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Carbo Ceramics Inc  (NYSE:CRR)
Q3 2018 Earnings Conference Call
Oct. 25, 2018, 11:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello and welcome to today's CARBO Ceramics Inc. Third Quarter 2018 Earnings Conference Call. Please be advised this call is being recorded today, October 25th, 2018 and your participation implies consent to our recording this call. If you do not agree to these terms, simply disconnect.

Some of our comments today may include forward-looking statements, reflecting the company's view about future prospects, revenues, expenses or profits. These matters involve risks and uncertainties that could cause actual results to differ materially from our forward-looking statements. 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. Our comments today also include non-GAAP financial measures. These non-GAAP measures including EBITDA and adjusted EBITDA are not a substitute for GAAP measures and may not be comparable to similar measures of other companies. A reconciliation of net loss to EBITDA and adjusted EBITDA as discussed on this call is presented in the Company's earnings release, which is available on its website.

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 -- President, Chief Executive Officer

Thank you and welcome everyone to our third quarter 2018 earnings call. Before I discuss the third quarter, I want to discuss three key accomplishments we have achieved in our transformation strategy. These steps are important to understand the shareholders as they outline our long-term growth and profitability strategy. We have a clear strategy and a very experienced management team committed to execute it.

First, we have had very good year-to-date growth in our industrial and environmental businesses with each growing approximately 45%. We expect to keep growing these business sectors in the years ahead. Year-to-date, they are approximately 22% of our total revenue and we would like to keep increasing their percentage every year moving forward. We are focused on growing these two business sectors to increase our profitability and offset the deep cyclicality of the oilfield.

Second, we have had good year-to-date growth in our oilfield business in technology ceramic products, STRATAGEN consulting and FracPro software. We expect these subsectors to continue to perform well as we move into the future. This is important to understand as we have technology and technical experts that no other competitor has and E&P operators acknowledge this. The other two subsectors, base ceramic and sand are influenced by industry activity. We manage them with the goal of being cash producers.

Third, we've done a good job of reducing structural costs, finding new avenues of revenue generation for our idle plant assets, investing in new technology and building a very strong balance sheet. We ended the quarter with $59 million in cash. And with the LoI on the sale of Millen plant for $26 million, it implies a net debt of less than $10 million.

Now turning to the third quarter; we are pleased with the growth rates of both our industrial and environmental business sectors as a result of our long-term growth strategy to diversify our revenue streams. I'm confident we have the right strategy, technology and assets to execute our transformation plan. Although our oilfield sector revenue was down year-on-year, we're very pleased to see our oilfield technology revenue grow in what remains a tough environment. In addition, we are able to improve our cash position from the second quarter. A decline in oil & gas completion activity along with the increases in sand supplies from new regional sand mines impacted our oilfield business during the third quarter. Adjusting to this market decline, we incurred approximately $400,000 of severance during the third quarter.

Now, for a brief discussion on our business sectors. The oilfield sector; Oilfield technology ceramic revenue increased 20% year-on- year. The year-on-year increase was driven by strong sales of KRYPTOSPHERE HD. Our technology product portfolio continues to demonstrate its high value through increased usage in oil and gas wells. STRATAGEN consulting revenue increased 31% year-on-year. Trust in our expert field consultants to manage fracture completions continues to drive new client growth.

Base ceramic revenue, adjusted for the sale of our Russia's ceramic business, increased 26% year-on-year. Base ceramic is difficult to forecast due to uncertainty regarding timing of jobs, including clients' propensity to change completion designs. Frac sand-related revenues decreased 18% year-on-year. The pressure on our frac sand business increased as the quarter progressed, due to the decline in oil and gas activity, and more regional sand supply coming online. This negatively impacted both sales volumes and average selling prices.

Moving to the industrial sector, revenue grew 41% year-on-year. We continue to build upon the foundry and grinding markets we have served for decades as well as expanding into other industrial markets. Successful results from previous conversions have provided a tailwind for the marketing of our foundry products. We were recently awarded for full sand-to-ceramic foundry conversions, utilizing our ACCUCAST ceramic media. Our expanding grinding market product offerings provides us the ability to address a broader range of both fine and ultra-fine grinding applications.

