Baker Hughes Co - Class A (BKR) — Q1 2018 Earnings Call Transcript

Thank you, Sandra. Good morning, everyone and welcome to the Baker Hughes, a GE company first quarter 2018 earnings conference call. Here with me today are our Chairman and CEO, Lorenzo Simonelli; and our CFO, Brian Worrell. Today's presentation and the earnings release that was issued earlier today can be found on our website. As a reminder, during the course of this conference call, we will provide predictions, forecasts, and other forward-looking statements. Although they reflect our current expectations, these statements are not guarantees of future performance and involve a number of risks and assumptions. Please review our SEC filings for a discussion of some of the factors that could cause actual results to differ materially. As you know, reconciliations of operating income and other non-GAAP to GAAP measures can be found in our earnings release and on our website under the Investor Relations section. In addition, we adopted several new accounting standards this quarter mainly relating to revenue recognition and pension cost and benefit presentation. All our prior period financials have been updated to reflect these new standards. Please review our filings for recasted financials. Similar to prior quarters, all results discussed today are on a combined business basis as if the transaction closed on January 1, 2016. With that, I will turn the call over to Lorenzo.

Thank you, Phil. Good morning everyone and thanks for joining us. On the call today, I will give a brief overview of our first quarter results, my perspective on the market and how our company is delivering results in the current environment. I will also give you an update on the integration and our progress on synergies. We delivered $5.2 billion in orders and $5.4 billion in revenues in the first quarter, both in line with our expectations. Adjusted operating income in the quarter was $228 million; we saw improvements in our oil field services business more than offset by declines in our long cycle businesses. Free cash flow in the quarter was $226 million. Earnings per share for the quarter was $0.17 and adjusted EPS was $0.09. We remain committed to top-tier shareholder returns, since closing the deal we've returned over $1.6 billion to shareholders. Now I would like to take a few moments to discuss the overall market dynamics. In the oil market, we see global demand rising at a steady pace, driven by an improved GDP outlook for the United States and Europe. In Asia alone, strong economic growth is expected to add nearly 1 million barrels per day of demand in 2018. On the supply side, US production grew to more than 10 million barrels per day with first quarter average production up 7% versus the fourth quarter of 2017 driven mostly by shale. OPEC and Russia have committed to production cuts for the end of 2018. We have seen a draw on US crude inventories that have pulled stocks closer to the five-year average. These factors have resulted in a market equilibrium which we expect will keep crude prices relatively range-bound in 2018. This recent price stability has resulted in a customer spend forecast that shows solid year-over-year growth for our short cycle businesses, particularly in North America where operators continue to grow rig count and well counts. Internationally we're seeing signs of activity increasing in certain geo markets, though these remain competitive. The offshore market remained subdued in the first quarter, however we expect activity to increase through the year. While we expect our E&P customers to grow upstream investments, we continue to see them focused on capital discipline and limiting their CapEx spend within their operating cash flows, we're seeing this both internationally and with the large independents in the United States. We see the global energy mix shifting more to gas over the coming decades. Consumption is expected to grow more than twice as fast as any other fossil fuel through 2040, at roughly 1.5% per year. As part of this dynamic, we expect LNG demand to more than double to 500 million tons per annum by 2030, growing at a pace of 4% to 5% per year. We saw demand growth well above that projected pace in 2017, as global imports grew 11% to nearly 30 million tons versus 2016. Import volumes rose again significantly in the first quarter with global imports up 9% versus the first quarter of 2017. The increase in demand for LNG coupled with the lack of recent project final investment decisions points to the LNG supply-demand balance tightening. Market data suggests that new LNG capacity is required in the early to mid-next decade to meet demand, which should translate to project FIDs for which we're well positioned. While our outlook for LNG is becoming increasingly positive, we did not see any project FIDs in the first quarter. We expect projects to begin to move as we progress through 2018. Now I would like to share some highlights from the first quarter. Our priorities in oil field services remain unchanged. We're focused on gaining share in key markets and product lines and delivering best in class services to our customers. We're also committed to improving our operating margins by executing on the synergies we laid out and improving efficiency throughout our operations. We made great progress on these priorities in the first quarter with key wins in artificial lift and wireline and continued momentum for our well construction product lines. We secured a large five-year contract for 100% of Kinder Morgan's ESP work in four Permian Basin fields, displacing competitors. This award not only solidifies our leading position in artificial lift but also demonstrates our continued commitment to grow in the Permian. In the Gulf of Mexico, a large international oil company awarded us the open-hole and cased hole wireline services on all its rigs displacing a competitor due to our strong operational performance in 2017. We also displaced the competition with our drilling services product line on all of this customer's deepwater rigs in the Gulf of Mexico after drilling one of the fastest wells in the field to date. In West Africa, our Upstream Chemicals product line was awarded a three-year $100 million contract with a major oil company for a large mature field, displacing the competitor who had managed the field for several decades. This award was based on the strong performance of our Upstream Chemicals product line for this customer in other regions and builds on our strategy for international expansion in chemicals. We also made significant progress on our automation strategy and well construction by setting another record in the Marcellus Basin. Our MWD engineers and directional drillers performed a completely remote drilling operation from the customer's office. In this operation, we drove the longest extended reach single-run ever recorded at a total of over 20,000 feet in just eight days. Based on our performance and longstanding relationship with the customer, we won an additional multi-year award including oilfield equipment, displacing multiple competitors. In our oilfield equipment segment, we're providing our customers with innovative commercial models that serve their needs while maintaining focus on technology, system design, and project costs. Let me give you a few examples of how we're delivering for our customers. In the first quarter, BHGE, together with McDermott, was selected for BP's Tortue Field Development offshore Mauritania and Senegal. The initial contract is a FEED study for SPS and SURF in full well development. Our technical leadership in large bore gas and high pressure, high temperature applications combined with our partnership approach with McDermott