Baker Hughes Q2 2022 Earnings Call Transcript

Participants

Corporate Executives

• Jud Bailey, Vice President of Investor Relations
• Lorenzo Simonelli, Chairman and Chief Executive Officer
• Brian Worrell, Chief Financial Officer

Analysts

• James West, Evercore ISI
• Chase Mulvehill, Bank of America Merrill Lynch
• Arun Jayaram, JPMorgan Chase & Co.
• Marc Bianchi, Cowen and Company
• Scott Gruber, Smith Barney Citigroup
• Neil Mehta, The Goldman Sachs Group, Inc.

Presentation

[Operator]

Good day, ladies and gentlemen, and welcome to the Baker Hughes Company Second Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. 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.

[Jud Bailey, Vice President of Investor Relations at Baker Hughes]

Thank you. Good morning everyone, and welcome to the Baker Hughes second quarter 2022 earnings conference call. Here with me are our Chairman and CEO, Lorenzo Simonelli; and our CFO, Brian Worrell. The earnings release we issued earlier today can be found on our website at bakerhughes.com.

As a reminder, during the course of this conference call, we will provide forward-looking statements. These statements are not guarantees of future performance and involve a number of risks and assumptions. Please review our SEC filings and website for a discussion of the factors that could cause actual results to differ materially. As you know, reconciliations of operating income and other GAAP to non-GAAP measures can be found in our earnings release.

With that I will turn the call over to Lorenzo.

[Lorenzo Simonelli, Chairman and Chief Executive Officer at Baker Hughes]

Thank you, Jud. Good morning everyone and thanks for joining us. Our second quarter results were mixed as each product company navigated a different set of challenges ranging from component shortages and supply chain inflation to the suspension of our Russian operations. While OFS and TPS are managing through the current situation fairly well, OFE and DS have both experienced more difficulty.

As we look to the second half of 2022 and into 2023, the oil markets face an unusual set of circumstances and challenges. On one hand, the demand outlook for the next 12 to 18 months is deteriorating, as inflation erodes consumer purchasing power and central banks aggressively raise interest rates to combat inflation. On the other hand, due to years of underinvestment globally and the potential need to replace Russian barrels, broader supply constraints can realistically keep commodity prices at elevated levels, even in a scenario of moderate demand destruction. As a result, we believe the outlook for oil prices remains volatile, but still supportive of relatively strong activity levels as higher spending is required to re-order the global energy map and likely offsets moderate demand destruction in most recessionary scenarios.

In the natural gas market, the re-drawing of the energy map is having an even greater impact, with sustained high prices, a frenzy of offtake contracting activity, and a growing pipeline of major LNG projects that seem likely to reach FID. There has been a significant increase in long-term LNG offtake agreements in the US, totaling over 35 MTPA during the first half of 2022. For comparison, year-to-date LNG contracting activity is 3 times greater than the average annual US contracting volume going back to 2015. This sharp increase reflects the growing importance of natural gas and LNG as governments rebalance their priorities between sustainability, security, and affordability. We believe that solving this energy trilemma will be another long-term positive for natural gas. This theme will continue to grow in importance as countries around the world face acute energy shortages and are working to avoid industrial interruptions in certain sectors of their economies.

Overall, we remain very positive on the outlook for natural gas. We also believe that a significant increase in natural gas and LNG infrastructure investment is required over the next five to 10 years in order to make natural gas a more affordable and reliable baseload fuel source that can be paired with intermittent renewable power sources. Against this uncertain macro backdrop, Baker Hughes is preparing for all scenarios and will continue to execute on our long-term strategy. If commodity prices remain resilient as we expect, our portfolio is well-positioned to benefit from a strong LNG cycle and a multi-year upstream spending cycle. We will also continue to invest in our energy transition and industrial initiatives, while also returning 60% to 80% of free cash flow to shareholders.

However, if the global economy experiences further turbulence and commodity price volatility, we believe our balanced portfolio of short and long cycle businesses will enable us to generate peer-leading free cash flow and allow us to maintain our policy of returning cash to shareholders. In addition to a strong backlog that affords cash flow visibility, we have a best-in-class balance sheet that allows us to invest opportunistically, either through share buybacks or tuck-in investment opportunities. In either scenario, Baker Hughes is well positioned to create value for shareholders.

From an operational and strategic perspective, we were active over the first half of the year, executing on a number of exciting tuck-in acquisitions and new energy investments such as Mosaic, Net Power, and HIF Global, which position us in key technologies for the future. We have also been focused on setting up internal commercial structures like CTS and IAM, which will help us to capitalize on opportunities in the energy transition and industrial areas. In addition to these initiatives, our time is increasingly focused on optimizing and formalizing our operations around the two core business areas of OFSE and IET. As the energy markets continue to evolve, it is becoming clearer that aligning across these two core areas makes strategic sense.

We are focusing on ways to simplify our process and systems, with a distinct focus on productivity and efficiency across our operations, as we look to drive additional synergies between both TPS and DS, and OFS and OFE. We believe that this will be a significant area of opportunity for Baker Hughes, as we look to further streamline our organization and position it for the future.

Now, I will give you an update on each of our segments. In Oilfield Services, activity levels continue to trend positively in both the international and North American markets and net pricing is being achieved across multiple product lines. We also see improving visibility for growth in some key areas into 2023 and beyond. In international markets, broad diversified growth continues, with recent strength in Latin America, West Africa and the Middle East. We expect growth in most international markets to continue, with the strongest increases likely to come from the Middle East over the second half of the year and into 2023. Producers in the region are committed to an orderly increase in production and are beginning to execute drilling plans to improve both oil and natural gas production capacity in the region. In North America, activity and pricing remains strong, with the rig count continuing to track above our expectations. We expect continued modest growth in the rig count in the coming months, but the outlook for 2023 will be dependent on the broader macro factors and oil prices.

