CARBO Ceramics Inc. (CRR)
Q4 2013 Earnings Conference Call
January 30, 2014 11:30 AM ET
Executives
Gary Kolstad – President and Chief Executive Officer
Ernesto Bautista, III – Vice President and Chief Financial Officer
Analysts
Jeff Tillery – Tudor, Pickering, Holt & Co.
Blake Hutchinson – Howard Weil, Inc.
Avinash Kant – D. A. Davidson & Co.
Brandon B. Dobell – William Blair & Co. LLC
Marc Bianchi – Cowen and Company, LLC
Trey Stolz – IBERIA Capital Partners LLC
Darren Gacicia – Guggenheim Securities LLC
Stephen Gengaro – Sterne Agee & Leach, Inc.
Operator
Hello and welcome to today’s CARBO Ceramics Incorporated Fourth Quarter and Year End 2013 Earnings Conference Call. At this time, all participants are in 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 this call is being recorded today, January 30, 2014, and your participation implies consent to our recording of 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 those 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 fillings.
Your host for today’s call is Mr. Gary Kolstad, President and Chief Executive Officer, CARBO Ceramics Incorporated. Mr. Kolstad, please begin your call.
Gary Kolstad
Good morning and thank you everyone for joining us on our fourth quarter 2013 earnings call. This morning I’ll provide you with an overview of our fourth quarter results followed by an update on our outlook for the business and then we’ll open it up for questions.
In our Production Enhancement businesses, they had a good year with several company record set. The demand for our unique technology portfolio continues to grow as E&P Operators’ facture completion activity grows in the complex and conventional reservoirs.
Our Design, Build, and Optimize the Frac platform provides a complete solution to maximize our clients’ well production and increase estimated ultimate recovery or EUR. Using this approach, we are able to address each client’s specific needs, whether that be creating comprehensive fracture solution or simply providing a single component of our Design, Build, and Optimize the Frac platform. The three brands representing this platform: Fracpro, CARBO Ceramics and StrataGen achieved records in 2013.
Ceramic proppant volumes in 2013 set a record, topping 1.7 billion pounds, despite a market that was over-supplied with low-quality Chinese ceramic proppants. We grew our presence in the Resin-Coated Sand market, with RCS sales volumes growing over four-fold to little over 241 million pounds. Clients continue to trust CARBO to deliver the highest quality, highest conductivity proppants to increase production and EURs. We also had record business results and expanding client bases in both Fracpro and StrataGen businesses. Those finished the year on a strong note.
Activity rebounded in December after heavy rains and icy weather hampered sales volumes in both the Eagle Ford and the Permian during the early part of the fourth quarter. Although the marketplace remains competitive, our proppant pricing was stable when compared to the third quarter of 2013.
We continue our technical marketing campaign, which highlights the damaging effects low-quality Chinese ceramic proppants have on well production and EURs. The success of this campaign supports our increasing investments in manufacturing capacity. Construction on Millen Line 1 continued at our new ceramic facility. In addition, construction on Millen Line 2 will commence in the first half of 2014. When both lines are completed, they will add 500 million pounds of annual ceramic proppant capacity.
On the technology front, completion of formal qualifications with our clients for KRYPTOSPHERE, an ultra-high conductivity, ultra-high strength proppant, continued during the quarter. Client reaction to the testing results have been very positive as they see proof that this is the most highly conductive proppant ever made and they can envision the returns they will get from it. We remain very optimistic on this revolutionary product and its ability to increase production and EURs.
Our Environmental Services, Falcon Technologies, saw its fourth quarter 2013 results negatively impacted, largely due to seasonality as well as the idling of the tank-lining services during the third quarter of 2013. For the year in our Environmental Services business, we saw containments and tank bases grow. For 2013 Falcon generated $41 million of revenue.
With that, I’d like to turn to some brief remarks on the financial performance of the Company for the fourth quarter. Revenues for the fourth quarter of 2013 increased 7% compared to the fourth quarter of 2012. The increase is mainly attributable to an increase in proppant sales volume. North American, which we define as Canada and the U.S., proppant sales volume increased 38%, while international proppant sales volumes decreased 33%, compared to period last year, primarily due to China and Mexico.
Operating profit for the fourth quarter of 2013 increased 4% compared to the fourth quarter of 2012. This increase is mainly attributable to an increase in proppant sales volume, partially offset by a change in product mix as shown in the table in the press release and an increase in SG&A expense. Net income for the fourth quarter of 2013 increased 5% compared to the fourth quarter of 2012.
The year ended December 31, 2013, revenues increased 3% compared to 2012 and this once again is mainly attributable to an increase in proppant sales volume. CARBO’s worldwide proppant sales volume totaled 2.06 billion pounds for the full year, an increase of 20% compared to previous year. Sales volume in North America increased 29%. International sales volume decreased 17% primarily due to decreases in China, Mexico and Africa. Full year net income for 2013 decreased 20%.
