 2014 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 31, 2014, 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 releases and public filings.

Your host for today's call is Mr. Gary Kolstad, President and Chief Executive Officer of CARBO Ceramics. Mr. Kolstad, please begin your call.

Gary Kolstad

Thank you and good morning, everybody and welcome to our second quarter of 2014 earnings call. This morning, I'll provide you with an overview of our second quarter results, followed by an update on the outlook for the business, and then we'll open it up for questions.

In the second quarter, the CARBO production enhancement business based upon our design build and optimized the frac technologies strengthened in the second quarter of 2014. We are very pleased to achieve 19% sequential revenue growth. We gained new clients and several oil and gas basins where operators utilize the integrated technologies of the design build and optimized the frac platform and achieved exceptional well production results.

STRATAGEN engineers using frac proto design and optimized fracs, coupled with our high quality, high conductivity ceramic proppant has led the higher production EUR and ROI for the operators. Our ceramic proppant volumes increased sequentially as fracturing activity rebounded from the first quarters harsh weather conditions and the rail related logistical challenges.

Ceramic proppant demand exceeded our second quarter capacity, which necessitated our dipping into finished goods inventory. We've also continued to see growth from clients that became more aware of the negative impact that low quality Chinese ceramic proppant can have on their well production.

Pricing for our ceramic proppant was relatively stable during the quarter. We're excited to announce that Millen Line 1 is now operational. Once you reach its stated capacity, our total annual ceramic capacity will be 2 billion pounds. Construction continues on Millen Line 1 and the retrofit of an existing plant to our new proppant technology KRYPTOSPHERE. We are continuing to build out our distribution network as we grow and should start seeing benefits in the second half of the year.

We believe these investments should help address the distribution challenges resulting from quarterly fluctuations in industry activity and the increased amount of proppant being used for well.

Developing production enhancement technologies and improved well production and EUR remains the core element of our company's strategy. The latest CARBO production assurance technology, SCALEGUARD was pumped during the quarter in a number of wells with very positive initial results.

SCALEGUARD is a ceramic proppant infused with scale inhibiting chemicals that is placed throughout the fracture as part of a standard fracturing process. As proppant delivered technology affords our client's long-term protection against scaling compared to alternative products available today, which provide a much shorter-term benefit.

In the quarter, the Board of Directors recently approved a 10% increase in our quarterly dividend, and this marks the 14th consecutive year of increases and reflects the board's continued confidence in the long-term prospects for CARBO and the commitment to increase the value to our shareholders that we execute on our long-term growth strategies.

With that, I'd like to turn some brief remarks on the financial performance of the company for the second quarter. The revenues in the second quarter of 2014 increased 15% compared to the second quarter of 2013. This increase is mainly attributable to an increase in proppant sales volumes as specified in the table in the press release. The operating profit for the second quarter increased 43% and this increase is primarily the result of higher ceramic sales volumes and a favorable ceramic product mix, net of higher SG&A expenses.

Net income for the second quarter increased 41% compared to the second quarter of 2013.

Now let's discuss our outlook for the near to intermediate term. The third quarter has recently been the most active quarter in the year for the industry in North America. We believe our ceramic proppant sales volume will approximate our quarterly productive capacity with the possibility of drawing down some finished goods inventories, which are at a lower level than last year.

We anticipate pricing for ceramic proppant to remain relatively stable during the third quarter of 2014. Millen Line 1 production is ramping up and we expect to be at full rate by the end of the third quarter of 2014.

Construction on Millen Line 2 and the retrofit of an existing plant to produce KRYPTOSPHERE LD are proceeding well, and both are expected to be completed by the end of the second quarter of 2015. The completion of Millen Line 2 will take our total annual ceramic capacity to 2.25 billion pounds, and in combination with Millen Line 1 recently completed will result in an increase to our ceramic proppant capacity of 29% in approximately one year. We continue to believe there is increasing demand for our high quality, high conductivity ceramic proppant, which provides us with confidence in bringing on additional ceramic proppant capacity.

Distribution of proppant to the well site remains an important part of the CARBO service offerings to our clients. A recent challenge the industry is facing is the tight supply of trucking services in certain areas to transport proppant to the well site. Given this industry issue, we may face increased transportation costs and delivery issues. We continue to build inventories of KRYPTOSPHERE HD, our new ultra conductive, high density ceramic prop for deep well applications.

Completion activity in our target market for KRYPTOSPHERE HD in the Gulf of Mexico continues to be delayed. While its timing is out of our control, we are optimistic that opportunities for lower tertiary completions will increase in 2015.