Operationally, I am pleased overall with the progress made by the OFS team during the second quarter in navigating the challenges related to Russia, as well as supply chain constraints and inflation. During the second quarter, the suspension of our OFS operations in Russia accelerated quicker than anticipated as we moved closer to reaching an agreement to sell our OFS operations in the country. Outside of the impacts from Russia, our OFS business executed well in the second quarter, with improvements in our production chemicals business. After being weighed down for several consecutive quarters by supply chain and inflationary impacts, chemicals saw a sequential increase in margins and has line of sight to further increases in the coming quarters. Going forward, we expect to continue to drive margin improvement despite the cost headwinds from the suspension of our operations in Russia.

Moving to TPS, the second quarter represented another solid performance in orders, where we remain on track to generate $8 billion to $9 billion in orders in 2022 with an optimistic view of 2023. Operationally, TPS performed well despite some revenue impacts from the suspension of operations in Russia, as well as some project shipment delays across both equipment and services. We continue to believe that we are at the beginning of another constructive LNG cycle, particularly for US projects. Including the FID of VG's Plaquemines Phase 1 at the end of May and Cheniere's FID of Corpus Christi Stage 3 in June, we continue to expect 100 to 150 MTPA of LNG FIDs over the next two years with additional FIDs in 2024 and 2025.

During the second quarter, we were pleased to be awarded an order to provide seven mid-scale LNG trains to support the Stage 3 expansion project of Cheniere's Corpus Christi Liquefaction facility. Each train is comprised of two electric motor-driven compressors producing approximately 1.5 MTPA of LNG, totaling 10.5 MTPA of production capacity. This award builds on the strong relationship between Baker Hughes and Cheniere since 2012, as we currently provide all liquefaction equipment for Cheniere's Corpus Christi and Sabine Pass projects. Outside of LNG, the TPS team booked an important gas processing award in Saudi Arabia to supply 14 electric motor-driven compressors for the Jafurah unconventional gas field project, the largest non-associated gas field in the country. Baker Hughes is leveraging its local compressor packaging facility in Modon to deliver the equipment and support the Kingdom's in-country total value add program.

Also, during the quarter, TPS booked an award from Tellurian to provide electric-powered Integrated Compressor Line technology and turbomachinery equipment for a natural gas transmission project in southwest Louisiana. The project is expected to supply upwards of 5.5 billion cubic feet of natural gas daily, with virtually no emissions. ICL zero-emissions is landmark technology that lowers the carbon footprint of a key segment of the natural gas supply chain and is already reducing the climate footprint of pipeline projects in many regions that deliver vital gas supplies. This order marks the first time Baker Hughes will install its ICL decarbonization technology for pipeline compression in North America.

During the quarter, TPS' CTS organization continued to support the growth of the hydrogen economy. TPS secured a contract with Air Products to supply advanced syngas and ammonia compression technology for the production of green ammonia for the NEOM carbon-free hydrogen and ammonia facility in Saudi Arabia. This order builds on our hydrogen collaboration framework with Air Products and leverages Baker Hughes' broad experience and references in supplying syngas and ammonia compressors.

Next, on Oilfield Equipment, we are encouraged to see improving demand trends across the different business areas. However, we remain disappointed with the overall level of profitability of the business and are executing on further actions to drive additional cost out and improve operations across the portfolio. At a macro level, trends in the subsea and offshore markets continue to improve and should have solid order momentum over the next couple of years. Despite recent commodity price volatility, we believe that a solid pipeline of deepwater opportunities will continue to develop across a few key markets.

Importantly, we continue to see OFE gain momentum outside of Brazil with its offshore flexible pipe technology, securing several large contracts with multiple customers across the Americas and the Middle East. OFE will provide flexible pipe systems and services, including risers, flowlines and jumpers, to improve oil recovery and help to extend field life and profitability. OFE booked their highest orders ever in flexibles in the second quarter, and over $600 million in flexibles orders for the first half of the year in 2022, also a record. While activity and project awards are improving offshore, we recognize that we have work to do in OFE to drive operating margins back to an acceptable level. We are driving continued actions across the business to improve operations, while also ensuring we have the appropriate resources in place to take this business forward. We are also in the final stages of planning more integration between OFE and OFS, driving more efficient cost management across certain parts of the OFSE business area globally.

Finally, in Digital Solutions, while order activity was strong in the second quarter, the business continues to be hampered by supply chain challenges, mainly electronic shortages, as well as inflationary pressures. During the quarter, DS saw continued interest for its condition monitoring systems and services in the industrial sector. Bently Nevada secured a contract to upgrade the machinery protection systems for critical machines at a steel plant in the Middle East. The contract includes Bently Nevada's latest Orbit 60 system, which will provide the customer reliable protection and will enable advanced condition monitoring without additional hardware spend.

DS also gained traction with its emissions management portfolio of technologies. Following an MOU signed in February, DS secured a contract with Petrosafe for the first deployment of flare.IQ technology for refining operations in Egypt. The deployment will be implemented at the APC Refinery in Alexandria, supporting Egypt's low-carbon strategy, and tackling emissions in the sector as the country prepares to host COP27 in November. We also recently reached an agreement for the sale of our Nexus Controls product line to General Electric. GE will continue to provide Baker Hughes with GE's Mark control products currently in the Nexus Controls portfolio, and Baker Hughes will be the exclusive supplier and service provider of such GE products for its oil and gas customers' control needs. The transaction is expected to close in the second quarter of 2023.