were instrumental in securing this award from BP. We also secured our latest integrated full stream win, combining our oilfield equipment and oilfield service capabilities. BHGE was selected by Chrysaor, a leading independent E&P company in the UK, as preferred service partner and main provider of oilfield services and equipment for subsea wells in the Armada area. Chrysaor is another example of our competitive advantage and our ability to partner with customers and design novel commercial solutions that allow projects to move forward. We have a proven track record of implementing and executing new commercial models that align our incentives with our customers and enable us to deliver better outcomes. For example, we now have nearly two years of operating history with our partnerships with Diamond Offshore Drilling and Transocean Limited, where we developed a new service model for offshore drilling equipment. Our customers have realized meaningful performance improvements. Diamond has experienced a significant reduction in subsea non-productive time, achieving less than 0.75% over the last six months, while Transocean awarded BHGE with a performance bonus at the end of 2017. This shift from traditional transactional relationships benefits all stakeholders and is driving industry-leading reliability. Lastly on OFE, I'm pleased to announce that this week we've been awarded the subsea equipment contract by Chevron for Phase II of the Gorgon project in offshore Western Australia. We will supply 13 subsea trees and other subsea equipment including manifolds, wellheads, and production control systems. The Gorgon development is one of the largest natural gas projects in the industry today. BHGE has been a key partner since the early concept phase of this multi-stage development and we continue to drive efficiencies together with Chevron and its partners. In our turbomachinery and process solutions segment, we laid out four strategic priorities over the next 24 months. First, we will maintain our position in the LNG and capture the significant growth opportunities in the market. Second, we will optimize and maintain our service capability for outage schedules and transactional services. Third, we will expand into underpenetrated markets such as the industrial space. Fourth, we will simplify the structure of the business and drive costs out. The team is aggressively executing on these priorities. Over the last few years, we've continued to invest in technology to drive differentiation and value for our customers. We introduced the LM2500 + G5, the LM6000 PF+, and launched the LM9000 gas turbine last year. These technologies allow us and our customers to operate longer between service events, reduce emissions, and deliver more power, which lowers our customers' total cost of ownership. We secured some key commercial wins in the quarter. In Norway, we were awarded a $65 million contract to provide turbomachinery equipment to the Johan Castberg field. As part of the award, we will provide two LM2500 + G4 gas turbine generators coupled with two electric generators. This technology will be preassembled into three modules specifically designed for FPSOs which will help Statoil reduce the number of interfaces at the installation site, simplifying the engineering, execution, and construction phases. In North America, we secured an award to provide gas turbine and compressor equipment to an important customer for the first two phases of a large gas pipeline project. We will install three of our PGT25+ aeroderivative gas turbines and three of our PCL 802 centrifugal compressors for this customer. We also continue to gain traction with our lower megawatt NovaLT family of equipment, securing an award to provide four LT16 gas turbine-driven compressors for a pipeline project in Central Asia, building on the success we've already seen in this product line. As I shared on our last earnings call, we're focused on optimizing the cost base of the business. In the first quarter, we began this process by rationalizing TPS's regional structure. We're also driving lower product and service costs by looking at everything from product design to manufacturing to installation. We believe these cost-out actions will create a better and more profitable franchise and position us well for the future. In our Digital Solutions segment, we're gaining traction with our customers on our software offerings and our measurement and controls business is solidifying its position as a technology leader. Let me highlight a few examples from the first quarter. As we continue to focus our software offerings on analytics, we announced the partnership with NVIDIA to use artificial intelligence and advanced computing to help the oil and gas industry reduce operational costs and improve productivity. The partnership combines our portfolio with NVIDIA's computing power to significantly advance image recognition capabilities in the industry; disrupting conventional modeling techniques using algorithms, oil and gas companies can scale data modeling quicker and optimize their operations as conditions change. We're also gaining traction with our productive Corrosion Management software; we signed an agreement with an Asian refinery to enable real-time analysis of ultrasonic thermal and thickness measurements. This will enable our customer to materially lower inspection costs going forward. We see the growing corrosion management market as one particularly well-suited to predictive applications. Our software offering enables repeatable, accurate measurement of piping wall thickness and temperature, and reduces inspection costs. In our measurement and controls product lines, we continue to strengthen our technology leadership position, selling across a number of end markets beyond just oil and gas. In our inspection technologies product line, we saw double-digit growth in CT sales in Asia, including the first deployment of our CT technology for a major Japanese auto manufacturer. Our systems are capable of inspecting complex manufactured parts to ensure cracks and other structural anomalies are detected faster and easier than traditional methods. Our speed scan CT system, which is several hundred times faster than a conventional system, can be applied across our industrial segment. Turning now to integration, we've made tremendous progress over the first nine months as a combined company. In the first quarter of 2018, we delivered $144 million of synergies. Our total year commitment of $700 million remains firmly on track. We're making excellent progress on rooftop consolidation with an additional 25 locations closed in the first quarter. We have more facility consolidations planned for 2018 as we shift from reducing office locations to larger operational facility combinations. One of the early focus areas in bringing our two companies together was to integrate and optimize our respective artificial lift businesses. We've made significant progress on this to date. At the end of 2017, we completed an extensive assessment of our ESPs that included a market evaluation of customer preferences, product performance, and total cost of operation of the ESP system. We now have a set of new offerings that have rolled out to customers in the first quarter. The result of the effort is a portfolio of ESPs that is the most advanced and most complete in the market, offering the highest level of reliability and efficiency in the industry. We also began optimizing our manufacturing footprint and we expect to complete this consolidation by mid-year. Finally, our priorities for 2018 remain unchanged. We are focused on growing market share, improving margins, and generating more cash. With that let me turn the call over to Brian.

