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Edited Transcript of CRR earnings conference call or presentation 11-Nov-19 4:30pm GMT

Q3 2019 CARBO Ceramics Inc Earnings Call

HOUSTON Dec 5, 2019 (Thomson StreetEvents) -- Edited Transcript of CARBO Ceramics Inc earnings conference call or presentation Monday, November 11, 2019 at 4:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ernesto Bautista

CARBO Ceramics Inc. - VP & CFO

* Gary A. Kolstad

CARBO Ceramics Inc. - Chairman, President & CEO

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Conference Call Participants

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* Harold Weber

Aegis Capital Corporation - SVP

* John H. Watson

Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst

* William J. Dezellem

Tieton Capital Management, LLC - President, CIO & Chief Compliance Officer

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Presentation

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Operator [1]

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Hello and welcome to today's CARBO Ceramics Inc. Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please be advised that this call is being recorded today, November 11, 2019. And your participation implies consent to our recording this call. If you do not agree to these terms, simply disconnect.

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

Your host for today's call is Mr. Gary Kolstad, President and Chief Executive Officer of CARBO Ceramics Inc. Mr. Kolstad, please begin your call.

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [2]

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Good morning, everyone. The third quarter was challenging for CARBO, like many companies in the American oil and -- North American oil and gas industry. All of our businesses associated with U.S. onshore oil and gas are feeling the impact from the deterioration in activity. We were also notified after the quarter ended that our largest frac sand client intends to discontinue purchases of frac sand under our current contract. We are in discussions with this client to determine if there's an agreeable alternative to this matter. This contract covered significant fixed costs associated with our distribution facility and rail car leases. Our immediate focus is to find a solution to these and other fixed costs that are burdening the business today.

Given these market conditions, including expectations for these headwinds to persist going forward, we continue to be laser-focused on initiatives to preserve and improve our cash position. By protecting the balance sheet, we believe we can continue the execution of our transformation strategy to diversify and grow in profitable businesses outside the oil field. In order to accomplish this goal, we will focus on the following: asset dispositions; inventory reductions; significant cost reductions; increasing our existing cash generation businesses; and potential modifications to our capital structure, including the refinancing of our existing debt.

With support from our Board of Directors, management has engaged financial advisers to assist with certain of the company's liquidity-enhancing initiatives. Several potential dispositions are currently being evaluated and, if consummated, would improve our net debt position. While nothing is finalized yet, if we execute all that are being contemplated today, it could range between $20 million and $40 million. Further operational cost reductions will be sought through negotiations with our suppliers and lessors. If these negotiations are successful, it should make a significant improvement in our cash outlays in 2020 and beyond. On the SG&A front, we are targeting SG&A reductions of at least 20% in 2020.

We are focusing energies on increasing our existing cash-generating business both domestically and internationally, while managing through this lower activity environment. Outside the U.S. onshore oil field market, where better reservoir rock exists, our oil and gas sales are faring well, as evidenced by an approximate 27% increase year-to-date in our international oil field revenues. Unfortunately, this increase internationally is not enough to offset the decreases we're seeing in U.S. onshore oil field sales.

Given that significant challenges exist across the oil field industry, we plan to continue building a diversified company that's less dependent on the oil and gas industry, one that's based on our 4 key strengths: material science, manufacturing, technology solutions and the customer experience. We are aggressively taking steps to expand into product platforms that leverage these critical strengths as part of our transformation strategy. The industries we are targeting are large, and we believe that our existing manufacturing capacity and product development capabilities will facilitate growth in these markets. We are aggressively focused on certain business which are not only our higher-margin contributors but should help drive our future growth and free cash production, in particular 2 businesses: industrial ceramic and contract manufacturing of industrial products. I should note that we include agricultural products within the contract manufacturing business.

