GE Aerospace

Good day, ladies and gentlemen, and welcome to the General Electric second quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. My name is Brandon, and I'll be your conference coordinator today. If at any time during the call you require assistance, please press star followed by zero, and a conference coordinator will be happy to assist you. If you experience issues with the slides refreshing or there appears to be delays in the slide advancement, please hit F5 on your keyboard to refresh. As a reminder, this conference is being recorded. I would now like to turn the program over to your host for today's conference, Steve Winokur, Vice President of Investor Communications. Please proceed.

Thanks, Brandon. Good morning and welcome to GE's second quarter 2020 earnings call. I'm joined by our Chairman and CEO, Larry Culp, and CFO, Carolina Divex-Happa. Before we start, I'd like to remind you that the press release and presentation are available on our websites. Note that some of the statements we're making are forward-looking and are based on our best view of the world and our businesses as we see them today. As described in our SEC filings and on our website, those elements can change as the world changes. With that, I'll hand the call over to Larry.

Steve, thanks. Good morning, everyone. We hope you and your families are healthy and safe. We, like many others, had a challenging second quarter that the GE team met head-on. executing well operationally while we took actions to further de-risk our company. I want to thank all of my GE colleagues who are working tirelessly to serve our customers, our communities, and our company. Now, as we expected, our financial performance declined across the board in the quarter. The sharp deceleration caused by COVID-19 that we experienced in March continued through May. But we started to see some early signs of improvement in June and July. Nonetheless, we remain cautious going into the second half given the uncertainty associated with the pandemic. Now taking our second quarter results by business, at aviation and GCAS, many of the drivers we saw in March, airlines conserving cash, not flying the planes they have, limiting maintenance spend, and deferring orders are still relevant today. We're aggressively managing these businesses with cost and cash actions, and partnering closely with our customers on a daily basis. I'll provide more color on this shortly. In healthcare, we continue to have elevated demand for COVID-19 related products. However, procedure deferrals are still affecting other products, including those in our high margin pharmaceutical diagnostics business. Despite these volume and mixed pressures, our team held margins flat in the quarter. In power and renewables, outages pushed from the first to the second half and field mobility constraints impacted projects. To offset those pressures, we continue to improve the cost structures of these businesses. Carolina will discuss these segment results in detail later. With this backdrop, we saw revenue down 20% organically due to lower volume across all businesses. Recall that some of our shorter cycles higher margin businesses, like services and aviation and gas power, as well as healthcare, are more heavily impacted by COVID-19. Combined, their revenue is down three times that of the rest of GE Industrial. Despite this, our backlog remains a great strength at $381 billion, with about 80% in services. While services are hurting in the near term, they have a multi-year time horizon and keep us very close to our customers. Industrial margin was negative, and decremental margins were 44%. Our adjusted EPS was a negative 15 cents down significantly year over year. This was largely driven by lower volume at our shorter cycle higher margin businesses and impairment charges related to COVID-19 at aviation and GCAS. And industrial free cash flow came in above the guide we provided in May at a negative $2.1 billion. Better, but obviously still negative. This was largely driven by working capital improvement, primarily led by better than expected collections across the company. While this reflects improved operational execution, we have plenty more work to be the lean company we want to be. So clearly, this was a tough quarter. And the COVID-19 dynamics continue to evolve with global cases rising. We acknowledge that the full duration, magnitude and pace of this pandemic across our end markets, operations and supply chains is still unknown. The macroeconomic environment could deteriorate further before it recovers. That said, based on what we see today and the actions we've taken, sequential improvement in earnings and cash in the second half of 2020 is achievable. And we expect a return to positive industrial free cash flow in 2021. Moving to slide three, we're focused on what we can control in the near term while positioning the business for the long term. Importantly, the near term still starts with our COVID-19 response. Our top priorities remain the safety of our employees and our communities, serving our customers in these critical moments, and preserving our strengths. Here's how we're operating today in three core steps. First, embracing reality. The current environment is what it is. So we're further optimizing our cost structure, and as mentioned before, we're targeting more than $2 billion of cost actions and $3 million of cash actions this year. Second, redefining winning. For example, we've shifted our focus from margin expansion to decremental margin improvement. Our businesses also adjusted their priorities for 2020. Let me share a recent case that spans healthcare and aviation and illustrates the point well. Our team stood up patient care monitor production at our power and avionics manufacturing facility in Cheltenham. They use lean to deliver 300 units per week with quality and efficiency, achieving the necessary 13-minute average production time. This certainly wasn't on healthcare or aviation's priority list at the beginning of the year, but it's a priority today and a job well done. Third, we're executing our plan. We haven't lost sight of accelerating our transformation. For example, in gas power, the team is leveraging lean problem solving. in the new production introduction process for the third generation of the HA turbine, the 7HA.03. This allows us to drive efficiencies and solve potential problems earlier than ever, focusing on both the present and the future. This quarter, we also announced some important changes to our team, complementing our strong existing bench of GE talent. First is the retirement of GE Vice Chairman and Aviation President and CEO David Joyce. Over David's remarkable career, his leadership established GE Aviation as the world's foremost aircraft engine franchise. I personally thank him for his 40 years of service to our company. It was not easy to find a worthy successor to David, but I'm very excited to welcome John Slattery, a proven leader with extensive global commercial aviation experience, to our team. Pat Byrne, who recently celebrated one year with GE as our Digital CEO, was recently named Vice President of Lean Transformation. Additionally, two GE veterans were appointed to key leadership roles. Nancy Anderson was named Chief Information Officer, and Mike Barber was appointed Chief Diversity Officer, as we take steps to drive further inclusion and diversity. To support that effort, we've also named diversity officers across all of our businesses, in addition to Mike, to drive that accountability. Together, these leaders, both those new and those well-known to GE, will play critical roles in GE's operational and cultural transformation. In terms of de-risking the balance sheet, we prioritize maintaining liquidity in this environment, exiting the quarter with $41 billion of cash. We also proactively extended near-term maturities, and we continue to reduce debt. Since the beginning of last year, we've reduced debt by $22 billion. Concurrent with today's earnings, we're launching a program to fully monetize our Baker Hughes position over approximately the next three years. Executing this program in a patient and disciplined manner allows us to divest a substantial non-core asset, redeploy capital, enhance our financial flexibility, and strengthen our balance sheet. We also continue to focus our portfolio, recently completing the sale of GE Lighting. Now I'll give you a deeper dive on GE Aviation and GCAS, given the severity of COVID-19's impact on commercial aviation. On the left side of slide four, you'll see departures, which drives our services business much more so than RPKs. We track departures by region and by platform daily, and what we're seeing in July suggests continued improvement globally. GE and CFM traffic has rebounded off of a low of down 76% in April from the January baseline to down 43% in July. While we're seeing some improvement in aggregate, it varies by region as countries reopen. China has gone from being down over 70% to now being down 9%, which is obviously encouraging. In contrast, Europe is down 45% and has been rebounding since the beginning of July. The Americas are also down 45%, and we're getting better until very recently. This recovery will continue to be correlated with departure trends across global fleets and per aircraft, which ultimately impact the pace of shop visit growth. If we look at GE Aviation and the trends we're seeing through July, commercial units are down 50% year-on-year. In services, shop visits are down 55%, and CSA billings are down 60%. Services are critical to the recovery of GE Aviation as we generate a lot of cash here, especially within narrowbodies, which are more than 40% of our revenue. On the other hand, our military business remains strong, with unit growth up 10% year over year. Our teams are not standing still, carrying half of the $2 billion in cost reductions and two-thirds of the $3 billion of cash actions for all of GE. This has improved incremental margins slightly with further progress expected in the second half. Shifting to GCAS, similar to our peers, we continue to see elevated deferral requests from about 80% of our customers. To date, we've granted approximately 60% of short-term deferrals based on a thorough review process. Importantly, we're starting to see customers pay on these deferral plans. At quarter end, we had 17 aircraft on the ground. We have a daily operational dashboard that allows us to closely monitor developments, ensuring that customer by customer, we have line of sight on where we may have repossession or restructuring exposure. We're also actively managing our skyline to better align with customer demand and the airframers' production schedules. Our GCAS portfolio is also more diverse today than prior downturns. While approximately 60% of our fleet exposure is in narrowbody aircraft, our widebody aircraft make up less than 30%. and the remaining balances in regional jets and cargo. The wide body asset class has been hit hard during the pandemic, but we're being strategic around future placements and programs like cargo conversion help extend the life of these aircraft. For example, we recently delivered a prototype to Israel Aerospace as part of a partnership to convert 15 of their 777 passenger jets to cargo. We're planning for a steep market decline this year, and likely a slow multi-year recovery. Long-term, though, the aviation market has solid fundamentals, and we're committed to protecting the future of this business and our leadership position within the industry. And with that, I'll pass it to Carolina.

