General Electric Company (GE) Earnings Call Transcript & Summary

All right. Well, good afternoon, everybody. We're in the home stretch. The afternoon of Day 3 of the Goldman Sachs Industrials & Materials Conference. We're really excited to have with us here today, GE's Chief Financial Officer; Carolina Dybeck Happe. I'm going to turn it over to Carolina for some prepared comments, and then we'll get right into the Q&A. [Operator Instructions] With that, Carolina, it's all yours.

Hi, Joe. So thanks for having me. Thanks for giving us this special slot in the home stretch. So before we go to Q&A, let me just start with a quick update of what we're seeing. And more importantly, what we're doing to drive growth and value across our businesses. So in earnings last month, we shared some important bright spots from our first quarter. And to recap, we talked about our high-margin services that are recovering in all our businesses. Our total orders were strong, and we continue to expand margins and improve cash generation. We are managing increased pressures from inflation, renewable energy headwinds and the Russia-Ukraine war. We're also navigating supply chain pressures, including the impact of the COVID-related manufacturing shutdowns within China. And as we shared last month, given the fluidity around the duration and the magnitude of these factors, we are trending towards the low end of our 2022 outlook range, but we remain confident in the recovery in the second half. We're not quite halfway through the second quarter yet, and the team is diligently working through these challenges, and we're taking action to drive growth, to drive pricing, cost out and using Lean to do that across the businesses. This really means growing higher-margin services businesses, adapting our supply chain, improving execution, particularly in renewables and leading with innovation for our customers. We are committed to our selectivity strategy, being more disciplined about our commercial deals, the pricing, the geographies as well as the market segments where we choose to participate. Through Lean, we've been improving the way we work across the entire company. And then has always been important, but it's much more critical right now. I can see this first time from working closely with both our commercial teams and our operational teams as we help them to scale Lean, and we're focusing particularly on pricing and productivity. So we've heard questions from investors about that second half ramp this year. So importantly, let me start by saying, [ this is ] typical seasonality is back half loaded. To give you context, take last year. Second half of 2021, we delivered just over 50% of revenue, more than 60% of operating profit, 80% of net earnings and more than 100% of free cash flow. This year, we expect a similar, but slightly more weighted profile in the second half. So I think closer to about 55% of the revenue, 65% of operating profit, 75% to 80% of net earnings and more than 100% of free cash flow. So you can think about it as 2/3 of the growth dollars coming in the second half is similar seasonality to what we saw last year. And the remaining about 1/3 that's above that level, and that's because of the significant growth that we expect in Aviation and in Healthcare. So what does all of that translate to? Well, if you look at the growth expectations from the first to the second half implied in the low end of our range, that's about 20% to 25% revenue growth or call it, $7 billion to $8 billion of revenue set up. We expect about $0.5 billion of that to come from pricing and the rest from volume. If we take it down another layer and we look at the volume step up in a few different buckets, I would say we have higher conviction in roughly 2/3 of that step-up, such as equipment and service volume that we already have in the backlog and where we have higher confidence in the supply chain front to meet that demand. This includes the businesses like Gas Power, equipment and services, Aviation commercial services and Offshore Wind. Then we have another 20% to 25% from areas where we have the demand, but where we're working through the supply chain challenges. And here, think about Healthcare volume and Military. And then the last 10%-ish is tied to, I would say, an area with higher levels of market uncertainty. Clearly, the biggest thing here being North America onshore wind volume really associated with the PTC delays and the price pressure we're seeing across that industry. Nothing is certain in an environment where so much is changing day-to-day, but clearly, we have a path to significant growth in the second half. Overall, we expect top and bottom line growth across the segments in the second half versus the first half, and that's supported by the volume growth, the price realization from orders in the backlog and productivity initiatives that will help us drive down our costs. Now let me take a moment to provide some more detail at the business level, including an update on how we get to that second half ramp. Aviation is at the beginning of a significant industry recovery. The team had a good first quarter, more than 30% orders growth and double-digit revenue growth and over 300 basis points of margin expansion. We are expecting shop visits to continue to ramp through the remainder of the year, driven by the ongoing recovery and the growing customer confidence. And that will support 15% to 20% higher services revenue in the second half versus the first. We're also seeing significant step-up in both Commercial and Military with a 20% to 30% higher sequential equipment revenue. And this puts us on a path for full year revenue growth of 20% plus and midterm margins as cost productivity offsets the negative mix effect that we will see from the OE ramp. Healthcare demand remained strong as public and private investments in the sector increases, we're poised to capture it. Our challenge here is delivery, but we remain confident in the long-term prospects of our business and its recovery. For example, orders that are healthy in the first quarter, up 8%. In the near term, we anticipate some easing of the supply chain constraints, but with continued price cost pressure, and we're also closely watching the impact of China. We expect supply and inflationary challenges to persist at some level through 2022, but with sequential improvement. And it will depend on the degree to which the supply constraint is, but also our ability to drive pricing and Lean-enabled productivity. Importantly though, we expect to convert orders to revenue and reduce that overdue backlog by about half as shortages abate. So in all, we would expect to drive 10% to 15% higher revenue in the second half with further improvements in 2023. As mentioned, renewables had a challenging first quarter, and we're intently focused on driving the selectivity strategy driving price, driving cost out and better execution to improve our performance. In the second quarter, we'll likely see similar pressures as in the first quarter, with onshore down significantly year-over-year based on lower U.S. volume and mix and higher inflation across the segment. Our full year performance will depend largely on that North America volumes and the inflationary environment and of course, the execution of price and our own cost actions. We do have line of sight to better volume and mix at renewables in the second half with a favorable onshore wind mix from high North American market volumes and margins. And green automation growth and Haliade-X deliveries will also contribute to the growth. At Power, we're encouraged by the steadily improving performance, continued strength in Gas Power last quarter and stabilization in steel. Orders were up 90% in the first quarter. And if we look at the second quarter, we expect to have seasonally higher outages, but still lower year-over-year, really due to the maintenance intervals. So for the full year, we expect 25% to 30% higher sequential revenue in the second half versus the first half. And this will be driven by the outage growth, Aero services and more equipment deliveries. And we, of course, also expect margin expansion driven by that revenue growth by cost out and the continued improvement that we see still. All this progress gives us confidence that we'll continue to drive improvement in the second half, leading to the low end of the outlook that we discussed at earnings. And with the significant debt reduction that we have completed over the last few years, our balance sheet has become a source of strength, enabling us to play offense and invest in the business growth while pursuing capital allocation alternatives like the opportunistic share buybacks, which we've begun to execute. Given the valuation upside we see in the equity, we think this is good use of capital. This is an exciting time for us as we are prepared to stand up 3 industry-leading, independent investment-grade companies. And we are on track to launch Healthcare first in early 2023. And with that, Joe, let's go back to you and questions.

