Q4 2019 Earnings Call
Good day, ladies and gentlemen, and welcome to the Baker Hughes Company fourth quarter and full year 2019 earnings call. At this time all participants are any lift.
And the only mode. Later, we'll 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 touched on telephone.
As a reminder, this conference call is being recorded.
I would now like to introduce your host for today's conference Mr. Jud Bailey, Vice President of Investor Relations, Sir you may begin.
Thank you good morning, everyone and welcome to the Baker Hughes Company fourth quarter and full year 2019 earnings Conference call here with me are our chairman and CEO Lorenzo Semiannually, and our CFO Bryan Laurel the earnings release, we issued earlier today can be found on our website at Baker Hughes Dotcom.
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 web site for a discussion of some of the factors that could cause actual results to differ materially.
As you know reconciliation to the operating income and other non-GAAP to GAAP measures can be found in our earnings release with that I will turn the call over to Lorenzo.
Thank you John .
Good morning, everyone and thanks for joining us we delivered a solid fourth quarter with strong orders in our travel machinery and also the equipment segments.
Solid operating performance from our TPS business strong free cash flow and better execution in our digital solutions business.
These positives were partially offset by weaker than expected margin performance from our RFS business.
For the full year 2019, we achieved a number of key milestones, including 20% year over year order growth in GPS almost 300 basis points of margin improvement in TPS, 12% order growth in our fee and free cash flow of $1.2 billion.
In addition, we accelerated our separation efforts from GE.
Launched on New company brand and positioned ourselves to compete more effectively and a changing marketplace.
No. Thank our employees enough for their hard work and dedication to achieve our goals throughout the year.
As we look into 2020 , we see a macro environment that is slowly improving as well as a range of opportunities to further strengthen Baker Hughes on both a near term and long term basis.
In the near term, we continue to identify and execute on opportunities to improve our day to day operations and cash flow efficiency in 2020 .
Looking out on a longer term basis, we see a number of attractive growth opportunities for our company and we remain focused on positioning Baker Hughes for the upcoming energy transition and the digital transformation of the industry.
This balance between near term and long term objectives can be found in each of the strategic goals that I highlighted on our last earnings call.
To remind you. These goals are one margin improvement in our oilfield services and oilfield equipment businesses.
To evolving our portfolio, specifically leveraging some of our unique core competencies to expand our offerings in the industrial and chemical end markets as well as improving our position for the energy transition and free continuing to expand our digital offerings to drive greater efficiency as well as safer and more reliable operate.
And for our customers together with our partner see free.
Over the last several months, we have spoken at length about our first goal of execution and operational improvement.
Which remains an important focus for Baker Hughes in 2020 .
However, today I'd like to spend some time, providing insight on how we're thinking about our goal of portfolio evolution and positioning for the energy transition.
As you know energy transition is an important topic that has gained a significant amount of momentum in the industry and in the investment community over the last six to 12 months.
As we've stated previously Baker Hughes is firmly committed to playing a leading role and a lower carbon future.
One year ago, we made our own commitment to achieved net zero carbon emissions by 2050.
And our corporate strategy remains clearly focused on being the leading energy technology company to help facilitate the energy transition.
As we look ahead to the next two decades, yes, various published forecast on the long term demand outlook for hydrocarbons and the expected growth rate for renewable energy sources.
Within these forecasts are a wide range of predictions for growth or peak demand for the different types of hydrocarbons in the coming decades.
Our view remains that in almost any scenario natural gas will be the key transition fuel and perhaps even a destination fuel for a lower carbon future.
As a result, we believe the natural gas demand will grow up more than twice the pace of oil over the next 10 years and that LNG demand growth will be higher still at an annual rate of 4% to 5%.
Against this backdrop, we believe that Baker Hughes is uniquely positioned to provide technologies and solutions that help our customers lowered their carbon footprint.
While there is a strong recognition of our world class LNG franchise. Our broad portfolio also offers a wide range of products that help customers lowered our carbon footprint today and that are directly tied to the continued growth in renewable energy sources.
Some examples of these products are well known like our LM 9000, Aeroderivative gas problem, which can reduce nox emissions by 40% and overall seo to equivalent admissions by up to 25% compared to alternative turbines in its class.
However, there are broader system level uses where our TTS equipment has the opportunity to be deployed and carbon reduction applications.
For example, our core technologies and compression has the capability to help deliver carbon capture utilization in storage and we are actively marketing these solutions to customers today.
In one application, we reconfigured our Nova L. T gas turbine generator technology to operate 100% on hydrogen and we continue to explore opportunities in the hydrogen value chain in both transportation and production.
As another example, turbo machinery equipment can be used to help deliver mechanical storage of energy for use in peak demand for renewables, enabling customers to store and deliver renewable source energy to the grid efficiently and effectively.
In addition, we see free new technology areas emerging as part of the energy transition for which our digital solutions segment is uniquely position.
The first is emissions monitoring where our products such as lumen and advertise on directly applicable.
Luminance, a suite of meat fain monitoring and inspection solutions and advertise office not inspection and monitoring service solutions in both land and aerial applications.
The secondary as emissions reduction, where our flare acute flare management system allows downstream operators to reduce flaring emissions by 90%.
The fat area is condition monitoring for renewables specific getting wind turbine application.
