CRR CARBO Ceramics Inc

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

($ in thousands, except per share data)

(Unaudited)

The accompanying unaudited consolidated financial statements of CARBO Ceramics Inc. have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required for complete financial statements.  In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation have been included.  The results of the interim periods presented herein are not necessarily indicative of the results to be expected for any other interim period or the full year.  The consolidated balance sheet as of December 31, 2018 has been derived from the audited financial statements at that date.  These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2018 included in the annual report on Form 10-K of CARBO Ceramics Inc. for the year ended December 31, 2018.

The consolidated financial statements include the accounts of CARBO Ceramics Inc. and its operating subsidiaries (the “Company”).  All significant intercompany transactions have been eliminated.

The Company is currently producing ceramic technology proppants from its Eufaula, Alabama manufacturing facility, base ceramic proppants from its Toomsboro, Georgia manufacturing facility, and processing sand at its Marshfield, Wisconsin facility.  The Company also produces ceramic media at its McIntyre, Georgia and Eufaula, Alabama facilities.  The Company is also using its Toomsboro, Georgia facility for contract manufacturing.  In addition, the Company produces resin-coated ceramic proppants at its New Iberia, Louisiana facility.  The Company continues to assess liquidity needs and manage cash flows.  As a result of the steps the Company has taken to enhance its liquidity, the Company currently believes that cash on hand and cash flows from operations will enable the Company to meet its working capital, capital expenditure, debt service and other funding requirements for at least one year from the date this Form 10-Q is issued.  Our financial forecasts in recent periods have proven less reliable given customer demand, which is highly volatile in the current operating environment and no committed sales backlog exists with our customers.  As a result, there is no guarantee that our financial forecast, which projects sufficient cash will be available to meet planned operating expenses and other cash needs, will be accurate.  In the event that the Company experiences lower customer demand, lower prices for its products and services, or higher expenses than it forecasted, or if the Company underperforms relative to its forecast, the Company could experience negative cash flows from operations, as has been the case in prior years, which would reduce its cash balances and liquidity.    

The second phase of the retrofit of our Eufaula, Alabama plant with the new KRYPTOSPHERE ^® technology has been suspended until such time that market conditions improve enough to warrant completion.  As of March 31, 2019, the value of the assets relating to this project totaled approximately 83% of the Company’s total construction in progress and the project is approximately 75% complete.  

Deferred Taxes – Valuation Allowance

Accounting Standards Codification (“ASC”) Topic 740, Income Taxes, provides the carrying value of deferred tax assets should be reduced by the amount not expected to be realized.  A company should reduce deferred tax assets by a valuation allowance if, based on the weight of all available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized.  ASC 740 requires all available evidence, both positive and negative, be considered to determine whether a valuation allowance for deferred tax assets is needed in the financial statements.  Additionally, there can be statutory limitations on the deferred tax assets should certain conditions arise.    As a result of the significant decline in oil and gas activities and net losses incurred over the past several years, we believe it is more likely than not that a portion of our deferred tax assets will not be realized in the future.  Our valuation allowance against a portion of our deferred tax assets as of March 31, 2019 was $76,604.  Our assessment of the realizability of our deferred tax assets is based on the weight of all available evidence, both positive and negative, including future reversals of deferred tax liabilities.

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Restricted Cash

A portion of the Company’s cash balance is restricted to its use in order to provide collateral primarily for letters of credit, corporate cards and funds held in escrow relating to the sale of its Millen plant.  As of March 31, 2019 and December 31, 2018, total restricted cash was $10,578 and $10,565, respectively.

Lower of Cost and Net Realizable Value Adjustments

As of March 31, 2019, the Company reviewed the carrying values of all inventories and concluded that no adjustments were warranted for finished goods and raw materials intended for use in the Company’s manufacturing process.

Manufacturing Production Levels Below Normal Capacity

As a result of the Company substantially reducing manufacturing production levels, including by idling certain facilities, certain production costs have been expensed instead of being capitalized into inventory.  The Company expenses fixed production overhead amounts in excess of amounts that would have been allocated to each unit of production at normal production levels.  For the three months ended March 31, 2019 and 2018, the Company expensed $8,484 and $9,723, respectively, in production costs.

