Baker Hughes Company

Good day, ladies and gentlemen, and welcome to the Baker Hughes Company second quarter 2021 earnings call. At this time, all participants are in 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 our host for today's conference, Mr. Judd Bailey, Vice President of Investor Relations. Sir, you may begin.

Thank you. Good morning, everyone, and welcome to the Baker Hughes Second Quarter 2021 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 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. During the second quarter, we generated strong free cash flow, booked several peer awards, and took a number of positive steps in our journey to grow our new energy businesses. At a product company level, TPS once again delivered solid orders and operating income, while OFE booked a solid orders quarter and OFS continued to improve margins. As we look to the second half of 2021 and into 2022, we see continued signs of global economic recovery that should drive further demand growth for oil and natural gas. Although we recognize the risks presented by the variant strains of the COVID-19 virus, we believe that price environment looks constructive, with demand recovering and operators largely maintaining spending discipline. In the natural gas and LNG markets, fundamentals are equally as strong, if not better, than oil, as a combination of outages and strong demand in Asia, Latin America, and Europe have driven third-quarter LNG prices to levels not seen since 2015. Although hot weather in Europe and U.S. has contributed to solid demand improvement and lower gas storage levels, Structural growth continues unabated in Asia, with Chinese energy imports up almost 30% in the first half of 2021 versus the first half of 2020.

Given the strong pace of current growth and the increasing demand for source of energy, we maintain our positive long-term outlook for natural gas and energy. Outside of traditional oil and gas, momentum for cleaner energy projects continues to increase.

The U.S., Europe, and Asia, various projects around solar and green and blue hydrogen are moving forward, as well as a number of carbon capture projects. For example, so far this year, there have been 21 CCUS projects announced and in the early stages of development, compared to 19 CCUS projects announced in 2020.

During the second quarter, to build on some of these new energy frontiers.

Our team has moved quickly and decidedly in selected areas to establish relationships and build a strong foundation for future commercial success. Our approach has been one of collaboration and flexibility, which is reflected in the number of agreements we reached in the second quarter, ranging from early-stage partnerships and MOUs, immediate investments, commercial agreements,

and tangible orders for Baker Hughes. Most recently, we announced a collaboration with Samsung Engineering for low to zero carbon projects, hydrogen and CCUS technologies. As part of the collaboration, we worked with Samsung Engineering to identify joint business development opportunities for energy and commercial customers, domestic and abroad, to help reduce their emissions.

Baker Hughes will look to deploy compression and gas turbine technology as well as flexible pipes for transportation in hydrogen.

In CCUS, we'll be providing reservoir studies, well construction services, flexible pipes, condition monitoring solutions, and certain auxiliary solutions such as compression and look for key industrial assets. Another example of our early partnership

is the collaboration agreement we reached with Bloom Energy on the potential commercialization and deployment of integrated low-carbon power generation and hydrogen solutions.

This partnership will allow us to work with Bloom Energy on a number of areas, including integrated power solutions, integrated hydrogen solutions, and other technical collaborations.

Bloom Energy is a leading clean energy player with solid oxide fuel cell technology in natural gas and hydrogen and a growing electrolyzer presence. Through this agreement, we will gain further insights into fuel cell and electrolyzer technologies where Bloom has key offerings today and explore how we can integrate and utilize a world-class gas turbine and compression technology alongside these solutions. We were also very pleased to announce an MOU with bulk CO2. a Norwegian carbon capture and storage developer, to collaborate on a CCUS project to serve as a hub for the decarbonization of industrial sites in Norway announced last quarter. During the quarter, we also announced a 15% investment in electric air to expand Baker Hughes' CCUS portfolio with power to gas and energy storage solutions. Baker Hughes will combine its post-combustion carbon capture technology with ElectroCare's biomethanation technology to transform CO2 emissions into synthetic natural gas, a low-carbon fuel capable of being used across multiple industries. Lastly, during the second quarter, we were extremely pleased to finalize our collaboration with Air Products, a global leader in hydrogen, to develop next-generation hydrogen compression and accelerate the adoption of hydrogen as a zero-carbon fuel. As part of the collaboration, Baker Hughes will provide air products with advanced hydrogen compression and gas turbine technology for global projects. This includes Nova LT16 gas turbines and compression equipment for their net zero hydrogen energy complex in Alberta, Canada. We will also provide advanced compression technology using our high pressure ratio compressors for the NEOM carbon-free hydrogen project in Saudi Arabia. Through these two projects with air products, Baker Hughes will provide equipment on the world's largest blue and green hydrogen projects. As you can see from all these recent announcements, we feel confident in the momentum we're building in both CCUS and hydrogen spaces and believe that we have a differentiated technology offering that positions us as a leader in these areas.

Now I'll give you an update on each of our segments.

