CARBO Ceramics' (CRR) CEO Gary Kolstad on Q2 2016 Results - Earnings Call Transcript

| About: CARBO Ceramics (CRR)

CARBO Ceramics Inc. (NYSE:CRR)

Q2 2016 Earnings Conference Call

July 28, 2016 11:00 AM ET

Executives

Gary Kolstad - President & CEO

Analysts

Brian Uhlmer - GMP

John Daniel - Simmons & Company

Blake Hutchinson - Howard Weil

Operator

Hello, and welcome to today’s CARBO Ceramics, Inc. second quarter 2016 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 28, 2016 and your participation implies consent to our recording this call. If you do not agree to these terms, simply disconnect.

I would like to remind all participants that during the course of this conference call, the company will make statements that provide information other than historical information, and will include projections concerning the company’s future prospects, revenues, expenses or profits. These statements are considered forward-looking statements under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, and are subject to risks and uncertainties, that could cause actual results to differ materially from these projections. These statements reflect the company’s beliefs based on current conditions that are subject to certain risks and uncertainties that are detailed in the company’s press release and public filings.

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 2016 earnings call. This morning I’ll provide you with an overview of our second quarter results, an update on our technology, followed by an update on the outlook for the business, and then will turn it open to questions.

Recapping the second quarter. The operating environment within the oil and gas industry remained extremely challenging in the second quarter of 2016. Year-over-year, the low oil and gas commodity prices drove the North America rig count down 53%, which resulted in a decrease in proppant sales volumes, associated reductions in the average proppant selling prices, and a move to lowest cost completions. This combination of events resulted in second quarter revenues of $20.7 million, a decrease of 72% compared to the same period in 2015.

The GAAP net loss of $20.3 million included $8.7 million of after-tax costs associated with slowing and idling production facilities. Sequentially, the North America rig count declined 35%. However, we believe the second quarter likely marked the bottom for activity levels, as both oil and natural gas commodity prices and the North America rig counts started to recover.

Our ceramic proppant sales volumes began to improve as the quarter progressed. The second quarter was somewhat of a reverse image of the first quarter. In the first quarter, sales kept declining throughout the quarter following the large decline in the rig count and completion activity.

In the second quarter, we appeared to have hit the low point at the beginning of the quarter and saw monthly improvements as the quarter progressed, following a stabilizing rig count, modest commodity price increases and modest client activity increases and completions. In addition, with the increasing commodity prices, we have received increasing customer inquiries about procuring ceramic proppant for completions in the second half of 2016.

Turning to technology. On the technology front, we remain committed to developing industry-leading fracture technologies that increase oil production and EUR. We believe as the industry recovers that E&P operators will be even more receptive to technology that lowers their cost per BOE.

SCALEGUARD and KRYPTOSPHERE technologies continue to gain new clients. SCALEGUARD, the industry’s most effective in fracture long-term scale prevention technology is designed to improve the economic value wells, by both improving production and EUR, as well as lowering lease operating expenses.

KRYPTOSPHERE, the industry’s most durable and highest conductivity proppant is designed to improve production in EUR in the industry’s most challenging high-stress well completions. We’re pleased that another major E&P operator will utilize KRYPTOSPHERE HD in the prolific but challenging lower tertiary play in the Gulf of Mexico.

Talk a little bit about industry completion practices. So some analysts have pointed out that productivity gains, measured as production per rig, are leveling off in the U.S. Some of this is likely due to the drilling of the better prospects first and also the leveling off of rig efficiency gains.

We still believe there are opportunities to change this trend with technology. The fact remains that over 50% of the wells drilled in the Lower 48 will see stresses that crust the best white sand. Often the best engineered approach to maximizing EUR will not be to just to pump higher volumes of sand, but rather design the fracs that are durable, high conductivity proppant that lasts the life of the well. As a result, we believe there is significant opportunity for E&P operators to accelerate payback on their wells and increase EURs by using technologies such as KRYPTOSPHERE LD in tail-in applications.

