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CARBO Ceramics Inc. (NYSE:CRR)

Barclays CEO Energy/Power Conference Call

September 05, 2012, 10:25 pm ET

Executives

Gary Kolstad - President & CEO

Ernesto Bautista - VP & CFO

Analysts

Unidentified Analyst

Okay, good morning. Welcome back everyone. For our next presentation, I am pleased to welcome back the management team from CARBO Ceramics. Speaking for the company this morning will be President and CEO, Gary Kolstad, and the company’s Chief Financial Officer, Ernesto Bautista. CARBO Ceramics is the leading provider of high-quality ceramic proppants to the oil and gas industry.

Gary has been President and CEO for the past six years and Ernesto has been with the company in the role of Chief Financial Officer for more than three years. With that please help me welcome back Gary and Ernesto.

Gary Kolstad

Thank you, (inaudible) and thanks all of you this morning for showing up to listen. Pleased that you are coming here and see and learn about CARBO forward-looking statement. A little bit about the company if you don't know us. We have the leading products that make oil and gas wells producing recover more. For an oil field services technology company and sales products and services globally, we manage the company with commitment to building an enduring company and are financially conservative and we have a long history of growth and profitability.

If you look and see where we do business at, the yellow dot show where we sell our products and services at and that's about 50 countries around the world. The red stars indicate where we have ceramic manufacturing plants and that's in Russia, China and the US. The gold stars which get a little more difficult to see there, but that's resin-coating plants that we have in Marshfield, Wisconsin and New Iberia, Louisiana. Then the green stars indicate Falcon Technologies, that's an environmental business we brought back in 2009 that provides spill prevention and containment services.

Our main mission is that we make oil and gas wells produce better and increase recovery. And that's something we wake up everyday and talk about and try and build our business around. We do that by improving the effectiveness of fracs. We have the number one frac design software, it's call Fracpro. We have the highest conductivity proppant, we have expert consulting for completely wells, they work for E&P and both in the design as well as sitting on well sites for completions and analysis. And then we have data analysis for field development and that's really a 100,000 foot view we put in things such as geology, the reservoir information, completion information, production information, frac information and we will run it through our neural network and then tell the E&P which factor is causing the greatest impact on production and recovery.

So I think all of those businesses are very synergistic, the proppant business is obviously the biggest one by far of all of them. Speaking of the proppant business, we are the world leader in proppant. We have produced the highest quality, highest conductivity ceramic proppant in the world since 1979. We provide the broadest product range of products to fit any reservoir.

We are the largest ceramic producer in the world and as you will hear throughout the presentation, ceramic always makes wells produce better and recover more than any other type of proppant. We are growing in resin-coating sand business and we differentiate that business by only coating the Northern White sands which have the highest conductivity.

Here is a graph that shows our ceramics sales in the red line as well as our capacity in the bars since 2000. We are really very proud of that, we went from since I have joined the company, we kind of went from 500 million up to 1.75 billion pounds worth of capacity and we did all that while not have taken on any debt. So I don’t (inaudible) companies that can basically triple their company in that time period without taking on debt.

Our value proposition on the ceramic and this is important, we basically say if we use our ceramic proppant versus any sand based proppant, you will see a 20% increase in recovery, production and you will see rapid return on your investment and a very high payout. The uniqueness of CARBO I have mentioned a couple of those, but we have a lot of technical experts, industry experts that teach people about the value of conductivity.

We have over 200 SP papers document the value of conductivity and that’s worldwide and we have the light weight ceramics which is really important franchise for us and differentiates us and I am going to talk more about that later.

When I said we have the products to cover any reservoir or any range of circumstances, here are the products we have the base products we have. So at the bottom there we have CARBOHSP which is a bauxite and then we have CARBOPROP which is an intermediate density ceramic. The top three are light weights and today we sell about 85% of our sales are light weights and we clearly understand that is the direction that the business needs to go in.

And the other thing I would say about our products is that with a move towards liquids rich type of plays, those wells all have multiphase flow and more than anything they need even more conductivity and I always make the example of drinking milk out of a straw or drinking a milkshake out of a straw. Whenever we combine liquids, gas, the various things we call them NGLs, condensates et cetera, it creates little bit of emotion down there.

So it is difficult to produce, so it is like we call Delta Pi in technical terms, but it's really been a blessing that we moved into liquids rich and that creates more demand for ceramics. This graph shows the end of the year capacity and it includes our resin coated sand capabilities, our resin coating capabilities I should say because we resin coat ceramics and sand.

