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CARBO Ceramics Inc. (NYSE:CRR)

Q4 2012 Earnings Call

January 31, 2012 11:30 am ET

Executives

Gary Kolstad – President and Chief Executive Officer

Ernesto Bautista – Vice President and Chief Financial Officer

Analysts

Travis Bartlett – Simmons & Co.

Jeff Tillery – Tudor, Pickering, Holt & Company

Brian Uhlmer – GHS

James West – Barclays Capital

Trey Stolz – Iberia Capital Partners

Blake Hutchinson – Howard Weil

John Keller – Stephens Inc.

Brandon Dobbell – William Blair & Co.

Timothy W. Hurckes – John W. Bristol & Co., Inc.

Robert Christensen – Buckingham Research Group

Trey Cowan – Clarkson Capital Markets

Operator

Hello everyone and welcome to today’s CARBO Ceramics Incorporated Fourth Quarter 2012 Earnings Conference Call. At this time, all participants are in a 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 that today’s call is being recorded today, January 31, 2013, and your participation implies consent to our recording this call. If you do not agree to these terms, please 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, but 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 good morning to everybody. I want to thank you for joining us to discuss CARBO’s fourth quarter 2012 results and our outlook as we move forward into 2013.

We are pleased to report record revenue in 2012 despite a difficult industry environment. We also achieved total proppant sales volume of over £1.71 billion for the year. In particular, we are pleased to have achieved a new record in our ceramic proppant volumes with growth of 5% year-over-year to over £1.54 billion. This growth in ceramic proppant volumes was accomplished despite low natural gas activity and an oversupply of lower quality Chinese ceramic proppant.

In 2012, we engaged in a technical marketing campaign focused on educating the industry of the risks to well production and recovery, when using a lower quality Chinese ceramic proppant. Marketing the benefits of increased well production through Economic Conductivity analysis remains a key focus at CARBO.

Our Consulting and Software businesses both had record performances in 2012. Consulting revenues grew by 33% compared to 2011 as we expanded field operations to support additional client activity. Software revenue grew by 46% compared to 2011 this business continues to capitalize on the industry leading Fracpro platform. Both these businesses complement our proppant business and help us achieve our main mission of improving production and recovery in oil and gas wells.

Falcon Technologies, a business focused on reducing our clients’ environmental risks, also had a record year achieving revenue on $42 million or 21% revenue growth in 2012 compared to 2011. A primary driver of this growth is Falcon’s expanding client base, which grew by 25% in 2012 compared to 2011.

We continued to return cash to our shareholders, increasing the quarterly dividend by 13% in 2012. This marked the 12th consecutive year the Company has increased its dividend.

Turning to a few operational highlights from the fourth quarter of 2012. Total proppant sales volume increased 14% and importantly our ceramic proppant volumes 16% compared to fourth quarter of 2011. Notwithstanding this solid performance, the fourth quarter had its challenges as E&P companies reduced capital spending in the latter part of the quarter.

We remain confident both in the short-term and the long-term demand for our industry-leading, highest conductivity ceramic proppant and accordingly continue our investments in manufacturing capacity and distribution. Initial site preparation and construction began at our location of our next ceramic proppant plant in Millen, Georgia. Separately, we completed the expansion of our distribution center in South Texas late in the fourth quarter of 2012. The expansion of this facility will further our position to meet the needs of our clients.

Brief review of the financial results, revenues for the fourth quarter 2012 decreased 3% compared to the fourth quarter of 2011. North American, which is Canada and the U.S. proppant sales volume increased 12%, while international proppant sales volume increased 27% compared to last year.

Operating profit for the fourth quarter of 2012 decreased 39% compared to fourth quarter 2011. The decrease in operating profit was primarily the result of a decrease in average selling price and a change in product sales mix, partially offset by an increase in proppant sales volume.

On a sequential basis, although our average selling price declined approximately 3%, we were very pleased that our CARBO manufactured ceramic proppant pricing decline was very minimal. Most of the pricing decline was due to resin-coated sand sales. Net income for the fourth quarter of 2012 decreased 40% compared to the fourth quarter of 2011.

For the year ending December 2012, revenues increased 3% compared to 2011. This increase mainly attributed to the increase in proppant sales volume and an increase in the revenues of the company's other business units, partially offset by a decrease in average proppant selling price.

Our worldwide proppant sales volume totaled £1.71 billion for the full year 2012, an increase of 7% compared to 2011. Sales volume in North America increased 3%, primarily due to increases in U.S. sales volume. International sales volume increased 25%, primarily due to the increases in China, Russia, and Mexico, partially offset by a decrease in Europe. Full year net income for 2012 decreased 19% compared to 2011.

Now turning to the outlook, for 2013, we anticipate industry activity will be similar to that of 2012. In North America, we expect liquids-rich drilling activity to remain high, offset by low natural gas drilling activity.

As stated by other oil service companies, E&P activity spending slowed as the fourth quarter progressed and has been slow to recover. This makes it hard to predict the pace at which industry activity will increase and we expect continued quarterly industry fluctuations.

