Baker Hughes Company

Good day, ladies and gentlemen, and welcome to the Baker Hughes Company third quarter 2020 earnings call. At this time, all participants are in the listening mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone requires assistance during the conference, please press star then zero and your touchstone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Doug Ehrle, Vice President of Investor Relations. So you may begin.

Thank you. Good morning, everyone, and welcome to the Baker Hughes third quarter 2020 earnings conference call. Here with me are our chairman and CEO, Lorenzo Simonelli, and our CFO, Brian Worrell. 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 guarantees of 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 gap to non-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 are pleased with our third quarter results as we successfully managed the company through the immediate impact of both the pandemic and the industry downturn. while also accelerating our long-term strategy. From an operational perspective, I am pleased with continued solid execution on cost out from our OFS and OFE teams, as well as the commercial success and performance demonstrated by TPS and DS. We also saw continued free cash flow generation during the quarter and expect to be free cash flow positive for the year. As we move forward, we continue to be intensely focused on improving the margin and return profile of Baker Hughes, despite the near-term macro volatility, while at the same time executing on the long-term strategy to evolve our portfolio along the energy landscape. After significant turmoil during the first half of the year, oil markets have somewhat stabilized. However, there is still quite a bit of uncertainty expected over the next several quarters as as demand recovery is becoming to level off and significant excess capacity remains. The outlook for natural gas is slightly more optimistic, as forward prices have improved with strong demand in Asia and lower expected future gas production in the US. On the economic front, the global economy has rebounded from the severe contraction experienced in the second quarter. However, the recovery so far has proven to be quite uneven, and the risk of a second wave impacting economic demand remains relatively high. While some industrial sectors have experienced a rebound in activity, others have remained somewhat suppressed. The current environment has also resulted in the acceleration of different parts of the economy, including technology adoption and the acceptance of new ways of working and living. Importantly, one of these areas where we have been witnessing a step change in activity and mindset as the broader energy industry. The COVID-19 pandemic has revealed the speed at which the environment can respond to lower carbon levels. This has accelerated the debate on how to fuel economic growth while transitioning to a lower carbon future. We have not only seen this acceleration in government response to the pandemic, but we're also seeing it in society at large and increasingly from our customers. As we have recently highlighted, Baker Hughes remains committed to being a leader in the energy transition and becoming a key enabler to decarbonizing oil and gas and other industries from within. We also believe that the changes rapidly unfolding across the oil and gas landscape warrant an acceleration of this strategy. We have developed a free-form approach to accelerate our transition to an energy technology company. The first of these strategic pillars is to transform the core. This targets multiple work streams that are focused on improving our margin and return profile through a combination of structural cost reductions, portfolio rationalization, and the use of digital technology. On the cost side, we continue to execute the rigorous cost reduction program we outlined in April, targeting $700 million in annualized savings by year end. Through the third quarter, we have achieved approximately 75% of our target and believe that we will likely achieve a higher run rate by the end of the year. On the portfolio front, we have already divested of several businesses this year and will continue to evaluate further actions, specifically around businesses that likely don't have the potential to meet our return requirements. This process could lead to further divestments, alternative business structures like joint ventures or partnerships, or the exit of some product lines in select regions. In any scenario, We are taking a holistic view across Baker Hughes and will take decisive action to improve margins, while also maintaining business continuity and delivering for our customers. The other major component of our Transform the Core initiative will be the expanding use of digital technology and remote operations. We view the expansion of remote operations in OSS and TPS as key enablers to drive better cost and margin productivity. The second of our strategic pillars is to invest for growth. Given the subdued upstream outlook, the primary growth opportunities we see within our existing product and service footprint are the broader industrial sector, specialty chemicals, and nonmetallic materials. On the industrial side, we see the opportunity to develop a solid industrial platform by leveraging the strongest core competencies within our TPS and digital solution segments. Our efforts will be focused on delivering energy efficiency and process solutions, targeting adjacent non-energy industrial sectors. In addition to industrials, we remain focused on driving growth in the non-metallic and chemical sectors. Due to the lower carbon footprint associated with non-metallics, we believe this segment provides significant opportunity for expansion, as well as synergies with our upstream and chemicals businesses. In chemicals, we see the opportunities to grow internationally in the downstream segment and potentially into other adjacent specialty chemical markets to complement our current capability. The first pillar of our strategy is focused on positioning for new frontiers. As the energy landscape continues to evolve, we have spent considerable time evaluating key growth areas associated with the energy transition. and analyze where Baker Hughes can capitalize on these opportunities. Overall, we see a range of options for our technology with the greatest near-term potential in carbon capture, hydrogen, and energy storage. Although it is still very early in the evolution of these three markets, we believe that Baker Hughes can play a key role in the future development of these areas with the technology we have in-house. In fact, we are in active conversation today with multiple stakeholders in all three of these areas, primarily focused on how our compression and turbine technology can play a role in future projects. As we execute on these three strategic pillars and our broader evolution as an energy technology company, we are committed to operating in a disciplined manner that prioritizes free cash flow, returns above our cost of capital, paying our dividend, and maintaining our investment grade rating. Now I'll give you an update on each of our segments. The persistent weakness in oil prices continues to create a challenging environment for oilfield services. In the international markets, the decline in the first quarter activity was in line with our expectations as COVID impacted regions remained depressed and activity in the Middle East and other areas continued to decline. For the full year, we expect international drilling and completion activity the decline closer to the high end of the 15% to 20% range that we outlined on our last earnings call. As we look into 2021, we expect activity to stabilize early next year and see the opportunity for recovery in some markets over the second half of the year. However, we believe that any potential second half recovery in 2021 will require higher oil prices and that most of the activity increases are likely to come from low-cost basins. In North America, completion activity rebounded strongly during the third quarter, while drilling activity stabilized in August and September. A key driver helping to support our North American OFS results during the quarter was a recovery in our production-driven businesses, particularly in our artificial lift product line. Looking ahead, EMP customers in North America are increasingly signaling their commitment to capital discipline and a maintenance mode for spending that will allow for minimal or modest production growth. While this shift to maintenance mode likely implies an increase in activity from current levels, we believe that it suggests an uncertain outlook over a longer time period. While the outlook for OFS remains challenging into 2021, we are closely engaged with our customers to help find solutions and remain committed to structurally reducing our cost base and finding ways to improve the margin profile for this business. Although our company strategy involves pivoting the portfolio and leading the energy transition, the OFS business remains core to our company as we believe that oil and gas will still play a leading role in the energy landscape for the