At the end of 2011, we had a 100 million pounds of capacity and currently we have $400 million. Due to market conditions we've held off building any more resin coating capacity, but we will sometime in the future build another 600 million up at the Marshfield plant that we have. Now I am going to talk about some things about the client benefits from our products and you can see some of the ones I am going to be covering there. In particular I am going to talk about what differentiates us from every body else and what makes our ceramic franchise so valuable.

So let’s look at our advantages and I am going to start with over on the right side there when I talk about high conductivity ceramic and that is the most important factor in the production and recovery of wells after the rocks. That’s kind of the two things that dictate how successful all these E&P will be.

How were the rocks and what is the conductivity of the frac? Everything else is a little bit noise. So I am going to talk about high conductivity ceramic, I am going to talk about our proven production gains, some of the field history, are the cases histories we have on that, talk about our quality and I am going to talk about the light weight volume factor.

The other three there, there is a low cost reserves, the high efficiency plants and technology leader, those are pretty well acknowledged and they’re kind of built in that’s what provides us a nice business and mode for the future.

So first of all, little bit of an education on the types of proppants that are used in the industry. I built the slide about two and half years ago because lot of times people say well with pump sand or not necessarily be able to identify what proppants they’re putting in their wells. So there are three tiers in the industry. Tier one is high conductivity. That's ceramic. Tier two is medium conductivity that’s resin-coated sand and tier-three is low conductivity and that of sand.

The higher the conductivity, the higher the production, the recovery and return on investments. The science behind that is that ceramics are an engineered manufactured product. Okay? So the high strength that’s minimizes crush, their uniform size and shape which maximizes the porosity and permeability of the fluids and gases flow through and is thermally resistant. It doesn’t really care about temperature, doesn’t degrade.

Sand based products on the other hand are naturally occurring product. There is not much we can do with them. Sand itself is low strength and irregular size and shape and when we resin-coat sand, it doesn’t make the sand any stronger. What it does do is helps on the point loading stresses as well as when the sand does crush it contains the [fine]. That's why we call medium strength still irregular size and shape.

I want to go one step further and I haven't done this before yet but I think the industry needs no I want to talk now about the three tiers of sand itself. So under tier three proppant, which is sand we have tier three A, which is high conductivity, its also called Northern White Ottawa and that's when we made a commitment to our resin-coating business that we're going to have those reserves.

Tier three B is medium conductivity that's often called Brown or Texas or Brady sand. Tier three C is low conductivity often found in Arizona, Nebraska, River Sands. And tier three C actually [shouldn’t] used in the oil and gas industry. Now when we look at that from a science standpoint, what did Mother Nature do? Well, when you look at the top there, it is the highest it’s the highest string sand, its superior coat structure most uniform size and shape and as the minimal amount of impurities.

You go down to the Brady sands medium strength, moderate core structure and few impurities. And then you get down to the real bad stuff low strength, inferior coats, irregular and many impurities. So when you hear about all the people that are getting in the sand business need to know which one under tier three proppant A, B or C that they are having.

Now, how does that all applied to the fields we work here. So what we have here is the base line conductivity chart, so this is the figures that people will put in their books. All of these figures of course need to be reduced by much greater than 50% because of the effects of realistic condition meaning Non-Darcy Flow effects, multi-phase flow, some of you are turning your books these couple of sides are put in late so you won’t find them in your books.

So I hope you can see up there. And temperature effects etcetera gel damage, so all these figures are what come out of their books, so when you look at this and you look at some of these plays, you can see what I mean about the black dotted line is the Two Tier C River Sand. It really doesn’t have an application in our industry because you have to cut what you have there and have cut them.

So anytime you have stresses above 5,000 PSI you really don’t have any conductivity. The brown dot line is the three Bs which is what we call Brady and that is you has a little better application, the solid yellow line is the Ottawa Sand and you can see where is that.

So then you look at places like the Eagle Ford, the Haynesville, the Bakken and where these operators are working that will kind of tell you what kind of product they should use. The red line is our light weight ceramics in this case CARBO light, so I think this is a good guide for you to look at them when operators say they are using a lot of people I have heard in last day or so say they are using White sand, well that’s the best of the sands. I hope people wouldn’t be using three C, right. That’s also a reason why we feel comfortable in future about ceramics. You can look at the big delta on conductivity or some of these plays.