However, we are cautiously optimistic that completion activity will increase as the year unfolds, due to drilling efficiencies, which should be beneficial to all of our businesses. In the proppant market, we believe the supply-demand balance will continue to improve, which should have positive implications for pricing in 2013. We believe both the short-term and long-term positive trend in our sales volume remains intact this has evidenced by our volume growth in a difficult market in a large reduction in low quality Chinese imports. CARBO is differentiating its products through the technical and quality marketing campaign launched in 2012, which highlights important differences between a CARBO ceramic proppants and a lower quality Chinese ceramic proppant.

Our product development is progressing well. Before the end of the year, we plan to introduce a new ceramic proppant. This proppant will dramatically increase the production and ultimate recovery in ultra-deep reservoir completion by increasing the conductivity of the fracture. Applications for this product include the lower tertiary formations in the Gulf of Mexico where depths can reach greater than 30,000 feet, as well as other ultra-high stress completions. Currently, the Company is in the process of scaling up production for this product at its R&D pilot plant. Accordingly, quantities of this product will be limited in 2013. CARBO continues to identify additional product opportunities, which should build upon our successful and long history of leading the industry with innovative, value-added products.

Investments continue to be made to enhance our distribution and manufacturing capabilities. We are targeting completion of an additional distribution center in the Bakken region in the second half of 2013, and the first line of our Millen, Georgia ceramic proppant plant near the end of the first quarter of 2014. The first line at Millen will add 250 million pounds of high quality, high conductivity ceramic proppant capacity, bringing our overall ceramic capacity to 2 billion pounds annually.

As for our other businesses, we expect Consulting, Software and Falcon to have a solid year in 2013. Specifically the Falcon we anticipate revenue growth of approximately 20% in 2013 again. These businesses will continue to provide technical, engineering and environmental solutions to the oil and gas industry.

We will continue to execute on the growth plans we have identified, develop innovative products, provide the highest quality products and services, and focus on our clients’ needs, all while maintaining our long-term view. We believe this strategy will continue to grow an enduring company.

And with that we welcome questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Travis Bartlett from Simmons & Co. Please go ahead with your question.

Travis Bartlett – Simmons & Co.

Hi guys, good morning.

Gary Kolstad President

Good morning.

Ernesto Bautista

Good morning.

Travis Bartlett – Simmons & Co.

Good morning. First of all, one of the service companies out today said that they are seeing higher demand for deepwater completions in high pressure; high temperature areas that I presume would require ceramic proppants. So first of all, can you talk about what you’re seeing today in terms of demand in some of these markets and then provide any outlook that you may have. And then secondly, could you bracket for us what a typical deepwater well might require in terms of proppant usage?

Gary Kolstad

Well in terms of proppant volume, it is pretty small compared to the land operations. The North America land operations just dominate everything. So the volume on those wells would be fairly small. Now, our new product that’s coming out will actually allow E&P operators to actually complete those deep wells and confident about the reservoir not crushing the proppant and not being able to produce them. So that’s literally almost a new market for ceramic proppant. But the volume we do very well offshore around the world, but it’s not a big volume for us. I actually don’t know what the percentage would be, but it would be in the very small single digits.

Travis Bartlett – Simmons & Co.

Okay. And then second of all, I even follow-up on the margin front, it looks like operating margins compressed along the lines of 700 basis points year-over-year in 2012. So first of all, is it reasonable to assume that Q4 marks the trough for margins? And then secondly, can you walk us through how you are thinking about margin progression in 2013, and may be highlight some of the factors that we should be taking into consideration. And then to what extent we should expect the margin recovery from recent trough levels?

Gary Kolstad

I think I’ll make one comment and turn it over to Ernesto on that. But as I mentioned, we were very pleased with the pricing of our CARBO manufactured ceramic proppant and the pricing really didn’t change materially from the third quarter. So I think that addresses the first part of your question, I’ll let Ernesto talk about the rest of it.

Ernesto Bautista

So with respect to fourth quarter, what you saw was an increase in products, from a product mix standpoint, our margins not as great as they are in internally produced ceramic. We had an increase in ISP or that’s the third-party product. We had previously said that we would be opportunistic in the sale of that product. We try to monetize this in terms and inventory into cash. So we did some of that during the quarter.

We also had an increase in resin-coated sand sales quarter-on-quarter, which was obviously important to us because we want to continue to grow that business but from a margin standpoint it does compress margins. As we look forward, I think we mentioned in our press release that 2013 will be similar to 2012, and perhaps the better way of describing it is a mirror image if you will of 2012, where things may be are close to if not at bottom and we move up from here.

To say specifically when margins start to turn that’s difficult, but I think our expectation anyway is that volumes will come first. And then as volumes increase and we get to higher utilized state, then obviously what should follow would be price. Again, timing on that would be difficult to state though.

Travis Bartlett – Simmons & Co.

Okay. And so you are saying 2013 activity levels should somewhat mere 2012. Does the same apply for margins there?

Gary Kolstad

Let me step in there. We see the activity levels – we’re talking about the industry drilling activity levels, we expect completion activity to actually increase and you might think through that and probably deduce but we think our volumes will probably increase as the year goes on. If you want to add something on the margins, I think is Ernesto’s comment about mirror image makes a lot of sense, when you look at how 2012 progress from Q1 through Q4 and then little bit of a slow start in January due to the slowdown in last two weeks of December, the industry really slowdown last couple of weeks of December as you’ve heard from all the other companies that we like the trend at which its going now. I think you captured.