Thanks, Larry. Time flies, and I'm heading into month six with GE. These are difficult times, but everyone's very focused. on working as hard as humanly possible to make progress every day. Everything I've seen so far reinforces my conviction that we, as a team, can make GE stronger. I am an industrialist at heart. We operate in important spaces with a gritty team and leading technology, and we have many opportunities to improve. Operations, capital discipline, digitization, using lean to enhance processes, and deliver better results. Now, this was a very challenging quarter, which is evident in our financial results. The simple reality is that the broader macro environment impacted all our businesses. Aviation and GCAS were hard as hit, in line with what we expected in April. Orders were down 35% organically. all segments down double digits, other than healthcare, which was basically flat on the back of a 600 million of demand for certain COVID-19 products. Backlog was up year over year, but down 5% sequentially. Our backlog provides us with visibility as it spans over 15 years and normally covers more than 80% of annual revenue. Industrial revenue was also down, but to a lesser extent than orders. down 20% organically. This was largely driven by aviation, commercial engines, and services, both down more than 50%, in addition to some shorter cycle businesses, such as PDX, down 28%. Henceforth, our equipment was slightly better. Our teams delivered more heavy-duty gas turbines and wind turbines, despite issues moving people and goods across geographies. The bright spots in profitability came mostly from self-help. Our countermeasures are taking hold faster in healthcare. In our longer cycle businesses, we expect similar improvement through 2020. In aviation, military delivered strong results despite supply chain disruption. And in corporate, we continue to decentralize and reduce costs overall. This will continue in the second half. I'll now talk to the difference between continuing and adjusted EPS. Some of the typical adjustments include restructuring, non-operating benefits, and unrealized mark-to-market and gains, for example, Baker Hughes. In addition, we have two other items. First item, 20 cents of goodwill and related charges attributed to two businesses. First is our additive business within aviation, and second is our GCAP business. We now have no goodwill remaining in GA capital. Second item, two cents from one-time costs incurred for the multiple debt tenders we executed. This action helped extend our near-term debt maturity. To comment on restructuring, we spent 450 million this quarter, up about 100 million year-over-year, and about 200 million sequentially. This is mostly attributable to aviation. In 2020, we expect to spend more on restructuring expense and cash year over year. And the benefits from this spend come through the remainder of 20 and into 21. This is a good thing, as we expect sustainable returns from a leaner company. As Larry mentioned, we're targeting more than $2 billion of cost actions and $3 billion of cash actions this year. We've realized more than one-third to date, and you'll see further results in the second half. In total, we expect one-third to one-half to be structural cost out, which annualizes to $1.5 to $2 billion. Moving to cash, the tougher macro environment also negatively impacted free cash flow. So the underlying dynamics are different in a few ways versus earnings. Before I explain the dynamics, I note that our free cash flow this quarter excludes biopharma, a consistent cash generator of 300 million or more each quarter. So biopharma is an important driver of the year-over-year reduction. And remember, this will continue through the first quarter of 2021. At the high level, cash flow was clearly impacted by lower cash earnings. There were also puts and takes on working capital. This is a big focus area, as we have opportunities for improvement. As you'll see on slide six, receivables. Collections outpaced new buildings in the sweeter markets, but this wasn't a big swing factor as it was affected by lower monetization. We've made progress, but we expect continued momentum here. Inventory, similar story, was a slight positive, but given the volume decline, we still need to manage inventory better, a big opportunity for loan. Cables, a significant use of cash in the near term as we align with the markets. especially in aviation, but we expect that that produces some benefit here from fourth quarters. Progress payments were neutral. We had inflows from our military business within aviation, which offset outflows in power and renewables. Outside of working capital, there were a few favorable timing items. The largest was a $0.5 billion of discount and allowance payments on lower aircraft shipments in aviation. For the first half, our free cash flow was negative 4.3 billion. For the quarter, it was negative 2.1 billion. The second quarter was more volatile and difficult than normally to forecast. The end market dynamics, especially in commercial aviation, remain unpredictable. And therefore, the outlook for the rest of the year is uncertain. Our focus is always on cash flow generation. Our working capital programs are just beginning to yield improvement. Here, lean serves as a great tool. For example, in gas power, we've implemented daily management and standard work with regional accountability to track collections. This has improved on-time payments by almost 20%. And we will see more benefits from our cash actions. Together, we expect this will drive better sequential free cash flow in the second half. Moving to slide seven, we continue to strengthen our balance sheet and prioritize liquidity in the current environment. We ended the quarter with approximately 41 billion of total cash, 25 billion at industrial, and 16 billion at G capital. On top of this, we have 20 billion of credit lines. We executed several actions this quarter to enhance our liquidity. We issued 13.5 billion of long-term debt between industrial and GE Capital. This process was used to reduce near-term debt maturity by 10.5 billion. These actions will be leveraged neutral by the end of 2021. And following this, industrial has no remaining debt maturity in 2020 and 2021. GE Capital has 5 billion of remaining debt maturities in 20 and 3 billion in 2021. Strengthening our financial position happens over time. Since the beginning of 2020, we've decreased our debt by $9.1 billion. Since the start of 2019, we've decreased our debt by $22 billion. As Larry mentioned, we'll now start to fully monetize Baker Hughes in an orderly, straightforward program over approximately three years. We plan to use this process for further deleveraging. our finance and policy goals remain unchanged. We remain committed to achieving our deleveraging target. However, as we stated, we expect to achieve those targets over a longer period than previously