Bentley, Nevada business within digital solution has monitoring devices, which ensure deductibility of the most costly and critical drive train failure modes.
Deployed on more than 32000 wind turbines globally, a tremendous installed base, we have built over the last decade.
While these technologies combined represent a small percentage of Baker Hughes overall revenue today, they are products and services that we believe have a great growth potential and also provide a strong platform for future product introductions and carbon based initiatives with customers.
As we execute on these near term and long term strategic initiatives. We are also mindful of the ever changing macro backdrop across the energy markets.
This note we generally believed that macro fundamentals have slightly improved over the last few months as dynamics from both the demand and supply side have become more positive.
With that said our incrementally positive view of the macro environment is tempered by growing geopolitical risk most notably in the middle East under the demand side the outlook for oil and gas at modestly improved with the recent phase one trade deal the slight improvement and PMI is for key economies and continued positive economic data.
Outside the U.S.
We believe that these variable should be supportive of affirm oil demand outlook in 2020 and one in which our customers will continue to execute their budget plans and advance important projects.
On the supply side. The outlook has also fans with another recent round of OPEC production cuts and more signs of slowing U.S. production growth.
Importantly, we believe the continuation of solid demand growth combined with the growing commitment to MP capital discipline help support a more constructive macro outlook.
However, we believe the continuation of these trends could begin to reduce excess crude inventory by later this year or into 2020 , one as for multiple years of growth internationally.
Although the macro environment appears to be improving our overall outlook for RFS and other fee segments remain largely unchanged from the framework, we outlined on our first quarter earnings call.
For our FX segment, we now believe that North America DNC spend in 2020 is trending towards the low double digit decline rate pressures 2019.
This view is based on early MP budget announcements and the lower exit rate in the fourth quarter of 2019.
We continue to believe that our differentiated RFS portfolio will provide somewhat of a buffer to the challenges in the north American markets.
Internationally, our expectations remain mid single digit growth, but with a slight bias to the upside driven primarily by an improving pipeline of opportunities.
And the or a fee segment our outlook is for the subsea tree markets remained stable around 300 trees and 2020 , we expect to maintain our position in the sub sea market driven by strong execution for customers and continued traction with our sub sea connect strategy.
So TPS why we do not expect the exceptionally strong year for LNG, Fridays and 29 team to repeat and 2020 . Our outlook for this segment remains constructive as we execute the largest backlog and the company's history and expect continued growth and services and non LNG equipment Awards.
But the LNG portion of our TPS segment, our outlook remains constructive despite some softness in near term spot prices conversations with our customers have not changed materially.
If spot price weakness persists, we would expect this to shift the balance for future if I'd towards more economically advantaged brownfield projects in the 2021 to 2025 timeframe.
We were pleased to see around 90 mtpa of LNG F.I.D.'s between the fourth quarter 2018, and the end of 2019, while just short of the 100 Mtpa. We fought the industry could f. I'd in this period, we believe that if I'd activity in 2020 should remain solid and at least in line with the average annual F.I.D. level.
Witnessed in the prior cycle between 2011 and 2015.
And our digital solutions segment, we continue to believe global GDP growth is the most relevant metric by which the forecast this business given the variety of end markets itself.
The oil and gas market drives approximately 50% of the EPS revenue was 20% coming from the power market and the balance from a number of industries, including aerospace automation consumer electronics and other industrials.
We have over 90% of DS revenue coming from hardware and associated software solutions across a range of brands such as Ben in Nevada, Nexus controls truck kind of metrics and work to Stokes. This is a mature stable business with the best in class measurement sensing and inspection technology.
In summary, we delivered a solid fourth quarter and full year 2019, we're clearly focused on executing our strategy and generating strong free cash flow improving margins and driving returns.
With that let me turn the call over to Brian .
Thanks, Lorenzo I will begin with a total company results and then move into the segment details.
Orders for the quarter were $6.9 billion up 1% year over year and down 11% sequentially. The year over year growth was driven by strong orders and oilfield equipment sequentially. The decrease was driven by Turbomachinery, which booked a very large LNG order in the third quarter.
Remaining performance obligation was $22.9 billion up 3% sequentially equipment ARPO ended at $8.1 billion up 10% sequentially and services, our PEO ended at $14.8 billion.
Our total company book to Bill ratio in the quarter was 1.1, and our equipment book to Bill in the quarter was 1.2.
Revenue for the quarter was $6.3 billion up 8% sequentially, driven by Turbomachinery digital solutions and oilfield equipment offset by oilfield services year over year revenue was up 1% driven by Fs and aware fee offset by declines in TPS NDS.
Operating income for the quarter was $331 million, which is up 11% sequentially and down 13% year over year.
Adjusted operating income was $546 million, which excludes $216 million of restructuring separation and other charges, we incurred $135 million of new restructuring charges in our own fs business during the quarter as we continue to work through a new phase of cost out in productivity initiatives.
These are primarily focused on supply chain optimization, improving asset utilization and driving down product and service delivery cost separation and merger related charges in the quarter were $57 million.
Adjusted operating income was up 30% sequentially and up 10% year over year, our adjusted operating income rate for the quarter was 8.6% up 140 basis points sequentially and up 70 basis points year over year.
Corporate costs were $118 million in the quarter, which is modestly higher than third quarter levels and our initial expectations. A few months ago. We expect the corporate line to increased slightly from this level than 2020, as we continue to accelerate our separation efforts I will go into more detail on these costs in a moment.