Thanks Lorenzo. I'll begin with the total company results and then move into the segment details. As Lorenzo mentioned, we delivered a strong orders quarter. Orders were $5.2 billion, up 9% year-over-year. We grew orders in all segments led by turbomachinery which is up 10%. Oilfield equipment grew orders 5% and digital solutions was up 3%. Quarter-over-quarter orders were down 8%, driven by typical seasonality across our portfolio. Backlog for the quarter ended at $22.2 billion, up $1.2 billion versus last quarter. The growth was primarily due to the impact of adopting the new revenue recognition accounting standard. Service backlog ended at $16.8 billion, up $1.1 billion or 7% with long-term service agreements and turbomachinery driving the increase. Equipment backlog ended at $5.4 billion, up 1%. Going forward, we will report Remaining Performance Obligations (RPO), a requirement under the newly implemented revenue recognition accounting standard. RPO represents orders which meet specific contractual criteria and are not yet converted into revenue. RPO for the first quarter is $21.3 billion. Revenue for the quarter was $5.4 billion, down 7% sequentially driven primarily by typical seasonality across all of our segments. Year-over-year, revenue was up 1% as we saw continued growth in our short cycle businesses, oilfield services, and digital solutions but declines in our long cycle businesses, turbomachinery and oilfield equipment. Operating loss for the quarter was $41 million. On an adjusted basis, operating income was $228 million, which excludes restructuring, impairment, and other charges of $269 million. Adjusted operating income was down 20% sequentially as the growth in oilfield services was offset by seasonal declines in our other segments. Year-over-year adjusted operating income was down 19% driven by oilfield equipment and turbomachinery partially offset by oilfield services and digital solutions. Corporate costs were $98 million in the quarter, down 38% versus the first quarter of 2017. Depreciation and amortization for the quarter was $388 million. D&A was slightly lower than we expected due to purchase accounting adjustments we booked in the quarter. Next on taxes in the first quarter, we had a tax credit of $86 million which includes a positive $124 million impact driven by the US tax reform. This has been excluded from our adjusted earnings per share. Excluding this impact, our first quarter tax expense was $38 million. Earnings per share for the quarter were $0.17, adjusted earnings per share were $0.09. We delivered strong free cash flow in the quarter as the improvement actions we previously highlighted have started to yield results. Free cash flow in the quarter was $226 million which included $100 million of restructuring and deal-related cash outflows. We generated over $100 million of cash from working capital. On accounts receivable, we're focused on increasing our pace of collections and reducing cycle time. In the quarter, accounts receivable generated $125 million of operating cash flow. We also continue to make progress on inventory management despite our typical first quarter build-up; our inventory balance is down versus when we closed the deal. While there is still much more we can do, I'm pleased with the improvements we've implemented so far. Gross CapEx for the quarter was $177 million. Net proceeds from disposals of assets were $108 million in the quarter driven by increased asset sales as part of our ongoing integration efforts. Next, I wanted to give you an update on our progress in executing our capital allocation strategy. In the first quarter, we repurchased both Class A and Class B shares on a pro-rata basis for a total of $500 million. Since closing the deal, we've now returned over $1.6 billion to shareholders. We executed $1 billion of share buybacks and have paid over $600 million in dividends. Now I'll turn to the segment results. In oilfield services, market conditions continue to improve. In the first quarter, we saw a 5% sequential increase in US land rigs. However, the US offshore market was down 21% quarter-over-quarter. The US completed well counts slowed versus the fourth quarter driven by industry-wide supply chain challenges. With drilling activity outpacing completions, the drilled but uncompleted well count continues to rise. Given the commodity price backdrop, we expect to see North America completion start to pick up in Q2. Internationally, rig count was up slightly with small increases in the Middle East and Latin America. Revenue for our OFS business was $2.7 billion, down 4% versus the fourth quarter of 2017. North America revenue was $1.1 billion, flat versus the prior quarter as growth in our drilling-related product lines was offset by declines in artificial lift and pressure pumping in the Gulf of Mexico. Internationally, revenue was $1.6 billion, down 6% sequentially primarily due to the non-repeat of year-end product sales. We saw the largest declines in Latin America and Asia Pacific, partially offset by growth in our drilling services product line in Europe and Sub-Saharan Africa. Operating income was $141 million, up 39% sequentially driven by