General Electric Company (GE) — Q2 2017 Earnings Call Transcript

Good morning, everyone, and welcome to GE’s Second Quarter 2017 Earnings Call. With us today are our Chairman and CEO, Jeff Immelt; our next Chairman and CEO, John Flannery; and GE Vice Chairman and CFO, Jeff Bornstein. Before we start, I would like to remind you that our earnings release, presentation and supplemental have been available since earlier today on our website at www.ge.com/investor. Please note that some of the statements we are making today 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. And now, I’ll turn the call over to Jeff Immelt.

Thanks, Matt. GE had a solid quarter in a volatile world. Let me give you a few themes that describe the environment. The U.S. is stable on a slow growth rate; global growth is accelerating, and resource markets remain challenging. Our topline results are solid. In the second quarter, our organic results were: Orders up 5%; revenue up 2%; margins expanded by 10 basis points; and industrial profit grew by 4%. At the half, orders were up 6%; revenues up 4%; margins expanded by 70 basis points; and industrial profit grew by 11%. At the half, we reduced structural cost by $670 million ahead of plan. We generated $3.5 billion of cash in the quarter, in line with our expectations. In the quarter, we made progress on our portfolio strategy. In July, we closed GE Baker Hughes. This move significantly strengthens our position in the sector. This is a more competitive business positioned for growth. We closed LM, a critical vertical integration move for wind business. LM is already improving growth and margins. We remain on track to close the sale of Water in the third quarter and Industrial Solutions by year-end. We see good strategic and operational synergy with Alstom. Overall, we have no change to our 2017 framework. John will update you on his views for 2018 and beyond later in the year. Our orders have been strong, up 8% year-to-date and 6% in the quarter. We saw strength in both equipment and service. We grew the backlog by $3 billion. We continue to see pricing pressure in oil and gas; we have a slow industry with excess capacity. Let me give you a few order highlights that we consider most noteworthy. Aviation was up 14%, really an amazing performance. At the Paris Air Show, we announced $30 billion of commitments, 10 times our nearest competitor. Oil and gas equipment orders grew by 50%; this includes one of the few big project deals in the industry with Eni in Mozambique. Renewables were up 12% behind some big global deals. We’re gaining share in Europe. We took orders for 9 H turbines in the second quarter with 33 in backlog. Global orders were up 11% and represented 66% of our total. Nine of 12 regions experienced growth with China up 26%, India 36% and Europe up 35%. Transportation signed an LOI worth $575 million for locomotives in Egypt. Digital orders were up close to 40%. At the half, Meridium orders were up 86% and ServiceMax orders grew by 101%. Healthcare created a collaboration with partners for an artificial intelligence solution. And in service, aviation spares grew by 14%, military grew by 28% and power received a $3 billion service commitment for power plants in Algeria. There is no doubt that we’re outperforming competition in many markets and gaining share, which is in turn building our install base for the future. With this order rate and backlog, we feel great about the 3% to 5% organic growth for the year. Organic revenue was up 2% and margins were up 10 basis points in the quarter. Year-to-date organic revenues up 4% and margins were up 70 basis points; service revenues are up 8% year-to-date. So, here are some key revenue highlights. Global revenue was up 7% with growth in nine of 12 regions; Europe grew by 15%; China by 16%; India by 35%; and MENAT by 15%. For the half, we had organic service growth in all segments. We’re gaining share with our products. LEAP has an unprecedented advantage in the market. We believe that GE has greater than 50% share in the gas turbine market and the market for H. In wind, we’re gaining share in Europe for the first time. Healthcare closed a number of big enterprise deals for both healthcare solutions and life sciences. Our new cell therapy business grew by 37%, and our mammo business where we launched new products grew by 20%. Digital revenue growth was 17%, and we see this accelerating through the year. Let me give you some perspectives on our margin performance. As I said earlier, our structural cost is $670 million year-to-date with strong performance in the business and corporate; we expect to beat our $1 billion goal. We had $150 million of non-repeat items that impacted our oil and gas and power businesses; Jeff will review these in the segment reviews. We grew equipment in a few areas that are dilutive in the CM rate in the short-term but open up service growth in the long term; these include the H and LEAP products and the power balance plan. This was expected and reflected in our margin goals for the year. In the second half, we’re targeting 120 basis points of improvement to generate 100 basis points for the year. This kind of second half expansion is typical for GE. We see sustained revenue growth and structural cost out helping us achieve this goal. In all, we expect to hit the EBIT target we’ve discussed in the past. For cash, CFOA was $3.5 billion in the quarter, $2 billion from capital and $1.5 billion from industrial CFOA, in line with expectations. Here are some of the main drivers from industrial CFOA. Net income was actually below last year due to increased restructuring costs not covered by gains; working capital performance was very good, up $1.5 billion from a year ago, and a $700 million improvement in the quarter. We saw improvement in receivables, inventory, and progress, which was partially offset by lower payables. Contract assets were a drag but better than a year ago. The second half CFOA profile will be a lot like last year. We expect higher earnings. We expect to reduce working capital by about $4 billion in the second half. Last year, this was actually more; it was $5 billion. Contract assets will grow at about the same level, and we will benefit from the timing of other items. We ended the quarter with $14 billion of cash on the balance sheet, in line with expectations. And we should be within the $12 billion to $14 billion goal for industrial CFOA. Now, over to Jeff.

