Baker Hughes Company

Ladies and gentlemen, and welcome to the Baker Hughes Company fourth quarter and full year 2019 earnings call. At this time, all participants are on a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Judd Bailey, Vice President of Invest Relations. Sir, you may begin.

Thank you. Good morning everyone, and welcome to the Baker Hughes Company fourth quarter and full year 2019 earnings conference call. Here with me are our Chairman and CEO, Lorenzo Simonelli, and our CFO, Brian Morel. The earnings release we issued earlier today can be found on our website at Bakerhughes.com. As a reminder, during the course of this conference call, we will provide forward-looking statements. These statements are not guaranteed to future performance and involve a number of risks and assumptions. Please review our SEC filings and website for a discussion of some of the factors that could cause actual results to differ materially. As you know, reconciliations of operating income and other non-GAP to GAP measures can be found in our earnings release. With that, I will turn the call over to Lorenzo.

Thank you, Judd. Good morning everyone, and thanks for joining us. We delivered a solid fourth quarter with strong orders in our turbo machinery and all-throw equipment segments. Solid operating performance from our TPS business, strong pre-cash flow, and better execution in our digital solutions business. These positives were partially offset by weaker than expected margin performance from our OFS business. For the full year 2019, we achieved a number of key milestones, including 20% -over-year order growth in TPS, almost 300 basis points of margin improvement in TPS, 12% order growth in OFS, and pre-cash flow of $1.2 billion. In addition, we accelerated our separation efforts from GE, launched our new company brand, and positioned ourselves to compete more effectively in a changing marketplace. I cannot thank our employees enough for their hard work and dedication to achieve our goals throughout the year. As we look into 2020, we see a macro environment that is slowly improving, as well as the range of opportunities to further strengthen Baker Hughes on both a near-term and long-term basis. In the near-term, we continue to identify and execute on opportunities to improve our -to-day operations and cash flow efficiency in 2020. Looking out on a longer-term basis, we see a number of attractive growth opportunities for our company, and we remain focused on positioning Baker Hughes for the upcoming energy transition and the digital transformation of the industry. This balance between near-term and long-term objectives can be found in each of the strategic goals that I highlighted on

our last earnings

goal. To remind you, these goals are, one, margin improvement in our oilfield services and oilfield equipment businesses. Two, evolving our portfolio, specifically leveraging some of our unique core competencies to expand our offerings in the industrial and chemical end markets, as well as improving our position for the energy transition. And three, continuing to expand our digital offerings to drive greater efficiency, as well as safer and more reliable operations for our customers, together with our AI partner, C-Free. Over the last several months, we have spoken at length about our first goal of execution and operational improvement, which remains an important focus for Baker Hughes in 2020. However, today I'd like to spend some time providing insight on how we're thinking about our goal of portfolio evolution and positioning for the energy transition. As you know, energy transition is an important topic that has gained a significant amount of momentum in the industry and in the investment community over the last six to 12 months. As we have stated previously, Baker Hughes is firmly committed to playing a leading role in a lower-carbon future. One year ago, we made our own commitment to achieve net zero carbon emissions by 2050, and our corporate strategy remains clearly focused on being the leading energy technology company to help facilitate the energy transition. As we look ahead to the next two decades, there are various published forecasts on the long-term demand outlook for hydrocarbons and the expected growth rate for renewable energy sources. Within these forecasts, there are a wide range of predictions for growth or peak demand for the different types of hydrocarbons in the coming decades. Our view remains that in almost any scenario, natural gas will be the key transition fuel and perhaps even a destination fuel for a lower-carbon future. As a result, we believe that natural gas demand will grow at more than twice the pace of oil over the next 10 years and that LNG demand growth will be higher still at an annual rate of 4 to 5%. Against this backdrop, we believe that Baker Hughes is uniquely positioned to provide technologies and solutions that help our customers lower their carbon footprint. While there is a strong recognition of our world-class LNG franchise, our broad portfolio also offers a wide range of products that help customers lower their carbon footprint today and that are directly tied to the continued growth in renewable energy sources. Some examples of these products are well-known, like our LM9000 aeroderivative gas turbine, which can reduce NOx emissions by 40% and overall CO2-equivalent emissions by up to 25% compared to alternative turbines in its class. However, there are broader system-level uses where our TPS equipment has the opportunity to be deployed in carbon reduction applications. For example, our core technologies in compression have the capability to help deliver carbon capture, utilization, and storage,