Travis Bartlett – Simmons & Co.

Perfect. Well, that’s it from me. Thanks guys, I’ll turn it back.

Gary Kolstad

Thanks.

Operator

Our next question comes from Jeff Tillery from Tudor, Pickering, Holt & Company. Please go ahead with your question.

Jeff Tillery – Tudor, Pickering, Holt & Company

Hi, good morning.

Gary Kolstad

Good morning.

Jeff Tillery – Tudor, Pickering, Holt & Company

I think Ernesto you answered a lot of this with the last question, but it was mix that drove the margin compression sequentially. Anything notable on the distribution cost, I know you guys talked about a good kind of execution quarter in the third quarter, how would you compare the fourth quarter versus third in that regards?

Ernesto Bautista

Yeah. I think the trend remain strong. We are still seeing cost higher than what we are accustomed to believe where they should be, but due to increasing volume, it absorbs a lot of that fixed component of the cost. So I wouldn’t say that distribution specifically was a burden on the quarter. It’s still a focus for us, because the costs in general just remain high.

Jeff Tillery – Tudor, Pickering, Holt & Company

Okay. Gary, you’ve talked about in the supply and demand of proppant comments, closing that gap bodes well for pricing, do you view that more as just the kind of relief from downward pressure or do you see opportunity for potential increases late this year?

Gary Kolstad

Well, in our normal conservative fashion I would agree with the first half of your statement and leave the second half open to talk about as the quarters roll on.

Jeff Tillery – Tudor, Pickering, Holt & Company

Okay. That’s fair enough. The last question I have is just around mine. The startup roughly a quarter later than you guys have talked about before. Is that – I guess could you just provide us a little bit color around that.

Gary Kolstad

Yeah. I think you should think about in terms of what we’ve done in past years when difficult industry conditions take place; we have the flexibility either speed up or slow down. So you might think of it in terms of us, we drug our feet a little bit last year, and now its I would characterize it as full speed ahead.

Jeff Tillery – Tudor, Pickering, Holt & Company

(Inaudible) one more question just around the lower treasury revenue potential. I know that the volumes wont be comparable to an onshore well, but have you guys talked about a revenue opportunity per well for some of these deepwater completions?

Gary Kolstad

We are probably going to keep that close to our sales. Right now, our marketing and sales, chief, Don Conkle was talking to clients, so we better get through that process first. I think one of the things it’s probably worth while mentioning because the question probably come up later. But about three years ago, one of the supermajors contacted us and they gave us a huge challenge. They wanted the proppant they could withstand the pressures that 30,000 plus feet and they want to twice the conductivity of our current existing strongest proppant in the industry bauxite.

And I am very pleased to say that CARBO’s had this break through technology. So we are introducing a proppant that can go into deepest wells in the world and have twice the conductivity at 20,000 plus closure stress. So when you think about that in the supermajors so all of their larger independence they now have the ability to complete these deep wells whereby there was no proppant that would withstand it before. And so we are incredibly excited about this and just so there isn’t lot of questions about this later. This has ramifications for our entire business.

Jeff Tillery – Tudor, Pickering, Holt & Company

Great. Congratulations on that. Thank you very much.

Operator

Our next question comes from Brian Uhlmer from GHS. Please go ahead with your question.

Brian Uhlmer – GHS

Thank you. Good morning, Ernesto, Gary. How are you?

Gary Kolstad

Good.

Ernesto Bautista

Good. Thank you.

Brian Uhlmer – GHS

I want to dig into a little bit of here when you are talking about 33% increase and 46% increase in your other Consulting and Software. Can you give us an idea what the order of magnitude is in terms of other value there and also what were the company increases in operating income, how is that hitting your bottom line?

Gary Kolstad

Well, operating income, it helps of course – the software business is an incredible business. We really only talk about the revenues of Falcon because of the nature and size of it and we promise to do that every year. But we – they are becoming very important and more important than themselves as a business alone, its importance in the whole scheme of things that CARBO is doing and that's improving production and recovery to wells wherever they are out in the globe. So it's a nice synergistic package and we have all the reasons to believe that all these businesses will keep growing until we get up to something that approaches 10% I guess the threshold will probably not ever going to break them out.

Ernesto Bautista

Yeah that’s right. And Brian, this is something we visit periodically. But again overall, below 10% there are positive contributions I don't think any different than previous quarters. Unfortunately I don’t know that we would go into much more detail than that at this point.

Brian Uhlmer – GHS

Okay. Fair enough. And you – following what you just said and maybe I missed it, but you have in the past given there percentage growth or some churn growth on the Falcon business and I did not see that or hear I might have missed out, I apologize for that, but are you going to provide that type of guidance?

Gary Kolstad

It went – it was 25% growth in 2012 and we said to 42 million and we said that we would expect 20% growth again this year, that’s very consistent. Last year, we – at the beginning of the year we said 15% to 20% because of the collapse of the natural gas, but they really overcame and we've seen a lot of demand both geographical growth as well as client growth. So they’re really doing well in oil plays and so we just keep that 20% figure out there and hopefully they'll exceed it.