As we have mentioned in the past, we continue to make strategic and operational changes across DS, including recent leadership changes in Bently Nevada during the quarter. We are also conducting a review of the broader DS portfolio, taking actions to ensure we have the right business composition to serve our customers and drive returns. As we move forward, there is clearly more work to do. We are committed to driving better performance, profitability and returns for the DS business.

Before I turn the call over to Brian, I would like to spend a few moments highlighting some of the achievements from our Corporate Responsibility Report that was published at the end of the second quarter. This report provides an expanded view of our environmental, social, and governance performance and outlines our corporate strategy and commitments for a sustainable energy future. We again lowered our emissions footprint and expanded our emissions reporting. We achieved an 8% reduction in our Scope 1 and 2 carbon emissions in 2021 versus 2020, and a 23% reduction in 2021 compared to our 2019 baseline. We also expanded reporting of Scope 3 emissions across our value chain to include emissions from several new categories. I am also pleased to say that in 2021, we launched Carbon Out, an internal company-wide initiative to take carbon out of our operations and meet our pledge to achieve a 50% reduction in emissions by 2030 and net-zero emissions by 2050.

We further expanded our programs and processes to embed Diversity, Equity, and Inclusion into our operating process. We launched a Global Council in 2021 to increase accountability on this strategic priority and we updated our process to evaluate and reconcile pay equity across the company.

Overall, Baker Hughes is successfully executing on its vision as an energy technology company and to take energy forward, making it safer, cleaner, and more efficient for people and the planet. Our Corporate Responsibility Report demonstrates our progress in many of these areas. Baker Hughes is well positioned to drive energy efficiency gains to meet global energy demand and support broader decarbonization objectives.

With that, I will turn the call over to Brian.

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Thanks, Lorenzo. I will begin with the total company results and then move into the segment details.

Orders for the quarter were $5.9 billion, down 14% sequentially driven by TPS and OFE, partially offset by an increase in Digital Solutions and OFS. Year-over-year, orders were up 15%, driven by increases across all four segments. We are pleased with the orders performance in the quarter, following strong orders performance in the last two quarters. Remaining Performance Obligation was $24.3 billion, down 6% sequentially. Equipment RPO ended at $8.8 billion, down 11% sequentially and services RPO ended at $15.5 billion, down 3% sequentially. The decrease in the RPO was driven by the suspension of our operations in Russia and foreign currency exchange movements. Our total company book-to-bill ratio in the quarter was 1.2 and our equipment book-to-bill in the quarter was 1.2.

Revenue for the quarter was $5 billion, up 4% sequentially, driven by Digital Solutions, OFS, and OFE, partially offset by lower TPS volumes. Year-over-year, revenue was down 2%, driven by decreases in OFE and TPS, partially offset by increases in OFS and Digital Solutions. Operating loss for the quarter was $25 million.

Adjusted operating income was $376 million, which excludes $402 million of restructuring, impairment, separation, and other charges. Included in these charges was $365 million related to the suspension of our operations in Russia. As I will explain in a moment, our Russian activities were either prohibited under applicable sanctions or unsustainable in the current environment.

Adjusted operating income was up 8% sequentially and up 13% year-over-year. Our adjusted operating income rate for the quarter was 7.5%, up 20 basis points sequentially. Year-over-year, our adjusted operating income rate was up 100 basis points.

Adjusted EBITDA in the quarter was $651 million, up 4% sequentially and up 6% year-over-year. Adjusted EBITDA rate was 12.9%, up 100 basis points year-over-year. Our adjusted operating income and adjusted EBITDA margins were largely impacted by the suspension of our Russia operations during the quarter and foreign currency exchange movements.

Corporate costs were $108 million in the quarter. For the third quarter, we expect corporate costs to decline and be more in line with first quarter levels. Depreciation and amortization expense was $275 million in the quarter. For the third quarter, we expect D&A to decline roughly $5 million sequentially as a result of the impairments taken in the second quarter. Net interest expense was $60 million. Income tax expense in the quarter was $182 million.

GAAP diluted loss per share was $0.84. Included in GAAP diluted loss per share are $426 million of losses related to our OFS business in Russia due to its classification as held for sale at the end of the second quarter. Also included was an $85 million loss from the net change in fair value of our investment in ADNOC Drilling, and a $38 million loss from the net change in fair value of our investment in C3 AI, all of which are recorded in other non-operating loss. Adjusted earnings per share were $0.11.

Turning to the cash flow statement, free cash flow in the quarter was $147 million. Free cash flow in the quarter was impacted by lower collections, which are largely timing related, as well as a build in inventory as we get ready to execute on our large order backlog. For the third quarter, we expect free cash flow to improve sequentially, primarily driven by higher earnings and seasonality. We now expect free cash flow conversion from adjusted EBITDA to be below 50% for the year, due to lower cash generation from Russia. In the second quarter, we continued to execute on our share repurchase program, repurchasing 6.7 million Baker Hughes Class A shares for $226 million, at an average price of $34 per share.

Before I go into the segment results, I would like to give an update on our Russia operations, how these impacted our second quarter results, and how the current situation factors into our forward outlook. As I mentioned earlier, our OFS business in Russia was classified as held for sale at the end of the second quarter. During the second quarter, we took the step to suspend our Russia OFS operations to ensure compliance with all sanctions. As a result, our OFS Russia revenue declined 51% sequentially to approximately $60 million in the second quarter, leading to meaningful cost under absorption as we maintained our full cost base. Looking ahead, we are required to maintain our operating costs in the country until we reach a resolution for our Russian operations.