Carolina, that was very helpful in helping to frame a year that I know that a lot of people are interested in a lot of those details. Before we dive into some of those details, I wanted to ask you on your -- just your approach to guidance, right? You're now trending towards the lower end of the range. There were several opportunities throughout the quarter to give an update, including the Investor Day in March. And so I just want to understand a little bit more when you guys think about changing the guidance for the year, how are you thinking about -- under what circumstances do you make the change? I know we're talking about the lower end now. And did things materially deteriorate since the Investor Day in that we're now talking about the lower end as opposed to the mid to the upper end of the range?

Well, Joe, I'll start by saying that several areas did deteriorate meaningfully since our Investor Day. If you think about it, where we are on inflation, where we were then, if you look at the spot buys, we talked about logistics. I would say the Russia-Ukraine war happened -- continues. The China COVID impact also more severe and also the renewable outlook. So you put that together, that's really what drove us to move to the lower end of the guide. And in general, I mean we are navigating this very dynamic environment, so to say. And we are intently focused on sort of the inflation impact from the Russia-Ukraine war, talked about renewables, the supply constraint and China. It is still early in the year, though. And when we talk about macros like that, I would say both the duration and the magnitude of this is pretty difficult to call for the full year. So we do our best on that. But where we really focus is what we can impact in our own execution. And if anything, we're focusing on managing what we can manage, and that's why we talk so much about how we're driving growth, the selectivity, the right type of growth, how we're pushing pricing, how we're pushing cost out and cost out in many different ways. You have it in sourcing, you have a new productivity. You have it in restructuring. So we're focusing on the initiatives that are really within our control to help drive the results that will then in the end be our actuals.