Contract manufacturing revenue reached new high during the third quarter. Increasing contract manufacturing revenue is important in achieving our goal of returning the Company to profitability and this revenue stream will have high incremental margins as we layer in these opportunities.

In environmental sector, ASSETGUARD revenues for the third quarter of 2018 increased 73% year-on-year, driven by increased GROUNDGUARD sales and other manufactured products. During the quarter, GROUNDGUARD was utilized in a new application to line a three acre recreational pond for a client. This is another example of how we continue to expand the applications for our products outside the oilfield.

Before turning to a brief overview of our third quarter financial results, I wanted to highlight two important events that bode well for CARBO. First, we recently signed a non-binding Letter of Intent to sell our Millen plant for approximately $26 million. We decided to monetize this asset as there is no near-term or intermediate term use on the horizon. We eliminate the ongoing cost of this facility, while strengthening our cash levels and maintaining a strong balance sheet. And we expect this transaction to close before year-end.

We also signed a non-binding Letter of Intent to contribute certain idle assets for a minority ownership in PicOnyx, developer of M-Tone, a new family of functional pigments for the plastics, paints, ink, coatings and adhesive markets. This transaction is consistent with our long-term growth strategy to diversify our revenue streams outside of the oilfield and in particular, invest in new technology. We believe this is a great opportunity for us to get certain idled assets back to work and anticipate the manufacturing operation to be operational in early 2019. We believe PicOnyx, novel black pigment technology combined with our high-quality consistent manufacturing capabilities will capture market share in an estimated $2 billion market, as there's already customer interest and desire to see PicOnyx scale up. The next 12 months, would be telling as PicOnyx ramps up its business but we believe the opportunity to be a solid EBITDA contributor to CARBO.

Now a brief overview of the third quarter financial results, revenues for the third quarter of $53.8 million increased 7% compared to $50.2 million in the same period of 2017. The largest contributors to this increase were oilfield technology products, environmental products and industrial products. The year-on-year increase in revenue combined with a more favorable sales mix, contributed to an incremental gross margin of 268%. Operating loss for the third quarter of 2018 improved to $14.8 million as compared to $177.1 million in the same period of last year, primarily due to prior-year charges that did not reoccur, a reduction in certain fixed structural costs combined with the increases in revenues. Approximately 67% of the operating loss for the third quarter of 2018 consisted of non-cash expenses. Cash and cash equivalents, and restricted cash grew sequentially by approximately $4 million to $59 million.

Year-to-date, we've experienced a very strong 65% adjusted EBITDA incremental margin. Although reduced completion activity along with seasonality will impact fourth quarter revenue, we expect to see improved year-on-year margins in the fourth quarter of 2018 as well. In North America, the combination of lower completion activity, customers' budget exhaustion, and additional regional sand capacity coming online, leads us to estimate our full-year 2018 consolidated revenue will approximate $210 million. The main driver for the reduced revenue forecast for the full year of 2018 is softening industry demand for both our base ceramic and frac sand proppants. In addition, this decline in industry activity has shifted our path to positive EBITDA into next year.

We continue to be very encouraged by customer interest in our three sectors technology products increasing international activity and the expected recovery in the North American oil field in 2019. This combined with continued reduction in structural costs gives us confidence in reaching positive EBITDA. We expect our efforts to reduce working capital levels and the sale of the Millen plant to strengthen cash levels and maintain a very strong balance sheet. In the oil field sector, we expect our ceramic technology sales to finish the year strong relative to the third quarter of 2018, driven by sales in KRYPTOSPHERE the Guard family, NRT and CARBOAIR products.

Demand for STRATAGEN's consulting services is expected to stay healthy during the fourth quarter of 2018. We have seen our client list expand as operators rely on STRATAGEN to provide consulting services to optimize their well completions and enhance production.