In TPS, we have suspended work on equipment and service contracts in Russia. As a result, these projects have been removed from RPO and second quarter revenue was impacted by roughly $160 million, but with minimal impact to TPS operating margins. For the full year, we estimate that TPS revenue will be impacted by approximately $400 million but, again, with minimal impact to TPS margins in 2022. In OFE, we have suspended all equipment and service contracts in Russia. OFE will be impacted by lower volume and cost under absorption over the next few quarters due to the removal of these projects from RPO.

Now I will walk you through the segment results in more detail and give you our thoughts on the outlook going forward.

Starting with Oilfield Services, revenue in the quarter was $2.7 billion, up 8% sequentially. International revenue was up 8% sequentially, led by increases in Sub-Saharan Africa, Latin America, Europe, and the Middle East, partially offset by lower revenues in Russia Caspian. North America revenue increased 9% sequentially, with low double-digit growth in North America land. Operating income in the quarter was $261 million, up 18% sequentially. Operating margin rate was 9.7%, with margins increasing 80 basis points sequentially, driven by price improvements and productivity, partially offset by impacts from Russia and cost inflation. Year-over-year margins were up 240 basis points. Excluding Russia, OFS operating margin rate was 10.3% and OFS EBITDA rate was 18%.

As we look ahead to the third quarter, underlying energy fundamentals continue to improve, and we expect to see growth in both International and North American activity, as well as continued improvements in pricing. For the third quarter, OFS revenue should increase sequentially in the mid-single digit range. With this revenue framework, we would expect our margin rate to increase by approximately 50 basis points to 100 basis points sequentially, which assumes that we will continue to carry between $25 million to $30 million of cost per quarter related to Russia.

For the full year 2022, we continue to see an improving outlook across most major markets. In the international markets, we expect the continuation of a broad-based recovery with industry-wide activity growth in the mid-double digits. In North America, we expect continued activity increases, with the broader market set to experience strong growth of 50% or greater.

Given this macro backdrop, we would expect OFS revenue to increase in the mid-double digits in 2022. We expect EBITDA margin rates to increase over the next two quarters and to be between 19% and 20% in the fourth quarter, depending on timing of the resolution of our Russia business.

Moving to Oilfield Equipment. Orders for the quarter were $723 million, up 6% year-over-year, driven by a strong increase in Flexibles and Services, partially offset by a decrease in SPS and the removal of Subsea Drilling Systems from consolidated results. Revenue was $541 million, down 15% year-over-year, primarily driven by SPS, SPC, and the removal of SDS, partially offset by growth in Services and Flexibles. Operating income was negative $12 million, down $40 million year-over-year, primarily driven by lower volume in the quarter. OFE's lower operating margin rate was primarily driven by lower volumes in SPS and some operational challenges on certain projects. Although OFE has had to navigate some challenges this year, the current level of performance is unacceptable and, as Lorenzo mentioned, we are evaluating additional ways to drive cost-out and better operating performance, which includes more integration across OFS and OFE.

For the third quarter, we anticipate revenue to be approximately flat to down low-single digits sequentially, depending on the timing of backlog conversion. We expect operating income to be below breakeven due to cost under absorption following the suspension of contracts related to Russia. For the full year 2022, we still expect a recovery in offshore activity and project awards, which should help drive a double-digit increase in orders. We expect OFE revenue to decline double digits, primarily driven by the de-consolidation of SDS, and OFE margins to be below breakeven.

Next, I will cover Turbomachinery. Orders in the quarter were $1.9 billion, up 23% year-overyear. Equipment orders were up 38% year-over-year, driven by a gas processing award in Saudi Arabia and an order for Cheniere's Corpus Christi Stage 3 expansion. Service orders in the quarter were up 14% year-over-year, driven by installation orders and growth in contractual and transactional services, partially offset by a decrease in upgrades. Revenue for the quarter was $1.3 billion, down 21% versus the prior year. Equipment revenue was down 30%, driven by changes in project schedules, and foreign currency movements. Services revenue was down 11% year-over-year, driven by a decrease in upgrades, transactional services, and Russia-related impacts during the quarter, offset by contractual services. Operating income for TPS was $218 million, down 1% year-over-year. Operating margin rate was 16.8%, up 330 basis points year-over-year. Margin rates in the second quarter were favorably impacted by higher services mix.

Overall, the TPS team has navigated multiple headwinds as the year has unfolded, including Russia-related impacts, foreign currency movements, and a challenging supply chain environment. Despite these headwinds, we still feel confident in the full year operating income outlook relative to our expectations at the beginning of the year. For the third quarter, we expect revenue to increase mid-single digits on a year-over-year basis, driven by higher equipment volume from planned backlog conversion. With this revenue outlook, we expect TPS margin rates to be moderately lower on a year-overyear basis, depending on the ultimate mix between equipment and services. For the full year, we still expect TPS orders to be between $8 billion and $9 billion, driven by increasing LNG awards.

We now expect revenue growth to be roughly flat to up low-single digits versus 2021. The lower revenue growth versus expectations earlier in the year is primarily driven by the suspension of operations in Russia, the depreciation of the Euro versus the dollar, and some modest changes in project execution schedules. On the margin side, we now expect operating income margin rates to be slightly higher on a year-over-year basis, depending on the mix between services and equipment.

Finally, in Digital Solutions, orders for the quarter were $609 million, up 13% year-over-year. DS continues to see a strengthening market outlook and delivered growth in orders across Oil & Gas and Industrial end markets. Sequentially, orders were up 7%, driven by higher Industrial and Power orders. As oil and gas end markets finally start to recover, DS orders are now at the highest level since the fourth quarter of 2019. Revenue for the quarter was $524 million, up 1% year-over-year, driven by higher volumes in PPS and Waygate, partially offset by lower volume in Bently Nevada and Nexus Controls. Sequentially, revenue was up 11%, driven by higher volume in PPS, Bently Nevada, and Nexus Controls, partially offset by lower volume in PSI.