and we are

actively marketing these solutions to customers today. In one application, we reconfigured our Nova LT gas turbine generator technology to operate 100% on hydrogen, and we continue to explore opportunities in the hydrogen value chain in both transportation and production. As another example, our turbo-machinery equipment can be used to help deliver mechanical storage of energy for use in peak demand for renewables, enabling customers to store and deliver renewable-sourced energy to the grid efficiently and effectively. In addition, we see three new technology areas emerging as part of the energy transition, for which our digital solutions segment is uniquely positioned. The first is emissions monitoring, where our products such as Lumen and Avitas are directly applicable. Lumen is a suite of methane monitoring and inspection solutions, and Avitas offers smart inspection and monitoring service solutions in both land and aerial applications. The second area is emissions reduction, where our FLIR IQ, FLIR management system, allows downstream operators to reduce flaring emissions by 90%. The third area is condition monitoring for renewables, specifically in wind turbine applications. Our Bentley Nevada business within digital solutions has monitoring devices which ensure the detectability of the most costly and critical drive-frame failure modes. Deployed on more than 32,000 wind turbines globally, a tremendous installed base we have built over the last decade. While these technologies combined represent a small percentage of Baker Hughes' overall revenue today, they are products and services that we believe have a great growth potential and also provide a strong platform for future product introductions and carbon-based initiatives with customers. As we execute on these near-term and long-term strategic initiatives, we are also mindful of the ever-changing macro backdrop across the energy markets. On this note, we generally believe that macro fundamentals have slightly improved over the last few months as dynamics from both the demand and supply side have become more positive. With that said, our incrementally positive view of the macro environment is tempered by growing geopolitical risks, most notably in the Middle East. On the demand side, the outlook for oil and gas has modestly improved with the recent Phase 1 trade deal. This light improvement in PMIs for key economies and continued positive economic data out of the U.S. We believe that these variables should be supportive of a firm oil demand outlook in 2020 and one in which our customers will continue to execute their budget plans and advance important projects. On the supply side, the outlook is also firm with another recent round of OPEC production cuts and more signs of slowing U.S. production growth. Importantly, we believe the continuation of solid demand growth combined with the growing commitment to EMP capital discipline helps support a more constructive macro outlook. Further, we believe the continuation of these trends could begin to reduce excess crude inventory by later this year or into 2021 and support multiple years of growth internationally. Although the macro environment appears to be improving, our overall outlook for our OFS and OPEC segments remain largely unchanged from the framework we outlined on our first quarter earnings call. For our OFS segment, we now believe that North America's DNC spend in 2020 is trending towards a low double-digit decline rate versus 2019. This view is based on early EMP budget announcements and the lower exit rate in the fourth quarter of 2019. We continue to believe that our differentiated OFS portfolio will provide somewhat of a buffer to the challenges in the North American market. Internationally, our expectations remain -single-digit growth, but with a slight bias to the upside driven primarily by an improving pipeline of opportunities. In the OFC segment, our outlook is for the subsea tree markets to remain stable, around 300 trees in 2020. We expect to maintain our position in the subsea market driven by strong execution for customers and continued traction with our subsea connect strategy. For TPS, while we do not expect the exceptionally strong year for LNG FIDs in 2019 to repeat in 2020, our outlook for this segment remains constructive as we execute the largest backlog in the company's history and expect continued growth in services and non-LNG equipment awards. For the LNG portion of our TPS segment, our outlook remains constructive. Despite some softness in near-term spot prices, conversations with our customers have not changed materially. If spot price weakness persists, we would expect this to shift the balance for future FIDs towards more economically-advanced brownfield projects in the 2021-2025 timeframe. We were pleased to see around 90 MTPA of LNG FIDs between the fourth quarter of 2018 and the end of 2019. While just short of the 100 MTPA we thought the industry could FID in this period, we believe that FID activity in 2020 should remain solid and at least in line with the average annual FID levels witnessed in the prior cycle between 2011 and 2015. In our digital solutions segment, we continue to believe global GDP growth is the most relevant metric by which to forecast this business, given the variety of end markets itself. The oil and gas market drives approximately 50% of DS revenue, with 20% coming from the power market and the balance from a number of industries including aerospace, automation, consumer electronics and other industrials. With over 90% of DS revenue coming from hardware and associated software solutions across a range of brands such as Bentley Nevada, Nexus Controls, Druck, Panometrics and Wurzio Stokes, this is a mature, stable business with the best in-class measurement, sensing and inspection technology. In summary, we delivered a solid fourth quarter in full year 2019. We are clearly focused on executing our strategy and generating strong free cash flow, improving margins and driving returns. With that, let me turn the call over to Brian. Thanks,

