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CARBO Ceramics, Inc. (NYSE:CRR)

Q4 2008 Earnings Call

February 05, 2009 11:00 AM ET

Executives

Gary Kolstad - President and Chief Executive Officer

Ernesto Bautista, III - Vice President, Chief Financial Officer

Analysts

James West - Barclays Capital

Jeff Tillery - Tudor, Pickering Energy & Co.

John Daniel - Simmons & Co. International

Pierre Conner, III - Capital One Southcoast Inc.

Brian Uhlmer - Pritchard Capital Partners

Roger Reid - Natixis Bleichroeder

Steve Ferazani - Sidoti & Company

Robert (Bob) Christensen - Buckingham Research

William C. Conroy - SMH Capital

George Shiau - Copia Capital

Waqar Syed - Tristone Capital

Milan Gupta - South Point Capital

David Epstein - Claymore Securities, Inc

Operator

Hello and welcome to today's CARBO Ceramics Fourth Quarter 2008 Year-End Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session.

Please note that this conference is being recorded. I would like to remind all participants that during the course of the 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 provisions 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. Mr. Kolstad, please begin your call.

Gary Kolstad

Good morning and thank all of you for joining us to discuss CARBO's fourth quarter results and the outlook for 2009.

As an opening statement, I would just say that we had an incredible fourth quarter and our fourth quarter results reflect a continuation of the successes we have experienced throughout the year in a number of respects. The success of our Economic Conductivity technical marketing campaign and the strong demand for CARBOHYDROPROP continued during the quarter, and as a result, we operated our proppant plants at full capacity.

Reflecting the strong demand, we benefited from higher average selling price of our ceramic proppants during the quarter. We successfully restarted our New Iberia manufacturing facility after idling it earlier in the year. This facility will focus on certain specialty products for which we have seen an increase in demand during the second half of the year.

We finalized the sale of our fracture and reservoir diagnostics business to Halliburton, which closed on October 10th, in which we received approximately 142.3 million in cash.

We repurchased and retired approximately 1.1 million shares at an average cost of 39.79 per share at an aggregate cost of 42.2 million, and this is in accordance with our previously disclosed Board of Directors' approved share repurchase program.

Last but certainly not least, we reported fourth quarter net income from continuing operations of 20.5 million or $0.85 per diluted share on revenues of 105.6 million.

Looking at the detail of the fourth quarter results and in discussing the results from operations, I will be focusing on the continuing operations, which conclude our ceramic proppant, software, consulting services and geotechnical monitoring businesses.

Revenue for the quarter increased 30% compared to last year's fourth quarter. The total proppant sales volume for the fourth quarter was a record 293 million pounds, a 19% increase from last year's fourth quarter. The revenues for the quarter also reached record levels.

Sales volume in North America increased 30% compared to the fourth quarter of 2007 due to sustained demand in areas that have traditionally used ceramic proppant, continued acceptance of ceramic proppant reservoirs that have previously used sand-based proppant and the development of new reservoirs such as Haynesville in which the high stress, high temperature operating environment is conducive to the use of ceramic proppant. And in fact every region in the U.S. saw increased demand except for one.

Overseas sales volume decreased 25% compared to same period last year, primarily due to our undersupplying them. Improvements in proppant pricing continue to benefit our gross profit margins on both a year-over-year and a sequential basis.

SG&A expenses for the fourth quarter increased compared to same period year, both in absolute terms and as a percentage of revenue. The increases primarily related to higher spending for marketing and sales activities supporting the growth in the proppant sales, increased costs associated with supporting the company's new enterprise resourced planning system, SAP, and start-up costs associated with the New Iberia manufacturing plant restart.

Income from continuing operations for the fourth quarter of 2008 increased 8.5 million compared to the fourth quarter of 2007.

Looking at a couple of technology and business highlights, E&P operators continued to employ economic conductivity in their proppant selection decisions in the Haynesville Shale of East Texas and North Louisiana. And the demand for CARBO's high quality ceramics in this resource play, particularly CARBOHYDROPROP, experienced exceptional growth.

CARBO signed a one year contract with a major Russian oil producer to supply engineering support including fracture candidate selection and fracture treatment effective analysis. This work is being performed across several Western Siberia fields.

The Applied Geomechanics sold and installed a fiber optic monitoring system for a large copper mine operator in Arizona. The ongoing operation with dual 2400-ft fiber optic cables, monitors deformation in the underlying rock strata during large-scale pumping of the water table.

When we look at the future outlook, we have already experienced over a 27% decline in the U.S. rig count from its peak in late quarter... late in the third quarter of 2008. And analysts forecast the industry will experience additional declines over the course of 2009. This downturn in drilling activity prompted by the continued weakness in the U.S. credit markets, weakness in commodity prices and the current global economic uncertainty posses serious challenge for all service companies.

What is important to remember is that while CARBO is not immune to the effects of this downturn, we find ourselves well positioned with demand for our proppant in North America currently continuing to be strong, especially in developing resource plays. We believe that steep decline curves in resource plays providing much of the incremental natural gas supplied in North America will also help in bringing supply and demand more into balance as the rig activity continues to decline. The unknown is how detrimental an effect the U.S. economic crisis will have on natural gas demand.

Accordingly, we are committed to moving forward with our previously announced capacity expansion in Toomsboro, Georgia, which is currently scheduled for completion in the first half of 2010.

Additionally, with the sale of our fracture and reservoir diagnostic businesses, we have built a cash reserve that will allow us to follow through on our near-term capacity expansion efforts and continue to fund our strategic technology development initiatives.

Our strong financial position will also allow us to be opportunistic when considering strategic opportunities, including the sourcing of our raw materials and acquisitions. With oil and natural gas reservoirs becoming more complex, current economics being challenging and exploration and production companies seeking a greater return on their investment, we believe that in CARBO ceramics proppants should continue to be in demand, given the fact that it enhances productivity and recovery in wells when compared to using lower performing sand-based proppants.