foreseeable future. Moving on to TPS. This segment, as you know, is a multifaceted business with a leading position in LNG, a robust aftermarket services franchise, and an improving valves business. It also has attractive growth potential in industrial and new energy applications. TPS has remained resilient in a challenging market environment. The most significant development for TPS in the quarter was the award for the main refrigerant compressors for four megatrains at Qatar Petroleum's Northfield East LNG project, executed by Qatar Gas. The order reinforces over two decades of trust in successful turbo machinery collaboration between Baker Hughes, Qatar Petroleum, and Qatar Gas. With six LNG megatrains driven by Baker Hughes technology already in operation, the NFE award underscores the strength of our offerings for the world's most complex LNG projects. Taking a broader view of the LNG market, our long-term outlook for LNG demand growth remains intact. We continue to view natural gas as a transition and destination fuel for a lower carbon future, supported by a few key drivers. First, the phasing out of coal should support natural gas demand in the power generation space. With coal still accounting for nearly 30% of global energy supply, natural gas has ample opportunity to displace coal in both developed and developing markets over the coming decades. China's recent pledge to be carbon neutral by 2060 implies continued growth in gas consumption And India is also expected to see almost a doubling in natural gas demand over the next 15 years. Second, we also believe that LNG and gas more broadly is well placed to support renewables growth. It can provide cleaner, flexible, reliable, and competitively priced power for peak load management and grid stabilization. Third, we see the capacity to further reduce the carbon footprint of existing and future LNG operations through the use of new technologies. We have been a pioneer from the early days of LNG and a clear leader in LNG development for almost 30 years, introducing new technologies to enable more efficient production and operations. For example, CTS continues to partner with customers to reduce their carbon footprint across our installed base of over 5,000 gas turbines and 8,000 compressors. So far in 2020, we have booked upgrade orders that will result in a reduction in excess of 160,000 tons of CO2 per year. We are also having productive discussions with customers regarding the use of carbon capture technology and hydrogen for various projects. Carbon capture technology can be added to liquefaction trains through upgrading existing equipment or new installations, which can meaningfully reduce carbon emissions. For hydrogen, we are seeing increased applications for hydrogen blend turbine for mechanical drive in LNG. At Baker Hughes, we have turbines running on 100% hydrogen as well as blended hydrogen in several power generation applications across our fleet. We believe that hydrogen blend applications will grow as LNG operators seek to reduce the carbon footprint of their projects and as the hydrogen infrastructure becomes more efficient around the world. Importantly, As customers weigh the economics of future projects with the demands for a lower carbon footprint, we have a technology portfolio in place that can help execute their plans and satisfy all stakeholders. Next, in digital solutions, while broader industrial activity trends are improving, we see continued weakness in the oil and gas and aerospace markets. Despite these challenges, our team is executing well, taking decisive cost actions. Our strategy for DS is focused on driving continued expansion across the oil and gas and industrial end markets and building on our condition monitoring and other leading technologies to deliver outcome-based solutions for a range of industries. An example of where we'd like to see our DS business in this environment is reflected in an important contract we won this quarter with Petrobras to deliver innovative solutions and safer operations in plants across Brazil. The three-year frame agreement combines digital solutions hardware and edge devices with our leading software offerings to provide holistic, outcome-based solutions to the customer. DS will deliver to Bed4Us a wide set of hardware technologies from our Bentley Nevada, Nexus controls, and Panametrix product lines to enhance multiple aspects of the customer's operations through risk mitigation and performance standardization and improvements. On the software side, We will also be deploying our new Bentley Nevada Orbit 60 series, a machinery protection and condition monitoring system for the first time in Latin America. When combined with our System 1 condition monitoring and diagnostic software, Orbit 60 provides customers with the ability to create proactive maintenance and fleet management programs for maximum productivity and cost reduction. Finally, on oilfield equipment, we continue to navigate a difficult environment and remain focused on cost-out efforts and improving the margin profile of this business. In the third quarter, we made solid progress on these initiatives, executing on our cost goals related to the restructuring plan for the business. Also, during the third quarter, we reached an agreement to sell our surface pressure control flow business, which operates primarily in North America. We are retaining the SPC project business, which operates in the Middle East, Africa, North Sea, and Asia. This position is in line with our strategy to focus the portfolio on core activities. For our offshore leverage businesses, the market outlook remains challenged. Lower oil prices and continued macro uncertainty has led offshore operators to focus on conserving cash flow and reprioritizing their portfolio of potential projects and investments. As a result, although tree awards are now trending closer to 150 trees for the year, we are not expecting any material growth in new awards in 2021. Within our shorter cycle services business, we continue to experience weakness in intervention work due to both budgets and mobility constraints. While we believe this type of activity will improve with higher oil prices, we do not anticipate a material change in this business for the next few quarters. A bright spot within our OFE portfolio remains the non-metallic and flexible pipe business, which is seeing positive momentum with customers around the world. Our offshore flexible pipe business continues to book solid awards in Brazil, while our non-metallic business continues to provide significant opportunity for expansion in the broader energy markets. Overall, we are executing on the framework we laid out on our first quarter earnings call. We are on track to hit our goals of right-sizing our business and generating free cash flow for 2020 and to achieve the $700 million in annualized cost savings by year-end. Baker Hughes is uniquely placed to navigate the challenging market environment the industry is currently facing and positioning to lead the energy transition. We remain focused on executing for customers, being disciplined on cost, and delivering for our shareholders. With that, I'll 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 $5.1 billion, up 4% sequentially, driven by TPS and DS, partially offset by declines in OFS and OFE. Year over year, orders were down 34% with declines in all four segments. Remaining performance obligation was $23 billion, up 1% sequentially. Equipment RPO ended at $8.3 billion, up 4% sequentially, and services RPO ended at $14.7 billion, down 1% sequentially. Our total book-to-bill ratio in the quarter was 1, and our equipment book-to-bill in the quarter was 1.1. Revenue for the quarter was $5 billion, up 7% sequentially, driven by TPS, OFE, and digital solutions, partially offset by declines in OFS. Year over year, revenue was down 14% driven by declines in OFS and digital solutions, partially offset by an increase in TPS. Operating loss for the quarter was $49 million. Adjusted operating income was $234 million, which excludes $283 million of restructuring, separation, and other charges. Adjusted operating income was up 124% sequentially and down 45% year over year. our adjusted operating income rate for the quarter was 4.6%, up 240 basis points sequentially. We are particularly pleased with the margin improvement in the third quarter, which was largely driven by our restructuring execution. We have achieved roughly 75% of our $700 million in cost-out initiatives and are on track to complete the rest during the fourth quarter. Based on our execution to date, as well as additional opportunities that we have identified through this process, We feel confident that we can exceed our initial cost out estimates by the end of this year. Corporate costs were $115 million in the quarter. We expect corporate costs to decline slightly in the fourth quarter versus third quarter levels. Looking ahead to 2021, we expect our cost out effort and lower separation costs to reduce corporate expenses. Depreciation and amortization was $315 million in the quarter. We expect DNA to be flat sequentially in the fourth quarter. Net interest expense was $66 million. Income tax expense in the quarter was $6 million. Included in income tax is a $42 million benefit related to the CARES Act, which will lower our net cash tax payments in future periods. Gap loss per share was 25 cents. Adjusted earnings per share were 4 cents. Free cash flow in the quarter was $52 million, which includes $178 million of cash payments related to restructuring and separation activities. For the fourth quarter, we expect free cash flow to be roughly flat to sequentially higher, supported by stronger operating results, continued CapEx discipline, and modest improvement in working capital. For 2021, we expect free cash flow to improve significantly versus 2020 levels, largely driven by higher operating income as well as lower restructuring and separation charges. Lastly, as Lorenzo mentioned, in the third quarter, we reached an agreement to sell our surface pressure control flow business, which operates primarily in North America within OSE. We expect the transaction to close in the fourth quarter. Additionally, during the quarter, we completed the sale of our specialty columnar's business in OFS. These dispositions are part of our strategy to exit businesses that do not meet our return requirements and are aligned with our broader portfolio evolution objectives. 