We continue to drill deeper and hotter as time goes on. I am going to get some field examples now. So here is the Bakken Shale, in this case 23 wells were done with our ceramic, 91 wells done with sand, you can see that the ceramics average 40% higher initial production rate and overtime that gap widened that’s not surprising as the closure stress increases and the sand crushes. These comes from the SP paper noted below that was done by petroleum which is owned by St. Mary’s now. Here is another Bakken example and in this case 10 wells have done with their light weight ceramics, 12 wells done with sand and the [SP] papers denoted below, this is seven groupings of wells comparing direct offsets in Montreal County, and after 22 months 34% increase in production a 300,000 investment in conductivity yield of $1.5 million increase in value in the well and when we look at those areas under those graph you can see you get your money back extremely quickly, right? It’s a matter of months.

Here is one that really kind of change a lot of this is the Bakken again, this is the Brigham [paper] now owned by Statoil and in this case they did seven wells with our light weight ceramics, 12 wells were [sent] and the results were phenomenal. 100% increase in production and 125,000 barrels more $8.7 million that the calculation show mere $70 barrel realized.

So these always keep coming up, okay and this is what once again that gives us so much confidence moving forward that ceramics will always be in demand. Here is an example of that we did because of some recent comments where people say sand works just as well and what we did is we looked at Montreal County because that’s where the operators were saying that we took recent completion data, so we wanted wells that were only six months old; in this case operator A had a 11 ceramic wells, operator B had 10 wells and operator C had seven wells both of them which use sand and you can see the difference there; roughly 40% to 50% increase in production in the first six months.

Sometimes when we look at field we would like to start it the very top. So here is the broad brush look at the Eagle Ford, we looked at 679 wells that were leased 12 months old, okay and sometimes we don’t get production that of six months in place like in Texas.

So this is 12 months of production data and what we saw is 44% increase in production, 57,000 BoE per well, roughly $2 million revenue increase, based upon $85 oil and $4 gas, and once again we keep saying this, we like to start off at first glance at the high level, but then we like to go down and we like to look at direct offsets in counties.

Here is an example of a client Rosetta Resources and the SP paper shown at the bottom there and what they show is the 12-month cumulative gas production, normalized to the number of stages and they do a cumulative frequency graph. But what they saw is 15 million Fcf increase in cumulative production first stage, 1.5 million revenue increase per well based upon $75 and $375 and their payback they say was an eight to nine months of use in ceramic.

Here is one that’s in Haynesville. Now gas is on the top of the hip crate right now, but we like to show this because we're 32 months into watching this, 20 wells done with our hydroprop, 35 wells done with other peoples proppant, which could be resin coated sand or somebody else’s ceramic and what they saw is 19% increase in production, but once again, when did they get all their money back. Its back in you know, certainly less than a year because you look at the area underneath the two curves there; 0.36 Bcf per well, $250,000 investment conductivity yielded the wells by $1.5 million.

This one is much I would say a large, large independent, one of the major drillers in the Haynesville. We recently had one of the other major independent that when the crisis hits, they want all the sand and they kind of acknowledged that they lost one Bcf on the EURs by doing that.

Now I want to switch over and tell you a little bit about and I think some of you get worried about the Chinese ceramics and they certainly have over built in China and there is surplus on the market, but my title is not all ceramics treated equal.

So a question, as an E&P operator and investing $4 million to $1&2 million on a well last 20 plus years, how much conductivity are you sacrificing which mean lower production and EURs by using low quality Chinese Intermediate Density Ceramic? We call that IDC in the industry. So I have some images here and later on, I’ll follow with conductivity chart, but these are all 20-40 Intermediate Density Ceramics, three different suppliers, number one, number two, number three.

At the top there you see the whole pellet grade and because that irregular size and shape when the frac closes you have a lot more compaction and lots of flow channels that reduces the flow rates. You also have these incredibly rough surfaces which reduces flow rates. The lower set of pictures of the same proppant not the exact same grades, but the same sample of proppant, we put in a proxy let set up we cut a cross section of the grain and you can see all that internal porous here all the dug space there all the dark things that leads to low strength and the proppant will crush as the closure stress increases and it all results in lower conductivity.

Now how is that compared to our lightweight in this case CARBOLITE 20-40. You can see around the actual pellets are and those pellets blow actually are cross section that is in pellets again that’s pellets with a cross section so that’s are internal strength of our pellet which quite frankly is more important than anything in the ceramic world.

Now let's look at sample four, five or six so we now have six different Chinese suppliers. These samples are actually all taken from the Bakken that was our first place we focused on, but we're going to explain to the industry about how this low quality which results in low conductivity ceramic supply has been brought in however it hurt their wells.