announced due to the impact of COVID-19. So moving to the segment results. First on aviation. Larry has already provided you with some context on the market, so I'll dive into the results. Orders were down significantly. with declines north of 80% in both commercial engines and services. For context, airlines have slowed or deferred new engine orders and elective maintenance on existing aircraft. Our orders were supported by our military business, but had an impressive plus 60% growth rate, primarily driven by equipment and new development orders. Our backlog at aviation stands at 258 billion, This is up 6% year-over-year due to higher CSA commitment, but down $15 billion sequentially. This is largely driven by a reduction in our commercial services backlog of $12 billion. This reflects both lower utilization of customer-first and customer-specific adjustments. In addition, but to a lesser degree, we had cancellations of commercial engine orders. This includes 795 LEAP-1Bs and 22 Significant, but for context, our ending backlog still has more than 10,000 GE1A and 1B units and 600 GE9X units. Revenue was down more than 40%. The decrease in equipment revenue was driven by commercial engine as we shipped 403 fewer units year over year. This is partly due to the 737 MAX grounding and slower production. This was offset slightly by military, which shipped 61 more units year over year. Military now represents 26% of aviation revenue, becoming a larger portion of the business versus pre-pandemic. As expected, commercial services experienced a steep decline, down a full 68%. And this is due to lower spare parts sales, shop visits, and CSA charges. Statement margin was negative 15.5% and was heavily impacted by restructuring and charges directly related to COVID-19. These charges included approximately $600 million related to CSA contracts, affecting lower engine utilization, anticipated customer fleet restructuring and contract modifications, and a higher bad debt expense. Without these charges, margin would have been negative 1.5%. Separately, there was another 200 million of supply chain expenses from lower production. We're making progress here on the more than 1 billion of cost and 2 billion of cash actions. During the quarter, we reduced aviation headcount by 11% for 5,400 people. Our plan includes a 25% headcount reduction globally. Decremental margin improved sequentially from 62% to 59%. Excluding the COVID-19 charges, this would have been 48%. We have now executed 30% of the cost and 40% of the cash actions. We'll build on this momentum in the second half. As you can see, we're aggressively repositioning GE Aviation so we can continue to serve customers and perform better as the market recovers. Moving to healthcare, the team delivered in a tough market and pivoted quickly as healthcare needs shifted from routine procedures to urgent COVID-19-related care. To support customers, healthcare dedicated field engineers to ensure the installation and uptime of virus-related products. They also moved quickly to deploy new products. Neuron, for example, allows one clinician to monitor several patients at once, reducing clinicians' virus exposure and preserving PPE. our PDX business declined due to lower procedure volumes, particularly in Europe and in the U.S. But while April was difficult, PDX saw sequential growth in May and June as procedures increased. And going forward, we expect PDX to recover alongside procedures. But we continue to watch for pressure given by regional outbreaks. With that backstop, healthcare system orders increased 3% organically. We saw strong demand for COVID-19-related equipment. This was partially offset by other product lines with less correlation to COVID-19. Our pandemic-related demand included a roughly $300 million order from the US Department of Health and Human Services for 50,000 ventilators. In partnership with Ford, we started to shift this quarter with the balance converting in the third quarter. Revenue was down 4% organically. This is a tale of two cities. Elevated COVID-19 demand in HCS. It was not enough to offset decline in PDX and product less correlated to COVID-19 in HCS. Organically, PDX was down 38%, and overall, HCS was flat. Importantly, segment margin was 14.9% flat organically. The team faced significant headwinds from a shift away from higher margin product lines and disruptions in logistics and the supply chain. They affect this with cost savings, including roughly 600 headcount reductions. Transca continues to focus on margin expansion with an eye on serving urgent COVID-19 needs while prioritizing investments for future growth. We're continuing to implement changes to our engineering processes to drive greater efficiency and R&D prioritization. In the second half, we're targeting several hundred million dollars of cost reduction. Moving on to power. Given pre-pandemic, this segment has been a turnaround journey. Power's quarterly performance largely reflects commercial challenges related to COVID-19 And this was partially set by accelerated turnaround actions. Starting with the market, global electricity demand declined mid-single digits. But both gas-based electricity generation and GE gas turbine utilization were resilient. We saw improvement year-over-year in June. And we saw our CSA billings improve in the quarter. Total power orders were down for both equipment and services. Equipment orders were down 84%. Our orders activity was impacted by constrained customer budgets and access to financing due to oil prices and economic slowdown. This is especially true in gas power. Over the remainder of the year, our current pipeline suggests improved equipment orders while we expect service orders to remain challenged. In power, we exited the quarter with lower backlogs. So specifically at gas power, backlog was 66 billion, down 4.7 billion sequentially. The team delivered more out of the backlog than what we added to new orders. They also revised our estimates for extra work and upgrade billing in our long-term service agreement, which drove almost half of the sequential decline. Gas power equipment revenue was up double digits on higher shipments. We shipped 25 gas turbine units. including 5 HA and 10 error derivatives this quarter. Gas power service revenue was down double digits. This was driven by the outage shifts and weaker commercial conversion in transactional and upwards. While approximately 20% of our first half planned outages were rescheduled, gas power still performed outages in 31 countries, The term commissioned projects adding 4.3 gigawatts of power to the grid globally. Based on our current view, we still expect to deliver 45 to 50 heavy-duty gas turbine shipments in 2020 and execute 95% of the outages that were planned for the year. Power portfolio revenue was down double digits. We think about this as three businesses. Approximately 25% of our first half planned outages