Going forward, we remain excited not only about advancements we are making in proppant technology with KRYPTOSPHERE, but also in the production enhancement technologies we are developing our three platforms: production assurance, flow enhancement, and fracture evaluation.

Using proppant as the delivery mechanism for these technologies is unique, as this is the only thing that stays in the reservoir for the life of the well. We see significant opportunities to leverage our proppant delivery technology to solve production related problems, maximize production, increased EURs, and provide valuable information about the reservoir.

And with that, we'll now turn it over to questions.

Question-and-Answer Session

Operator

Yes. Thank you. We will now begin the question-and answer session. (Operator Instructions).

And the first question comes from Jeff Tillery from Tudor, Pickering, Holt.

Jeff Tillery - Tudor, Pickering, Holt

Gary, I just want to make sure I'm using the right baseline in regards to one of your comments around selling volumes in the third quarter near capacity. Is that presuming kind of a full quarter of Millen line 1, so the 500 million pounds per quarter capacity?

Gary Kolstad

Well, we've said that we expect Millen; we've given you guidance that during the quarter, we'll probably go from 0% to 100% during the quarter. So may be the best thing to do is, use the Q2 numbers and use 50% type rate on Millen to try and look at the Q3 numbers.

Jeff Tillery - Tudor, Pickering, Holt

Okay. Perfect. Thank you. And then as you look at the transport and distribution cost kind of -- you have one going one direction, you've got enhanced distribution capability, but also cost going up on the trucking and rail side. How does that look like on a net basis as we go through the second half of the year? Are those a wash? Do you net benefit or net see some erosion?

Gary Kolstad

Well, let's comment on the second best site. Think overall, we're very pleased with what we've done on the distribution side. The team has done a great job of building a lot of storage and everything and just making our whole distribution system work more efficiently. And so that's -- we're starting to see some marginal benefits of that that's much more an H2 deal. But we are seeing some unique areas on the trucking side where there's a little bit of a shortage. It's not wide spread, but there are some areas and I don't know. Ernesto, do you want to?

Ernesto Bautista

Yes. So to your question, Jeff, I would say, it's -- we still believe that we'll see a net benefit which would translate to net benefit to margin as we look into the second half from all the efforts that the distribution teams put forth. So I think that addresses what, what you're looking for.

Jeff Tillery - Tudor, Pickering, Holt

It does. And the last question I had just around gross margin and looking at second quarter relative to first, very slight decline there. Was that a function of product mix or did some of the inflationary items hurt the margin release at least around the edges?

Ernesto Bautista

So, it was definitely more, a bit more of product mix than it was anything else. As Gary commented, we're starting to see a little bit of benefit from a distribution standpoint. The trucking or the trucking services matter, I think is something that happened that we started to see more towards the end of the quarter, we're monitoring closely as we enter the second half.

Gary Kolstad

Yes. I think, I'd add that we didn't see -- we didn't per se see a decline in our ceramic proppant margins.

Ernesto Bautista

Correct. More a function of --

Gary Kolstad

Yes.

Ernesto Bautista

Mix of proppant type.

Operator

Thank you. And the next question comes from John Daniel with Simmons.

John Daniel - Simmons

Hi, Gary, just two for me. Can you talk a little bit about pricing improvement opportunities, if any, within the resin and the sand businesses, your outlook for the next couple of quarters?

Gary Kolstad

Yes. I think the resin-coating business; resin-coating sand business is still very oversupplied. And so, we wouldn't expect to see much there. We've seen a -- for us, we've seen an improvement year-on-year of course but we wouldn't expect much out of that. Towards the end of the second quarter we saw lot of improvement in sand. And so, I think, we'll see the benefits of that in Q3. But how much more upward movement, I don't know. I think we and a lot of others believe there is plenty of sand out there. It's just the capability of distributing it to the well site when and where is needed is the bigger issue.

John Daniel - Simmons

Okay. The next one for me, you guys had a comment, Gary, in the release about, I would say, confidence in bringing on additional ceramic proppant capacity. Would that be a Toomsboro 5 or a Millen 3? And just the virtues of one versus the other and potential timing?

Gary Kolstad

We've already got things permanent at Millen. So if we had to make a decision today, it would be Millen. We are working on some things at Toomsboro, which may allow us to do something there later. But both about the same, we are probably just to address that, when it comes time to do that, we haven't asked for board approval yet. But as we kind of guided, we fully expect to keep on that in capacity.

John Daniel - Simmons

Okay. And the last one is just a clarification on Jeff's question about margins. Do you -- Ernesto, I though you mentioned that you would expect margins to be up. I wasn't sure if you were referring to sort of at the operating level or gross margin level? If you could just clarify thoughts on margin?