Brian Uhlmer – GHS

Okay. Fair enough. And final question on, (inaudible) I apologize for that. On the proppant would you say that you're talking about pricing following in a mirror image, but you had a 10% drop in overall pricing this year quarter-over-quarter. Earlier in the year would you expect a step change like that on the pricing front for this mirror image that you're talking about?

Gary Kolstad

No, I think, Ernesto captured that earlier to the other gentlemen asked question. We expect volume to come first and then subsequently pricing to follow.

Brian Uhlmer – GHS

Absolutely. But you expect to step change or grind back higher?

Gary Kolstad

In our conservative fashion, there is no way we are going to see step change.

Brian Uhlmer – GHS

Didn’t think of it. I'll turn it back over. Thank you.

Gary Kolstad

Thank you.

Operator

Our next question comes from James West from Barclays. Please go ahead with your question.

James West – Barclays Capital

Hey good morning, Gary. Morning, Ernesto.

Gary Kolstad

Good morning.

Ernesto Bautista

Good morning.

James West – Barclays Capital

So Gary, this new propphat that you are successfully introducing now that's going to be higher connectivity withstand higher pressures, what's the brand name here? Is going to be CARBO Super Prop or something like that?

Gary Kolstad

Come on James, we are more clever than that, come on. We know what it is and like I said Don Conkle was talking to clients as we speak. So we are going to tell them first before we tell to public, and we’ve got a process going right now and it’s just and you have to think about that right. The industry hasn’t had anything that they complete these reservoir swift because the strongest proppant we had prior to this crushers and we loose conductivity. So it’s set of breakthrough and like I said it took us three years and a request came in from a supermajor. So we know we are in the right zone, we know they are spending billions of dollars on these wells, these platforms and so we are pretty excited and let Don introduce it to the market in the way we go.

James West – Barclays Capital

Okay. Looking to – we afford to hear in the brand name. Second question for me, in terms of the telecom marketing campaign you went on during 2012, what’s the success rate then at this point? I know it takes six months or so before you can determine that, but presumably it’s been the normal 50% or higher?

Gary Kolstad

Brian, I’m going to give you data point. I don’t like to give you data points, but I will give you one on the Chinese. Our volumes were up; you saw they were up in the fourth quarter, right.

James West – Barclays Capital

That’s right.

Gary Kolstad

16% on our ceramic year-on-year. The rig count was down 10% in the fourth quarter, right year-on-year in U.S. and the amount of Chinese proppant leaving China was down almost 60% in Q4 2012 versus Q4 2011. So there is enough data points and you can work through it.

James West – Barclays Capital

Okay. That’s very helpful. Thanks, Gary.

Operator

Our next question comes from Trey Stolz from Iberia Capital Partners. Please go ahead with your question.

Trey Stolz – Iberia Capital Partners

Morning and thanks for taking the questions here. I guess to follow-up on may be somewhat Brian was trying to get at and may be get a little more detail or understand the other revenue side of it. You give the average profit price in the queue easily, are you willing to share that now for the quarter?

Ernesto Bautista

I think what we stated was, we had a 3% drop in average proppant price, so looking back into the…

Trey Stolz – Iberia Capital Partners

Is the quarter-over-quarter figure?

Ernesto Bautista

That’s correct.

Gary Kolstad

Yeah. Sequentially. Sequential drop is 3%.

Ernesto Bautista

And we saw very minimal price deterioration in order, CARBO producer in the CARBONRT.

Gary Kolstad

Correct. So it’s mostly resin-coated sand.

Trey Stolz – Iberia Capital Partners

Got it. Okay, 3% on the blended average price?

Gary Kolstad

That’s right.

Trey Stolz – Iberia Capital Partners

And then digging into the cost of good sold little more and trying to understand distribution and has been asked a couple of times in the call here. In manufacturing cost and distribution cost going forward, can you give us any more guidance on how to think about that or really struggling on those line items in particular. How can you help us in modeling there?

Ernesto Bautista

So I think maybe there is more to it than just these three items, but maybe this will help a little better and (inaudible) things little bit. We had a component of third-party product that we sold, that cost is higher than our internally manufactured product. Margins are lower for that region. We don’t anticipate the same volume of sales in 2013, anywhere near 2012 and 2013, so that’s a benefit if you will from a margin standpoint.

Offsetting that to some degree is going to be the fact that we do anticipate increased sales and resin-coated sand. We have said from the very beginning that business is going to have good margins, but they are not going to be the same as ceramic margins and in this environment, still compressed even further. So that somewhat offsets the reduced amount of third-party product we sell.

And then finally, I think over the course of the year, it’s still our goal and intention to reduce the distribution costs. We don’t anticipate really seeing the impact of the benefit is adding larger distribution centers strategically placed whether it’s the Bakken or South Texas until second half of the year. So I think that is things might be a little bit variable up – for the first half of the year and potentially getting better as we exit the year.

Trey Stolz – Iberia Capital Partners

Okay. And when you talk about lower distribution costs, I assume you are talking on an average per pound basis?

Ernesto Bautista

That’s correct.

Gary Kolstad

Yeah.

Ernesto Bautista

Exactly, yeah.

Trey Stolz – Iberia Capital Partners

And as you add capacity how should we think about the factory overhead line?

