GE Aerospace Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 25, 2021

There are 13 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to the General Electric Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen only mode. My name is John, and I'll be your conference coordinator today. Please press star followed by 0 and the conference coordinator will be happy to assist you. If you experience issues with the slides refreshing or there appears to be delays As a reminder, this conference call is being recorded.

Operator

And I would now like to turn the program over to your host for today's conference, Steve Winoker, Vice President of Investor Relations. Please proceed.

Speaker 1

Thanks, John. Welcome to GE's Q3 2021 earnings call. I'm joined by Chairman and CEO, Larry Culp and CFO, Carolina Diebeck Hoppe. 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 may change as the world changes.

Speaker 1

With that,

Speaker 2

I'll hand the call over to Larry.

Speaker 3

Steve, thanks, and good morning, everyone. Our team delivered another strong quarter as orders margins and cash improved. While the aviation market is showing continued signs of recovery and contributed to the quarter, our focus on continuous improvement in lean is driving broader operational and financial progress. At the same time, we're managing through significant challenges that we'll discuss further today. Starting with the numbers on Slide 2.

Speaker 3

Orders were robust, up 42% with growth in all segments in both Services and Equipment, reflecting continued demand for our technology and solutions and better commercial execution. Industrial revenue was mixed. We saw continued strength in services, up 7% organically. Aviation improved significantly, benefiting from the market recovery. Equipment was down 9% organically, largely due to supply chain disruptions, the Ford Ventilator comparison in healthcare and as expected lower power equipment.

Speaker 3

Adjusted industrial margin expanded 2 70 basis points organically, largely driven by operational improvement in many of our businesses, growth in higher margin services at Aviation and Power and net restructuring benefits. Adjusted EPS was up significantly driven by Industrial. Industrial free cash flow was up $1,800,000,000 ex discontinued factoring programs due to better earnings, working capital and the short term favorable timing impact of aircraft delivery delays. Overall, I'm encouraged by our performance, especially at Aviation. Let me share what gives me gives us confidence there.

Speaker 3

First, our results reflect a significant improvement in near term market fundamentals. Departure trends are better than the August dip and have recovered to down 23% of 2019 levels. We expect this acceleration in traffic to continue as travel restrictions lift and vaccination rates increase. Our results also reflect operating improvements. For example, at Aviation's overhaul shops, our teams have used lean to increase turnaround time by nearly 10% and decreased shop inventory levels by 15% since the Q4 of 2020.

Speaker 3

These improvements are enabling us to get engines back to customers faster and at a lower cost. No business is better positioned than GE Aviation to support our customers through the coming up cycle. We're ready with the industry's largest and youngest fleet, While we continue to invest for the next generation with lower carbon technologies such as the CFM RISE program, This platform will generate value for decades to come. We're also clearly navigating headwinds as we close this year and look to 2022. We're feeling the impact of supply chain disruptions in many of our businesses with the largest impact to date in Healthcare.

Speaker 3

Based on broader industry trends, we expect company wide pressure to continue at least into the first half of next year. Our teams are working diligently to increase supply by dual sources, qualifying alternative parts redesigning and requalifying product configurations and expanding factory capacity. We're also focused on margins as we deploy lean to decrease inventory and costs as well as implement appropriate pricing actions and to reduce select discounts. Our Our CT team in Japan, for example, has been experiencing higher customer demand, so we're making our production even more efficient to help offset the challenge of delayed inputs. The team used value stream mapping, standard work and quarterly kaizens to reduce production lead time While this is a single example within Healthcare, taken together with other efforts and over time, these add up.

Speaker 3

At Renewables, we're encouraged by the U. S. Administration's commitment to offshore wind development. However, in onshore wind, The pending U. S.

Speaker 3

Production tax credit extension is creating uncertainty for customers and closing much less U. S. Market activity in preparation for 2022. As we've shared a blanket extension, while a well intended policy as the unintended consequence of pushing out investment decisions. In our business, given the lag between orders and revenue, The impact will continue through the Q4 and into 2022.

Speaker 3

This environment along with inflation headwinds picking up next year makes Renewables' ongoing work to improve cost productivity even more urgent. Given these puts and takes, we now expect revenue to be about flat for the year, driven by changes to some of our business outlooks, which Carolina will cover in a moment. Importantly, even with lower revenue, we're raising our margin and EPS expectations, underscoring improved profitability and services growth and reflecting our strengthened operations. And we're narrowing our free cash flow range around the existing midpoint. Looking further out to next year, as our businesses continue to strengthen, we expect revenue growth, margin expansion and higher free cash flow despite the pressures that we're managing through currently.