Thanks, Jeff. Starting with consolidated results. Revenues were $29.6 billion, down 12% in the quarter; industrial revenues of $27.1 billion were also down 12%. As you can see on the right side of the page, the industrial segment was down 2% on a reported basis but up 2% organically, driven principally by the appliances disposition. Industrial operating plus verticals EPS was $0.28, down 45% versus the prior year, driven by substantial appliance gain in the second quarter of last year. We had $0.06 of restructuring with no gains in the quarter versus $0.11 of net gains after restructuring last year. Operating EPS was $0.19 in the quarter, down from $0.39 in the second quarter of 2016. This incorporates the other continuing GE Capital activity, including excess debt and headquarters runoff costs that I’ll cover on the GE Capital page. Continuing EPS of $0.15 includes the impact of non-operating pension; and net EPS of $0.13 includes discontinued operations. The total discontinued operations impact was a charge of $152 million in the quarter, driven by the GE Capital Exit Plan item. GE tax rate was 13% in the quarter; we still expect the ongoing operations of the business to have a mid-teens tax rate for the year. However, the Water disposition will be a low-tax transaction and will bring the overall tax rate for our industrial to around 10% for the third quarter and about that for the total year. The GE Capital tax rate was favorable, reflecting a tax benefit on a pretax continuing loss. We had a better cash quarter. CFOA was $3.5 billion, including $2 billion dividend from GE Capital, and industrial CFOA was $1.5 billion in the quarter. It was up $3.1 billion from the first quarter and up substantially from the second quarter of last year. At the half, industrial CFOA is $200 million usage. We expect substantial improvement in cash in the second half driven by higher earnings, continued working capital improvement on higher shipment, partly offset by contract assets. For the year, we are guiding to the bottom end of the $12 billion to $14 billion range on CFOA, driven by pressure principally in power and oil and gas. John and I are reviewing our capital allocation plan for the year. The dividend remains our priority. We are relooking at the $11 billion to $13 billion range on cash use for buyback, based on the timing of disposition. Year-to-date, we bought back $3.6 billion of shares. On the right side are the segment results. As I mentioned, the industrial segment revenues were down 2% on a reported basis and up 2% organically. For the half, the industrial segment revenues were up 4% organically. The industrial segment op profit was down 4% reported and down 1% organically; and industrial op profit which includes corporate operating cost was down 1% reported and up 4% organically. The demonstrated industrial op profit and industrial plus vertical EPS year-over-year is driven by the effects of restructuring, the appliance gain, and associated tax impacts of the appliance. Through the half, industrial op profit of $6.8 billion is up 4% reported and up 11% organically. On an EPS basis, we’ve earned $0.48 of EPS, which is $0.62 excluding the first half naked restructuring. Given our outlook on oil and gas and power, we are trending to the bottom end of the range of $1.60 to $1.70 EPS for the year. Next, on industrial and other items for the quarter. As I said, we had $0.06 of charges related to industrial restructuring and other items that were taken at corporate. Charges were a little more than $700 million on a pretax basis. This was slightly less than expected, driven by lower costs to execute projects and short-term timing delays on projects we will likely execute here in the third quarter. Corporate, power, renewables, healthcare, and oil and gas had the largest investments in the quarter. Restructuring charges totaled about $500 million, and BD charges were approximately $200 million mostly related to Baker Hughes news, the LM Wind acquisition, Water disposition as well as the Industrial Solutions disposition and the digital transaction. There were no gains in the quarter. For the year, we expect about $0.25 of restructuring to be offset by $0.25 of gains from the Water and Industrial Solutions dispositions. We’re targeting a third quarter close for the Water transaction and the fourth quarter close for Industrial Solutions. The Industrial Solutions transaction may push to early 2018, but our plan is to do $0.25 of restructuring this year. We’ll update you on deal timing as we get closer. Next, I’ll cover the segments, starting with power. Our recorded orders of $7.7 billion, down 1% in the quarter. Excluding the large Halcyon steam order in the second quarter of last year, orders actually grew 11%. Equipment orders were down 1%, but up 33% ex the Halcyon order. Gas power system was up 26% on higher H turbine orders of nine versus five last year and six HA units booked in Mexico, our first in the account. The H backlog totaled 33 units. HRSG orders grew by 100% to 10 versus 5 a year ago. Offsetting GPS was steam power, down 42% with no repeat of that Halcyon order, which totaled about $800 million. Equipment backlog grew 27% year-over-year. Service orders were down 1%, primarily driven by lower AGPs in the quarter of 20 versus 24 last year, and the larger mix of light AGPs versus full scope, and by lower outages which were down 9%; this was partially offset by growth in installations and other upgrades. Service backlog grew 7% year-over-year. Power revenues were up 5% to $7 billion. Equipment revenues were up 12%, driven primarily by gas power systems, up 17% on higher scope balance of plant and higher HRSG shipped of 10 versus 4 last year; this was partially offset by lower gas turbine shipments of 21 versus 26. Service revenues grew 1%; our distributor power services up 10% offset by flat power service. Power service is flat on lower outages, and fewer and lighter scope AGPs, 21 versus 28 offset by higher other upgrades which were up 42%. Operating profit in the quarter was down 10% on higher equipment versus services, including higher balance of plant volume at low margin. Fewer AGPs and lower variable cost productivity, which was partly offset by structural base cost down 7%. Lower VCP in the quarter was impacted by about $70 million of liquidated damages with delivery delays and fuel mod costs of about $20 million that we don’t expect to repeat going forward. The business is finding opportunities for growth. We took nine H turbine orders in the quarter. We also booked the largest services deal in the history of the business, the $3 billion Algeria deal with Sonelgaz that included 68 AGPs. This showed up in backlog, not orders in the quarter. However, we’re planning for a down market this year. We expect the power market to see demand for about 40 gigawatts of power this year, down about 10%, consistent with what we said in March. We’re also planning for a down market in 2018. We expect to ship 100 to 105 gas turbines in the year, no change in that outlook. We believe that we have a technology advantage relative to competitors, and we’re gaining share. Having said that, the market is very competitive, and overcapacity and new product introductions will continue. For services, we expect 2017 now to just be down about 4%, driven by F-class major outages, which we think will be down about 9% as a result of lower utilization, lower capacity payment, particularly North America, and extended intervals between outages. This is softer than we expected coming into the year. We are targeting total upgrades to grow, and AGPs to total between 155 and 165 for the year. However, we have a risk of 20 to 30, driven by timing of large second half AGP deals that are yet to be agreed to. In the first half, the business is up 10% on revenues and higher by 7% on operating profit with margin rates down 50 basis points. Power has taken out around $143 million of structural base costs to date, and we are continuing to work on additional actions on cost for the year. Next is renewables. Orders in the quarter were $2.1 billion, up 2% reported and down 2% organic. Onshore wind orders of $1.7 billion were down 5%, driven by lower repower orders and services. Onshore equipment orders were higher by 4% on strong international winds. The number of units ordered was 567 versus 637 last year, down 11% but the megawatts grew 12% on larger machines. Hydro orders of $250 million were up 38%, and LM had $80 million of water orders in the quarter. Revenues were $2.5 billion, up 17%, up 13% organic. Onshore revenue grew 12%, and hydro grew 79%. Onshore was driven by the repowering product that we introduced last year. Wind turbines shipped totaled 757 versus 856 last year, down 12% but the megawatts shipped were 8%. Operating profit of $160 million was up 25%, driven by repower volume, better product cost and foreign exchange, partly offset by price. Margin rates improved by 40 basis points. The wind market continues to be very competitive; product cost out is absolutely imperative and the team has made progress on the 2 megawatt platform and needs to execute the same on the 3 megawatt turbine as we begin to deliver that machine. LM will be critical to drive cost and differentiation going forward. This business is on track with double-digit growth and improved margin rates for the total year. Next, on aviation, the market continues to be robust. Global passenger RPKs grew 7.9% year-to-date through May, with strong growth on both domestic and international routes. Airfreight volumes have been very strong as well, growing over 11% year-to-date through May. And load factors globally are above 80%. Orders in the quarter totaled $7.3 billion, up 14%. Equipment orders grew 11% and services grew 15%. Within equipment orders, commercial engine orders grew 35% to $1.9 billion on higher LEAP, GE90, and GE9X orders. These orders did not conclude any of the Paris Air Show announcements we made. Military equipment orders of $292 million were down 48%, driven by no repeat of an order last year for 212 T700 helicopter engine. Service orders grew 15%, as I mentioned, with commercial services higher by 16% on strong spears of 14% to $21.6 million a day, and strong military services growth of 14%. Backlog finished the quarter up 2% to $159 billion. Revenues in the quarter were flat at $6.5 billion. Equipment revenue was down 16%, driven by commercial down 15% and military down 39%. Commercial engine shipments were lower by 10% on pure legacy engines, partly offset by higher LEAP volume. The business shipped 