General Electric Company (GE) Earnings Call Transcript & Summary

Hi, everybody, and welcome to the afternoon session of Day 2 of the Industrials and Materials Goldman Sachs Conference. We're really excited to have Carolina Dybeck Happe, the CFO of General Electric, here with us today. Carolina, thanks for being here with us. I know that you have some opening remarks. So I'm going to turn it over to you, and then we'll kick off Q&A afterwards.

Hi, Joe, thanks for having me. Good to be here with you. It's hard to believe we're actually almost halfway through the second quarter, right? It's been busy, but exciting. And I thought just before we get to the Q&A, I'll just share some insights on where we are right now and where our efforts are concentrated. So I'll start by saying that our journey to become a more focused, simpler and stronger industrial company is accelerating. With the AerCap and GECAS combination that we announced in March, we're focusing GE on our core industrial businesses. And we're really capturing the opportunities that we see in energy transition, precision health and the future of flight. Upon close, it will also drastically simplify our reporting structure. We'll go from 3 columns to 1 column financials, and it will serve as another catalyst to significantly reduce our debt by more than $70 billion over 3 years. In particular, our finance team is instrumental in making this happen. At the same time, we're fortifying our foundation and our lean progress is key. As we scale lean, we're working to deliver safety, quality, delivery and cost improvements, in that order, as well as high-quality growth. So lean, coupled with our significant decentralization effort, is enabling this work and really maximizing our impact close to the customers. And right now, we are really going through all our operating reviews, so I'll touch briefly on each of the business. So we met with our Power team 2 weeks ago, and it was really good to see the progress, especially at Gas Power services. So last year, as you may remember, we put a new organizational structure in place. And this is really landing, and we're starting to see traction, as you could see by our service growth in the first quarter. Specifically, the CSA team is working with the transaction team to ensure we're maximizing the opportunity here. So we're increasing customer satisfaction while improving profitability across our services portfolio. And equipment was down year-over-year as expected since we're more selective on the turnkey projects. So we're really transitioning to more equipment projects, which is a better risk/return equation over time. At Renewables, we're focused on building a profitable growth business. In Onshore Wind, we're expecting the U.S. market to slightly decrease this year while we expect to see good growth abroad. In Offshore Wind, the strong market trends are expected to continue through the decade. We have some strong interest in our Haliade-X with over 5 gigawatts of customer commitments. And we're excited to announce the strategic partnership with Toshiba yesterday to localize, I would say, critical phases of manufacturing in Japan. And Grid is gaining momentum, broadly speaking, as the energy transition accelerates and government investment increases. Taken together, that really drove the strong first quarter order growth that we saw in onshore, offshore and grid. So we're confident that this continued improvement in operational excellence and cost productivity will lead to better margins this year. And we met with Aviation last week, clearly, still the most challenged market. Our GE CFM departures were down 40% year-over-year, but we're encouraged by the improvement in March and April despite some regional pressures. As we shared at earnings, our shop visit inductions were off to a slower start this year, and it's really a result of the lower January and February departure trends. So this will impact the timing and potentially scope of our shop visit profile in the second quarter versus the second half of the year. That said, we're really focused on improving services with Russell spearheading our efforts. And we're staying close to our customers to understand their needs while we're implementing standard work and changes to improve engine on-time delivery in our overhaul shops. So we're planning for some recovery in the second half, and we're ready. Our Aviation business is comprised of the largest and youngest engine platforms. And we have more than 37,000 commercial engines. And more than 60% of our fleet has not yet had the second shop visit. So our platform is well positioned to generate value for decades to come. Our Healthcare business, management met on that yesterday evening, has been a real standout. And we're seeing improved market fundamentals. In the first quarter, global procedure volumes were up double digits and elective procedures are bouncing back, even reaching pre-pandemic levels, yet many customers are running at reduced capacity with longer waiting times for patients, and we're working hard to support them. In the first quarter, we delivered revenue growth with impressive margin expansion. Notably, orders growth at our diagnostic and imaging businesses was above 20%. And this has not come at the expense of investments as we position ourselves to lead the precision health revolution. And just last week, we announced a bolt-on technology acquisition similar to Prismatic. It's called Zionexa, and it will be part of our PDx business. So a solid start to the year. And across all of our businesses, services remain a core strength. Despite some near-term pressures, service orders were up 6% organically in the first quarter, excluding Aviation. And longer term, with more than half of our revenue in services, this is a tremendous growth opportunity for us. Underpinning our business improvement is the significant progress on solidifying our financial position. So following our outlook in first quarter call, we've received questions related to factoring. First, as requested by many investors, we provided these quarterly data points for 2020 on our website today. Now I want to take some time, though, to provide a little bit more color why we're talking about this. So as a reminder, since the beginning of '19, we've already reduced our factoring balance by $8 billion. And this includes $800 million in the first quarter, bringing the balance down to about $6 billion at quarter end. Effective as of April 1, we discontinued the majority of our factoring programs. And this decision was made along with the AerCap transaction as we wind-down the active business at Capital and better focus GE on our industrial core. So therefore, starting the second quarter, we'll exclude the cash flow impact of the discontinued factoring going forward. And as we've shared, we expect this to be between $3.5 billion and $4 billion, primarily felt in the second quarter. And at the end of this process, our factoring balance will really be around $2 billion, right? And that will be in our continued off-balance sheet programs. And I would say that, that represents a level of factoring which we believe is effective and efficient really to support our industrial businesses. Now how does this decision impact the free cash flow bridge from 2020, the one we shared at outlook, right? So at outlook, we provided a walk that starts with a rebased 2020 free cash flow number about breakeven, including BioPharma and the COVID-related volume. So if you want an apples-to-apples construct, excluding the discontinued factoring, then the 2020 free cash flow was $2.4 billion. So 2 ways to think about 2021. On a reported basis, we remain at the $2.5 billion to $4.5 billion, but that includes the first quarter discontinued factoring impact of about $800 million. On a comparable basis to the $2.4 billion in 2020, you'd have to add back the same $800 million in the first quarter. So broadly speaking, the majority of our year-over-year cash flow improvement comes from earnings. And this is an important point, right? In addition to that, we continue to see working capital improvements. And then as you think about 2022, there is no discontinued factoring impact to adjust. And I would say, as we reduce our reliance on factoring, our businesses will continue to deepen their operational improvements around billing and collections. So for example, what I shared at the first quarter that our peak quarterly cash needs decreased by more than $4 billion year-over-year, obviously, a significant improvement. And that came on the back of reducing factoring, managing working capital and cash better. Stepping back, this decision will really enable the businesses to focus on what matters, running the business better, including operational cash drivers that improve working capital, increasing the frequency of our operating rhythms and a more linear cash flow generation throughout the quarters and the year. And those are our current finance priorities that together will help lead to a more sustainable cash flow over time. So in summary, we're making measurable and sustainable progress. And we're set up well to deliver on our 2021 commitments that we shared with you in March. And we're confident that there's upside potential across our businesses and that, that will lead us to our high single digit free cash flow generation. And reflecting on my 1 year plus at GE, I'm really happy to be part of the team at this critical point in our transformation. So thanks for letting me share those thoughts. And Joe, over to you.

