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Edited Transcript of CVIA.N earnings conference call or presentation 6-Nov-19 1:00pm GMT

Q3 2019 Covia Holdings Corp Earnings Call

Nov 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Covia Holdings Corp earnings conference call or presentation Wednesday, November 6, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew D. Eich

Covia Holdings Corporation - Executive VP & CFO

* Matthew Schlarb

Covia Holdings Corporation - Director of IR

* Richard A. Navarre

Covia Holdings Corporation - Chairman, President & CEO

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Conference Call Participants

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* George Michael O'Leary

Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research

* John H. Watson

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

* Kurt Kevin Hallead

RBC Capital Markets, Research Division - Co-Head of Global Energy Research & Analyst

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Presentation

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Matthew Schlarb, Covia Holdings Corporation - Director of IR [1]

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Thank you, Chelsea. Good morning, and welcome to Covia's Third Quarter 2019 Earnings Conference Call. Joining us on today's call are Rick Navarre, our Chairman, President and CEO; and Andrew Eich, our Executive Vice President and CFO.

Our remarks this morning include forward-looking statements, which are subject to various factors that may cause our actual results to differ materially from those projected in the forward-looking statements. Forward-looking statements speak only as of today's date, and we undertake no obligation to update those statements. For more information, please refer to the risk factors discussed in our filings with the SEC in this morning's press release.

We would also like to remind you that during today's call, we will provide non-GAAP financial measures, including segment contribution margin, EBITDA and adjusted EBITDA. These financial measures are used by management to monitor and evaluate the ongoing performance of the company and to allocate resources. Reconciliations of GAAP results to non-GAAP results are included in this morning's press release, which is available on the Investor Relations section of our website.

This morning, we published an investor presentation to accompany this call, which can be found on the Investor Relations section of the website as well. Additionally, our commentary during this call regarding periods prior to June 1, 2018, will focus on the pro forma combined financial results for Covia, which will reflect the combined legacy Unimin and Fairmount Santrol results for the entire periods discussed and exclude the results of the high-purity quartz business, shown as a discontinued operation for periods prior to June 1, 2018. The reconciliations to reported numbers have been included in our earnings release issued this morning.

Now I'll turn the call over to Rick.

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [2]

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Thanks, Matt, and good morning, everyone, and thank you for joining us. Today, I would like to update you on our third quarter results, provide an update on our markets and discuss our strategy.

In the third quarter, energy market headwinds intensified starting in late August, resulting in a disappointing quarter. Our E&P and servicer customers reduced work earlier than we have seen in previous years. We were on pace to meet our guidance in August. However, the rate of decline in September was significant. This led to an underperformance of our results relative to our expectations. Despite the market challenges, we continue to make substantial progress in executing on our strategy to reposition our energy business, organically grow the profitability of our industrial business and to strengthen our balance sheet.

We closed on $240 million in noncore asset sales, we improved our working capital, and we pulled cost out of the business. In fact, we lowered SG&A 8% or $3 million compared to the second quarter and 17% or $7.5 million compared to prior year period, and we also made progress reducing other costs.

Our Industrial segment demonstrated the benefits of serving our diverse end markets as we posted year-over-year profitability growth. The growth in industrial profitability was a result of operating the business more efficiently as we had slightly lower volumes, driven by the sale of our Calera line of business early in the quarter and the impact of the General Motor strike on the metals and foundry markets. All in, our industrial segment gross profit was up 11% year-over-year after excluding the impact of the asset sales.

Our coatings and polymer business had excellent volume growth, up 15% from the prior year, driven by continued market share gains and strength in end markets. As a reminder, our coatings and polymers business is primarily served by our Canadian nepheline syenite asset. We control the only nepheline syenite asset of its kind in North America, which gives us an industry-leading position. Our containerized glass business in Mexico also continued its solid growth, with volumes up 5%. Our Canadian and Mexican markets remain strong with attractive growth prospects going into 2020. Our industrial profitability was driven by improved pricing and better cost controls. And after monetizing 2 noncore assets, we are now sharply focused on organic growth and optimizing costs to grow our industrial profitability.

Turning back to Energy. As I mentioned earlier, demand in the third quarter was relatively strong through July and most of August, and we were on track to meet our guidance. However, we saw a volume decline throughout September across all basins. Although we took actions and realized significant cost reductions in the second quarter, we were unable to further reduce our fixed costs enough late in the third quarter to match the volume declines. This naturally impacted our profitability as we do not have the volume to absorb our fixed costs. And this is something that we are definitely addressing. The sharp turn in September has also reinforced our view that we must adapt and evolve our business model to the new realities of the Energy market. We have demonstrated in the past year that we are willing and able to drive expense out of the business, and we've continued to take significant steps to streamline our organization so that we can react more quickly to meet our customers' changing needs.