Ernesto Bautista

I said, I would say, it's anticipating an increase in both.

John Daniel - Simmons

In both, okay.

Ernesto Bautista

In both.

Operator

Thank you. And the next question comes from Blake Hutchinson with Howard Weil.

Blake Hutchinson - Howard Weil

Gary, can you help us understand, we're creeping up on a year here from the official kind of KRYPTOSPHERE introduction and re-branding with this integrated technology strategy, some language in the release about gaining customers on the integrated technology strategy. Can you give us a picture of over time what portion of your product base has been attached to these integrated technology and may be how that's changed over the last year or so?

Gary Kolstad

Yes. It's both a combination of people and products. And so we're going from years ago being a proppant company, today we talk about being a production enhancement company. And we have such an incremental exciting line-up of technology that we are developing that will be delivered via the proppant that it's one of just the things makes us feel so good about the company for the next decade. We have to have people out in the field both at the rig site, the office site, in town et cetera that can work that for the clients, explain it to the client so we keep adding to our STRATAGEN, the amount of engineers we have there.

FRACPRO is, obviously, an unbelievably important part of the entire flow of data and design and everything in the look at how to optimize wells taken production data. So internally it is getting very, very integrated and we will expand that more externally to the client. And a lot of this is just around all this great technology we're developing, and KRYPTOSPHERE will be off-the-charts good right, that's a function change in proppant performance, but all these other things will be there and what we will do is we’ll enhance the EURs and the way we look at it is we're trying to do the best frac on a well we possibly can and try and get the highest EUR of it and of course the short-term high production too.

So that's the way we look at things. We're developing things for the life of the well and we think we have an unending job to educate our clients on that which is, means nothing but opportunity.

Blake Hutchinson - Howard Weil

So I guess in terms of the portion of the business, I mean that's kind of a way of saying all of our volume has some sort of interaction from an engineering standpoint. But is there a portion of it that has gotten more intense? And just to help us understand the protection that the franchise has from a competitive standpoint?

Gary Kolstad

We will of course provide these product and services on a single basis, whether you want to buy FRACPRO or you want to have STRATAGEN or you want us buy a prop we'll do that. But some of things we're seeing and we're no longer going to provide what basin this takes place and because couple of quarters ago, we provided some of that information and the competitors try and run there. But we're seeing people that start off with field consulting and then those fellows that we have working out there are very talented. And so we're just trying to get them to recommend the best thing on the completion practice, which if we do the best thing for the well by default it will involve lot of these production enhancement technologies that we have. So we are at the first inning of this but this will just be part of our culture moving forward.

Blake Hutchinson - Howard Weil

And then just I want a quick clarification on the KRYPTOSPHERE HD commentary. I mean understanding it was designed with a lower tertiary in mind, I mean that the wells are very visible. I mean that's the first well that you're probably going to go into, so would you rule out having a well that's not a lower tertiary well be the first well, perhaps, to take proppant and, therefore, this is really going to be a 2015 occurrence?

Gary Kolstad

Oh no, we wouldn't rule that out, and in fact we have had some conversations with operators, the mile scenes and stuff like that in couple of places around the world. But yes, just our main target, initial target was that because that's what the super majors asked us to develop the product for, that's why it's our target market.

But no, we would put it in other places and we may. But I think 2015 shaping up to be pretty good. And, of course we're incredibly excited about KRYPTOSPHERE LD, because then we start moving into the mass market, and that product will outperform nearly everything out there.

Operator

Thank you. And the next question comes from Stephen Gengaro with Sterne Agee.

Stephen Gengaro - Sterne Agee

I guess two questions. One, more housekeeping but the SG&A in the quarter was up a bit, a little higher than we thought. How should we think about that going forward? Is that a function of a percentage of revenue or can you give is a little bit of guidance there?

Ernesto Bautista

Yes, sure. I think previously we had commented for the full year that we would anticipate something in the 10% to 10.5% of revenue range. I think we're still -- or we would stick with that particular range for the full year -- or in the second quarter, what you saw was an increased amount of equity compensation expense, mainly associated with or surrounding the Director elections that was a pretty hefty chunk of SG&A that happened in one quarter.

Stephen Gengaro - Sterne Agee

Okay. Thank you. That's good clarification. And as I think about the pricing dynamic and I think about your commentary over the last several quarters on your ceramics have been I think relatively flat, so is the difference as we sort of do the calculations simply fluctuations in the volumes of raw sand and RCS and how that sort of calculation works through? It's a little tough to triangulate. I just wanted to get your help on that front as far as the direction of ceramic pricing and has it been real stable kind of for four or five quarters, or how has it been evolving?