Lorenzo. I will begin with the total company results and then move into the segment details. Orders for the quarter were $6.9 billion, up 1% year over year and down 11% sequentially. The year over year growth was driven by strong orders and oil field equipment. Sequentially, the decrease was driven by turbo machinery, which booked a very large LNG order in the third quarter. Remaining performance obligation was $22.9 billion, up 3% sequentially. Equipment RPO ended at $8.1 billion, up 10% sequentially, and services RPO ended at $14.8 billion. Our total company book to bill ratio in the quarter was 1.1 and our equipment book to bill in the quarter was 1.2. Revenue for the quarter was $6.3 billion, up 8% sequentially, driven by turbo machinery, digital solutions and oil field equipment offset by oil field services. Year over year, revenue was up 1% driven by OFS and OFE offset by declines in TPS and DS. Operating income for the quarter was $331 million, which is up 11% sequentially and down 13% year over year. Adjusted operating income was $546 million, which excludes $216 million of restructuring, separation and other charges. We incurred $135 million of new restructuring charges in our OFS business during the quarter, as we continue to work through a new phase of cost out and productivity initiatives. These are primarily focused on supply chain optimization, improving asset utilization, and driving down product and service delivery costs. Separation and merger related charges in the quarter were $57 million. Adjusted operating income was up 30% sequentially and up 10% year over year. Our adjusted operating income rate for the quarter was 8.6%, up 140 basis points sequentially and up 70 basis points year over year. Corporate costs were $118 million in the quarter, which is modestly higher than third quarter levels and our initial expectations a few months ago. We expect the corporate line to increase slightly from this level in 2020 as we continue to accelerate our separation efforts. I will go into more detail on these costs in a moment. Depreciation and amortization was $354 million, down sequentially and flat year over year. We expect depreciation and amortization to remain around this level in the first quarter of 2020. Tax expense for the quarter was $212 million, which was higher than expected, driven by the geographic mix of earnings and certain year end provisions. Gap earnings per share were 7 cents, down 3 cents sequentially and down 21 cents year over year. Adjusted earnings per share were 27 cents, up 6 cents sequentially and up 1 cent year over year. Free cash flow in the quarter was $1.1 million, which was above our expectations. We delivered $639 million from working capital driven by strong collections and inventory management in OFS, as well as progress collections in TPS and OSE. Overall, we are very pleased with the cash performance in the fourth quarter, as OFS saw improvements after the shortfall in the third quarter. We continue to see improvement in our working capital processes and are focused on optimizing our cash operations to ensure we deliver on our free cash flow conversion target. When I look at the total year 2019, I am pleased with our financial results, which reflect our consistent execution on the priorities we set out at the beginning of the year. Orders for the full year were up 13% in 2019, driven by 20% order growth in TPS and 12% order growth in OSE. TPS booked to bill was 1.4 in the year and OSE booked to bill was 1.2. Full year revenue was up 4%. Our OFS and OSE businesses were both up 11%, offset by declines in TPS and DS. Despite a challenging macro environment for the broader energy market, we were able to grow total company adjusted operating income margins by 60 basis points. We drove margins higher in three of our four segments with improvements of 270 basis points in TPS, 190 basis points in OSE, and 40 basis points in OFS, offset by a 120 basis point decline in DS. Overall, the results of each of our product companies are in line with the framework we outlined at the beginning of the year. Corporate costs for the year were $433 million. As I mentioned, we expect to incur an additional 50 to 60 million of corporate costs in 2020 related to the ramp up and separation efforts. We have a significant number of transition services agreements in place with GE across a range of functions, including IT, HR, Treasury, and other infrastructure to ensure we maintain the continuity of our business operations. Importantly, we expect these incremental costs to recede in 2021 as we roll off the transition services agreements and utilize our own systems. In conjunction with the separation activities, we are also taking the opportunity to upgrade our systems and fund sets and aging processes and infrastructure to ensure Baker Hughes is best positioned to drive further efficiencies in our operations, which should lead to higher margins. We generated $1.2 billion of free cash flow in 2019. We were very pleased with our cash performance in the year and continue to improve our working capital metrics. We invested $976 million in net capital expenditures in 2019, and we expect to see similar net capex levels in 2020. Included in our 2019 free cash flow results are $307 million of restructuring, separation, and merger related cash outflows. As we have outlined, we expect restructuring related outflows to decline in 2020, offset by an increase in separation related cash outflows. Given the strong level of free cash flow generated in 2019, we ended the year with $3.2 billion of cash on hand and net debt of $3.4 billion after returning $1 billion of cash to shareholders through buybacks and dividends. We continue to see our balance sheet as a key strength and differentiator in this cyclical industry. Now I will walk you through the segment results in more detail and give you our thoughts on the outlook going forward. In oilfield services, the team continues to navigate a challenging environment in North America while driving strong growth internationally. OSS revenue in the quarter was $3.3 billion, which was down 2% sequentially. North American revenue was down 11% sequentially, driven by declining rig count and weaker completions in U.S. land, as well as a double digit sequential decline in our Gulf of Mexico operations. International revenue was up 4% sequentially, driven by continued growth in the Middle East, Asia Pacific, and Latin America. Operating income in the quarter was $235 million, down 14% sequentially, and margins declined 110 basis points. OFS margins were below our expectations, primarily due to weaker North American results and lower product sales than originally planned. Despite coming in slightly below our expectations, we believe the margin headwinds in the fourth quarter are largely transitory and our expectations for 2020 are unchanged. As we look at 2020 for our OFS segment, we expect international spending to increase in the -single-digit range, with most of the growth coming from a number of offshore markets and regional strength in the Middle East, North Sea, and parts of Latin America. Given our focus on execution and improving margins, I would expect our international OFS business to generally track in line with industry trends. In North America, we expect U.S. DNC spend to decline low double digits versus 2019, as domestic EMPs continue to restrain spending to generate more free cash flow. Similar to 2019, we would expect revenue for our North American OFS business to outperform industry spending trends given our production-weighted mix. For margins, we expect to deliver -over-year growth driven primarily by our cost-out and productivity enhancement actions. I will also reiterate that over time, our goal remains to close the margin gap with peers. As we look ahead to the first quarter, we expect North America to get off to a relatively slow start and expect typical seasonal trends in key eastern hemisphere markets like the North Sea and Russia. As a result, we expect total OFS revenue to experience a modest sequential decline and for margins to decline slightly but still remain well above year-ago margin levels. Next, I will cover oil-filled equipment. Orders in the quarter were $1.1 billion, up 6% -over-year, driven by growth in both equipment and service orders. Equipment booked to bill in OFE was 1.7. We booked several key awards in the quarter, totaling 22 trees, which brings our 2019 total to 73 trees. With this level of awards, we maintained a similar position in the market as in 2018. Revenue was $765 million, up 5% -over-year. This increase was primarily driven by better subsea services activity and subsea production systems volumes, partially offset by lower revenues and flexibles. Operating income was $16 million, up 28% -over-year, driven by increased volume and SPS. Operating margins were up 20 basis points sequentially and up 40 basis points -over-year. As we look at our OFE segment in 2020, we believe that offshore market fundamentals should support another solid year of orders with subsea tree awards expected to remain relatively consistent with 2019. For 2020, we believe that OFE should see revenue growth in the high single-digit range following two years of strong orders growth. We expect volume growth and SPS and improving mix from flexibles to drive solid margin improvement in OFE in 2020. For the first quarter, we expect the trend of -over-year revenue growth to continue as we execute on the positive momentum from our SPS and flexibles product lines. Based on our anticipated project conversion schedule, we expect OFE revenues to increase in the mid single-digit range on a -over-year basis along with modest margin improvement. Moving to turbo machinery. Orders in the quarter were $1.9 billion, down 10% -over-year. Equipment orders were down 16% -over-year and equipment booked to bill was 1.5. During the quarter, we booked an award for the liquefaction equipment on Tatal's Mozambique Area 1 LNG project and we had some important wins in onshore, offshore production, including two SPSO awards in Latin America. Service orders in the quarter were down 4% -over-year, mainly driven by lower contractual services offset by higher transactional services and upgrades. Revenue for the quarter was $1.6 billion, down 8% versus the prior year. For the quarter, services revenue was down 2% versus the prior year and equipment revenue was down 18%, driven primarily by business dispositions. Operating income for TPS was $305 million, up 19% -over-year, driven by higher services mix and cost productivity. Operating margin was 18.7%, up 430 basis points -over-year and up 520 basis points sequentially. Overall, TPS results for the quarter came in slightly above our expectations with a much stronger margin rate offsetting revenue that was below our expectations. While the supply chain issues that impacted the third quarter lingered into the fourth quarter, the primary driver behind the -than-expected revenue was slower conversion of our equipment backlog than we anticipated. Rod and the team have done a very good job of managing cost and execution as they work to deliver on the largest LNG equipment backlog in TPS's history. The 2020 outlook we provided for TPS last quarter remains largely similar. Given the consecutive years of strong order growth in 2018 and 2019, we expect -over-year revenue growth of roughly 20% and for margins to continue to expand. I would note, however, that our current expectation for revenue conversion is weighted more towards the second half of the year based on project timing. For orders, we still believe that TPS could be flat to down low double digits compared to 2019 levels. As you know, timing on large projects can vary, which drives a wide range of scenarios. As we think about the first quarter, we expect TPS revenues to be roughly flat with first quarter 2019 levels given the equipment conversion schedules that I previously mentioned. On the margin front, we expect to show solid improvement on a -over-year basis. Finally, on digital solutions, orders for the quarter were $645 million, down 4% -over-year. In the past quarter, growth in our controls and inspection businesses was partially offset by declines in measurement and sensing and pipeline and process solutions. Regionally, we saw strong orders growth in Asia and the Middle East offset by declines in the other regions. Revenue for the quarter was $659 million, down 5% -over-year, primarily due to the sale of the digital APM product line. Excluding the impact of this disposition, revenue was down slightly with growth in Bentley, Nevada, inspection and measurement and sensing offset by declines in controls and pipeline and process solutions. Operating income for the quarter was $109 million, down 5% -over-year, driven by lower volume. Despite the decline in -over-year revenue, we deliver on productivity and cost out to hold the margin rate flat versus the fourth quarter of 2018. Looking ahead to the full year 2020 for DS, we continue to expect revenue growth in the low single digits and modestly higher margins. This outlook takes into account a GDP-plus growth rate, but anticipates that DS is likely to see some continued softness in the power business. Revenue growth will also be impacted as we pivot our software strategy with the sale of the digital APM offering and work closely with our AI partner, C3, on new opportunities. For the first quarter, we expect revenue to decline in the mid-single digits -over-year and for margins to decline modestly due to the non-repeat of a large project in the first quarter of 2019. In closing, we delivered a strong fourth quarter, finishing out a solid 2019 for Baker Hughes. As we look forward to 2020, we are clearly focused on executing our strategy and generating strong free cash flow, improving margins, and driving returns. With that, I will turn the call back over to Judd.