In industrial ceramic, we continue to look for opportunities to grow our geographic reach and expand our product offerings. We expect our product marketing agreement and initial investment in DAKOT to contribute to an increase in our overall industrial ceramic business, increasing it by 20% in 2020. In contract manufacturing, the opportunities for 2020 lead us to believe we will have substantial growth. We have had many client requests regarding the agricultural industry. The technology the agriculture industry is investing in and developing fits our company's strengths well and provides a solid foundation to build upon. As previously announced, we signed a production agreement with INNOVAR AG to produce an enhanced efficiency fertilizer product. We believe these EEF agricultural technologies are needed to address future global food demand and the environmental impact from inefficient fertilizers being used today. This represents another building block in our transformation strategy to redefine CARBO. Our oil field technology ceramic, software, consulting and ASSETGUARD offerings will make up the areas within the oil field industry where we maintain a continued focus and a differentiation.

Base ceramic and frac sand will likely only be pursued where conventional rock is being exploited or if the economics for CARBO yield cash return worth pursuing. We are by no means giving up on our oil field roots, but for the long-term benefit of CARBO, we have to develop more of our revenue generation outside this industry. We are currently undergoing complete strategic review of our businesses to ensure we are positioning ourselves for success as we navigate the challenges associated with oil and gas markets.

With respect to the fourth quarter, we expect revenues to be down approximately 30%, primarily driven by a decline in sand revenues. However, we do anticipate both industrial and contract manufacturing revenues to increase sequentially.

Ultimately, we are seeking to create a balanced end market company portfolio that can minimize the extreme volatility witnessed in the oil and gas industry. Acquisition targets are currently being evaluated with a focus on companies that have an established technology-based product portfolio, are currently generating positive EBITDA, with a solid runway for future growth and can leverage an increased utilization of our existing manufacturing assets. Transformation is never easy, but we will continue to execute with energy, reduce costs wherever we can and diversify outside the oil and gas industry. We look forward to delivering these updates as they unfold.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from John Watson of Simmons Energy.

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John H. Watson, Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst [2]

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Gary, can you help us think about the cost or margin impact from idling your sand operations in Q4?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [3]

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Yes. Ernesto, do you want to take that from an annual basis?

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Ernesto Bautista, CARBO Ceramics Inc. - VP & CFO [4]

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Yes. John, from an annual standpoint, sort of the cash cost [variances] when you include the entire supply chain, we're looking at something between $8 million and $10 million of cash impact. So it's pretty hefty.

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John H. Watson, Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst [5]

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Okay. That's helpful. I thought the SG&A guidance for 2020 was encouraging. Gary, could you, or Ernesto, could one of you elaborate on the specific initiatives you're looking at to meet that goal?

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Ernesto Bautista, CARBO Ceramics Inc. - VP & CFO [6]

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Sure, John. So obviously, while it's not our preferred approach, we're looking at and have implemented some reductions in force beyond just head count. We are looking at any discretionary spend and eliminating that. Unfortunately, we do have fixed costs within SG&A to support the organization, but we won't leave any stone unturned as far as where the reductions may come from. I think we're pretty darn confident in that 20% number.

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John H. Watson, Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst [7]

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Okay. Okay. Understood. And I would assume that you're able to reduce costs and simultaneously go forward with your industrial and agricultural growth. Is that fair?

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Ernesto Bautista, CARBO Ceramics Inc. - VP & CFO [8]

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That's a fair statement.

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Operator [9]

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(Operator Instructions) Our next question will come from Bill Dezellem of Tieton Capital Management.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO & Chief Compliance Officer [10]

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I had a few questions relative to INNOVAR. Would you please discuss the financial impact of that relationship? And separately, if you were to be able to do 500,000 tons with then -- with them, what would that mean to you all?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [11]

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Well, 500,000 tons would mean quite a bit. I don't think we'll disclose what our dollars per ton fee would be for manufacturing it. But if you did 500,000 tons, it'd be a significant amount of money. And any time, Bill, we utilize those plants that have cash drains on us, it makes a material difference. The amount of fall-through we see is really incredible. To characterize what it is, it goes beyond [then when you] have a lot of people that are inquiring about our ability to manufacture agricultural products. With INNOVAR, we really see they're kind of leading edge on a lot of the technology there. So with them and others -- and it's quite interesting, what's happening in the industry. And our strengths are the plants and, of course, the ability to develop those products quickly and manufacture them.