shifted to the second half. More than 5% of those outages are rescheduled. Power conversion continues to show underlying sequential operational improvement. And nuclear, largely a regulated service business, remains stable. Segment margin of negative 1.3%. Contracted 390 BICs organically. primarily due to the decline in our highly profitable service volume and some charges. This includes approximately 100 million related to an underperforming joint venture for global aero derivative packaging and 50 million quality reserves on the power conversion product line that we have exited. We continue to take cost action across power, which includes roughly 800 headcount reductions in this quarter. Gas power had a positive operating profit this quarter The fixed costs down 13% year-over-year. At renewables, our turnaround efforts are driving underlying operational improvements, better project execution and more post-outs. However, our quarterly performance continues to be challenged due to COVID-19. Starting with the market. Onshore wind market growth continues to be supported by international demand and the US extension of the production tax credits. So the U.S. government granted an additional year to the PTC-eligible projects that started in 2016 and 17, which now have five years to achieve commercial operation. In offshore wind, we're working towards certification of our industry-leading 12-megawatt Halyard X. We're building a large pipeline of this to capture secular growth through the decades. Orders were down 17% organically, primarily driven by the U.S. onshore wind and grid. These orders pushed to the second half due to financing and permitting delays related to COVID-19. Indications suggest that these are genuine delays versus cancellations, but we are actively monitoring. The team also continues to be more selective on new deals, pressuring growth now, but setting the stage for profit and cash. in the future. International onshore wind was a bright spot with orders up over 30% despite some delays in Europe as well. Revenue was up slightly organically as our onshore wind firm delivered nearly 1,200 new units and repower kits in line with our May guidance. We expect deliveries to increase sequentially again in the third quarter. Grid and hydro revenues were down primarily driven by COVID-19-related fulfillment delays and execution issues. Our grid and hydro factories are now operating at approximately 90% capacity. Renewables overall is operating at 96%. Segment margin of negative 5.6%, with operating profits down slightly. This was driven by supply chain and fulfillment disruptions, currency headwinds, and quality-related costs. It was partially assessed by better onshore wind price, product cost and mix, improved project execution, and accelerated cost out. We're making progress on our turnaround. We saw sequential profit improvement in onshore wind and in grid. We reduced employee headcount by 600 and contracted by 500 this quarter. These are encouraging steps forward on the path towards positive margins and free cash flow. At three capital, continuing operations generated a net loss of $522 million this quarter. This excludes the impact of the GCAP goodwill impairment of $836 million after tax and the day one cost of $119 million related to tendering approximately $10 billion of debt. We ended the quarter with $101 billion of assets, including liquidity. Sequentially, this is slightly higher. primarily driven by unrealized gain in insurance, partially upset by GCAS aircraft impairment. We typically complete our annual aircraft portfolio impairment review in the third quarter. But in the light of COVID-19 pressures on let's see, GCAS completed a risk-based review this quarter. We analyzed the GCAS portfolio based on our customer's probability of default. Those customers with the highest probability represented about 20% of our aircraft operating list book. Our review including a significant reduction in rent and extended downtime, and this resulted in an impairment of 292 million pre-tax. We finalized our annual review of the entire portfolio in the third quarter. We anticipated some pressure on our cash flow assumptions. In addition, we'll continue to monitor for credit risk deterioration. Moving to our insurance business, earnings were higher. We saw a reversal of mark-to-market adjustments and real-life gains as financial markets recovered this quarter. We've seen some variability in our recent claims data. We believe this is driven by COVID-19, and this resulted in a lower insurance loss this quarter. On the long-term care block, we're seeing lower new claims and higher terminations than expected. We believe policyholders are delaying entering care facilities or bringing care into their homes. For lifeblocks, we're seeing the opposite, higher claims, and we believe that this is driven by higher mortality from COVID-19. It is too early, though, to draw conclusions for this short-term volatility, given the long-term nature of our insurance. We're in the process of completing our annual reserve adequacy review in the third quarter. GE Capital ended the quarter with 4.2 times debt to equity. We're committed to achieving a debt to equity target of less than four times over time. We still plan to provide the required parent funding in 2020 in line with insurance debt funding. We anticipate funding any future capital needs for GE Capital through a combination of asset sale, liquidity, future earnings from GE Capital, and capital contributions from GE. At corporate, our focus remains on decentralization. Corporate and its operating units continue to reduce headcount, which is down 400 sequentially this quarter. Excluding this position, about 14,000 headcounts have been transferred out of corporate or exited from GE. In total, this has reduced corporate headcount by more than half since mid-18. And some cost reductions we're seeing in the units occur as they right-size their needs for people and functions. We are also using Lean to increase our efforts to simplify and automate processes at corporate, especially while many employees work from home. This includes the closed process, where we continue with a new auditor, Deloitte. I'm excited to work with them and get a fresh view. In the quarter, adjusted corporate costs were down 66%. which really comes down to a handful of factors. There was continued improvement in digital operations and cost structure. We had lower functional costs and lower new reserves related to legacy EHS issues. But we clearly made progress on reducing corporate expense. Please remember that we had some offsets in our number this quarter. For the remainder of 2020, we expect the quarterly adjusted corporate costs to be roughly in line with the first quarter. We have more work to do. Over time, we'll take further actions to reduce costs as we create a nimbler organization. With that, I'll pass back to you, Larry.