Our software business is expected to be steady during the fourth quarter of 2018, following the modest growth pattern we have seen in Fracpro sales throughout the year. We continue to look for new opportunities to grow our software business. Due to the well-publicized lower completion activity in the industry, we now believe our full revenues for base ceramic and sand to be down 20% to 25% from where we anticipated as we exited the second quarter of 2018.

In base ceramic proppants, one of our strategies to reduce working capital is to change the traditional business model from manufacturing and stocking of inventory, to one which incorporates production on demand along with upfront cash commitments. For frac sand, we are very pleased to have signed a contract for an estimated 550,000 tons of annual capacity during the third quarter of 2018, which will offset some of the softening demand we've encountered during the quarter. The benefits of the contract include the use of our sand facility, rail cars and distribution center.

In the Industrial sector, we anticipate our industrial revenues to increase year-on-year during the fourth quarter driven by increased industrial ceramic media sales along with continued contract manufacturing revenue. The client gains we have made in industrial ceramic and contract manufacturing this year is building a growing base of business for 2019. The Industrial sector outlook through 2019 is positive and we should continue to see double digit revenue growth along with strong margins.

In the environmental sector, ASSETGUARD continues to perform well and its profitability has significantly improved year-on-year. Given the recent slowdown in oil and gas activity, we believe the fourth quarter will result in more modest growth year-on-year than what we witnessed in the third quarter of 2018. We also expect continued growth in industrial application for ASSETGUARD's products.

As demonstrated by our evolving revenue mix, our long term growth strategy to diverse our revenue streams across multiple industries is proving to be successful. Swings in oilfield activity have a significant impact on us today but successful execution of our transformation strategy will help lessen the negative impact of those swings and improve our profitability. Maintaining healthy cash levels during this transformation is key and we continue to take actions to maintain a strong balance sheet.

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

Questions and Answers:

Operator

We will now begin the Question and Answer session (Operator Instruction). Your first question comes from Stephen Gengaro with Stifel. Please go ahead.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Thanks. Good morning, gentlemen.

Gary Kolstad -- President, Chief Executive Officer

Good morning.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Two things but I'll start there's been signs of deepwater improvements starting to get hold a little bit and do you -- what is your market opportunity there, how should we think about that from a KRYPTOSPHERE perspective as you look into 2019?

Gary Kolstad -- President, Chief Executive Officer

Well, any of the real deep wells, sometimes called Lower Tertiary wells, we do extremely well there and almost exclusively well there with KRYPTOSPHERE HD. It's really the only proppant that can withstand those pressures and then there's this real neat thing that takes place. The smooth surface of our KRYPTOSPHERE allows the operators and the service companies to do multiple fracs with the same tool string so they don't have to run in and out of the hole and with the day rates and stuff offshore, we recently had one of the super majors tell us that it saved them, I think was close to $2 million on a single well. So you have the combination of great conductivity as well as the ability to run multiple fracs and not have to poll and have delays.

So we do extremely well there, there's also a growing use of KRYPTOSPHERE LD for the Gulf of Mexico for wells that aren't that deep then don't have those stress levels. Once again you have the same thing, you have high conductivity, smooth surface all those things. So we do extremely well there and I think we will continue to do well outside the Gulf of Mexico, wherever there are deep critical wells. So the marketing team has done a great job there and actually a lot of the clients are good salesmen for us too because there's generally co-ownership among all those deep wells.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

And have you seen any early increase yet and if not sort of what's the general timing when you would kind of hear about a potential project versus when you would ship product?

Gary Kolstad -- President, Chief Executive Officer

Well, we've basically been involved in all the projects, so it's just ongoing with us. If your question is more on just the activity of deepwater, I think we've been told which we can't disclose all that but we've been told what they think their activity is for 2019 and I think you should logically think that the second half of 2019 would probably see increased activity moving forward into the coming years. So you guys probably keep up with rig bids and stuff like that. So I think there's been a lot more enthusiasm about getting back in the game there as we get into the latter part of 2019 but there'll be work in the first half of 2019 too for us.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Thank you. And then just as a second question, what is your current take on in basin versus Northern White and how operators are looking at that balance and any color from your perspective on that?