Yes, Carolina. That was helpful. It was clear. And it is crazy to think that it's been over a year since you've been at GE. Time does fly. Hoping that next year, we can do this in person as opposed to virtually. But I'm curious, as you think about the past year and as you think about the path forward, talk a little bit about your priorities as the finance leader of the organization and the change you're trying to effect as that leader?

Yes. What I think is important is that finance is here really to support the business and the transformation of GE, right? So what we talk about is, how can we best support? And the first part of it is really making sure that the way the businesses are looking at the numbers is the best possible way to drive insights and also actions. And that's why we talk about the more operational P&L and a working capital definition that fits GE in a good way to put focus on that. Then on top of that, it's also the frequency. In what frequency do you get data, right? How often do you get actuals to faster be able to take decisions? And that needs to be, we talk about daily management and monthly closings, right? So faster or higher frequency of data. The third part is really about decentralization and our part in that. So you go from 5 P&Ls to 30 P&Ls. So clearly, that's the difference, right? So we need to make sure that we can provide that kind of insight and numbers package on a P&L level, right? And then on top of that, an area we've talked a lot about and also shared with you is linearity on how we can improve our nonlinearity. And the reality is that it's really an end-to-end work where you start with the commercial, sort of the whole operations and then also finance involved because it's about looking at how can we deliver our services in a much more linear way. And that also drives billings sort of earlier in the quarter, right, which also drives collections. So the improvement of linearity in the company also drives improved linearity in cash flow and overall, a better free cash flow generation.