Already in the fourth quarter, we have taken action to consolidate more capacity into our lowest cost assets by idling another 5 million tons, including the full idling of our Kasota, Minnesota plant. Although these actions are always difficult, they are necessary to help us navigate the current market challenges and position us for future success when the markets improve.

Now I'd like to turn the call over to Andrew to cover the financials.

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [3]

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Thanks, Rick. Our second quarter revenues totaled $409 million, an 8% decline from the second quarter, driven primarily by lower proppant volumes and pricing. Total segment gross profit was $77 million compared to $99 million in the second quarter and $118 million in the prior year period. Total segment contribution margin totaled $84 million compared to $106 million in the second quarter and $125 million in the prior year period.

In our industrial segment, third quarter 2019 revenues, excluding the impact of our asset sales, declined 3%, driven by lower transportation-related revenue, which was partially offset by volume strength in coatings and polymers and a favorable mix in building products. We also benefited from low single-digit average pricing increases that were instituted at the beginning of the year. Third quarter 2019 industrial gross profit and contribution margin were $59 million compared to $57 million in contribution margin for the third quarter of 2018. Excluding the impact of asset sales, segment gross profit grew 10% year-over-year, driven by both price increases and the improved operating performance of our assets. It's important to remember that going forward, Calera and the W&W will no longer be included in the results, but are still included in prior periods.

In our Energy segment, third quarter 2019 revenues were $223 million, representing a sequential decrease of $28 million. The decline was driven by lower Northern White volumes and pricing across most product lines, which declined approximately $1.25 per ton, led by local sand pricing declines. Northern White sand pricing was more resilient during the quarter, but we did experience pricing pressure in September. Our Energy gross profit was $18 million. Contribution margin was $25 million for the third quarter or approximately $5.88 per ton. This compares to $41 million or $8.93 per ton in the second quarter. The decline in contribution margin was driven by lower volumes particularly in September, which resulted in substantially higher operating costs that Rick discussed earlier. As we mentioned earlier, we have made significant additional adjustments to our capacity to consolidate production into our lowest-cost facilities. However, the higher costs are expected to persist throughout October. Once volumes are covered to more normalized levels in 2020, we expect to benefit not only from the recent cost actions we have taken, but also those made in prior quarters.

Total SG&A for the quarter was $35.6 million, down 8% compared to $38.6 million in the second quarter. The decrease was driven primarily by the realization of cost-reduction actions that we announced on our last call. Since we completed the merger in the second quarter of 2018, we have reduced our SG&A levels by 31% or $64 million annually. Adjusted EBITDA for the third quarter totaled $43.2 million versus $65.3 million in the second quarter due primarily to the performance of the Energy segment.

Our third quarter tax expense was $22 million, driven by the book gain on sales of our noncore assets. Cash taxes on these asset sales will mostly be deferred as we will utilize NOLs to offset our 2019 tax liability. Third quarter capital expenditures were $16 million, a decrease of $10 million from the second quarter. Nearly all spending during the quarter related to maintenance capital and the expansion of our Canoitas plant in Mexico, which will support our industrial customer growth.

Operating cash flow was $17 million for the quarter, driven by lower working capital. We ended September with approximately $530 million of liquidity comprising $340 million in cash and $190 million available under our revolver. The large increase in cash from the second quarter was driven primarily by the net proceeds from the sale of the Calera line business and W&W railroad as well as improved working capital.

Before turning the call over to Rick, I would like to address the question that we get asked most frequently, which is how we will deploy the cash from the asset sales. As we mentioned on the last call, we believe that lowering our debt is the single best way in the near-term to deliver shareholder value. At the same time, we also believe it is important that we maintain an appropriate level of flexible liquidity to support our business given the uncertainty around the Energy segment. For this reason, we expect to replace our existing standby $200 million revolver with a less restricted facility. Once that facility is in place, I expect Covia to begin opportunistically purchasing debt at market rates.

Now I'll turn the call back over to Rick to cover current market dynamics.