That makes sense, Carolina. And I guess in the way that you framed the guidance for the rest of the year, the 2/3 that's sitting in backlog, that seems like you've got some good visibility into that piece of it and you feel confident there. There was the piece that obviously relates to renewable, which calculated at about 10%. That seems to be potentially a swing factor. And then there's the piece in the middle, right, which is supply chain oriented. So help us gain confidence in the pieces that are not in backlog today where you're navigating supply chain where you're dealing with the renewables environment? And ultimately, like what drives a good outcome in those 2 buckets?

Well, I would say, again, it is early. So of course, there are scenarios where if you think about the headwinds that I mentioned, depending on how severe they are, they could also help us get to a better sort of part of our range. And yes, we've talked about the growth from the first half to the second half. And that's why I find it that this morning that if you think about it, that you have this 2/3 that are basically in backlog and that we have confidence in delivering 20% to 25% where we have the demand and the orders, but -- and I mean, there is also going to build both the situation in supply chain, but also what we are doing to improve the opportunity to deliver. And we're doing a lot of different things there to deliver for our customers. I mean it's not one thing. It's a lot of different things. For example, we are qualifying different or new components instead of the ones that we have a hard time getting so that we can manufacture and then deliver to our customers. We, what do we call it, rearranging our supply chains even, to make sure that we can deliver. So in that part, it's also really, really important to get out. And then it comes to the part where more of sort of the PTC dynamic will play a part. I would say what is important is that we deliver on the orders that we have, and we make sure that we continue to improve the way we run the business and also by taking cost out so that we mitigate some of that risk that is coming from that part of the top line. I just wanted like to be very clear on the different pieces because it sort of almost puts it into different buckets and makes it easier to understand how we see that growth from first to second half and why the trajectory there makes sense with the seasonality combined with the growth in Aviation and Healthcare.

That makes a lot of sense. And just to be clear on PTC, since we haven't gotten an extension embedded in the guide right now, is there any expected extension embedded in your guidance for the year? Or is it just based on the backlog that you know today? I know that you mentioned in your prepared comments, that you would see a benefit from Grid and from Haliade-X as well?

So what we have is that we expect to see some decision, but later on in the year. And if you think about it like this, you would basically need 6 months from when an order comes to delivery which means that in year convertibility, which you would see show up in the P&L, you would need to get the order literally before -- being Swedish, I'm going to call it, before mid-summer. If you get the order mid-summer, then you can convert within the year as leading in the P&L. So what's in our guide is that we expect a decision within sort of the year, but not before mid-summer. And that's really, really the only impact that we would see. And that's sort of within that 10% of the top line sort of risk that we're mentioning.

Got it. That makes sense. I've asked every company this on China. I know it's fluid. You just reported 2 weeks ago. And so -- but it's a situation that obviously is clearly evolving. Maybe just talk a little bit about how China is impacting your business? And I know we get the question all the time around the Aero piece of your business. specifically, but any thoughts around China and how that's evolved since you reported earnings a couple of weeks ago?

Yes, I know. You see, time flies, but it's actually only 2 weeks.

It feels longer, that's for sure.

It feels longer, maybe. It feels longer. So I would say we haven't seen any material changes in the COVID situation sort of in China. And for us, it's sort of how it impacts manufacturing, but it's also the utilization of people well, flying less in China, clearly. I have to say though because I literally just came back from a business review with the Healthcare team, where the head of PDx was there and talking about how the team is really solving for the end customer. And you can think about it in Healthcare, we're really talking about patients and how the team is working in China, in the factory and moving sort of from having 60 people on-site manufacturing, now being able to have 101 people on-site driving manufacturing of our products, which are key because there are customers all over the world waiting for those products. And the customers are patient. So it's really about saving lives. And I have to say what we -- so I heard from the team, including the team from China, who then had to Skype in, of course, because of the situation. Very impressive and strong resiliency and amazing creativity to solve for the customers.