That makes a lot of sense. So that was a good segue into free cash flow. You know it's going to be a topic of conversation. So perhaps maybe we can just start with the near term. So helpful to get the factoring adjustments on a quarterly basis. So thank you for that. But as you think about your second quarter number, you talked about an improvement of $1.7 billion, and I know consensus is somewhere in that minus $400 million to minus $800 million number for 2Q. How are you thinking about the working capital puts and takes for 2Q? And what kind of drives us maybe above the better part of that range or towards the low end?

So Joe, I get so excited when I talk about working capital. I just want to start with the most important part. That for the second quarter, a big part of the improvement is that we expect better cash earnings, right, really driven by the cost-out actions we did as well as the sort of the recovery especially in Healthcare since it's high-margin business, right? On working capital, so we are working to improve the processes to improve the underlying efficiency, right? And we've talked about receivables and inventory as 2 big important areas. What we do see specifically for the second quarter, though, is that you have to look compared to where we were last year, right? And last year, we had this big non-repeat payables pressure, right, from the COVID hitting us. And we won't have that this year. So that's obviously a positive for us. On the other hand, we had the military progress that we received last year, which we don't expect to happen again this year. So those are sort of 2 anomalies. And then on top of that, this year, in the second quarter, we also expect headwind from AD&A and the goodwill because it means that our customers are delivering to their customers, but that has a negative impact on our free cash flow and the working capital overall.

Okay. That's helpful. And then maybe just kind of stepping through the guidance for the year, the $2.5 billion to $4.5 billion. Look, I love that you guys reset the 2020 number to baseline it, really at $2.4 billion when you exclude the factoring component. I guess as you're thinking about factoring specifically, why not discontinue the entire program? Is it economically viable for you to keep it at $2 billion? And then, of course, like as we think about 2022 and beyond, how should we be thinking about the rebasing of the free cash flow going forward?

So Joe, that's a really important point for us. So basically, when you take away the noise from factoring last year and this year. Basically, the majority of the improvement in free cash flow in 2021 comes from earnings. And that's an important point because we talk about how to get, it's an important proof point on our way to the high single digit returns, right? I would say, when you're down to $2 billion of factoring and off book, then you're on a level which is an effective way for us to use it. Then you're less than 3% of revenue. So I see that as a reasonable and good level for us to keep. And when you talk about sort of how you get into 2022, you talked about as well, right? So I would say, 2022 is obviously a step on the way to that high single digit margin. So we expect the majority of the improvement again to come from earnings growth, right? And then we'll continue to improve the underlying processes in working capital and offset some of the pressure you get from the volume as we grow with Aviation specifically coming back in 2022.

Got it. No, that makes sense. Go ahead.

Yes. I would just say that the jumping-off point. So when you look at sort of where 2021 ends, you do need to sort of mentally adjust for those $800 million as well in the 2021 numbers, right?

That's a nice tailwind already for 2022. But I guess maybe let's talk about the jumping-off point for one second. So if you think about the first half improvement, let's assume the negative $400 million is the right number for the second quarter, the improvement that you'll see in the first half of the year alone is over $3 billion versus what you saw last year, right, from free cash flow. I guess based on what you know today, what precludes you from tracking at least towards the higher end of your free cash flow guide for 2021?

I would say, we have a range, right? Now we're sticking to that range. So we still expect to be within that range. If we look at where we started the year, right, the first quarter, you know, good start on free cash flow. We talked about the second quarter improvement in line with that. So to your math then, all things together. If I looked on that, specifically the second half, so of course, we expect to see sort of operational improvements, basically improving earnings and working capital, but there are also a couple of headwinds that we need to remember basically. So I'm taking you back to the second half of 2020 now, right? So we have the Boeing 737 MAX payments. That was about $500 million. It's going to be a headwind, right, this year. We also had significant progress payments from Renewables orders coming in the end of 2020. We know it's really lumpy by nature, very hard to predict, but we know that they were there in end of 2020. And we also had some impact from the CARES Act and the deferred payroll taxes. So those were sort of the big ones in end 2020. And now if you think about, so what about end 2021 or second half? So there's still a lot to go in the year, and I would say it's a mixed business story here. And so if you just take the majority of the range or the middle of the range, clearly, that has to do with the timing of the recovery in Aviation and what that does to our numbers, right? And on top of that, we're also watching those lumpy payments in Renewables, not knowing exactly when they will happen. And then on the other hand, we have Healthcare, which continues to really go from strength to strength. So that's how you get sort of the range and remembering what happened end of last year.