Depreciation and amortization was $354 million down sequentially and flat year over year, we expect depreciation and amortization to remain around this level in the first quarter of 2020.
Tax expense for the quarter was $212 million, which was higher than expected driven by the geographic mix of earnings and certain year end provisions.
GAAP earnings per share were seven cents down three cents sequentially and down 21 cents year over year.
Adjusted earnings per share were 27 cents up six cents sequentially and up one cent year over year.
Free cash flow in the quarter was $1.1 billion, which was above our expectations, we delivered $639 million from working capital driven by strong collections and inventory management in Lss as well as progress collections and TTS Endo FC overall, we're very pleased with the cash performance in the fourth quarter as fast.
Our improvements after the shortfall in the third quarter.
We continue to see improvement in our working capital processes and are focused on optimizing our cash operations to ensure we deliver on our free cash flow conversion target.
When I look at the told a year 2019, I'm pleased with our financial results, which reflect our consistent execution on the priorities, we set out at the beginning of year.
Orders for the full year were up 13% in 2019, driven by 20% order growth in TPS and 12% order growth in the west fee.
TPS book to Bill was 1.4 in the year and LSD book to Bill was 1.2.
Full year revenue was up 4% are aware fs and aware fee businesses were both up 11% offset by declines in TPS and DS.
Despite a challenging macro environment for the broader energy market, we were able to grow total company adjusted operating income margins by 60 basis points.
We drove margins higher in three of our four segments with improvements of 270 basis points in TPS 190 basis points in the resi and 40 basis point to know Fs offset by a 120 basis point decline in DSS.
Overall, the result of each of our product companies are in line with the framework, we outlined at the beginning of the year.
Corporate cost for the year were $433 million as I mentioned, we expect to incur an additional 50 to 60 million of corporate cost in 2020 related to the ramp up in separation efforts.
We have a significant number of transition services agreements in place with GE across a range of functions, including I.T. HR Treasury and other infrastructure to ensure we maintain the continuity of our business operations Importantly, we expect these incremental costs to recede and 2021 as we roll off the transition services agree.
Payment and utilize our own systems.
In conjunction with the separation activities. We're also taking the opportunity to upgrade our systems and sunset some aging processes and infrastructure to ensure Baker Hughes is best positioned to drive further efficiencies in our operation, which should lead to higher margins.
We generated $1.2 billion of free cash flow in 2019, we were very pleased with our cash performance in the year and continue to improve our working capital metrics.
We invested $976 million in net capital expenditures in 2019, and we expect to see similar net capex levels in 2020.
Included in our 2019 free cash flow results are $307 million of restructuring separation and merger related cash outflows as we have outlined we expect restructuring related outflows to decline in 2020 offset by an increase in separation related cash outflows.
Given the strong level of free cash flow generated in 2019, we ended the year with $3.2 billion of cash on hand, and net debt of $3.4 billion. After returning $1 billion of cash to shareholders do buybacks and dividends, we continue to see our balance sheet as a key strength and differentiator indices.
Cyclical industry.
Now I will walk you through the segment results in more detail and give your thoughts on the outlook going forward.
In oilfield services. The team continues to navigate a challenging environment in North America, while driving strong growth internationally.
Oh Fs revenue in the quarter was $3.3 billion, which was down 2% sequentially North American revenue was down 11% sequentially, driven by declining rig count and weaker completions and us land as well as a double digit sequential decline in our Gulf of Mexico operations.
International revenue was up 4% sequentially driven by continued growth in the Middle East Asia Pacific and Latin America.
Operating income in the quarter was $235 million down, 14% sequentially and margins declined 110 basis points.
Fess margins were below our expectations, primarily due to weaker north American results and lower product sales than originally planned despite coming in slightly below our expectations. We believe the margin headwinds in the fourth quarter are largely transitory and our expectations for 2020 are unchanged as we look at 2020 for our office segment, we expect Internet.
Actual spending to increase in the mid single digit range with most of the growth coming from a number of offshore markets and regional strength in the middle East North Sea and parts of Latin America.
Given our focus on execution and improving margins I would expect our international Fs business to generally tracked in line with industry trends.
In North America, we expect us DNC spend to declined low double digits versus 2019 as domestic MPS continue to restrained spending to generate more free cash flow.
Similar to 2019, we would expect revenue for our North American Fs business to outperform industry spending trends given our production weighted mix.
For margins, we expect to deliver year over year growth driven primarily by our cost out and productivity enhancement actions I will also reiterate that over time, our goal remains to close the margin gap with peers. As we look ahead to the first quarter, we expect North America to get off to a relatively slow start and expect typical seasonal trends in key eastern hemisphere.
Your markets like the North Sea in Russia.
As a result, we expect total RFS revenue to experience a modest sequential decline and for margins to decline slightly but still remain well above year ago margin levels.
Next I will cover oilfield equipment.
Orders in the quarter were $1.1 billion up 6% year over year, driven by growth in both equipment and service orders equipment book to Bill and fee was 1.7, we booked several key awards in the quarter totaling 22 trees, which brings our 2019 total to 73 trees with this level of away.
Award, we maintained a similar position in the market as in 2018.