our strong progress on synergies, solid incremental margins, and drilling services and lower depreciation and amortization. These improvements were partially offset by seasonal volume declines, most notably in completion and artificial lift. Our outlook for oilfield services is unchanged. We expect volume improvements as we move through the year with strong incremental margins. As Lorenzo mentioned, our overall synergy expectation for 2018 is unchanged. Next on oilfield equipment, the business performed in line with our expectations but continues to operate in a difficult environment. Orders in the quarter were $499 million, up 5% year-over-year. Equipment orders were down 5% year-over-year primarily due to the timing of flexible pipe orders, which was only partially offset by increased equipment orders in our subsea production business. Service orders were up 18% versus last year, driven by increased activity particularly in the North Sea and slightly improved aftermarket activity in our rig drilling systems business. Revenue was $664 million, down 7% versus the prior year. This was driven by lower subsea production equipment revenue and continued volume softness in our rig drilling systems business. These declines were partially offset by growth in North American surface pressure control. We still expect the large equipment orders we won in 2017 to begin to convert into revenue in the second half of 2018. Operating loss was $6 million, which was unfavorable year-over-year, driven primarily by continued volume pressure across the business and lower productivity, but was lessened by cost-out and synergy execution. Overall, the OFE business will continue to be challenged in the second quarter, but we expect it to improve as volume increases in the second half of this year. Our technology and solutions position us well for upcoming customer FIDs. Moving to turbomachinery, the business continues to operate in a mixed environment with muted activity in both upstream production and LNG. We're focused on the priorities Lorenzo mentioned and we're executing within the framework we've previously communicated. Orders in the quarter were $1.5 billion, up 10% year-over-year. Our orders performance was broadly in line with our expectations with no FIDs for LNG in the first quarter. Equipment orders were up 23% year-over-year driven by activity improvements in the onshore and offshore segments. Service orders were up 4% versus the prior year driven mainly by an increase in upgrades. Transactional services were up 1% year-over-year. Revenue for the quarter was $1.5 billion, down 11% year-over-year. Equipment revenue was down 9% as a result of lower gas turbine and generator volume. Service revenue was down 13% with both contractual and transactional services lowered due to fewer outages. We did see revenue growth in upgrades. Operating income was $119 million, down 53% year-over-year, the decline was driven by lower volume and negative services mix as well as lower cost productivity. We incurred slightly higher than anticipated costs in the quarter to position the business for future commercial wins. Overall, we expect TPS to perform in line with the framework I laid out on the fourth quarter earnings call. We continue to expect TPS margin rates to improve as we progress into the second half of 2018 benefiting from higher margin backlog and the cost-out initiatives. We're confident in and continue to invest in our strategic position and anticipate capturing market opportunities as they arise. Next on digital solutions, the business had a strong first quarter driven by increased activity in the oil and gas end market, which was partially offset by continued pressure in the power generation sector. Orders were $649 million, up 3% year-over-year driven by solid growth across oil and gas and industrial end markets. In inspection technologies, activity increased in the global automotive space as well as in the electronics sector in China. Our pipeline and process solutions business saw significant growth in pre-commissioning orders; this growth was partially offset by declines in our controls business primarily due to lower overall activity in the power generation sector. Sequentially, orders were down 7% driven by typical seasonality. Revenue was $598 million, up 4% year-over-year, the volume increase was driven by pipeline and process solutions and inspection technologies, partially offset with lower volume in our controls business. Regionally, we saw increased volume in Asia, the Middle East, and Latin America offset by declines in both Europe and North America. Operating income was $73 million, up 16% year-over-year. The improvement was primarily due to productivity across the portfolio and synergy realization in our pipeline business, which were partially offset by negative product mix. We expect the oil and gas markets to continue to improve throughout 2018 and for the power market to remain muted. As we've previously stated, we expect sequential revenue and margin improvements in digital solutions over the course of 2018 driven by both seasonality and operational improvements. With that Lorenzo, I'll turn it back over to you.