Many times you hear about companies in the industry managing pressure, or in other words, not drawing down on the well for fear of crushing the large amounts of sand that are being pumped in these completions. This doesn’t actually solve the problem, as over the life of the well, the sand will eventually see closure stresses that will crush it, thereby losing the majority of the conductivity of the frac.

The primary outcome that’s happening by managing well pressures is delaying the inevitable. Our solution is to utilize an extremely durable high conductivity proppant such as KRYPTOSPHERE LD at the very least as a tail-in on each stage. In doing so, there is no need to manage pressures and choke back the well, but rather, you could later rip because KRYPTOSPHERE LD is able to better withstand the closer stresses over time, maintain connectivity with the well bore and accelerate early time production, all of which drive better well economics for the operator.

Turning to the finance side and our cost base. We significantly lowered our cost base in the quarter and remain focused on cost reductions and cash preservation. We have dramatically reduced cash compensation costs since Q4 2014, and expect Q3 2016 costs to be over 60% below Q4 2014.

CapEx has been reduced dramatically and is expect to remain low in coming years. Our assets are unique in that even in busy times, they require a very little maintenance cap and have extremely long lines. We have largely reduced discretionary spending and are seeing reductions in costs from our suppliers in nearly all areas.

In regards to railcars, we have negotiated concessions on nearly a third of the fleet, reducing our total rail leasing costs by 15%. We have also consolidated some DC locations to be more efficient.

In regards to natural gas contracts, the amount under contract keeps dropping off. The following percentages are in comparison to 2015 volumes under contract. 2016 will be down 16%; 2017 down 40%; 2018 down 57%, and we have no natural gas contracts after 2018.

Turning to liquidity. As announced in May, we bolstered our cash reserve through a $25 million placement of subordinated notes on attractive terms. This morning, we filed a $75 million after-market equity offering program. Given that we do not have an immediate need for a large amount of capital, we like the flexibility this program provides to the company, specifically the ability to opportunistically raise capital, if and as needed, at prevailing market prices. Further if we choose to raise capital, we prefer the low-cost feature of the ATM versus other structures. Maintaining financial flexibility remains essential as we move forward.

Before turning to the outlook, I want to provide a brief overview of how we view the proppant industry today. It’s clear that with the severe downturn the industry has faced, the proppant market, especially value-added technology such as ceramic proppant have suffered more than other low cost alternatives. This resulted in an oversupplied ceramic proppant industry. The good news is that the industry has been working through the large inventories but low quality Chinese ceramic proppant that made its way into the States prior to the severe downturn.

The industry will recover, and today we believe the U.S. ceramic proppant suppliers can adequately produce and supply the domestic ceramic proppant market with no need for the low quality Chinese imports. We also believe that pricing has likely bottomed for base ceramics.

Price for base ceramic proppant will start to recover, however it’s unlikely that will return to levels seen prior to 2015. Based on these factors, we believe this results in minimal future imports from China.

Now, I’d like to turn to the outlook. We’re becoming more optimistic on the industry operating environment given that the oil and natural gas commodity prices appear to have firmed. Communications with our clients lead us to believe third quarter 2016 ceramic proppant sales will increase from the second quarter. In addition, the third quarter typically sees an increase in activity in the northern regions as well as in Canada with spring breakup over. We anticipate an environment where E&P operators gradually step back into using more durable high conductivity proppants, likely concentrated on tail-in applications.

On the technology front, KRYPTOSPHERE and SCALEGUARD continue to see acceptance in this challenging market. We now have wells using SCALEGUARD producing scale-free for over two years. We are particularly excited about the success of KRYPTOSPHERE HD and SCALEGUARD in the deep wells in the Gulf of Mexico. We also believe there is untapped value residing in other areas of our technology suite and we continue to explore ways to accelerate the value of these technologies.

Efforts to reduce our cost structure continue including the reduction of our railcar lease expense and SG&A costs. In addition, higher natural gas commodity prices provide a cash benefit relating to our excess natural gas commitments as these contracts are net settled.