Operating income for the quarter was $18 million, down 28% year-over-year, largely driven by mix, inflation, and lower productivity. Sequentially, operating income was up 21%, driven by higher volume. Overall, DS continues to be affected by both chip and electronic component availability shortages, negatively impacting the convertibility of our backlog, and our ability to drive higher productivity. As Lorenzo mentioned, we continue to make strategic and operational changes across DS designed to improve performance, as evidenced by recent leadership changes and the recently announced sale of Nexus Controls to GE.

For the third quarter, we expect to see low-single digit sequential revenue growth and a slight increase in operating margin rates. For the full year, we expect DS revenue growth in the mid-single digit range and operating income margin rates to average in the mid-single digits for the full year.

With that, I will turn the call back over to Jud.

[Jud Bailey, Vice President of Investor Relations at Baker Hughes]

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

Questions and Answers

[Operator]

[Operator Instructions] Our first question comes from James West with Evercore. Your line is open.

[James West, Analyst at Evercore ISI]

Hey, good morning, guys.

[Lorenzo Simonelli, Chairman and Chief Executive Officer at Baker Hughes]

Hi, James.

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Hi, James.

[James West, Analyst at Evercore ISI]

So Lorenzo, Brian, I'd love to just kind of flush-out Russia. It's obviously been a lot of noise in the last two quarters and something you guys are working to resolve. And I'd love to kind of hear how you're thinking about the ultimate resolution here in Russia, whether it's management buyout or outright sale or -- and then also kind of when we should expect kind of the numbers to -- I know you have it held for sale now. So they're a little bit out of the income statement. But when we should expect to see the numbers from Russia no longer be something we even need to talk about, just kind of the final last flush, if you will, on the Russia situation?

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Yeah, James, look, you're right. There's been a lot about Russia over the last couple of years. And just to frame it up for you, when I step back and take a look at the full year, there is going to be some impact on operations, obviously, due to the disruption and the suspension of our operations, but also just as you point out, just managing through this and the time commitment from dealing with the complexities of the current environment. So at the beginning of the year, we were expecting around $300 million of EBITDA for Russia this year. And our Russian operations are generally quite accretive to our overall mix really due to the risk premium of operating there as well as some business mix, primarily in TPS services as well as in some OFS product lines. And look, we did generate some level of this EBITDA in first quarter and quite a bit less in the second quarter. So when I think through the rest of the year, OFS is the largest product line that we have in Russia, and we will see cost under absorption there with virtually no revenue generation, roughly about $25 million to $30 million per quarter. That will remain in place until we get resolution of a transaction, whether it's an outright sale or a management buyout. Look, we're continuing to work that.

James, we're working hard on things that are in our control and trying to get those done quickly. Some of it's out of our control. So for planning purposes, I'm thinking by the end of the year, that should be done. We'll try to get it done sooner if we can. But I will point out that Maria Claudia and the team have been able to offset some of the negative impacts from Russia and other areas across the world. So they've done a nice job there. And really, their overall outlook hasn't changed versus our first quarter earnings call, so offsetting a lot of that Russian impact in other parts of the world.

The biggest negative impact for Russia this year is likely in OFE, where some of the contracts that were quite profitable and sizable have now come out of the backlog. And as you know, it takes time to get cost out of the business to be able to deal with that. So that's where you'll see the biggest impact. And then TPS, like I talked about earlier, you'll see some revenue impact there. But roughly margin impact is de minimis. You might see some movement across quarters in terms of timing of how things were laid out. But generally, no real impact there. And so like I've said earlier, short-term discontinuity, long term manageable for Russia.

And then James, just kind of to round out the year for you as you're thinking through it, while it's not directly related, FX is obviously being impacted by what's going on in Russia and the overall macro environment and I'd say it's worth highlighting that with the weakness in the euro versus the dollar relative to our original plan, we'll have about $200 million to $300 million of revenue pressure. To be clear, our costs are coming down as well. But the actual translation of income from euro to dollar is going to be slightly lower. So that kind of rounds out how we're thinking about Russia and the full year there. So like I said, manageable over the long-term.

[James West, Analyst at Evercore ISI]

Okay. Brian, that's very helpful. And then maybe just a quick follow-up for me on the overall OFS business. We're at this stage, I think, in the cycle where we're going through somewhat of a tipping point. Lots of countries, lots of national oil companies trying to ramp-up activity, so they can ramp production into an under-supplied market. And so I guess, maybe Lorenzo or Brian, are you in agreement with that, that there is somewhat of an inflection point underway? And then secondarily, kind of where do you expect to see the most benefit from that in the second half and as we enter 2023?

[Lorenzo Simonelli, Chairman and Chief Executive Officer at Baker Hughes]

Yeah, James. And again, as you say, and based on our conversations with our customers, internationally, we continue to expect a broad-based recovery, all major geographies really growing and growing up to double digits. As we look at Middle East, that could be one of the strongest markets in 2022 with a lot of that coming through in the second half, as we stated before. You've seen their capital budgets increase. We also see strength in Latin America, led likely by Brazil and Mexico. And then also, as we look at North Sea and Asia Pacific continuing to see solid growth in 2022, not as strong as Middle East or Latin America, but still solid growth. And lastly, West Africa should see pretty good growth off a low base. As you look at North America, again, activity and pricing remained strong, the rig count continuing to track above our expectations and we expect continued activity increases with the broader market sector experience, strong growth of 50% or greater. So again, as you look at the rest of 2022, barring any, again, big changes from a recessionary outlook perspective, we remain constructive.

[James West, Analyst at Evercore ISI]

Okay, Very helpful. Thanks, guys.