Speaker 3

We'll provide more detail as usual during our Q4 earnings and outlook calls. Moving on to slide 3. Challenges aside, our performance reflects the continued progress in our journey to become a more focused, simpler, stronger, high-tech industrial. The GECAS and AerCap combination is a tremendous catalyst, enabling us to focus on our industrial core and accelerate our deleveraging plan. Just last week, GE and AerCap satisfied All regulatory clearances for the GECAS transaction and we're now targeting to close November 1.

Speaker 3

We'll use the proceeds to further reduce debt, which we now expect to reach approximately $75,000,000,000 since the end of 2018. This is enabling GE to look longer term even as we execute our deleveraging. As we accelerate our transformation, Lean and decentralization are key to improving operational results. This quarter, we hosted our Global Kaizen Week in each of our businesses with over 1600 employees participating. John Slattery, the CEO of GE Aviation and I joined our military team in Lynn, for the full week, while our business CEOs join their teams across the globe.

Speaker 3

Lean is fundamentally about going to Gemba, where the real work is done and is best learned in operations where you can see it, touch it, smell it firsthand. And in Lynn, we were there to serve those closest to the work, our operators. Our mission was to improve first time yield on midframes, A key sub assembly of the military engines we produce in Lynn, whose stubborn variability has been directly and negatively impacting our on time delivery. By the end of the week, we had improved processes for welding and quality checks on midframe parts. Improvements that we're convinced will help us reach our goals for military on time delivery by the middle of next year, if not earlier.

Speaker 3

And we can improve our performance on the back of these changes for years to come. There are countless other examples of how our teams are leveraging lean to drive sustainable, Impactful improvements in safety, quality, delivery, cost and cash. They reflect how we're running GE better and how we're sustaining these efforts to drive operational progress and lasting cultural change. Our significant progress on deleveraging and operational execution sets us up well to play offense in the future. Our first priority, of course, is organic growth.

Speaker 3

This starts with improving our team's abilities to market, Sell and service the products we have. There are many recent wins across GE this quarter, but to highlight 1, Our Gas Power team delivered, installed and commissioned 4 TM2500 aeroderivative gas turbines in only 42 days to complement renewable power generation for California's Department of Water Resources during peak demand season. These turbines Using jet engine technology adapted for industrial and utility power generation, start and ramp in just minutes, providing rapid and reliable intermittent power, helping enhance the flexibility and sustainability of California's grid. And we're bolstering our offerings with innovative new technology that serves our customers and leads our industries forward. For example, at Renewables, Our Hollyotte X offshore wind turbine prototype operating in the Netherlands set an industry record by operating at 14 megawatts, more output than has ever been produced by any wind turbine.

Speaker 3

From time to time, we'll augment our organic efforts with inorganic investments. Our recently announced acquisition of BK Medical represents a step forward as we advance our mission of precision healthcare, Bringing BK's intraoperative ultrasound technology together with the pre and postoperative capabilities in our ultrasound business creates a compelling customer offering across The full continuum of care from diagnostics through surgical and therapeutic interventions as well as patient monitoring. Not only does BK expand our high performing $3,000,000,000 ultrasound business, but it also is growing rapidly with attractive margins itself. We expect the transaction to close in 2022 and I'm looking forward to welcoming the BK team to GE. All told, we hope that you see that GE is operating from a position of strength today.

Speaker 3

We delivered another strong quarter and we're playing more offense, which will only accelerate over time. We're excited about the opportunities ahead to drive long term growth and value. So with that, I'll turn it over to Carolina, who will provide further insights on the quarter.

Speaker 4

Thanks, Larry. Our results reflect our team's commitment driving operational improvement. We're leveraging lean across GE and our finance function. In addition to TridentWeek that Larry mentioned, Over 1800 finance team members completed a full waste work week, applying lean and digital tools to reduce non value added work by 26,000 hours and counting. For example, at Renewables, our team streamlined and automated so we can focus more on driving higher quality, faster operational insights and improvements, helping our operating teams run the businesses more efficiently.

Speaker 4

Looking at Slide 4, I'll cover on an organic basis. Orders were robust, up 42% year over year and up 21% sequentially on a reported basis, building on revenue momentum heading into 'twenty two. Equipment and services in all businesses were up year over year with strength in aviation, renewables and healthcare. We are more selective in the commercial deals we pursue with a greater focus on pricing in an inflation environment, economic terms and cash. Together with targeting more profitable segments like services, we're enhancing order quality to drive profitable growth.

Speaker 4

Revenue was up sequentially with growth in services driven by Aviation and Power, but down year over year. Equipment revenue was down with the largest impact in Healthcare and Power. Overall, mix continues to shift towards higher margin services, now representing half of the revenue. Adjusted industrial margins improved sequentially, largely driven by Aviation Services. Year over year, total margins expanded 2 70 basis points, driven by our lean efforts, cost productivity and services growth.