Revenue was $765 million up 5% year over year. This increase was primarily driven by better subsea services activity and subsea production systems volumes, partially offset by lower revenues in flexibles.
Operating income was $16 million up 28% year over year, driven by increased volume and Sps.
Operating margins were up 20 basis points sequentially and up 40 basis points year over year.
As we look at our Olathe segment in 2020, we believe that offshore market fundamentals should support another solid year of orders with subsea tree awards expected to remain relatively consistent with 2019.
For 2020, we believe that Olathe should see revenue growth in the high single digit range. Following two years of strong orders growth.
We expect volume growth in Sps and improving mix from Flexibles to drive solid margin improvement in our fee in 2020.
For the first quarter, we expect the trend of year over year revenue growth to continue as we execute on the positive momentum from our Sps and Flexibles product lines.
Based on our anticipated project conversion schedule, we expect fee revenues to increase in the mid single digit range on a year over year basis, along with modest margin improvement.
Moving to Turbomachinery orders in the quarter were $1.9 billion down 10% year over year.
Equipment orders were down 16% year over year and equipment book to Bill was 1.5 during the quarter, we booked an award for the liquefaction equipment onto calls Mozambique area. One LNG project and we had some important wins in onshore offshore production, including two ESP DSO Awards in Latin America.
Service orders in the quarter were down 4% year over year, mainly driven by lower contractual services offset by higher transactional services and upgrades.
Revenue for the quarter was $1.6 billion down 8% versus the prior year.
For the quarter services revenue was down 2% versus the prior year and equipment revenue was down 18% driven primarily by business dispositions.
Operating income for TPS was $305 million up 19% year over year, driven by higher services mix and cost productivity.
Operating margin was 18.7% up 430 basis points year over year end up 520 basis points sequentially.
Overall TPS results for the quarter came in slightly above our expectations with a much stronger margin rate offsetting revenue that was below our expectations, while the supply chain issues that impacted the third quarter lingered into the fourth quarter. The primary driver behind the lower than expected revenue was slower conversion of our equipment backlog than we anticipated.
Right and the team have done a very good job of managing cost and execution as they work to deliver on the largest LNG equipment backlog and TPS as history.
The 2020 outlook, we provided for TPS last quarter remains largely similar given the consecutive years of strong order growth in 2018, and 2019, we expect year over year revenue growth of roughly 20% and from margins to continue to expand I would note. However that our current expectation for revs.
New conversion is weighted more towards the second half of the year based on project timing for orders, we still believe that TPS could be flat to down low double digits compared to 2019 levels. As you know timing on large projects can vary with strides a wide range of scenarios.
As we think about the first quarter, we expect TPS revenues to be roughly flat with first quarter 2019 levels given the equipment conversion schedules that I previously mentioned.
On the margin front, we expect to show solid improvement on a year over year basis.
Finally on digital solutions orders for the quarter were $645 million down 4% year over year growth in our controls and inspection businesses was partially offset by declines and measurement and sensing and pipeline in process solutions regionally, we saw strong orders growth in Asia, and the middle East offset by did.
Clients in the other regions.
Revenue for the quarter was $659 million down 5% year over year, primarily due to the sale of the digital ATM product line.
Excluding the impact of this disposition revenue was down slightly with growth in Bentley, Nevada inspection and measurement and sensing offset by declines and controls and pipeline and process solutions.
Operating income for the quarter was $109 million down 5% year over year, driven by lower volume.
Despite the decline in year over year revenue, we delivered on productivity and cost out to hold the margin rate flat versus the fourth quarter of 2018.
Looking ahead to the full year 2020 for DS, We continue to expect revenue growth in the low single digits and modestly higher margins. This outlook takes into account at GDP plus growth rate, but anticipates that DS is likely to see some continued softness in the power business.
Revenue growth will also be impacted as we tibbett, our software strategy with the sale of the digital ATM offering and work closely with our AI partner C on new opportunities.
For the first quarter, we expect revenue to decline in the mid single digits year over year and for margins to decline modestly due to the nonrepeat of a large project in the first quarter of 2019.
In closing, we delivered a strong fourth quarter, finishing at a solid 2019 for Baker Hughes as we look forward to 2020, we are clearly focused on executing our strategy and generating strong free cash flow improving margins and driving returned with that I will turn the call back over to John .
Thank you operator, let's open the call for questions.
Thank you if you have a question at this time please press the star than the one key on your Touchtone telephone. If your question has been answered you wish to move yourself from the Q. Please press the bounty we ask that you. Please limit yourself to one question unrelated follow up.
Our first question comes from James West with Evercore ISI.
Hey, good morning, gentlemen.
Hi, James.
So the Rins, though.
You guys recruiter leaders in the energy transition here and I wanted to to maybe talk a little bit higher level of the various buckets you're attacking this mean clearly natural gas is a big part of the strategy. We have some some lead products. There you also have your own internal SG plans and goals many of which you.
And highlighted over the last.
The year, but then you also products and services did hit all ports the carbon chain, whether that's monitoring and then carbon capture so how do you think about I mean, if a bucket those into those three years. That's the way you think about it if not please let me know how do you think about which ones do you want to you allocate more capital to less capital too.
Do which is a bigger.
Growth drivers maybe in the intermediate term for for Baker, and I guess, what is your overall strategy.
Good afternoon. Thank.
Thanks, and as you know the energy transmission NB.