Got it. That's clear. I guess, as you move on to 2022, 2023, and everyone's trying to figure out what 2023 is going to look like and the path. It sounds from what we're hearing, like a lot of it is going to be earnings based from 2021 on. But I'm curious, when you think about the working capital component, you just mentioned being excited about it, is there a tailwind from working capital that we should expect at least for the next couple of years as well?

I look at it like this. Let's start with what we talk about. We talk about getting to high single digit free cash flow margin, right? Okay. So high single digit, where are we? So let's assume the midpoint of that is 8%, right? And if you just based that on, let's say, the sales that we had in '19, so before COVID, $85 billion, $90 billion. So the math on that is $7 billion of free cash flow. And looking at what that would comprise of, I would really say that the big, big part is earnings-based, right? And it's earnings that comes from healthy organic growth, OMX expansion, both by improving the mix, driving towards more services and cost out, both fixed costs and restructuring as well as productivity cost out, right? Then on top of that, we also have, well, I'm sorry, going forward, we expect to have lower restructuring costs, legal costs, pension and sort of seeing them fading over time. And then the third bucket is really the working capital part. And here, I think it's important to remember that it's sort of, you have 2 parts here. One is depending on how much organic growth and where we have it, that will create working capital needs. And then we are working to offset those needs by improving the processes underlying, right? So it's going to be basically dependent on where the growth is versus how effective we are on the working capital part. But we do see that especially as receivables and inventory, just looking at where we are, talked about 2.5 turns, talked about 86 days, there is room to improve there. It's not a quick fix, though, and it takes some time. But it's really, there's more we can do there, and we're working on that.

Okay. No, that makes sense, Carolina. I think maybe it makes sense at this point to shift into the segments and the earnings performance. So perhaps starting off with Aviation. The performance this quarter from a decremental margin perspective was pretty outstanding. And we know that there was some benefit from contract margin reviews that impacted the quarter as well and benefited the quarter. But we should be talking about, hopefully, incremental margins now instead of decremental margins in the business going forward. So just talk to us about how we should be thinking about the trajectory of that business from an incremental margin standpoint from here on out?

Yes. Joe, I totally agree with you. I have to say, when you do the earnings, you often, well, you compare year-over-year, right? So of course, it was a tough quarter to compare to for Aviation. But if we look sequentially, Aviation improved their margins. And if you look at the decremental specifically, we went from 48% decrementals in Q4 to only 19% in the first quarter. And that's on, well, on the 20% top line drop. So that was definitely good, and we're very happy with that. Business remains challenged, though, right? And the market recovery, well, it's to be continued, I would say. And we will have to see that. I would say the drivers in the first quarter on the margin, clearly from the cost actions, right, significant cost actions taking hold there, but also some, to your point, on the CSA margin reviews that were positive. So if I look going forward now, I think you have to remember that we do those reviews ongoing. And we continue to work with our customers to see what their expectations are of the utilization and the fleet assumptions there, but I think we can expect some quarterly volatility still because we're still in COVID. Obviously, not, we don't expect it to be of the magnitude that it was last year because Q1 and Q2 were clearly impacted by the marks we took then, right? Looking at the margin, excluding that part. So since the cash comes from utilization. And the billings is one thing, but the margin really comes, if you talk about the services side, you have the margin, it depends on when we see the shop visits because that's when we rev rec and that's when you see it in the P&L. So for us, it's going to be important to look and sort of say, what will the mix be of shop visits and what scope will they have? So basically, what engines will come into the shop, how much work will they do? And then we have the external MROs. And there, it's about what inventory do they have versus what they need. As in, what will they buy from us, right? So I would say, there's still a lot of uncertainty, and that's why we're holding the low double-digit margin for the year. We need to see the departures, shop visits and customer behaviors really, really play out.