Now, let’s discuss our outlook for the coming year. An increase in capital spend on the part of E&Ps in 2014 should result in solid industry activity. Consequently, we anticipate demand for our industry-leading production enhancement services and products to remain intact. Specifically regarding proppant sales, we believe 2014 will be another good year for volumes, aided by our technical marketing campaign that continues to highlight the superior conductivity of CARBO’s ceramic proppant compared to low-quality Chinese ceramic proppant.
In the near-term, we expect ceramic proppant volumes for the first quarter of 2014 to increase when compared to the fourth quarter of 2013. Current market conditions remain competitive, which leads us to believe that pricing may remain at current levels.
Based on the solid demand we witnessed in the second half of 2013, we are pleased that Millen Line 1 remains on schedule with completion expected by the end of the second quarter of 2014. This addition could prove timely as the third quarter is typically an active quarter. With construction commencing soon on Millen Line 2, we anticipate startup could occur before the end of the second quarter of 2015. Once both lines are completed, our ceramic manufacturing capacity will increase by 500 million pounds to a total of 2.25 billion pounds per year, resulting in an approximate 29% increase of our capacity in the next 18 months.
We are starting to build inventory of KRYPTOSPHERE-H, our new ultra-high conductivity, ultra-high strength proppant technology. Product testing and qualification with clients are continuing and all results to date have been positive. While many deep completions in the Gulf of Mexico have been delayed in 2014, it’s anticipated that initial sales of KRYPTOSPHERE-H could begin as early as the third quarter of 2014.
As we’ve mentioned before, the next phase of our KRYPTOSPHERE product development will be to apply this technology to our existing manufacturing footprint. Engineering of a retrofit of an existing plant is underway. Once the retrofit is complete, applying KRYPTOSPHERE technology to our production platform will expand our technology lead in the industry and, most importantly, further assist in increasing the production and recovery of our clients’ oil and gas wells.
Our RCS product line continued to see further market expansion during the fourth quarter of 2013, with sales volumes near quarterly capacity levels. We anticipate continued demand for our high quality, high conductivity resin-coated sand during 2014.
New product development continued across our proppant-delivered technology platforms: Production Assurance, Production Intelligence and Production Flow Enhancement. We have seen increased client involvement in tailoring these new products to solve their particular needs. Production improvement solutions delivered via proppant provides a more efficient, longer-lasting solution for wells. During 2014 we expect to use field trials to test new products across these proppant-delivered technology platforms.
Regarding our Environmental Services business, as mentioned before, Falcon Technologies’ growth during 2013 was negatively impacted by lower demand for tank lining services. As a result, near-term growth lagged internal projections. However, long-term growth projections remain intact with a renewed focus on new and existing product lines aimed at protecting the environment and our clients’ assets and reputations.
Before I open the call to questions, I’d like to reiterate a few points. CARBO’s Design, Build, and Optimize the Frac platform describes more than our production enhancement businesses. It symbolizes a culture within CARBO committed to the long-term profitable growth of the Company, supported by continuous efforts to develop new technologies, while creating value for our clients. We think this culture enables us to build an enduring company. We have many opportunities ahead of us, and our strong balance sheet positions us well to capitalize on these opportunities in 2014 and beyond.
And with that, I’ll turn it over to questions.
Question-and-Answer Session
Operator
And ladies and gentlemen, at this time we’ll begin the question-and-answer session. (Operator Instructions) And our first question comes from James West from Barclays. Please go ahead with your question.
James C. West – Barclays Capital, Inc.
Hey, good morning, Gary.
Gary Kolstad
Good morning.
James C. West – Barclays Capital, Inc.
Gary, Millen Line 1, which will be operational here, I guess, around the mid-year, typically you guys, when you bring a new line on, I know it’s kind of a states process, and you don’t sell out everything right away, but it seems like the market is demanding a lot of proppant. So can you presell part of this line or a big chunk of this line, so that you all see ramp up faster than you may have historically?
Gary Kolstad
Yes, I don’t know if presell would be the word we’d use but, what’s working very well is that we commented over the last couple of years that just given the weather patterns and where we’re working nowadays that Q3 might be the highest activity quarter in calendar years ahead. So what we think is that this is going to come online at probably just the right time. I don’t know if we’d call it preselling, but it’s – more goes along with just our relationships with our clients and the activity increase. So, yes, we’re anxiously looking forward to completing that just in time for the Q3.
James C. West – Barclays Capital, Inc.
Okay. Okay. Got you. And then just on KRYPTOSPHERE, the retrofit program that you’re doing right now, can you do a retrofit on more than just this facility, more of your facilities? And then what’s the cost for a retrofit?
Gary Kolstad
We don’t know the cost yet because we’re right in the middle of engineering and figuring that out. We can do it as many plants as we would like to do it with. We pick one in particular right now and what’s been very interesting and very beneficial is that our R&D plant, our pilot plant, we’ve learned a couple of things here in this last couple of months that really helps the process of retrofitting or building new plants with it and that’s due to just the manufacturing quality and cost and everything. So it’s tough for us to put a number on it right now, James, but we will work into it over the years.
James C. West – Barclays Capital, Inc.
Okay. Fair enough. Thank you.
Operator
Our next question comes from Jeff Tillery from Tudor, Pickering, Holt & Company. Please go ahead with your question.