Theme of any transition has gained a lot of attention over the course of the last 12 months a year ago, you'll recall that we actually made our commitment relative to reducing our own carbon footprint top 50% by 25 and achieved net narrowed by 20 safety and as you look at Baker Hughes, We've really got playing a critical role at the.
Turning to transition across a number of areas given our broad portfolio and I highlighted some of those van.
Script.
<unk> was pad, but as you look at some of the key areas. The fast I'd say is as you look at natural gas and you look at LNG clearly for the any do transition and reducing the amount of Seo too there's going to be increasing use of natural gas as a transition but also destination.
Target and we see that LNG is going to continue to grow over the next few decades, even as renewables grows as well and Thats a key focus for us with the introduction that we've made of the about 9000 I also our fast application of the Nobel tea, which is hydrogen based so clearly I shift towards.
On the rotating equipment side, helping in the energy transition beyond that as you look also the digital solutions platform.
Clearly with what we have as lumen and also Abbott's has these are.
Solutions that enable customers to monitor and also understand how they can reduce carbon footprint. So you look at opera portfolio, we're uniquely positioned and Thats why we say from a standpoint of moving Energyforward. Then also being in energy technology company, we're going to be helping our customers.
Some partners through this energy transmission.
James If you look at how we're allocating capital clearly, we're continuing to invest in TPS, which is having an impact today, we've got lots of opportunities.
Jason fees.
In Tvs, we can put a little bit of capital to work either through technology development or some partnerships and can grow our footprint. There and then digital solutions you know, it's a high margin business get good returns will continue to invest capital. There. So I think you'll see us balanced capital allocation with short term and in long term as we continue to pivot the portfolio.
Of energy transition. So we'll update you if there any any changes to that but I think we've got a pretty good approach.
Right now to drive short term growth and margins as well as position the portfolio for the long term.
Totally agree.
Maybe a follow up vote on the LNG pricing.
Issue.
Short term pricing weakness has impacted perception of the LNG liquefaction Buildout story, but it seems to me that well two things one that hasn't really changed the conversations on the.
Better capitalized projects of and number two lower prices now probably even better demand in the future for for LNG or those fears statements that are making and do you agree that no that's not going to cause any real weakness in the kind of build off cycle beyond the <unk> I know you'll see the same record year, we saw last year, but.
But other than we're pretty much full steam ahead.
Add James you're looking at the right way if you look at Vsan LNG spot price weakness it doesn't change the overall long term LNG demand and supply dynamics and in fact, the conversations we're having with our customers already towards to continue.
Demand for LNG over the long term and if you take a step back.
You look at where we're going to be by 20 fatty acid, it's going to be between 550 to 600 million tons of demand and to produce that you're going to need 700 million tons of installed capacity, so even with where we are today with.
The construction of 16 Mtpa and also the 90 that was that by the last year you still got another 150 to 150, that's Gotta go into next coming here. So.
We feel good about the LNG space and we feel good about the longtime aspect of it.
Thank you are next question comes from anticipated over Goldman Sachs.
Good morning, guys.
Angie Angie.
So I appreciate the details Brian on on a revenue side, when we think about 20 twinkie wine, but if we can drill down a little bit on the margin side thoughts around oilfield service margins in 2020, you're not where you really want to be thats. How much self help you think you could have billion a year for 2020.
And when do you think with respect to see some parity versus your peers.
Hi, Andy you know look we did see margins below where we wanted them to be in the fourth quarter and there wasn't really one thing.
I can point to that says was the main driver there were a couple of things going on that email impacted the margin rate I'd say, it's a first as we saw slightly.
Lower than anticipated activity in the us land market for us, which we think was really largely customer in basin.
Specific we also saw as we you know went into the ended the year some weakness in our Gulf of Mexico operations, which obviously carries.
Hi, or margin rates for for obvious reasons, there and then lastly, I'd say our product sales.
Were lower than we anticipated we knew they were going to be lower because if you remember we had a very strong third quarter as we accelerated some of those product deliveries to meet customer demand and we did have some of those slipped out of the quarter. So those three things combined.
Put pressure on the margin rate versus what we expected, but based on what I'm seeing today. They are largely transitory in nature and I don't see them impacting us as we roll into 2020 units if I look at 2020.
We expect a large portion of that margin improvement.
To to as you say be self help with cost out and productivity initiatives.
And that we're driving and you saw we posted some restructuring reserves in the quarter as we have very specific programs in supply chain in service delivery across Maria cloudy as portfolio to help drive the margin rate improvement and I'd say that the other thing that supports margin rate improvement in 2020 is we're reading.
Are you getting to the maturation phase of some of the larger integrated contracts internationally, where we saw some ramp up costs. This year and we've we've come up the learning curve. So I can see strong margin improvement in those contracts. So that should certainly help the overall margin Baden if if I look at the overall cost out in productivity in it.
Should if they are really in two buckets, Angie one is around efficiency and operations optimization and the others around product cost. So for instance around product costs, we've been working for quite some time with the engineering and product teams and identify specific areas, where we can go in and drive cost out some of that is target costing some of its looking at a broader.
A supply base and some of its looking at overheads to see how we can leverage overheads globally more efficiently on the efficiency and productivity side. We're looking at a lot of opportunities to cross trained individuals to make sure. You don't have to said multiple people who were going to have idle time, when they're out on a rate again it's.