And I don't know if I want to characterize what the range of revenue would be with INNOVAR. But if you're talking those type of levels, which could very well happen because the industry is so big, it would be very significant for us. And I would characterize just our contract manufacturing overall because we work -- this isn't our first contract with agriculture clients. There's another one that has some terrific technology that we've been working for. Just our overall contract manufacturing growth, we expect, next year will be very large and we also throw into that, of course, the processing of minerals and other things. And we've got -- we put a team in place a couple years ago, and I think we're now really starting to see the opportunities getting close to fruition. And I think we're moving in the right industries to get high-volume growth.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO & Chief Compliance Officer [12]

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So what is INNOVAR's size relative to other ag companies that you're either currently working with or is that you are in discussions working with? Are they a large player? Or are they smaller?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [13]

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I would characterize it as being a significant international player and just entering the U.S.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO & Chief Compliance Officer [14]

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And on their -- well, I guess, the information they provide, they say they have 2 southern locations that are producing this product. Are you doing both? Are you in both of those locations that they're referencing?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [15]

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Initially, we'll probably be making it at one of our locations. And as that goes on and other products are developed, we might move into the second location. But yes, we are working with them. And you look at it geographically, where is the high volume? Where are assets sitting? All that stuff. And it makes a lot of sense to be where we're at.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO & Chief Compliance Officer [16]

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And Gary, you did say that 500,000 tons would mean a lot to you. They did reference that that's kind of what they intend to be producing. Will that be split between you and another contract manufacturer? Or is this an exclusive that however much they sell you'll be producing?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [17]

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I think there's a certain exclusivity that exists in there. I don't think we want to make all that public, and we haven't said that figure before, or I guess they must have to you or something. But anyway, we -- it's a great working relationship, and we're excited about it, and we can grow together. And it's just you really need to watch the macros that's happening in -- with the fertilizer market and why it needs to change. And the environmental side of that is enormous, plus of course, just the yield side of it. And it's nice that they've already had success internationally. So you got some proof points out there already. Now your entrance into the U.S. just allows you to expand quickly.

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William J. Dezellem, Tieton Capital Management, LLC - President, CIO & Chief Compliance Officer [18]

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Okay. And I do have one final question. Is there anything specific to the type of fertilizer that they are producing that is more conducive to your extended-release ceramic technology or could this be used for ammonium sulfate or any other fertilizer that is used in a granular form?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [19]

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Well, what we provide is the -- we're really good at forming pellets, let's say. We're really good at infusing chemicals. We're really good at coding. We're really good at distribution, all those things. So any and all things they bring to us, there's a great likelihood that we can produce. And there's other people that are bringing different products to us. We like contract manufacturing. We like producing great products for them. And I think what these companies find is our manufacturing skill and the way our people work with them to quickly solve problems and develop these products is very unique. So that team of ours is really performing well, the plants and the group that's growing contract manufacturing. So we welcome all of it. And yes, I don't want to get into particular products because some of that's a little bit proprietary of the way we're dealing with each one of these clients.

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Operator [20]

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(Operator Instructions) Our next question will come from Harold Weber of Aegis Capital.

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Harold Weber, Aegis Capital Corporation - SVP [21]

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Could you try to expand a little bit on the non-energy markets that you're expanding with the new products and the size of those markets?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [22]

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The non what? Sorry...

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Ernesto Bautista, CARBO Ceramics Inc. - VP & CFO [23]

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Non-energy.