93 LEAP engines in the quarter. Service revenues grew 13% on higher commercial spares up 14% and good military performance, including our military spares. Operating profit of $1.5 billion was up 11%, primarily driven by higher service volume and base cost productivity which more than offset the negative LEAP margin. Margins were 210 basis points higher in the quarter. At the Paris Air Show, we announced $31 billion in orders and commitments, including new engine commitments of $21 billion and services up $10 billion. None of these announcements were booked in the orders of the second quarter. Additionally, we announced the development of the world’s largest laser powder machine targeted to the aerospace segment. We also announced a partnership with Stryker to provide machines, materials, and services for the global supply chain operation. The LEAP engine continues to perform to spec with 62 aircraft flying today. The business is on track to ship 450 to 500 LEAP engines this year. The business executed well in the first half. As LEAP shipments accelerate in the second half, we expect the margins to be pressured and still expect total year margin rate to be roughly flat with 2016. Next, on oil and gas. We closed the combination of our legacy oil and gas business with legacy Baker Hughes on July 3rd. The new company’s listed on the New York Stock Exchange under the symbol BHGE. In September, Lorenzo and his team will give you an update on the outlook of the new company and the progress on integration and synergy. Today, we will discuss only the results of GE’s legacy oil and gas business and not the results of the legacy Baker Hughes business. The oil and gas environment remains challenging. Our legacy business sees some improvement in activity, but we have not seen meaningful increases in customer capital commitment. Oil prices remain volatile, and as a result, our customers remain cautious. As we’ve said previously, we expect shorter cycle activity to increase in the second half of the year. So far, these improvements are tending below our expectations. Orders in the quarter of $3.2 billion grew 12% versus last year and grew 14% organically. The equipment book-to-bill ratio was 1-to-1 for the first time in the better part of two years. Equipment orders totaled $1.4 billion, up 50%. Every business segment grew. Subsea was higher by 177% on orders in Brazil and the Eni Mozambique Coral project. Turbomachinery was up 14%, also driven by the Eni Coral scope, and service orders grew 57% on strength in the Middle East. We had terminations in the quarter totaling $542 million, driven predominantly by one project scheduled to deliver beyond 2018. Service orders were $1.8 billion, down 6% on softer markets, driven by turbomachinery down 13%, surface down 11%, subsea down 6%, partially offset by strong performance by digital solutions, which grew 6%. Total backlog ended the quarter at $20 billion, down 12% versus last year. Revenues of $3.1 billion were down 3% versus last year. Equipment revenue was down 8%, driven by subsea down 31% which more than offset growth in surface up 12% and turbomachinery up 3%. Service revenues were flat year-over-year. Operating profit of $155 million in the quarter was down 52%. Performance was driven by unfavorable pricing and negative variable cost productivity that more than offset sourcing and structural cost out. On variable cost productivity, I put the impacts in two categories. First, we had two big one-time items: Rework on a nonrecurring issue related to a single contract totaling about $30 million and a write-down of obsolete inventory for about $25 million. Second, lower volume impacted both overhead absorption and supply chain benefit. We also had $25 million of integration costs in the business in the quarter. As the market recovery has been slower and more volatile than we planned, performance of the business in the second quarter was below expectations. Customers are delaying purchases for both larger projects and shorter cycle OpEx activity. Given the slower market activity, we expect that numbers in the second for legacy GE Oil & Gas to be lower than previously anticipated but improve from the first half. The business is very focused on the synergy pipeline with the integration in order to offset as much of the market pressures possible. Beginning with the third quarter results, BHGE will release its own financial statements and hold a separate earnings call. Next on healthcare. Orders of $5 billion grew 3%, 4% organically. On an organic basis, the U.S. was up 1%; Europe was up 2%; and the emerging markets grew 11%, driven by China up 18%, ASEAN up 15%, Latin America grew 5%; and the Middle East actually declined 6% organically in the quarter. On a product basis, healthcare systems orders grew 3%, 4% organically, driven by ultrasound up 8% and imaging products higher by 4%. Mammography and CT were particularly strong due to new product launches. Life Care Solutions was flat, driven by the impact of healthcare reform uncertainty in the U.S. market. Our Life Sciences business grew orders 5% organically, with core imaging up 8% and bioprocess up 5%. Revenues in the quarter of $4.7 billion grew 5% organically. Healthcare systems grew revenues 5% organically and life sciences grew by 8% organically. Operating profit was up 6% in the quarter to $826 million, driven by volume and productivity, partially offset by price and programs for product cost reduction. Margins improved by 30 basis points in the quarter. We expect the second half performance to be similar to the first half with low to mid-single digit revenue growth and stronger operating profit growth. The business is executing well, and we will continue to simplify structures to drive lower product costs. On transportation, North American carload volume continues to improve off a low base. Carload volume grew 7.3% in the quarter, driven by intermodal higher by 5.6% and commodity carloads up 9%. Commodity carload growth was driven by export coal up 18% and agriculture up 10%, partially offset by petroleum down 4%. Despite improving trends since mid-2016, overcapacity remains in parked locos around 4,000 and very little investment appetite from U.S. customers. Orders in the quarter of $830 million were higher by 22% on easy comparison. Equipment orders of $231 million doubled on international demand for 26 locos. Service orders of $600 million grew 7%, good growth in loco parts and mining. Revenues of $1.1 billion were down 14% with equipment down 27% and services flat. We shipped 120 locos in the quarter versus 222 a year ago, with international shipments up 34%, partly offsetting North America which was down 77%. Operating profit in the quarter was down 26% on lower volume, partly offset by cost actions. The North American locomotive market will continue to be challenging in 2017 and 2018. We expect 2017 loco shipments to be lower by about 50%, with operating profit down double digits based on our guidance. The business is focused on growing internationally. The business recently announced a $575 million win in Egypt for 100 locos plus service. We expect this to book as an order in the third quarter. Executing on resizing the business to market has been ongoing, and we continue to evaluate additional actions as needed. Next on energy connections and lighting, orders for the segment totaled $3 billion with energy connection orders of $2.6 billion and current orders of $380 million. The energy connections orders were down 12% reported and down 7% organic, driven by grid down 8% on no repeatable large Egypt order and power conversion down 14%, offset by 1% growth in the industrial solutions. Revenues ex appliances were reported down 2% but up 2% organic. Energy connection revenues were higher by 4% organic on strength in grid and industrial solutions, partly offset by power conversion. Lighting revenues were down 9% with current down 2% and legacy down 17%, as a result of the market exits and restructuring we’ve been doing over the past year. Operating profit in the quarter was $80 million, up over 400% ex appliance. Energy connections nearly doubled profits to $68 million on grid and industrial solutions performance and productivity, partly offset by power conversion on weak volume. Lighting earned $13 million versus a loss last year. As announced, energy connections will be consolidated with power in the third quarter, which we believe will create significant opportunity for future structural cost out. We’ll provide a recast date once we finalize it in the third quarter. Finally, I’ll cover GE Capital. The verticals earned $544 million in the quarter, up 20% from the prior year, driven primarily by higher base earnings. GECAS, Energy Finance, and Industrial Finance all had strong quarters and they delivered a solid first half of the year. They executed ahead of the plan on their 2017 guidance. In the second quarter, the verticals funded $1.9 billion of on-book volume and enabled approximately $3.9 billion of industrial orders. Overall, portfolio quality remains stable. Other continuing operations generated a $716 million loss in the quarter, driven by $343 million of excess interest expense, a $182 million preferred dividend, $146 million of restructuring costs related to portfolio transformation, and $45 million of headquarters run-off expense. Other continuing was $335 million better than last year, driven by lower excess interest and lower headquarters cost. Discontinued operations generated a $152 million loss from trailing costs and exit plan related items. Overall, GE Capital reported a net loss of $324 million, 72% better than last year. GE Capital paid $2 billion in cash dividends during the quarter, bringing the year-to-date total to $4 billion and ended the quarter with $160 billion of assets, including $37 billion in liquidity, down $7 billion from the first quarter. Looking ahead, during the second half of the year, we expect lower asset sales. And as a reminder, we will conduct our annual impairment review with GECAS in the third quarter. In the fourth quarter, we will perform our annual cash flow test of our run-off insurance business. We recently have had adverse claims experience in a portion of our long-term care portfolio, and we will assess the adequacy of our premium returns. We will update you in the fourth quarter. Lastly, in other continuing operations for the second half of the year, we continue to expect incremental tax benefit associated with recovering a portion of the exit plan tax cost we incurred. With that, I’ll turn it over to John.