Having (ph) provided some short-term comments, let me return to a broader perspective. Our current situation can be characterized by saying we are cautiously optimistic as we begin 2009, find ourselves in a strong financial situation and are committed to growing CARBO's future business during this downturn through capacity additions and hopefully acquisitions.

I want to close these prepared remarks by commenting on how our financial strength helps us and differentiates us from others as the industry goes through the global economic crisis.

First, we have no debt and we have about 155 million in cash and cash equivalents sitting on the balance sheet. We pay a dividend and have been increasing it for over seven years. We are continuing to fund all of our manufacturing capacity increases with internally generated cash. And finally, the Broad of Directors' share buyback authorization gave us another tool to use for our shareholders, and we brought about 4% of our shares back since it was initiated in August.

What this also means is that our management team gets to focus our time on satisfying our client needs and not have to spend on trying to resolve balance sheet concerns. We prefer to spend our time informing our clients on how our products improve both the production and the ultimate recovery in their oil and gas wells.

This completes our prepared remarks and at this time we'll take questions. We are ready for questions.

Question-and-Answer Session

Operator

We'll now begin the question-and-answer session. (Operator instructions). Our first question comes from James West from Barclays Capital. Please go ahead.

James West - Barclays Capital

Hey, good morning Gary.

Gary Kolstad

Good morning James.

James West - Barclays Capital

Congratulations on an excellent quarter, very impressive.

Gary Kolstad

Thank you.

James West - Barclays Capital

How much... during this quarter, you had nice margin expansion and certainly volumes were strong, pricing was up sequentially. How much of the expansion, though, was caused by some weakness in pricing to raw materials or some costs going down on the raw material side, bauxite and fuel costs et cetera?

Gary Kolstad

It was much more on the other side and not so much on the cost side. When you look at the margin increase, first of all, the one big factor you have to think about is product mix. And we shifted, because of the huge demand, we shifted some of our manufacturing more to lightweights. And since as you know, we have better backward integration into the orders (ph) and everything for detail (ph) and we had those high efficient plants unproducing like once we showed better margins. So we typically kind of told you what our lightweights percentage are and kind of said around that 70% figure. Well, in this quarter, it was higher than that. And so that was one of the big things.

We did have some pricing from some Q2... I mean Q3 increases that were fully in effect in Q4. And then we also were... we are starting to sell some specialty products, as you are aware. We don't really get to see the natural gas benefits until the second half of 2009, in which... we buy forward of course. And so our second half is currently better than the second half of 2008 in terms of pricing.

James West - Barclays Capital

Okay. Then what about... so you reaping the benefits (ph) I guess of things like fuel costs and some of the bauxite, other products earlier this year?

Gary Kolstad

Well we have really brought ahead on bauxite products, so I would say there we haven't seen any benefit. Now I think we announced in Q3 or maybe it's in this release that we had purchased a domestic source of bauxite. And that will supply about 30% of our heavyweight products needs. So that's just getting started. So really didn't see anything there. And so what we are focusing on as we move into 2009, and one of the great things about an economic crisis is that potentially, we will get to source our bauxite from wherever we decide to get it at more attractive rates. And as we mentioned before, we would love to get that back integrated just like we are in our lightweights.

James West - Barclays Capital

Okay, makes sense. And then on the pricing side, given the declines we have seen rig count since the peak and what we expect to be a pretty difficult first half of this year, do you think you can maintain pricing at current levels, or do you think you have some ground there?

Gary Kolstad

Well, we don't typically comment too much on price. But the one thing I have consistently said is that if you look at us historically, we don't really raise the price a lot in an upturn. We are nothing like a drilling contractor per se nor have our prices fallen much during downturns. We are a fixed cost business, we tend to be much more level on pricing and of course our focus is on growing the volume. And so we are going to... you also need to understand what the demand side is. So I think we'll probably be fairly steady. We are certainly not immune to the pressures of course.

James West - Barclays Capital

At this point in early February, are you still running at full capacity?

Gary Kolstad

Well, since we don't provide future guidance, I would stay away from that. Nice try though.

James West - Barclays Capital

Though I'd try. Okay, I appreciate it. Thanks Gary.

Operator

Thank you. Our next question comes from Jeff Tillery from Tudor, Pickering, Holt. Please go ahead.

Jeff Tillery - Tudor, Pickering Energy & Co.

Hi, good morning.

Gary Kolstad

Good morning Jeff.

Jeff Tillery - Tudor, Pickering Energy & Co.

Just to stay on the operating cost side for a second, to the extent your mix from the lightweight versus back writing (ph), do you think that probably it makes it sustained. Any reason your costs per pound that you realized in the fourth quarter wouldn't sustain at that level at least?

Gary Kolstad

Well, yes, the sector I did mention is in the second half, we'll get a slight benefit on natural gas. But once again, that's not a major shift. We'll just see more of a benefit. One of the things we are doing is we tend to move our manufacturing around a little bit. So while we sometimes really put them all to work producing lightweights, then we have to ship some of them back to get caught up on heavyweights. So you are going to see some fluctuations there. I wouldn't... I doubt if the stars will line up as perfectly in Q1 as they did in Q4. That was just a great product mix, nice volume and everything was working well.

Jeff Tillery - Tudor, Pickering Energy & Co.

To the extent that volumes stay reasonably healthy, any reason your margins wouldn't stay somewhere between the Q3 level and Q4 level as we go through '09?

Gary Kolstad

I don't remember what the Q3 one were, but yes, I just would candidly say, I don't... we are not going to duplicate Q4 '08 I don't think in the near term. But I don't actually remember what Q3 was, but yes, it probably goes somewhere in between I suppose.

Jeff Tillery - Tudor, Pickering Energy & Co.

Okay. And in the release, you mentioned HYDROPROP being sold into the Haynesville. I think thinking back to November, I think you guys talked about CARBOPROP and EconoProp as being the primary products used in that play. Is HYDROPROP utilization new in that play and what's driving that?