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [24]

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Non-energy. Yes. The -- in particular, industrial ceramic, I think we've put out before that, that one deals with hundreds of millions of dollars. And that one we've been a presence for a couple decades in foundry and grinding. Our investments into new product development, our investment into DAKOT really expands our grinding portfolio. So those really, I would characterize in hundreds of millions type of market. The fertilizer market, I mean you can probably look at public data, but that is extremely large and obviously well over $100 million. You're probably up in -- it might have a B after it when you get all these things figured out. Now that's on a global basis it would be in the billions. The U.S. is obviously a very large agricultural producer. And I think they're going to lead the way with technology and the adoption of environmentally sensitive fertilizers. So very large markets. We also don't dismissed our ability because our contract manufacturing is pretty all-encompassing. So our processing averse minerals, whoever wants to bring one of [our] minerals there, we welcome with open arms. And we really like, in particular, the agricultural clients that come forth. They all are unique and have unique technologies, and I think they've got a great future in front of them.

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Harold Weber, Aegis Capital Corporation - SVP [25]

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So what's it going to take for us to increase our market share within these categories?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [26]

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Happening as we speak, the industrial ceramics -- just to characterize it a little bit. If we go to the bottom of whatever, oil field kind of 2016, our industrial ceramics has grown 100% from 2016 to 2019. We fully expect it to grow another 100% in the next 3-year period or greater. When we look at contract manufacturing, we really just kind of put our group together in 2017. And so we've seen steady growth in that 2017, 2019, but we expect very large growth in 2020 and moving forward as people get comfortable with our skill set, as we define these big markets that we're going to go into. And once again, we're just trying to produce great products for companies that got big markets and great technology.

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Harold Weber, Aegis Capital Corporation - SVP [27]

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Okay. Could you also expand possibly on what type of potential asset divestments you're considering?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [28]

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Well, we've certainly got an abundance of big assets, plants in particular. So we've had inbound calls on those. We've had inbound calls on other assets that we have. We're working through that and we've obviously engaged a financial consultant to look at that with us as well. I should probably also add on just the cash generation side. We still have a lot of inventory that we've built up for the oil field that we still plan on liquidating as we go into 2020. We really -- our past model of building inventory and having it out there and people using it when they use it, you can't live within that anymore. So our business model will be as such that if you order it, you really need to pay for it in a relatively short time period in the oil fields. So I don't want to go in much more detail on the assets. But we certainly have a lot of inbound calls.

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Harold Weber, Aegis Capital Corporation - SVP [29]

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Well, is it reasonable to say that sometime over the coming quarter, there'll be some movement in this space for you? Can you come up with some scenarios of what you will or won't be doing?

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Ernesto Bautista, CARBO Ceramics Inc. - VP & CFO [30]

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I think it's reasonable, as our expectation goes, that here prior to the next call, there'll be some actions taken, and we will report on them accordingly.

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Operator [31]

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Our next question will come from [Eric Castro of Schultz Family Office].

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Unidentified Analyst, [32]

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Just to clarify, the $8 million to $10 million that you referenced, was that a quarterly number or an annual number for the sand business?

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Ernesto Bautista, CARBO Ceramics Inc. - VP & CFO [33]

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Yes. That's an annual cash cost number. Where we're taking action, as noted in our filings, to idle the facility, it's more associated with the supply chain within that -- that we developed within that contract, distribution center, rail cars, those types of things.

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Unidentified Analyst, [34]

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And in terms of immediate onetime costs, like for severance or anything, could you disclose that?

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Ernesto Bautista, CARBO Ceramics Inc. - VP & CFO [35]

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It's going to be relatively small at this point. So I don't know that it's going to move the needle necessarily.

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [36]

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Yes. The bigger items are the leased facilities and the leased rail cars.

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Ernesto Bautista, CARBO Ceramics Inc. - VP & CFO [37]

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Right.

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Unidentified Analyst, [38]

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Okay. The -- on the prior conference call, you mentioned one other opportunity, contract manufacturing opportunity in the fourth quarter. Can you comment on how that's progressing?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [39]

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There's -- do you remember what that one was, Ernesto? What was -- the...