Carolina, thanks. In summary, this was without a doubt an exceedingly challenging quarter. But I hope when we look back on this quarter, we'll remember it as one where we rose to a challenge of historic uncertainty and difficulty, to embrace our reality head on, and drive better operational execution while taking actions to de-risk the company. Better earnings and cash performance in the second half are achievable based on what we see today and the aggressive actions we've taken. As Carolina said, we do have work to do and the environment is still fluid. It remains a game of inches. I have no doubt we're accelerating GE's transformation for the long term though. We're increasing our focus on lean and taking action on the factors within our control. That, coupled with our fundamental strengths, our exceptional team, our leading technologies, and our global reach, give us confidence in our ability to unlock the potential across GE today. So with that, Steve, let's go to Q&A.

Great. Thanks, Larry, Carolina. Before we open the line, I'd ask everyone in the to consider your fellow analysts again and ask one question. There are quite a number of people today lined up, and that way we can get to as many people as possible. Brandon, can you please open the line?

Yes, ladies and gentlemen. If you'd like to ask a question at this time, please dial star 1 on your telephone. If your question has been answered or you wish to withdraw your question, please press the pound sign. And from Wolf Research, we have Nigel Coey. Please go ahead.

Yeah, thanks. Good morning, everyone. Good morning, Nigel. Morning, Larry. Morning. Morning, Karina. Steve, I'll keep this to just one question, not one question with five parts. So just obviously aviation is a very fluid situation, but what's your perspective? Is 2Q the low point? Clearly the departure trend suggests that it is. That's a very encouraging trend. But I'm curious if you could just give some perspective on the scope for USM spare parts, use spare parts to provide a headwind into the backup for the year? And what's the perspective on shop visits relative to the trend you saw in 2Q? Thank you.

Okay. Well, Nigel, I think you touched on a number of the variables within the industry on top of those that are a function more directly from COVID-19 that make the first part of the question so challenging to answer and to work through, of course, inside the company and inside the industry. I think our view is that we are encouraged by the sequential improvement we've seen broadly around the world, but we're still down over 40% from a departures perspective. China being down high single digits is encouraging. If they were first in and first out, perhaps that suggests some of the potential from here. I think by no means are we suggesting that things get meaningfully easier from here, at least in the short term. I think this is going to continue to be a challenging environment as governments and the public sort through how to react just broadly to the case trends. It'll be a different dynamic country to country. With respect to those things within our control, again, we're trying to make sure that we continue to push safety first within our own operations, doing what we can to help align the industry around a safe return to flight. Operationally, tremendous amount of focus, as you well know, on cost and cash preservation. all the while looking for those opportunities to quicken the cycle time with their shop visit to improve productivity. So we're not only reacting to this unprecedented headwind, but they're working through the dynamics that will really dictate how well we perform in the second half in 21 and beyond. You mentioned USM. Clearly, as the carriers make decisions with respect to how they want to transition those planes that are parked, into retirement status. We saw some of that. I suspect we will see more of that over the next couple of years. We think we're well positioned to participate given that USM is a source of material for our CSAs and has been for many years. We'll have to see how all this plays out. Again, I don't think we're looking for anyone to do us any favors. I don't think we have a different posture than anyone else in the industry. These are difficult times in commercial aviation, but we'll work through that all the while doing what we can to continue to feed a strong and growing military aviation within our company.

From Barclays, we have Julian Mitchell.

Please go ahead. Hi, good morning. Hi, Julian. Good morning. My question will just be around the free cash flow. You talked about an improvement there in the second half, which I think you'd always see seasonally anyway. But maybe just if I could try and frame that scale of improvement. Your first half of free cash flow was down about $4.5 billion year-on-year. Second half of last year, you did about $4.5 billion annually. So if we take your comments on improvements and that base number of 4.5 billion, should we expect free cash flow to be positive then in the second half?