Thank you. Operator, let's open the call for questions.

Thank you. If you have a question at this time, please press the star then the 1 key on your touchtone telephone. If your question has been answered and you wish to move yourself from the queue, please press the pound key. We ask that you please limit yourself to one question and one related follow-up. Our first question comes from James West with Evercore ISI.

Hey, good morning, gentlemen. Hi, James. Lorenzo, you guys are clearly leaders in the energy transition here. I wanted to maybe talk a little bit high level about the various buckets you're attacking this. Clearly, natural gas is a big part of this strategy and you have some leading products there. You also have your own internal ESG plans and goals, many of which you've been highlighting over the last year. But then you also have products and services that hit all parts of the carbon chain, whether that's monitoring and then carbon capture. How do you think about, if I bucket those into those three, if that's the way you think about it, if not, please let me know. How do you think about which ones do you want to allocate more capital to, less capital to? Which are the bigger growth drivers, maybe in the intermediate term, for Baker? And I guess what is your overall strategy?

Yeah, thanks. And as you know, the energy transition and the theme of energy transition has gained a lot of attention over the course of the last 12 months. A year ago, you'll recall that we actually made our commitment relative to reducing our own carbon footprint 50% by 2030 and achieving that zero by 2050. And as you look at Baker Hughes, we're really playing a critical role in the energy transition across a number of areas given our broad portfolio. And I highlighted some of those in script that was prepared. But if you look at some of the key areas, the first I'd say is as you look at natural gas and you look at LNG, clearly through the energy transition and reducing the amount of CO2, there's going to be an increasing use of natural gas as a transition but also destination target. And we see that LNG is going to continue to grow over the next few decades, even as renewables grows as well. And that's a key focus for us with the introduction that we've made of the LN9000, also our first application of the new LC, which is hydrogen-based. So clearly a shift towards on the protecting equipment side helping in the energy transition. Beyond that, as you look at also the digital solutions platform, clearly with what we have is Lumen and also Avid has these are solutions that enable our customers to monitor and also understand how they can reduce their carbon footprint. So you look at our broad portfolio, we're uniquely positioned and that's why we say from a standpoint of moving energy forward and also being an energy technology company, we're going to be helping our customers and partners through this energy transition.

Yeah, you know, James, if you look at how we're allocating capital, clearly we're continuing to invest in TPS, which is having an impact today. We've got lots of opportunities in adjacencies in TPS where we can put a little bit of capital to work either through technology development or some partnerships and can grow out for print there. And then digital solutions, you know, it's a high margin business. It gets good returns. We'll continue to invest out in there. So I think you'll see us balance the capital allocation in the short term and in the long term as we continue to pivot the portfolio as part of energy transition. So we'll update you if there are any changes to that, but I think we've got a pretty good approach right now to drive short term growth and margins as well as position the portfolio for the long term.

Yes, I totally agree. And maybe a follow up on the LNG pricing issue. Short term pricing weakness has impacted, you know, perception of the LNG liquefaction build out story. But it seems to me that two things. One, it hasn't really changed the conversations on the better capitalized projects. And number two, lower prices now probably lead to even better demand in the future for LNG. Are those fair statements that I'm making? And do you agree that, you know, it's not going to cause any real weakness in the kind of build out cycle beyond the, I know we won't see the same records here we saw last year, but we're pretty much full steam ahead.

Yes, James, you're looking at it the right way. If you look at recent LNG spot price weakness, it doesn't change the overall long term LNG demand and supply dynamics. So in fact, the conversations we're having with our customers are really towards the continued demand for LNG over the long term. And if you take a step back, you know, you look at where we're going to be by 2030, it's going to be between 550 to 600 million tons of demand. And to produce that, you're going to need 700 million tons of installed capacity. So even with where we are today with, you know, the construction of 60 MTPA and also the 90 that was FID'd last year, you've still got another 130 to 150 that's got to go in the next coming year. So, you know, we feel good about the LNG space and we feel good about the long term aspect of it.

Thank you. Our next question comes from Angie Sedita with Goldman Sachs.

Good morning, guys. Hi, Angie. Hi, Angie. Hi. So I appreciate the details, Brian, on the revenue side when we think about 2020 and Q1, but if we could drill down a little bit on the margin side, thoughts around oil field service margins in 2020. You know, you're not where you really want to be, but how much self-help do you think you could have going into the year for 2020? And when do you think we could start to see some parity versus repairs?

Angie, you know, look, we did see margins below where we wanted them to be in the fourth quarter. And there wasn't really one thing that I can point to that says, well, the main drivers, there were a couple of things going on that, you know, impacted the margin. I'd say first is we saw slightly lower than anticipated activity in the U.S. land market for us, which we think was really largely customer and basin specific. We also saw, as we, you know, went into the end of the year, some weakness in our Gulf of Mexico operations, which obviously carries, you know, higher margin rates for obvious reasons there. And then lastly, I'd say our product sales were lower than the anticipated. We knew they were going to be lower because, if you remember, we had a very strong third quarter as we accelerated some of those product deliveries to meet customer demand. And we did have some of those slip out of the quarter. So those three things combined, split pressure on the margin rate versus what we expected. But, you know, based on what I'm seeing today, they're largely transitory in nature, and I don't see them impacting us as we roll into 2020. And if I look at, you know, 2020, we expect a large portion of that margin improvement to, as you say, be self-help with cost out and productivity initiatives that we're driving. And you saw we posted some restructuring reserves in the quarter, and we have very specific programs in supply chain and service delivery across Maria Claudia's portfolio to help drive the margin rate improvement. And I'd say that, you know, the other thing that supports margin rate improvement in 2020 is we're really getting to the maturation phase of some of the larger integrated contracts internationally, where we saw some ramp up costs this year. And we've come up to learning curves. So I can see strong margin improvement in those contracts. So that should certainly help the overall margin rate. And if I look at the overall cost out and productivity initiatives, they're really in two buckets, Angie. One is around efficiency and operations optimization, and the other is around product cost. So for instance, around product cost, we've been working for quite some time with the engineering and product teams to identify specific areas where we can go in and drive cost out. Some of that is target costing. Some of it's looking at a broader supply base. And some of it's looking at overheads to see how we can leverage overheads globally more efficiently. On the efficiency and productivity side, we're looking at a lot of opportunities to cross-train individuals to make sure you don't have to send multiple people who are going to have idle time when they're out on a rig. And it's taken us some time to really get through those details and understand how to attack that. But with what we put up in restructuring in the quarter, the plans we have in place, we feel good about our ability to continue to grow margins in 2020 in OFS. So our framework is really unchanged. And Maria Cloudy and the team, as well as the whole enterprise, are focused on getting those margin rates up.