And I think when you reported earnings, I think you talked about commercial shop visits being up 25% in April. Has there been any change on the margin there? I know it's only been a couple of weeks, but just curious whether there's been anything that you guys have seen specifically.

Well, what I would say is that we don't really see changes, but we continue to monitor it very thoroughly. And you need to sort of look at this regionally as well because it's also different by regions, right? You have the U.S. doing pretty well. China in a pre-COVID level, right, but Europe, my own home turf, is not flying yet so.

Okay. Got it. That's helpful. Maybe switching gears a little bit into the renewable sector. So know that this sector is really about just the turnaround story, the profitability enhancement in the business. I think as I think about the key priorities there, you've got a grid business that you've talked about gaining some momentum. But historically, we thought of that business as being fairly unprofitable. Maybe we start there on what you're doing to improve the profitability of that business, then also how that business could potentially benefit from stimulus measures here in the U.S.

Yes. So I would say, to your point, in Renewables, you really have to look at the different parts. We have the Onshore, Offshore, and then we have different turnaround businesses. And the big important part here is Grid. And as we continue to restructure Grid, we are taking cost out. And we're also working through a pretty tough backlog with legacy projects, right? So there's pressure on the margins as we continue to execute there. Also, improving working capital management also in Grid, so good progress on receivables and overdue specifically, but also on the inventory side. But overall, a lot of work going into the turnaround there and moving along as we were expecting. That said, in the energy transition, you think about sort of the whole move towards renewables and the wind part. For that to really work, you need a grid that is adapted to that and a grid that can work in that new world. So what we see is sort of the CapEx supercycle basically with investments being made into the grid. And we are really well positioned there, right, because we have both the grid automation business, but we also have the digital grid part, right? So an important part in the energy transition as well.

That's helpful. And you mentioned earlier, offshore is a big opportunity that you've talked about. Clearly, you've made investments in the Haliade-X. It feels like that could be a pretty big swing factor as you start thinking about 2023, 2024, 2025 in terms of earnings and free cash flow. I guess what are your latest thoughts on the traction that the Haliade-X is getting on offshore projects and the momentum there?

Yes. So I would say, to your point, this is a really interesting area for us over time because people sometimes confuse it with the short term. But if you just look at this sector, right? So we have, let's say, more than, where we're expecting more than 20% annual growth over the next decade, right? And you have the Biden administration support. They're pushing for 30 gigawatts. And we talked about our Vineyard Wind project as well. For us, we have a strong pipeline. We've talked about it being more than 5 gigawatts. And we're focusing on getting the, I would say, we need the profitable shares in the different projects. And to your point, yes, it would be a meaningful business. So we talked about this being a $3 billion business by 2024 and with a path to breakeven and positive free cash flow already in 2022. So I mean, Haliade-X, it's impressive, right? It's basically the biggest offshore wind turbine beast. We've talked about 12 megawatts, 13 megawatts. We're now going for certificate in 14 megawatts. And I mentioned in my comments that we're working with Toshiba to localize in Japan as well. What I would say is that, this has the typical signature of the wind part. The orders are lumpy. They are big. We don't know exactly when they will come, but we do expect to book more orders in the second half already of this year that would then come with progress.

Got it. Yes. That's great. No, it seems like a great opportunity for you guys. I think maybe shifting gears a little bit, so we touch on Power as well. So I'll start by asking you, provide an update on, you mentioned Gas Power in your prepared comments, but I know that you're tracking to high single digit margins for 2021. So maybe provide a little bit more of an update on what you're seeing in that business specifically.

Yes. I think this is really exciting. And we have a lot of good momentum here. And the team is really fired up in gas as well because they know that they are on track with the high single digit margins this year, right? You saw the first quarter performance, great proof point. And the team sees this, and we do have the path to get there, the path. I mean, it's a combination of a lot of good things. We have the fixed cost out, right? We talk about productivity. We're clearly pushing a focus overall in gas with more services, right? And we expect to see the low single digit services growing this year. So I would say, we're really on a good path here.

How do you think about the free cash flow margins on this business? I know that there's an expectation beyond 2022 to get free cash flow conversion above 90%. But where is the kind of starting point today and the path to get there?