Thanks Brian. Overall, we've made a lot of progress in the quarter. I'm encouraged by our performance on the synergies and the key commercial wins we've secured. The macro outlook is favorable and we continue to position the company for further growth and profitability. Let me reiterate that our priorities are unchanged. We're focused on executing to deliver on our commitments on market share, margins, and cash. Phil, now over to you for questions.

Thanks. With that, let's open the call for questions.

It looks like you guys are delivering well on the synergies, the cash flow and it looks like commercial intensity is up, so all good on those fronts. I wanted to ask, first about the offshore and typically your subsea with Tortue coming in, and sources indicating more projects to be awarded here in the near term. How do you see that business evolving? It appears to me like we're starting to see you finally see that pick in that business. And Lorenzo, if you could comment on what kind of outlook you have there and if I'm right, that the pickup is now underway.

James, as we mentioned before, we like the position we have within the subsea and our subsea portfolio today. Regarding the market, we're coming off a very low base of 2016 and 2017 and we do expect 2018 to be up, but it's still going to be at about half the levels that we saw in 2013. We're coming off the back of some good project awards as you mentioned BP Tortue with fairly leverages, also the key technology that we have on the large bore gas and high pressure, high temperature applications and then as I mentioned in the commentary, we've been awarded Gorgon with Chevron which really is extending the long-term partnership we have with Chevron on a critical project out there. We're going to be supplying 13 subsea trees, other subsea equipment, manifolds, wellheads and production control systems. So we're seeing project activity start to pick up, we like where we're positioned and still some way to go, but we feel encouraged. James, on the international market as you break it down, we expect the year to be relatively flat with pockets of certain activities. Pricing will remain competitive and our focus on margins constructed with the synergies. If you break down the regions, in the Middle East we don't really see that much material growth in the first quarter, we expect some more activity in the back half of 2018 with some pricing pressure. Our strategy continues to be really to gain some share there in the region. As you look at Latin America, there is political and economic stability in some countries. We see modest growth through the year, we're missing Venezuela but partially offset with increase in Argentina so internationally relatively flat through the year.

So Lorenzo, maybe you could talk a little bit more about the opportunities for Baker Hughes and LNG given your very clear leading market share. I believe what, 85%, 90% on the compression side and maybe the size and scale, that opportunities that revenue per MTA and timing of the award.

So Angie, let's take a start at looking at the market place. If you look at some of the activity that's taking place, we've mentioned the demand that's been increasing over the course of 2017 for LNG and we see expected demand to double for LNG to 500 million tons per annum by 2030. So the outlook remains positive over the long term and when you look at the project activity to get ready for that, we do start to anticipate final investment decisions in the back half of 2018 going into 2019. We continue to like our position from the TPS business; we've been investing heavily in new technology. I've mentioned some of those with the LM6000, the LM2500, the LM9000 and we continue to act very closely with our customers. So we feel this is an industry space that we've got an opportunity to continue to improve upon and feel positive about the outlook going forward, as these final investment decisions come through. I would say we didn't see any final investment decisions in the first quarter and again, we see those coming through in the second half of 2018 and beginning of 2019.