Long-lived and Other Noncurrent Assets Impairment

The Company has temporarily idled production at various manufacturing facilities.  The Company does not assess temporarily idled assets for impairment unless events or circumstances indicate that the carrying amounts of those assets may not be recoverable. Short-term stoppages of production for less than one year do not generally significantly impact the long-term expected cash flows of the idled facility.   As of March 31, 2019, the Company concluded that there were no events or circumstances that would indicate that carrying amounts of long-lived and other noncurrent assets might be impaired.  However, the Company continues to monitor market conditions closely.  Further deterioration of market conditions could result in impairment charges being taken on the Company’s long-lived and other noncurrent assets, including the Company’s manufacturing plants, goodwill and intangible assets.  The Company will evaluate long-lived and other noncurrent assets for impairment at such time that events or circumstances indicate that carrying amounts might be impaired.

Reclassification of Prior Period Amounts

Certain prior period financial information has been reclassified to conform to current period presentation.

The following table sets forth the computation of basic and diluted loss per share under the two-class method:

Natural gas is used to fire the kilns at the Company’s manufacturing plants.   In an effort to mitigate volatility in the cost of natural gas purchases and reduce exposure to short term spikes in the price of this commodity, we previously contracted in advance for portions

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of our future natural gas requirements.  Due to the severe de cline in industry activity beginning in early 2015, the Company significantly reduced production levels and consequently did not take delivery of all of the contracted natural gas quantities.  As a result, the Company had accounted for the relevant contrac ts as derivative instruments.  However, as of December 31, 2018, the last derivative contract expired and no future natural gas obligations existed.

During the three months ended March 31, 2019 and 2018, the Company recognized a gain on derivative instruments of $0 and $218, respectively, in cost of sales.

The Company leases certain property, plant and equipment under operating leases, primarily consisting of railroad equipment leases, certain distribution center assets and real estate.  Leases with an initial term of twelve months or less are not recorded on the balance sheet.

Most leases include one or more options to renew, with renewal terms that can extend the lease term from one to ten years or more. The exercise of lease renewal options is typically at the Company’s sole discretion. Certain leases also include options to purchase the leased property.

As a result of the underutilization of some of the Company’s assets, we rent or sublease certain assets to third parties, primarily consisting of a portion of our railroad equipment and distribution center assets.

We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets, operating lease liabilities, and noncurrent operating lease liabilities on our consolidated balance sheets.

Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives and initial direct costs incurred. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. As of March 31, 2019, it is not reasonably certain that we will exercise any of these options.  Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.  

We have lease agreements with lease and non-lease components, which are accounted for as a single lease component, primarily related to railroad equipment leases.

The components of lease cost were as follows:

^{( a )} As a result of the adoption of ASC 842, sublease income is classified within revenues for three-months ended March 31, 2019.  Prior to the adoption, sublease income was recorded as a reduction to cost of sales.  Sublease income excludes rental income from owned assets of $406, which is recorded within revenues.

Future minimum lease payments under non-cancellable leases as of March 31, 2019 were as follows:

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The adoption of ASC 842 resulted in the Company recording a right of use asset of $56,591 and a total lease liability of $64,877 on January 1, 2019.  The Company also reduced its other long-term liabilities by approximately $6,500 and accrued expenses by approximately $ 1,800 as of January 1, 2019 given that deferred rent is now included within the total lease liability.  These adjustments represented non-cash changes during the period ended March 31, 2019.

Other information related to leases was as follows:

For the three months ended March 31, 2019, the weighted average remaining lease term was 5.75 years and the weighted average discount rate was 10.3%.

T he Amended and Restated 2014 CARBO Ceramics Inc. Omnibus Incentive Plan (the “Amended and Restated 2014 Omnibus Incentive Plan”)  provides for granting of cash-based awards, stock options (both non-qualified and incentive) and other equity-based awards (including stock appreciation rights, phantom stock, restricted stock, restricted stock units, performance shares, deferred share units or share-denominated performance units) to employees and non-employee directors.   As of March 31, 2019, 100,528 shares were available for issuance under the Amended and Restated 2014 Omnibus Incentive Plan.