Gary Kolstad

Yes. The ceramic pricing has been very stable. I think I've said on a couple of quarters ago, we after the 2011 run up, we basically are -- our pricing decline took place in Q1 2012 and Q2 2012 and it's been fairly stable since then. And our gross margin has seen some modest improvement this year versus last year. You might expect Q2 2013 was the bottom of the cycle for us. So we're very pleased with the ceramic margins and they're very stable and will probably see somewhat of a modest uptick here in Q3.

Operator

Thank you. And the next question comes from Darren Gacicia from Guggenheim.

Darren Gacicia - Guggenheim

Hey. Good morning, guys. I wanted to ask, when you look at -- obviously I've listened to a couple sand calls and even Superior earlier today talking about the sand market being tight. Given the fact that activities ramping, and sand use is obviously ramping as well, are you able to, with respect to overall activity, is there anything happening from a technological or kind of best practices standpoint where may be people are starting to consider using ceramic kind of closer to the well bore where within a mix and a cocktail within a frac job? And is that's something, and if so, what's the market potential or kind of absorption that could happen if that sort of took a bigger hold?

Gary Kolstad

I think what you're talking about their oftentimes called tailing in with ceramics on each stage, that's been taken place for a lot of years, there is just more activity now. So I don't -- that's not that big of a thing for us. We just keep increasing the amount of ceramic that we sell out there to more customers. So I don't think it's been too much. There has been one late issue that I -- we disagree with, and that's the use of 100 mesh sand, because I think a lot of clients are unaware of the long-term effects of using 100 mesh. It has very little conductivity but we see more use of that versus 4070 sand or 2040 sand.

So we think that probably come back around, because from recent studies we've done, it looks like as the wells produced, and get in that one-year timeframe, you start to lose the production and therefore you'll start to lose your EURs. So we don't think that trend will stay in the industry, but the trend of tailing in with ceramic, yes, absolutely that started years ago and will continue on.

Darren Gacicia - Guggenheim

And is that something -- does it have -- is there an element to where the absorption of that practice is kind of capped out? Is that what you're sort of basically telling me, or is that something that could expand further?

Gary Kolstad

I think we probably, I can only people for CARBO now, because we're gaining clients and the volume keeps going up. You might imagine that we're probably participating in more of those wells that have tail end ceramics. So I guess that's a benefit for us. And then it's just the number of wells being done and the efficiency of drilling and completing. I think just brings up the volume.

Darren Gacicia - Guggenheim

And if I could ask one unrelated. Is there any consideration to expanding your presence in sand?

Gary Kolstad

We like to be in it that expands the amount of client contact we have, it gives us a foot in the door, so can sell up the technology that actually mix wells produce better. There's really two things that drive these low permeability wells and that's reservoir contact area and then the conductivity of the frac. And the multiple stages are being done, the increased amount of stages and everything and the increased amount of sands, what that's addressing is the contact area, it does not address the conductivity. So we will stay committed forever to conductivity, and that's the part we bring to it. We'll bring -- we -- our STRATAGEN folks and they're designing things, we stress both of those things, but we absolutely stress the conductivity side, which is what ceramics bring in all these other production enhancement technologies that we have.

So we like being in where we're at, that's not to say we can evaluate further expansion in sand, but our priority is investing in technology to improve well production and recovery. And that doesn't come from sand that's just the contact area. And our team at Marshfield did a great job, we challenged them to maximize the output of that asset and you can see from the figures, that's what they've done and they just did a marvelous job what that, and to be commended. We might as well work the asset well, we have it, and like we said, we really like the additional client touch points.

Operator

Thank you. And the next question comes from Trey Stolz with IBERIA Capital Partners.

Trey Stolz - IBERIA Capital Partners

Hey, guys. If we could just go back to the margins real quick, in particular the cost, I'm trying to break down the cost of sales line to the typical components. The Millen line startup, what kind of impact did that have on the quarter, and how could we interpret that going forward? Also we're bring in another line next year, just trying to judge that, if it's a basis point impact on margins, and trying to separate that from the distribution cost that you're seeing?

Gary Kolstad

The Millen Line didn't have any impact on Q2 other than the plant startup cost, we showed on there, which was I think that's about $800,000.

Ernesto Bautista

That's right.

Gary Kolstad

So, it had a negative connotation there. We didn't sell any product in Q2 out of Millen. As we roll into Q3, we've kind of said it's going from 0% to 100% in the quarter, obvious that means it's not working at its maximum capacity. So we'll have a little bit higher product cost there of the proppant that's produced there. But we'll start to see the benefit of that in Q3. Ernesto, any other comment?

