Flowco Holdings Inc. (FLOC) Earnings Call Transcript & Summary

All right. Let's get this thing started. Good morning, everybody. My name is Jason Kim.

I'm [indiscernible].

And we are the equity research associates on JPMorgan's oilfield services and equipment team. Today, we have the pleasure of hosting Flowco and its President and CEO, Joe Bob Edwards, we're very honored to have him. Since its IPO a year ago, Flowco has quickly established itself as a pure-play leader in production optimization, artificial lift and emissions management solutions for the North American oil and gas industry. [indiscernible] thanks for joining us. I'll hand it over to Joe Bob for some opening remarks, and we'll proceed with a Q&A fireside chat.

Excellent, thank you. Well, good morning, everybody, and thank you for coming. It's great to see some familiar faces, some new faces, and it's great to tell you about my favorite subject, our company, Flowco. As Jason said, we IPO-ed just over a year ago and are really pleased with our young life as a public company. We have, I think, a very unique story to tell. I'm thrilled to share it with you. and tell you a little bit more about what makes Flowco unique. I want to leave plenty of time for Q&A. We've got some interesting current events to talk about some interesting geopolitical current events to address, and yes, tell you a little bit about how the future looks for us. But just to set the stage, Flowco is the only public company that is purely focused in the production phase of the oil and gas industry. Once a well in the United States is drilled, you all know this, it has to be fracked. And then the oil company has to manage that production for, in some cases, up to 20 to 30 years. So our revenue our very reason for being begins when a well gets turned in line. Every well in the United States has to have some kind of help in order for it to maximize its production. That type of help is typically referred to as artificial lift. And that actually describes what is done. We are helping a well lift its fluid to the surface by providing various techniques to lift the fluid out of the well to the surface so that the oil company can then move it to market. So the way that we actually go to market is through the various methods of lift, and it's best seen really on Slide 8. I'd love to start all my presentations on Slide 8. For some reason, it makes sense to flip all the way there. So our business is organized in 2 segments: Production Solutions, artificial lift, natural gas technologies, which is another form of production optimization. We have several brands that we have acquired over the years, and our customers procure their products through these brands, but we go to market as one Flowco. So within Production Solutions, we have various ways of addressing the early reduction in the life of the well. There are 2 main forms of production, high-pressure gas lift and electrical submersible pumps. We have both forms of lift for the early life of the well. Typically, when a well matures, you go through a decline curve as seen here on Slide 9. And the appropriate form of lift early in the life of the well needs to be handed over to something else. That typically is conventional gas lift. We also lead the market in that. And then as a well gets out to years, 8, 9, 10 and beyond, we have a late life solution called plunger lift that is fit for purpose for a large portion of the addressable market in the United States. On the natural gas technology side, we have a vapor recovery system, which leads the market [indiscernible] recovery, again, is what it sounds like. We help all companies capture fugitive emissions that are escaping from [ tanneries ]. These emissions have BTU content, so they have economic value, our vapor recovery systems allow oil companies to capture this production or this lost production and actually monetize it. So yes, it's an environmental solution. But above all else, this is a moneymaker for our clients. So our oil company clients actually deploy this environmental solution to help their bottom line. All along the way, we have various digital solutions, which help oil companies actually manage their production systems remotely. And we are well down the path toward autonomous control of some of our systems through advancements in AI. We can talk more about that in the Q&A. But we are thrilled with the position that we hold in the market. We have a growth plan that is, I think, very clearly demonstrated. We had very nice growth last year. We're projected to continue to grow this year at what I think is industry-leading rates, that's both organic and inorganic. Our M&A pipeline is full. But my commitment to you guys is that we are going to stay true to what we know, right? We understand the production phase of a well's life inside and out. We understand the adjacent technologies that are required by our clients to help manage that production. We have strategies to round out our product portfolio, both organically and inorganically, and I'm excited and honored to lead the company. So with that, maybe an appropriate time to maybe pause for some Q&A.