Speaker 4

Both Aviation and Power delivered margin expansion, which offset the challenges in Healthcare and Renewables. Consistent with the broader market, we are experiencing inflation pressure, which we expect to be limited for the balance of 2021. Next year, we anticipate a more challenging inflation environment. The most adverse impact is expected in onshore wind due to the rising cost of transportation and commodities, such as steel and resin, impacting the entire industry. We are taking action to mitigate inflation in each of our businesses.

Speaker 4

Our shorter cycle businesses felt the impact earliest, while our longer cycle businesses were more protected given extended purchasing and production cycles. Our service business is full in between. Our teams are working hard across functions to drive cost countermeasures and improve how we bid on businesses, including price escalation. Finally, adjusted EPS was up 50% year over year, driven by industrial. Overall, we're pleased with the robust demand evidenced by orders growth and our year to date margin performance.

Speaker 4

While we're navigating headwinds caused by supply chain and This has impacted our growth expectations. We're now expecting revenue to be about flat for the year. However, Due to our continued improvement across GE, we are raising our 'twenty one outlook for organic margin expansion to 3.50 basis points or more and our adjusted EPS to a range of $1.80 to $2.10 Moving to cash. A major focus of our transformation has been strengthening our cash flow generation through better working capital management and improved linearity, ultimately to drive more consistent and sustainable cash flow. Our quarterly results show the benefits of these efforts.

Speaker 4

Industrial free cash flow was up $1,800,000,000 ex discontinued factoring programs in both years. Aviation, Power and Healthcare all had robust free cash flow conversion in the quarter. Cash earnings, working capital And allowance and discount payments, or AD and A, driven by the deferred aircraft delivery payments, contributed to this significant increase. Looking at working capital, I'll focus on receivables. We saw the largest operational improvement.

Speaker 4

Receivables were a source of cash, up Overall, strengthening our operational muscles in billings and collections is translating into DSO improvement as evidenced by our total DSO, which is down 13 days year over year. Also positively impacting our free cash flow by about $500,000,000 in the quarter was AD and A. Given the year to date impact and our 4th quarter estimate aligned with the current Airframe aircraft delivery schedules, We now expect positive flow in 2021, about $300,000,000 which is $700,000,000 better than our prior outlook. This year's benefit will reverse in 2022 and together with higher aircraft delivery schedule expectations will drive an outflow of approximately 1,200,000,000 next year. To be clear, this is a timing issue.

Speaker 4

You'll recall that we decided to exit the majority of our factoring programs earlier this year. In the quarter, discontinued factoring impact was just under $400,000,000 which was adjusted out of free cash flow. The 4th quarter impact should be under $500,000,000 bringing our full year factoring adjustment to approximately $3,500,000,000 Without the factoring dynamics, Better operational management of receivables has become a true cross functional effort. Let me share an example. Powertrain Powertrain recently shifted to this from a more siloed approach.

Speaker 4

Leveraging problem solving and value stream mapping, they have reduced operations drive better and sustainable free cash flow. Year to date, ex discontinuing factoring across all quarters, Free cash flow increased $4,800,000,000 year over year. In each of our businesses, our terms are driving working capital improvement, which together with higher earnings make a real and measurable impact. Taking the strong year to date performance, coupled with the headwinds we've described, We're narrowing our full year free cash flow range to $3,750,000,000 to 4,750,000,000 Turning to Slide 6. We expect to close the GECAS transaction on November 1.

Speaker 4

This strategic transaction not only deepens our focus on our industrial core, but also enables us to accelerate our debt reduction with approximately $30,000,000,000 in consideration. Given our deleveraging progress and cash flow improvement to date, plus our expected actions and better pension performance, We now expect a total reduction of approximately $75,000,000,000 since the end of 2018. GE will receive a 46% equity stake in 1 of the world's leading aviation lessors, which we will monetize as the aviation industry continues to recover. As we've shared, we expect near term leverage to remain elevated, and we remain committed to further debt reduction and our leverage target over the next few years. On liquidity, we ended the quarter with $25,000,000,000 of cash.

Speaker 4

We continue to see significant improvement in lowering Tisch cash needs, Currently at $11,000,000,000 down from $13,000,000,000 In the quarter, peak needs decreased due to reduced factoring and better working capital management. This is an important proof point that we are able to operate with lower and more predictable cash needs, creating opportunities for high return investments. Moving to the businesses, which I'll also speak to on an organic basis. First, on Aviation. Our improved results reflect a significantly stronger market.

Speaker 4

Departure trends recovered from August. It's early, But the pickup that began in September is continuing through October. Better departures and customer confidence contributed to higher shop visits and spare parts sales that we had initially anticipated. The impact of green time utilization has also lessened. We expect these positive We continue into the Q4.

Speaker 4

Orders were up double digits. Both commercial engines and services were up substantially again year over year. Military orders were also up, reflecting a large Hindustan Aeronautics order for nearly 100 F404 engines along with multiple T700 orders. For revenue, commercial services was up significantly with strength in external spares. Shop visit volume was up over 40% year over year and double digits sequentially with overall scope slightly improved.