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 delivered a strong quarter despite the ongoing market challenges. OFS revenue in the quarter was $2.3 billion, down 4% sequentially. International revenue was down 3% sequentially, while North America revenue was down 7%. Operating income in the quarter was $93 million, which was a solid increase sequentially and a 200 basis point improvement versus the prior quarter. The improvement in margins was driven by strong execution on the cost of initiatives we announced in April. As we look ahead to the fourth quarter, visibility in both the North American and international markets remain limited. Internationally, activity remains soft in multiple regions, which is likely to be further impacted by typical seasonality. We expect year-end product sales to be muted in the fourth quarter due to customer budget constraints. Based on these factors, we expect our fourth quarter international revenue to decline modestly on a sequential basis. In North America, we expect relatively firm drilling and completion activity versus the third quarter and a modest sequential improvement in our production-related businesses, partially offset by typical seasonality. Given these dynamics, we expect our North American OFS revenue to be roughly flat with third quarter levels. While we expect to experience modest volume pressure in the fourth quarter, we remain committed to executing on our cost out actions and believe that OFS margin rates could be roughly flat to slightly higher in the fourth quarter. Although we still do not have great visibility for 2021, I will give you some initial thoughts on how we see the market next year. In the international market, we expect activity levels to stabilize late this year or early next year and remain relatively unchanged for the first half of 2021. Based on conversations with customers, we believe that a second half recovery in activity in select international basins is a reasonable expectation if oil prices begin to improve. However, despite a potential second half recovery, we believe that international activity will still be down on a year-over-year basis for 2021. In North America, we have limited visibility next year due to the short cycle nature of the market. uncertainty in oil prices, and the rapidly evolving business models of some of the largest U.S. producers. As more EMPs commit to maintenance mode CapEx levels, minimal production growth, and returning more cash to their shareholders, we believe that overall North American drilling and completion activity will struggle to be flat on a year-over-year basis in 2021, and that U.S. oil production should decline on a year-over-year basis. Although this activity outlook suggests that OFS revenue will be down modestly in 2021 on a year-over-year basis, we believe that our cost-out actions should still translate to a modest improvement in OFS margins and operating income for 2021. Moving to oilfield equipment, orders in the quarter were $432 million, down 58% year-over-year, with no major subsea tree awards in the quarter and the challenging offshore environment impacting results. Our offshore flexible pipe business saw solid orders quarter, specifically in Brazil, continuing to build on the strong momentum we have seen from that segment over the past 18 months. Revenue was $726 million flat year over year. Revenue growth in subsea production systems and flexibles was offset by declines in subsea services. Operating income was $19 million, a 37% improvement year over year, driven by higher volume in our subsea production systems and flexibles businesses, along with solid cost-out execution, partially offset by softness in services activity. For the fourth quarter, we expect revenue to be roughly flat sequentially, driven by continued backlog execution in SPS and flexibles. With roughly flat revenue and further cost-out actions, we expect an increase in operating income versus the third quarter. Looking ahead to 2021, We expect the offshore markets to remain challenged as operators reassess their portfolios and project selection, as well as how they will allocate capital internally moving forward. We expect OFE revenue to be down on a year-over-year basis due to lower order intake in 2020 and a likely continuation of a soft environment next year. Although revenue is likely to be down in 2021, our goal is to maintain positive operating income as a decline in volume is offset by our cost-out efforts. Next, I will cover turbo machinery. The team delivered another strong quarter with solid execution. Orders in the quarter were $1.9 billion, down 32% year-over-year. Equipment orders were down 39% year-over-year, and equipment booked to build was 1.7. We were pleased to receive the order from Qatar Petroleum for the Northfield expansion that Lorenzo mentioned earlier. Service orders in the quarter were down 17% year-over-year, mainly driven by fewer upgrades, and lower transactional services orders. Revenue for the quarter was $1.5 billion, up 26% versus the prior year. Equipment revenue was up 78% as we executed on our LNG and onshore offshore production backlog. Services revenue was up 1% versus the prior year. Operating income for TPS was $191 million, up 18% year over year, driven by higher volume and strong execution on cost productivity. Operating margin was 12.6% down 90 basis points year over year, largely driven by a higher mix of equipment revenue. For the fourth quarter, we expect strong sequential revenue growth due to the continued execution on our LNG and onshore-offshore production backlog, as well as typical fourth quarter seasonality. Based on these dynamics, we expect TPS revenue and operating income to increase on a sequential basis. For the full year 2020, we now expect operating income to increase modestly on a year-over-year basis. Looking into 2021, we are planning to generate solid year-over-year revenue growth driven by the conversion of our current equipment backlog and a modest increase in TPS service revenues. Although a higher mix of equipment revenue may be a slight headwind for growth in margin rates next year, we still expect solid growth in operating income based on higher volume. Finally, in digital solutions, orders for the quarter were $493 million, down 20% year-over-year. We saw declines in orders across all end markets, most notably aviation, oil and gas, and power. Sequentially, orders were up modestly as the global economy began to recover. Revenue for the quarter was $503 million, down 17% year-over-year, due to lower volumes across most product lines. This was driven by a reduction in maintenance activity in pipeline and process solutions, as well as the weaker automotive and aviation sectors, which impacted the weigh gate, truck, and Panametrics product lines. Sequentially, revenue was up 7% as most industrial end markets began to recover. Operating income for the quarter was $46 million, down 44% year-over-year, driven by lower volume. Sequentially, operating income was up 12%, driven by higher volume across all product lines. For the fourth quarter, we expect to see sequential growth in revenue and operating income, driven primarily by typical seasonality and backlog execution. Looking into 2021, we expect a modest recovery in revenue on a year-over-year basis driven primarily by a rebound in industrial end markets. With higher volumes and the benefit of our cost-out program, we believe DS margin rates can get back to low double digits for the full year. Overall, I am pleased with the execution in the third quarter amid a challenging economic backdrop. As I discussed on our last earnings call, Our goal through this downturn is to remain disciplined in our capital allocation to preserve our financial strength and liquidity. We remain focused on free cash flow, improving financial returns, and protecting our dividend while maintaining our investment grade rating. With that, I will turn the call back over to Judd.