Jeff Tillery – Tudor, Pickering, Holt & Co.
Hi. Good morning, guys.
Gary Kolstad
Hello.
Jeff Tillery – Tudor, Pickering, Holt & Co.
On your KRYPTOSPHERE, I guess can you help us out just understanding what sort of capacity you’re – or just color around maybe, is there an older facility you’re doing it to, so we can gauge to some degree what sort of capacity you are going to have available?
Gary Kolstad
It’s an existing facility and literally all of our plants, even the ones that have been around for a while, they product 250 million pounds, 300 million pounds. You get the bigger complexes that have lines that each produce 250 million pounds. So you should probably thinking along the lines of 250 million pounds.
Jeff Tillery – Tudor, Pickering, Holt & Co.
Okay. Great. So it’s not just putting some new equipment into Iberia. It’s one of the other facilities? Okay.
Gary Kolstad
Yes, it won’t be New Iberia. New Iberia is where we run our R&D, although that is where we will produce KRYPTOSPHERE-H.
Jeff Tillery – Tudor, Pickering, Holt & Co.
And then, Gary, could you just give us some color on how you see the competitive dynamics, kind of the import market? Obviously your technical marketing campaign is geared to educate in that regard, but what are you seeing just volumetrically in terms of imports?
Gary Kolstad
Well, if you look at the calendar year, 2011 was a peak, 2012 was down, 2013 is down from 2012. I think we would expect, just given the demand for our products and maybe just some overall industry, more stages, better rig efficiency, et cetera I think the demand is increasing. So it would not surprise us at all to see the imports increase in 2014. But this is the fundamental basis of why we are increasing manufacturing capacity. There is a shortage of quality ceramic proppant here in North America and we all have to work to get this low-quality Chinese product out of the country.
E&P suffers from production and recovery, shareholders suffer, royalty owners suffer. So we have to replace that. That’s why we’re going to continue to build and we get 500 million pounds coming now that we won’t stop there, but we really see that. And when you look at plays, some people incorrectly called this, but you get to play like the Bakken
that continues to use more and more ceramic, the Eagle Ford well, the Permian well, Canada well. So we see growth in the ceramic business. Obviously our resin-coated business is doing fine too, but now we continue to see that on a macro level and we all have to work at getting this Chinese low-quality stuff out of the country.
Jeff Tillery – Tudor, Pickering, Holt & Co.
And last question I had just on the non-ceramic volumes, you sold in Q4 progress nicely. Do you think about what we saw in Q4 as being sustainable over the course of the year for both the sand and resin-coated sand businesses?
Gary Kolstad
Yes, sand business is immaterial. That's just a byproduct. So it will go up, it will go down, whatever, but on the resin-coating side, yes, we expect to have – we’re pushing ourselves this year and I think what that means is at some point during 2014 we’ll have to make a decision on what to do. We previously announced we were going to put 600 pounds more capacity into our business that we held off because of market dynamics and we’re still holding off a little bit. We like some of the trends on pricing on RCF, but we’d like to see some time pass and continued market discipline, let’s say, before we do that, but it’s probably a decision we’ll make in 2014.
Jeff Tillery – Tudor, Pickering, Holt & Co.
Okay. Thank you very much.
Operator
And our next question comes from Blake Hutchinson from Howard Weil. Please go ahead with your question.
Blake Hutchinson – Howard Weil, Inc.
Good morning.
Gary Kolstad
Good morning, Blake.
Blake Hutchinson – Howard Weil, Inc.
Gary, I think you’ve laid out I think a pretty nice backdrop for the company heading into the year. I just wanted to get your thoughts on really what has more power this year in terms of your pricing dynamic? Is the state of kind of pressure pumping customer more of a limiting factor than actual specific in a supply demand characteristics for ceramic at this point and we should really kind of be taking our cues from there, more than the market itself or is it still really just true supply demand out there on the ceramic site?
Gary Kolstad
Well, I mean we’re part of a big ecosystem, right? So the pressure – pricing and pressure pumping has been well documented by all the folks that have released already and everything. So, yes, that affects us. E&P operators are still trying to optimize some cost basis and stuff like that, but I think maybe even starting as early as Q3 last year we started to see E&P now turn towards recovery and that’s sort of we come into play. But we’re basically planning not to see any near-term price increases and we're okay with that. We just have to get capacity. And, so I think it's driven by just the oil and gas industry, not so much competition because our job absolutely is just to educate people on how bad this training stuff is.
Blake Hutchinson – Howard Weil, Inc.
Okay. And then just some clarification around KRYPTOSPHERE. As we see the introduction in the second half that the initial sales here will be at whatever you deem that the ongoing commercial terms for the product. This is kind of a test well or discounted to kind of start in the market?
Gary Kolstad
Yes, I think what's affecting us more than anything is just E&Ps moving their completions later in the year and a lot of that is, best to understand it’s driven by everything from wellheads to some of the other completion hardware, things like that. So these really deep wells require some pretty complex things. So that’s what’s moving it out for us. We originally, I think, told people at our Investor Day last year we thought we’d sell 10 million pounds and we don’t know. We still may. But the only thing we see is that the wells are moving later into 2014 than what we thought let’s say, six, 12 months ago.