Well, I would say, an important part is the focus on services, right, because fundamentally with the cash conversion as well. And we've talked about that. You would expect a business like this overall to convert at least 90%, right? But let's get the margins up first. Let's get to the 90%, right, step by step.

Okay. Got it. And then I guess just maybe just on the, since you have talked about the services growth. In 1Q, it was up 13%. So kind of nice to see the uptick there. One of the questions that we get a lot is just a comparison to some of your peers in that business. How do you think GE differentiates on the services side of the business versus like, say, the likes of the Siemens of the world?

Well, if you think about services, you are servicing something, right? So you need to start with what's your equipment. And I would say, we really have the best technology, and we've shown that. We've shown how reliable it is, and we really see sort of good commercial wins continuing to happen. So I would say, with services, we talked about different types of services. You have the CSA. You have transactional. So you have different type of services. And I mentioned that with the new organization, the teams are working much more together, but also in a very, very professional way of improving. I would basically start by saying servicing our own fleet, right? So focusing on penetration and scope of service of our own fleet. I would say that's the biggest focus right now.

Okay. Fair enough. We got one question from the audience. So I'll read it to you, I guess. It's more around like the framework for free cash flow, going back to free cash flow as we always tend to do. And so this is more of kind of like a near-term thing with specifically, this person is asking about the AD&A headwinds in the second quarter. So when we think about kind of like positive free cash flow into the second half of the year, are there any other variables that can kind of push to positive free cash flow even earlier than the second half of the year just given some of the headwinds that you see in 2Q?

I wanted to say that the AD&A is really about our customers delivering to the end customer, right? And then this is paid out. So that's a good thing. The timing of that is not up to us. The way it looks now with what our customers are saying, basically, we expect to have a big negative in the second quarter from this, but not as much for the rest of the year. But I would say that, that could move a little bit depending on the customer schedules, right? Apart from that, overall, I would say that for the rest of the year, I mean, it is really back to what I talked about, so the Aviation recovery and utilization as well as those lumpy payments for Renewables on progress. That's probably the biggest uncertainties. But it's the timing issue, but still, right, because you asked specifically about the quarters, right, so.

Yes. Yes. That makes sense. Just a couple of quick ones just to end here. So clearly, one of the key positives kind of coming out of this quarter for us, at least, was just the pension now being funded through the end of the decade. So kudos. We've gotten some questions from investors around like how you would break that up in terms of what impacted that. How much came from the American Rescue Plan Act? How much of it came from like the investment portfolio performance, the funding that you did in 2020? Just any thoughts around what kind of got us to this really, what seems like a really good outcome.

Oh, it is. It is a really good outcome, at least a decade, right? So no, that's a really good outcome. And it's really all 3, right. So we had the prefunding in 2020, $2.5 billion. We had really good investment returns on the portfolio and then we have the Rescue Act. So all 3 contributed.

Okay. Fair enough. And then again last one, we didn't talk about the balance sheet. We're not going to go into all the specifics because I'm sure there's a lot to unpack there. But I guess the one question is, and we get this from a lot of folks, like at what point do you think GE is going to be ready to start playing offense with their balance sheet? So maybe I'll leave it open-ended there for you, and any thoughts around that would be helpful.

You can see my smile through the Microsoft Teams screen probably. When we talk about offense, I think we just need to start by saying that, first, we mean organic growth, right? And playing offense and growing organically, it's really about investing in R&D and the products and services as well as commercial investments, right? And then we had just a couple of, feels like days ago at least, we talked about Zionexa acquisition, right? I think that's a perfect example of a bolt-on acquisition literally at the forefront of precision health. It's about personalizing diagnostics and treatment in a better way. And in this case, it's for Stage 4 breast cancer patients, but that will be a typical acquisition that makes total sense for us to do. And I would say, over time, as we earn our right to do this as our free cash flow improves, but also as the business sort of are stable, profitable and growing, then there are also really good targets of acquisitions and integrating them in a successful way, right? So a combination of that, we expect to see deploying our capital smartly going forward across the businesses, I would say.

With that, Carolina, thank you for spending time with us today. It was great spending the time with you and hope you have a great rest of your week.

Thank you. You too. Thanks for having me.

Bye.