Thanks, Brian. Operator, let's open it up for questions. operator, let's open it up for questions, please.

Well, ladies and gentlemen, as a reminder, to ask a question, you will need to press star 1 on your telephone. We ask that you please limit yourself to one question and one follow-up question. You may then return to the queue. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question will come from James West with Evercore ISI. Please go ahead.

Hey, good morning, Lorenzo and Brian.

Hi, James.

Hi, James. Liz, I'd love to dig in a little bit further on LNG so I can level set expectations here. Clearly, the cycle seems to be restarting with a major award in the third quarter in Qatar. Is this the restart of the liquefaction build-out cycle, or was that one-off? There's a large number, as you know, of main projects that were going to be FID this year, but things changed. Are we at the beginning of that F&E process again?

Yeah, James, as we've mentioned before, I think you've got to look at LNG on a longer-term basis, and we've always said it's cyclical, and obviously very pleased with the Northfield expansion project in Qatar, and I think, again, it's in line with our expectations with where we see LNG in on the long term. And if you look out to 2030, again, we expect there to be demand in place and a capacity requirement for about 650 to 700 million tons. So if you think about going forward for the next three to four years, you've still got between 50 million tons to 100 million tons of projects that need to be FID. We're very well positioned for those, and we stay very close to those. And, you know, as you think about LNG natural gas, we see it as a key aspect of the energy transition, both from a transition and destination fuel and enabling the reduction of coal usage. So, again, we're very much in line with the continued expansion of LNG and natural gas usage.

Thanks for the update there. And then Lorenzo, hydrogen becoming a very big topic, part of a lot of the rebuilding stimulus around the world. Something you and I talked about back in April when we talked more about LNG, but it seems like the topic has just grown in size. You mentioned on the call that you're in discussions, but could you talk about what you're seeing in the background here, what we're maybe not seeing on hydrogen, how much activity is really out there, and what's the opportunity set for Baker? Sure.