In oilfield services, increases in activity level became more broad-based during the second quarter, and the outlook for the second half of the year continues to improve. Internationally, we have seen a pickup in activity across multiple regions over the last few months, including Latin America, Southeast Asia, and the North Sea. Looking at the second half of the year, we expect stronger growth across a broader range of markets, most notably in the Middle East and Russia. Based on discussions with our customers, we expect international activity to gain momentum over the second half of the year and lay the foundation for growth in 2022. In North America, strong second quarter growth was evenly distributed between our onshore and offshore business lines. Given the strength in oil prices and bid activity, we expect to see additional growth over the second half of the year. While we expect to capitalize on the growing improvement in global activity levels, we are committed to being disciplined through this upcycle, with a focus on profitability and returns. This includes maintaining focus on our various cost reduction and operating efficiency initiatives, as well as navigating the inflation and supply chain costs, a situation that our team is managing well. As a result, OFS remains on track to achieve our goal of 20% EBITDA margins in the medium term. Moving to TPS, the outlook continues to improve. driven by opportunities in LNG, onshore-offshore production, pumps and valves, and new energy initiatives. While the order outlook for TPS in 2021 should be roughly consistent with 2020, we are growing increasingly confident that a multi-year growth opportunity will begin to emerge in 2022. Underpinning this framework is the strength that is developing in multiple parts of the TPS portfolio and the diversification of the business, which has commercial offerings in several end markets with high growth opportunities. In LNG, we booked two awards during the second quarter, with gas turbines and compressors for Train 7 at Nigeria LNG, and liquefaction equipment for New Fortresses Energy's first fast LNG project. Following these two orders, we still expect one or two more LNG awards in 2021 and see a strong pipeline of opportunities that should produce a step up in LNG activity in 2022 and beyond. For the non-LNG segments of our TPS portfolio, we were pleased to book awards in the Middle East and Asia Pacific in our refinery and pipeline and gas processing segments. TPS also secured a key industrial win with our Nova LT 12 megawatt gas turbine technology in the Middle East for a combined heat and power application. We continue to see our Nova LT range of gas turbines gain further traction for lower megawatt industrial applications. For TPS services, We are beginning to see real signs of recovery and remain optimistic about the outlook for 2021 and 2022. In the second quarter, we experienced strong growth in service orders, which grew year over year due to the significant upgrade awards across multiple regions and for the various applications, including pipeline, offshore, and solutions to support customers' operational decarbonization efforts. We also saw further improvements in transactional service orders as customers continued to increase spending. In our contractual services business, TPS maintains strategic long-term relationships with LNG customers, achieving a major milestone by securing a six-year services contract extension in North America for a key producer, building on the success we saw in the first quarter. Our TPS services RPO now stands at close to $14.1 billion which is up almost 10% year over year. Next, on oilfield equipment, we remain focused on right-sizing the business, improving profitability, and optimizing the portfolio in the face of what remains a challenged long-term offshore outlook. While Brent prices are near $70 and FID activity is beginning to pick up, we continue to expect only a modest improvement in industry subsidiary awards in 2021. followed by some additional growth in 2022. However, we continue to believe that it will be difficult to achieve and sustain 2019 order levels in the coming years as the deep water market becomes increasingly concentrated into low-cost basins and upstream spending budgets for many larger operators are reallocated to other areas. However, one deep water area that we expect to benefit from this environment is Brazil. where the pre-salt reserves are viewed as attractive by a number of IOCs. This quarter, our flexible business signed an important frame agreement with Petrobras for a number of pre- and post-salt fields offshore Brazil. In the first half of 2021, and including the two contracts we were awarded in the first quarter, Petrobras has contracted Baker Hughes to provide up to 370 kilometers of flexible pipe. This is larger than the volume of flexible pipe awarded by Petrobras to Baker Hughes, in 2019 and 2020 combined. Finally, in digital solutions, we were pleased to see orders continue to recover despite a challenging operating quarter. Year over year, growth in orders was led by strong performances in our industrial and transportation end markets. We saw continued traction in industrial end markets in the second quarter, which represented over 30% of DS second quarter orders as we continue to grow our presence in this key area. During the quarter, DS continued to expand its industrial asset management presence with a number of wins across multiple end markets. Bentley Nevada secured a contract with a large corrugated paper manufacturing company for its condition monitoring and protection solutions to optimize production and reduce maintenance costs. We were also pleased to see the recently acquired Arms Reliability Business secure some industrial asset management orders during the quarter, including a subscription for its 1PM software to be deployed by a Global Chemicals customer with initial rollout in China and Chile. The deal will include software and consulting services to develop the customer's equipment reliability strategy library, driving the deployment of best-in-class asset reliability strategies and real-time alignment for its assets. We're also having success integrating some of our emissions management solutions with our Bentley Nevada business. This quarter, DS secured a FlareIQ contract with BP, marking the first time FlareIQ will be used in upstream oil and gas. This contract builds on our partnership with BP to measure and reduce their emissions across global flaring operations. FlareIQ will be embedded into BP's existing System 1 condition monitoring software from Bentley Nevada, requiring no additional hardware for the customer. Before I turn the call over to Brian, I'd like to spend a few moments highlighting some of the achievements from our corporate responsibility report that was published at the end of the second quarter. This report provides an expanded view of our environmental, social, and governance performance and outlines our corporate strategy and commitments for a sustainable energy future. For 2020, we achieved several notable milestones in our CR report. First, we continue to advance our reporting around sustainability and climate-related disclosures. This year, we included new reporting frameworks from the Sustainability Accounting Standards Board and the Task Force on Climate-Related Financial Disclosures. Second, we again lowered our emissions footprint and expanded our emissions reporting. We achieved a 15% reduction in our Scope 1 and 2 carbon emissions compared to 2019, and we reset our base year from 2012 to 2019 to account for corporate changes in line with the greenhouse gas protocol. Importantly, we also expanded our reporting of scope-free emissions to include new categories. And third, we made significant improvements in HSE performance and engagement during 2020. We increased our number of perfect HSE days to 200, reduced our total recordable incident rate by 18%, and conducted more than 1 million HSE observations and leadership engagements globally. Overall, Baker Hughes is successfully executing on its vision to become an energy technology company and to take energy forward, making it safer, cleaner, and more efficient for people and the planet. Our corporate responsibility report demonstrates our progress in many of these areas, while our second quarter results illustrate our progress towards our financial and strategic priorities. We believe that Baker Hughes is uniquely positioned in the coming years to deliver sector-leading free cash flow conversions while also building one of the most compelling energy transition growth stories. We will also continue to evaluate our portfolio in order to drive the best financial returns and create the most value for shareholders as the energy markets evolve. 