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Ernesto Bautista, CARBO Ceramics Inc. - VP & CFO [40]

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So we have several contract manufacturing opportunities, at least 2 of which have been ongoing since last quarter. We feel pretty confident. Well, obviously, we announced the INNOVAR matter or opportunity here last week. We have several more that we're in negotiations on within the agricultural space. And we have one sort of in the minerals processing space that is still in negotiation that carried over from last quarter. We don't have an update on that at this point.

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [41]

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I think all the -- what -- well, I don't know if we would call them field trails or product trials. Most of our product trials have worked out pretty well, which gives us a lot of confidence as we move forward there for 2020.

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Unidentified Analyst, [42]

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Okay. And can you give us an update on PicOnyx, on how that's progressing?

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [43]

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Well, we've certainly produced the product on a small scale. The product is out with some clients. PicOnyx' assignment now is to go out and gather capital for further investments so we can really move into commercial type of production levels. So we've done our part. And I think the product is still going to be a great product and our team down there at one of our plants really did a good job. So now we're a little bit waiting on them.

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Unidentified Analyst, [44]

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Okay. And then one more, can you give us an update on the [oil field] technology ceramic outlook for 2020? I know it might be early, but I know earlier in the year, you mentioned the U.S. Gulf of Mexico offshore might be up 20% in 2020. I was just curious what your updated view is on that.

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [45]

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Yes. I think we will have -- we got some big jobs out there. And all these things can move around a lot. We -- our oldest one was -- a couple of years ago moved a full year on it, and we've seen one recently move that we thought was going to be in 2019. Now we kind of think it will be a 2020 job. And I would say we're seeing good adoption of not only KRYPTOSPHERE HD, but now we've introduced KRYPTOSPHERE XT, and we've got LD and all that stuff. So I think that's good. I think internationally we've seen more interest in some of the KRYPTOSPHERE products, some of the SCALEGUARD, some of those things. I think we'll probably feel good about everything where there's good rock. So Alaska, Gulf of Mexico and most of the international world. Where there's low-quality rock, i.e., the U.S. onshore, everybody is going through the pain. And I think the industry is starting to realize that. We've been saying it for some time. But -- so I think we'll -- we hope to see a better year next year actually in oil field technology ceramic. By that, I mean higher revenue.

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Operator [46]

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This concludes our earnings call. I would like to turn the conference back over to Mr. Kolstad for any closing remarks. Please go ahead, sir.

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Gary A. Kolstad, CARBO Ceramics Inc. - Chairman, President & CEO [47]

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Well, thank you all for joining us this morning. I'm just going to talk about a couple of key points.

On the challenges side, I think it's really clear. The U.S. onshore oil field market is very tough. A low-quality reservoir of rock, combined with low oil and gas commodity prices, has resulted in little or no returns for the industry. And that means activity, pricing and the use of technology products is likely lower. So therefore, we have to reduce the legacy costs of what was once a big business for us, i.e., base ceramic, and also sand now. In particular, the costs of distribution assets, which includes rail car leases and distribution facility leases, we have to lower those. We're also reducing the SG&A costs in line with this reduced business as we previously described.

Now on the positive side, our focus and growth in industrial ceramic and contract manufacturing of industrial products provide sound profitable growth now and in the future years. It's nice not to just have to wait on an increased rig count or commodity price in the oil and gas industry. Our oil field offerings in oil field technology ceramic, software and consulting provide a base of business in the U.S. and currently and likely in the future a growing business and international activity. ASSETGUARD, our environmental business, is a participant in the difficult U.S. onshore market but is seeing good growth in the industrial opportunities we are focusing on.

And as mentioned, we have engaged financial advisers to help us with these challenges, and we fully expect to put all our energies towards solving these problems.

And I want to thank you for joining us today, and we will see you next quarter.

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Operator [48]

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