Taken us some time to really get through those details and understand how to attack that boat with what we put up in restructuring in the quarter. The plans we have in place we feel good about our ability to continue to grow margins in 2020, no. It fast. So our framework is is really unchanged and and Maria clouding. The team is as well as all enterprise or folk.
I'm getting those margin rates up.
Thanks. Thanks, that's very helpful. Grant I appreciate that there may be unfunded the same thing around TPS given the strong backlog already had in hand thoughts around margins for 2020, I think you've said in the past maybe low to mid teens is that still a fair assumption and do you think ultimately that the high teens is where you would consider your run rate.
Yeah.
I'm very pleased with how rod and the team have closed out the year are managing customer expectations with this incredibly large backlog in balancing.
Cost and returns as a as they go through this so pleased with where they are today look our outlook for 2020 margins again largely unchanged from what we've talked about in the last call in just to remind you. There are few dynamics that come into play that really impact how much margin accretion will have in the year.
Our first you know, we expect contractual services and transactional services to grow in 2020, which is accretive to margins you mentioned to you know the large backlog the largest it you know in our history, we will see more LNG equipment revenue come through in in 2020, while that is accretive to own.
Overall equipment margin. It does have a negative mix effect as we talked about for the for the total business and then we are in the early stages of executing on the two very large LNG projects, Arctic too and Vg, which tend to have their lowest margin point at the beginning of the.
Execution and you start to see that accrete over time, so that will that will have an impact payer and then we've talked a bit about the technology spend in TPS and we said we were evaluating that and back actually the changes earlier question, we see a lot of opportunity in energy transition to continue to grow this franchise.
And strengthened its position in the marketplace. So I'd expect technology spend to be roughly where where it is this year. So if you add all that up you know I'd say that the more revenue we have the faster grows impacts the magnitude.
Of the upside in margins and you saw that come through in the dynamics third and fourth quarter and how strong the services was versus the versus the equipment, but overall goal is to continue to drive margin enhancement in the business and over time, you know, we do see mid to high teens as revenue normalizes.
Finally on services continue to grow and with the large equipment backlog. We have now 15, LNG, you'll start to see that services backlog grow overtime as we signed customers up for long term service agreements. So you know largely unchanged tailwinds in the business and I think rod and the team are doing a great job managing through that.
Thank you. Your next question comes from Chase Mulvehill with Bank of America Merrill Lynch.
Hey.
Good morning, I guess I wanted to come back to the TPS service.
Commentary.
Earlier, you talked about the largest LNG backlog in the history.
Kind of touched on some of the digital thing is that you're doing could you talk a little bit about you know the opportunities that you have allowed us the LNG service side with this significant backlog and then you know what digital ultimately means for.
The TPS sort of LNG service business.
And potentially maybe some shift over to the contractual side of the services business.
Okay. So look I you know.
Happy with how the services businesses is performing in TPS and on a reported basis for the year. The service revenue was flattish or slightly down you take into account some of the dispositions that we had as well as the impact of FX for the total year revenue actually was up mid single digits operationally.
So performing pretty much in line with how you'd expect this portfolio to perform and you know this year. It represented about 60% TPS is a revenue and well obviously change over time as the equipment starts to convert and as you pointed out contractual services is a big piece of that as our.
Transactional services met contractual services backlog.
He is about $13 billion.
Today, and we expect that to to continue to grow and just to round out services, we do have installations.
And upgrades, including there as well as some services on pumps and valves, but the large majority are contractual services. If I take a look at the transactional piece, we had growth in 2019 in mid single digits I would expect that can to continue in to 2020.
And from a digital standpoint lots of opportunities in the services portfolio, one internally to help us operate better and use our partnership with C. We've got tons of date on this equipment and and how we operate in the field, we think that C can help us unlock even more internal productivity.
As we execute on the service contracts and provide transactional services an upgrade and in addition, there are opportunities to introduce some of this into these contractual services to help the customers equipment performed better and then there's lots of things we can do with the data.
That that we have from things that aren't on contractual services and put together offerings for costs customers to help drive better productivity.
And better uptime for for the equipment. So I think it's an untapped opportunity right now we're not counting on a lot of that as we roll into 2020, we'll be working a lot with C and I and our teams and and I would expect to see some of those digital things kick in in the outer years to having meaningful impact on on revenue.
Okay very good chase just maybe to add if you look at on the digital side and the sea freight partnership we've actually launched already too.
Solutions into the marketplace, one around reliability, which really targets the uptime for the equipment in that can be applied to the service agreements and drive efficiency and productivity and then also optimization and so really as we look at the next few years digital is a key area of focus on its going to drive love them efficiencies.
Got it understood. Thank you wouldn't real quick follow up.
Obviously, you got the GE offering overhang out there still could you talk to you know how much Neo Baker Hughes would look to repurchase.
Thanks out an offering should we think of it kind of free cash flow after dividends for 2020.
Or would you actually add a little bit of leverage to take down a little bit more stock.
Yeah Chase I, you know I'd say that look our overall capital allocation and corporate finance policy really hasn't changed from what we've talked about in terms of commit commitments turned 40% to 50% of met to to shareholders through dividends and buyback in I'd I I think you know as we as you in that I've talked before you know we will certainly evaluate.
Any potential offerings by GE and put that into our thinking as we.