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 12% sequentially, driven by OFE, OFS and TPS, partially offset by a decrease in digital solutions. Year over year, orders were up 4% driven by increases in TPS and digital solutions, partially offset by decreases in OFE and OFS. Remaining performance obligation was $23.8 billion, up 3% sequentially. Equipment RPO ended at $7.6 billion, up 1% sequentially, and services RPO ended at $16.2 billion, up 3% sequentially. Our total company book-to-bill ratio in the quarter was 1.0, and our equipment book-to-bill in the quarter was 0.9. Revenue for the quarter was $5.1 billion, up 8% sequentially, with increases in all four segments. Year-over-year, revenue was up 9%, driven by increases in TPS and DS, partially offset by decreases in OFE and OFS. Operating income for the quarter was $194 million. Adjusted operating income was $333 million, which excludes $139 million of restructuring, separation, and other charges. The restructuring charges in the second quarter primarily relate to projects previously announced in 2020. We expect to see restructuring and separation charges taper off through the second half of the year. Adjusted operating income was up 23% sequentially and $229 million year over year. Our adjusted operating income rate for the quarter was 6.5%, up 80 basis points sequentially. Year over year, our adjusted operating income rate was up 430 basis points. Adjusted EBITDA in the quarter was $611 million, which excludes $139 million of restructuring, separation, and other charges. Adjusted EBITDA was up 9% sequentially and up 38% year-over-year. Corporate costs were $111 million in the quarter. For the third quarter, we expect corporate costs to be slightly down compared to second quarter levels. Depreciation and amortization expense was $278 million in the quarter. For the third quarter, we expect DNA to be roughly flat sequentially. Net interest expense was $65 million. Net interest expense was down $9 million sequentially, primarily driven by one-time interest on tax credits. Also slightly reducing interest expense in the second quarter was the repayment of our UK short-dated commercial paper facility. For the third quarter, we expect interest expense to be roughly in line with first quarter levels. Income tax expense in the quarter was $143 million. Gap loss per share was $0.08. Included in gap loss per share is a non-recurring charge for a loss contingency related to certain tax matters. Also included are losses for the net change in fair value of our investment in C3.ai. These charges are recorded in other non-operating income. Adjusted earnings per share were 10 cents. Turning to the cash flow statement, free cash flow in the quarter was $385 million. Free cash flow for the second quarter includes $62 million of cash payments related to restructuring and separation activities. We are again particularly pleased with our free cash flow performance in the second quarter following the strength we saw in the first quarter. We have worked hard to improve our billing and cash collection process and have also updated the company's incentive structure with an increased focus on free cash flow. And we are pleased to see the performance so far this year. We have now generated $883 million of free cash flow in the first half of the year, which includes $170 million of cash restructuring and separation-related payments. For the total year, we believe that our free cash conversion from around 50% given the capital efficiency of our portfolio and the winding down of the restructuring and separation costs. 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 good quarter in an improving market environment. OFS revenue in the quarter was $2.4 billion, up 7% sequentially. International revenue was up 6% sequentially. led by increases in Asia Pacific, Europe, and Latin America. North American revenue increased 11% with solid growth in both our U.S. land and offshore businesses. Operating income was $171 million, up 20% sequentially, and margin rate expanded 80 basis points to 7.3% due to higher volume and lower depreciation. While we continue to execute on our cost-out program in the second quarter, this was partially offset by mix and cost inflation in some areas. Although we have moved quickly to pass inflation on to our customers, there is a timing lag relative to the increase in costs. As we look ahead to the third quarter, we expect to see strong sequential improvement in international activity and continued improvement in North America. As a result, we expect sequential revenue growth for OFS in the third quarter to be similar to the second quarter. On the margin side, we expect the sequential increase in operating margin rate to solidly exceed the improvement in the second quarter due to more favorable mix and better cost recovery. For the full year 2021, our industry outlook remains largely intact, with second half activity in North America modestly better than previously expected. Overall, we still expect our OFS revenue to be down slightly year-over-year, with North American revenues roughly flat and international revenue down mid-single digits. On the margin side, we continue to expect growth in operating income and margin rates on a year-over-year basis. Moving to oilfield equipment, orders in the quarter were $681 million, down 3% year-over-year, and up 97% sequentially. Strong year-over-year growth in subsea services and flexibles orders was offset by declines in SPC projects and subsea production systems. The sequential improvement in orders was driven by an increase in orders in SPS, along with several orders in flexibles outside of Brazil. Revenue was $637 million, down 8% year-over-year, primarily driven by declines in subsea drilling systems and the disposition of SPC flows partially offset by growth in flexibles. Operating income was $28 million, which is about $42 million year-over-year. This was driven by increased volumes in flexibles as well as productivity from our cost-out programs. For the third quarter, we expect revenue to decrease sequentially driven by lower SPS and flexibles backlog conversion. We expect operating margin rate in the low single digits. For the full year 2021, we believe the offshore markets will remain challenged as operators reassess their portfolios and project selection. We expect OSE revenue to be down double digits on a year-over-year basis due to the lower order intake in 2020 and a likely continuation of a lower order environment in 2021. Although revenue is likely to be down in 2021, We expect to generate positive operating income as our cost-out efforts should continue to offset the decline in volumes. Next, I will cover turbo machinery. The team delivered another strong quarter with solid execution. Orders in the quarter were $1.5 billion, up 15% year-over-year. Equipment orders were up 8% year-over-year. As Lorenzo mentioned, orders this quarter were supported by LNG Awards for Nigeria LNG Train 7, and for New Fortress Energy's Fast LNG project. We were also pleased to book a number of non-LNG awards, specifically in our refinery and petrochemical and industrial segments. Service orders in the quarter were up 20% year-over-year and up 15% sequentially, primarily driven by increases in upgrades and transactional services. Revenue for the quarter was $1.6 billion, up 40% versus the prior year, Equipment revenue was up almost 90% year over year as we continue to execute on our LNG and onshore-offshore production backlog. Services revenue was up 14% versus the prior year. Operating income for TPS was $220 million, up 48% year over year, driven by higher volume and continued execution on cost productivity, partially offset by a higher equipment mix. operating margin was 13.5%, up 70 basis points year-over-year. We continue to be very pleased with the TPS margin rate improvement, particularly as our equipment revenue mix has increased from 36% to 48% year-over-year. For the third quarter, we expect revenue to increase modestly on a sequential basis based on expected equipment backlog conversions. With this revenue outlook, we expect TPS margin rates to improve modestly on a sequential basis. For the full year 2021, we expect TPS to generate strong double-digit year-over-year revenue growth driven by equipment backlog conversion and growth in TPS services. Despite a higher mix of equipment revenue, we now expect TPS margin rates to slightly improve year-over-year. Finally, in digital solutions, orders for the quarter were $540 million, up 16% year over year. We saw strong growth in orders in industrial and transportation, offset by declines in power. Sequentially, orders were down 2% driven by declines in power and oil and gas, partially offset by improvements in transportation and industrial. Revenue for the quarter was $520 million, up 11% year over year, primarily driven by higher volumes in PPS and Waygate, offset by lower volume in Nexus controls. Sequentially, revenue was up 11%, driven by a higher order intake in the first quarter of 2021. Operating income for the quarter was $25 million, down 39% year-over-year, largely driven by costs related to a legacy software contract that we do not expect to repeat. Sequentially, operating income was up 3% driven by higher volume. For the third quarter, we expect to see strong sequential revenue growth and operating margin rates back into the high single digits. For the full year 2021, we still expect modest growth in revenue on a year-over-year basis, primarily driven by a recovery in industrial and markets. With lower margins in the first half of the year and higher volumes over the second half, we expect DS margin rates to be in the high single digits on a full year basis. Overall, we delivered a solid quarter and continued strong free cash flow. While we face challenges in our DS business, we are confident in our ability to execute as the rest of the year unfolds. With that, I will turn the call back over to Judd.