Gary Kolstad -- President, Chief Executive Officer

I think it's absolutely cost driven and when you look at onshore US or North America, it's not an engineering decision anymore, it's a cost decision and in low perm rocks they'll put anything and then they're just increasing the contact area, right. So just pump more stages, pump more sand, no matter how bad it is. So that's the nature of that beast.

Now, if we ever go back to high permeability rocks, which is kind of international, Gulf of Mexico, all these other things, it would be pretty silly to do what we're doing in onshore US or onshore Canada, because there you need conductivity. But now we think you've seen it happen, right, I mean any place there's fracturing, there's a sand mine opening up regionally and we heard anecdotal comments about well we're seeing better production out of Northern White. But ultimately somebody comes in and says, yeah, but it's lower cost here. So we don't get too worried about that, we just do what we do and move on, but yes it's just taking place.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Great. Well thank you for the color.

Operator

Our next question comes from Bill Dezellem with Tieton Capital Management. Please go ahead.

Bill Dezellem -- Tieton Capital Management -- Analyst

Thank you. I have a group of questions. First of all, beyond KRYPTOSPHERE and SCALEGUARD, what technologies are you anticipating or seeing that you think will be likely to have the biggest opportunity to contribute to revenues on a material basis going forward?

Gary Kolstad -- President, Chief Executive Officer

We'd probably, a little bit call it the Guard family, we had a lot of success up the Northeast with SALTGUARD, which obviously by the name inhibits salt. And there's a lot of clients that have that problem. One of the things about the Guard family, we know the technology works, the challenge is that oftentimes the capital driven versus the CapEx versus OpEx thing gets in the way to where the completions people will just do their thing and try and lower cost versus the operating people or production people have to live with the problems forever.

So for us we have to cover both of them. In small companies it works very easy because all of the management is sitting around the table. In big company it's more difficult to sell it, but that's a little bit away from your question.

But -- so it's SCALEGUARD, SALTGUARD, we have a product that we haven't commercialized called H2SGUARD. We have some interest in the various other things like asphaltene and paraffin, which we would gladly participate in, but we want some funding from E&P on that on specific applications. We've seen a lot more interest in CARBOAIR this year, which is a really cool product. It is 25% lighter than sand. And so you get the transportation and the better frac geometry by using it. So, that's caught on a little bit. NRT, which stands for nonradioactive tracer is having a real good year, and we're doing some things there to expand our tracer line. And then, we have that incredible technology quantum, but we're still trying to lower the cost of that from the detectable proppant side.

So it's still more in the science mode with E&P operators, but it is unbelievable technology. Then if you look on the industrial side, we're putting out a much broader range of grinding products. We really like this investment in PicOnyx because that just fits our strategy to get underutilized assets working. And this will be a very high-end technology product that can probably go a long way to replacing carbon black. Both from a performance and an environmental standpoint, it just stands out.

So we love that kind of stuff. On the contract manufacturing, we probably -- we're always looking for things and it could be in the catalyst market, it could be in various other industrial-type markets. So we have a very broad range of technologies. And our environmental business, too, is, obviously, the leader in the world of polyurea technology and the products it can go in. So we have a mentality, as the management team, that we love technology. We are genetic hard wired to it. And we like it in all of our businesses and it's what we think about every day, because it's the only way you ever get away from the commoditization of upstream oil field, which has a terrible history of doing that. So, we'll do well in all three sectors we work in with technology.

Bill Dezellem -- Tieton Capital Management -- Analyst

Okay. So I'm going to ask if it's possible to narrow down that wide range of options to say, the top two that you think over the next, let's say, two years that are going to contribute to revenue in the most meaningful way?

Gary Kolstad -- President, Chief Executive Officer

In the oilfield there will be KRYPTOSPHERE, whether that's HD or LD in the GUARD family. In industrial, it will be the grinding products, CARBOGRIND.

Bill Dezellem -- Tieton Capital Management -- Analyst

And CARBOGRIND --

Gary Kolstad -- President, Chief Executive Officer

And the recent investment in PicOnyx.

Bill Dezellem -- Tieton Capital Management -- Analyst

So let's say, CARBOGRIND just for a moment, do you -- how material are you anticipating that revenue contribution to be, say, relative to the GUARD family?