A summary of restricted stock activity and related information for the three months ended March 31, 2019 is presented below:

As of March 31, 2019, there was $4,844 of total unrecognized compensation cost related to restricted shares granted under the Amended and Restated 2014 Omnibus Incentive Plan.  That cost is expected to be recognized over a weighted-average period of 2.4 years.  The total fair value of shares vested during the three months ended March 31, 2019 was $1,011.  For restricted stock awards granted to certain executives of the Company, there is a holding period requirement of two years after the vesting date.  For the portion of such awards that are not expected to be withheld to satisfy tax withholdings, the grant date fair value for the January 2019 awards was discounted for the restriction of liquidity by 20.6%, which was calculated using the Finnerty model.

The Company made market-based cash awards to certain executives of the Company pursuant to the Amended and Restated 2014 Omnibus Incentive Plan.  As of March 31, 2019, the total target award outstanding was $3,019.  The payout of awards can range from 0% to 200% based on the Company’s Relative Total Shareholder Return calculated over a three year period beginning January 1 of the year each grant was made.  During the three months ended March 31, 2019, a total of $708 was paid relating to the 2016 grant, which was approximately 61% of the total target award. During the three months ended March 31, 2018, a total of $526 was paid relating to the 2015 grant, which was approximately 76% of the total target award.

The Company also granted phantom stock and cash-settled restricted stock units (collectively discussed as “phantom stock”) to certain key employees pursuant to the Amended and Restated 2014 Omnibus Incentive Plan.  The units subject to a phantom stock award vest and cease to be forfeitable in equal annual installments over a three-year period.  Participants awarded units of phantom stock are entitled to a lump sum cash payment equal to the fair market value of a share of Common Stock on the vesting date.  In no event will Common Stock of the Company be issued with regard to outstanding phantom stock awards.  As of March 31, 2019, there were 319,892 units of phantom stock granted under the Amended and Restated 2014 Omnibus Incentive Plan, of which 115,020 have vested and 27,862 have been forfeited.  As of March 31, 2019, nonvested units of phantom stock under the Amended and Restated 2014 Omnibus Incentive Plan had a total value of $620, a portion of which is accrued as a liability within Accrued Payroll and Benefits.  Compensation expense for these units of phantom stock will be recognized over the three-year vesting period.  The amount

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of compensation expense recognized each period will be based on the fair value of the Company’s common stock at the end of each per iod.

On March 2, 2017, the Company entered into an Amended and Restated Credit Agreement (the “New Credit Agreement”), as last amended on June 7, 2018, with Wilks Brothers, LLC (“Wilks”) to replace its term loan with Wells Fargo Bank, National Association (“Wells Fargo”) and provide the Company with additional liquidity for a longer term.  The New Credit Agreement is a $65,000 facility maturing on December 31, 2022, that consists of a $52,651 term loan that was made at closing to pay off Wells Fargo and an additional term loan of $12,349 that was made to the Company after the Company satisfied certain post-closing conditions.  The $52,651 term loan was a non-cash transaction to the Company as Wilks directly paid Wells Fargo and assumed the New Credit Agreement.  The Company’s obligations bear interest at 9.00% and are guaranteed by its two operating subsidiaries.  No principal repayments are required until maturity (except in certain circumstances), and there are no financial covenants.

The loan cannot be prepaid during the first three years without making the lenders whole for interest that would have been payable over the entire remaining term of the loan.  The Company’s obligations under the New Credit Agreement are secured by: (i) a pledge of all accounts receivable and inventory, (ii) cash in certain accounts, (iii) domestic distribution assets residing on owned real property, (iv) the Company’s Marshfield, Wisconsin and Toomsboro, Georgia plant facilities and equipment, and (v) certain real property interests in mines and minerals.  Other liens previously in favor of Wells Fargo were released.  

As of March 31, 2019, the Company’s outstanding debt under its New Credit Agreement was $65,000.   Within 270 days of completion of all post-closing matters relating to the sale of its Millen, Georgia plant, the Company is required to use 100% of the Net Cash Proceeds (as defined in the New Credit Agreement) from the sale to either (1) prepay the outstanding principal amount of the Term Loans or (2) reinvest in fixed or capital assets of any Credit Party (as defined in the New Credit Agreement).  The Company continues to evaluate these options, and the Company is currently in negotiations with its lenders with respect to other options.  As of March 31, 2019, the Company has classified $15,733 of the outstanding debt as current liabilities, which represents an estimate of the Net Cash Proceeds that the Company would be required to prepay if it did not reinvest in fixed or capital assets.  As of March 31, 2019, the fair value of the Company’s long-term debt approximated the carrying value.