And here is the traditional long-term conductivity graph; you would think an intermediate density ceramic would outperform a lightweight; actually it doesn’t; this is a chart from comparing sample one, the Chinese IDC actually has 31% less conductivity than CARBOECONOPROP and 55% less than CARBOLITE.

Now, I am going to add one other thing to that and so we call the lightweight volume factor. Our lightweight just because of bulk density provides 20% more volume than the intermediate density proppants. Now the industry for some silly reasons buys proppant by the pound. And so if you had bought 2 million pounds of our lightweight ceramic you convert that to cubic foot which is what ends up down whole in our frac, you get 20,600 cubic feet and each railcar holds 2,000, so that’s visual, fix 10 railcars to equal 2 million pounds.

That does not equal 2 million pounds of Chinese IDC because the bulk density difference you only get 17,100 cubic feet down hole. And for those of you who are not familiar with fracturing, when we fracture a well usually our height will be something between a 100 to 200 feet, but our width is a quarter of an inch. So that frac will go for hundreds if not thousands of feet in length, so when you change this much frac volume down hole you are going to get better well.

Now conversely you get the same size frac volume, you get to pay more, so 2 million pound of ours equals 2,400,000 pounds of Chinese, so you would have to buy a couple more railcars or 400,000 more pounds. So one of our missions is to try and educate the industry both on the low quality of the Chinese as well as the difference in the volume factor.

And I want to switch over and talk about the product development and I got a list of products we have introduced in the last few years; it’s when I joined the company I thought we really needed to accelerate that, we need to start building proppant pit reservoirs so that’s why we came out with hydroprop which is heck of a hit for us, build for slick water fracturing. It’s interesting today in 2011 40% of our ceramic proppant sales were products that didn’t exist back in 2007, so I think we are on the right path here.

Our main objective in product development is that we want to continue to introduce new products and particularly with the focus on making even higher conductivity products as well add technology applications to existing products for lack of better orders put in the axe on it. So that was what we did with CarboTech, CARBO NRT and we are doing couple of field trials with some other products now, but I feel very comfortable in the future we will produce a proppant that will have higher conductivity even than in our existing products.

So you kind of summarize all that and when the E&P are all done the only thing that’s left the frac equipments gone, the drilling equipments gone the only thing that’s left is the well and the prop frac and that is why conductivity is so important. In conductivity you know not to get too technical, but basically it’s the permeability of the frac times, the width of that frac and so we kind of turn into a question how wide is the road and how good is the pavement, are you putting something in there that will get all these reserves out, that will last the life of the well of 20 years, are you putting in short term stuff.

And we understand why E&P have to lower cost sometimes right; that’s sometimes I mean they are forced to do that, but technology wise and recovery wise, it's nice to have the products that ultimately will increase recovery to its highest level.

Moving on to Falcon Technologies, that’s a business we bought back in 2009. It's an environmental business that provides spill prevention and containment. That includes containments, tank lining and tank basis. It's based on proprietary poly (inaudible) technology and it supports the grown environmental awareness and stewardship by the E&P in the entire oil and gas industry.

We expect the growth to be at 15% plus. It's a run a little bit ahead of that. You can see that when bought it in 2009 and did 19 million, this year we expect over 40 million and we would expect that to continue to grow to be a fairly big business for us. On the right there in the picture, you will see a containment around one of the tanks. That’s what I mean by containments.

The value proposition for that is risk mitigation for clients. Environmental stewardship as well as it lowers the operating cost overtime. Just like our ceramic proppant, we build these containments, tank basis, tank linings for the life of the well site. That’s what differentiates us from others there. Public and image enhancement for the E&P and eliminates product loss. When you have a spill with our stuff, it isn’t really a spill, you don’t have to report it. You save all the product, you just pump it back in the tanks and I think that’s one of the things the operators are picking up on versus their firms and stuff, the things that will eventually go away. There is a lot of remediation cost, a lot of reporting issues, things like that.

On the financial side, we've had a pretty good run here, from 2005, you can see the revenue, the net income and the cash from operations which we defined as net income plus depreciation. You can see that we kind of tripled everything over that period from 2005 to 2011 and we also have the trailing 12 months here shown through the first half of this year.

You convert that to per share numbers and here its look like. We really like growing the cash flow from the business, its give such freedom of choice moving forward. We have no debt; I think I mentioned it before we never had any debt. So its give a lot freedom of choices do it we want to do.