Yes, James, and as you said correctly, there is a lot of interest in hydrogen, and congratulations also on the report you published. I think the excitement is really around where hydrogen can be used in the energy transition towards the zero emissions fuel source, and we're seeing increasing activity. I think it's important to note that hydrogen has been around before, and in fact, from a Baker Hughes standpoint, we've been active in hydrogen since 1962 with our compressors, And in fact, we have over 2,000 compressors that are utilized in hydrogen applications today. Where we play is clearly on the compression and generation side. As we see hydrogen continue to evolve, we see an opportunity to play across more of the value chain. And if you think about it, we've got our turbines today that already can run 100% on hydrogen, as well as a mix of both natural gas and hydrogen. We see that increasing as we go forward. also our compressors that are actively used. And so when you look at the value chain, there's really an opportunity across the generation and also the movement, the storage, liquefaction, and also end destination of hydrogen. I look at hydrogen paralleling the story of LNG. And if you look back 30 years ago, the natural gas expansion and also what we've seen in LNG is, I think, what we'll see also with hydrogen, and they'll play together as we go forward. And we're uniquely positioned with the technology investments we've made to participate in the evolution of hydrogen like we have done with natural gas and LNG. So I feel very good about the future prospects there. Early days, but again, it's something we're staying close to, and we've got a history of proven technology in it.

Thank you. Our next question will come from Chase Mulvihill with Bank of America. Please go ahead.

Hey, good morning, everyone. Hi, Chase. Hey, Chase. First question, just kind of talking about OFS and the restructuring initiatives that have been ongoing there, you know, some obviously pre-COVID. But really, I think there's kind of two components as we kind of dissect kind of OFS and restructuring. You've got the associated cost out from the total of the $700 million that you mentioned across the entire organization. So you've got a portion of that that's allocated to OFS. And then also kind of pre-COVID, you had initiatives in OFS to drive better connectivity, optimize supply chain, enhance the service delivery platform, and really drive down product costs. So maybe if you can just take a minute, update us where you are today on these initiatives and maybe talk to the path towards double-digit margins in OFS.

Yeah, Chase, look, you hit the highlights there. I'm very pleased with how Maria Claudia and the team, you know, exercised their operating muscle this quarter. The whole company did a great job on the restructuring. We're about 75% of the way through that. OFS is ahead of that. And you're absolutely right. Their margin improvement is not just coming from what we launched in April, but it's the results of a lot of the work that we talked about in 2019 around supply chain, around product costs, around process optimization. So really a lot of efforts from the team and the results of multiple work streams. Well, what I will say is that, you know, we do anticipate having some better results from a cost-out standpoint, and that's really a result, Chase, of all this work and finding opportunities as we execute on the restructuring and then some of these other initiatives that we've talked about. In terms of, you know, opportunities and the path to get, you know, OFS back to double digits, feel good at these volume levels and what we talked about, the outlook for what we're seeing in the market in 2021, that the team can certainly get there. We've got more to go on the restructuring. As I said, there's more to come in the fourth quarter, and we're confident that we're going to exceed the targets that we talked to you about. And we're still in relatively early days in some of the other process improvements around supply chain, around facilities optimization, process optimization. that we've embarked upon. So there's certainly opportunities there and feel good about the pathway to get to double-digit margins. We're not going to stop at where we are today, and the pipeline keeps growing.

Okay, perfect. A quick follow-up, Brian, really is on free cash flow, and obviously you give us some guide points to 2021 across the segments, and obviously it looks like it's leading to implies EBITDA will be up on a year-over-year basis. And, you know, when we think about 2021 free cash flow, could you talk to the moving pieces? You know, obviously I think you talked about $800 million of – or there had been $800 million of kind of cash restructuring and severance and things. But maybe talk to, you know, how much of that goes away next year. and, you know, working capital, CapEx, and just kind of the different moving pieces for free cash flow. And we'd be happy if you want to give us a number, but definitely the moving pieces would be helpful. Yeah, nice try there, Chase.

Anyway, look, it's a bit early to be very specific, obviously, but based on everything we're seeing in the market today and how the business is performing, I'll give you kind of the framework and the way I think about it. I think Around CapEx, it should really be similar to what we're seeing this year, assuming similar activity levels that we talked about in how we're seeing the market. Working capital should actually be neutral. And I think how that plays out is really going to depend on the OFS activity levels and then progress payments from any new orders that come in on TPS and OFE next year. But based on what I see today, I'd say neutral is a pretty good assumption around working capital. And then you highlighted one, the biggest change coming into next year is really around restructuring and separation charges. We expect that to be materially lower in 2021. with the increase in earnings coming through and then the tailwind from restructuring and separation charges, it should support a material improvement in free cash flow in 2021. And look, Chase, I think you've seen the power of the portfolio and what we can do from a free cash flow standpoint in the last couple of years before we headed into this heavy restructuring. And in those years, we had restructuring and you know, merger-related charges come through there. So that gives you a good gauge about the power of the free cash flow conversion of the portfolio. Okay? Okay. Perfect.

Thank you. Our next question will come from Sean Mecham with J.P. Morgan. Please go ahead.

Thanks. Hey, good morning.

Hey, Sean. Good morning, Sean.

