Good morning and welcome to the Solaris Oil Third Quarter 2020 Earnings Conference Call. [Operator Instructions] After today's presentation, there will be opportunity to ask questions. Please note that this event is being recorded. I'd now like to turn the conference over to Ms. Yvonne Fletcher, Senior Vice President of Investor Relations. Please go ahead.

Good morning and welcome to the Solaris Third Quarter 2020 Earnings Conference Call. I am joined today by our Chairman and CEO, Bill Zartler; and our President and CFO, Kyle Ramachandran. Before we begin, I'd like to remind you of our standard cautionary remarks regarding the forward-looking nature of some of the statements that we will make today. Such forward-looking statements may include comments regarding future financial results and reflect a number of known and unknown risks. Please refer to our press release issued yesterday, along with other recent public filings with the Securities and Exchange Commission that outline those risks. I would also like to point out that our earnings release and today's conference call will contain discussion of non-GAAP financial measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. Reconciliations to comparable GAAP measures are available in our earnings release. I'll now turn the call over to our Chairman and CEO, Bill Zartler.

Thank you, Ivan, and thank you, everyone, for joining us today. I'd like to begin this morning by saying thank you to our employees. I recognize how challenging this environment has been. Amidst the presence of a global pandemic and an unprecedented industry downturn, we have adapted well to the rapidly changing needs of our customers, new work safety guidelines and organizational changes without missing a beat in continuing to provide safe, first-in-class service. Their efforts have helped us navigate this downturn while continuing to generate cash and maintain a debt-free balance sheet. This is quite an accomplishment. I'm very proud to share it with the investment community today. Thank you again for your flexibility, commitment and hard work, and I'm excited to see what this team can accomplish on the other side of this. Now turning to our third quarter results. Solaris had an increase in fully utilized systems of 70%, generated over $20 million in revenue, had adjusted EBITDA of approximately $3 million, had our seventh quarter of positive free cash flow and paid our eighth consecutive quarterly dividend despite the continued challenging environment. Our customers returned to a modest level of completions activity during the quarter as pandemic-related lockdowns were lifted and oil prices recovered modestly. This drove to 70% increase to 34 fully utilized systems for the third quarter, up from 20 fully utilized systems in the second quarter. This increase was primarily driven by increased completions activity in the Permian Basin, which saw the sharpest activity pullback in the second quarter and was the first to rebound in the third quarter. While we are active in nearly all basins, we are positioned well in the Permian and benefited from this trend in the quarter. Today, our overall activity is running slightly higher than the third…

Thanks, Bill, and good morning, everyone. During the third quarter, we generated over $20 million of revenue, adjusted EBITDA of over $3 million and positive free cash flow of approximately $2 million. We averaged 34 fully utilized systems deployed to customers, which represents a 70% sequential increase. Total revenue increased 120% sequentially, driven by an increase in activity as well as an increase in last-mile services, which, as a reminder, has a large trucking revenue component that can be multiple higher than the rental contribution from a typical system, but contribute similar margins on a dollar basis. Over the course of the quarter, we deployed a total of 65 proppant systems, which worked with varying degrees of utilization in the third quarter. Our calculation of 34 fully utilized systems reflects the number of equivalent systems that generated revenue every day in the quarter, which we believe is the best measurement for modeling purposes. Total SG&A costs for the third quarter were approximately $4 million, inclusive of non-cash stock-based compensation. For the fourth quarter of 2020, we expect total SG&A to be approximately flat at $4 million, inclusive of the normal quarterly expensing of non-cash stock compensation. During the quarter, we generated a GAAP net loss of $3.3 million or $0.12 per share. Adjusted pro forma net loss for the second quarter was $4 million or $0.09 per share. As a reminder, adjusted pro forma net income or loss adjust for non-recurring items and also assumes the full exchange of all Class B shares for Class A shares for a more comparative period-over-period presentation. Please refer to our press release issued last night for a full reconciliation of adjusted pro forma net income. Operating cash flow was approximately $3.7 million in the quarter. And after total capital expenditures of approximately $1.3…

[Operator Instructions] First question comes from George O'Leary from TPH & Co.

Just with active system count up 70% during the quarter, which was quite impressive, Bill, your comment that you were seeing a record system volumes seem intriguing to me. Just curious if you could frame how much sand is moving through your systems today from a throughput standpoint and maybe give us some historical context as to how that's changed over time? And just tell us what that implies about system efficiency maybe versus the competition or some other metrics that you guys track?