[Operator]

Our next question comes from Chase Mulvehill with Bank of America. Your line is open.

[Chase Mulvehill, Analyst at Bank of America Merrill Lynch]

Hey, good morning, everybody.

[Lorenzo Simonelli, Chairman and Chief Executive Officer at Baker Hughes]

Hey, Chase.

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Hey, Chase.

[Chase Mulvehill, Analyst at Bank of America Merrill Lynch]

Hey, I guess the first question, you mentioned a couple of times about business realignments and opportunities to better streamline the organization and ultimately unlock more synergies. It seems like it's really kind of between TPS and DS and then also on the OFS and OFE side. So Lorenzo, I don't know if you could spend some time here to just kind of expand on exactly kind of what you're doing here and then maybe help us understand the potential financial impact of some of these synergies.

[Lorenzo Simonelli, Chairman and Chief Executive Officer at Baker Hughes]

Yeah, sure, Chase. And as we think about when we formed the company back in 2017, running it across four product companies made the most sense based on the size of each business, the outlook at the time. As you know, the business has run relatively independently of each other with separate leadership and other supporting functions; finance, communications, technology. As we've evolved, the energy markets have evolved also, and the outlook for some of the businesses have changed quite a bit. And so we think that there's the opportunity to manage them differently as well. And as you've seen over the years, we've made a couple of divestments, made some of them smaller. And so we conducted a broader portfolio review that could lead to some further changes. And as a result, we think there are multiple ways we can drive more alignment between TPS and DS as well as OFS and OFE that can drive synergies between the businesses. Also, you'll recall that last year, we started saying we were evaluating our corporate structure across the two broad business areas of IET and OFSE. And we've been conducting an exhaustive and deep analysis. So as part of this exercise, we've been looking at a number of organizational structures that could make sense. So in summary, we've got several things that we're evaluating. We think there are synergies as we go forward to drive better productivity and efficiencies across the organization, and we know what needs to be done.

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Yeah. Hey Chase, on the financial side, I'd say it's probably -- it would be a bit premature for me to give you a range at this point in time. There's definitely opportunity there and we see synergies. We're still working through that. I feel good about where we are and what we'll be able to drive there. I talked about earlier some more synergies with OFE and OFS as we look to make OFE more profitable. So look, we'll update you guys when we feel like we've got a solid number that we can talk to you about.

[Chase Mulvehill, Analyst at Bank of America Merrill Lynch]

Okay. All right. Perfect. Follow-up, just want to pivot over to kind of Europe and the energy crisis there. It seems like that there's lot of worries around winter and soaring energy prices and the potential for some rationing of supply in the winter. So really, I guess, maybe two questions for you. Number one is, could you help us kind of understand your European manufacturing exposure and how energy intensive your manufacturing footprint is across Europe? And then number two, what steps are you taking to mitigate the potential power rationalization that could happen in the winter in Europe this year?

[Lorenzo Simonelli, Chairman and Chief Executive Officer at Baker Hughes]

Yeah, Chase, and I'll cover both of them as we go through this because generally, we don't see a major risk to operations imminently, but we're continuing to monitor the situation carefully and also putting in place contingencies in the event of disruptions or power outages to facilities. Most importantly, we use most of the gas within our TPS business through the string test. We've got a number of those scheduled during the winter, and we're looking at ways to proactively manage that. I think it's important to remember that we are considered a critical industry. And as the designation we had during the pandemic period, we'll be protected in the event of any gas shortages. And so we feel that we've got enough contingency in place as we go forward. And it shouldn't be a major factor.

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Yeah. And Chase, I'd say the one other thing that we've been working on for quite some time, so it's not like we just started today, is we've been working with our supply base. And we've actually shifted some supply out of Europe for energy-intensive supply like castings and forgings and where we still have that supply in Europe. We are working with the supply base to make sure we understand what risk is there, and I have to give kudos to the supply chain team for working through that for the last few quarters.

[Chase Mulvehill, Analyst at Bank of America Merrill Lynch]

Very good to hear. Thanks for all the color. I'll turn it over.

[Operator]

Our next question comes from Arun Jayaram with JPMorgan. Your line is open.

[Arun Jayaram, Analyst at JPMorgan Chase & Co.]

Yeah. Good morning. My first question is just on LNG. You guys continue to highlight $8 billion to $9 billion of inbound orders in TPS for 2022. I was wondering if you could talk about visibility in the second half and into 2023. And if you're seeing more interest in some of the modularized solutions that you have kind of put forward with Venture Global?

[Lorenzo Simonelli, Chairman and Chief Executive Officer at Baker Hughes]

Yeah, definitely, Arun. And look, as you think about the leading edge indicators for LNG, they remain extremely positive. And based on our conversations with customers, the pipeline of opportunities has continued to grow since the first quarter call. If you look at overall growth in projects, we are seeing a notable trend towards modular LNG designs as well as fast LNG concepts. And given the success that we've demonstrated with Venture Global and the speed to market of the modular designs, this presents a growing opportunity. I think as you look at other indicators, just look at the activity on long-term supply agreements. I mentioned in the prepared remarks that we've seen over 35 MTPA contracted on the long-term agreement so far this year. And that's three times greater than the average for the entire year going back to 2015.

Another good data point, Conoco agreeing to an investment in Port Arthur, which again reflects the attractiveness of LNG from a long-term perspective. So overall, we still feel comfortable with the 100 to 150 MTPA of FIDs over the course of the next two years and also continuing FID activity in '24, '25. Just to frame it up this year so far, we've already booked 27 MTPA with the awards of VG Plaquemines, Cheniere Corpus Christi Stage 3 and also some other small award for NFE. So for the year, feel good about the $8 billion to $9 billion of orders for TPS. And also looking out into 2023, again, consistent with what we said before, feel good about $8 billion to $9 billion of orders for TPS.