Thanks, Jeff. I just wanted to give you a quick update on our transition process. As you know, my official start date is August 1st, and we’d indicated earlier that I’d be doing a full review of the Company and be back to investors in the fall with my views. We are on track with this process. I am in the middle of a series of deep dives into each of the businesses, looking at everything you would expect: What is the market outlook, where can we grow, where can we improve margins, how is the cash conversion, what returns are we getting on investment? For example, next week, we will be visiting our power and aviation businesses. We are also taking a hard look at our corporate spending, going through a zero-based budgeting exercise on all of our functions and making sure 100% of our GE store outlays are accretive to the overall results of the Company. In addition to the business reviews, I want to repeat the process I used in healthcare to really get out and listen to what people are thinking, both good and bad about the Company. I always start with customers and employees, but it’s also important to get the view of our government partners and especially our investors. As I was out with Matt Cribbins last week and we saw about 100 different analysts and portfolio managers, and we will be doing more of that over the next couple of months. There is a lot of positive feedback from these listening sessions but also plenty of suggestions on ways we can improve. This is all leading to a report out in November. Our main focus then will be translating the business assessments into our thoughts on cost out and capital allocation choices as well as reframing our look at 2018 and beyond. I’m really excited to get started officially on August 1st and look forward to our ongoing dialogue. So, Jeff, back to you to wrap.