As of March 31, 2019, the Company had $640 of unamortized debt issuance costs relating to the New Credit Agreement that are presented as a direct reduction from the carrying amount of the long-term debt obligation.  The Company had $4,625 and $2,625 in standby letters of credit issued through its banks as of March 31, 2019 and December 31, 2018, respectively, primarily as collateral relating to railcar leases.

On March 2, 2017, in connection with entry into the New Credit Agreement, the Company issued a Warrant (the “Warrant”) to Wilks.  Subject to the terms of the Warrant, the Warrant entitles the holder thereof to purchase up to 523,022 shares of the Common Stock, at an exercise price of $14.91 per share, payable in cash.  The Warrant expires on December 31, 2022.   Based on a Form 13F filing with the SEC on February 7, 2019 as of December 31, 2018, Wilks owned approximately 10.7% of the Company’s outstanding common stock as of March 31, 2019, and should Wilks fully exercise the Warrant to purchase an additional 523,022 shares, it would hold approximately 12.3% of the Company’s outstanding common stock.  Upon issuance of the Warrant, the Company recorded an increase to additional paid-in capital of $3,871.  As of March 31, 2019, the unamortized original issue discount was $2,808.

In May 2016, the Company received proceeds of $25,000 from the issuance of separate unsecured Promissory Notes (the “Notes”) to two of the Company’s Directors.  Each Note matured on April 1, 2019 and beared interest at 7.00%.  On March 2, 2017, in connection with the New Credit Agreement, the Notes were amended to provide for payment-in-kind, or PIK, interest payments at 8.00% until the lenders under the New Credit Agreement receive two consecutive semi-annual cash interest payments.   On April 1, 2017, the Company made a $997 interest payment as PIK, and capitalized the resulting amount to the outstanding principal balance.  On October 1, 2017, the Company made a $1,043 interest payment as PIK, and capitalized the resulting amount to the outstanding principal balance.  As of March 31, 2019, the outstanding principal balance of the Notes of $27,040 was recorded within current liabilities.  On April 1, 2019, the Company made a $27,040 payment to repay the Notes.  As of April 25, 2019, the outstanding principal balance of the Notes was $0.

Interest cost for the three months ended March 31, 2019 and 2018 was $2,077 and $2,035, respectively.  Interest cost primarily includes interest expense relating to the Company’s debts as well as amortization and the write-off of debt issuance costs and amortization of the original issue discount associated with the New Credit Agreement and Warrant.

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In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” which amends current lease guidance.  This guidance requires, among other things, that lessees recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.  Lessees and lessors must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements.  In July 2018, the FASB issued ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements,” which simplifies the implementation by allowing entities the option to instead apply the provisions of the new guidance at the effective date, without adjusting the comparative periods presented.  The Company adopted this guidance effective January 1, 2019 without adjusting the comparative periods.  In addition, the Company elected the package of practical expedients permitted under the guidance, which among other things, allowed the Company to carry forward the historical lease classification.  As of March 31, 2019, the Company’s operating lease ROU asset was $54,452 and its total lease liability was $63,362.  In addition, upon implementation, the Company’s deferred rent balances, recorded primarily within other long-term liabilities and accrued expenses as of December 31, 2018, of approximately $8,300 were removed and recorded to the lease liability.  The Company has implemented a lease accounting system for accounting for leases under the new standard.  There were no significant impacts to the consolidated statement of operations and consolidated statement of cash flows.  See Note 4 for additional information.