Ernesto Bautista

No, I think that's right. So that initial amount of volume that comes through may be a little bit higher cost but relative to the overall may be expected volume as we look into Q3, it won't have a significant impact.

Trey Stolz - IBERIA Capital Partners

It was less than a 100 basis points?

Ernesto Bautista

I don't -- I don't know that, I comment on that granular level.

Trey Stolz - IBERIA Capital Partners

Okay. And then looking at pricing, I guess a couple guys have asked this a couple different ways. When I look at or try to back into a ceramic proppant price, average price taking out other revenues and using a very conservative number for the other revenues, I'm having a little trouble with the flat quarter-over-quarter pricing, as well, and just wondering if there isn't a sequential, even if it's very slight, very slight decline that I'm seeing here quarter-over-quarter. So if we look at certain grades of ceramic proppant this year now versus six quarters ago, two years ago, is there a very moderate decline?

Gary Kolstad

It depends on, Trey; it depends on how far back you're talking about. If you have an opportunity and we'll put out our 10-Q today actually, it may already be out where we are actually breaking out the pricing associated with each of those components and I think that will help address that question.

Trey Stolz - IBERIA Capital Partners

Okay. I'll take a look at that. And your inventories, where do they stand now? Are you mostly depleted there? Or you have several more quarters of being able to fill in like you have recently?

Gary Kolstad

Well, we certainly don't have the inventory we did as we entered Q3 last year, which remember we are coming out of down cycle for 18 months. So we headed into Q3 last year with basically $100 million extra beyond working inventory. And as we mentioned in the press release, we used part of that -- first of all, we did not have that much as we entered Q2 and we had to use some of it in Q2 because you saw what our volumes were and our productive capacity is not that high. So we certainly have well less than half of what we did a year ago as we head into Q3.

Trey Stolz - IBERIA Capital Partners

Yes, okay. That will do it for me. Thanks.

Gary Kolstad

I want to add a little bit to Ernesto's other point too. Once again the gross margin in ceramics is incredibly stable and I think you have to be careful about trying to figure out all the pricing because mix comes into play on that and what type of ceramic products we're selling? Is it international? Is it domestic? All those things. So when we say gross margins been stable, that's probably a better indicator for you.

Operator

Thank you. And the next question comes from Marc Bianchi with Cowen and Company.

Marc Bianchi - Cowen and Company

I'm just curious, a lot of the questions around margins, that's very topical, but I'm curious about the Bakken exposure you have, and it seems like activity there is very strong and that's perhaps some of the reason that you're feeling pretty good about third quarter volumes. Could you talk a little bit about market shares in the Bakken and may be some kind of proppant intensity, ceramic proppant intensity in the Bakken and how that's been changing and may be what you're seeing in terms of competition?

Gary Kolstad

Yes, I think some people get confused about that. I've seen articles where people think that's where most of the ceramic is in the U.S. and that's not the case with us anyway. So we have several other basins that are extremely big for us, and obviously we'll always have new one pop here and there. But the Bakken is very big for us. We don't deny that. We won't break out what percentage of it is, but we got a couple of other ones that are close to it. So we tend to look at across North America, and it is in, of course, the U.S. -- only the U.S. right. Canada is good for us, as well.

So I just I think people need to correct themselves little about it. The Bakken is absolutely, I mean, it's very established. So people obviously really know the benefits of ceramic. I think that's getting more established every day especially when some people moving more in the slick water and finer mesh ceramics, and stuff like that, and the guys -- the success that people like Liberty have had and everything. So that one is established, that one is very good for us, but other places are very good for us as well.

Marc Bianchi - Cowen and Company

And how are you seeing competition? You mentioned that you're continuing to make progress on educating customers and getting some customer acceptance from moving away from lower quality product, but could you just talk to that a little bit?

Gary Kolstad

I think that's always measured by the volume of proppant we sell. And if I tell you we have new and growing client base. I think that's all the further we want to go down and granularity on that. But now, we're very pleased with what marketing and sales team has done. And the other thing people need to realize is, we're developing new technology that makes wells produce better. And so, in order to get that technology you might imagine you need to buy our base ceramic proppant too. So all these things strategy towards an end of just making wells produce better and I think that's what separates us from everybody else to conductivity plus a technology and I think that will separate us as far as anybody can see in the future.

Marc Bianchi - Cowen and Company

Okay. And then just one more if I could. Do you have any visibility on fourth quarter, in terms of the seasonal downturn that we've usually seen? Is there any reason not to expect that again this year, or do you have any indications from customers?

Gary Kolstad

I think December, we have always said for as long as I've been here, December is always just, it's a two-week month and really is it all that just never changes. As far as activity in October and November, I don't know. Last year, we started getting some pretty powerful weather; it seems like there in November.