Gary Kolstad

Well, so first of all, think about the Haynesville. You are drilling horizontal wells, your fracs are transverse. So three critical items there. One is that your wellbore contact with your frac is very limited, which is one reason you need a heck of a lot of conductivity, okay? Two, the pressure is... it needs to be ceramics, right, the stress on the proppant. Three, the temperature. Sand-based products degrade like crazy, if you would have listened to my... the webinar presentation I did on the Haynesville recently, we have all the graphs and stuff on that.

Jeff Tillery - Tudor, Pickering Energy & Co.

Sure.

Gary Kolstad

Finally, a lot of people are using slick water in the Haynesville. So why did we create HYDROPROP? One, they have the strength of ceramic, but two, the transportability of it. So you are going to get that proppant transported out to the long link. So HYDROPROP has really come out strong in the Haynesville.

Jeff Tillery - Tudor, Pickering Energy & Co.

That's helpful. And then my last question, could you just talk about your expectations for your Russian plants as we go through '09 and just conceptually, how you are thinking about utilization relative to '08?

Gary Kolstad

Well, I mean there are... there is a lot of pressure in the market in Russia. I think everybody that works there has mentioned that. We tend to be a little bit quieter about Russia as I had explained every quarter, and there is reasons for that since we are the only outside company in there. But I would just say, we have done a good job of taking some costs out on the production side. And I think we'll see more benefits year-on-year than... in '09, we'll see a lot more benefits than even we saw in '08. So we are happy with the cost side and we have got a team of people there that are doing a pretty darn good job of marketing and selling the product. And once again, the thing you can count on from CARBO is the quality and the distribution and everything like that. So we are okay in Russia.

Jeff Tillery - Tudor, Pickering Energy & Co.

Thanks. Okay, thank you very much.

Operator

Thank you. Our next question comes from John Daniel from Simmons & Company. Please go ahead.

John Daniel - Simmons & Co. International

Hey guys, good quarter. Just two questions for you. Recognizing that ceramics has better qualities than the other sand-based proppants, but in this environment when the E&Ps are doing everything possible to drive service costs down, do you think that any of your customers will, on a short-term basis, switch back to sand in order to reduce your current cash cost?

Gary Kolstad

Well, I'll repeat the comments I made over the years that we always get asked the same question. And at the end of the day, the one thing that's happening today is that the E&P operator better understands the production and recovery you get from ceramics. And we candidly throw out a 20% type increase for both productivity as well as ultimate recovery. And so those paybacks happen in weeks or months and on a crazy case, one year. So the economics work in down cycles or up cycles.

Secondly, our historical information tells us once people figure out... figure that out and get to use it in fields, they tend to stay there. That's not to say that there isn't some deflections. We know that's when the production manager tells the engineer hey, we need to cut costs and he does something silly like change the proppant away from ceramics. But as a general sense, that's not the case.

Now third, you need to combine in these new plays, okay. And so I already talked about the Haynesville, the stress, the temperature and all those things.

And then four is that what's happening in horizontal drilling and what does that mean for our business. Well, first of all,, we are putting a heck of a lot more proppant into these wells, these transverse fracs, these reservoir contacts (ph) and everything like that. So I think when you combine all those things, your question gets asked every cycle we have, but it's not a material nature.

John Daniel - Simmons & Co. International

Okay, fair enough. Just one last one on the New Iberia facility. I didn't hear you if you said it, but is it fully operational today?

Gary Kolstad

Yes, it is, it is. And we are making a specialty product there, yes.

John Daniel - Simmons & Co. International

Okay. Thanks.

Operator

Thank you. Our next question comes from Pierre Conner from Capital One. Please go ahead.

Pierre Conner, III - Capital One Southcoast Inc.

Good morning Gary.

Gary Kolstad

Good morning Pierre.

Pierre Conner, III - Capital One Southcoast Inc.

Hey, actually just following on to John's question, just about the costs for the restart on New Iberia, I'm assuming that you are fully operational that those costs are behind us now in the quarter.

Gary Kolstad

Yes, we took some of that in Q4, yes, absolutely.

Pierre Conner, III - Capital One Southcoast Inc.

Okay, great. Let me ask you about the international in the mix. Still there?

Gary Kolstad

Yes, we are still here, Pierre.

Pierre Conner, III - Capital One Southcoast Inc.

Got it. Do you feel that you're undersupplied internationally? You mentioned obviously that you decreased international because you were supplying domestic needs. Did you make any exports at all from domestic production into international markets?

Gary Kolstad

Well, I am not going to name the region, but we basically break the world in six regions. But there was one that we made a conscious decision to undersupply. And some of that had to do with the lower quality Chinese proppant being put out. So we said, okay, fine. But we also have been moving some products back to North America. So the answer to your question is yes, we made conscious decisions to lower the supply in some areas.

Pierre Conner, III - Capital One Southcoast Inc.

Okay. And so that kind of ties into the earlier question about Russia. Is there ability to take that production out of the country?

Gary Kolstad

Yes, there is. There is. I would make the same comment, don't plan on making a living at that, very similar to the China transport. We have proven to ourselves that transporting proppant around the world is not the best economic position to be in and it's much better to be local in your manufacturing. But during stressed times, we do it, and so, yeah, we can do that.

Pierre Conner, III - Capital One Southcoast Inc.

Okay. All right. Going back to the mix issue and CARBOHYDROPROP in the Haynesville, and that is pretty impressive. But there are some... the Haynesville developments, they are deeper as I appreciate it and someone with... 13,000 feet TD (ph) or even higher pressures of temperatures. Would you tell us if CARBOHYDROPROP is appropriated in those or is that requirement of an HSP?

Gary Kolstad

Well, we... I don't want to give too much out here because we don't really want to help our competitors, let's say. But everything we are producing for the most part out of New Iberia is going in there. So we have some specialty proppants we are making of more of a heavyweight type of nature that we are shipping in there. So we are seeing different products. We pumped four of our five products into the Haynesville. So it depends on where you're at in the field and it would also be dependent of course on the frac fluid you are using. All we are saying is that there has been enormous demand for HYDROPROP.