Ernesto Bautista

Really less, that will be 2014 impact and it’s not really – historically it’s not been material, as far as impact on a per pound basis. This is not a labor intensives business.

Trey Stolz – Iberia Capital Partners

All right, thanks so much.

Operator

Our next question comes from Blake Hutchinson from Howard Weil. Please go ahead with your question.

Blake Hutchinson – Howard Weil

Good morning guys.

Gary A. Kolstad

Good morning.

Ernesto Bautista

Good morning.

Blake Hutchinson – Howard Weil

Just to be clear around the margin line of questioning for 4Q, as we think about it going forward, good volume quarter, but it doesn’t necessarily suggests that you sequentially got much in terms of absorption relief, newer with the Eagle Ford facility being operational. No benefit in 4Q – to 4Q margins for that and in fact may be a little bit more spend, when it went to completing the facility. Is that the correct way to think about kind of where we are in terms of baseline?

Gary Kolstad

I think that's right. Generally, that's right.

Blake Hutchinson – Howard Weil

Okay. And then looking at RCS and thinking about your strategy here going forward, you say you want to grow the business, but clearly the way it worked into the model – maybe not clearly, the way it worked in the model maybe the timing is less than optimum, is this just something that you maintain volumes at a steady-state until the market improves or where we see a more pronounced ramp up in that business and its influence on financials over the year?

Gary Kolstad

So let me start with that. So we have resin-coating capability in New Iberia, we did not – we have held off on developing the rest of it in Marshfield, because we said there is overcapacity in the industry. So we decided to wait until the market cut better.

And when we entered the market here, one of the worst times of course with the collapse in natural gas, we are entering it on a spot market basis, spot market pricing. So the fourth quarter was difficult. What we believe will happen over the year is that we will increase our sales volumes to get up closer to our manufacturing capacity, and that has a benefit on utilization as you might imagine spreading the fixed cost et cetera.

And Q4 for us might have likely been the lowest pricing and I don't say that because of resin-coated sand overall, because people that have contractual relationships as those expire, the pricing is going to be lower from them versus us working in the spot pricing world. I think we’ve likely seen the worst for ourselves. So we will increase the volume during the year and we have some expectations that the pricing will increase during the year.

Blake Hutchinson – Howard Weil

Could we end up in a situation that if you go to acquiring a plan that you actually get back to RCS being accretive to margins?

Gary Kolstad

Yeah, you can get there. Don’t come on the next quarter.

Blake Hutchinson – Howard Weil

Yeah. Understood, understood, okay. Given what you’ve said about pricing sequentially, I guess it would lead you to believe just going through the math that pricing is already improving, just averaging on par with 3Q would indicate to your approving. How much – last quarter, there were a lot of talk about field studies. How much were the field studies actually sitting on pricing still and was that a source of relief or how do that play into it?

Gary Kolstad

Yeah, its impacted Q3 and Q4 negatively obviously, and it probably has less of a negative impact as we go into Q1 and Q2. And but just to clarify my comments on that sequential part, we saw very minimal reduction price at our own produced ceramic, but it was slightly down from Q3…

Blake Hutchinson – Howard Weil

Okay.

Gary Kolstad

That’s right.

Blake Hutchinson – Howard Weil

Gotcha. And then earlier today some comments from core labs with regard to their recognizance on completion intensity. Just wondering what you’ve seen over the second half of the year in terms of any discernible trends toward the volumes of proppant being used for stage or from your standpoint is it just too difficult to tell as customers kind of blend and use different formulas. When you talk about intensity, is that a very definitive component that you see.

Ernesto Bautista

And I think on balance it will be similar. You have some people that are increasing, some people that may still have the pressures in natural gas, trying to decrease. The thing we really like in Core Labs comments right is that, they are kind of telling the industry the importance of conductivity.

Basically, they don’t see, those what they say additional profit per stages recommended to increase productivity and increase reserves, some others pacing on the staging of the partner, that’s exactly what we say we put it in terms of conductivity. So we really applaud the fact that they have good understanding of the reservoir and are supporting what we say and they also reference in the E&P client in their report as well that have something in Q3, right.

So on balance thought I think it will be very similar and then as the industry picks up, which we think will happen during the year, we might see more of what you just asked.

Blake Hutchinson – Howard Weil

Well, great. Thanks for the time and I will turn it back.

Operator

(Operator Instructions) And our next question comes from John Keller from Stephens. Please go ahead with your question.

John Keller – Stephens Inc.

Hey good morning guys.

Ernesto Bautista

Good morning.

John Keller – Stephens Inc.

Gary, just had a couple of questions for you following on your comments around improved supply-demand balance as we move through the year. First is, kind of on your incremental capacity at mill and I think you have got one, one coming on and I think your quote was full steam ahead right now in terms of getting that up and running. Does that speak well for line two or an acceleration of line two? I mean do see, getting to that from a positive supply-demand balance standpoint?

Gary Kolstad

The way I look at the industry from 50,000 feet is that the North American absolutely needs more high quality, high conductivity lightweight ceramics, as we build capacity, that’s why we keep building capacity, we will displace this stuff coming in from China and other places that E&P and Service companies I think are better understanding. You are running a risk to the reservoirs when you pump that stuff.