Thanks. That's very helpful, Brian. I appreciate that. So maybe we can do the same thing around TPS, given the strong backlog you already had in hand, thoughts around margins for 2020. I think you said in the past, maybe low to mid-teens. Is that still a fair assumption? And do you think ultimately that the high teens is where you would consider your run rates?

Yeah. I'm very pleased with how Rod and the team have closed out the year and are managing, you know, customer expectations with this incredibly large backlog and balancing, you know, costs and returns as they go through this. So pleased with where they are today. You know, look, our outlook for 2020 margins begins largely unchanged from what we talked about in the last call. And just to, you know, remind you, there are a few dynamics that come into play that really impact how much margin accretion we'll have in the year. First, you know, we expect contractual services and transactional services to grow in 2020, which is accretive to margins. You mentioned, you know, the large backlog, the largest, you know, in our history, we will see more LNG equipment revenue come through in 2020. While that is accretive to overall equipment margin, it does have a negative mix effect, as we talked about, for the total business. And then we are in the early stages of executing on the, you know, two very large LNG projects, Arctic II and VG, which tend to have, you know, their lowest margin point at the beginning of execution and you start to see that accrete over time. So that will have an impact there. And then, you know, we've talked a bit about the technology spend in TPS and we said we were evaluating that. And back actually to James' earlier question, we see a lot of opportunity and energy transition to continue to grow this franchise. And strengthen this position in the marketplace. So I'd expect technology spend to be roughly where it is this year. So if you add all that up, you know, I take it the more revenue we have, the faster it grows, it impacts the magnitude, you know, of the upside in margins. And you saw that come through in the dynamic third and fourth quarter and how strong the service was versus the equipment. But overall goal is to continue to drive margin enhancement in the business. And over time, you know, we do see mid to high teams as revenue normalizes and the portfolio and services continue to grow. And, you know, with the large equipment backlog we have now, especially in LNG, you'll start to see that services back on grow over time as we sign customers up for long-term service agreements. So, you know, largely unchanged tailwinds in the business. And I think Rod and the team are doing a great job managing through that.

Thank you. Our next question comes from Jason O'Reilly with Bank of America Merrill Lynch.

Hey, good morning. I guess I wanted to come back to, you know, the TPS service, you know, commentary. You know, earlier you talked about the largest LNG backlog in the history. I mean, you kind of touched on some of the digital things that you're doing. Could you talk a little bit about, you know, the opportunities that you have on the LNG service side with this significant backlog and then, you know, what digital ultimately means for the TPS or the LNG service business and potentially maybe, you know, some shift over to the contractual side of the services business?

Yes, Chase. Look, I, you know, very happy with how the services business is performing in TPS. And on a reported basis for the year, the service revenue was slattish, slightly down. You take into account some of the dispositions that we had as well as the impact of FX for the total year revenue actually was up mid-single digits operationally. So performing pretty much in line with how you would expect this portfolio to perform. And, you know, this year it represented about 60% of TPS's revenue and obviously change over time as the equipment starts to convert. And as you pointed out, contractual services is a big piece of that as are transactional services. And that contractual services backlog is about $13 billion today and we expect that to continue to grow. And just to round out services, we do have installations and upgrades included there as well as some services on pumps and bows. But the large majority are contractual services. If I take a look at the transactional piece, we had growth in 2019 in mid-single digits. I would expect that to continue into 2020. And from a digital standpoint, lots of opportunities in the services portfolio. One, internally, to help us operate better and use our partnership with C3. We've got tons of data on this equipment and how we operate in the field. We think that C3 can help us unlock even more internal productivity as we execute on these service contracts and provide transactional services and upgrades. And in addition, there are opportunities to introduce some of this into these contractual services to help the customer's equipment perform better. And then there's lots of things we can do with the data that we have from things that aren't on contractual services and put together offerings for customers to help drive better productivity and better uptime for the equipment. So I think it's an untapped opportunity right now. We're not counting on a lot of that as we roll into 2020. We'll be working a lot with C3 and our teams. And I would expect to see some of those digital things kick in in the outer years to have a meaningful impact on revenue.

Okay,

so a quick

taste just maybe to add. If you look at on the digital side and the C3 partnership, we've actually launched already two solutions into the marketplace, one around reliability, which really targets the uptime for the equipment and that can be applied to the service agreements and drives efficiency and productivity, and then also optimization. And so really if we look at the next few years, digital is a key area of focus and it's going to drive a lot of efficiencies.

Got it. Understood. Thank you. One real quick follow-up. Obviously, you've got the GE offering overhanging out there still. Could you talk to how much Baker Hughes would look to repurchase alongside an offering? Should we think of it kind of free cash flow after dividend for 2020? Or would you actually add a little bit of leverage to take down a little bit more stock?