Hi, Carolina here. Yeah, we do have, as you point out, a seasonality in the second half of the year. So that we expect to see as well. But it's a bit of a different year compared to normal years for us. The second half, it will be a combination, obviously, of our cash earnings. But then we also have the working capital dynamics that you sort of mentioned. If I look through that, I would say that on the receivable side, we expect to see improvement. We've put a lot of work into process and focus on this. We saw it help already in the second quarter, and we expect to see more of that in the second half. And we also have the Boeing max payments then. And we believe that monetization will be less of an impact. Talking about payables, here I have to explain the story. So basically by purchasing significantly lower volumes versus paying old purchases, you create like a hole in the working capital. So that tailwind will sort of gradually get better in the third quarter, and then we'll see, sorry, gradually better in the third quarter, but in the fourth quarter, I would see that as a tailwind as the volume stabilizes. On inventory, we worked hard, but we need to do more, so we believe we would see better execution there. And here you do have, for example, the seasonality with renewables, right? And then on the progress, we believe that we will see also headwind in the second half, because that will mainly depend on the aviation orders, right? And to our point that Larry mentioned earlier, our cash countermeasures, the $3 billion of cash, I mean, two-thirds of that we expect to come in the second half, which is sort of weaved into some of the comments that I had. And we also see continuous underlying improvements. So that's our estimate for now. And we also believe, as we said, that we'll come back to positive cash flow then in 21. Those are what we see today.

From JP Morgan, we have Steve Tusa. Please go ahead.

Hey, guys. Good morning.

Hey, Steve.

Good morning. Morning. Maybe just asking that question in a bit of a different way. You mentioned the $500 million of, I think, deferred discount payments in the quarter that would have gone out the door, I guess, was the comment. Can you maybe give clarity on that account? I think other cash flow was relatively strong. And then just all in, when you kind of mix all this stuff in, all these dynamics, I think you also had a $700 million early defense payment. I don't know how that kind of trends in the second half that helped progress. Can you get to positive in total in the second half? I think that was Julian's question. All in.

All in. Well, on the AD&A, yes, it was 500 billion in the second quarter. You can think about the dynamic basically that basically as the aircraft are shipped, you pay out the discounts, right? So it depends on how the aircraft are delivered. You also asked about the progress payments from the military. Yeah, we did get progress payments from the military. We got, I would say, a bit earlier than expected because also part of the comments that we had between our estimates and where we landed. But overall, the comments that I made on the working capital are what they are and also the comments on the results. So that still stands.

Yeah. Steve, I think Caroline has laid it out. We've got work to do. Again, I think what we're saying this morning is that we came in better than we thought in the second quarter. Obviously, a lot of good work. We certainly had a benefit from the lower production schedules with the air framers. But I think as we look at the second half, we're going to drive sequential improvement. We're going to do the best we possibly can. and we'll see where we end up at the end of the year.

From Bank of America, we have Andrew Ovid. Please go ahead.

Yes, good morning.

Good morning, Andrew.

The July comment on aviation on trans are based on unit volumes, but I think there are some factors that might hurt pricing as well. I think Honeywell highlighted used materials. competition on shop visits, et cetera. So would you expect a meaningful difference between volume declines and revenue decline in the second half in aviation once you put all these factors together?

I'm not sure that we would go there today. I think what we're focused on clearly is the trajectory around shop visits. We've got better visibility today in the third than we do in the fourth. With respect to our own shops, as you know, when we talk about shop visits, some of that activity is performed within our own facilities. But there's other volume that we support through material supply into third parties that do similar work. So there are a raft of factors. in play here, but again, I think given what we see today, we continue to believe the principle pressure that we're all under is how the carriers are going to operate and maintain the existing fleet. There are other dynamics that we haven't talked about, such as green time, that are realities that we need to embrace, realities we need to help our customers manage. So again, I think it's going to be challenging for us and for really everybody in the industry until we have better visibility on a sustained trajectory. That said, we continue to take the actions internally, not only on the cost and cash front, but also operationally to drive the lead implementation so that we're reducing cycle time and reducing delinquencies and past dues to make the most of this COVID period.

From UBS, we have Marcus Mittermeier. Please go ahead.

Hi, good morning, everyone. Good morning. Morning, Marcus. Hi, good morning. Morning. On the $1.5 to $2 billion structure cash out that you referred to in the prepared remarks, Would you say they're structural, obviously, at the 2020 sort of volumes? Or, you know, dare I say, as we work our steps back to sort of like maybe 2019 volumes at some point, how should we think about that? And then how would you model the net benefits of all this over the next couple of quarters?

Yes, Markus, you're raising an important area for us, and this is the cost and the cash action. With our cost and cash actions, we said $2 billion of cost and $3 billion of cash actions in the year, right, 2020. And basically, the $2 billion of cost flows through to cash, and then there's additional cash actions like CapEx and other working capital parts. Now that we have worked through sort of where we are now, what we can see is that a third to a half of those $2 billion are structuring costs out. And that actually annualizes to 1.5 to 2 billion. And we do see, of course, the biggest chunk of that is in aviation, but also in big parts in the other parts of the businesses. And we see that as true structural costs out. And it's basically changing the way we do things. And if you think about it, part of the whole lean transformation is to change the way we do things so that we do them in a better way and therefore also have sort structural way of taking the cost out so that they would not come back even with the volumes improving. So it's basically helping our decremental margins now, but we're also expecting that to help our incremental margins as markets come back with volume growth.

Hey, Marcus, I would just add that I think what Carolina has framed well there is the the efforts that are underway. But right behind that, we are continuing to look for opportunities and efficiencies. And that's just the nature of Kaizen, really, right? With the passage of time, you see more, you can do more, you build that momentum. So as we continue to look to just drive efficiency overall, but at the same time deal with these headwinds, you should expect us to root out as much costs as we can and to preserve and generate as much cash as possible. But in terms of the hard targets for today, Ray and Carolina has laid that out.