Okay. Kyle, do you want to...

Yes, George, I'll jump on that one. Yes, it's a great point. I think in the early days, we identified sand intensity going up as a pretty significant trend. And obviously, that's driven the underlying growth in our business. But we continue to see more of it every day. The notion of the simu fracs that are going on today, the high grading of the frac crews that are operating today, we went from 350, 400 frac crews to 100 to 120 frac crews working today. So every crew is more efficient, better trained equipments being taken care of. So the pump hours per day just keep going up. And so where does that translate for our business is into throughput into our systems. So for the most part, we rent our equipment, and so our customers pay a fixed cost to run our equipment. So every time they increase their throughput rate, they're actually paying less for our equipment on a dollar per ton equivalent basis. And so we did see roughly a 70% increase in the number of fully utilized systems deployed. But I'd say when we look at the actual total throughput that went through our systems, it's going to be higher in the quarter than the 70%. Roughly anywhere from, call it, 20% to 40% more loads or volumes of sand likely went through our systems in the quarter versus the second quarter. Clearly, in the second quarter, we saw people slow down their intensities and just tried to make it through. It was obviously a very difficult quarter for everyone. But we are seeing volumes go up on a daily basis in each of our systems. And the big value that we provide is a large buffer directly at the blender in a very reliable system that's been tested and proven to work very well and a very simple process. Sand gets loaded into the silos and it's effectively gravity fed into the blender with the assistance of a couple of belts. And then further from that, as this intensity keeps going up, we've driven significant automation into the operation of the system. Historically, you would have somebody that physically operated the system, looking into the blender Hopper. And we've automated that through our AutoHopper system that we've talked about in the past. And what we're seeing with the AutoHopper system is a significant ramp-up in adoption among our clients. During these times, people are always looking for ways to save more money, reduce people on location, make it safer, et cetera. And so we have customers running our system from the data van. So as we see trends going forward, we see fewer people and we see intensity continue to go up. And technologies like Solaris' AutoHopper and other things we're working on, I think will really prove to be valuable to both operators as well as pumpers.

Yes. I'd add a little bit to that, George. So we did see an increase in the -- I wouldn't call it complete rebundling, but the last mile solution where we actually handle the sand and do it on a dollar per ton basis. And in those specific instances, we saw fairly significant on the high-end of cows range increase of sand throughput per set of silos. So the throughput overall, we think, from an industry perspective was up significantly through our systems above the 70%.

And then the fourth quarter outlook commentary. Just curious if that's more predicated on discussions with customers, just given the comment you clearly ended the quarter higher than you started it, you're saying you're still above the average system count that you had in the third quarter as we sit here today, is the flat to modestly up, more predicated on customer discussions? Or just, hey, we typically see seasonality, let's throw a little dose of conservatism in the guidance and just be prudent and practical and have crude oil prices, recent crude oil prices sound like they've also factored in? Just trying to think through how you guys have thought about that? And then sorry to ask a bunch of questions in one, but could you define modest for us just so we have some sense of what that upper bound might be?

Well, I think, George, you hit the nail. I mean we just don't know going to December, what things are going to look like. Obviously, we have an election coming up. We have prices with fairly extreme volatility over the last few weeks. I mean we are seeing through October, significantly better than the quarter. And just don't know what we see in December. There's no specific customers that said we're going to take a holiday through Christmas kind of conversations happening at this point. Kyle, anything to add to that?

I think that's right.

And then the cash war chest that you guys have built up is very impressive. And clearly, you mentioned in your opening remarks, you want to keep returning excess cash to shareholders. How do you think about priorities for that cash balance above and beyond the dividend? Is it kind of -- given all the uncertainty for now kind of hunker down and play defense? Or is there anything on the offense side that you guys are thinking about with respect to that cash?

Well, George, we -- yeah, go ahead Kyle.