Yeah, Chase. You know, I'd say that, look, our overall capital allocation and corporate finance policy really hasn't changed from what we talked about in terms of commitments to turn 40 to 50 percent of net to shareholders through dividends and buyback. And I think, you know, as you and I have talked before, you know, we will certainly evaluate any potential offerings by GE and put that into our thinking as we, you know, allocate capital over the course of the year. So no real change there in terms of how we think about it. And you should assume that we're certainly taking that into account as we look at our free cash flow and all of our metrics for the year.

Thank you. Our next question comes from David Anderson with Barclays.

Hi. Good morning. I was hoping to dig into a little bit on your chemicals business here, which is getting some more attention lately with your biggest competitor changing hands. I was wondering if you could just talk about the business makes and what you see as the primary growth drivers the next several years in terms of offshore, onshore, now and downstream, which is not really a market we hear much about. You highlighted a big contract with Valero today. Could you just kind of talk about that business and how you see that developing?

Yeah, Dave, if you look at our chemical franchise, and again we've mentioned it before that we think it's a great area that we've been in on the upstream side and actually got a good footprint in North America. And we've actually allocated capital to increase our presence internationally. If you look at our expansion in a Singapore facility as well as in the Kingdom of Saudi Arabia. And I think actually the M&A activity you just mentioned validates a lot of the approach that we've had. You've got an increasing usage of chemicals when you look at enhanced oil recovery. You've also got an opportunity on the downstream side, as you mentioned, which we've got an opportunity to grow in. And when you look at the specialty chemicals that we provide and its application, it's increasing across both the upstream and downstream. So we feel good about the strategy and what it implies and also the growth trajectory for this chemicals business at the time.

Yeah, and Dave, if I

look

at where we are today, we're predominantly North America. We do have an international presence, but with the investments we're making in Singapore and Saudi to shift capacity, we see more growth coming for us internationally. And today we're mostly upstream. We do have some downstream and I think there's a lot of growth opportunities for us

in

downstream as well. And the other thing I point out about the investments that we're making, the Singapore investment is really going to reduce our cost base. Better manufacturing, better supply chain costs, better logistics costs. And then what we're doing in Saudi is really sized for the region to allow us to be very responsive to a lot of very large customers in that region. So again, we like this space. We're putting capital to work there and we would expect to see growth and margin accretion in chemicals.

Yeah, I was going to say presumably this is rather accretive for your OFS business, I would assume, correct?

Yeah, we like this business, yes.

Okay. And maybe just on a different subject, I just want to ask you about kind of your OFS business mix in North America and just kind of how do you feel about kind of where you are, whether or not you're satisfied out there? There's been some reports out there that potentially you may be looking to exit the left-hand rod-lift business. I would have thought that would be kind of part of your longer-term strategy. You talked about more of the production side, but maybe this is more capital intensive than you'd like. I was just wondering maybe if you could comment on that and perhaps more broadly on your North American mix in terms of where you want to be.

Yeah, Dave, I say we talked about the portfolio before. And I basically said that we want to focus the company in areas that are highly differentiated with less fragmentation that allow us to generate higher returns. And look, as we look at the energy transition and how we expect that to unfold, if there are areas that don't meet that criteria, we would potentially look to generate cash by not having those in the portfolio and redeploying that cash in the areas where we can get higher returns over the short-term end and are a better fit long-term within portfolio. So I'd say look, the North American market has changed quite a bit over the last few years. And there are some areas where we think the technology or the fragmentation are going to make it harder to get returns that justify them being inside the portfolio. We'll continue to look at that. But nothing right now that I need to update you on in terms of things that are changing. And as we have news, we'll certainly let you know. But we'll just understand we are focused on reference here and where we deploy those incremental capital dollars. And I think the market has changed quite a bit. And we're relooking some things.

Thank you. Your next question comes from Sean Neeson with JPMorgan. Hey,

good

morning.

Hey, Sean.

So good free cash in the quarter, typical seasonality and maybe some catch-up from 3Q and LFS like you mentioned. Of the $600 million working capital benefit, how much would you attribute to just typical seasonal collections versus progress payments on some of the new projects coming in? I'm just thinking maybe with perhaps the peak order cycle in 19, we'll see. Can we just talk about how the cash flow profile looks over the course of a typical TPS project and how that should influence expectations for free cash in 20 and 21 as you start to convert these projects?

Yes, I would say we did have typical seasonality. And I think the majority of what we saw in the quarter was related to that typical seasonality. As we talked about on the third quarter call, OSS came in below expectations. And they really turned the corner here in the fourth quarter by making up on some of that. And it was really driven by strong collections process overall. And that's all the way from billing on time, following up, getting the collections in. And then the team did a really good job of managing inventory inputs as we had been making a lot of process changes over the course of the year. And that came through. We did have some benefits from progress collections in TPS and OSC. But I think you have to look at it in totality. It's a small piece. But progress is only one piece of the equation because at the same time you're getting down payments or you're getting progress collections as you're executing a project, you're also bringing in inventory as well. So it's not a -for-one fall through in terms of free cash flow. You have to look at more accounts on the balance sheet. And in TPS typically, you start out with a down payment. We have long-needed items that you bring into the project. And then based on certain milestones, you build a customer and you collect. So one of the first things I look at in any TPS project is the cash curve to see what our cash position looks like in that. And our goal is to have them be favorable from a cash flow standpoint. So you will see adds and flows and progress collections over the lifecycle of a project and receivables and inventory. But I would say it was a small impact in the fourth quarter. As I go into 2020 and look at how I think it will play out, we should see, you know, a smaller impact from progress payments than we saw in 2019. But do believe that the improvements we've been driving in working capital processes across the franchise, not just in OSS, should help offset that. The other thing I would say is we expect net cap X to be roughly flat from a dollar standpoint. But down is the percentage of sales is obviously using more growth in TPS and OSC. And in the roundout, free cash flow and total, Sean, you know, we do expect restructuring cash outlay to be down significantly. But the separation cash outlay will offset that. So net, you know, see good dynamics as we roll into 2020 for free cash flow strength.