Thanks for that helpful. And then Brian, maybe as a follow-up to that, can you talk a little bit more about TPS margins, how you think about TPS margins going into the back half of the year, in part driven by LNG awards in 2017, cost cutting and maybe a little return on the transactional side and then thoughts into 2019. I think you're thinking that potentially we could be back into the mid-teens on TPS from 8% today.

Yes, Angie, you reiterated a couple points we highlighted in the 4Q 2017 earnings call. In the medium term, we'd be around levels we were in the fourth quarter and do expect to see a pick up here in the second half with the visibility we have into the backlog and what we see coming through the services portfolio. If you roll this forward into 2019, we have said that we did see us getting back to mid-teen rates; a couple of things drive that. First, we talked about the cost actions, $200 million of cost-out they were driving in the business that will clearly impact margin rates. You get a full year impact as we roll into 2019. So self-help there is a big piece of that recovery. On the services side, we have good line of sight into both the transactional and contractual service outage schedules and the types of outages that are there, favorable for margin rates as we look out into 2019. We'll start to see some of that in the back half of this year and then finally, you know, you highlighted the LNG market with some FIDs starting to pick up late this year and early next year. We should start to see, in the back half of next year, some revenue starting to come through associated with those since we're the long-lead items in those projects. That's the dynamic we see playing out for 2019 to get the margin rates back up in the mid-teens in TPS.

Thanks, very helpful. I'll turn it over.

I wanted to follow-up on TPS and specifically ask about the LNG services business. You've noted that's been a bit of drag and has not really, has been a bit of disappointment I guess in the last few quarters. I wonder if you could talk about your visibility on service activities starting to improve and maybe comment on, is there any opportunity for some sort of catch-up effect because it's best we can tell that business has been relatively flat while capacity has been growing. Could you help us think through the growth trajectory on LNG services and to the extent you're seeing any visibility that could ultimately play out this year in 2019.

Yes, sure Jud, I'll give you some color on that. So if you look at services, it's a big part of the business today and you're right, it has been relatively flat. And we talked about some of the reasons there in terms of safety stock going down, destocking as well as the outage timing in the installed base. If you think about services in total, we installed the equipment and then the equipment operates. So there is a generally a lag before you start to see a lot of the service activities come through, it depends on how the equipment is being operated. We have a large installed base under contractual services agreements and we have pretty good visibility into the types of outages that are going to happen and the activities that come along with those. The LNG contracts are typically 10 to 20-year service contracts and the way you think about those, year one you have provisioning of parts and installation, and then again depending on where the equipment is operated, you start to get into service events two, three years out but major service events, four, five years into the lifecycle and that follows through the rest of the lifecycle of the LNG plant. So if you go back and look at where we've been in the LNG build cycle primarily we're starting to enter a phase early next year where you start to see some larger service events that will come through and they bring more revenue with them as well. In addition to the visibility we have into these outages, we've been driving productivity in these contracts both for our customers and for ourselves, so as we progress through these contracts we can make them more profitable and provide better output for our customers, so that's another tailwind in the services portfolio. With the LNG build that's happened over the last few years, services will pick up sooner. We expect to see benefits from the service revenue a few years after commissioning.

Okay and if I could follow-up and maybe try to ask about some numbers. Should we think LNG services, is it reasonable to think they could grow mid-to-high single digits? Can we see double-digit growth at some point? I'm just trying to think about the magnitude of growth as some of this stuff that you're talking about plays out.

Yes, I think the best indicator there is if you go back and look at our installed base growth in LNG when that cycle really started early part of this decade; our services growth roughly will track to that with the lag. I wish I could tell you it's exactly two and half years you'll start to see it, but it really depends on where the equipment is operating, the type of equipment. But there is generally a lag versus the installed base in service growth.

All right, I appreciate that. And my second question if I may is, free cash flow during the quarter was above our estimates. I think largely due to lower restructuring. Can you help us think about free cash flow as we go over the next few quarters? I assumed free cash flow grows, but maybe you could help us think about the progression over the next couple of quarters.

Jud, to kick it off here. We're really pleased with the progress we've made on the cash flow. You can expect those operational improvements to continue.