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [4]

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Thank you, Andrew. I'll begin with the industrial market where overall conditions remain very solid. The growth we experienced for coatings and polymers throughout the year is expected to continue. Our container glass markets remain solid, particularly in Mexico, and beginning in the first quarter of 2020, we expect to benefit from the commissioning of a customer's new furnace and the completion of our contracted Canoitas expansion.

In our foundry business, the GM strike lingered into the fourth quarter, which will have a negative impact on the business as well as the glass windshield market. The positive news is that these disruptions were temporary, and now the strike is resolved, we expect demand to rebound.

As we've seen over the past several quarters, our industrial segment's predictability and diversity plays a critical role in offsetting some of the market-driven volatility in the energy segment, and we are further focused on growing and strengthening this segment. While we've been more vocal about the recent sales of noncore industrial assets, we've also been working behind the scenes to expand our profitability through more efficient operations, expanding our business with existing customers and adding new customers and new products to this business. We believe our industrial business provides exceptionally attractive returns.

Moving to the Energy segment. It is widely known that the customer budget exhaustion has led to sharp decline in demand, and this is expected to continue in the fourth quarter. Looking further into 2020, longer-term visibility remains challenged. However, most of our customers expect activity to bounce back in the first quarter as budgets refresh. With this is a backdrop, it is our view that pricing has fallen well below the level of all-in cash production costs for many proppant producers particularly when factoring in SG&A, maintenance and capital spending. This cannot continue indefinitely and has resulted in reduced economical production capacity. We expect this trend to continue in the near term in most basins, particularly in the Permian, which has the greatest supply and demand imbalance.

For the past several weeks, we've noticed an increasing amount of reported local supply in the Permian coming offline, either through plant de-ratings or complete shutdowns. As suppliers have exited the market, we have received increasing interest from customers looking to procure sand from a reliable source. Particularly those multi-basin offerings, they know they can count on Covia to reliably deliver the products they need, and we are establishing long-term partnerships with E&Ps and servicers who we believe will be the industry leaders.

Our competitive position for these customers is further strengthened by our large and diverse industrial segment, which helps support us through troughs in the Energy market. And our strong liquidity of nearly $530 million, including $340 million in cash, more than 5 years remaining on our debt. We will continue to focus on repositioning the Energy business to ensure that we remain a safe, low-cost producer, and that we can efficiently meet the needs of our customers. This will include optimizing production to leverage our lowest cost plants, tightly managing capital spending, and reducing overhead and excess costs, including excess railcar and terminal costs as you've seen us do throughout 2019.

As I reported last quarter, in connection with these strategic goals, we've launched a company-wide process improvement program to realize efficiencies and improve margins. We're in the process of implementing these initiatives and expect to fully realize the benefits by the end of next year. We believe the execution of our strategy will allow us to delever the business and manage through the current energy downturn as well as position us to benefit when market conditions improve.

Now I'll turn the call back to Andrew to cover guidance.

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [5]

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Thanks, Rick. Starting first with industrial for the fourth quarter, we are forecasting volumes to be between 3.3 million and 3.5 million tons. This guidance includes the negative impact from the sale of Calera. Within Energy, and as Rick has mentioned, we've got very limited visibility in the back half of Q4, and we're planning for volumes to decline at least 15% from the third quarter.

SG&A for the full year is expected to be in the range of $145 million to $155 million, and that includes $10 million of stock compensation. CapEx for the full year is expected to be between $85 million and $95 million, which is a narrowing of the range we have previously provided. This implies fourth quarter CapEx of approximately $10 million to $20 million.

With that, I'll turn it back over to Rick.

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [6]

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So before we open the lines for Q&A, I want to remind you, we do expect the fourth quarter in Energy to be challenging. However, we also expect continued positive contributions from our industrial business, and we believe that the execution of our strategic and operating initiatives, coupled with the quality of our energy and industrial assets, and most importantly, our outstanding team here at Covia, will position us to be profitable in all market conditions and strongly leverage us to market improvements.

So that concludes our prepared remarks. I would like to ask Chelsea to open the line for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Your first question comes from Kurt Hallead with RBC.

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Kurt Kevin Hallead, RBC Capital Markets, Research Division - Co-Head of Global Energy Research & Analyst [2]

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I appreciate that update and context around what's going on in both the industrial and Energy markets. And I think I was just going to start my line of questioning here on the Energy front as you probably expect.

So in the context of prior calls, you guys have provided some general sense of what was going on in terms of pricing dynamics. So I was wondering if we get an update on that. And as you talked about the decline in volumes in the Energy business going into the fourth quarter of the year, challenges around fixed cost absorption and so on. Just wondering what the decremental margin could be on that Energy business as you go into the fourth quarter.