Blake Hutchinson – Howard Weil, Inc.
But again any – the related pricing on kind of these initial wells would be at what you would deem commercial terms, not anything that’s kind of introductory?
Gary Kolstad
Yes, I don’t think we’ll talk too much about that. We’re in the process of stopping the E&P and the service companies right now on that. And it’s going to be a more expensive product just because of the cost of it and the value of it. It’s off the charts, right? I mean, this investment will pay for itself faster than all these great products we have to date plus it’s the only thing that will survive these deeps wells and the testing has proved that. So it will be more expensive, yes, but it’s okay.
Blake Hutchinson – Howard Weil, Inc.
Okay. And then any quick thoughts, last one, to potential downtime that you might have to experience during a retrofit process? Is this pretty seamless and measured in days and weeks or something more involved?
Gary Kolstad
Well, everything we’re doing from an engineering standpoint is to avoid having to shutdown and so, yes, of course it’ll be a few days, yes. But we don’t – we’re doing everything we can to make sure that this doesn’t shut us down for a month or anything like that.
Blake Hutchinson – Howard Weil, Inc.
Fantastic. I’ll turn it back. Thanks for the time.
Operator
Our next question comes from Avinash Kant from D. A. Davidson and Company. Please go ahead with your question.
Avinash Kant – D. A. Davidson & Co.
Good morning. I had a few questions. Thanks for taking my question. The first one was on the margin side. Gary or Ernesto, can you give us some idea about the relative margin profile in the three ceramic sales or ceramic and the RCS and the sand sales that you have at this point?
Ernesto Bautista, III
Yes, we don’t breakout the margins between the product lines. I think I would point you back to a previous call where we suggested that fourth quarter margins would be modestly better than second quarter, the variability being driven by one or two things, product mix, the more sand-based product that we have in relative terms that will impact margin negatively and then also the delivery methodology that impacts cost. Today we deliver in three forms. We’ll deliver direct to the well site, we’ll have customers pickup from our locations or we’ll deliver directly to a customer’s stocking location, each of which have a different margin profile. So it will all depend on the given facts and circumstances over months, weeks, quarter. That will have an influence over the overall margin.
Avinash Kant – D. A. Davidson & Co.
The one reason that I was asking this question is it’s a bit hard to reconcile, because your sales in the RCS have been very, very strong, but still margins on a relative basis actually were good. I was wondering what was the play there.
Ernesto Bautista, III
What we will say with respect to RCS, I think and we have mentioned this historically as well, we are doing a lot better from a comp standpoint with respect to resin-coated sand in order to get margins where we had expected them to be. We would really need to see an appreciation in pricing before that occurs. But over the last few quarters we have seen through the efforts of our team from a manufacturing standpoint that the cost profile get a lot better for resin-coated.
Avinash Kant – D. A. Davidson & Co.
So would you say that it’s coming closer to the ceramic margins now or still slightly below?
Gary Kolstad
It will be below. It will remain below.
Avinash Kant – D. A. Davidson
Okay. And the other side of the question of course when you give the mix of course of pricing and you said pricing was flat, did you give out exactly what was the average price for the quarter and how should we think of the different segments?
Ernesto Bautista, III
We basically just give – we’ll disclose the average price for the quarter part of the disclosure in the 10-K, but we don't break out byproduct line.
Gary Kolstad
Okay, I think actually that’s the color of that. The ceramic is flat and we saw marginal improvement in RCS.
Ernesto Bautista, III
Marginal improvement that right.
Gary Kolstad
Yes.
Avinash Kant – D. A. Davidson
That's clear. Thanks
Gary Kolstad
Marginal.
Avinash Kant – D. A. Davidson
Okay. Thanks.
Operator
Our next question comes from Brandon Dobell from William Blair & Company. Please go ahead with your question.
Brandon B. Dobell – William Blair & Co. LLC
Thanks. Kind of a two-part question on resin-coated. As the volumes pick up what would be the trigger point for you guys to, I guess really think about expanding capacity there, and as part of the ongoing volumes for potentially more volumes, should we expect you guys to need to put any more transportation or storage infrastructure in place as those volumes grow?
Gary Kolstad
Part of our decision making on the Resin-Coated Sand is pricing, profitability and all that. So that's something that we constantly look at. Regarding the storage, that we work dependent on whether we have more RCS or not because we except for last couple of years we're going to increase storage. So that is what’s been taking place. Our distribution team has done a fantastic job on that and we're in a multi-year type of planning on that and ultimately we get the little bit of benefit on the cost side of the equation from that.
Brandon B. Dobell – William Blair & Co. LLC
Okay. And then, and somewhat related I guess, the last couple of quarters you talk about infrastructure spending, R&D spending and put out some relatively specific kind of EPS impacts. How do we think about those factors in 2014 relative to 2013 i.e. are we going to see some more quarters where those I guess it becomes a tailwind on a relative basis to margins or should we expect that level of kind of infrastructure spending and R&D spending to remain consistent here in the near-term?