So I think we got to get a little bit closer to it before any of us can really comment on that. I would say from just completions needing to be done, I think it's very positive for the fourth quarter, but we probably got to get closer to it to figure out some of the other things.

Operator

Thank you. And the next question comes from Brandon Dobell with William Blair & Company.

Brandon Dobell - William Blair & Company

Thanks. May be take that the last question one step I guess in a different direction. How do you guys think about, I guess thought forward staging inventory, just in case you've got bad weather or recognizing that there's kind of ongoing logistical challenges. Should we expect you guys to keep building inventories if you can through the third quarter, just to be in front of the issues that's kind of caught the industry last year?

Gary Kolstad

Yes, I wish we could build inventory, but I don't think that's going to be the case, so.

Brandon Dobell - William Blair & Company

Got it.

Gary Kolstad

But no, and that's one of our strategies, right, over a very long-term look. We're going to have more storage out there, because this industry is getting more cyclical, not less, not just because of the cycles our industry always goes through every few years, but because of the weather, and the wells, and the well -- and the pad drilling, and the amount of problems. Yes, when we can full up the cookie jar, we're going to do it, but I don’t think we’re going to get a chance in Q3.

Brandon Dobell - William Blair & Company

Okay. And as you think about the roll out of KRYPTOSPHERE LD in particular, I know the price is probably going to be a little bit higher given the performance of the product. Any more visibility or better visibility into manufacturing costs for LD? Should we see those be similar on a per ton basis to what you have right now or is there something that's going to change the manufacturing cost profile?

Gary Kolstad

I think -- I think we characterize this longer-term, we expect it to be similar, initially when you start-up, you always have some initial costs that are higher, and we will work into that. And our Marketing and Sales Chief, Don Conkle, will figure out how to price it to make up for that and everything. And we're just unbelievably impatient on getting that done. But our manufacturing team is doing a good job of building, and we'll get there, but we're unbelievably excited about that.

Brandon Dobell - William Blair & Company

Okay. And then final question may be going back to the different basin discussion. Is there evidence or color you can give us about a customer starting with maybe just a tail-in and then moving to full -- a full well full of ceramic, or starting with a certain percentage of a drill program and base, and then over time moving to a much larger percentage of those wells using ceramic? I guess I'm just trying to get a feel for I call it same customer growth in a particular basin, as opposed to following up customer into multiple basins?

Gary Kolstad

I think it's -- we have seen that. The fellows that we really do well with, do the whole well with ceramic and they obviously get the best wells and that's the people that aren't necessarily worried about short-term. They think about the EURs in long-term.

So we've got a mixture of all clients in all basins and we respect them all. We're just trying to educate them on how they can make each well have higher EURs. So we like the way the trends are going.

Brandon Dobell - William Blair & Company

Okay. And then final one for me. On the 100 mesh question or comment, Gary. Any sense of how long it's going to take people, if indeed your comments about longer-term impact of 100 mesh play out? How long before you think people start to see the impact on the decline rates or production rates? Are we talking here in 2014, or is it going to be more of a 2016 kind of timeframe before that evidence starts to show up in scale?

Gary Kolstad

Well, I think you have to go of course when the well is drilled, but some of the initial basin study we did it kind of shows that one year you're really starting to see some stuff happen. In two years you really see it happen things like that. And once again, this is all about, number one, we crack open these well some are prolific, as all heck, right. Great pressure all that stuff, then you have the big flush production for X amount of time. So you get great production at the beginning and then as closer pressure increases as we drain the reservoir that's when conductivity matters. And so it's just very natural. It's just physics that's all it is. So we just need to do a better job ourselves of educating our wonderful clients on that.

Operator

Thank you. And the next question comes from Avinash Kant of D. A. Davidson & Co.

Avinash Kant - D.A. Davidson & Co.

A few clarifications. Just wanted to check, you had a component of inventory pull-in in your Q2 revenues. Should we assume the same level of inventory reduction in Q3 also in your revenues?

Gary Kolstad

I think I commented earlier, right; it was probably the first question. I think if you kind of modeled Q2 in which we pulled some inventory, the same for Q3, and just add in what we said would probably get produced out of Millen, meaning half the potential of Millen, that's probably the best way to try and model Q3.

Avinash Kant - D.A. Davidson & Co.

Okay. So that would imply that you intend to pull in the same amount in Q2 and Q3 from the inventory?

Gary Kolstad

We don't know that I'm just telling you how you should maybe model it.

Avinash Kant - D.A. Davidson & Co.