Got it. That's helpful. And good to see there's been some progress there. I know we're focused a little bit on the near term right now, but it is top of mind for everybody. I'd say from like -- from a free cash flow standpoint, the 2Q free cash flow number being negative, I think it was probably something that surprised people a little bit. And so maybe just walk through some of the dynamics on what's driving negative free cash flow in 2Q.

Yes, sure. So if we start with free cash flow and our I would say seasonality, we expect free cash flow to be better in the second quarter, but still negative. And if you do it business by business, with Aviation, clearly, we would expect to see sort of earnings growth and that comes through in profit and cash, some inventory build to offset parts of that, but strong delivery from Aviation. Healthcare, better sequentially, but worse year-over-year. And it's really because of the sort of hampered top line. Renewables also better sequentially, but worse year-over-year, which I talked about earlier with the sort of the lack of the volume and therefore, the losses. I would expect to see working capital improvements in Renewables in the second quarter, but it will be enough to offset the lower profit. And then for Power, I would say flat sequentially and basically year-over-year. We have some working capital pressure here because we expect lower down payments or progress payments in the second quarter and also some inventory build for the second half. Corporate, I expect to do better, including capital, so some headwinds there, but overall to do better. So overall, the still -- the improvement, but still negative, is really due to the pressures that we talked about in Renewables and in Healthcare.

Okay. That's helpful. When we started the year, right, there was a bridge to get to your free cash flow number for 2022. And we know the net income number has come down a little bit, but still, call it, roughly around $3 billion, maybe a little bit more than that number. I'm just curious whether there are any other pieces of that bridge that have changed? So specifically, working capital was supposed to be a $3 billion tailwind. AD&A was supposed to be about a $0.5 billion headwind to net income. Just any thoughts around the major pieces of the bridge and whether that's changed at all?

So I know you were with us at earnings, but everyone remember that page -- even the page number, so did I. So clearly a page to look at. Well, I would start by saying, of course, income or growing profit is going to be an important part of the free cash flow in 2022 because even at the lower end of our range, if you compare to last year's sort of $171 million and the lower range at $280 million, we have a significant improvement in profit. So that's an important part of free cash flow for 2022. If you look outside of that, I would say where there would be pressure is on the inventory side. So I'm assuming that some of the inventory will still be weak because we don't have all the components and you can't ship everything. So some pressure on working capital, I would say, especially from inventory. But I would say, overall, we're comfortable with the low end of our guide. We talked about the whole guide being $5.5 billion to $6.5 billion. And I would say the $5.5 billion, that's appropriate with what we know today.

Can we dig into the net income portion and really kind of start digging into some of the segments? Because one of the biggest questions I've gotten is how quickly will Healthcare snap back? We can talk about 2023 in a minute, but just maybe focusing on the now, right? You're seeing a lot of supply chain constraints, right, that are impacting the business. I think you called out 7 to 8 points of growth in the Healthcare business that was impacted. How do you see this playing out over the next few quarters? And then we can talk about on 2023, like how does this look in 2023? And how quickly can Healthcare snap back in 2023?

Well, if you start with Healthcare, it's important to sort of acknowledge that it's not a demand situation. It's really an output situation. And we had significant pressure in the quarter. And we do expect to see that sort of continue to see pressure for the second quarter. I'm not going to quantify it sort of yet, but we do see good progress. If we talk about -- we've talked about where the shortages were. We've talked about semiconductors. I would say today, probably 2/3 of where we had shortages are electronics related, but we do expect that to continue or to slowly improve through the year, and that's also what we have in our outlook for 2022. And I mentioned earlier, we've also worked to literally redesign products to find work around so that we can deliver to our customers. Redesign supply chains, have multiple sourcing. So we're doing quite a lot to make sure that we can solve for our customers. We're also working on increasing price here. And as you know, this is not an industry which has a tradition of price increases. So that's also been an important part for us. And it's been really good to see the team. You start to see price increases in the orders and then when the orders are shipped to see it in the revenue. And it's been really good to see that in the orders already in Q4 last year, we started to see positive trending and now continuing in Q1. But the impact of more of that orders being delivered as revenue, we expect to see more of that in the second half, and that will also help, both on the top line and obviously on the margin. So I would say we are taking a lot of actions in the situation the way it is. We are well aware of the risk that we have on sort of supply chain constraints and the situation in China clearly under a lot of scrutiny, but we are really focused on what we can control and how we can step out of this. And what's in our guide is also the -- if you think about it, with the orders coming in and sort of part of them being shifted towards the second half, I also mentioned that we would expect to have half of the -- what today is overdue backlog out by year-end. So basically, that would help the growth in the second half, but that would also help continue to grow into next year in 2023. And that's also why we expect to continue to see really good growth in 2023 for Healthcare.