As a result of these cost reduction efforts, coupled with our efforts to further lower inventory levels, we anticipate our quarterly cash burn to improve next quarter. We’re looking forward to the second half of 2016, which should see improved overall industry activity levels due to the improvement in commodity price environment from the first quarter of 2016.

We’ll continue our focus on driving additional value from our technology platforms and strengthening our balance sheet to afford us financial flexibility to capitalize on opportunities during the next up cycle. And with that, I’ll turn it over to questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions]. We will pause momentarily to assemble our roster. Your first question comes from Brian Uhlmer of GMP. Please go ahead.

Brian Uhlmer

Thank you. Good morning gentlemen and John [ph].

Gary Kolstad

Good morning.

Brian Uhlmer

Wanted to clarify, did you actually sell any KRYPTOSPHERE HD this quarter?

Gary Kolstad

We sold some, yes, but not on the big offshore wells.

Brian Uhlmer

Okay. So looking at your average pricing, what led to the apparent improved pricing level? Was it more GUARD product, or was it just a little bit of that mix of the HD. What was the benefit there?

Gary Kolstad

Yes, it basically the technology product, SCALEGUARD, little bit of HD, and we also sell products into the industrial space as well. So it’s primarily the technology that makes a difference. The price you get to see. The base ceramic price, I think as I mentioned on the opening call there, I think that’s likely hit bottom and I think that will be headed up next.

Brian Uhlmer

Okay, great. I’m curious, when you talk about - you mentioned tail-in specifically, and as well know that’s our thesis as a no-brainer to use it for volumes of sand we’re pushing, what percent of well volumes are you seeing on the folks that are ordering in terms of percent of total proppant that are using the tail-in? Number one. Number two, you specifically said using LD as a tail-in. Is that becoming the norm or are you using - or are folks buying a comp proppant and other lines as your prop ceramics as well the tail-in?

Gary Kolstad

The first part of the question, it’s usually 15% to 30%, although we have seen cases where somebody might go 50% on a stage with ceramic. It’s still early days for KRYPTOSPHERE LD. Some of the most prolific wells have used KRYPTOSPHERE LD but it’s still early days there. And what was the latter part of that question, Brian? Sorry.

Brian Uhlmer

Just the feedback on people who are using it and why - what’s going to help them turn the corner in terms of using more and gaining market share on the tail-in?

Gary Kolstad

I think that KRYPTOSPHERE LD, which has greater conductivity than intermediate density ceramic and all the bauxite let’s say, you can buy a low density ceramic that outperforms all of those by default. That’s going to drive that as the industry recovers. And I think the tail-in part of it people see over time, I’m very interested in what the analysts say when they say, well, the decline rates in the Eagle Ford and various other places were larger than what we expected and you see some adjustments to EUR.

I think the downturn in sometimes allows operators to go back and do a more comprehensive look at what’s really happening in their wells and there has been enough time passed now to where we have enough time on the production to where I think some operators may likely choose that path.

And then furthermore, I think when you’re watching natural gas price now, I think there is an enormous opportunity there and I think a lot of operators in places such as the Haynesville which used to be a ceramic market and still needs to be because of the closure stresses, I think there will be some conversion there. I think parts of the Northeast, very high stress places, there will be potential.

And then offshore, there is no reason to use intermediate density ceramics or bauxites anymore when you can use KRYPTOSPHERE LD or use KRYPTOSPHERE HD for the really, really high stress wells.

Brian Uhlmer

Okay. A rig operator announced two rigs going back to work in Haynesville, they got contracted this quarter, will be back to work. Is that part of your confidence in increasing 3Q volumes? Have you already begun to get calls for the Haynesville, and are you looking at full well fracs with ceramic, or is it still a tail-in type sales pitch?

Gary Kolstad

No, I don’t think we see a lot of full well, Brian. Not in…

Brian Uhlmer

Those days are gone, yes.