Okay. The second question is that could you clarify a little bit in terms of the overall transportation that you do of your proppants, what percentage is being run on railways and how much is going on the trucks?

Gary Kolstad

Well, it all goes on railways for the most part. You're 95% on railways to get to distribution centers. And then, either the client can pick it up in trucks or we will deliver to the well site so most of the mileage of course is rail.

Avinash Kant - D.A. Davidson & Co.

So you're fine on the rail side at this point though the truck seems to be more of an issue in Q3?

Gary Kolstad

We've been able to overcome the increases that the rail have put on the industry. Our team has really done a good job with that on the efficiency side overcoming those increases. And it's once again, it's not all across the North America, but there are pockets, where there is a little bit shortage of trucks and things like that so we're just seeing a little bit of that.

Avinash Kant - D.A. Davidson & Co.

But given the higher volumes you see in Q3, you still do not anticipate issues with the railway, at this point though?

Gary Kolstad

Well we have couple things going there. We have more storage built, so we can get it to DCs, get it unloaded. And then, so when the trucks need it, take it to the well site, but we don't see the railroad as messed up as it was in Q1 and the latter part of Q4, now that really, really was messy in Q1.

Avinash Kant - D.A. Davidson & Co.

Okay. And the final question on KRYPTOSHERE, of course we are waiting for traction on that one, but given the kind of wells this product could go into, the deepwater, have you done any work in terms of what's the opportunity, market opportunity for this product?

Gary Kolstad

We share data else we wouldn't have developed the product. And so we're not going to --

Avinash Kant - D.A. Davidson & Co.

But would you share that?

Gary Kolstad

We're not going to put that out in public at this point. And remember it was originally a request from a client, which is wonderful so that tells you the need was there. And it's just incredible conductivity, it's incredibly durable. It has some things that service companies and everybody loves so does LD, it’s very low erosivity. So all these pressure pumping companies, whether it's LD or HD will see less wear on their iron, it's going to save them a lot of money. The durability of cyclical loading is incredible and then just the conductivity so this is quite a breakthrough in proppant technology.

Operator

Thank you. And the next question comes from Luke Lemoine with Capital One Southcoast.

Luke Lemoine - Capital One Southcoast

Gary or for Ernesto, I think, only just a slight price decline in ceramics of 2% quarter-on-quarter. I think you're saying this is solely attributable to mix, as you had a 100% of lightweights because, I mean, gross margins like you said stayed pretty stable in Ceramics? So --

Gary Kolstad

Yes, probably stable.

Luke Lemoine - Capital One Southcoast

So shouldn't read into this the whole lot.

Gary Kolstad

No, you shouldn't read anything into it.

Operator

Thank you. And the next question comes from Neil Gore, a Private Investor.

Neil Gore - Private Investor

Hi, it's been a long time that you've been excited about KRYPTOSPHERE being across the entire product line. About how much in your testing lab has it increased the conductivity in the wells versus the existing proppant?

Gary Kolstad

What was the first part of that?

Ernesto Bautista

What was that first part of that, Neil?

Gary Kolstad

We're working on KRYPTOSPHERE for some time. What is the incremental benefit? Purchase incremental?

Neil Gore - Private Investor

You people have been quite excited about KRYPTOSPHERE since it was announced about a year-and-a-half ago and extending through the entire product line. And so obviously, you've done testing and determined how much it's increased the conductivity, we're seeing in the existing similar proppant that you would set-out there. Can you share that number with us?

Gary Kolstad

Yes. We haven't put up the LD numbers yet publicly, the HD numbers, we basically said that it's got more than twice the conductivity of our bauxite product, which is called HSP or skyrim barbas or single veins all those guys is in bauxite more than twice the conductivity at 20,000 PSI closure. So it's just -- it's just miraculous. And then once again, the cyclical stress the way it handles that the, less erosivity. So in those wells that in the amount of reserves in those wells, this is going to be a very large gain for the E&P.

Neil Gore - Private Investor

And at the same time I imagine that this will increase your profit margins, because, as you said, once it rolled out the cost to produce it will be about the same, and with those kinds of returns I'm sure you'll charge them a little bit more.

Gary Kolstad

And we’ll probably charge them for the value it creates, and that we are -- you're more talking about the LD now versus the HD, but yes.

Operator

Thank you. The next question comes from John Daniel with Simmons.

John Daniel - Simmons

Hey, guys. A couple here. Gary, you mentioned that one way to measure the success of CARBO Ceramic products is to look at the growth of your customer base. So given that comment, do you expect the growth of your customer base to accelerate at a faster pace than in prior quarters?