I'm not sure if you have the number, but like for -- what's in backlog that's going to ship? I'm assuming that's higher price backlog and you called out $0.5 billion in second half versus first half. Is a lot of that coming through Healthcare? Or is it coming across the different businesses?

It's across the different businesses. Healthcare is one of them, but it's across the different businesses.

Okay. Okay. Great. And then it sounds also, again, maybe hard to put a number to it at this point, but when you take a look at the profitability of this business, 2020, 2021, it was kind of like high 16%, low 17% type margin, it's going to be hard to replicate that this year. But as we think about next year, is there a path to get back to those types of margins that quickly?

Yes.

All right. Great. Shifting gears a little bit. I want to talk about Aviation. So your -- again, Aviation, it's on its path to recovery, put up a good quarter this quarter. The aftermarket business grew strongly. I think you mentioned that shop visits are expected to pick up also in the back half of the year. Talk to me a little bit about what's been going on from a shop visit perspective. Was there any disruption in the second quarter also that we need to be aware of in that business? I mean you put up good margins, but I was just curious whether that was impacted at all and then how you see that over the course of the rest of the year?

I know you're ahead of us, but you mean the first quarter, any disruption?

Oh, that's what I meant. Yes.

I would say it went pretty well. We had some workshops where basically sort of it takes longer to finish. But overall, a good situation. You know that the recent trajectory is very [ smoothly increasing ] in the second half, both from utilization, but also therefore, from shop visits. So what we are seeing is that we expect that trend to continue, not only in 2022, but also in 2023. And we've talked about how we expect narrow-bodies to be back sort of way before the widebodies. Narrow-bodies by '23, widebodies by '24. And on the shop is -- it also depends on what kind of shopping that we're seeing. And what we are seeing is that the basically revenue per shop visit is growing, so it's higher scope, which means that we make more money. So that's also a positive. So that's what we expect to see not only through this year, but also next year.

And the pricing, I've [ gotten ] any question from the audience regarding the pricing in your LTSAs to help protect the cash margins to help offset inflation. How do you feel about the pricing that you're getting in your Aviation business today?

I would say the -- in Aviation, and the CSA sort of we have inflation escalators. So basically, we are getting good coverage on our service contracts. And you sort of continue to update that. So there's sort of an index that you continue to update. And then you are allowed to then invoice including the escalation of the inflation. So I would say in Aviation, that's good.

Got it. Great. One of the questions -- that I've gotten a few questions on like the spins. And so given the backdrop that we're in, Healthcare being impacted from a supply chain standpoint, we know about some of the issues associated with Renewables as well this year. A few questions from the audience have been, does this put into risk the timing of the separation of either the Healthcare business in the beginning part of 2023 or the Power, Renewables business in 2024?

We are on a good path to execute on our spins, I'll say that. It's a lot of work. We have like 9 work streams with everything moving on. We're covering everything from what you've asked me often about, sort of capital allocation. And we talk about balance sheet, we talk about legal entities separation, we talk about tax. We talk about untangling lots of things, but we are clearly on the path. And that's what I mentioned this morning as well to spin Healthcare early 2023. So going -- all going well and all on plan. A lot of work, but all on plan.

I'm sure it is. I'm sure it's a ton of work. Okay. I want to talk about Renewables. Clearly, a hot topic of discussion. Onshore, I think you guys have called out some international projects that you're still kind of working through some legacy backlog. I'm just curious, what are your kind of thoughts on when we finally work through some of that backlog and start to get like a cleaner line of sight into improved profitability in the business?