Gary Kolstad
Yes, I’d say it's probably consistent in the near-term, Brandon. It will tail off to some degree, but it won't get to zero. As we complete or go through the retrofit process we’ll continue to see some of those costs continue throughout the year, but at least in the near-term continue at the same levels as we’ve seen the last couple of quarters and it's been relatively flat. Maybe second half of the year we’ll start to see that decrease some, but as the pace of the retrofit increases you will see some it just won't be at the same level.
Brandon B. Dobell – William Blair & Co. LLC
Okay. And then finally one Gary. Maybe – since you talk about the Chinese imports. Have you seen any change in the quality of imports and I guess that's from China or other places the last couple of years, have they gotten any better at doing what you guys do or is it still the same stuff we saw a couple of years ago?
Gary Kolstad
We continue to see some really bad stuff, especially as we’ve now developed not only just looking at the outside of pellets, but looking at the inside of pellets and we’re arming our sales force to show the clients that. No, it’s – we don’t see much of a change and that's a very good thing.
Brandon B. Dobell – William Blair & Co. LLC
Okay. Thanks a lot, guys.
Gary Kolstad
Thank you.
Operator
Our next question comes from Marc Bianchi from Cowen. Please go ahead with your question.
Marc Bianchi – Cowen and Company, LLC
Hey. Good morning, guys.
Gary Kolstad
Good morning.
Ernesto Bautista, III
Good morning.
Marc Bianchi – Cowen and Company, LLC
It seems like December was quite a bit busier than you guys had anticipated. I’d suspect this momentum carried over into January? If we have sort of similar activity through February and March, what sort of volume increase would that translate to for first quarter? Is it something of sort of full capacity utilization? Is that what we should be thinking about?
Gary Kolstad
I think you described the first part of that correct. We were pleased with December, which is normally one of the worst months of the year. So that worked out pretty good. Then I think we’re very comfortable with the first quarter. I’d maybe echo some of the comments you heard from the pressure pumping guys that have announced already, and it’s no surprise to anybody. It’s been a little bit chilly out there and a little bit, so the north part of NAM [ph] has been a little bit slower out of the shoot, but I think that February and March can help us catch up to that and I don’t think we’re going to, at this point, tell you we’re so early in the quarter whether or not we’re going to sell our manufacturing capacity. We just believe that the volume is going to be higher in Q1 and Q4.
Marc Bianchi – Cowen and Company, LLC
Okay, great. Back to the resin-coated, where is the demand coming from? And do you think that the demand that you’re seeing is reflective of the broader market or it just happens to be where you have some good customer relationships?
Gary Kolstad
I think that’s to do with the product itself, the conductivity. Resin-coated sand primarily is the conductivity gets dictated by the substrate and so we have been committed to having very good substrate. So we have high conductivity numbers and that’s what drives it. And as far as telling people where our product is at or which clients, that’s generally something we don't like to put out of playbook for the competition. But we do have some very good clients that are seeing some very good results and we got a pretty focused area we move it to. I would still say overall, and this is why we’re not building the rest of it right now. We still see an overcapacity there, but what the industry and ourselves are seeing is the differentiation between the substrate and so those who don’t have good substrate will have lower conductivity numbers and all that stuff starting to show up in the industry.
Marc Bianchi – Cowen and Company, LLC
Okay. Just last one for me. Natural gas prices have moved up here pretty briskly in the front months, not so much in the longer term, longer dated contracts. But you guys mentioned a hedge position that you have as natural gas is an important cost for your manufacturing process. Where do you stand with that right now and how should we be thinking about the impact of natural gas to margins going forward?
Gary Kolstad
Well, just like we run the company we look long ways ahead. So I don’t see it impacting us. We buy forward and so the effects on us will be very minimal. Ernesto, I don’t know if you want to add to that, but I just don’t see much of it.
Ernesto Bautista, III
Yes, I would agree with Gary. I think as far as the spot pricing goes, we’ll have much of the influence on a cost structure. As Gary mentioned, we do sell – I mean, we buy forward pretty far out. So it’s not something that we worry about on a day-to-day basis.
Marc Bianchi – Cowen and Company, LLC
Excellent. Thanks, guys.
Operator
Our next question comes from Trey Stolz from Iberia Capital Partners. Please go ahead with your question.
Trey Stolz – IBERIA Capital Partners LLC
Good morning, guys. Thanks for taking the questions. Just following up on the 51 million pounds of other proppant sales volumes, you talked about some of the sand sales being a byproduct or a side business, and they can go up and down. Can you provide any additional color on that 51 million pounds and what we should expect going forward? You help us with modeling that, understanding that over the course of 2014.
Gary Kolstad
Well, I mean it could move a lot it could be zero, it could be 100, whatever, 200, but it doesn't matter to us, right because the price of it is so low. It's not CARBO, right. We're ceramics and resin-coated sand, but in the course of making resin-coated sand whatever our clients want whether it's 20, 30, 40, 50 – 70 the other cuts, we’d like to move some place. So we move it and sell it where we can and don’t consider that part of our true business today.
Trey Stolz – IBERIA Capital Partners LLC
Is it like a $0.02 or $0.03 per pound product and something like much lower along those lines?