Thanks, Brian. Operator, let's open the call for questions.

Thank you. If you have a question at this time, please press the star, then the one key on your touch-tone telephone. If your question has been answered or you wish to move yourself from the queue, please press the pound key. And we also ask that you limit yourself to one question and one follow-up. Our first question comes from Chase Mobile with Bank of America.

Hey, good morning. Lorenzo, you know, early in your prepared remarks, you talked about a looming, you know, new order growth cycle in the TPS segment. that should get underway next year. Could you maybe just take a minute and provide some details around kind of really what's driving this revised, more positive outlook for TPS as we get into next year?

Yeah, definitely, Chase. And as you mentioned, for TPS, we see several avenues of growth developing as we go forward, and really it's for a prolonged growth cycle of orders and EBITDA. As you look at the near to intermediate term, it's really going to be LNG and the orders that we've seen. You can also see the small awards we've booked this year. We still see some other, maybe one or two small projects being awarded this year. But as we go forward, the next two to three years, we see a step up in LNG order opportunity. That's been highlighted by the increasing demand and also what we announced previously for the long-term outlook of LNG out to 2030. Then as you go longer term, you know, also the next five to ten years, we expect to see significant growth around our energy transition initiatives, most notably hydrogen, CCUS, but also in areas like valves, integrated power, as the clean energy ecosystem continues to evolve. And I think as you look at our recent announcements with our product that was given, we see some near-term opportunities for hydrogen, and those will actually be additional awards over the course of the next two to three years. as a first wave, but continuing through the rest of the decade. And CCUS, you know, you looked at our announcement with Borg and Horizon Energy, and we're in a number of active collaborations with our customers across several geographies of increasing opportunities around CCUS. And lastly, our service business, you know, it's got solid growth potential for the next 10 years when you look at the installed base as well as the upgrade opportunities. I think... With LNG growing, our installed base has grown by about 30% by 2025 with the increasing tonnage of LNG. And then you look also going forward with what we announced, our CPS services RPO now standing at $14.1 billion, which is up from $13 billion a year ago. So good signs of continued growth on the services side.