[Arun Jayaram, Analyst at JPMorgan Chase & Co.]

Great. And maybe one for Brian. I'm trying to better understand within DS maybe the disconnect between some of the order strength that you talked about and just overall profitability, converting those orders into cash flow.

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Yeah, Arun. The biggest thing we have going on in DS right now that's preventing us to be at the levels that a conversion that we would normally be is really around chip and component shortages. So that's really impacting convertibility of the backlog and negatively impacting delivery schedules as well as our ability to drive more productivity with more volume flowing through the business. We did see a little bit of pressure from cost inflation as well as a little bit of labor inflation, but we've been pushing through pricing increases to offset those pressures. And if I take a step back and look at what's happening with the chip and component shortages, we've been working this for some time and our on-time delivery rates, particularly in Nevada, to our customers have, we think, troughed this quarter. But to give you a perspective, Arun, right now, we're sitting at 60% on-time delivery from our suppliers of electronics and chips to us. And it's been stable at that 60% for some time. The problem is the P80 confidence interval in terms of the lateness has more than doubled from third quarter of last year from 11 days to 25 days.

So on top of that, lead times have gone up by 2.5 times. So planning and working through that volatility is really what's been pushing the team a bit in terms of things being laid into the factory. We've been running engineering programs for redesign. We've got projects and programs in place right now that are going through testing that should come out of testing. And all indications are pretty good that, that will come through in August. So we're anticipating the convertibility and on-time delivery of us to our customers going up here. But fundamentally, that's what the core issue is in DS. And once we are through that, you'll see the profitability of this business improve because it's at higher gross margin.

So team is all over it, working it a lot. We're just in the mix of what's going on in the broader industry here, and I'd say working everything we can in our control. The good news, as you point out, is demand is pretty strong. Orders are back up to high levels. We're not seeing any cancellations. Customers really want the product and services. So everybody is on deck to work the supply chain issues with the electronics.

[Arun Jayaram, Analyst at JPMorgan Chase & Co.]

Okay. Thanks a lot, Brian.

[Operator]

Our next question comes from Marc Bianchi with Cowen. Your line is open.

[Marc Bianchi, Analyst at Cowen and Company]

Thank you. I think if I've got my math correct here, it seems like fourth quarter could be sort of bracketing consensus depending on what happens with OFS in Russia. Maybe if you could comment on whether that conclusion is correct. And what gives you confidence in kind of that significant increase from third quarter to fourth quarter?

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Yeah. Marc, look, your math is certainly in the right ballpark for what we see as a potential for fourth quarter. I'd say a couple of things that underpin our view of the quarter. One, OFS is quite strong. Even with the Russian implications, you saw the performance in the quarter was pretty solid. We see pretty strong growth there, especially internationally, where we've got obviously a pretty good presence and have been doing well there over the last few quarters.

Look, the other thing I would say is TPS generally has a very strong fourth quarter just given the seasonality of that business, particularly in the services franchise. And then if you look at the backlog, the schedules that are there with customers, how things are lining up, we've been growing backlog. And I don't see any execution issues there or any significant issues coming from customers that would impact that delivery schedule today. And look, those things really offset the weakness really in OFE because of the Russia contracts being suspended and coming out of RPO. So look, we understand what's got to happen. The teams are aligned to get it done, but it's not outside the realm of what we've seen before in terms of the jump in fourth quarter.

[Marc Bianchi, Analyst at Cowen and Company]

Okay. Great. And then I guess just kind of zeroing in on TPS a little bit more for fourth quarter. It would appear that the margin rate got to be sort of flattish from third quarter to fourth quarter there, which, to your point, you usually get a pretty strong improvement in the fourth quarter. Could you just unpack that a little bit for us?

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Yeah. Marc, again, it basically comes down to the mix between equipment and services. You're right. You usually do see an uptick in fourth quarter because of the services mix coming in strong. Just given the timing of what was laid out from a schedule in the backlog and then some of the pushes that have come out of this quarter into later in the year, we are anticipating a pretty large equipment number in the fourth quarter that will mitigate some of that upside that you see from a stronger services. So it really ultimately will come down to the mix of equipment and services. Look, as we've talked with you guys before about, we really run those businesses to drive higher profitability in both. And the ultimate margin rate in any given quarter really just comes down to the mix of how much services come through versus equipment.

[Marc Bianchi, Analyst at Cowen and Company]

Okay. Great. Thanks. I'll turn it back.

[Operator]

Our next question comes from Scott Gruber with Citi. Your line is open.

[Scott Gruber, Analyst at Smith Barney Citigroup]

Yes, good morning. I wanted to turn back to digital. Brian, you mentioned how your efforts at managing a tight supply chain will begin to bear fruit here. But are you also seeing the supply chain itself improve? We're starting to hear about more general chip availability. Are you seeing improvement in the availability of the chips that you order? And if so, is there a line of sight to seeing a normalization of deliberate timing in digital? And when could that happen?

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Yeah. Look, talking specifically about chips first, I haven't seen a lot of relief yet as we talked about here in terms of what was going on with late deliveries, but we do believe based on what our suppliers are telling us and how we're working with them and what we're hearing from others that we should start to see some relief in the second half. A lot of that is driven by these programs that I've talked to you about, where we've changed supply and standardized some things so there's more availability and would anticipate a better overall environment in this space in '23.