We did have some good results as I highlighted earlier on working capital specifically around receivables. You did point out, restructuring spend was about $100 million in the quarter. If I look at that going forward, as I said early the bulk of the expenses will be through there in the second quarter, some ongoing costs will flow into the second half but relatively small versus what you see in the first half year. And typically, with all these projects, the expenses precede the cash as people exit as we close down facilities, exit product lines and those types of things. So you will see an uptick in the restructuring cash here in the second and third quarter again trailing off in the second half of the year. From an overall working capital and free cash flow generation standpoint, we've talked about this being a big focus for the leadership team here. We've started to make quite a bit of progress. Inventory levels are down versus when we closed the deal and we usually have a spike up in the first quarter, but we still managed to generate cash since we closed the deal despite inventory build.

Okay.

So Lorenzo, you noted in your prepared comments plan for 2018 includes taking market share, improving margins, and generating more cash. Obviously, synergies are a big part of the mix, but leaving aside synergies, you've been pretty vocal about your trend. You're trying to be aggressive on some of these larger projects out there, to take advantage of the broader scope of the combined companies. Often times, that interplay between share gains and margins can be in conflict. So I was just hoping to get a little more clarity from you on how you prioritize top line growth via market share versus driving margins at this point of the cycle and as the companies are coming together through the integration.

Yes, Sean, to reframe our approach, when we combine the businesses, it really shapes how we engage the market by introducing new commercial propositions, and I believe you're beginning to see that. We mentioned Chrysaor, which is yet another award of full stream; we're integrating the capabilities we provide throughout oilfield equipment and services, presenting a new offering that wasn't previously available in the market. We have the necessary capabilities, which you've observed emerging. We're leveraging 3D printing, new technologies, and lean methodologies, allowing us to achieve a more favorable cost structure for our products. If you consider the foundation of our strategy, we are executing it effectively, which enables us to gain market share while enhancing margins and profitability, and naturally generate cash. I feel very confident in our progress towards these goals.

Okay fair enough and then just one point of clarification. On the Tortue project, is that fair that the contract that we have today is just for the FEED as opposed to reinstalling EPCI work? Is BP obligated to use BHGE for the EPCI work or is that still up for debate depending on how things progress?

Yes, so just to clarify, so the initial contract is a FEED study for SPS and also for the full well development.

I came on late to this call, so you may have answered this question. I get the mix shift in revenues on TPS with regard to LNG driven service agreements. Can you provide us with some commentary and expectation on your transactional services? Your installed base is growing but the unit spend is a declining margin of safety is eroding and so the spring continues to coil. What's your expectation for that business starting to inflect into revenue generation?

Yes, Bill, we have talked about that a little bit, but to reiterate, with the visibility we have with the outages in the contractual services space as well as what we see from the installed base on transactional services, we do see that picking up in the second half of the year into 2019. We did see a slight increase year-over-year which is a good sign in transactional services, but it’s difficult to predict exactly when the customers are going to decide on the inventory they need for an outage, so we're constantly working with them. So there can be some movement between one quarter and another, but generally if you look at the installed base growth over the last few years and where things are in the service cycle, it should be a general tailwind.

So I really wanted to ask about uses of cash given your performance in the first quarter. I believe you have $2 billion left authorized for buybacks and just wanted you to refresh if you could if that pace is sustainable. We have a pretty high forecast for further free cash flow generation, even beyond this current authorization. Any further thoughts on cash management?

Timna, look we like the strategy we have communicated to return 40% to 50% of net income to shareholders. We do have plans to increase the free cash flow conversion, so we like the free cash flow outlook here. In terms of what we've done, we launched the share buyback program in November and it bought back $1 billion of stock in four months, returning $600 million to shareholders in dividends. I think the stock rate is today is still an attractive investment. We continue to work with the board on the pace of our buyback and you should expect us to continue to execute here. We do have $2 billion of authorization left and we remain committed to our stated objectives here, returning cash to shareholders.

Okay, thanks for that. And then if you wouldn't mind, just eyeballing your second quarter EBITDA current consensus was about 15% trajectory and given the seasonality and what you just laid out, I just wondered if it were possible for you to say high level that seems like a reasonable progression. Thanks.

So Timna, again we don't really talk about the consensus out there. We're committed again to what we see from a trend perspective in the industry. You've got North America activity that is improving. This is a story of short-cycle businesses that see tailwinds given the activity in the industry, so positive momentum if you think about oilfield services, the digital solutions. When you look at the longer cycle businesses, you're really looking at the back half of the year as some of these larger projects' final investment decisions come through.