Allocate capital over the course of the year. So no real change there in terms of how are we thinking about it and you should assume that was certainly taking that into account as we looked at our free cash flow.
All of our metrics for the here.
Yes.
Thank you. Your next question comes from David Anderson with Barclays.
Hi, Good morning, I was hoping to dig into a little bit on your chemicals business here, which is getting some more attention lately with your.
Biggest competitor changing hands I was wondering just talk about the business mix and what you see as the primary growth drivers and next several years in terms of offshore onshore now and downstream, which is not really a mark can we hear much about you highlighted a big contracted Valero today.
Could you just kinda talk about that business and how you see that developing.
Yes, Dave if you look at Tom how chemical franchise and again, we've from mentioned it before that we think it's a great area that we've been on the upstream side and actually got a good footprint in North America, and we've actually allocated.
Capital to increase our presence internationally. If you look at our expansion in Singapore facility as well as in the Kingdom of Saudi Arabia, and I think actually the M&A activity. You just mentioned validate a lot of the approach that we've had we've got on increasing usage of chemicals. When you look at enhanced oil recovery.
We've also got an opportunity on the downstream side as you mentioned, which we've got an option is growing and when you look at the specialty chemicals that we provide and the its application it's increasing across both the upstream and downstream. So we feel good about the strategy in place and also the growth trajectory for its chemicals business.
The time, yes, David I look at where we are today were predominantly North America, we do have an international presence, but with the investments, we're making in Singapore and Saudi to shift capacity, we see more growth coming for us internationally and and today, we're mostly upstream we do have some downstream and I think.
There's there's a lot of growth opportunities for us.
And in downstream as well and the other thing I'd point out about the investments that we're making the Singapore investment. It is really going to reduce our cost base better manufacturing better supply chain cost better logistics costs and then what we're doing in Saudi is really size for the region to allow us to be very responsive to a lot of very large.
Customers.
That region. So again, we like this space, we're putting capital to work there and we would expect to see growth and margin accretion in chemicals.
Going to say and presumably this is rather accretive for your office business I would assume correct.
We'd like this business, yes, okay.
And maybe just on a different subject I just want to ask about kind of your lss business mix in North America, and just kind of.
How do you feel about kind of where you are at whether not you're satisfied out there. There's been some reports out there that potentially you maybe looking to exit the lufkin rod lift business.
I would've thought they'd be kind of part of your longer term strategy you talked about more of the production side, but maybe this is more capital intensive then you like I was just wanted maybe if you could comment on that and perhaps more broadly on your north American mix in terms of where you want to be.
Yeah, Dave I think you know we've talked about the portfolio before.
And now have basically said if you want to focus the company in areas that are highly differentiated we're seeing the less fragmentation that allow us to generate you know higher returns and and look as we as we look at you know the energy transition and how we expect that to unfold. If there are areas that don't meet that criteria.
Yes, we would potentially look too you know generate cash by by not having those the portfolio and redeploying that cash into areas, where we can get higher returns.
Over the short term hand, and our a better fit long term within portfolio. So I'd say look the north American market has changed quite a bit over the over the last few years and.
There are some areas, where we think is all the technology or the the fragmentation are going to going to make it harder to get returns that justify then being inside the portfolio will continue to look at that but nothing right now that I need to update you on in terms of things that are changing and as we have new.
Whose we'll certainly let you know, but but I won't get understand we are focused on return to year end and where we deployed as incremental capital dollars and and I think the market is changed quite a bit and where are we looking some things.
Thank you. Your next question comes from Sean maybe from JP Morgan.
Hey, good morning patient referral.
So good free cash in the quarter typical seasonality and maybe some catch up from Threeq, even though assess like you mentioned.
Of the 600 million, our working capital benefit how much would you attribute to just typical seasonal collections versus progress payments on the new projects coming in I was thinking maybe with.
Perhaps the peak order cycle in 19 will see can maybe just talk about how the cash flow profile looks over the course of a typical TPS project and how that should influence expectations for free cash in 20, and 21 days as you start to convert these projects.
Yes, I would take you know we didn't have typical seasonality and I'd say the majority of what we saw in the quarter was related to that typical seasonality as we talked about on the on the third quarter call I'll Fs came in below expectations.
And you know they really turned the corner here into in the fourth quarter by.
You know by making it up on on some of that this and it was really driven by strong collection process overall and that's all the way from from billing on time following up getting the collection and and then the team did a really good job of managing inventory inputs is we had been making a lot of a process changes over the course of the year.
And that came through we did have some benefit from progress collections and keep yes.
And let's see but I think you have to look at it in totality. It's it's a small piece, but progress is only one piece that the equation because at the same time, you're getting down payments, where you're getting progress collections that are executing on project. You were also bringing in inventory as well. So it's not one for one follow through in terms of free cash flow.
You have to look at more accounts on the balance sheet and the TPS typically.
No you start out with a a down payment we have long lead items that you bring into the project and then based on certain milestones you build a customer and you collect so one of the first thing that look at any TPS project is the cash curve to see what our cash position looks like in that and our goal is to to happen and the fate.
From a cash flow standpoint, so you will see adds inflows and progress collections over the lifecycle of a project in receivables and inventory.
But I would say it was a small impact here in the fourth quarter as I go into.
2020 look at.
How I think it'll play out we should see you know.