Pierre Conner, III - Capital One Southcoast Inc.

Okay. That's helpful. On a bigger global picture then, you still hedge your remaining capacity under your buyback, but you also did note that one of the great... one of the good things about an economic crisis was opportunity. So my question is as you look at capital structure, are you inclined to be a bit more conservative here in anticipation of some opportunities for supply or something like that and... or be optimistic on your buybacks? What's your perspective there?

Gary Kolstad

Yes, you're absolutely right. We like silliness in the markets, just like some of you do too. And so we... like I made in my opening comments there, we are not spending time trying to figure out how to fix anything. If Ernesto and I spend time, it's more what do we want to do with this, right? Do you want to buy back shares? Do you want go buy some supply? Do you want... is there a business that we would find attractive? So we've got time. And we are very long-term thinkers. We are not worried about what happens in a quarter. So I think over the next year, there is going to be opportunities are going to show up and we are patient people and we'll wait.

Pierre Conner, III - Capital One Southcoast Inc.

I guess what I was getting at was that information might imply that you not be as aggressive on the buyback in order to maintain maximum flexibility on those opportunities.

Gary Kolstad

We can probably do everything, because of the amount of cash we have.

Pierre Conner, III - Capital One Southcoast Inc.

I understand. All right, I'll let some other guys get some questions in.

Gary Kolstad

Thank you.

Pierre Conner, III - Capital One Southcoast Inc.

Thank you.

Operator

Thank you. Our next question comes from Brian Uhlmer from Pritchard Capital. Please go ahead.

Brian Uhlmer - Pritchard Capital Partners

Good morning, Gary.

Gary Kolstad

Good morning.

Brian Uhlmer - Pritchard Capital Partners

I had a couple of questions for you. I wanted to follow up on the costs. You say buy your gas well out. Does that mean to expect... what portion do you hedge, 50%, 75%?

Gary Kolstad

If you looked at an '09, we are certainly at the 70% plus. And once again, the opportunities that are showing up, we have moved out farther and we are into 2010 with a certain percentage. And so you just have to take advantage of these things as they show up. So we are... we keep a little bit open that we play on the spot, so we are even benefiting even more on that. You might imagine what current prices of the current months. But yeah, we are... we have got a good 70% plus base for '09 and we have got pretty darn good base building for 2010.

Brian Uhlmer - Pritchard Capital Partners

Okay. Can you provide us with a little detail of kind where you expect your percentage of revenues to come from as far as the North American plays at the Haynesville and the Bakken and Barnett, just some kind of detail relative?

Brian Uhlmer - Pritchard Capital Partners

We don't... we really try not to benefit others by telling them that. But you might imagine, I mean you guys hear what's happening in the Haynesville and how many pounds of proppant are put in a well and how many rigs are running or various other places. But you should just never forget about things such as the Rockies too, the Pinedale Anticline, Canada, some of the new plays there. So yes, we'll have a much bigger percentage in '09 going into places such as the Haynesville and we're putting a hell of a lot of focus on that to supply our clients. But we look all over it, we'll try and serve everybody all around North America. And some of these other plays are huge and very economical plays.

Brian Uhlmer - Pritchard Capital Partners

Okay. And final question, with increasing margins and this being a good spot for proppant, have you seen competitive pressures from foreign suppliers increase in recent months?

Gary Kolstad

Not really. But I think we got asked that question last quarter too. We know there has been some Chinese proppant coming in. But if you remembered my earlier comments, that's not a long-term economic game plan. And two, they have some rather large issues with consistence of quality. So I think the E&P operators are smart enough to know that and... but having said that, if we are under serving people, and that's our focus, we need to fix that, right, so if they don't have to use the lower quality Chinese proppant. And so we are working hard on that and it's one of the other benefits of a downturn is that I think we'll be able to satisfy our client needs better.

Brian Uhlmer - Pritchard Capital Partners

Great. Thanks.

Operator

Thank you. Our next question comes from Roger Reid from Natixis. Please go ahead.

Roger Reid - Natixis Bleichroeder

Hello, good morning, guys.

Gary Kolstad

Good morning, Roger.

Roger Reid - Natixis Bleichroeder

Hey, Gary, can you help us say a little bit? CARBOHYDROPROP when introduced at the beginning of '08, the idea was it was coming in pricing as resin coated sand. Given the sort of pricing realization per pound that's gone on during the year and you saw on the fourth quarter. How much of that was CARBOHYDROPROP maybe going to the level it ought to be at, consistent with number one, the value it delivers and number two just the market acceptance there is no longer like you haven't to give people a reason to try, as I am looking a blended sort of price per pound number?

Gary Kolstad

Everything you just said, I couldn't have said it better.

Roger Reid - Natixis Bleichroeder

Okay. So we have seen the price of that come up then as a safe result?

Gary Kolstad

Correct.

Roger Reid - Natixis Bleichroeder

Okay. The Bakken is one of the areas you mentioned in the fourth quarter along with the Haynesville as a big driver of incremental revenue or incremental volumes. We have seen Marathon cut the rig count there, we have seen EOG talk about differentials hurting them on the production and on the drilling side, kind of $50 oil is the economic level required. How critical is the Bakken to you at this point, and let say the Bakken activity drops by half, is that something is that something that we should expect to see flow through in terms of volumes as we look into, I don't know mid '09 or something like that?

Gary Kolstad

Yes, but that will be a detriment for sure and that will put some pressure on the volumes. You need the balance part of that with the fact that we will move that product other places and satisfy needs we haven't been satisfying such as Southern Rockies or places like that, right and Canada or... once again, we saw increases in other regions throughout the U.S. So as that frees up, and yes, I think that you are exactly right on the economics if we didn't hedge the oil, then we've got some economic challenges up there. But the great thing is that the EconoProp in particular was well accepted up there. So in the future, when things get back on line and that's a multi-multi year play, we'll all benefit. So it's just a temporary deal, whether it's one quarter, two quarter, three quarter, we don't... it's just is what it is.