So for us, it is clear, we will continue to grow our style. If you remember over many years is that, we kind of tell you about one line and then when we get the other one moving forward, we tell you about that. We permitted Millen for four lines, I will give you that. So that kind of tells you where we are going and I don't lose a lot of sleep over the Chinese, because this isn’t bad stuff. And with our recent breakthroughs everybody in the industry is below our conductivity of the products we have today and we are just setting a new benchmark in the industry with what we will have in the future. So we're not going to get too worried about that.

John Keller – Stephens Inc.

Fair enough. And then just maybe a little bit more near term here and it – I guess goes to your philosophy or if there has been any change? Given what the industries are seeing over the last year or two especially with the influx of both domestic and Chinese competitors, did that change the way you think about your pricing strategy?

Gary Kolstad

No, I think our pricing strategy has been pretty constant over a lot and lot of years, right? We have a bias towards volume and trying to get the best price we can, but we're biased on volume which is that overwriting theme. This makes wells produce more, recover more. So it will always be in demand and everybody else will probably price a little bit below us because they won't have the same conductivity.

So, now we don’t see much change at all. When we introduce a new product that can materially change E&P’s investment, these wells are hundreds of millions, platforms of billions, there is new product coming out, yeah, that's going to have a different pricing level. But for our big volume stuff, no I think we stick with our same strategy we've always had, keep growing the volumes.

John Keller – Stephens Inc.

Fair enough. Appreciate. Thanks guys.

Operator

Our next question comes from Brandon Dobbell from William Blair & Co. Please go ahead with your question.

Brandon Dobbell – William Blair & Co.

Thanks. May be an extension of the last question, as you think about the interplay between resin-coated and some of the ceramic stuff that you do maybe on the lighter or lower end, do you worry about any cannibalization by resin-coated or do you think the new ceramic high connectivity will give you enough of I guess pricing umbrella to kind of offset whatever mix issues might come out looking at this modestly will become a two year question than a two quarter question?

Gary Kolstad

Well, resin-coated sand is a much lower conductivity than ceramic. If you go out and look in our web page, put proppant triangle out there to explain the industry the generics of conductivity. So there is many resin-coated sand that comes close to our ceramic. So it's really a different market.

And even if it was closer we've been through this so many times, when we invented high-strength and then we invent the low strength, I mean the light weight not low strength and then we come out with HYDROPROP. We just been through this so many times, we know where the target markets are, we know the target client, so now we don't expect that at all. Remember resin-coated sand sounds that are on for ever. There’s quite an oversupply of it right now, but it's been around. So now that doesn’t really change our marketing and sales approach at all.

Brandon Dobbell – William Blair & Co

Okay. Then I guess quick numbers questions. We think about the G&A and D&A lines looking out the next four, five quarters or so. Any material kind of trajectory changes that we should expect given CapEx direction or kind of moving parts here in the back half of the year on the G&A side, I don’t think I’m not going to [mull] in those lines?

Gary Kolstad

Brandon I'll give you a few data points and you can use this information. So I’d say we ended the year with $77 million in capital. We would anticipate 2013 to be somewhere between $110 million and $120 million in capital backing in incremental D&A from perhaps fourth quarter levels.

With respect to SG&A, I would say it’s going to vary, we don’t have identified fixed pattern specifically on certain areas like R&D, but it will be something probably between 9.5% and maybe lower than 10% of revenue at least into the foreseeable future.

Brandon Dobbell – William Blair & Co

Great. Thanks a lot.

Ernesto Bautista

You’re welcome.

Operator

Our next question comes from Timothy Hurckes from John W. Bristol & Company. Please go ahead with your question.

Timothy W. Hurckes – John W. Bristol & Co., Inc.

Good morning, Gary and Ernesto.

Ernesto Bautista

Good morning.

Timothy W. Hurckes – John W. Bristol & Co., Inc.

You’ve talked about the higher conductivity breakthrough taking about three years to develop for the supermajor. In the applicability across the rest of your product line, is that more of a one year R&D effort? Is that going to be a three year R&D effort? Could you give us some type of guess on that?

Ernesto Bautista

The R&D efforts are primarily behind us. We are now into the scale up part of it and the only thing I’m going to say about application beyond that is stay tuned, very probable.

Timothy W. Hurckes – John W. Bristol & Co., Inc.

And again the effort to actually apply it to the broader product line...

Ernesto Bautista

That was my last part. If we have learned things that will absolutely benefit us and we don’t really want to go into that too much more than that, but put at this way I’ve never been more excited about a product in my life.

Timothy W. Hurckes – John W. Bristol & Co., Inc.

We all know you get very excited, Gary.

Gary Kolstad

I know that this on....

Timothy W. Hurckes – John W. Bristol & Co., Inc.

Thank you.

Gary Kolstad

Thank you.

Operator

And our next question comes from Bob Christensen from Buckingham Research Group. Please go ahead with your question.

Robert Christensen – Buckingham Research Group

Thanks guys, and good to hear your voices and good quarter. I got three questions. What is the target market broadly for resin-coated sand, where is it go, where is it?

Gary Kolstad

The big volume of course was being used in natural gas and there was generally speaking of a smaller image size which created quite a disruption to the industry when the breaks got put on that. Today, you see some operators using it in some of the all the big plays. You'll see some operators too that will pump resin-coated sand first on the stage and tail in with ceramics, because they are trying to do some economic things, but yet they are smart enough to know that they need the high conductivity near the well bar with the drawdown in the trends refract and the velocity going through there.