From Citigroup, we have Andy Keplowitz. Please go ahead.

Good morning, guys. Good morning. Larry and Carolina, I just wanted to follow up on the decremental margins, particularly in aviation. you mentioned you were at 48% in aviation, excluding the charge, and you only delivered 30% of your cost action so far. So, you know, when you talk about the runway for improvement, how much more did you have here, and does your decremental have a chance of getting down into the 30% to 40% range as you go into the second half of the year here?

Andy, I would say that there is a lot that's in flight, pardon the pun, with respect to aviation. improving the cost structure in aviation. What we've clearly been hit hardest from a volume perspective and internal margin perspective in services, I don't think that the sequential improvement that we see in the second half is going to take us into a zone that starts with a three, but I think we will be in a zone with a four, with the third quarter showing us some modest improvement, and I think we'll see even more in the fourth.

From RBC Capital Markets, we have Dean Dre. Please go ahead.

Thank you. Good morning, everyone. Good morning, Dean. Can we get some more color on the Baker Hughes exit plan? Just a little sense of the structure. I'm just not clear whether are you locking into a price or is that subject to market pricing during the next three years?

Well, Dean, I think what we wanted to highlight today is we're going to take the next step toward full monetization here. We're going to do it over a multi-year period, as you saw. And the program, at a high level, is basically designed to enable us to sell our shares basically at the VWAP over, call it the next three years. We think This makes sense in this environment. Clearly, we started the monetization of Baker back in the fall of 18, nearly two years ago. But this allows us to be, I think, still patient and disciplined while we divest this non-core piece of the portfolio. And that sets us up clearly to redeploy that capital. And I think we're excited about the enhanced financial flexibility that it will give us.

Yes, I would just add to that that it's a sort of technically we call it, it's called a structured forward sale, and it's really that you sort of go quarter by quarter, but you're not bound by it, but that's how the plan works, and by that you also get sort of the average share price over that period.

From Vertical Research, we have Jeff Sprague. Please go ahead.

Thank you. Good day, everyone. Hey, Jeff. I wonder if we could just – hey, Larry. Good morning. I wonder if we could get a little more color on GCAS and the process there. As you indicated, just customer events dictated you had to take some actions in the second quarter. Can you give us some idea of what percent of the portfolio was impacted by that and you know, some maybe order magnitude of what we should expect and kind of the, you know, the residual value assessment in Q3 for GCAS?

Yes, sure. If we start then with the second quarter impairment. Basically, given what we're seeing in the market, we decided to make, a risk-based approach in the second quarter. In the third quarter, we have the big one. But in the second quarter, we decided, because of what's happening in the market, to look, you can say, start by looking at our customers and choosing the ones that we felt were highest risk. And that's basically from that angle. Then we took their assets and we looked at or tested significantly lower utilization and possible repossessions and not getting funding from governments, right? And with that, we could see that roughly 300 million was needed as an impairment. And if you take that in perspective to the whole portfolio, this was around 6 billion of our whole portfolio of operating losses, which is around 30 billion in total. So those 292 pre-tax was the impairment for the second quarter. And then if we then look at the third quarter, I would say that that's a little bit different. That's basically looking at the whole balance of our portfolio, actually including the 20 we've reviewed. And here we have a full annual impairment review. I won't bore you with the but I can tell you it's very and a very thorough process where we have three different appraisals on each aircraft that's incorporated. We update all the assumptions on discount rates and maintenance cash flows, et cetera. So it's a much bigger process. But I would say we do anticipate pressure on our cash flow assumptions and the value sort of driven for possible elevated repossessions and prolonged recovery for the industry. And we'll continue to monitor credit risk impairments, I would say, as we go over the year. Larry?

You know, I think you covered it well. We thought that we would take an early look at that highest risk portion of the portfolio, roughly 20%, as you said, Carolina. And then we'll just run through our normal course process here in the third quarter. and we'll update folks later. But I'm pleased that we pulled that forward given the environment that we're in. I think that's very consistent with our effort to be transparent and on top of these things, but more work to do, normal course here in the third.

From Gordon Heskett, we have John Hinch. Please go ahead.

Good morning, everybody. Hi, Don. Morning, guys. Morning, Carolina. Welcome. So just going back to kind of the cancellation discussion that you guys talked about, or Carolina, you mentioned, I think, with the LEAP. I mean, there are mounting 737 max cancellations. And I'm just curious if you, as in GE, are on the hook to have to repay any of the down payments or progress payments you may have received. any good size that risk for us and, you know, by extrapolation, do you think any of your aviation previous progress payments are at risk just given the aviation environment due to COVID and what you're seeing?

If I look at what we have then on progress and cancellations, for aviation, let's start by looking at the progress collection balance that we have, right? It's 5.5 billion, and it's a liability, because basically it pertains to us. And this is largely commercial engines, and the largest portion of that is elite 1Bs. And I would say that the second quarter progress refunds were very small, and we're not expecting significant impact in the second half. If you think about how the flow is, our risk is sort of limited to refunds on straight-up cancellations. And, of course, we coordinate with both the airframers and our customers since the situations are pretty unique. And I would say that the cancellations we have done, but the airframer is the lead on negotiating new terms. If the airframer agrees to refund progress, also GE and CFM would be required to refund.

From Velious Research, we have Scott Davis. Please go ahead.

Good morning, everybody. Hey, Scott. Hi. Good morning. If we kind of isolate the businesses, I mean, aviation, power, renewables have just rough macro, health care a little bit more stable. Is the health care business cash flowing at levels you would find consistent with profits?