Gary Kolstad

And I think it’s still early days in the Haynesville. All I’m saying is that we learned these things years ago and then we shifted to other things. Whether it is the Haynesville, you remember the TMS [ph], all those places, the stress is way beyond what the best white sand can handle. So I would encourage you to tell all your friends out there that.

Brian Uhlmer

Well, I don’t have many friends here, because I’m not very nice. Moving on, you do provided some cash flow guidance in the front half of the year. Would you be willing to provide that? It looks like you burnt in excess of $20 million this quarter, if my numbers are accurate. I don’t know how much you brought in on the tax return. Can you provide a little more guidance maybe for the back half? And I know it’s uncertain times with the oil price move but just to help us out a little bit?

Gary Kolstad

Yes. Sure, Brian. So for the quarter, it’s probably - it’s in the $20 million range. That was directly impacted by some severance payments that we made that totaled about $4 million. You’re really back to that mid-teens range that we had talked about prior quarter. Going forward and maybe focusing on second quarter - I’m sorry, third quarter, first of all, I think as we look forward, our cash burn picture would be something in the low double-digits.

We’ve done a lot to reduce costs, so we’re benefiting from that. As we look out further beyond the third quarter, it’s a little bit difficult only because if the market looks to improve, we will invest in building some inventory bringing on a line or two, etcetera. All other things equal, I think we should see improvement in the third quarter and maybe potentially in the fourth quarter, unless we see a change in market condition.

Brian Uhlmer

Okay. And I’m going to turn it over because that was enough questions, but thanks.

Gary Kolstad

Thanks.

Operator

The next question is from John Daniel of Simmons & Company. Please go ahead.

John Daniel

Thank you for taking my question. Gary, we had a lot of chatter over the last couple of years of people switching away from ceramic, trying to take the lower cost options. Some would say that they were getting good results with sand, etcetera. But have you had any customers in the last several months or so come back to you and say, look, we’re going to start returning to ceramic because we’ve now found that the value proposition is better. I guess, provide some color along that topic?

Gary Kolstad

I think what’s interesting for me is some of those clients that up until the last day held out and they were still tailing in with ceramics until, let’s say, the fourth quarter of last year, the first quarter of this year. We see some of those folks starting up activity and still tailing in with ceramic, and I think that’s your best testament.

The other one, it’s just a practical reality of the closure stress and you can bump a gazillion pounds of sand in a well but it’s still going to crush. And I think there is other ones we gave a great example last year, the Eagle Ford, where people were pumping white sand at 11,000, 12,000 feet and their wells just come crashing to a halt once the closure space gets there.

So I think people intuitively know this. We can’t change chemistry and physics. But during the down cycles people are going to do what they’re going to do. And I don’t have any illusions about things going back to the way they were and that doesn’t trouble us that much because we are - as you watch us, we’ll focus more and more on high technology and I think the base ceramic will grow and pricing on it will come up, but we really charge forward on the technology front.

John Daniel

But when you go see that customer that had his well come crashing down, I mean, you say to him, hey, dummy, there is another better alternative here. What’s his retort to you?

Gary Kolstad

We, of course wouldn’t ever call our clients that, but it was interesting there. We did some field trials, proved the results and now unfortunately there is this liquidation of the crappy Chinese proppant out there and some other fellows liquidating inventory. So that person is using ceramic, not ours right now because we don’t participate at those price levels. But you gain them back. We do that with our STRATAGEN folks. They are extremely good at showing what happens to this when it happens. So we always try and engineer it with the client and work with their engineers to come up with a solution.

John Daniel

I know you really don’t like giving specific financial guidance, but I’m going to throw one your way anyways. Do you have enough confidence in the visibility at this point to say that Q3 or Q4 ceramic volumes, sort of, return to the Q1 level, or it’s still unclear?

Gary Kolstad

I don’t think we have that much confidence or visibility yet. I absolutely believe the worst is over, and that took place in Q2. So what we kind of think is that, well, if you take Q1, which of course has strong Canada results and you look at Q2, it’s probably going to be around somewhere in the middle of that we kind of think for Q3. I think people got very excited about oil price at $50 and they’re less excited at $42.