So let me spend a little more time on TPS. Good results in the quarter. You know, you're able to hold in the margin. You pulled through a lot more throughput and a backlog. That was good to see. Orders were solid. Guitar not in there yet, so that's also helpful. One of the key concerns for investors is the trajectory for TPS beyond 21. So next year, you have pretty good visibility on top-line growth. Some margin benefits should get pulled in there. Post-guitar, large awards look limited, at least in the near term. And so I think there are concerns around 2022 and beyond. So maybe you could just give us an updated view on the trajectory in terms of the moving parts where you have visibility beyond next year?

Yeah, hey, Sean, I'll talk through some of that. And I will say that the first phase of Qatar is in the orders number this quarter. So that's a good first step here. So, look, thinking beyond 2021, the orders that we've got in backlog right now and that we'll book here in the fourth quarter, will definitely have a positive impact on 21 and 22, given the conversion cycle. So there is some visibility into that. And based on what we're seeing today, Sean, the orders environment next year should be okay. It looks pretty solid. So I'm feeling relatively positive about that. And then I think the other thing that, you know, somebody's got to, you know, take into account, and we certainly look at it as you think about 2022 and beyond, is that the service revenue should continue to expand given the growth in our installed base, a lot of the installs that you've seen come in over the past couple of years, and the service agreement profile that we have. So, look, this combo of services likely growing faster than equipment when you get beyond 2021 is certainly a tailwind for margin rate. And then the other thing that I would add, Sean, is, you know, we talked a lot about growth initiatives for the company. and where we're, you know, pivoting to from a capital allocation standpoint. A lot of that is in turbo machinery, and I'd particularly highlight some of the industrial growth areas where it's not really a lot about technology. It's about commercial models. It's about commercial resources, you know, some small investments there. So you will start to see some of that kick in a little more materially when you get to 2022, 2023. So, look, I think overall the TPS, backdrop for 2022 and beyond is constructive. And obviously, we'll continue to update you as things evolve. But I think there's a lot of positive momentum in the business. And with the cost out and the way Rod and the team have restructured things to run the business, I feel positive about where we're headed.

Just to compliment that, Sean, if you think about, again, a question previously around LNG, again, we still see about three to four projects for next year. And to the point of the energy transition and also the application of our products in the industrial space, you've got the industrial gas turbines, the Nova LT family, which has been released. You've also got the valves business. And so we're increasingly having conversations on how can people drive efficiency and lower carbon footprint across pulp and paper, across metallurgy and other industries. So There's an adjacency aspect there, and, again, it will take some time, but we feel good about the prospects of TPS.

Got it. Thank you for that. I think that's helpful. And then maybe to clarify the prior question on free cash in the 21, or just to dig in a bit deeper, you know, we're going to, by the middle of next year, we'll be wrapping your fourth year post the initial deal between Baker and GE. If anything, the challenges of the pandemic accelerated the restructuring plan, And so, I'm just curious why there should be any charges of materiality next year. Could you maybe just clarify where and why we should still see more charges next year that could have a drag on cash?

Yes, Sean. I mean, anything that would come through would not be material anywhere near the level that we're talking about here. You're right. We have accelerated a lot of the actions that we were looking at into this year. The thing I would say is as we go through this process and as, you know, we work on driving OFS margins and returns higher, you know, we have seen some areas where there could be some potential opportunities for additional costs out and, you know, additional improvements. Anything that we would do, Sean, in this space would have incredibly quick paybacks and, you know, again, nowhere near the levels that we're talking about right now, so minimal. Okay. in terms of additional charges, if at all.

Thank you. Our next question will come from Angie Sedita with Goldman Sachs. Please go ahead.

Thanks. Good morning. Hi, Angie. Hi. So thanks for all the details, Brian. Really very helpful and nice to see the margins across the board given the cost-out program. So if you could, maybe you could talk about 21 margins and maybe the path of margins across your segments. You touched on it briefly, but additional color there. And then if you could also give us an update around where you think normalized margins will be for each of these businesses given the cost-outs.

Yeah, Angie, thanks. Look, as I said, I'm really pleased with how all the teams have performed here, you know, in executing on the restructuring in this incredibly tough environment. So, look, just a little bit on 21, and then we can move over to, you know, what we think on a longer-term basis. Given the profile of oilfield services, you know, with a potential second-half recovery if oil prices improve but international is still down year over year, you know, in North America relatively flat. We believe all the cost out actions that we've taken in OFS should translate to modest margin improvements in 2021. So, you'll have the carryover of all this cost out that we've worked on. Similar story for oilfield equipment, while revenue will be down year-over-year given the order intake in 2020, and I think the environment will be a little soft next year as well, we think we'll maintain positive operating income given the cost out, you know, that we've done that should offset the volume declines. On CPS, look, you know, again, the revenue growth, you know, next year will be driven by backlog conversion, and we think services, should rebound some given that, you know, maintenance can't continue to be pushed out. So I'd expect solid growth in operating income driven by higher volume, but that equipment mix could actually impact the margin rate, Angie, but still great performance by both pieces of the business. And then DS margin rates should be getting back into the low double digits for the full year as volume recovers in the broader industrial space. I think, you know, aerospace and oil and gas might still lag a little bit, But given how we position the business, I think we're in good shape there. And if you take a step back and look more broadly, look, as I said earlier, I feel really confident about OFS getting into the double-digit margins over the medium term. You know, there's more costs that will come out in the fourth quarter. We've taken some portfolio actions that will certainly be accretive to margins. And look, there's there's no stone being left unturned in terms of looking at the OFS business and which pieces need some more work to get to the right level of return. So I feel good about how we're looking at that business and how we're operating. Oil field equipment, honestly, it's a challenging market. There are some bright spots with flexibles and non-metallics, but it's tough for that to offset kind of the core FPS space. And I think in this market environment, You know, probably you're looking at high single-digit levels. I think our long-term goal is lower double digits, but, you know, I think we're going to need to see some more volume there. And then in turbo machinery, haven't changed our outlook really in terms of, you know, mid-double digits to high double digits in terms of what that business can do. And a lot of that's going to depend on the mix of services and equipment in any given year. and then overall i think you know ds should continue to be a mid-teens uh margin business through through the cycle uh especially given the costs out that you've done during this downturn um and um you know feel good that as volume picks back up you'll see those high gross margins fall through to the operating income level so pretty constructive view on margins uh across the portfolio energy great great thank you very helpful so