Awesome, awesome. Appreciate the additional color there. Seems like the TPS has got a nice future ahead of it. Maybe if I can transition over to buybacks and ask Brian, you know, about buybacks. You know, in our numbers, you have, you know, in excess of $1.3 billion of free cash flow after dividend through the end of next year. Your net debt to EBITDA is going to be sub one at the end of next quarter and So, Brian, I kind of asked you the question, you know, why not do a buyback to help partially offset the continued drag on your stock from GE continuing to kind of sell down their stake?

Yeah. Hi, Chase. We are pleased with our free cash flow generation this year. and the outlook going forward. You know, as I mentioned, the teams have done a great job in changing a lot of processes. And so, look, our view really on capital allocation hasn't really changed. But, you know, as you pointed out, the pace of our free cash flow is improving, particularly as restructuring is winding down over the rest of this year. So that's a big capital allocation, you know, action that won't be repeating there. So it leaves us, I think, in a position to have quite a bit more optionality We're primarily focused on investing in areas where we see the ability to grow offerings and new frontiers like energy transition and digital, as well as some interesting places in industrial technologies. And you've seen some of those examples like C3.AI, compact carbon capture, and more recently, arms reliability. And look, I think beyond some small-scale acquisitions and investments in some of the new energy frontiers, share repurchases, could certainly be an attractive piece of the capital allocation portfolio view. And the pace that we're generating pre-cash flow certainly gives us more optionality to evaluate that and continue to look at ways to return value to shareholders. So look, we will keep you guys updated as, uh, we're evaluating that. And, uh, and, uh, you know, it's, uh, it's good to have this flexibility.

Alrighty. Thanks, Brian. Look, look forward to, uh, to hearing more about that. I'll turn it back over.

Thank you. Our next question comes from James. Hey, good morning, Lorenzo, Brian, Judd. Hey, James. So, uh, Lorenzo, you, you, you highlighted it a couple of times, uh, In your prepared comments and also to the last question, but the service orders for TPS up nicely year over year. Could you expand a bit more on that, what that means for the margin profile of that business, what that's signaling for the future of TPS? And I agree with what the comment Chase made, that there's a bright future here, and we really want to kind of understand exactly what we're looking at.

Yeah, James, I'll start off with the outlook on the activity side and then let Brian jump in on the margin side. Because, you know, we're definitely seeing improvements across the whole TPS service business. And it's really driven by some of the positive macro backdrop, some of the improving outlook we're seeing with customers reengaging with us on service equipment across our installed base following 2020 that was disrupted, of course. And, you know, we're seeing strong growth and upgrades here. with recovery across regions and various applications, pipeline, offshore, solutions also to support our customers on the operational decarbonization efforts with the upgrades that we can provide them. And you saw the double-digit growth in transactional services in the quarter as customers are returning to normalized spending levels. And also, we've got a solid CSA revenue stream that's been resilient. So, you know, overall, we think we could be reasonably back closer to a 2019-type level in 2022. with the continued upgrade and transactional activity continuing strongly as we go forward.

Yeah, and James, on the margin front, I'd say it's certainly a positive backdrop as service grows for TPS overall. And, you know, Rod and the team are doing a great job in driving productivity in the services portfolio. And as Lorenzo mentioned, you know, the install base is growing, particularly in LNG. So I think that is all a pretty positive backdrop for what the business can deliver.

Sure, right. Okay. Well, you guys made a lot of moves in new energies this quarter. You have been doing that for several years now, repositioning the portfolio. One of the things that caught my eye that we haven't really discussed is the Electrochia investment, the CCUS plus biomethane technologies. I'd love to hear a bit more about that and what the investment is, what the outlook is, what's going on with that transaction.

Yeah, James, I think it's part of our strategy, as we've said, to develop our portfolio for energy transition. And we're very pleased with the ElectroKia investment, 15% investment, which really allows us to expand our whole portfolio around power to gas and energy storage solutions. We'll have a seat on the board of ElectroKia. And we're really going to combine our post-combustion carbon capture technology with ElectroKia's biomethanation technology to transform CO2 emissions into synthetic natural gas. And this is maybe an area that we haven't discussed much before, but we really see synthetic natural gas as being applicable to multiple industries. And ElectroKia's technology allows CO2 recycling into grid-quality, low-carbon synthetic natural gas, which helps to drive decarbonization in hard-to-abate sectors such as transportation and heating. You know, it's going to be a great suite of our capability that we're providing. And, again, we see this being applicable to power industrial plants. And, again, it's increasing our portfolio of applications.

Got it. Thanks, Renzo. Thanks, Brian. Thank you. Our next question comes from Scott Gruber with Citigroup.

Yes, good morning.

Hey, Scott.

Good morning, Scott. Brian, one for you on inflation. You mentioned that you're pushing through price increases to offset inflation, but a couple questions. One, are customers generally willing to accept the price increases across the portfolio? Are there some puts and takes we should be thinking about? And B, based upon the time lag, when will the price increases catch up with inflation that we've seen thus far?