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [3]

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Sure, Kurt. I'll start. I mean, I think as it relates to pricing, certainly you've seen the pricing come off in the Permian, on spot business to some extent. We don't think that's sustainable in the long term as we said earlier on. We're -- fortunately, we have contracted business over the long term that allows us to mitigate some of that softness. But we're not immune from it, so we have some of that will flow through our numbers going forward as we see a little bit, on average, our costs decline as we try to keep the volume up in the business in the short term. And we're seeing some of that in the Northern White markets as well. We're pretty stable in Northern White throughout most of the third quarter. We saw it come down a bit towards the end. I think we were down overall in Energy $1 plus -- $1.25 in overall price. So as we look into the fourth quarter, we don't -- you asked a question about volumes in the fourth quarter, we just don't have as good a visibility. I think in our guidance, we said probably down 15%. It could be higher, it could be lower. It's just tough to see what happens after Thanksgiving.

Andrew, do you have anything?

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [4]

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I think that's right. I would just echo that the lower volume is going to negatively impact our margins. We do have certain fixed costs. Some of which that we are addressing through the idling of the facilities, but we have other costs around railcars and certain terminal cost, which will persist in the quarter. And that's going to weigh on our margins in addition to the price declines that we've seen.

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Kurt Kevin Hallead, RBC Capital Markets, Research Division - Co-Head of Global Energy Research & Analyst [5]

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Okay. I appreciate that. And maybe just as a follow-up, Rick, you mentioned the opportunity to kind of grow your industrial business. Just wondering if you could provide some additional insights on where you might see those opportunities whether it's U.S., Mexico. What kind of submarkets are you looking at?

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [6]

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Sure. We think we'll -- and you mentioned U.S. and Mexico. In Mexico, of course, we've -- I've mentioned the 350,000 tons that we expect to get next year related to the Canoitas expansion as they add a furnace, a new furnace down there. So we see some growth in that container glass business there. We've also feel like we've got some new offerings in our coatings and polymers area that as we expand that market and reach into markets that we haven't had before, our nepheline syenite assets out of Canada. And in the building products, we're looking at some new products and some ability to expand our touch point with a number of customers there. So we think we've got some good opportunities to continue to focus on growing that business. At the same time, we think we can reduce our cost to deliver as well.

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Operator [7]

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Your next question comes from George O'Leary with TPH & Co.

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George Michael O'Leary, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [8]

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On the industrial side of the equation, it sounded like there were some -- a, you had the sale of some assets, but some idiosyncratic issues that may not repeat that kind of dented demand on a sequential basis or a year-over-year basis. As you think about the end markets fundamentally, can you talk about whether you're seeing underlying demand kind of stagnation or retrenchment, or if the underlying demand trends actually look good and maybe break that down a little bit by what looks best and maybe where there's the most softness or sluggishness?

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [9]

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Sure, sure. I think we feel good about what we see on containerized glass out of Mexico. In the U.S., we see that down a little bit as customers choose other alternatives potentially. So we've seen that kind of slip off, but we're still up on the containerized glass. At coatings and polymers, we expect to remain strong, and it's been a good driver as we issued -- as we noted, we were up 15% in the quarter. And on metals and foundries, we certainly had the GM strike, but we are seeing a bit of softness in metals and foundry which as you can imagine with economic concerns. So that's the 1 market that's probably will be impacted more on economic concerns. So that's kind of around the horn on most of the industrial markets. You want to add, Andrew?

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [10]

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I'd say on balance, we're pretty constructive about the outlook. As Rick said, there's some things that we expect to do quite well and some others that will soft, but we're not expecting significant declines at all, based on how we see conversations with customers.

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George Michael O'Leary, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [11]

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That's helpful. I appreciate that. And then in the Energy business, in particular Q4 '18. Last year, I think gross profit or contribution margin collapsed, call it, 40% to 50% quarter-over-quarter in the fourth quarter. Just given what you guys have done on the cost side but taking into consideration things like fixed cost absorption and the volume compression quarter-over-quarter, is thinking about margins compressing to that degree in the fourth quarter a reasonable bogey to use? Or are we being overly punitive, again, given the cost measures that you guys have taken?