Smaller impact from progress payments and we saw in 2019, but do believe that the improvements we've been driving in working capital processes across the franchise not just to know Fs should help offset that the other thing that would say is we expect capex net capex to be roughly flat from a dollar standpoint.
But down as a percentage of sales is obviously, we see more growth in TPS.
And endo at the end into round out free cash flow and total Sean.
We do expect.
Restructuring cash outlay to be down significantly.
But the separation cash outlay will offset that so net net you know see see good dynamics as we roll into 2020 for free cash flow strength.
Got it. Thank you that Brian So maybe just just come back to margin progression and TPS.
So you've got strong revenue growth. This year, you topped up your guidance today versus last quarter I think that makes sense.
We have somewhat limited historicals from last cycle. So how much of a track record in terms of incremental margins and I think earlier in the call you talked about.
At a high level the impact between fixed cost absorption versus services versus equipment mix just as we as you all that together in terms of the flow through the year over year incremental margins. How do you think about that on a normalized basis.
Yeah.
So as I said, it really does it really depends on how quickly revenue grows on the equipment side as to what the at the absolute.
Margin percentage increase will be but you know under all the scenario is that I see today, we do see some margin accretion in TPS I will note that based on the customer requested delivery schedules in way the projects are executing we do see.
The second half being much heavier from an equipment standpoint overall revenue standpoint, so would it would expect the second half to be a much larger from a revenue standpoint, and then obviously has an impact on the fixed cost absorption as you look at more revenue in the first half. So look we'll continue to update you throughout the year if that changes.
But right now that's how I see things or see things playing out.
Thank you. Your next question comes from Bill Herbert with them.
Thanks, Good morning, so back to cash flow and free cash flow, Brian just very quickly one do you expect working capital to be a cash generator or cash consumer in 2020 in the secondly.
Remind us what's your free cash flow conversion targeted.
Okay, I think it's like 90% of net income and if that's the case it seems like you're going to question that again so.
Maybe update us on both of those please thank you.
Okay Bill.
So if it's if I look at if I look at the free cash flow conversion target. It is 90% of of net income.
Over time, and again and you're going to have some years based on the the projects business and and and how we're driving working capital where you can exceed that in some years, where it could be below that based on mix of business. So 90% is the the through the cycle goal and if I look at overall working capital with the dynamics, we talked about earlier.
You know the the strong progress payments in 2019 again, you know not quite as strong in 2020, but we'll have some offsets with the other working capital processes that are driving I mean, you could see a year, where you know working capital that capital as a slight usage based on those tightening and makes him the growth that.
That we have in the portfolio, but you should expect our working capital metrics to continue to improve.
Thank you.
Your next question comes from Scott Rowe Citigroup.
Yes, good morning, Hi, Scott.
Just a couple of detailed ones here what was the profitability split between the North American well assess business and international business and for Q and and is that spread pretty similar to what you're looking for it and one two and then it sounds like.
You believe that the golf activities slump, which impacted for Q is transitory does that snap back Q1 is that in your guide or is that more of a to queue of it yeah. Scott. We look we do see some improvement in a Q1 and the golf I don't know that I call. It a snap back, but we do see improve.
Movement, there and obviously that has a positive impact on on margin rate as I said for obvious reasons.
So you know look Frac boats were down in Fourq, you, which was which is a big driver of that and we do expect that to come back as far as the profitability. No look we don't we don't disclose profitability.
By region, there, but I would say from a dynamic standpoint, we continue to expect to see the softness in North America.
And feel pretty good about the growth opportunities that we're seeing in international and the thing that I would I would remind you of that I think I mentioned in.
I talked to Angie is that a lot of these large integrated projects, where the learning curve, there and we should see margin accretion.
In in 2020, as we execute on those projects and auto startup cost as well as just getting to know the field cost.
You know have have abated, so feel pretty good about that margin progression internationally and the growth backdrop there.
Got it and then just coming back to the chemicals business. It sounds like the growth investments there will be beneficial to your overall assess mix and return profile are you able to provide any color on the magnitude of the new plants relative to the size of your current chemicals business just trying to think about the APAC.
Most of those for the better light as they come on.
And when do they come on in the years ahead.
Yeah, Hey look from a timing perspective again, it's time the fat plants. During construction. So why don't you won't see anything can 2020, they'll stop going into a commissioning phase and Warren credit 21, as we mentioned, we see international growth opportunities.
Stay tuned we'll give more updates as we start completing the plants, yeah and again I'd just reiterate here, it's not all going to be incremental capacity, we are shifting capacity here and again.
The the Singapore.
Facility is going to be very cost advantage. So in addition to growing internationally will have the benefits of higher margin rates for product that's coming out of Singapore, I look as we get closer to commissioning and things from up we'll give you guys. Some insights into into how we're thinking about that but Tom spending a lot of.
Hi, there and again like I said, we'd like this business and like the capital we're putting to work there.
Ladies and gentlemen, this concludes today's Q and a portion of the conference I'd like turn the call back over to our hosts for any closing remarks.
Just staff. Thanks again for joining us we closed out a strong 2019, you saw the full quarter adults and we feel that the macro environment is improving as we look at 2020 I feel good about our outlook.
Thanks.
Ladies and gentlemen, suppose conclude todays presentation, you may now disconnect and have a wonderful there.