Yes, absolutely. We'll get started. That's a great introduction, Joe Bob. Thank you very much. So you mentioned your companies very uniquely levered to the production phase side of the activity. But let's just take a step back and start with the macro. It is our Natural Resources conference after all. So given the first half of '26 has been marked by significant geopolitical volatility, you have commodity prices going higher, North America is starting to see some early signs of increased short-cycle investment, but Flowco levered to production phases. So it tends to be more stable. How has the recent Middle East conflict and resulting supply disruptions, shaped customer conversations and activity levels in North America for your company?

So we generate very little revenue from the Middle East. Obviously, it's a big world out there. We'll talk about international expansion for Flowco in a minute. But this disruption that is taking place in the Middle East has definitely impacted us in the U.S. And it's net-net, a very positive development. No one likes conflict, no one likes the violence that comes with armed conflict. But when you think about what emerges on the other side of this conflict, the security that the United States Energy conflicts enjoys is going to be at a premium. The production that the North American shale business, in particular, has provided to the world stage, should have a higher call on it. So we're thrilled with, I think, the new normal on the other side of this, there should be a sort of a permanent geopolitical bid in the market for what our clients are selling, which is net-net and good for us. Specifically related to activity, yes, you alluded to it, Jason. The -- our clients are starting to add rigs. They're starting to add frac spreads. So these are great early leading indicators for more activity for us. but you also nailed it. It's -- there's a definite lag. We see really good early green shoots for later this year and into next year. And we're yes, gearing up for that with our CapEx programs and with our forecast that we've put out to the Street.

Wonderful. And we'll get to a little bit of the CapEx plans later on today as well. Loco delivered a strong 1Q, just posted some updated thoughts on guidance for the second quarter. Earlier this week, reflecting already a full quarter of valuing contribution and continued rental growth, but recognize you're seeing some margin compression in the current environment within a particular subset of your business? So as we move into the second half, investors are focused on the sustainability and margins, the cash flows that you have. Can you walk us through some of the main factors driving your updated thoughts on that updated guidance and how this sets up for the second half of the year?

Yes. And to be clear, and we will reiterate the growth story that we are telling the revenue that we are generating is in line with expectations. So the demand for what we do is incredibly solid. And if you look on a full year basis, our growth story leads the industry. It's going to -- we're going to be up somewhere in the 15% to 20% range year-over-year, which we're thrilled about. But yes, we are seeing some margin pressure in the short run. We put out some updated guidance for Q2. We think we're going to come in at or slightly below the low end of the range, 100% driven by some cost issues. Really, it's in a couple of big buckets. We've got some increased pressure on lube oil, and we are a large consumer of lube oil. We run over 5,000 compressor packages and they consume lube oil as just to run. So we've seen a definite cost pressure there. We think that's going to persist into Q3. We've also seen some maintenance expenditure -- maintenance expenditures that are a little higher than we had forecast, and that's a mix of parts and people and timing candidly. We're digging into both of those as aggressively as we can, but we estimate a couple of hundred basis point margin pressure in Q2, which might persist longer into the year. We also suffered from some mix -- unfortunate mix shift during the quarter, which we think is not permanent. So yes, look, again, to reiterate, the outlook for the year is solid. We just think here in Q2, we're going to suffer some things that are a little -- that need our attention, some which are transitory, some of which we're digging into and make sure they're not structural.

That's very helpful. And you mentioned some of these are shifting maintenance CapEx, working capital. What are some of the key puts and takes to think about free cash flow conversion for the rest of the year as working capital normalizes?