Thanks, John. Overall, we have no change to the framework, but there are puts and takes in each area. We see the key elements of earnings to be on track: 3% to 5% organic growth and 100 basis points of margin enhancement. We have pressure in power and oil and gas, but we’ll outperform structural cost out. We’ve set a target of $17.2 billion for industrial EBIT, and we expect to hit it, even with those headwinds. Jeff discussed the impact of additional pressure from the resource sector that could have on the EPS range earlier. We expect to hit $16 billion to $20 billion of free cash flow plus dispositions. We still expect to have solid industrial CFOA between the $12 billion to $14 billion, again somewhat dependent on the resource sector. Our dispositions are taking longer than expected, but we have to close both in the year. I expect John to take a fresh look at capital allocation, but GE will always have a strong commitment to the dividend. Let’s take a bigger picture view of the Company. We have created a very strong position in power, healthcare, transport, and resources, big industrial segments. We don’t like the current gas cycle, but our business is significantly improved and will prosper as the cycle recovers. We are gaining share in most of our markets with $327 billion of backlog. We have a leadership position in the industrial internet and additive manufacturing, which are two growth areas and drivers of industrial productivity. In a volatile global economy, our industrial EBIT plus the earnings from our GE Capital verticals should be about $19 billion and again generate between $16 billion and $20 billion in free cash flow plus disposition. So, a pretty good performance in the volatile environment. I know John Flannery can improve on this. John is off to a great start, and I look forward to working with him. Matt, now over to you for some questions.