Yeah, Scott, look, I'd love to tell you that customers, all customers say, yeah, sure, go ahead and pass on price increases. But look, they clearly understand what's going on in the commodity markets. We have some contractual arrangements that allow us to pass those along, and we're having discussions in places where it's not so clear. And look, we have seen some traction there and started to see some pricing power come back across the portfolio, not everywhere, but we're certainly, you know, seeing that capability. We did get some price in the second quarter, but as I mentioned, you know, it takes a little while longer for some of that to kick in, you know, versus the inputs that are coming in. So, look, I'd say over the course of this year we'll continue to push that. and, you know, try to make sure that the price increases are offsetting as much of the inflation as possible. The one thing I would point out, too, is that, you know, look, we've got a global supply chain. We've got pretty good contractual arrangements in place. And I've been working with our suppliers as we started to see this coming through to mute some of the impact this year. Obviously, we have some hedges in place as well. And, look, really focused on you know, looking at 2022 and making sure we're securing things for next year as well. So I'd say it's great collaboration with the sourcing and the commercial teams in working through this, but feel good about the actions that we've taken.

Got it. And then, you know, based upon your efforts there and your activity outlook, how are you thinking about the timing of when you could get back to the 20% EBITDA margin in OFS?

Yeah, look, you know, listen, Maria Claude and the team are continuing to do a great job in executing on all the restructuring and cost out and transformation initiatives that the team has been driving there. And you've seen that come through in the results here in the first half with the margin rate improvements that the team has posted. They're working hard to offset some of this inflation, you know, like we talked about here. And, you know, I'd say with the backdrop we see in volume for the second half of this year into 2022, I could certainly see us, you know, hitting that 20% rate, you know, sometime next year in any given quarter and be really well set up. as we execute in 2022 and exit the year. But I think that the team is doing a really good job of managing cost and driving productivity. And I think we're still on a really good trajectory here.

Got it. Appreciate the call, Brian. Thank you. All right. Great. Thanks, Scott.

Our next question comes from David Anderson with Barclays.

Hey, good morning. I just want to follow up on Scott's question there on that 20% margin. So, So maybe not timing, but maybe how do you get there? I mean, is it pricing? You talk about operating leverage, or is there a component of mix here that's required to get to that 20%? You talked about a couple of integrated drilling and well services contracts, which I assume are more accretive than traditional services. So is that another component here? Maybe just kind of talk about that mix, what do we have to see to get to that 20%.

Yeah, David, look, we're not counting on a significant mix shift to be able to deliver that level of margin. Sure, if some of the product lines that have higher margin rates get more tailwinds, that will certainly help. But we've taken the approach of driving improvement across the entire business. We've done a lot around remote operations. We've multi-skilled our the workforce to be able to deploy them in different ways and more effectively. We've made massive changes inside the supply chain and in our service shops, and you've seen us take a lot of costs out with the restructuring. And so a lot of those process improvements and costs out are going to, you know, continue, and that's really what's going to drive the margin rate. So the actions have already been launched. and the team is certainly executing on those. Now, the pricing that we're talking about here is really to offset some of the inflation that we're seeing, so we're not counting on any pricing increases to to drive that margin improvement. But if, you know, we can get those pricing increases to stick and hold inflation levels down, I think, you know, that could provide some upside. So it's been a fundamental change in how that business is operating, how Maria, Claudia, and the team are leading it, and how we're allocating capital. And that's really what's driving the improvement here. And we're making it fundamental and long-lasting.

Great. Thanks for the insight there, Brian. Kind of a different question, Lorenzo, sort of a bigger picture. We're starting to get more generalist investors back into the space here. People are starting to look and people are starting to buy into the cycle, starting to pick up. Now, Baker Hughes has a very different business portfolio than your peers. So I was just wondering maybe you could just kind of talk about kind of over the next two to three years, maybe helping people understand what parts of your business do you think are going to have more pronounced growth and margin expansion in And really, I guess what I'm asking, what parts of your business do you expect to outperform over the next two, three years as the cycle accelerates? I guess I'm just sort of thinking about your four segments and how you sort of see them kind of progressing here.

Yeah, David, if you look at it from a macro picture, and again, you look to the response given on the TPS cycle that's really taking place here with the opportunity of LNG in the You know, in our last call, we mentioned the addressable markets of hydrogen by 2030 being $25 to $30 billion and CCUS being $35 to $40 billion for Baker Hughes. So, clearly, as you look at the macro picture, the long-term growth prospects of our TPS business look very solid. Also, in the short term, with the continued rebound in some of the – Upstream and also the production side, oilfield services continuing to perform well. So short-term, you'll see that pick up, and longer-term, the TPS business continues to have a good future.

Great.

Thank you very much.

Thank you. Our next question comes from Ian McPherson with Piper Sandman.

Thanks. Good morning. Hi, Ian. Brian, you – hi. Hi. Good morning. Brian, you gave us the 50% free cash flow conversion from Eva Davogi for this year. And in that, you are overcoming the cash restructuring charges headwind. But also, on the other hand, year to date, you've had favorable working capital. So when we net those out or try to normalize for those looking into next year, it's 50%. free cash flow conversion from EBITDA a sustainable area, or would you point higher or lower than that when we normalize working capital and substantially remove the cash restructuring items?