Gary Kolstad -- President, Chief Executive Officer

Probably bigger. We don't like to talk too much about that for obvious reasons, competitive reasons, but, yes, it will be a bigger contributor.

Bill Dezellem -- Tieton Capital Management -- Analyst

Okay, that's quite helpful. And then --

Gary Kolstad -- President, Chief Executive Officer

I'd say that in terms, Bill, of -- keep in mind that the client base, when we look at this, is completely different. And the oil -- upstream oilfield, of course, is very competitive. And if you work on the industrial side, you have longer-term contracts, which make us -- it takes longer to win them, but they're usually several years in duration. And the clients are sticky, once they find a good technology -- and that's why I say it. So they've got good margin, but your -- just your volume in your contractual side is much more secure.

Bill Dezellem -- Tieton Capital Management -- Analyst

That's very helpful. And then you did reference PicOnyx and that relationship could be material. Would you go into some more detail at how you anticipate that relationship to unfold? I mean the comments in the press release were helpful, but really more sparked curiosity and probably created more questions for me than it did answer. So can you fill in as many blanks as possible, please?

Gary Kolstad -- President, Chief Executive Officer

Okay. First of all, from a product standpoint, I would direct you to Melior Innovations, that's the parent company and then you can go into details about the product and what they put out there. On our part, we have an equity position today, as you know, and we can grow that equity position. And so we would like to just probably throw out there, it's roughly 15%, could be 20%. And then longer-term, what we like to see, assuming that product is successful maybe we'd be the logical handoff for that product and ownership of that product completely.

So we like the approach we're going in with it. It's a good partnership we have. They are a very talented -- Melior Innovations is a good technology incubator, I'd call them, and this is one of their companies. We like the fact too, we have a commercial arrangement to get paid for the manufacturing of the product. So we have that as well as an equity investment. And so you have two things going there that really work for us. And you know us, one thing we're really good at is marketing and sales and technology.

So you'd get us excited about something, and we'd push like hell on that to grow that. So, we're pretty excited about that, and we're glad we got it over the finish line, so now we can just push operations to get going. They have enormous amount of client interest actually. And yet beyond -- this isn't a North America thing, this is carbon black used around the world and it's an extremely large market. But we and PicOnyx will be targeting the specialty market, which has a much higher margin. And just the performance characteristics are really quite interesting. So they really -- and they've got IP on it of course. So we're pretty excited about it. We're just anxious to go, go, go now.

Bill Dezellem -- Tieton Capital Management -- Analyst

And Gary, my familiarity with carbon black is limited, but I think of it -- the primary use as being in tires. Is that when you're talking specialty carbon black where you're going in addition to some of the --

Gary Kolstad -- President, Chief Executive Officer

That's just the opposite, Bill. Just the opposite. That's the high volume, low value. Just the opposite spectrum. And once again, you could go to their website and learn more than I can probably teach you in this short time. But the -- it's really the high end. And you might imagine high performance automobiles, high-temperature, high corrosion, all that stuff is just a better product. And literally, I mean, if you look around you, wherever you are at, anything that's black, of course, has black pigment in it, right? But no, it's not the rubber side, it's not the tire side though, we'll leave that to others.

Bill Dezellem -- Tieton Capital Management -- Analyst

Great, that's helpful. And may I ask a couple more questions or would you prefer I jump back in the queue?

Gary Kolstad -- President, Chief Executive Officer

You might still keep going. I mean, you're doing good so far, right?

Bill Dezellem -- Tieton Capital Management -- Analyst

Right, thank you. Relative to the frac sand contract that you referenced in the release, would you talk in a bit more detail about that contract? How it came about, and the financial implications for you, please?

Gary Kolstad -- President, Chief Executive Officer

Yes. It was a very welcome contract. We are working with an E&P company that has some great assets, but coincidently their great assets are close to our assets, meaning distribution center, that whole distribution channel. So the value existed there when you combine both of those things. And that's why we like it, they like it, and we've already started on it. It will ramp up. And for the most part kind of that gets pretty well to consuming our Marshfield, Wisconsin plant, which we really like.