So it's little bit all over, but the nice thing is when the gas business finally does improve and some day they will and we have decades of gas drilling ahead of us, that will probably of absorb some of this excess capacity in this resin-coated sand.

Robert Christensen – Buckingham Research Group

And the advantages of resin-coated sand over regular sand just briefly?

Gary Kolstad

The conductivity is so much higher. I think we – I don't know if we got the chart out there, we’ve also characterized the different sand. So…

Robert Christensen – Buckingham Research Group

Yes you had, I have seen that. Yeah.

Gary Kolstad

Yeah. So the lower stuff you really shouldn’t pump in any well, right, some of those river sands in Nebraska and Arizona sands. Then you have brighter sense in Northern Light and you just can’t change Mother Nature, right so the Northern Light sort of the break through for the ultra-high temperature high pressure. This was conceived, I guess in a pilot plant, does the pilot plant can expand it to be a smaller manufacturing, what’s the transition between so the experimentation and success level to something that’s more – where is this plan?

Ernesto Bautista

Well, we have an R&D plant and that’s – we kept some I don’t know, I hate to tell you exactly what we said, but nonetheless it produces a smaller amount and we could have it as a production line for that. We actually build it for R&D, Bill. And so it’s been pretty busy with this product for a while now. And you don’t produce enough to where Don can sell this on a commercial level, but I’m more excited about what comes after that and I’m really hesitant to divulge our ladder at this time because we are still working through lets just call it scale up. So…

Robert Christensen – Buckingham Research Group

Is this one of your existing major facilities or is it just (inaudible) somewhere?

Gary Kolstad

It’s existing at an X ceramic plant that still had infrastructure within it.

Robert Christensen – Buckingham Research Group

Okay. And my last question Gary, thank you. You said that the Chinese stuff is a risk to the reservoir. Are we going to see that displayed anywhere or have you heard of some of these risks? When you say risk, you emphasize the production could go to zero in some of these wells, I’m just being – I’m interpreting it that way. Have you witnessed that or what do you mean by the risk to the reservoir?

Ernesto Bautista

Bob, our job is to tell people upfront the right way to complete wells to maximize production recovery. So what we’ve done in our tech – for marketing campaigns, we’re trying to educate the industry by showing them both conductivity graphs as well as we’ve done cross sections on all the ceramic stuff. And when you visualize this, you don’t necessarily have to be a petroleum engineer to understand this. It’s both conductivity as well as when you look at the internal [powered] itself it will scare you.

Robert Christensen – Buckingham Research Group

No. I’ve seen your pictures. When you say risk, you sort of imply that the EURs and companies might be counting on could be far or less with the passage of time as this is sort of a wake up moment that could happen to a producer.

Gary Kolstad

Yeah. That’s not my job to talk about that. My job is to talk about how bad the conductivity and the quality of the product is. And what will happen is, when you have all those worried spots is that you will see crushing, okay. And so then that collapses and you have left conductivity and you are correct channel. So we like to stop at the technical side of it, but we do mention the ultimate consequence of not having conductivity, that’s the productivity in New York.

Robert Christensen – Buckingham Research Group

Very good. Thank you.

Gary Kolstad

Thank you.

Operator

Our next question comes from Trey Cowan from Clarkson Capital Markets. Please go ahead with your question.

Trey Cowan – Clarkson Capital Markets

Good morning everybody. Looking at your ceramic province, quarter-over-quarter up about £9 million, can you speak to how much of the incremental growth was from international versus North America?

Ernesto Bautista

Mostly, do we have those figures and they are still – we have global figures, I don’t know if we have a breakout. But intuitively the international grew a lot more quarter-on-quarter.

Trey Cowan – Clarkson Capital Markets

Okay.

Gary Kolstad

And since we don’t sell any resin-coated sand internationally, outside of NAM, you might imply that a lot of it was international.

Trey Cowan – Clarkson Capital Markets

Okay. And then just drilling down a just a little bit further, whenever you think about North America and the Spring breakup for Canada, how much seasonality is there with ceramic proppants?

Gary Kolstad

Oh gosh, there is seasonality in business cycles both. Generally speaking every Q2 Canada slows down, and that’s – they know how to do that very well. It’s usually offset for us by other things that pickup. And then we always say we have a December every year, December is always slower no matter what anybody says. And this last year September was very unique. I think you are hearing that from everybody, but I think we only, I think the industry only kind of effectively work two weeks in December.

Trey Cowan – Clarkson Capital Markets

Gotcha. And whenever, I’m going to switch gears here, on Latin America, we’ve been hearing industry wide that things are looking pretty good there for the next few years. Can you speak to what you are seeing down in Latin America?

Gary Kolstad

Yeah. We saw tremendous growth in Mexico. We’ve got some of our great service company clients really active down there. And so that grew a lot for us, and we would have expectations giving the political outlook there that, that would continue on. You see the normal excitement in Argentina which (inaudible) watch that excitement over many, many years. So we will watch it closely, but there’ll be increased activity there. And then Brazil isn’t a huge market, it’s an offshore environment, so you don't have a huge drops or anything like that. So that's really Mexico is the big gun.