Thank you. With that let’s open up the call for questions.

My question would really be on the CFOA for the year coming in at the lower end of the $12 billion to $14 billion guidance. Sounds like that’s mostly power and oil and gas. So, I wondered if you could give us some transparency around what is the cash conversion or free cash flow margin like in those two businesses in 2017. And when you think about their cash flow performance this year, how much do you think it’s weighed down by short-term one-time factors? In other words, how quickly do you think it can spring back to an acceptable level of cash flow in those two businesses?

Yes, Julian. We expect the power business to generate a positive cash flow from operations this year, as well as oil and gas. In fact, we anticipate that oil and gas will perform reasonably well in terms of cash flow from operations for the year, given the current environment and our expectations for the second half. The power business is projected to have a conversion rate of approximately 50% to 60% for the year, while other segments will likely perform better. Healthcare is expected to be close to 100%, and aviation should also do well. However, I would estimate that the power business will achieve a conversion rate between 50% and 60% this year.

I would also add, Julian. We’re doing $2 billion of cash related to restructuring. A lot of that’s in the power sector. None of us expect that to repeat in 2018. So that’s a natural tailwind, let’s say, in terms of CFOA in 2018.

So, why don’t I walk from the first half to the second half a little bit in terms of how we’re thinking about it. There is no doubt we have a big second half to deliver on cash, and that’s similar to where we were last year. Relative to the first half, there are really three big drivers. One, we’ve got higher earnings, in line with our volume; our cost-out profile; and gains versus restructuring. In the first half, we had a $0.14 headwind; in the second half, with the gains, we’ll offset that $0.14 headwind and have $0.14 offset in earnings. We’ll have significantly better working capital performance. Although I think we feel pretty good about the second quarter. We generated $700 million in CFOA in the second quarter from working capital, and that was almost $1.5 billion better than where we were in the second quarter of the last year. I think importantly within that there was a couple hundred million of inventory improvement, which I don’t think we’ve ever realized in the second quarter of any year in recent history. As we look to the second half, the working capital will get better, largely driven by inventory, a bit by payables and we’ll have some receivables improvement. And that’s consistent with where we were last year. So, working capital last year, we improved in the second half, better than $5 billion; we’re not anticipating $5 billion but looking more at just under $4 billion improvement this year. So, we think we’ve executed before, we can execute again in a similar way. Lastly, on contract assets, we still expect contract assets to be a cash usage in the second half but not nearly the rate that we saw in the first half. We expect it will look very similar to the change in contract assets in the second half of last year, which was about $1.4 billion or $1.5 billion. So, if you look at second half cash flow versus 2016, we delivered $11 billion of CFOA in the second half of last year. We need to do about $1 billion more this year, which is primarily a function of earnings. We expect working capital to be about $3.9 billion better in the second half. So, the total improvement for the year of about $3.3 billion, which is less than the $5.1 billion of working capital improvement we had in the second half of last year. As I say, contract assets have been a little bit of a drag in the second half but in line with where we were in the second half of last year. Lastly, I’d say other operating, all the other elements of cash flow will be better in the second half than the first half and will be better substantially versus 2016. So that’s kind of how we think about going from the first half to the second half.

In 2016, we operated with about $3 billion less in working capital, and we are following a similar approach in 2017. However, I believe there's still significant potential for improvement. We fully expect to continue decreasing the working capital required to manage GE in the near future.

So, could you give us a little more color on what you are seeing in power? You mentioned trending toward the bottom of your EPS range for the Company, I think despite a lower tax rate. And power specifically, is services overall just a tougher market than you thought? You talked about the delays you are seeing in services, but how much of the power weakness would you say is execution-related and how much low-hanging fruit does Russell have to improve delivery timing and overall execution of the business?