Yes. We are very proud to have a very strong cash flow story, okay? So if you think big picture, even after a healthy dose of growth capital, and for the last several years, we've invested around $100 million a year of growth CapEx even after that we're on a 50% free cash flow conversion from EBITDA to true free cash flow. That speaks to our very appropriately leveraged balance sheet, speaks to some excellent work by the team on working capital management and our discipline around capital expenditures. We have -- we're a very returns-driven organization. And if I may, I'm going to go back to the presentation, Gaby, what slide is the money slide. The end. Thanks. Okay. There we go. Back one. We make capital allocation decisions based on this graph. We have a number of very specific products that we invest the vast bulk of our growth capital in high-pressure gas lift, conventional gas lift and vapor recovery being the 3 that we've talked about most substantially since IPO. Most recently, we added a new product line in ESP through our [ Valeant ] acquisition. Each one of these areas has a clearly defined growth effort behind it, and we allocate capital based on ROCE, okay? So what is it, right? Return on capital employed. Everybody knows that. Everybody has a different calculation about it for it. But we look at true full-cycle returns on every dollar of incremental capital we deploy. So we are thrilled with the result of that capital allocation strategy between these 4 main areas leads to industry-leading ROCE and industry-leading growth. And last I checked, any textbook will tell you, that's a path to superior equity returns. So we're thrilled with this result, and this is the way we make decisions every day.

We always love a good call back to our valuation textbooks with the McKinsey book. So really appreciate that. I think that's a good segue into some of the business models and the commercial models that Flowco deploys and I'll hand it off to [indiscernible].

Definitely. Thank you. So Joe Bob, turning to your rental platform. I think we've seen Flowco position its platform is a core driver of visibility, especially as rental revenue represented around 60% of total revenue as of the first quarter, and it's increased 9% sequentially, supported by steady demand you're seeing across surface equipment and vapor recovery rental specifically, plus your newly added ESP offering through the Valeant acquisition. So can you help us understand the main advantages of locos rental model customers as well as the company? And how do you see this rental versus sales mix evolving over the rest of the year and going forward?

So for our customers, they've got a very challenging business model right? They've got to go find the hydrocarbons, drill for them, frac the wells and then manage the production. They are really, really good at the subsurface analysis and the technical skills that go into finding and producing oil and gas. What they're not good at by their own admission, is running surface equipment to help make all that a reality. So the business has evolved over the decades into a rental model for things that need to be maintained and moved around. And so within our business we have over 5,000 pieces of surface equipment that every day are helping maximize production on site for an oil and gas company. So that's our rental fleet. It's a mixture of high-pressure gas lift, conventional gas lift and also within our rental line item of revenue on our GAAP financials, we have our vapor recovery business. So that's -- and that's what's growing most aggressively is our investment in each of those 3 categories. The newly added ESP product line interestingly, has a little bit of both rental and sales revenue. So we respond to our customers' demand and look at maintaining that rental equipment to the best possibility. We win business based on the service quality that we provide, the mechanical uptime of the rental items that we have on site, and we're with them for the life of the well as the wells mature.

That's helpful. And Flowco has really highlighted continued investment alongside these customers' activity increases in 1Q '26. And we've seen Flowco report investing $26 million of growth capital specifically, primarily to expand this rental fleet across surface equipment and vapor recovery, right? So what is the deployment strategy for further rental fleet expansion? And how do you manage lead times in your supply chain?

Sorry, I'm going to go back to Page 8. And if you look at our rental opportunities. It's in the high-pressure gas lift business, the ESP and conventional gas lift, as we said. And the rates of return on those are well north of our cost of capital, okay? Without getting into specifics, without giving away a little bit of what makes us truly unique. We have a really kind of hard and fast 20% to 25% minimum ROCE expectation before we deploy $1 of growth capital. Some of our high-returning opportunities are well into the 40s. So -- you compare that to other oilfield service companies that don't enjoy the contract cover that we do, don't enjoy just the visibility of the free cash flow stream that we do. And I'd say we're sitting in a pretty good spot. So I'd say the vast bulk of our growth capital for this year, and I would expect it to be somewhere in that $80 million to $100 million range for the year is going to be in those 3 key areas with vapor recovery being a #4 as well. So we constantly look at where to deploy capital. We have a vertically integrated manufacturing model. So we make all of our own stuff which is, I think, a competitive advantage. We have about a 6-month lead time if we want to build new kits, if a customer asks today for any kind of additional rental expansion upset, it'd be about 6 months. That compares very favorably to some of our brethren and other sectors of the oil field that are competing for engine availability, for instance, from the likes of Caterpillar and then maybe 3 or 4 years out. right? So with our supply chain, with our vertically integrated model, we can respond much more favorably to customer demand.