Roger Reid - Natixis Bleichroeder

I understand. It's just not a market that's at this point looking much past tomorrow, much less three quarters out?

Gary Kolstad

Yes. All we can tell you is just the way we think. I understand the way the market thinks.

Roger Reid - Natixis Bleichroeder

Yes. You comments about being able to shift proppant to other markets given the overall rig count declines, I mean do you see the market as undersupplied to the tune of, let's throw out the various numbers, 30 to 50% kind of rig count declines across the board?

Gary Kolstad

I don't think I am going to go there. We... you've just seen, I will put some color on the... just watch I think a lot of you have put up verbiage on the decline in the vertical rigs versus the horizontals. And you guys can do the math. What does one horizontal well with 10 to 15 fracs on it mean versus X amount of rigs drilling vertical wells. And whatever your number you come up with, five or something like that, you got to be careful about that. It's not a linear equation anymore on the percentage of rigs that drop to our business dropping. And a lot of that's due to the horizontals. The second component is HYDROPROP that went into a new area and just performed so much better than the raisin coated sand.

Roger Reid - Natixis Bleichroeder

Right. Final question for you, kind of going back to the... I guess a last couple of guys were asking about on the Chinese competitors here in the broad, your patterns expire on all the lightweights come June of this year, is that correct?

Gary Kolstad

Correct.

Roger Reid - Natixis Bleichroeder

Including HYDROPROP?

Gary Kolstad

Yes.

Roger Reid - Natixis Bleichroeder

Okay. Given that you're seeing them in here, how do you think... or is there anything you need to do other than kind of what you mentioned, maybe focusing a little bit on quality differences and I guess just your volume availability. But I mean what else do you want to do to make sure that you don't see a market share erosion to new competitors in the North America market?

Gary Kolstad

Yes, I think I had mentioned before, we don't worry about the expiration of patents. That's old news and it doesn't influence our thinking. If we are the leaders in the business, we are committed to remaining the largest ceramic proppar in the world... proppant supplier in the world, we have the broadest product range, we have five different products, which means we can satisfy any reservoir need better than anybody else. We keep investing in new product technology, and I think CARBOHYDROPROP is the best example of that. And we fully intend on doing that again. We keep investing in adding people, technical people, marketing and sales people to help our E&P design the job better and understand what they gain from productivity and ultimate recovery. We keep spending on distribution networks, because remember, we deliver just in time and we'll continue to do that. And that's something they won't be able to do.

So in other words, we keep, I call it moats, right, we keep continuing expand the moat around our business and we don't include patents as part of that moat. So it is what it is and we are looking forward and not backward. And we fully expect I think in the past we've said, we expect competition to increase, that's okay.

Roger Reid - Natixis Bleichroeder

Yes, I guess kind of record level margins or least record EBIT margins going back for several years are concerns that that's going to create... well, I should say some headroom for those guys to get in here. And with the patents coming off, just wondered if that would impact you in the back half of the year or not.

Gary Kolstad

Yes, well... once again, we hate to get caught up in one quarter. I think you should look year-on-year in things like that and average these things out. And the other nice thing about an economic crisis is it probably slows some people down and any type of thought process they have on getting in our business.

Roger Reid - Natixis Bleichroeder

Okay. And then just one final housekeeping question. The remaining, I won't call it Pinnacle, but I guess the consulting business and all that, what was the rough top line performance out of that in that in the fourth quarter?

Gary Kolstad

Since we don't disclose below the threshold, we are going to keep from reporting that. As those businesses grow, at some point, we will have to break that out for you, but for now, we won't.

Roger Reid - Natixis Bleichroeder

Okay. Is it fair to assume it was in the third range of what Pinnacle use to be to what was kept?

Gary Kolstad

Well we fell below the reporting requirements, so that tells you it's something less than that.

Roger Reid - Natixis Bleichroeder

All right. Thanks guys.

Gary Kolstad

Thank you.

Operator

Thank you. Our next question comes from Steve Ferazani from Sidoti & Company. Please go ahead.

Steve Ferazani - Sidoti & Company

Good morning, Gary. I guess I'll take one last shot at following up on the other questions there. Can you tell us what the average selling price you (inaudible)

Gary Kolstad

Well, if you take the... you can do that yourself, since we don't disclose that other than you have to make some estimate of what those other businesses meant to the top line.

Steve Ferazani - Sidoti & Company

Okay. New Iberia, when you announced a restart of that, you were turning away a lot of business. Obviously, the markets weakened a bit since then. I know customers would pick up some of the cost if you shut that down. Any chance of that? How are you looking at that right now?

Gary Kolstad

We just got started. And we are being pressed to put more products out.

Steve Ferazani - Sidoti & Company

Okay. And that's more... that's the higher end stuff, right? So even if the market is shifting more towards the lighter weight, there is still demand there for your HSP or your higher end?

Gary Kolstad

There is demand for our heavyweight products, absolutely.

Steve Ferazani - Sidoti & Company

Okay. So that would indicate that demand is still overwhelming supplier, right?

Gary Kolstad

We see a lot of demand for our products, yes.

Steve Ferazani - Sidoti & Company

Okay. The 150 million in cash, I'm guessing there is a lot of fairly low priced, or I guess depending on how you value it, acquisition targets out there. Are you getting a lot of calls? Are you looking around at all, or are you much more focused on proppant manufacturing at this point?

Gary Kolstad

No, we're constantly looking. We're not sitting back. We are absolutely focused on the proppant business, but we're looking and I think at some point here, we'll see opportunities. We're very patient and we are very tightfisted. So it will have to fit into our criteria.

Steve Ferazani - Sidoti & Company

Can you run through that a little bit, just in general terms, what makes a good acquisition target for you guys?