But that other one that’s sitting there with over $3 on the strip right now, natural gas, I think that activity might be here to stay. And we don’t care where we work, oil or natural gas, it’s irrelevant to us. We just think about the stress and stress in the earth. So that’s what I kind of think about for Q3. And Q4 is a long ways away on the commodity price and everything like that, so I think we’ll stay away from that and just say we expect the volumes to improve in Q3.

John Daniel

Got it. Okay. I’ll turn it over to others and jump back in.

Operator

[Operator Instructions]. The next question is from Blake Hutchinson of Howard Weil. Please go ahead.

Blake Hutchinson

Good morning.

Gary Kolstad

Good morning.

Blake Hutchinson

Just, Gary, I think you did mention in the release at least having some increased inquiry of visibility into next couple of quarters or so. Is that - should we take them as mainly being within the standard product suite, and could you maybe also address the pace and difficulty of maybe introducing LD as the standard product as we proceed through this market?

Gary Kolstad

Yes. The activity for Q3, that it’s particular client-based and it involves certain amount of new technology including KRYPTOSPHERE HD and LD. And we see increase in SCALEGUARD usage, whether that be the Bakken, the Permian, places like that. So it’s really - we really - on a Q3 visibility side of it, is pretty good for us. You see some pickup in the Bakken as well with ceramic usage, some of the guys going back to work. And what was the latter part of that then your…

Blake Hutchinson

Yes. I guess to that end that your color would suggest that you actually have fair amount of technology content likely with incremental volumes here rather not [ph]. I guess I would have assumed with incremental volumes, it might be within the standard product suite and therefore we might need to be attentive to mixed base price changes and also attentive to efforts to steer the customer base towards the new LD product but it sounds like your visibility on incremental volumes is squarely within the more technology-based product orientation.

Gary Kolstad

It’s a little bit of both. We have both. There is some real key wells being drilled around the U.S. that are looking to use KRYPTOSPHERE, whether it’s LD or HD. And so we see that and now those are pretty precise orders. I mean, it takes a lot of engineering ahead of time on that. But we do see just the base level of ceramic coming up.

And as we watch the Chinese stuff getting consumed and they’ve been liquidating that at sand prices and everything, there is a lot of places we’re just not going to participate. There is people out there that are basically liquidating inventory and it doesn’t make any sense for any of us to produce proppant at some of these base ceramic prices. So I think it’s best to wait and just let it get consumed and move forward.

But we’re very happy with a lot of things and we haven’t talked about Quantum yet. But I personally am thrilled with what we’re doing there. That was a project thought of in 2006. So 10 years later, we finally get to breakthrough these incredible technical barriers that really allow us to see what that frac looks like down hole and what’s the proper reservoir volume. And what that does is it goes back and feeds into our whole system about conductivity and is the proppant getting out there? It helps us develop products like CARBOAIR, which is 25% lighter than sand and yet has all of the benefits of ceramic.

So for us, our whole picture is kind of coming together there to really provide an engineered solution and that’s just our path forward. And we’ve taken the costs out and we’ll be happy as base ceramic volumes increase but the price has to come up.

Blake Hutchinson

Thanks. That’s very helpful. I’ll turn it back.

Operator

[Operator Instructions]. We do have a follow-up from John Daniel. Please go ahead.

John Daniel

Hey, I’m back. Thank you for letting me come back in. Actually the covenant in the credit agreement, that minimum cash, it’s about - what is it? $40 million is the level right now?

Gary Kolstad

That’s correct. Yes, $40 million through the first quarter of 2017, starting in August of 2016.

John Daniel

Right. But then it steps down to I think, what, $30 million or $25 million?

Gary Kolstad

It steps down to $30 million through year-end 2017 and then steps down again to $25 million through year-end 2018.