Yeah, Ian, you know, as you know, it's really early to predict exactly what's going to happen next. you know, next year. But what I would say is our goal ability of this portfolio is to generate free cash flow conversion at the 50% level or higher. I think if you look at next year, probably the biggest variable that you probably know and you pointed out is really working capitals as we're early in the cycle for OFS. And the working capital, you know, intensity will really be driven by that pace of growth. And then if I step back and look at, you know, some of the other factors for next year, look, we'd expect to see EBITDA continue to grow on higher revenues and, you know, the continued focus around productivity. CapEx in absolute terms will be higher, but as a percent of revenue should be in the same range as it's been the last couple of years in that 3.5% to 4% range. You know, taxes will likely be higher because of the refunds that we've gotten this year. And then, you know, you pointed out restructuring and separation charging will go away. And so that's roughly, you know, $200 million, which should contribute to material improvement in free cash flow. So, you know, that 50% level is certainly what this portfolio is capable of, and we're going to keep driving it higher.

Understood. Thanks, Brian. Lorenzo, I was going to ask a separate follow-up regarding portfolio optimization. I would imagine that we've seen some more smaller OFS mergers and transactions recently, and I wonder if the improvement in oil field fundamentals has opened the window wider for any further disposals within the OFS or the portfolio that might be more achievable now than they looked a few quarters ago.

Yeah, Ian, I think, you know, our focus is on creating shareholder value and what's best for shareholders longer term. So we're running the company today really to execute on the three pillars of our strategy, transform the core, invest for growth, and also new frontiers. And, you know, we're going to be looking at margin accretion and continuing to allocate capital accordingly. I think as we look forward, you know, it's going to require from an energy transition perspective scale for an extensive customer reach and sizable R&D. So technology spending going into that. We think, you know, our current footprint provides for that. I think when you look at overall, it's becoming apparent that, you know, the new energy growth opportunities in TPS are significant, where when you look at the OFSE business, it's more of a mature business.

Certainly. Well, I'll stay tuned to that. Thank you both for all the insights today.

I think your next question comes from . Hey, thank you.

I first wanted to ask about OFS, the outlook in 22. You know, there's one of your peers reported the other day and said that they expect mid-teens compound annual growth over 22 and 23. I'm just curious, you know, how you're looking at that outlook and what you think specifically in 22.

Yeah, just maybe let's start off with the international outlook. And again, we do see a solid step up in growth internationally over the second half of the year. So far this year, we've seen strong recovery in Latin America, North Sea, Southeast Asia. The Middle East has somewhat lagged, but we expect incremental stronger activity over the course of the second half and into 2022, as well as in Russia being bigger contributors to the second half as well. So we've been somewhat more conservative in forecasting international activity. I think you know that. It really depends on how some of the regions come back. Right now, we think growth in the second half of the year could be in the high single digits or low double digits on a year-over-year basis, and we expect that momentum to continue into 2022 with solid growth opportunities. North America, you know, we generally expect the rig count to continue to trend a little higher over the second half. maybe adding an additional 50 rigs or so by the end of the year. So that would imply a modest improvement in the third quarter and fourth quarter. When you look at 2022, again, we anticipate solid growth with the prices holding at the range they are now. But similar to this year, you know, we expect some of the privates to be active at these prices, but some of the public EMPs also will continue to be only increasing their spending modestly as they continue to adjust some of their operating cash flow to some of the other areas of capital spending.

Got it. Thanks for that, Lorenzo. Shifting over to – you have these two awards with Air Products, and they've got very large projects that they're pursuing, but they don't come on stream until, I guess, NEOM is 25 and this thing in Canada, the Blue Hydrogen, is 24. Do those projects need to be up and running for the floodgates to kind of open on these types of awards, or could we see more from-air products for Baker Hughes over the nearer term?

You know, I think it's fair to say that we're seeing a number of discussions with customers and partners continuing to gain momentum. It's great to have achieved the announcement with their products and Again, when you look at those orders converting, we expect it to be in the near term. And I think that, again, as these projects start to get on the go, you'll see others also follow as well. So we're focused on enabling the technology. And, you know, with our products, we're going to be on the largest blue and green hydrogen projects that are out there at the moment providing our best technology.

Yeah, Mark, and I would just add, actually, in terms of, you know, bid activity and inquiries with customers over the last six months, they're up 2X what we were seeing in the fourth quarter of last year. So activity levels have definitely increased. I expect to continue to see that to increase. And, you know, look, exactly when they'll turn into orders, it's a bit tough to say right now, but there's a lot going on.

Got it. Thanks very much, guys.

Thanks, Mark. Our next question comes from Arun Jayaram with JP Morgan.

Yeah, good morning. Lorenzo, a number of announcements on the ET front during the quarter. I was wondering if you could maybe talk about some of the competitive dynamics in CCS, you know, your views on Baker's position, and maybe just as a follow-up, could you talk a little bit about the scope of the Borg project and how do these initial projects in CCS, line up? You know, could these be accretive to your margins, assuming, you know, good execution?

Yeah, firstly, I think I feel very good about the positioning that we're developing around CCUS. And if you look at it from a value chain perspective, we really go across the board of CCUS from the initial identification of where CO2 can be sequestered all the way to the transportation and also the compression capability. We've also developed multiple solutions for CCUS you've seen in the past. We've got the chilled ammonia process. We've got the mixed salt. We've also got compact carbon capture. So, you know, we're providing the different solutions because there's no one solution that's going to be for everybody. And like in LNG, we want to be able to provide capabilities for small, medium, and large scale as they get undertaken. Specifically on Borg, you know, the Borg MOU announcement allows us, again, to really play at the forefront of capturing and storing up to 630,000 tons of CO2 emissions annually. And, you know, they're going to be utilizing our technology to do that. And we're also going to be able to see an industrial cluster approach. That's a great opportunity for us because we think those industrial clusters are going to continue to emerge elsewhere in the world as well. So Norway is at the forefront there. And we're at the forefront with both CO2 and also the Norwegian lights.