Gary Kolstad

Well, if anything that could enhance... in the proppant business, we know what we are going to do, right, spell that out. We'll control that. And the other businesses, we would be very pleased to add anything to them that we had in those spaces, the consulting or the geotechnical monitoring and/or the software business. Then if look outside that, we want a business with good economics; we don't want to get into a business that the only tools to complete on price, it's going to have a have a technology component, it's going to have to have a strong intellectual capital component, it's going to have to have the ability to build the brand. And it's going to leverage the strengths that we have. And if it happens to be the same client base that's our main client base, that's all the better.

Steve Ferazani - Sidoti & Company

Okay. And then with the new line in Toomsboro, do you have a target there at this point? Are you probably not rushing as much now, or what's your... what's the plan to get the new line going?

Gary Kolstad

No, we haven't altered our speed at all. And we are still leaving that open, say, in the first half of 2010. Multiple processes in that. So no, we haven't changed anything there.

Steve Ferazani - Sidoti & Company

Okay. Thanks a lot guys.

Gary Kolstad

Thank you.

Operator

Thank you. Our next question comes from Bob Christensen from Buckingham. Please go ahead.

Robert (Bob) Christensen - Buckingham Research

Perhaps you guys save the best for last, I don't know. The New Iberia, you had a cost line there in the fourth quarter. Will there be any costs for startup in the first quarter at all, or will that be zero?

Gary Kolstad

I don't think so, Bob. I think we've got it all covered there. If it will, it would be a very, very small amount.

Robert (Bob) Christensen - Buckingham Research

Fantastic. Second question, if I may. Any exposure to Venezuela and someone who is not paying their bills?

Gary Kolstad

No, no. And of course, in these times, you watch your DSOs very carefully. But we haven't seen any deterioration nor do we have exposure there that will create any concern whatsoever.

Robert (Bob) Christensen - Buckingham Research

Another question, if I may, please. Just here in the first quarter, is there any kind of forward guidance you can give us on domestic proppant sales? I mean any indicators that it's still going well here mid quarter?

Gary Kolstad

Yes, probably, can't share that, Bob, but it's an interesting way to ask the question. No, I think just like I said before, right. I wouldn't expect the Q4 '08 and I would expect probably some results better than Q1 '08. So it's around there.

Robert (Bob) Christensen - Buckingham Research

And a final one, just big picture, maybe not even pertinent to CARBO, but given your experience in industry and where you came from Gary, Russia and oil production, we've seen decline rates now of 1 and 1.5% year-on-year. A research piece said that last week, dug back in time and saw in the early 90s oil declined at 10, 11, 13% per annum, think it was 91 to 93. And times are different now. The last five years, my observation has been Schlumberger, Halliburton, you guys have all been pressure pumping fracture stimulation of oil wells. If they lay off that activity some, could we see double-digit decline rates in Russian oil production a few years out? I mean, we see gas oils decline so quickly once the fracs are stimulated, but so much thereafter, if I am right, you maybe can confirm this has been pressure pumping.

Gary Kolstad

The only thing I would probably add to that is that one, if you take the comments that Schlumberger made about Russia in their release where they said, I think they termed it production enhancement ex-release (ph) were down. So that will hurt... from a 100,000 foot view, in the oil and gas industry, we always tend to cycle really hard and we always overshoot, probably not much different than the stock market I guess. But so we are going to contract here and we are going to contract way too much; that's the way it works. And then we are going hit it hard again evenly and we'll put the pedal to the medal the other way. So they are, in my opinion, in which we tend to be fairly long-term thinkers, there is another problem coming here around the corner. Whether that's one year or 18 months, I don't know. But it will be the problem in the opposite way.

Robert (Bob) Christensen - Buckingham Research

But the pressure pumping has been their emphasis, right, fracture stimulating oil wells whereas in I guess the late 80s, it wasn't facture stimulating oil wells over there; that's the emphasis. Here would be to potentially greater declines sooner. Is that something that an ex-Schlumberger guy could imagine?

Gary Kolstad

I don't know. Maybe I should go find someone for you. No, I mean --

Robert (Bob) Christensen - Buckingham Research

But it's helpful.

Gary Kolstad

Too much into that other than you're probably directionally right, absolutely. And I think once again, as I always say, the great long-term excitement for me about Russia is when they start cracking the gas wells.

Robert (Bob) Christensen - Buckingham Research

Yes, yes. Well, great to hear from you. Congratulations.

Thank you.

Gary Kolstad

Thank you.

Operator

Thank you. Our next question comes from Bill Conroy from SMH Capital. Please go ahead.

William Conroy - SMH Capital

Gary, good morning, just a couple left. First one, really, maybe just to close the loop on this. Was there any margin improvement that resulted from the sale of the Pinnacle assets? In other words, with the consulting business that's left, did that remain... that stub piece, did that tend to help margins or have any margin impact?

Gary Kolstad

I would say it was extremely minimal on margin impact.

William Conroy - SMH Capital

Okay. And maybe it's going to sound like a silly question, but I'd ask you to consider the comments that you made this morning about what's going on in the Haynesville. You made the statement, to paraphrase, that first quarter maybe things don't... the stars don't quite align like they did in the fourth quarter. We've all watched rig counts, we've all watched commodity price, but you've made this statement a couple of times about what's going on in the Haynesville. What's different in the first quarter for CARBO versus what you saw in the fourth quarter?

Gary Kolstad

Overall Bill or just specifically there?

William Conroy - SMH Capital

How about both?

Gary Kolstad

Well, I think overall, you'd have to back up and see what's happening to everybody. The ring count, we mentioned the percent it's declined and it's continued on into Q1, so. But I caution on that, don't linearly plot CARBO versus the rig count decline. And the reasons I mentioned that is because of some of these things we mentioned, the Hayneville, HYDROPROP, some of these other things, us finally getting to supply other places that have wanted our product. So I would be cautious on that. And I think a lot of folks are very interested in seeing what their investment in the Haynesville can do from an E&P standpoint. And there is probably obligations to drill and all these other things there too. But they are just getting some incredible wells out of there.