Gary Kolstad
Well, I think the industry and there’s enough articles out there on the dollars per ton and stuff. I think we’re not much different to anybody else. So we’d probably reflect the same thing.
Trey Stolz – IBERIA Capital Partners LLC
Okay. And you answered some of the questions on the cost side of things and I guess we’re trying to normalize margins for this lump of sand sales. I guess, I’m coming out with margins similar to around first quarter and tell me if I’m wrong Ernesto, on that and you talk about higher cost persisting, in the past you talk about a 200 basis points improvement and I guess you’re saying maybe second half of 2014. Ain’t numbers changing there the specific cost guidance numbers or margin guidance numbers, and am I wrong on an apples-to-apples trying to put it back with, say 1Q gross profit level?
Gary Kolstad
1Q 2013 is what you’re referring to?
Trey Stolz – IBERIA Capital Partners LLC
1Q 2013, yes.
Gary Kolstad
Yes, I would say to answer the first part of your question about cost on the distribution side, yes, we had actually mentioned previously that we – some of those initiatives have pushed into 2014. So we really wouldn’t see the full benefit of the initiatives until some times exiting the second quarter, maybe into the early second half. So that’s part of it. I would say unfortunately it’s going to depend on the variables I mentioned earlier. It’s going to be product mix obviously and then it’s going to be the delivery method. All those things equal, might you see a little bit of a potential improvement. You might see a potential improvement, but the influence of product mix and delivery method can be pretty sizeable and that’s not going to remain static. It really never does.
Trey Stolz – IBERIA Capital Partners LLC
All right. And so with gas prices up a little bit, the Haynesville previously being a big target market for you all, are you seeing additional orders or requests in your initial indications of interest from gas plays, Haynesville in particular?
Gary Kolstad
I would say not a lot, some of them you can see of course increased their hedging positions with this little bump up and everything, but I think it will take a much more sustained outlook there and a lot of those operators their unfortunately went to some proppants that they have to for economic reasons there. So until it gets up and they start using the right proppant in the Haynesville, I don’t think it’s going to affect us too much. Having said that, when the price of gas doesn’t show up, there is tens of thousands of wells and this is the thing that just keeps driving North America forever. We have so many places to drill and so gas, oil, we don’t really care, but near-term I don’t think we see it too much.
I think in regard to the last question, we tend to think of our business in terms of years. So when people ask us questions about the margin in the next quarter or volumes next quarter, I think the way we look at it is that we expect to have a better year in 2014 and 2013. We expect volumes to be up in ceramic, resin-coated sand to be doing pretty well, growth in the other businesses. So I hope you don’t get too caught up because the reason I say that is ever since – few years ago and where we work nowadays, meaning up north and with the congestion in the railroads and all this other stuff, you’re going to see more movements in a calendar year and that doesn’t change the way we think about things. We think about it in terms of years, but you’ll move up and down. So I would encourage people to think of years instead of quarters.
Trey Stolz – IBERIA Capital Partners LLC
All right. And speaking on the distribution side, is there additional outreach or different strategies being employed in reaching out to the Bakken whether it’s using third-parties with that? Like helping us understand as things push maybe to 2Q and second half of the year on the cost side, maybe understand the particulars of that and what is going on?
Gary Kolstad
Yes, we – like I said, the distribution team has done a good job. We will keep increasing storage at all the big plays that we see working for next five, 10, 15, 20 years. We will try and minimize increase in railcars so that whole switched there. The things that all of us have to overcome the railroad keeps raising the rates every year and they’ll do it again in 2014 or have been already, I guess. So for us we will continue for that and we will control our destiny. We will never dilute the brand, CARBO Ceramics with our ceramic proppant. So ours won’t get in – put into third-party paid stuff. We will control our own destiny on that.
Trey Stolz – IBERIA Capital Partners LLC
All right. And Ernesto, I know you haven’t given out an average selling price, I guess since it came out, but as I understand it with a higher amount of lower priced sales that ASP should come down a few cents, but doesn't necessarily mean anything as you sated ceramic proppant sales?
Ernesto Bautista, III
That’s exactly right, Trey. You got it. That’s right.
.
Trey Stolz – IBERIA Capital Partners LLC
All right. That’s it for me. Thanks.
Ernesto Bautista, III
Thanks.
Operator
Our next question comes from Darren Gacicia from Guggenheim Securities. Please go ahead with your question.
Darren Gacicia – Guggenheim Securities LLC
Hey, guys. Good quarter. You guys have done a very, very good job of managing the variables you can control in terms of moving everything from sort of a well cost perspective to an ultimate return perspective. One of the things I wanted to sort of touch on was process. You know you’ve had pad drilling, rig efficiencies, different things that have happened that refined the process and it seems like kind of the current way things are being done on a play-by-play, you guys have managed to get yourself into the sweet spot of kind of what the solution is. And I guess, as things have sort of ebbed and flowed with what people have been using in the conventional, unconventional plays over the last two years, how much do you think kind of the use of either RCS or ceramic or sand has become sort of standardized play-by-play at this point in the game, as part of what people see as a go forward process?