Maybe going back to the hydrogen and carbon capture and so forth, I mean, it's really nice to see this leadership and the energy transition. And maybe, Lorenzo, you could talk about where you see the biggest near-term opportunities versus long-term opportunities, whether it's hydrogen and the hydrogen blend or 100% hydrogen on the turbines, or is it compression? And compare that to the path and opportunity set for carbon capture.

So, Angie, first of all, I think clearly it's going to take some time as we evolve on the energy transition. And, again, if you look at the presence of oil and gas, that's going to remain in the short term. As we position ourselves, I think CCUS is particularly important as you look at the Paris Agreement and reaching some of the climate goals. We see an increasing discussion with our customer base of both on brownfield and greenfield LNG projects of incorporating CCUS In fact, we've got experience of already some LNG projects utilizing carbon capture and sequestration. So I think near term, there's the opportunity there. Hydrogen is going to be longer term as the infrastructure is built out. As you look at energy transition, though, I think, Angie, a lot of this is going to be predicated also on some of the government policies. The technology is very much in place today, and we've proven the technology in many cases, and we've had it some time. We need to make these, from an economic justification standpoint, stand alone as well, and some of that's going to come through with the increasing government policies over the next few years and some of the subsidies that get put in place. We're seeing a lot of activity in Europe. You've seen the statements by China on where they want to get to from a net zero perspective. So, again, evolving space, and we're going to be playing our role with the technology that's required.

Thank you. Our next question will come from Bill Herbert with Simmons. Please go ahead.

Thanks. Good morning. Hi, Bill. Hey, Ryan. So getting back to cost down, I'm curious to say how much more relative to the original $700 million target. And so these are a few questions embedded in one. One, how much of that is OFS? Secondly, in light of the redefined market opportunity in lower 48, it's not just that they're in maintenance mode, but the industry from your client's standpoint is consolidating rapidly and significantly. That's not a good outcome for lower 48 OFS anyone. And so I'm just curious as to how you guys think about that and how much more you need to cost out and then moreover additional portfolio adjustments in light of the fact that you're not only in maintenance mode, but your client base is shrinking.

Yeah, Bill, I'd say on the cost outlook, not really going to provide a revised estimate at this time, but, you know, we do see upside coming through here in the fourth quarter. And roughly, we said about two-thirds of the cost out comes from oilfield services. And the incremental is probably about – it's about that level, maybe a little bit higher from where the cost is going to come out. I mean, again, I just want to, you know, again, congratulate Maria, Claudia, and the team for exercising some pretty strong operating muscle here and working hard on the cost out. That gives you a rough guide as to where you'll see that come through, and we'll update you as we roll through the quarter and report on our earnings, just how much that was. In terms of, you know, what's going on from a portfolio standpoint and what's happening in the marketplace, and Lorenzo can jump in here as well, but I think if you look at some of the consolidation that's happening, you've got, you know, you're going to have larger players. I think a lot of those players are going to look at technology to help them drive better costs, better performance, you know, better returns to their customers. And actually that bodes well for us. So, you know, we've got good relationships with these customers and think that we can help them make a difference. And from a portfolio standpoint, look, we'll continue to look at the places where we actually can generate returns for you know, that meet our hurdles. And that may mean that we don't do some things or we partner in different ways with others to do things that maybe we don't think are the right thing for us to offer as part of an integrated package. But we're being quite flexible and very pragmatic about it and are committed to getting higher margins and returns, particularly in OSS.

Okay. And last one from me. With regard to Q1, is the seasonality that you're expecting At this point, typical or atypical? And if it's atypical, how is it so?

You know, look, I'd say right now everything I'm seeing, Bill, would say it's going to be typical seasonality. I don't see anything that will change that at the moment. If we see any different indicators, we'll certainly let you guys know. But right now, I'd say it seems pretty normal from a seasonality standpoint.

Thank you. Our next question will come from Scott Gruber with Citigroup. Please go ahead.

Yes, good morning. Hey, Scott. It's Scott. Brian, I want to circle back on your comments that working capital would be broadly neutral next year. I think it's better than the expectation in the marketplace. So just drilling down a little bit, you know, I thought, you know, as we, you know, look at the contract liability in TPS, you know, I thought that that would unwind some and present a headwind, maybe a couple hundred million bucks. Correct me if I'm wrong there. And then I think about OSS, you know, since working capital is driven by changes in your current accounts, you know, from year end to year end, it would seem that the recovery in OSS exit to exit would present another working capital headwind, even if we just get back to the maintenance levels. So is that fair? And if so, what are the offsets? You mentioned down payments under TPS orders. Are there others that neutralize the potential headwinds, you know, from your The two larger segments?