So economically it's a real good fit for us when you use our railcars, you use our distribution center, you kind of do the bulk of our Marshfield plant. That's a real good thing for us. I don't think that we spell out revenue or anything like that, that's not our nature, right. But we like the business, we like the operator and we like the relationship, and we look forward to ramping it up. Q3 of course is pretty tough for everybody, right? There's a puzzle around the U.S. or North America, had to get settled down a little bit. And you're seeing production shutdown. So if you don't have those things I mentioned, as part of that, I think you'll see production come down and then it will grow again whenever your guess is as good as ours and when it starts, whether it's second quarter of 2019 or third quarter or whatever. We listen to the industry just like you do.

Bill Dezellem -- Tieton Capital Management -- Analyst

So this is not a take-or-pay contract, is that correct?

Gary Kolstad -- President, Chief Executive Officer

I don't know of anybody in the industry that has got a take-or-pay contract, really. I mean we need to -- I'm being facetious about that, but we kind of know other way the oilfield works, right? It has the same pattern over multiple years and most of us have been around it for so long, chuckle at the take-or-pay contracts.

Bill Dezellem -- Tieton Capital Management -- Analyst

Right. And so essentially, the intent here from the E&P's perspective is they want to lock up the opportunity to buy that mine's capacity. And I guess, the question -- I want to make sure that's correct, first of all, and then the question is given your comments that only cost is all that seems to matter, whether it would be regional versus the Northern White, what caused or lead this E&P operator to decide they wanted to lock up Northern White as opposed to just going with the less expensive regional providers?

Gary Kolstad -- President, Chief Executive Officer

It has to do with -- this is a regional sand, per se. It's up in the northeast. So we -- you could equivalent, it's Northern -- it's a high-quality Northern White sand, but you can also say we're a regional supplier because that's where it's going. And keep in mind that the whole distribution side of the game is extremely important. So once again we've got the distribution sitting up there, we got railcars, we got a plant, it all came together that way and we both benefit. It's one of those nice occasions where both people see the value and both benefit from it.

Bill Dezellem -- Tieton Capital Management -- Analyst

Great. That is helpful. And then one additional question. The Millen plant sale, are you expecting a loss or a gain on that, and of what magnitude?

Gary Kolstad -- President, Chief Executive Officer

Right. Bill, so we wrote down Millen for book purposes to approximately $19 million. Obviously, assuming a close at the $26 million level, we will have a gain plus or minus $7 million based on where everything shakes out once we close the transaction.

Bill Dezellem -- Tieton Capital Management -- Analyst

Great. Thank you both and look forward to some of these things coming together.

Gary Kolstad -- President, Chief Executive Officer

Right. Thank you, Bill. Well, thanks, everyone, again, for joining us this morning. I want to close by summarizing some key points for you. We've been hit with a pretty big industry change and subsequent business challenge over the last couple of years, but we're very confident that we're headed the right way, and that the solution to building an enduring the company is to profitably grow by diversifying our revenue streams. Everything we do going forward is being done with a well thought out measured pace.

And while we would all like for this to turn around to be overnight, the reality is transformation takes time. We're adding resources to accelerate our industrial and environmental business sectors growth, and we expect to show progress on diversifying the business outside of oilfield. I would like to reiterate a couple of my other earlier points too and said we've had good year-to-date growth in our industrial and environmental business with each growing about 45%. We expect to keep growing those business sectors in the years ahead. We've had good year-to-date growth in oilfield business and technology ceramic products, STRATAGEN consulting and Fracpro software. And we expect these subsectors to continue to perform well as we move into the future too.

And finally, when you consider our quarter-end cash balance along with the announcement (ph) of the Millen plant, it implies net debt of less than $10 million, and we will continue to stay very focused on maintaining a strong balance sheet. With that, I thank you, and we will see you next quarter.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 33 minutes

Call participants:

Gary Kolstad -- President, Chief Executive Officer

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Bill Dezellem -- Tieton Capital Management -- Analyst

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