When I look at sort of your question around broader supply chain and really not only in DS, but outside of DS, things have been relatively stable. but there's definitely some tension in the system in a couple of places. I'd say the biggest challenge for us continues to be in chemicals, where we're seeing shortages in specialty chemicals. Commodity chemicals are pretty stable now, and I'd say almost back to normal in terms of how we're planning and operating there. You continue to see pricing for metals like copper, steel, nickel stabilizing. And some have actually gone down but are still elevated versus '21, but manageable. And look, we've been working price hard to make sure we can offset that. And then I talked a little bit about what was going on in Europe with energy pricing and some availability around alloys and pig iron and how we've been diversifying supply base there.

And I'd say the big thing we're working through there, Scott, is just really around lead times and validity of quotes from suppliers. As we've got all these orders coming in or specking out orders for TPS, we want to make sure that we're protected on that input cost side. So we tightened our order validity as well to deal with that. And as I said, we've moved some supply to other parts of the world where we already had supplier set up and we've worked with for a long time but diversifying that to get at some of those impacts. So stabilizing, I think, is the right term there. And just back to the chips, we think we'll see some relief in the second half, but looking forward to a better '23.

[Scott Gruber, Analyst at Smith Barney Citigroup]

Got it. And turning to the service side of TPS, just given how high LNG prices have been, have you seen much deferral of maintenance within TPS? And if you are seeing this a bit, how long could this last? And I'm asking because, obviously, LNG prices could sustain at a very high level through the winter. So I'm curious if there is a drag on service demand in TPS. Could that actually extend into '23 or is this just not possible from an operational risk perspective?

[Lorenzo Simonelli, Chairman and Chief Executive Officer at Baker Hughes]

Yeah, definitely. And again, on the contractual side, again, we're seeing the anticipation of the outages and customers continuing with the contractual side. On transactional services, customers are looking to defer the maintenance, as you say, to produce the higher commodity prices. That's just being deferred, and they will have to catch-up. So that comes in later on. And again, as you go through the actual cycle, you'd see that normalizing itself.

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Scott, just to add one thing on the contractual services side. You have to remember the guarantees that we have in place and the bonus-malus structure. The changes in schedule really have to happen within a certain window, especially around life-limited parts and inspections and things for those guarantees to continue to hold. So yes, while prices are high, and you're going to have to have some outages, it's definitely the right risk call to make sure the equipment is maintained and is running because, again, an unplanned outage is much worse than a planned outage. So look, we work proactively with customers on those schedules, but we haven't seen any significant movements there and the contracts are pretty good from that regard.

[Scott Gruber, Analyst at Smith Barney Citigroup]

Got it. Appreciate the color. Thank you.

[Operator]

Our next question comes from Neil Mehta with Goldman Sachs. Your line is open.

[Neil Mehta, Analyst at The Goldman Sachs Group]

Thank you, team. I know we're at the top of the hour, so I'll be quick here with two questions. The first is, what is your latest thoughts around return of capital? The company did buy back stock in the second quarter at a higher price than where we are right now. But of course, you have to weigh that return of capital with a slightly lower free cash flow outlook that you talked about on the call and economic uncertainty. So any color there?

And then the second question is, just your latest thoughts on closing the sum of the parts gap and whether it makes sense to be a combined business or to ultimately break the businesses apart? So two strategic questions. Thank you.

[Brian Worrell, Chief Financial Officer at Baker Hughes]

Yeah. Neil, I'd say first on capital allocation. Look, our intention to return 60% to 80% of our free cash flow back to shareholders through dividends and buybacks is unchanged. And during the first six months of the year, we have bought back $462 million of our shares, so roughly about $75 per month. We talked about what the average price was, did [Indecipherable] in the quarter. So happy about that. And I would say that we'll probably continue roughly at the same level that you've seen here in the third quarter as the final tranche of the GE sell-down happens. And then as we've said consistently, once that is done, we'll take a step back and relook things. For free cash flow, we talked about the impact of Russia in the quarter, but fundamentally, no real change to the free cash flow generation capabilities of the portfolio. So again, I see this as a short-term discontinuity, something that we can manage through long term. So no real change there from a capital allocation standpoint.

And then look, in terms of the company and how we're structured, we talked about some of the steps that we have taken to better align the businesses and drive some of the synergies there. As I said, we're working through that, and I'll update you on those synergies that we see from some closer alignment. But look, we've always talked about the scale and size of the combined organization and how that's a positive for growth and profitability. The current environment that we're operating in certainly makes us appreciate the scale, diversity and financial strength of the company.

So look, we'll continue to weigh the benefits around scale with our customers, the same customer base, technology overlaps that drive a better cost or competitive position and obviously the operational benefits of sharing infrastructure around the world and what that delivers for the company with the potential benefits of a more purely focused entity. But right now, I'd say we like what we're doing. We'll continue to update you guys if there are any changes in our thought process. But look, overall, and like I've said many times, overall return and ability to drive return on invested capital and higher margins and free cash flow for shareholders is what's going to drive the decision.

[Neil Mehta, Analyst at The Goldman Sachs Group]

Thank you.

[Operator]

That's all the time we have for questions. I'd like to turn the call back over to Lorenzo Simonelli for closing remarks.

[Lorenzo Simonelli, Chairman and Chief Executive Officer at Baker Hughes]

Thanks, and thanks to everyone for joining our earnings call today. Just before we end, I want to leave you with some closing thoughts. Despite some of the challenges this quarter, we continue to remain optimistic on the outlook across both of our core business areas, given the need for energy, sustainability, security and affordability. At Baker Hughes, we continue to execute on our long-term strategy. Our portfolio is well-positioned to benefit from a strong LNG cycle and a multiyear upstream spending cycle. We'll also continue to invest in our new energy transition activities and industrial initiatives while also returning 60% to 80% of free cash flow to shareholders.

So thanks a lot for the time, and look forward to speaking to you all again soon. Operator, you may close the call.

[Operator]

[Operator Closing Remarks]