Gary Kolstad
I think a lot of times when you go through the cycles in the industry, sometimes we see operators go into new plays and it’s just – there have to be a go on this, spend a lot of money and lot of things, just break it in. Then there is a period of trying to reduce the cost and the various things that take place in those decision making and then it moves into optimization, okay. And those same thing gets impacted by the cycles in the industry what’s the commodity price, how does it feel and all that stuff. So we kind of mentioned this in Q3 that we feel like the operators are now balancing that teeter-totter of ASP cost on the side and EUR on the other side in more balanced fashion and this is everything about us from technology development to the organization of the company, the whole Design, Build, Optimize, the whole Fracpro, StrataGen and CARBO Ceramics. Everything we do is around that to make fracs produce. And so we think we can continue to influence that. I think the pad drilling helps a lot from a deficiency standpoint.
I think one of things the industry will have to better balance is in some cases the answer is not just to keep having closer infield well drilling. We’re now seeing some infield wells that the spacing between them is so small your economics would be much better by pumping an effective frac. And that’s the other education part we have do to moving forward. And so when people say well, we've drilled here and we found virgin reservoir pressure, the reality is if you had a better frac on your adjacent well we’d be draining that. So for us we just see continued opportunities here for the way we got our company structured and we have StrataGen folks sitting on rigs, getting to see both best and worst practices. We learn from that. We try to encourage the best practices that we know that all feeds into the design side which is Fracpro. It feeds into building the right kind of frac that will last and get the right the half lengths that’s CARBO Ceramics. So there is just a lot of improvement that will take place and in my opinion the biggest benefit the E&P industry will see or our industry is the increase in the recovery factor and I think that’s the spot we live in.
Darren Gacicia – Guggenheim Securities LLC
Got it. In one of the prior responses you mentioned it just kind of popped out at me, maybe it’s okay, but in the Haynesville different choices made for economic reasons and obviously that’s a function of gas prices and what the realizations are in those – in any particular basin given differentials and the rest. There is some concern over watching WTI with regard to, like crude absorption on the refinery basis and what that may do to WTI-Brent spreads. Timing is probably a bigger variable that’s debated on the issue, but even today they’re asking questions and having hearings about oil exports in Washington. If the WTI-Brent issue becomes a factor sort of at what level for Brent do you start to get concern that maybe some of these decisions to make an economic choice kind of towards ceramic or RCS potentially reverse out? Maybe if asked the wrong way then how do you perceive sensitivities right now around activities versus kind of you have in your outlook especially kind of in the second half of the year.
Gary Kolstad
We’re certainly not any experts on oil price or anything like that. So I’ll leave that to better qualified people, but the one thing I will say is that when you invest in a lot of our technology and particular conductivity that accelerators your entire return. So most of the share wells operates and put out there you got to pay back in 18 months, 24 months, something like that. We don't know of any case when you don't make the additional investment in making that well produce, dominated by conductivity, but that doesn't accelerate the payback because when you invest in increase conductivity the payback time is anything from two weeks to six months. So it's faster than the actual well payout under normal condition. So good times or bad times, it still makes sense.
Darren Gacicia – Guggenheim Securities LLC
The last year is kind of marked the adoption of that concept. Where do you – and from a mine share perspective where do you think your market penetration lies now you’ve obviously made progress there and do you think that’s completely accepted at this point of the game or do you think that there is a chance for some variance in case of activity?
Gary Kolstad
I think you're giving us more credit than we deserve there. I think we’re at the intensity of this, but once again I’ll go back to my other statement there. I think the biggest opportunity for the oil and gas industry is to increase the recovery factor and that's the world we work in.
Darren Gacicia – Guggenheim Securities LLC
Great. I appreciate the color. Thank you.
Gary Kolstad
Thank you.
Operator
And our next question comes from [indiscernible] from Sterne Agee. Please go ahead with your question.
Stephen Gengaro – Sterne Agee & Leach, Inc.
Hi. It’s actually Steven Gengaro. I wanted to ask two things, Gary, if you don't mind. The first is, how involved are you currently and maybe even percentage of projects you are on, but how involved are you with the sort of design of the actual frac? And the decision on what product to the [indiscernible] at what level does that get down to?
Gary Kolstad
It depends and this is why we’ve set it up, our company that way under design, built, optimize. We will – the Fracpro is the highest market share frac design software in the world it’s used all over the world. So as an independent product it does extremely well. You combine all of these things and sometimes for – it depend on the clients, a smaller E&P that maybe lacks the technical resources or staff or just getting starting may incorporate all three of our design, built, optimize. Some may pick one. So it's very hard to say that. All I want us to do is just more and more over time, help our clients to produce more and have higher recoveries and built technologies for that. That's all we're trying to do and so to say that we influence things in a major way I think that's way too optimistic at this time, but we're just trying to do the right thing with technology to make these wells produce.
Stephen Gengaro – Sterne Agee & Leach, Inc.
Okay. Thank you. And then, as you think about the pricing dynamic and I know we sort of see it as we speak right now. What do you think it takes to get some traction on the ceramic side from a pricing perspective?