One other things we like to do is increased the dividend here you can see what we've done. We've I think basically we tripled that's since ’05 as well.

And every now and again when we get the opportunity we don't mind buying back the shares in ’09 when we sold the frac mapping business to Halliburton with a bunch of extra cash we about 7% on the shares back then. At a very least, what we would like to do is prevent share (inaudible) so every year we like to buy buyback whatever issued.

A comment on the industry factors and just the continuation of our Q2 conference call, we said that there is a currently an oversupply of proppant in the market. There is oversupply of all types of sands even the Northern White and I think that’s shown we're hearing and seeing some things where one person has gone bankrupt, another one shutdown the mine. The resin-coated sand business, we don't think it make sense to build more capacity in an oversupply markets so we're holding up on Marshfield and then on the ceramics businesses an oversupply of the low conductivity [Chinese].

So that one we feel very comfortable in sighting that. The other ones will have to balance themselves out over time. We said the second half is going to be lot tougher force than the first half and we're seeing lot of sales volume volatility in particular because some clients are running off the Chinese inventory they bought. That's a both if short-term makes a little bit tough, long-term is the right thing. So we are very comfortable with that. I said in ‘08 what would happen in ‘09 was that as the market goes into down cycle which we are in now, people would stop buying the Chinese and that’s what they did. I think the same thing is happening now.

We have certain amount of things that we monitor globally and so we are very comfortable with the decline in the imports of the Chinese product in the US but we have a bunch of inventory we have to work off and I think a lot of our good clients when they have their choice off course we are going to pick higher conductivity ceramic proppant from us rather than the Chinese.

And so we are seeing sales volume volatility, we kind of implied in Q2 that we could see a 10% lower volume as compared to Q2 and I think those comments are still valid. We experience continued pressure on pricing for all the reasons mentioned above. Longer-term we are very happy. I think the supply-demand is working itself out and the conversations we have with clients especially about the Chinese is very good. And we have kind of gained some broadening of our client base to in all the key basins. So we do very well in the Bakken, the Eagle Ford we are gaining in the Permian. So long-term, it still gives me a lot of positive energy about continuing to build more manufacturing capacity.

We are in a down cycle they come every two, three years it seems like there is more volatility because the pie just got so much bigger. You back up five years ago, we were selling 20 billion pounds of total proppant in like environment today we are at 70 billion per say. So the price is getting bigger there is lot more variability but we are pretty happy about the long-term outlook.

In summary, we have the leading products that make oil and gas wells produce better and increase recovery, that’s our main mission in life. Conductivity matters the most, it’s the only reason we (inaudible) wells is to create a conductive channel for oil and gas to flow. We have built the leading ceramic proppant business through a quality of products and innovation; I think our best products are yet to come and I am we are very excited about that.

Our Falcon’s business that are engineered to protect solutions have gotten out there and are growing very well, I think the clients will become one of our best sales men as time goes on. I think we are just starting to see that now; in other words one operator is doing at the other operator season doing that and it helps all that way and finally we expect to lead the proppant industry.

And with that I guess I will take some questions.

Question-and-Answer Session

Unidentified Analyst

I think sometimes you hear some comments out there saying that we are in the first second and third stage of innings of fracking technology. Based on what you see out there is this something that still be used in the lengthening of so called fracking technology?

Gary Kolstad

Yeah you know we are 60 years into it now and fracking lets say 60 plus, ceramics 33 plus; we never found I think to replace that on an economic basis and we have looked at everything and we have altered the niche products and there is one other rise there is niche product and it’s way too expensive; we can duplicate it with ceramics that other guys have duplicate it and you know the performance characteristics; we see things happening with plastics solid stuff and we explore all of that.

But the reality is you got to have the economics; so for us we pay attention to all of that; the industry is still like we haven’t found anything so we still continue on the path make what we have even better and I think that’s really going to. It excites me is that we are 33 years old and I am more excited now about the conductivity we are going to have in the future years than we do at this age and the other thing that’s exciting for me is kind of like iPhone and putting apps on it, right. That’s what we’re really trying to do.

We're trying to put apps because we put the most invasive thing and the most valuable thing in oil and gas industry. Our value starts in the reservoir right and we're the guys that’s picked the most invasive thing in there, that stays forever. So a lot of our mindset around product development is based upon that; increased conductivity and provide apps that help us with reservoir.

Unidentified Analyst

Gary, Ernesto thank you. Gary and Ernesto will be available on the Riverside Ballroom for further questions.

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