William Conroy - SMH Capital

Anything different for CARBO specifically then?

Gary Kolstad

No.

William Conroy - SMH Capital

Okay. That's helpful. Thanks Gary.

Operator

Thank you. Our next question comes from George Shiau from Copia Capital. Please go ahead.

George Shiau - Copia Capital

Hi Gary. This is probably a longer term question. Given the $6 that you have cash on the balance sheet and you talked about being able to buy back stock, looking at acquisitions. What about another plant expansion or is it too soon to think about building up another train?

Gary Kolstad

Well, we have mentioned in the last quarter and then maybe even the quarter before that, we are doing the engineering for Toomsboro line four right now. So we want to be ready to push the button, and by getting the engineering done in conjunction with Toomsboro line three, that speeds up the process. So we are absolutely in tune with that.

George Shiau - Copia Capital

Okay. And what do you think about the I guess the various factors in kind of analyzing or deciding, getting comfortable with the demand, will this extra line be needed, I guess?

Gary Kolstad

Once again, long term, absolutely.

George Shiau - Copia Capital

Okay.

Gary Kolstad

And you just need to back up and look and don't get caught up in a quarter or six months or a year, just back up and look what happens in the U.S. and Canada to a smaller extent. And we keep having to drill a lot more wells to produce the same amount of gas. Consumptions hasn't really changed, right, over the last 10, 12 years. But we have to drill more now. Then you say, well, Gary, we've got these new wells that produce like crazy and I say, yes, thank you, because they are being drilled horizontally, they are transverse fracs, there is a whole bunch of reservoir contact, which means that we have to put more proppants down there.

So long term, none of this concerns us. We understand the way the mechanics work, the mass balance in the U.S. and stuff and you're going to have a continued demand and you're going to keep growing the natural gas reserves in the U.S. What I think will be interesting, will be how does this play into all the other things, the LNG and the global gas development and all those things that take place. And don't worry about the future.

George Shiau - Copia Capital

I appreciate it. Thanks.

Operator

Thank you. Our next question comes from Waqar Syed from Tristone Capital. Please go ahead.

Waqar Syed - Tristone Capital

Good morning, Gary. Great quarter. I've got a couple of questions. First, you mentioned in your press release that North American volumes were up 30% year-over-year. Could you break that down between U.S. and Canada?

Gary Kolstad

Did we release that? I don't think we broke that out that, did we, on our release? So since I'm not going to characterize it other than saying that the U.S was much higher than Canada and we did say what the rig count differential was. So that probably tells you the magnitude because the rig increase in the U.S. was much less than the rig increase in Canada and yet the U.S. grew a lot more. And that tells you the effects of in particular HYDROPROP.

Waqar Syed - Tristone Capital

Sure. Okay. My second question relates to the Marcellus, it's obviously a shallow play. Probably you don't need pressure temperature characteristics of ceramics. But do you have any sense of what the fracture orientation is and what the conductivity characteristics of ceramics may come in handy in that play?

Gary Kolstad

I think they are going to have the same mechanism, Waqar, as the other horizontal plays. And I'm no expert on that nor do I profess to be, but I think what you'll see overtime is you're just going to see horizontal drilling more transverse fracs, which once again the component there ignoring stress and temperature is you want to have a lot conductivity at that small contact point at the well bore. So in that shape, they would probably be same.

Waqar Syed - Tristone Capital

Okay. And then just one final question. Do you know what your competition is doing in terms of capacity expansion projects for '09?

Gary Kolstad

Yes, nothing that we've heard of. I think we've mentioned that Saint-Gobain has got their plant in Venezuela running in '08. But other than that, I don't think anything. And once again it's one of the nice things about economic crises, it tends to make people sit back and think.

Waqar Syed - Tristone Capital

Okay. And that's a 100 million pounds plant, is that correct?

Gary Kolstad

Yeah, maybe slightly over that I think. But I'm not sure.

Waqar Syed - Tristone Capital

And how about Curran Bob (ph), what are they doing these days, do you know?

Gary Kolstad

Nothing that I'm aware of from an expansion standpoint.

Waqar Syed - Tristone Capital

Okay, great. Thank you very much.

Gary Kolstad

Thank you.

Operator

Thank you. Our next question comes from Mark Finca (ph) from DSO International. Please go ahead.

Unidentified Analyst

Great quarter, guys. Congratulations.

Gary Kolstad

Thank you.

Unidentified Analyst

Well, looking at the sales, I'm trying to figure out what the terms are when you do sell a product. Is it 70 days, 80 days, 90 days, or what is the typical terms in your product mix?

Gary Kolstad

Ernesto, you want to make a comment on what our DSO is? I don't think we want to spell out our terms. It's less than what you've just described. But our DSO trends --

Ernesto Bautista, III

Sure. DSO trends over the last few quarters have stayed within the 60-day realm and have been consistent for the last four, five quarters.

Unidentified Analyst

Kind of looking like what I am calculating... I'm just trying to figure out how you all calculate that, it looks like it's 90, 100, 105 days. So there is something wrong with my calculations. How do you all define it?

Gary Kolstad

Can you guys... can you call Ernesto?

Ernesto Bautista, III

Yes, we can go through that offline.

Unidentified Analyst

Okay.

Operator

Thank you. Our next question comes from Edward Uwarka (ph) from First Financial. Please go ahead.

Unidentified Analyst

Good morning Gary.

Gary Kolstad

Good morning.

Unidentified Analyst

I just wanted to follow up on, we've heard an awful lot about how the company is involved in the Haynesville. What about the other unconventional plays including the Fayetteville, the Marcellus?

Gary Kolstad

Yes, we have had, as I mentioned on the Marcellus a little bit about that, but we've had some requests there. And unfortunately, during the quarter, we couldn't... the last quarter, we couldn't really help out there. Fayetteville hasn't used much ceramic, other places have, especially the Deep Barnett in West Texas, the Woodford. There has been an interest in some other plays in the Rockies that we haven't been able to get into yet. There is new interest in up Northern BC with the new plays opening up there. So we participate in a lot of them and involved in most of them I guess you could say.