Gary Kolstad
I’ll tell you what I think about. I think about building more capacity and selling more volume. That's what I think about and the pricing will do it, the pricing does. Having said that, technology and new technology always has the higher price, right. But you don't build the business or the company based upon constantly increasing prices. We focus a lot on the cost side of the question. Our manufacturing folks do a great job that way. Our distribution folks really helped us bend the cost curve, all these things. So we think about volume and we think about getting into more and more wells. So that's what drives us except for technology in which case there you will see higher pricing.
Stephen Gengaro – Sterne Agee & Leach, Inc.
Thanks and then one follow-on and I realize you are caveat about putting too much particular emphasis on any quarter but as I think two dynamics one is the rollout of the Millen Line combined with any maintenance you maybe encountering as go through the year or there any quarters that are better sort of the in the plans right now where we’ll unquestionably see any impact on your capacity throughput. And then as part of that is there a point on which you’ll rebuild inventories to any level or is that just of kind of going to be based on the production relative to the demand in that quarter?
Gary Kolstad
Part of your questions are that we like refineries, the answer is no. We have so many kiln [ph] lines and our manufacturing folks do a great job that’s just part of business for us, so we don’t really have major shutdowns or anything like that during the quarter like refineries or something. In regards to the other on the cyclical side of the business, Q2 is always low because we have Canadian breakup and that shifts two weeks one way or other. North Dakota has a bit of similar like the Canadian breakups right, the road bans things like Montana. So that whole Northern nature in which we’re doing a heck of a lot more work in the industry impacts us a lot more.
So Q2 is historically the slowest and then the latter of the part of the fourth quarter if generally the slowest much more dominated by just the holidays and stuff like that, but that’s kind of how it lays out during calendar year.
Stephen Gengaro – Sterne Agee & Leach, Inc.
That’s good colors, thank you.
Operator
Our next question comes from Jeff Tillery from Tudor, Pickering, Holt & Company. Please go ahead with your question.
Jeff Tillery – Tudor, Pickering, Holt & Co.
Hi, just two follow-up questions. One on Falcon, you talked about the long-term optimism there. As you think about 2014, should we think about businesses being flat or do you see some growth?
Gary Kolstad
No, I think we see some growth and I think it will be much more a second half related. One of things we’re trying to do is put out a new product little bit, change everything on the containment side again. And I have to say this the containments grew last year, the tank bases grew last year’s our struggle was in the tank lining business and so we finally just idled that. But we like to change and can’t guarantee success when you are in a R&D world but that’s drives longer-term Jeff. When you drive around the country and I know you do and you see dirt berms all over the place I tend to think that two things will happen long-term one; E&P was their environmental focus will start to get rid of those, two; the regularly agencies will start to get rid of those. So I think we’ll move into a world where we’ll start to see less and less dirt berms and tank sitting on the ground and things like that and that’s really what drivers my incredible optimism about that business over many, many, many years that plus I think we can introduce technology.
Jeff Tillery – Tudor, Pickering, Holt & Co.
Great. That’s makes perfect sense. My second question just around the second line at Millen. You talked about retrofitting an existing plant for KRYPTOSPHERE, something like Millen where it’s early stage if you decide to go ahead and make that a KRYPTOSPHERE capable plant today what would that take? And when would you have to make that decision?
Gary Kolstad
We are building Line 1 and Line 2 that’s just going to happened in conventional mode, so if that’s the question. We picked another plant to do this with and for a whole of bunch of reasons I won’t explain but once we see how that happens then you learn so much, we’ve just learned so much in the R&D plant in the last couple of months, so this is very dynamic. The one thing we do know it’s constant. This product is just incredible from a conductivity standpoint. So that's what drive this, but now we're trying to optimize, reduce the cost all those things and so we really need to get through this one retrofit before we can probably intelligently answer that.
Jeff Tillery – Tudor, Pickering, Holt & Co.
Okay, that makes sense. Thank you.
Operator
And ladies and gentlemen, at this time we’ve reached the end of today's allotted Q&A session. I’d like to turn the conference call back over to Mr. Kolstad for any closing remarks.
Gary Kolstad
Thanks everybody for joining us again this morning. Couple of points just to follow up there. We’re very pleased with our Production Enhancement businesses performance during the quarter and we think the 2014 is just beginning to see how these synergies help drive the growth in the Fracpro, the CARBO Ceramics and StrataGen businesses. By incorporating that platform I talk about the design, built and optimize the frac platform.
In the near-term, which I know a lot of you care about. We expect ceramic proppant volumes in the first quarter to be increased compared to fourth quarter. We think the pricing it's pretty competitive out there right now. So we expect that to remain at current levels. And then just the opportunities we have in front of us, they’re pretty exciting and it's all driven by technology as well as increased capacity and we keep adding intellectual property and intellectual capital and that's a good mix and we have the balance sheet to literally do all that. So we’re optimistic about 2014. We thank you for joining us today and we’ll see you next quarter.
Operator
And ladies and gentlemen, that does conclude today's conference call. We do thank you for attending today’s presentation. You may now disconnect your telephone lines.
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