John Daniel

Okay. And cash is what? $81 million, and you’ve got - I think you mentioned to Mr. Uhlmer sort of low double-digit cash burn, so call it $10 million to $15 million a quarter, right?

Gary Kolstad

Yes, low double-digits is what I mentioned. Yes.

John Daniel

In the near-term?

Gary Kolstad

Right.

John Daniel

And then presumably the requirements will grow as the business recovers as you - for working capital. Just trying to get a sense of realistically, you need to take advantage of the equity facility, the AMT [ph].

Unidentified Company Representative

Yes, I mean, I think maybe just to touch on what Gary covered earlier, we put a program like this in because it gives us flexibility. It gives us the opportunity - the ability to be opportunistic selling at prevailing market price. We’re not in a rush. We’re not backed up against the wall. We can use it as necessary especially as we focus on general corporate matters such as technology advancement, working capital as I mentioned earlier. As the market changes positively and we are in need, whether it’s in 2016 or early 2017, then we have a tool available to us to utilize.

And I think another important piece of the puzzle or maybe two, is that it affords us an ability to raise some capital at a very low cost relative to other equity type of offerings. And also it gives us the ability to do block trades if they avail themselves through reverse inquiry, so it gives us a lot of flexibility as we look forward. We’re obviously not at a point today where we can say some certain that we would utilize the program but I’m sure at some point in time, we will utilize it.

John Daniel

Okay. It just seems like you’ve got at least three quarters runway here and one would think that if all of a sudden the business has improved materially or there is that visibility that this covenant could be easily waived for a quarter or two from the banks. Just your thoughts.

Unidentified Company Representative

I’ll communicate that to our bank suggest that John Daniel said so.

John Daniel

Okay. Thanks guys.

Gary Kolstad

All right. Thank you, John.

Operator

The next question is a follow-up from Brian Uhlmer of GMP. Please go ahead.

Brian Uhlmer

Thank you. I do John Daniel a friend, so there is one. Since you threw out the line there, can you talk about Quantum, the results that you got from the second well? What wells are lined up and any updates on the monetization of that?

Gary Kolstad

Yes, I think we kind of talk about it in phases. So phase one is just proving up the technology which we’re basically through. We’ve really seen outstanding definition on the imaging and really no failures [ph] on the execution and confirmation of everything we’re doing is what we expected.

And then as we move into phase two, we are really going to drive the cost of the service out because we’d like to make it more mainstream. And so we’re kind of in phase two right now. Don certainly has clients lined up that would like to try it.

And then I think in terms of monetization, that’s probably out at phase three, and that’s after we make the business more mainstream and figure out whether we want to build the business and keep it or if it would fit better in somebody else’s hands to take it and run with it. And we just keep on providing the product side of that business. So we have a lot of options there, but what we’re just amazed with is how well the tests have turned out and the resolution that we can see fractures.

Brian Uhlmer

All right, thanks. Looking forward to hearing more about it as we move through the year.

Gary Kolstad

Thanks.

Operator

There are no additional questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Kolstad for closing remarks.

Gary Kolstad

Thank you for once again joining us this morning. I’ll close by summarizing a few key points. Overall, I think the worst is behind us. I think Q2 marked that low point for our industry I think, and we’re more optimistic on the industry environment than just a few months ago. We took hard decisions to lower our cost base and yet remain committed to developing and introducing new industry-leading technologies. The ongoing adoption of those technologies would be a key differentiator during the next up cycle and provides a lot of leverage.

Communications with our clients lead us to believe the third quarter ceramic proppant sales volumes will increase when compared to the second quarter. Our cash preservation and cost reduction remains our key focus and we expect to make additional progress during the third quarter.

And then finally, I want to thank our employees who work so hard through these tough times to make sure we continue to provide industry-leading technology. R&D group has done great and provide excellent service and quality, execution. And so we want to thank our distribution, our manufacturing folks because it hasn’t been easy, but I think it’s only going to get better.

Thank you for joining us today.

Operator

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

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