Trey Cowan – Clarkson Capital Markets

Gotcha. Columbia as well I assume?

Gary Kolstad

Not a big one, no, not at all.

Trey Cowan – Clarkson Capital Markets

Okay. And relating to that is your Falcon Technologies, the products there, is that something that you can offer into Latin America or are you already?

Gary Kolstad

We will, I think we kind of nowhere we are going to go next. We still have a lot of – remember we lost this business back in ‘09 and the business started I think in ‘05 so it's been on this rapid trajectory of growth. Then we really had to build an organization and today there are service execution, the whole business itself is starting to really get well put together, and we have manufacturing things, we’re lowering cost on and some things like that, and then we have this geographical expansion in the U.S., we have this client expansion in the U.S., so we felt like we better pay attention out of 20 percent plus growth rate to the U.S. We know, I think where we're going to expand next, but I don't think it would be worthwhile at this time talking about it on conference call, because it is little ways away.

And it also, we think there is opportunities. Today, we work in upstream oil field. The Falcon business has applications in downstream oil field, it has applications in the chemical industry, it has applications in municipal et cetera. So it's got a platform that we're trying to make sure; one, our service quality is great; two, improve the profitability which is really starting to happen, and so we’re kind of go and had measured pace be at good, but we just love the client acceptance.

Trey Cowan – Clarkson Capital Markets

Great. And then just one final question. When you look at the U.S. on a regional basis and you look at this mirror projection that you and other guys are looking for. Is there any region that stands out right now is this probably going to lead the way as we progress and improve also where we are right now?

Ernesto Bautista

You mean globally or in the U.S.?

Trey Cowan – Clarkson Capital Markets

In the U.S., any other regions, like Eagle Ford, Bakken, Marcellus or is there one that looks like its going to be ahead of the others bringing the rig count back?

Gary Kolstad

Well, we more selfishly think about our business that’s in rig count, but the Bakken is just so clear that you need ceramics up there. The Eagle Ford is so clear you need ceramics down there. And then the Permian had a nice growth year-on-year for us as well. So those three lead the way and not to say that we are not watching the Utica, we always have the Rockies and stuffs that’s been out there, and Oklahoma is having some very nice stuff in the Western part there. So we really like to trend it, but I think those big two, the Eagle Ford and Bakken, will lead the way of course.

Trey Cowan – Clarkson Capital Markets

Great. Thanks for your help.

Ernesto Bautista

Hey, Trey, this is Ernesto. Just circling back on your first question, Gary obviously pointed you in a direction that number is probably to those weighted towards international on the ceramic proppant.

Trey Cowan – Clarkson Capital Markets

Perfect. Thanks a lot guys.

Operator

Our next question comes from Trey Stolz from Iberia Capital Partners. Please go ahead with your question.

Trey Stolz – Iberia Capital Partners

Just in the follow-up on the pricing outlook you gave earlier, I guess with the lot of additional capacity coming on domestically, you’ve got Paramax out there and £500 million Saint-Gobain potentially another £250 million – yourselves adding £250 million. And then maybe on the outside you got certain Chinese producers they could turn their production back up. What is your outlook I guess with additional potential capacity out there, and how that factors into your pricing outlook in 2013 and beyond?

Gary Kolstad

I would say in 2013 we expect our volumes to be higher. We don’t like to comment on pricing in the future, we’ve given the indications there. But various people have asked various questions this morning about that and we kind of said, we had very minimal price reduction in our ceramic in Q4 versus Q3. And some of these throughout the world drops and things like that, so we’ll kind of stick by that. Regarding new competition, since nothing new for us, I think new competition will probably displace this low quality, low conductivity Chinese just like we are. But also this isn’t easy step to make. For those of you pay attention right, it some times takes some of these new comers a long, long time to get a product that meet specs. And sometimes that’s months, sometimes it’s more than a year. So for us it happens pretty rapidly.

Trey Stolz – Iberia Capital Partners

All right well and I guess, I guess, if could any further comment on future outlook…

Gary Kolstad

Volumes to be higher.

Trey Stolz – Iberia Capital Partners

All right, thanks.

Operator

Ladies and gentlemen at this time, there appear to be no more questions. I like to turn the conference call back over to Mr. Kolstad for any closing remarks.

Gary A. Kolstad

Well thank you all for joining us today. We’re kind of excited about 2013 we think to mention of a mirror image in some respects that we think 2013 could possibly be, compared to 2012, we’re confident in both the short and long term demand for our ceramic proppant. And once again I’d like to say that’s evidence by our volume growths in a difficult market and a large reduction in the low quality Chinese imports. Even though industry activity really slowdown last two weeks of December, and maybe the first week or so and January little bit slow, I think we’re going to see a recovery and the industry always has these quarterly fluctuations, but we are going to keep on investing for organic growth and we'll keep expanding our ceramic proppant franchise, and we got to make some of these investments drive up the inefficiencies in the distribution business, and I think of our other three business will have another bang up here.

Finally we once again still have the strong balance sheet, and pretty physically conservative.

So, thank you again today, and we will see again next time.

Operator

Ladies and gentlemen we thank you for attending today's conference call it has now concluded. You may now disconnect your telephone lines.

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