Yes. So on Renewables and on the backlog, if you -- maybe just to sort of frame it, Renewables as a total has about $32 billion of backlog, roughly half of that is Onshore Wind, so $16 billion. And then 1/4 of that is international, which gets you to $4 billion. And out of those, I would say, probably less than $2 billion are really legacy projects or challenged projects. So that's sort of the area where we have the issues. And then I also talked about Grid. And actually, Grid was -- I mean, it was about $3 billion when I started in that kind of backlog. Now we are less than $1 billion of, what I'm going to call, legacy backlog, and Grid expects to be through that backlog in 2023. So that's really sort of sizing it so that people don't confuse it with the total for Renewables. I would say, of course, it's important for us with the PTC, and it's important for us that something happens in the U.S. that then we'll get our customers to take decisions and move forward with new projects. What I would say -- what we are doing as well is sort of not only waiting for that, that's an important part. But we're also together with the team with Scott and Philippe and many other team members, really looking at what can we do to improve the business in what we have? One thing is making sure that we follow selectivity, both sort of geographically, but also within what segments. And then it's taking a hard look at different sort of cost structures and seeing what can we afford where? But I would say, if you take all of that together, the team is working through a lot of opportunities as well. And I have to say I have full confidence in the team that, together, we get to a much better position where we have healthy growth and a business that's making money.

And the one piece of the backlog that you didn't discuss that's still kind of early stages and is still ramping is really the offshore side of the business. And I know that, that backlog has now grown to roughly $7 billion. The view on GE's Renewable business is that you're going to approach breakeven, right, next year. I'm just curious, as the environment as you're writing the contracts for that backlog, I'm sure has changed, right? And bringing a more inflationary time than when some of those contracts came into backlog. Are you assuming some kind of like negative profitability from the Offshore business? And then like how does that potentially switch when we get to 2024 and Renewables, maybe Offshore business becomes a much bigger business for you guys?

Well, let me start by just saying that we do expect to have about a $3 billion business by 2024, and that we will be profitable by 2024. And clearly, it's a big area of growth for us. Inflation is an issue here as well, sort of near term. But I'll put that aside a little bit. You said what will happen as this grows? Well, basically, if you think about it, we are now focusing on launching our products like Haliade-X, we continue to invest. But as we grow the volume, we also come down the cost curve, basically, when you learn and basically make more money through that. So I do think that's an important part. Just getting the experience and the volume will help. When it comes to inflation, I would say -- I mean, we -- I sit in on weekly or biweekly depending on how many reviews we have meetings where we go through all the new big commercial agreements in all of the businesses. And of course, Offshore is one of them. So the team has been very focused on making sure that we have escalation terms in the new contracts. One part of that is focusing on inflation. But I would say, overall, and also focused on price. And that's part of the commentary we have around selectivity and driving pricing.

Okay. Great. And then Carolina, we're going to be bumping up on time, but I did want to ask you one last question on 2023 and the bridge from 2022 EBIT to 2023 EBIT. I know that you have a $10 billion number out there for 2023. But as we've already discussed, 2022 right now is coming in at the lower end of the range. I'm curious like how much "cushion" do you have to achieve the $7 billion plus in free cash flow if, in fact, we're at the lower end of the range and maybe the $10 billion isn't achievable in 2023 because of the environment that we're in?

So, Joe, you will remember, this was maybe also on the swing list side. We had $7 billion plus. That was our guide. I would say, if earnings come in a bit lighter, it's going to be less of a plus, but we do have a path to $7 billion of free cash flow. I would say, clear profit is the main driver of the free cash flow, not a sustainable free cash flow. But we also have a couple of other areas with positive cash, both contract assets and progress payments were basically in an environment, especially with Aviation coming back, we expect that in a growing environment to be positive for us on the cash flow. And then we have trade working capital. We don't have time to talk about that as much as I would wish today, but there's a lot of opportunity there. We've talked about inventory and how lean is actually enabled to improve how we work with inventory. So I also see reducing inventory as a multiyear opportunity to improve free cash flow. And I'll just say that when we talk about improving working capital, of course, a big plus is better free cash flow. But the reality is improving working capital processes means you're running your company better. So yes, you get the cash flow. But you also, [ on this ] if you're serving your customers better, means you're driving growth better and you're lowering costs better. So there's a win, win, win in that one.

Great. Carolina, thank you so much for spending time with us today. It's always a pleasure to see you.

You, too. Thank you.

Take care.

Take care.