Great. And just my follow-up is just on digital. It sounds like just the margin missed this quarter is just driven by a one-time legacy contract. And as if maybe you could outline, do you still feel good about, you know, trending towards perhaps a low double-digit margins as we go through the year on digital?

Yeah, we do feel good about the volume recovery. We're seeing in quite a few of the end markets, particularly on the industrial side of DS and you know, we were disappointed in the margin rate, which was really a function of, you know, project delays for this legacy software contract. And just to clarify, this legacy software contract goes back several years and isn't associated with, you know, our C3.AI partnership. And so this resulted in some, you know, higher cost and not revenue here in the quarter. And that was the biggest driver. I will note there was a little bit of incremental costs we had in the R&D front in DS this quarter related to some strategic areas like the arms reliability acquisition that we did earlier in the year and some acceleration of some work we were doing around emissions management. And I'd say looking ahead into third and fourth quarters, I don't expect the overall level of costs in DS to be at the levels that you saw here in the second quarter. So we do think the business is going to be back on track to generate higher margins with the volume growth that we're seeing and cost levels back to, you know, lower levels to support those higher margin rates.

Great. Thank you. Thanks a lot. Our next question comes from Stephen Gengaro with P4.

Thanks. Good morning, gentlemen. Hi, Stephen.

I was curious, you've talked a lot about, you've done a tremendous amount on the energy transition front, and I was curious if you could talk more about the collaborative relationship you have with Bloom.

Sure, Steve. And, you know, we're very pleased to be collaborating with Bloom on a number of customer engagements which really are going to come to the forefront of the course of the next two to three years on really looking at the way in which we can provide integrated power solutions, and also the way in which we can provide integrated hydrogen solutions. So I think you may know that Bloom Energy is a leading player in solid oxide fuel cells, and really it enables us to provide our technology of lightweight gas turbine technology within their proficient technology. to really enable integrated power solutions for customers that are looking to be independent of the grid. We've got the NOVA LT gas turbines. So we're looking at opportunities of combining there. And then on the integrated hydrogen solutions, they've got an increasing portfolio of electrolyzer cells that can produce 100% clean hydrogen. And with our compression technology, we think we can provide really a efficient production and also transport of hydrogen and usage again, with our 100% NOVA LT gas turbines that can run on hydrogen and our compression capability. So it's an evolving space here, and we think a lot of good opportunities as the energy transition continues.

Very good. Thank you.

Our next question comes from Connor Leidenhag with Morgan Stanley.

Yeah, thank you. I was wondering if you could just discuss some of the trends you're seeing in OFV. Obviously, a nice trend. inflection in orders in the quarter here. Based on that and what you're seeing right now, obviously you're anticipating a step down in the third quarter, but would you say the direction of travel beyond that seems to be higher? And I'm wondering if you could just characterize the big end markets within that business.

Yeah, if you look at, again, OSE, and we've mentioned this before, we continue to see the outlook for the offshore segments challenged. We do expect you know, a modest improvement in the industry of awards during 21 and some additional growth in 22. But we still think it's going to be difficult from a tree perspective to get back to the 2019 order levels. We are seeing some strength on the composite flexibles, as you saw from the Petrobras frame agreement. Also, some international well-held business, which is good, and subsea services coming back. But again, as you look at... You know, overall, I think it's a subdued growth trajectory for RFE.

Understood. At the same time, you guys have obviously taken a lot of action on costs. So is there a sort of target that we should think of similar to the 20% EBITDA margin target in OFS? You know, how do you think this business's earnings power should be in this lower activity environment?

Yeah, Connor, absolutely. OFE has done a great job in terms of taking costs out, restructuring their infrastructure to deal with the lower industry volume that we're seeing. I'd say just given the mix of the portfolio and where things are, we talked about the business at these volume levels being high single digits from an operating income rate standpoint. I think if you roll forward, you see some incremental growth come in in flexibles and some, you know, other things beyond tree growth around, you know, manifolds and, you know, the onshore business doing better. You could get higher than that. But right now, based on the trajectory of the industry right now, I'd say, you know, in the near term, near to medium term, expect high single-digit operating income rates.

Okay. That's helpful. Thank you.

Well, ladies and gentlemen, that concludes the Q&A portion of today's conference. I'd like to turn the call back over to Lorenzo for any closing remarks.

Yeah, thank you very much, and thanks to all of you for joining our earnings call today. I just wanted to leave you with some closing thoughts. Very pleased with the second quarter results. We generated another quarter of strong free cash flow and saw good levels of performance across a number of our product companies. We also see a multi-year growth opportunity developing in our TPS business driven by the LNG and new energy initiatives. As we continue to execute on our strategy of becoming an energy technology company, We'll maintain our discipline and prioritize free cash flow and returns. We'll also continue to evaluate our portfolio in order to drive the best financial results and create the most value for our shareholders as the energy markets evolve. So thanks for taking the time. Look forward to speaking to you again soon. And, operator, you may close the call.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone have a great day.