Gary Kolstad

I don't know if accelerate is the right word, but we did, it is -- it does kind of match the activity, I will say that. Q3 last year was big, Q2 this year was big. I think Q3 was right behind. We're little bit limited in Q3 quite honestly.

John Daniel - Simmons

Okay. And looking at the Utica, there's been some success up there I think using your product. Can you talk about the opportunity set that you see? Do you have a distribution facility in place? Are you looking at building one? Just any color about that market would be appreciated.

Gary Kolstad

We are excited about it and Mr. Conkle has made sure that I won't talk too much about the Utica. So you are correct. In fact I think probably the best well in the Utica probably had our product in it. But I don't think we're going to comment much on the strategy and the tactics that we're doing there.

John Daniel - Simmons

Okay. I think this is a fair question. Do you have to rail it in or are you trucking it in? Can you just --?

Gary Kolstad

No. Yes, yes, yes, no we rail it in for sure.

John Daniel - Simmons

Yes, okay.

Gary Kolstad

And we're doing all those things you might imagine that we do and we don't like to talk about it. We're not the kind of company that puts out a press release on opening up a DC with a rail.

John Daniel - Simmons

Right. Fair enough. Last one for me since I got you. Coming back to the inventories, first, thank you for putting the pricing by product line, that's helpful in the 10-Q. When we look at finished goods inventories, Ernesto, can you give us any sense of a weighting between the various product lines, ceramic, resin, and white sand? I imagine most of it would be ceramic.

Ernesto Bautista

The majority is going to be ceramic. And I think just also add a little bit of information there. We've been building KRYPTOSPHERE HD inventory. And as we've commented in the past, that's much more expensive to manufacture than any of our other ceramic proppant. So when Gary mentioned early on that historic with Q2 volume and then add 50% of the potential quarterly production out of Millen for 3Q that's at least a very reasonable starting point for 3Q as we look forward.

John Daniel - Simmons

Okay. Just a dumb question for me. My accounting is bad, and I only have the 10-Q today in front of me, but you're finished goods inventory at December 31 was $87 million, $90 million today. But I would assume that there's less ceramic in that number than at year-end just because the growth in the other, the resident sand?

Gary Kolstad

That's fair.

Operator

Thank you. And we have a follow-up question from Stephen Gengaro with Sterne Agee.

Stephen Gengaro - Sterne Agee

Thanks guys. Just to clarify, when I sort of back in, based on price per pound you gave us, which is extremely helpful, the other revenue, how should we think about that? And is that evolving as expected, as far as sort of the non-proppant revenue growth? How should we think about that line going forward?

Gary Kolstad

I think that STRATAGEN business and the FRACPRO business is evolving just as expected and goes in lockstep with the proppant business. We have had challenges in FALCON. I think we mentioned in probably Q4 that we were exhibited the tank lining business, and we've had some a little geographical shifts, and a little bit more competitive issues. So we're a little bit getting refocused there. I think the second half will be better than the first half in that business. But the first half and the fourth quarter was tough due to those changes that we went through.

Stephen Gengaro - Sterne, Agee

Okay. Now that was the missing T's, I think, the tank-lining businesses, but I was missing there, so that's helpful. And just one other clarification, as you look at the second half, you've talked about the improvements in the distribution side. I know you've made great strides there, have we started to see the impact there? Is there any -- is there any inflection point we should look forward in the back half of the year or is it sort of just kind of smoothly bolstering gross margins over sort of several quarter period?

Gary Kolstad

I think -- I think it’s probably the more the latter, Stephen. You're not going to see a flip of a switch necessarily. There are a lot of different things that are going on all at the same time. So it would probably be the best to look at it as something happens over the course of the second half as opposed to at any one point in time.

Operator

Thank you. And as there are no more questions at the present time, I would like to turn the call back over to Gary Kolstad for any closing comments.

Gary Kolstad

Thank you. And thank you, everybody for joining us this morning. A few points, developing those production enhancement technologies that improved our customers' well production EUR are a core element of our company strategy and we're very excited about things we're developing there and things that are in the pipeline and in field test.

For the third quarter, we believe our ceramic proppant sales volume will approximate our quarterly productive capacity with the possibility of drawing down some finished goods but once again that's lower than last year. So we're kind of guiding that model towards Q2 actuals and then throw in the about half of Millen for the quarter.

And speaking of Millen we're very pleased, the Millen team has done a great job getting that plant up and running. We're just amazed by how well they've done and how fast that is coming online.

On the pricing, we expect the ceramic proppant price to remain relatively stable during the third quarter and we're going to continue to work on the new ceramic capacity at Millen 2 and retrofitting an existing plant for the KRYPTOSPHERE technology and we look forward to seeing you next quarter. Thank you very much.

Operator

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

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