Yes, and Timna, our outlook for the year is unchanged at this time. I think Lorenzo summarized the dynamics in the product companies pretty well.

On turbomachinery if I could. Lorenzo, you talked about the significant demand that is expected to be 500 million tons by 2030 over the next many years. You guys have talked in the past about your revenue potential in turbomachinery being somewhere between $30 and $70 per ton and when we look back historically, it looks like on the equipment side that it has historically been closer to about $25 a ton. I'm just wondering are we missing the service component of that and is the service component what really drives the revenue potential in the $30 to $70 range? I'm just trying to gauge if we can model this effectively, as we can have opinions of what the FID rate is going to be over the next couple of years. But I just want to make sure that we're judging the revenue potential over the next couple of years in the same frame.

Yes, Jim. I think we really have to take a step back and we really need to look at this from a project-by-project perspective. The revenue opportunity is going to vary a lot depending on the technology and the scope that we're actually playing with on the project. The type of compression, the driver equipment is going to really dictate what the revenue potential is. It’s a wide range as you go through and actually look project-by-project.

Okay and does the - I mean when we're trying to model this, is it both the equipment and the follow-on service? I mean I know the service has a great tail and that's always been a fabulous part of GE. But how soon, I guess just the service component part really kicks in? You guys have talked about awards and work done last year that the service starts to kick in. I just wondered what kind of delay are we looking at generally on some of these projects before service revenues start to ramp up.

Yes, Jim. When the projects are commissioned, you get a little bit there around installation and some initial spares provisioning, but you start to see material service work really come in three to four years after commissioning, depending on the type of equipment, depending on the size of the project and where it's actually operating. So there is a lag there like I said earlier. It typically tends to be three to four years and then there are other cycles that spread out over the 15 to 20-year life of the contract, so that's a rough guide.

I guess a question on some of the international markets. You start to see a lot more lump-sum turnkey contracting models out there. It's not something Baker is traditionally been very active in. Just wondering if you could talk about your appetite for going after this type of work and how you assess the risks and opportunities for this model?

Dave, as you mentioned lump-sum turnkey contracts. They've actually been around for a number of years and you can go back in time and see where they've been tried before. I think you're seeing a number of activities in the Middle East and when we look at it, it's really a question of taking project-by-project and looking at the returns. We also think that LSTK is only one model. We think it's important that we continue to look at new innovative contractual structures that are positive for our customers and ways in which we can work with them looking at what we've discussed with applying potential leasing, other services. As the industry continues to evolve, there are going to be different models that come through.

Dave, if I look at it, I think we've got the capability in-house to execute on LSTK projects. We understand the history both within Baker and within some of the competitors who have a larger portfolio of that. But we think that the model needs to change, and we think the customers understand that just given the history here. We think we've got the capabilities and the one thing that I want to make sure you understand is that we'll be selective and we're going to balance the risk and reward here to make sure that we retrieve adequate returns for the company, if we're taking on incremental risk.

Lorenzo, a question for you when we think about the potential for full separation of Baker Hughes from GE. From a strategic and operational standpoint, what are you doing or what needs to be done to prepare for this potential full separation?

Chase, good to hear from you. As you know, the GE CFO early on this year restated at a conference that there is nothing anticipated from GE at this stage and we have everything in place with regards to running the business and we're committed to what matters most, delivering for our customers and for our shareholders. We've got the majority of the value creation opportunity is within our control, BHGE. So we're going through the aspects of integration, we've got the synergies in place and we feel good about what we have in hand going forward.

Okay, all right. That's helpful color. I guess turning to the subsea market a little bit. How do you see the subsea market evolving over the next few years? Do you see more of your customers requesting kind of more integrated models and then maybe comment on what you're seeing in the market today on pricing?

So, I think it's still an open area for discussion. We're clearly seeing some increased activity and also different models that are being applied. You've seen the recent wins that we've also indicated. We do think that the offshore market and subsea deepwater are necessary from the industry segment perspective in the long-term, and so pricing remains challenging. We're looking at different models and I think it's going to be playing out over the course of the next 12 to 18 months.

Thanks a lot. Thanks everybody for joining us. I just wanted to mention this is the third quarter as BHGE, and we're making great progress on all the strategic priorities that we've laid out. We've mentioned the share; we've mentioned the margin, and also returning the cash generation and cash to our shareholders. The environment is positive. We see some tailwinds and we're remaining focused on our key priorities. I also want to give a shout out to all the employees for all the hard work that they've endured during the integration. We're making good progress, and thanks for joining us today.