I would just say, we're always thinking about offense. We view the growth of this business in the downturn of 14 and 15. That was driven by a slowdown activity and we played offense in developing new technologies. And we're continuing to do that today. So our R&D in dollars are going into enhancing our current offering as well as developing further offerings that can continue to play to the themes that we've benefited from an automation standpoint, from an improvement in equipment and technology to be fit for today's frac. We're pretty uniquely positioned. We're sitting behind roughly 35-plus percent of the blenders currently working in the U.S. today. So we see a lot. And so that just gives us a unique perspective. And so we've got -- one of the areas we've actually increased from a personnel standpoint during the downturn has been on the engineering front. So we believe that dollars going into prudent R&D investments make sense. Now you can see in the CapEx numbers that we're not spending a ton of money doing it, but we are putting a lot on the whiteboard and having a lot of discussions with customers to make sure that we're at the forefront of technology development, where we really sit at the core, which is what we refer to as the backside. So the low-pressure side of the well site, where water, sand, chemicals are all coming together before they hit the pumps. So that's something we're going to continue to pursue. And then from an M&A perspective, obviously, we've seen a tremendous amount of consolidation as of late in the upstream world, a little bit on the services side. And where we look for opportunities is where we think we can do something a little bit different, whether it's integrating with the software that we alluded to and the data that we alluded to earlier in the prepared remarks or something that really fits uniquely with what we have. So we're being very cautious, and we have been. We've only really done one M&A transaction in the last couple of years, which is very modest, but we've got our eyes wide open.

Next question comes from Jacob Lundberg of Crédit Suisse.

I wanted to start-off, if you could just touch on any changes you've seen in the competitive landscape. It's obviously been a pretty volatile environment the last couple of quarters. How do you expect ongoing E&P consolidation to affect your business or how has it so far? And then, Kyle, on your comments earlier, I think I heard you say that you guys are sitting behind 35% plus of blenders, maybe reading a little too much into it, but I think the normal commentary that you guys have said is like around 1/3 share. So it maybe implies up a little bit. Do you think you've been gaining share or just mix shift?

Well, Jake, I hate to say, but I think you asked 3 different questions there. No, I'm just kidding.

Sneaking in together.

Yes. Working backwards, 35% was -- is -- its ranges every day. And so I wouldn't read too much into that, but I think it goes back to your first question, which is what is going on in our space in terms of a competitive standpoint. We've seen several of the same companies go through a restructuring process. The majority of them have been Chapter 11, so they're coming back around with less debt on their balance sheet or no debt on their balance sheet. So that's gone on. We haven't seen any new entrants really material amount of late. And where I think where we've got the edge is we've got the ability where we're just focused on this, really, the backside that I talked about. We're not running another business alongside of it. So we've been able to continue to invest R&D dollars to continue to differentiate and add to the offering. So I think that's kind of where the competitive landscape sits. We haven't seen any consolidation there at this point of significance. Silica obviously picked up the arrows up business last year or earlier this year. So that's kind of where that sits. And then from an E&P consolidation standpoint, it's always a question of who do you work for today? And are they being acquired? Or are they acquiring? We work for such a large diversified group of folks that were always going to have some wins there and some potential losses there, and sometimes it's just neutral. And so when we kind of look at the landscape of what's transpired over, I'd say, the last 2 months in the M&A standpoint from operators from the E&Ps. I'd call it neutral, really?

Okay. And then as a follow-up, I'll try and keep it to just one. Any color on working capital efforts from 3Q. You guys touched on it in the prepared remarks, but it's obviously notable to see working capital as a slight source of cash in a quarter when you grew revenues as much as you did. Any comments there and particularly interested in kind of sustainability of where we're sitting today on a cash conversion cycle basis? Or any other metric you guys use to judge working capital to be curious in your thoughts around sustainability at current levels?

Yes. Well, certainly, in the second quarter, we saw a significant unwind in our accounts receivable balance, significant efforts to collect there. More of that in the third quarter. And from a working capital intensity standpoint, we're not going to be buying a bunch of inventory as activity stands up, as activity increases, rather. We've got our inventory is the sand and chemical systems that are sitting ready to go to work today. So there isn't a ton of working capital build associated with growing our business. Clearly, the accounts receivable part of our business will grow, but nothing of significance.

The next question comes from Stephen Gengaro of Stifel.

A lot has been asked here, but there's 2 things that I was thinking about. I was curious if you could address. The first is, in a world where, let's say, we're in 2022, and you've had more consolidation on the E&P side. There's been some frac companies that have either consolidated or gone away, and there are sort of fewer, larger entities on both sides of the business. How does that affected?

Well, I think we're already sitting at a pretty significant sizable position in our space in what we did. So I think we're already of significant scale. We've been successful at being an independent provider to both operators and pressure pumpers. And so some healthy balance of large consolidated pressure pumpers, large consolidated operators, but with some independent service companies that can provide differentiated technology that can help keep everybody sort of playing fare. I think it's probably a pretty healthy piece to have into the market. Clearly, if we see a lower for longer activity level in the U.S. in the sand storage market, it's likely that you'll see either consolidation through transactions or consolidation through attrition in the market? We're clearly seeing that in the pressure pumping side. And so we would expect to see something similar in the sand management side.