Got it. Thank you for that, Brian. So maybe just come back to margin progression in TPS. So you've got strong revenue growth this year. You topped up your guidance today versus last quarter. I think that makes sense. We have somewhat limited historicals from last cycle. So there's not much of a track record in terms of incremental margins. And I think earlier on the call, you talked about at a high level the impact between fixed cost absorption versus services versus equipment mix. Just as we roll all that together in terms of the flow through to year over year incremental margins, how do you think about that on a normalized basis?

Yeah, look, you know, Sean, as I said, it really depends on how quickly revenue grows on the equipment side as to what the absolute margin percentage increase will be. But, you know, under all the scenarios that I see today, we do see some margin accretion in TPS. I will note that based on the customer requested delivery schedules and the way the projects are executed, we do see the second half being much heavier from an equipment standpoint and an overall revenue standpoint. So, you know, we expect the second half to be much larger from a revenue standpoint. And that obviously has an impact on the fixed cost absorption as you look at more revenue in the first half. So, look, we'll continue to update you throughout the year if that changes. But right now, that's how I see things playing out.

Thank you. Our next question comes from Bill Herbert with Simmons.

Thanks. Good morning. So back to cash flow and free cash flow, Brian, just very quickly. One, do you expect working capital to be a cash generator or cash consumer in 2020? And secondly, remind us what your free cash flow conversion targeted. I think it's like 90% of net income. And if that's the case, it seems like you're going to crush that again. So could you update us on both of those, please? Thank you.

Okay, Bill. Yeah, so if I look at the free cash flow conversion target, it is 90% of net income over time. And again, you're going to have some years based on the project business and how we're driving working capital where you can see that and some years where it could be below that based on the business. So 90% is the through the cycle goal. And if I look at overall working capital with the dynamics we talked about earlier, the strong progress in 2019, again, not quite as strong in 2020, but we'll have some offsets with the other working capital processes that we're driving. I mean, you could see a year where working capital is a slight usage based on those dynamics and the growth that we have in the portfolio. But you should expect our working capital metrics to continue to improve.

Thank you. Our next question comes from Scott Gruber with Citigroup.

Thanks, good morning. Thanks, Scott. Just a couple of detailed ones here. What is the profitability split between the North American OFS business and international business in 4Q? And is that spread pretty similar to what you're looking for in 1Q? And then it sounds like you believe that the golf activity slump, which in fact is 4Q, is transitory. Does that snap back in 1Q? Is that in your guide or is that more of a 2Q event?

Yeah, Scott, we do see some improvement in 1Q and the golf. I don't know that I call it a snap back, but we do see improvement there. And obviously that has a positive impact on margin rate, as I said, for obvious reasons. So, you know, the track votes were down in 4Q, which is a big driver of that. And we do expect that to come back. As far as the profitability, you know, look, we don't disclose profitability by region there. But I would say from a dynamic standpoint, we continue to expect to see the softness in North America and feel pretty good about the growth opportunities that we're seeing in international. And the thing that I would remind you of that I think I mentioned when I talked to Angie is that a lot of these large integrated projects were up the learning curve there. And we should see margin accretion in 2020 as we execute on those projects. And a lot of those startup costs, as well as just getting another field cost, you know, have abated. So feel pretty good about the margin progression internationally and the growth backdrop there.

Got it. And then just going back to the chemicals business, it sounds like the growth investments there will be beneficial to your overall FS mix and return profile. Are you able to provide any color on the magnitude of the new plants relative to the size of your current chemicals business, just trying to think about the impact of those, the petrolyte as they come on? And when do they come on in the years ahead?

Yeah, and look, from a timing perspective, again, it's these plants are in construction. So you won't see anything in 2020. They'll start going into a commissioning phase and more in 2021. As we mentioned, we see international growth opportunities. So stay tuned. We'll give more updates as we start completing the plants.

Yeah, and again, I just reiterate here, it's not all going to be incremental capacity. We are shifting capacity here. And again, the Singapore facility is going to be very cost advantage. So in addition to growing internationally, we'll have the benefits of higher margin rates for a product that's coming out of Singapore. And look, as we get closer to commissioning and things firm up, we'll give you guys some insight into how we're thinking about that. But spending a lot of time there. And again, like I said, we like this business and like the capital we're putting to work there.

Well, ladies and gentlemen, this does conclude today's Q&A portion of the conference. I'd like to turn the call back over to our host for any closing remarks.

Just thanks again for joining us. We closed out a strong 2019. You saw the four quarter results and we feel the MIPRA environment is improving as we look at 2020 and feel good about our outlook. Thanks.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.