Scott, I think we're pretty pleased by and large with health care's performance just given the mix of dynamics there, right, both from a top-line perspective. If you just look at orders, for example, we have positive orders in HCS despite all of the downdrafts largely a function of the COVID products giving us that back. So clearly PDX was way down. But the team did a really nice job with that volume mix pressure to really respond quickly, a little easier in a shorter cycle business like healthcare to take the cost actions that we did that allowed us to hold the out margins flat. And we had decent cash performance there. I think as we get into the second half, And really, as we think about the recovery from here, despite the pressures in aviation, folks are going to need to remember that we've got a good healthcare business that's going to get better, both in terms of the macro environment and our operation and management of it, as well as the turnarounds that are underway in both power and renewables. So that's really a large part of the self-help story, in addition to what we've talked about, in addition to what's happening, the way we're managing it in aviation.

And I'll just add a comment on healthcare, because you have to remember that we sold biopharma. So, basically, we had 300 million of cash flow every quarter from biopharma. That's obviously not going to repeat as of this quarter. So, you have to sort of take that into consideration when you look at healthcare.

From Oppenheimer, we have Christopher Glenn. Please go ahead.

Hey, thanks. Good morning. You know, we saw Jack Book Valley come in a little in the quarter, and you have some 3Q processes underway, longer-term, I guess, accounting adjustment, maybe 2022 for insurance. Just wondering, in terms of asset sales, what's the market and what's the scope of, you know, remaining potential asset sales where you'd expect a ready market to sell at book? You know, what's the state of play with asset sales?

I would say, Chris, with where we are today, particularly on the heels of the biopharma transaction with $41 billion of cash, and I think with lots within our control operationally to improve performance from here, we're not spending a lot of time on additional asset sales. I think we know we've got to bring these leverage numbers down. We've remain committed to our financial policy in that regard. No change. It's just going to take us a little while longer, both on the industrial side and, to a lesser degree, on the capital side. But we're going to move forward with this portfolio with the aim of creating as much value as we can over time.

From Credit Suisse, we have John Walsh. Please go ahead.

Hi. Good morning, everyone. Hey, John. Hey, John. So there's a lot of puts and takes as it relates to kind of cash flow, good guys and bad guys. You did make this comment that you think industrial free cash flow is up in 2021. I'm kind of just wondering if there's any way to frame the order of magnitude, if we were kind of to remove any kind of volume lift just from some of the timing around restructuring cash, biopharma, inheritance taxes, et cetera, if we already start positive before anything else or if all of those items aggregate to something negative and we need that volume lift to come through and help cash in the next year.

Okay, so let me do that. But as you say, there are a lot of good guys and bad guys and puts and takes. But we say we return to positive free cash flow in – industrial free cash flow in 2021, and that's based on what we see today, right? So in addition to some gradual improvement in end markets, there are really a number of items that give us this confidence. I would say the first and very important one is that we deliver on our 2020 cost and cash actions, right? So annualizing $1.5 to $2 billion of structural costs out, it flows to the free cash flow. And then, as you mentioned, we also have the reduction in inheritance taxes, a lot of that on the power side. with the deferred monetization and what have you. That would be basically a $1 billion year-over-year improvement in 21. Then on the businesses gaining traction, I would say power is more of a continued turnaround story, right? Cost out and keep the fleet running. Renewables, also turnaround on grid and hydro. Better project execution, we have the Halidex orders, and we see some growth on the international market that I mentioned in my previous comments. Healthcare, well, early signs of better trends. We saw those improvements through the quarter. And here we also have the program where we are working on improving our fixed costs, and what was a margin expansion activity is now a margin preserving activity, and then will also help in margin expansion. And I think this is super important, this operation of self-help and really working with the lean transformation that then takes hold in the whole company because that improves both the margins and the profit, but also the working capital. And we've just seen the start of sort of us gaining traction there. And you will see that in the results over time. Commercially, Mary, maybe you want to comment on that?

Well, as I mentioned earlier, we just think that there are going to be opportunities amidst the pressure of the moment, really across the portfolio, to smartly create new programming and products. You see that particularly in health care right now, given the way the teams responded around not only the ventilator, and patient monitor opportunity, but the way, frankly, we've been able to deploy some of the digital products in a more meaningful way than we might have otherwise, despite all the time and money that we have put into the digital healthcare effort. I think you covered it. It's really about sequential improvement from here. Again, the environment remains challenging, but with respect to those things that are within our control, We think healthcare is well-positioned to lead. The turnarounds in power and renewables continue, and we're expecting a multi-year recovery in aviation.

Hey, Brandon, we're past the hour. We have time. We'll fit in one more in the queue. I recognize there are more folks, and we'll get to you afterwards, but just one last one, please. Okay.

And for Morgan Stanley, we have Josh Pokrzewski. Please go ahead.

Hi. Good morning, everyone. Hey, Josh.

Good morning.

Larry, could you help us out with maybe a cadence element in terms of that aviation recovery over multiple years? What would you expect to be kind of the normal lag between departure growth and shop visits? Obviously, there's a lot of elements of, you know, maximizing green time and USM and, you know, retirements, a lot of factors at work. But what does normal look like so we can, you know, we try to understand the baseline for some of those other moving parts?

Josh, I'm not sure we really have a working definition of normal, if you will. We went back and we looked at the way this has played out for us over time, whether it be 9-11, the crisis. Every time that we've seen these sorts of pressures, the dynamics have been different every time out. I think the best that we can share today is that the airlines are working through what this means, not only in terms of their fleet plans and their own cash preservation efforts, their maintenance programs going forward will continue to be under some pressure in services. I just don't think there's really any two ways about it. Despite the improvement in departures and that sequential uplift, I think we're mindful that this is going to continue to be challenging for us in 2020 and that won't be the end of it.

Brandon, we are out of time at this point. I'm going Thank everybody, then, and we're going to have to move on. But, again, we'll be available for follow-up questions as needed.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for joining. You may now disconnect.