And then the other question is when you look at the revenue in the quarter, and I'm pretty sure that -- and I think you addressed in your remarks. I missed the beginning, but there's a revenue growth that's faster than the deployed systems growth. And I think a lot of that is sort of transportation-related revenue.

Correct.

Is there any thoughts on capturing that internally? Is it too capital intensive? And I think in the past, you've suggested that it's not a business you want to be in. Is that continue to be the case? And is there are there any bottlenecks to not owning it? I just -- I know you've addressed in the past. It is a question I get from some investors. So I fire I'd ask you all on the call.

It's a question that we ask ourselves frequently. Do we own trucks? Or do we just partner with folks that run trucks better than we do. And I think we continually come back to the answer that we're good at what we do at the well site. We're good at making that equipment better. We're not geared up and we're not experts at running truckloads a sand around. Now we manage the fleet in the last mile business, and we've beefed up that organization to the point where we do think it's profitable, and that makes sense. And at this point, our view is that it's not time for us to own a trucking company to be successful at what we do for our customers.

And then just one final one. Any update on the chemical side? I know it's a slow market these days, but any update on any progress, traction and outlook there?

Yes. We had a system working with the customer throughout the third quarter. Very happy with the results that, that customer has probably got work kicking off latter half of the fourth quarter. So we expect to get something back out there. And then today, we have a chemical system working for another customer. So yes, we still feel good about it as we've discussed, the value proposition from an operational standpoint, from a logistics standpoint is very clear. And ultimately, we do feel like we will get to a point where we get more of them deployed. But just what I like to always say is we've got several of them in the inventory today, ready to go and doesn't require incremental capital to put them out.

The next question comes from Jon Hunter of Cowen.

So I just had kind of a question about your outlook for profitability. I guess your margin per system. It seems like with flat activity, your margin per system would be kind of flattish, I guess, in the fourth quarter. But Kyle, you did note some costs coming back kind of later in 4Q. So just curious how you're thinking of profitability there?

It's obviously a moving target as activity goes up, we will have some additional costs that come through. But I think where we came out in the third quarter as far as profitability per system, if you will. I think that's probably a good number to be using here as we talk about a flat to modest outlook for the fourth quarter.

And then the press release and I guess your prepared comments note some cautious optimism about activity recovery in 2021. Is that based on your customer conversations today? Do you see customers talking about adding systems early in the first quarter? And then do you think some of that may be dialed back a little bit given what the commodity price is done?

I certainly -- go ahead, Bill. David, it will flow with the commodity price somewhat, but we have had specific conversations with customers that believe they're going to add back systems in 2021, more active in the gas basins as well as the oil basin. So there is a level of gas activity, Marcellus and Haynesville that we will see, and I think we see that stabilizing as well or growing. So I think we're cautiously optimistic, but most conversations we have about next year are that we will see an uptick in activity.

And next question comes from Ian MacPherson of Simmons.

Bill, Kyle, you just touched on the first thing, I wanted to ask about. It's certainly good to have some base in diversity right now, and we've had so much divergence recently with TI and gas. Do you think, Bill, there is a material amount of upside price elasticity with gas directed activity to offset the crude weakness right now? Or do you think that is oil activity is just more commodity price-sensitive in general than the gas basins are?

Well, I think it is going to be a little more volatile. The gas prices have been moving. It's moved up some. It's moved down some. I think the magnitude of its moves haven't been quite as volatile as oil, and we anticipate it being stable. I think you will not -- if oil stays in 30 and gas goes to 3, you will see a net loss of activity next year, not -- the gas will not make up for a significant down draft in crude price.

Okay. This has also been sort of paced out a little bit in prior questions. But really, I think what I wanted to ask a little more bluntly with regard to the consolidating upstream sector is where -- do you have a strategic view of where your 33%, 35% share should go? Is it something that you plan towards? Is this something that you can plan towards with the way your marketing efforts are structured in the line within the team? Or do you think that you need to take what the market gives you as the market evolves?

I think we really don't look at market share as our goal. Our goal is customers on a single one-off basis, whether it's direct to operators, whether it's direct to pressure pumpers and some combination of both that we go after and convincing them that the value that we add to their operations is significant and worthy effort. So the market share is really a fall out of the math of let's go get the customers, and we can demonstrate that we're going to be a reliable provider of services for them, and it's going to improve their operations, and we go at them one at a time. And that's really how we fundamentally approach it.