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [12]

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Yes. George, I think that we're -- we see the fourth quarter this year being more challenging than what we saw last year from a -- certainly from a pricing perspective. I think that we'll have -- volumes will be lower than what they were in the fourth quarter of last year as well. And so that combination, together with some of the fixed costs that we can't drive out of the business in the quarter, particularly around railcars and certain terminal costs, that's going to negatively impact the performance relative to what you saw last fourth quarter.

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [13]

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Another thing I would add, I mean, the good news is that we have reduced fixed costs and one in -- where we will be sourcing the volume out of our lower cost plants going forward. So that will help. And as Andrew mentioned, on the railcars and the terminals, we are working feverishly to reduce those costs. And at some point in time, those leases will expire, and we'll have the benefit of fewer railcars in our system, not having that overhang on top of our operations.

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [14]

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The other thing I'd add is, is we did not see as significant of a price decline in the third quarter, but we have taken actions in price, and that's going to be the primary driver around our margin degradation in Q4.

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George Michael O'Leary, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [15]

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All right. That's helpful. And is there any reason to think, just given the capacity that's come off-line, that the pricing doesn't go to where we were in the fourth quarter last year? Saw a nice rise in the first half of this year from a pricing standpoint but again, it seems like despite the volume that's come off, pricing should migrate back towards Q4 '18 levels. Am I thinking about that correctly or no?

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [16]

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I think when you look at pricing and the levels that we're seeing in the market today, we don't think those are sustainable long term. And -- because they're below most people's cash costs. So we're being very selective as to the new business that we're taking on and making sure that it's cash margin positive for us. So we'll see -- we've seen a decline certainly. We've got good contracts that continue to help us mitigate some of that. But as we continue to add volume to our facilities to make sure we're running them most efficiently, we are having to bring down our average price.

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [17]

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And the only thing I'd add to that, George, is we're at a point in the cycle, as it relates to pricing, that we have no intention of reactivating any capacity any time soon until we see a very significant, meaningful improvement in price.

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Operator [18]

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(Operator Instructions) Your next question comes from John Watson with Simmons Energy.

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John H. Watson, Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst [19]

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I apologize if I missed this, but could you provide some parameters to help us think about gross profit per ton within I&R for Q4?

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [20]

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Sure. So George, I think you typically will see a seasonal decline in the gross profit per ton for the industrial segment. So that typically can be $1, a couple of dollars. Generally speaking, we would expect our gross profit dollars to be relatively flat to Q4 of '18, excluding the impact of the asset sales. So we feel that, that's a reasonable assumption going into Q4.

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [21]

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And just a reminder, on average, I mean, in Q3 we -- our gross profit per ton was probably a margin of low 30% to 35%. And that also includes our lower-margin containerized glass. So it probably comes down a little bit into the mid- to high 20s probably in Q4.

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [22]

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That's right. Usually during the summer months, our higher-margin business out -- has higher volumes. And so you'll tend to see our gross margin percent decline in Q4 as well as Q1.

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John H. Watson, Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst [23]

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Okay. That's helpful. The release mentions de-rating capacity at several oil and gas facilities. Does that include any in-basin or local sites?

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [24]

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No, it doesn't. Those are all Northern White sites.

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [25]

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We actually had a very strong October in our in-basin facilities and set some record volumes for us in October.

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John H. Watson, Simmons Energy | A Division of Piper Jaffray - VP & Sr. Research Analyst [26]

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Okay. Great. And then lastly, if you have it and are willing to quantify, would you give us the percentage of your volumes that came from Permian mines in the third quarter? And then also, compare your Permian profitability to your overall oil and gas profitability.

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Andrew D. Eich, Covia Holdings Corporation - Executive VP & CFO [27]

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Sure, John. I would say that in the third quarter, the Permian and local MidCon plant, the Seiling facility, was probably a little less than 1/3 of our total volumes for the quarter, with Northern White representing the vast majority of the remainder. And in terms of the overall profitability, I would say that our regional plants probably did better than our Northern White. And that's really driven by a decline in Northern White volumes in the back half of the quarter, which we didn't -- we lost some fixed cost leverage. I mean I think we made significant improvements in our operating costs in the local plants. That was offset by pricing degradation that we saw. Northern White pricing actually held up much better. However, the volumes dropped and we lost fixed cost leverage.

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Richard A. Navarre, Covia Holdings Corporation - Chairman, President & CEO [28]

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Well, thank you, Chelsea, and everybody else on the call. Thanks to all for your interest in Covia today. And I'd also like to especially recognize the Covia team who has done a remarkable job in navigating through these challenging market conditions. So thank you for joining us today. That concludes our call.

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Operator [29]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.