I’ll begin and then others can chime in. Overall, I believe the equipment market is largely in line with our expectations. We anticipated a market of 40 gigawatts, down 10%. In that framework, we projected orders for 85 to 95 units this year, which still seems likely, having secured about 39 units in the first half. We estimated shipments of 100 to 105 units, and that prediction holds. Regarding the gas turbine segment, we expect improved profitability compared to last year. However, the service sector appears to be underperforming relative to our initial expectations, particularly regarding outage volumes. We had anticipated a mid-single-digit decline in outages, but currently, we're seeing a year-over-year decrease of about 9%, influenced by utilization rates, lower capacity payments, and longer intervals between outages. This situation has impacted our transactional business, which constitutes over 50% of our operations. However, it’s important to note that during the first half, revenues in this sector increased by 10%, while operating profit rose by 7%, reflecting solid execution. We addressed over $90 million in liquidated damages and fuel modifications but don’t expect those to persist. The $70 million in liquidated damages stemmed from risks taken during the pre-launch of the H unit, which took longer than anticipated to complete. We are confident in fulfilling the remaining H commitments. For the overall year, we still anticipate mid-single-digit revenue growth for the power business, with earnings expected to rise from the low to high double digits. While the current backlog feels softer than expected, the business aims to achieve 155 to 165 AGPs this year. However, the proportion of light AGPs compared to full-scope AGPs is heavier than we initially forecasted. I mentioned earlier that there are some significant deals in the second half that could pose risks to delivering 20 to 30 of those units. I'm not suggesting that the business is losing faith in delivering these units; I just want to highlight potential risks. Service remains softer than we anticipated, while the units business is as expected. Gas outages, alongside reduced steam and boiler work in service outages, contribute to this outlook. Nevertheless, if we end up this year with mid-single-digit revenue growth and high single digits to low double digits in operating profit, that would still be a satisfactory outcome.

As you combine the energy connections business with the power business, you might identify around $1 billion in structural costs that can be eliminated from the combined entity going into 2018. Additionally, there is likely around $100 million that we could have managed better in the quarter and won’t recur. The outlook for the segment this year remains appealing, and the team is formulating a solid cost plan for 2018, which should provide a safeguard against market fluctuations.

There is both, an opportunity and necessity to restructure the cost structure of this business, given the market that we are operating in. And I expected that the business on their structural cost commitments is going to overperform in 2017. As Jeff just talked about, we are building a plan around something close to a $1 of structural cost out of 2018.

Jeff Immelt. Good luck and thanks for all your thoughts and insights over the year, much appreciated.

Jeff, you and I have done this a long time. I’m going to miss you and I look forward to having a beer with you as a civilian someday.

I’d like to do that definitely. Just on cash flow, I guess maybe perhaps for Jeff Bornstein. The first half obviously came in short of what you thought; you thought you would equal last year at roughly $400 million. I wonder if you could also decompose what the source of that maybe $600 million shortfall was. And just your comment on share repo, are you linking the conclusion or execution of these divestitures to your share repurchase plan or what variable is really driving the reevaluation of the repo? Thank you.

So, I think what I said on the call, maybe I misspoke on the call. What I meant to say on the call was we expected the CFOA in the second quarter would be substantially better sequentially from the first and substantially better than the second quarter of last year. I didn’t mean to say that we would be flat year-over-year. I think generally speaking at $1.5 billion, $1 billion of CFOA, we felt pretty good about that. Would we have liked it to be a bit higher? Sure. But I thought the inventory performance was pretty good, and the receivables performance was pretty good; payables were used in the quarter, maybe a little higher than we expected. But that’s partly driven by the cost-out that’s happening and the inventory improvement. So, I think at $1.5 billion that was reasonable performance. And it puts us pretty close to where we were at the half. You were right, we’re down $600 million year to date year-over-year, but that was included in the context of how I kind of walked you from how we think about going from the first half to the second half total year and what that means for working capital and other cash flow improvement we expect to see. On repurchase, I think our share buyback has always been predicated on dividends from GE Capital and the disposition. So, no change in there. I think that there is a risk that industrial solutions won’t happen in the year. It’s hard for me to exactly handicap. But, I think there is at least an equal probability that will happen in the first quarter of 2018 as it will happen in the fourth quarter of this year. As I mentioned earlier, we feel pretty good about the fact that Water will get to a closing here in the third quarter. So, having said all of that, I think as part of John’s relook about what we’re doing, I think John wants to go back and rethink about how we think about capital allocation in the Company and embedded in that obviously is how we think about share buybacks. So, we’re being open and objective, and John wants to take a look at it and really work through with the team what the right way forward is and what the right alternatives are.

I understand I may sound repetitive, but there is $2 billion in cash linked to the restructuring in 2017, which is likely $500 million to $600 million more than in 2016, and this should not largely carry over into 2018. That figure is reflected in these numbers. I also want to emphasize what Jeffrey mentioned about capital allocation and what John should focus on. Additionally, I want to stress that everyone here places a high priority on the dividend. I want to ensure there's no misunderstanding regarding this aspect of GE and our approach, regardless of who the CEO is. I remember the day the dividend was cut; it was the most challenging day of my time as CEO, and the dividend is extremely important to our investors and our team.

Just one point of clarification on the restructuring cash. So, yes, we’ll probably spend slightly more than $2 billion in cash on restructuring in 2017. Everything else being equal, I’m trying to avoid giving the 2018 guidance here before John’s gone through his framework, but we would expect to spend substantially less than that in 2018; but it won’t be zero. There will be projects we do in the third and fourth quarter that allow cash that spills over.

For Jeff, congrats and best wishes on your last earnings call, and we are expecting to hear good reports about improvements in your golf game. A question for John. So, given the management transition and now the mid-November timing for the reset and the new vision for the Company, how can you minimize the effects of GE being in somewhat of a state of limbo until then, for want of a better word?