On July 28, 2016, the Company filed a prospectus supplement and associated sales agreement related to an at-the-market (“ATM”) equity offering program pursuant to which the Company may sell, from time to time, common stock with an aggregate offering price of up to $75,000 through Cowen and Company LLC, as sales agent, for general corporate purposes.   During the three months ended March 31, 2019, the Company sold a total of 893,650 shares of its common stock under the ATM program for $3,453, or an average of $3.86 per share, and received proceeds of $3,375, net of commissions of $78.   As of March 31, 2019, the Company had sold a total of 4,599,586 shares of its common stock under the ATM program for $52,980, or an average of $11.52 per share, and received proceeds of $51,788, net of commissions of $1,192.  Subsequent to March 31, 2019, the Company sold an additional 356,350 shares of its common stock under the ATM program for $1,259, or an average of $3.53 per share, and received proceeds of $1,231, net of commissions of $28.

The Company has two operating segments: 1) Oilfield and Industrial Technologies and Services and 2) Environmental Technologies and Services.  Discrete financial information is available for each operating segment.  Management of each operating segment reports to our Chief Executive Officer, the Company’s chief operating decision maker, who regularly evaluates income before income taxes as the measure to evaluate segment performance and to allocate resources.   The accounting policies of each segment are the same as those described in the summary of significant accounting policies in Note 1 of the consolidated financial statements included in the annual report on Form 10-K for the year ended December 31, 2018.

The Company’s Oilfield and Industrial Technologies and Services segment manufactures and sells ceramic technology products and services, base ceramic proppant and frac sand for both the oilfield and industrial sectors.  These products have different technology features and product characteristics, which vary based on the application for which they are intended to be used.  The various ceramic products’ manufacturing processes are similar.

Oilfield ceramic technology products, base ceramic proppant and frac sand proppant are manufactured and sold to pressure pumping companies and oil and gas operators for use in the hydraulic fracturing of natural gas and oil wells.   The Oilfield and Industrial Technologies and Services segment also promotes increased production and Estimated Ultimate Recovery (“EUR”) of oil and natural gas by providing industry-leading technology to  Design, Build, and Optimize the Frac ^® .  Through our wholly-owned subsidiary StrataGen, Inc., we sell one of the most widely used fracture stimulation software under the brand FracPro and provide fracture design and consulting services to oil and natural gas E&P companies under the brand StrataGen.

The Company’s industrial ceramic technology products are manufactured at the same facilities and using the same machinery and equipment as the oilfield products, however they are sold to industrial companies.  These products are designed for use in various industrial technology applications, including, but not limited to, casting and milling.  The Company’s chief operating decision maker reviews discreet financial information as a whole for all of the Company’s manufacturing, consulting and software businesses.  Manufacturing includes the manufacture of technology products, base ceramics, industrial ceramics, sand and contract manufacturing, regardless of the industry the products are ultimately sold to.  See Note 10 for disaggregated revenue information.

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The Company’s Environmental Technologies and Services segment designs, manufactures and sells products an d services intended to protect clients’ assets, minimize environmental risks, and lower lease operating expense (“LOE”).  AGPI, a wholly-owned subsidiary of the Company, provides spill prevention, containment and countermeasure systems for the oil and gas and other industries.  AGPI uses proprietary technology designed to enable its clients to extend the life of their storage assets, reduce the potential for spills and provide containment of stored materials.

Summarized financial information for the Company’s operating segments for the three months ended March 31, 2019 and 2018 is shown in the following tables.  Intersegment sales are not material.

Sales of oilfield technology products and services, consulting services, and FracPro software sales are included within Technology products and services.  Sales of industrial ceramic products, industrial technology products and contract manufacturing are included within Industrial products and services.  Sales of oilfield base ceramic and sand proppants, as well as railcar usage fees are included within Base ceramic and sand proppants.  Sublease and rental income primarily consists of the sublease of certain railroad equipment and rental income related to leases on some of our underutilized distribution center assets.  As a result of the adoption of ASC 842 as of January 1, 2019, these amounts were classified within revenues during the three months ended March 31, 2019.  These amounts were classified as a reduction of costs for the period ended March 31, 2018.  See Note 4.  

The Company is subject to legal proceedings, claims and litigation arising in the ordinary course of business.  While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

On April 1, 2019, the Company repaid a total of $27,040 related to two separate unsecured Promissory Notes with a current and former Director of the Company.

During April 2019, the Company sold an additional 356,350 shares of its common stock under the ATM program for $1,259, or an average of $3.53 per share, and received proceeds of $1,231, net of commissions of $28.

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