Unidentified Analyst

Okay. Thank you.

Operator

Thank you. Our next question comes from Milan Gupta from South Point Capital. Please go ahead.

Milan Gupta - South Point Capital

My questions have been answered. Thanks guys.

Gary Kolstad

Thank you.

Operator

Our next question company comes from Paul Zoran (ph) from Elco. Please go ahead.

Unidentified Analyst

Gary, I apologize if I missed it. Did you guys put a number on what the fiber optic monitoring system contributed to fourth quarter revs?

Gary Kolstad

No, we didn't put a number on any of those, either the businesses nor those projects we mentioned.

Unidentified Analyst

So you're not going to disclose it?

Gary Kolstad

No, not at this time.

Unidentified Analyst

Okay.

Gary Kolstad

If the businesses gets bigger in the future, then we probably won't.

Unidentified Analyst

Alright, thank you.

Operator

Thank you. Our next question comes from David Epstein from Advent. Please go ahead.

David Epstein - Claymore Securities, Inc

Hi, this is probably a naïve question, but can you help me understand, I mean would you characterize yourself as still capacity constrained? And if so, I am trying to reconcile that with why would volumes have declined from Q3 to Q4 unless your capacity also went down.

Gary Kolstad

Well, it wasn't of any material nature at all, Q3 to Q4. I can't remember what the percentage was. But I think we were at a little over 300 versus 293. So that's a little bit immaterial. We did... we were stretched on capacity in both Q3 and Q4. And once again, the thing you have to also think about, what always happens in December and January even though everybody forgets that every year, but at the end of the year, it always tails off because of holidays and then that gets started up in the new year. So we don't... 293 versus 300 or whatever is immaterial.

David Epstein - Claymore Securities, Inc

Okay. So you are still capacity constrained. Thank you.

Operator

Thank you. Our next question comes from Zanny Ernak (ph) from BlackRock. Please go ahead.

Unidentified Analyst

Yes, thanks. Great quarter, Gary. I've got two questions. Can you talk about the average number of pounds of proppant being used in the Hayneville, I guess frac stage and if you can compare that per frac stage I guess in the Barnett or the Bakken? If you don't want to give us the details, can you talk... give us the directional change? Is it more per frac stage or less or is it the same? Thanks.

Gary Kolstad

Yes, what's happening is that they are drilling fairly long laterals and they are seeing incredible success with these trends versus (ph) fracs and they are putting in fracs at... 10 of them, some moved up to 12, up to 15. And so your volumes, I'll just put a big range on it. You are seeing 2 million up to 3 million, let's say. So that's kind of your range. And the Bakken has some big fracs as well. And compared to the old vertical well days, it's... yes, we're putting a heck of a lot more proppant in wells.

Unidentified Analyst

But per frac stage, it's more or is it less? I am just trying to get a sense... I know there are more frac stages in the Haynesville wells, but is it a 150,000 per frac stage and it's maybe 100,000 in the... I mean I don't know if you want to give us the details, but --

Gary Kolstad

I would say you should... it is increased, it's in no fashion doubled or anything like that.

Unidentified Analyst

Okay.

Gary Kolstad

But it is an increase, yes.

Unidentified Analyst

All right, thanks.

Operator

(Operator Instructions). Our next question comes from Bob Christensen from Buckingham. Please go ahead.

Robert (Bob) Christensen - Buckingham Research

Yes, a follow up, if I may. One of the more aggressive drillers in the Haynesville keep saying they are quite satisfied with resin coated sand. Why would somebody continue to use resin coated sand?

Gary Kolstad

Well, I am not going to comment on why somebody does something. I'll maybe make an anecdote on that. We... as I said, you could download the presentation I did you can see the technical reasons on stress and temperature and that contact area of the well bore, why ceramics benefit.

I think just to make an analogy, it will be kind of in Houston, they have rebuilt I-10, they've expanded this, haven't they. And the only reason we track a well is to make a conductive channel for oil and gas to flow to the well bore. That's it, right. So the proppant is what creates that conductive channel. So if I'm building I-10 in Houston and I say, well, I am just going to lay down four inches of black top and I'm still driving that semi on that road at 70 miles an hour for a time. But what happens? The roads starts to disintegrate. Why does it disintegrate? Well, in this case, it's stress, it's temperature, everything like that. So why not lay down the reinforced 12-inch concrete conductive channel for that semi to drive for a couple of decades? So that's the thought process. So we know what happens to sand given the pressure and temperature, and that's all we can say on it.

Robert (Bob) Christensen - Buckingham Research

So there is some I guess short sightedness in some of the Haynesville players or not even Haynesville players, other players, at the moment because of the lack of availability or is it something else?

Gary Kolstad

Bob, I won't and nor do I want to answer that question.

Robert (Bob) Christensen - Buckingham Research

Fine.

Gary Kolstad

I'll just say, we are just trying to satisfy the demand in here and that's what we are focused on.

Robert (Bob) Christensen - Buckingham Research

All right, good. Thanks

Gary Kolstad

Thank you.

Operator: Thank you. At this time there appear to be no more questions. Mr. Kolstad, I will turn the call back to you for closing remarks.

Gary Kolstad

Okay, thank you and thank everybody for joining us this morning. And I'll just summarize a couple of keys points.

Our technical marketing program and the successful introduction of CARBOHYDROPROP really reflected in the financial success we achieved this whole year. And despite the decline in drilling activity, we believe in and are committed to the long-term objective of growing our production capacity and we'll continue with the construction of line three in Toomsboro. And we have an extremely strong balance sheet that allows us to focus our time in our clients and business and we think will provide us an opportunity to pursue other opportunities in the coming year.

So with that, we thank you and look forward to talking to you in the future.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect.

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Source: CARBO Ceramics Q4 2008 Earnings Call Transcript
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