Next question comes from Chris Voie of Wells Fargo.

So just to check the box on pricing. It looks like it's pretty much on track, pretty stable versus the prior quarter. Obviously, I think you had the same price look since 2017 and a bit of a concession in the first quarter. But just to confirm, any shifts going forward? And then do you expect any impact kind of related to the M&A on the customer side related to more higher quantity discounts going forward? Just curious what your view is there.

Yes. I think the pricing we saw in the third quarter is probably roughly where we see the mix coming out in the fourth quarter. It is driven as a function of mix, not only price. So I've got to keep that in mind. It's multiple variables. And then from a consolidation standpoint, I don't -- we're not forecasting any reduction in rates due to higher peers, if you will, in the pricing matrix?

Okay. And then second question, do you have any technology projects on the horizon or other kind of build-outs or maintenance that could drive higher run rate CapEx in '21? Or should we assume that it's mistake pretty close to these levels going forward?

I think from a maintenance standpoint, no, there's no deferred maintenance that would be associated with ramping up the systems of any significant magnitude. And from a technology standpoint, yes, I mean, we are constantly working on new technologies. And if we develop something that's got a neat home that provides good economic return to us and more important -- and just as important, good economic return for our customers, we feel comfortable in deploying capital there today. There's nothing today that's commercial, but we've got stuff that get tested in the field in the third quarter, and we'll have further testing in the fourth quarter. So we're constantly out trying to figure out new ways to grow.

Okay. Well, with that in mind, can you give maybe a range, an expected range for CapEx next year by any chance?

No. I don't think we're going to give any guidance on that at this point. But I think where we are from a maintenance standpoint, where we were this year is probably a fair number to be hit.

[Operator Instructions] Next, we have a follow-up from Stephen Gengaro of Stifel.

Just quickly on the sand on the dust mitigation side. It's a topic that's come up recently again. I know the ocean regulations are -- I think it's June of next year. How -- where is the issue in general? And how is the -- is your solution better or worse than the containers?

So you really have 2 points of transfer of sand, right? You're taking it from a truck and then when it goes either into the silo or from the box that goes into a stack. And then from that unit into the blender Hopper. So the first piece, the movement of sand from a truck into the silo or movement of sand from a box to a store box. There's really no emission, if you will. We designed our system many years ago to address that. We've got very large dust collectors that sit at the top of our silos, the fines are collected and then they're dropped back into the silo and ultimately pumped out whole. Where you have an exchange is when the sand leaves our system and goes into the blender Hopper, which typically is an open container with -- as an open piece of equipment that is exposed to wind could be exposed to rain. And what we've done with the AutoHopper system is we've eliminated the need to keep that piece of equipment open. Historically, it was kept open because people physically would look into the Hopper to see what the level was and they would increase or decrease the rate of sand based on the level in the Hopper. And by using the AutoHopper, we actually use the consumption rate within the blender to determine how much sand we're going to deliver into the Hopper. So you no longer need anyone there. So what that allows you to do is to enclose the one piece of clear exposure, which is in the Hopper at the blender. So it's in a piece of equipment that's generally controlled by the pressure pumper. And with our technology, what we've been able to do is in close that area, which ultimately is the fix. But just to be clear, yes. And to be clear, it's -- the regulations have been known for quite some time, and we have been very focused on it and working with our customers in collaboration to make it happen.

Thank the next question is Ryan Pfingst of B. Riley Securities.

I guess just one more for me. So commodity prices will obviously play a role. But because of the downturn we've already had this year, do you think it's plausible to say that the normal holiday seasonality might not be as pronounced this year as it's been in recent years?

It's certainly plausible, and we certainly hope that that's the case, but you just have to plan for what has been a historical trend over the last few years.

Thank you. This concludes our question-and-answer session. I like to turn the conference back over to Mr. Bill Zartler for closing remarks.

Thanks, Nick. I'd like to close with a thank you to all of our employees for your continued commitment and execution of our business and to all of our customers for their continued partnership over this difficult period. While we're not through the virus and its numerous lasting impacts on all of us, you all should be extremely proud that we've kept the business and industry alive and high functioning. Our operations will continue without interruption to provide essential services to our customers, employees, suppliers and shareholders, as we remain committed to helping our customers further increase efficiency, savings and safety on well sites by continuing to innovate and evolve our offering despite these market headwinds. Thank you all. Stay safe, and have a great day.

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