Listen, we are going through a process that we’ve laid out for you guys. It’s a substantial process in a large company that takes a commensurate amount of time. I’d say Jeff and Jeff have laid out a framework for the year already, so there should be no change in thinking around that. And then, we’re spending a lot of time internally with the team. So, I would say there is no risk of limbo inside the team. I actually start August 1st, but there’s a lot of interaction already. So I’m not worried about internal paralysis, if you will. You have our outlook for the year. So, I look forward to the robust discussion in November about the Company, and I’m not worried that we’re going to be dead in the water in the meantime.

And I think the teams are still executing against their AIP plans, their LTIP plans. There is a ton of operational focus inside the Company that investors can count on while John’s going through his kind of an over to the top review.

I would like to add that this is a large and complex company. We aim to reestablish and standardize everything we do, including the value of the GE store and how it contributes to our franchise. This is a significant amount of work, along with understanding the portfolio and John developing his own insights on where we will allocate investments and where we will not. I completely understand your point, Deane. I believe this is essential work, and when John presents to investors, we want him to be as informed as possible. Therefore, I think it requires time.

Yes, good morning. Jeff, thanks for all the work over the years. Look forward to working with your successor. Thank you very much. Just a question on power, the outlook for 2018, just sort of talking about lower and thinking about Siemens’ commentary, is it cyclical or is something structural going on in terms of outlook for power?

I believe that if you examine detailed studies like those from IEA or EPE, they indicate that there will be slow but consistent growth in natural gas over the next 20 years, especially regarding capacity additions. You can relate this to your expectations for increased solar energy and decreased nuclear energy. There are various factors to consider over the next five, ten, or twenty years. However, it's evident that with the ongoing situation regarding the cost of natural gas, gas turbines and gas power generation will remain essential in the industry's future. While it's uncertain if the short-term capacity will reach 50 gigawatts instead of 40, the market dynamics are complex, especially with places like Saudi Arabia needing capacity after a slowdown. Additionally, China's environmental policies will play a significant role. There are several key markets that could drive growth. That said, it may not be wise for Jeff, John, or Russell to be overly optimistic about the immediate dynamics of the industry. Nevertheless, I envision the industry stabilizing around the 40-gigawatt mark. The outages discussed by Jeff will depend on the renewable energy mix, seasonal weather, and the prices of coal and gas among other factors. However, I believe there are reasons to expect that this situation will stabilize over time.

Andrew, I think that when we get up in November, we will share our view of where we think the power business is going for 2018 and to some degree beyond that. We think the power market this year for gas turbines can be 40 gigawatts, that’s down roughly 10%. It might be down again next year. I think so far the business has been competitively in a good place. We’ve seen a little bit of price, but we are definitely outperforming the competition on both, price, orders, and share. When John is deep in the business and develops the view with Russell on where this is going, we will share that in November.

I believe, Jeff, that this year the power equipment market is projected to be around 10% or so. It's going to be substantial. That doesn’t necessarily indicate disaster, in my opinion.

I just had a question on the contract accounting long-term service agreements. Wondering if there is an update on the accounting change impact next year and also if there is any view to somehow monetizing the LTSAs in a way that’s different from the past?

I don’t have an update for you today on the 606 accounting change. We are working on it diligently. When we have more information regarding its impact on 2016, 2017, and a reassessment of the potential effects in 2018, we will share that with you. Currently, we are reviewing the first quarter actuals and auditing them to ensure we have the proper processes in place to address all the changes. Therefore, there is no change in guidance to provide at this time. I can only say that we are working through the mechanics of the process, which is quite complex, especially concerning long-term service agreements. Regarding monetization, I am particularly interested in exploring options for putting upgrades or other investments into contracts, provided there are capital market solutions to assist customers with this, and we would be pricing for that rather than setting prices ourselves. These structures can be complicated, but we continue to investigate potential implementations. We’ve made some progress, particularly in how we approach upgrades. The variable component, which is based on utilization, presents challenges for us in considering options around that. However, if there are fixed payments included, like for an upgrade, that is something we can explore. Lastly, I want to mention that in the quarter, our gains from CMRs and LTSAs amounted to $500 million, down from $600 million in the second quarter of last year, representing a year-over-year decline of $100 million.

Okay. Thank you. And just a reminder that the replay of today’s call will be available this afternoon on our investor website. And Jeff, to wrap up your last call.

Great, Matt. So, the first time I did this, all we did was fax a press release, and that’s been replaced 64 subsequent times by this incredible work. So, it shows you I’ve been doing this a long time or how much times have changed. I would like to publicly thank the GE finance team led by Jeff. You guys have no idea how much work goes into this. Matt, thanks for your great effort. By JoAnna, especially you, it’s been great to work with you for so many years. And I just want all of our investors to appreciate the incredible work that goes into this. We’ve always tried to be respectful, transparent and honest in this process. I’m looking across the table at Jeff Bornstein; he’s got a six-inch binder. He knows every fact and everything to do with the Company. I feel great about John Flannery and what he is going to do with the Company going forward. So, again, I’m sure I’ll see many of the investors over time. But I want to use this as an opportunity to do a shout-out for the GE team and the great work they do. Thank you. Great.