Yeah. So, listen, Scott, you're right on the progress collections. We have built up that progress collections liability as we've increased our orders, particularly in turbo machinery. But, you know, as we've talked about, you know, specifically, we look to keep those projects free cash flow positive over the life of the project. So, look, I don't expect this decline in the liability to be materially large cash drain in 2021 or 2022 at this point and a few things to think through look the increase that you have seen will draw down over the next two two and a half years as you mentioned you know look you can clearly see the progress liability on the balance sheet but what's harder for you to kind of untangle are partial offsets that you see on the asset side typically you know, when we get an upfront payment, we place orders for long lead items, we bring inventory in and build up inventory on a project. You know, in addition, there'll be some receivables associated with that project as well. So it's not, you know, exactly one for one in terms of the cash flow impact that you see in the progress collections line. Another consideration, as you mentioned, is what the future awards are going to be like over the next couple years. So look, based on the the project cycle where we are, how each of those projects, you know, should perform from a free cash flow standpoint. Again, I don't see that being a major drag as we go into next year. And then around OFS, you're right. As activity levels increase, you know, typically you do see a working capital drag. A couple things I would highlight. As part of the work we've been doing in OFS over the last couple years to really drive better free cash flow performance, we've made a step function change in both the collections and order to remittance process as well as the inventory input process. And feel good about the new processes that we have in place and that we'll be able to manage incremental volume while continuing to improve our inventory terms as well as our day sales outstanding. I mean, we've made great improvements since coming together in 2017. and there's more that can come there. So that's, you know, we're all incentivized on free cash flow. It's the largest piece of our short-term incentive plan, and we've got pretty good processes in place to capitalize on that as volume returns. The other thing I would mention here is OFE in particular. We're in a cycle in OFE that's probably been more of a draw on working capital, just given where the projects are in their execution phase. And that should turn around as we go into next year as well. Got it. That's a really good comment.

And then just a quick follow-up on TPS aftermarket. Obviously, you had material COVID disruptions this year, but there's also, you know, an upcoming tailwind from the last LNG build-out cycle. How much did TPS aftermarket recover in 2021? And then what's the follow-on growth potential in 2022? I think over there on growth rate potential would be great.

Yeah, look, you know, we do see a modest increase in services revenue next year after, you know, it's been declining in the low double digits so far this year. I'd say contractual and transactional services have behaved this year roughly as we expected. The areas that have been a little bit weaker have been in upgrades as well as services on pumps and valves in the midstream and downstream space as customers, you know, pretty aggressive on preserving cash and minimizing OpEx. So, when I put all that into 2021, I do expect some level of recovery. on the things that have been deferred from this year from the transactional services and for pumps and valves. So I would expect that there could be some movement from next year into 2022 in that space. But do expect the contractual services to improve next year and into 2022 and beyond based on the LNG build out as you pointed out. And then the other thing that I would say that could snap back relatively quickly depending on what's going on in the environment are upgrades. There's a lot of activity right now in that space, particularly around decarbonization and an opportunity to make a dent there. So, I'd say the commercial team and the engineering team are pretty busy. Customers aren't ready to pull the trigger. on those yet given the environment, but that could be materially better as we go into 21 and 22. So, again, a positive backdrop for services underpinned by the contractual services. And then on the transactional side, we know what parts have to be replaced. We know what maintenance needs to be done. It's just a question of when.

Thank you. And our final question on today's question and answer session will come from Blake Gendron with Wolf Research. Please go ahead.

Yeah, thanks. Good morning. Thanks for getting me on here. So two parts, two areas of the digital industrial realm that would be great to dig into. The first is on asset performance management through the BHC3 partnership. It appears that refiners and chem facilities are attacking the structurally lower demand environment by accelerating APM adoption. It seems like you're going up against some industrial software providers, perhaps some equipment OEMs. So what gives you confidence in being able to win in such a nascent competitive landscape? And then the second area I wanted to dig into is additive manufacturing. We've seen a kind of startup activity in this realm. It's not new technology per se, but perhaps nearing the inflection point for multi-industry adoption. Is this mostly a cost-efficiency lever for Baker and support, of course, segments kind of along the lines of Chase's question on supply chain, or is this something you can monetize in core and diversification end markets? Thanks.

Yeah, Blake, just first of all on the digital transformation, and you're right, we're seeing increased demand levels of activity around really implementing digital transformation at both our customer sites and then also internally ourselves within our internal processes. We're very happy with the BHC-free relationship. You'll have seen that we've developed applications that we're providing to our customers. And again, it's a drive towards reducing non-productive time. And we're able to do that through advanced analytics and What's unique about C3.ai is the artificial intelligence that it has and the ecosystem that it's created, which isn't just used within the oil and gas space, but it's used in multiple other industries, defense, banking, and C3 has been regarded externally as a pioneer in artificial intelligence. So we're having good success in the conversations with our customers and also with applying it internally ourselves. So we see that continuing. I'd say COVID has actually accelerated it. the application of digital transformation, as you've also seen with our remote operations that are taking place. And we see that continuing as people drive for productivity. On the aspect of 3D printing and additive, again, this is not new. And we see it both being an operational improvement for our customers, because obviously it reduces the cycle time in which we can get them parts. We can actually drive incremental productivity within our own manufacturing. You're moving away from... casting and metals to being able to have, again, 3D printing at site. And so it makes it much quicker. And we think it's an opportunity, again, to become more efficient and productive as we continue to drive efficiencies both internally for ourselves, but then also for our customers. So two areas that we've discussed before and we continue to invest in as we go forward. Okay, I think we'll go to the wrap and I just wanted to take a moment to thank everyone for joining us today and I'd like to leave you with some closing thoughts. We're pleased with our third quarter results and believe they illustrate and reinforce the potential of Baker Hughes as we execute on our margin and returns objectives and evolve our portfolio with the energy landscape. I want to take a moment to thank our employees for their continued commitment and dedication in delivering for our customers, shareholders, and each other. I'm extremely proud of the Baker Hughes team. Thank you, and I look forward to spending time with you again soon. Operator, you may close the call now.

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