Speaker 4

We continue to see higher concentration of narrow body and regional aircraft shop visits. Commercial engines was down double digits with lower shipments. Our mix continues to shift from legacy to more NPI units, specifically LEAP and lower production rates on GE and X. We're also navigating through material fulfillment constraints amplified by increased industry demand, which impacted deliveries. Military was down marginally.

Speaker 4

Unit shipments were flat sequentially, but up year over year. Without the delivery challenges, military revenue growth would have been high single digits this quarter. Given this continued impact, military growth is now expected to be negative for the year. Segment margin expanded significantly, primarily driven by commercial services and operational cost reduction. In the Q4, we expect margins to continue to expand sequentially, achieving our low double digit margin guide for the year.

Speaker 4

We now expect 21 shop visits to be up at least mid single digit year over year versus about flat. Our solid performance, especially in services, underscores our strong underlying business fundamentals as the commercial market recovers. Moving to Healthcare. Market momentum is driving very high demand while we navigate supply chain constraints. Government and private health systems are investing in capital equipment to support capacity demand and to improve quality of care across the markets.

Speaker 4

Building on a 20 year partnership, we recently signed a 5 year renewal to service diagnostic imaging and biomedical equipment with HCA Healthcare, one of the nation's leading providers of health care. Broadly, we're adapting to overarching market needs of health system efficiency, digitization as well as resiliency and sustainability. Against that backdrop, orders were up Double digits both year and versus 2019 with strength in health care systems, up 20% year over year and PDX up high single digit. However, revenue was down with a high single digit decline at HCS, more than offsetting the high single digit growth we saw at PDX. You'll recall that last year, the Ford Ventilator partnership was about $300,000,000 of Life Care Solutions revenue.

Speaker 4

This comp negatively impacted revenue by 6 points. And thinking about the industry wide supply shortages, we estimate that growth would have been approximately 9 points higher if we were able to fill our orders. And these challenges will continue into at least the first half of twenty twenty two. Segment margin declined year over year, partially driven by higher inflation and lower Life Care Solutions revenue. This was partially offset by productivity and higher PDX volume.

Speaker 4

Even with the supply chain challenges, we now expect to deliver close to 100 basis points of margin expansion as we proactively manage sourcing and logistics. Overall, we're well positioned to keep investing in future growth, underscoring our confidence in profit and cash flow generation. We're putting capital to work differently than in the past, supplementing organic growth with inorganic investments that are a good strategic fit. These are focused on accelerating our Precision Health mission, like DK Medical, and we're strengthening our operational and strategic integration muscles. At Renewables, we're excited by our long term growth potential, supported by new technologies like Halyard X and Cypress and our leadership in energy transition despite the current industry headwinds.

Speaker 4

Looking at the market, Since the Q2, the pending PTC extension has caused further deterioration in the U. S. Onshore market outlook. Based on the latest Woodmark forecast for equipment and repower, the market is now expected to decline from 14 gigawatts of wind installments this year to approximately 10 gigawatts in 2022. This pressures orders and cash in 2021.

Speaker 4

In offshore wind, global momentum continues, and we're aiming to expand our commitment pipeline through the decade. And modernizing the grid is a key enabler of the energy transition. And we saw record orders driven by offshore, where the project driven profile will remain uneven. This leads to continued variability for progress collections. Onshore orders grew modestly, driven by services and international equipment, partially offset by lower U.

Speaker 4

S. Equipment due to the PTC dynamics. Revenue declined significantly. Services was the main driver, largely due to fewer onshore repower deliveries. Ex repower, onshore services was up double digits.

Speaker 4

Equipment was down to a lesser extent, driven by declines in the U. S. Onshore and grid. This was partially offset by continued growth in international onshore and offshore. For the year, we now expect revenue growth to be roughly flat.

Speaker 4

Segment margin declined 250 basis points. Onshore was slightly positive, but down year over year. Cost reductions were more than offset by lower U. S. Repower volume, mixed headwinds as new products ramp and come down the cost curve as well as supply chain pressure.

Speaker 4

Offshore margins remain negative as we work through legacy projects and continue to ramp Haliadex production. At grid, better execution was more than offset by lower volume. Due mainly to the PTC impact, we now expect Renewables free cash flow to be down and negative this year. Looking forward, while we are facing headwinds, we're intently focused on improving our operational performance, profitability and cash generation. Moving to power, we're performing well.

Speaker 4

Looking at the market, global gas generation was down high single digits due to price driven gas to coal switching. Yes, you heard me right, gas to coal switching. However, GE gas turbine utilization continues to be resilient as megawatt hours grew low single digits. Despite recent price volatility, Gas continues to be a reliable and economic source of power generation. Over time, as more base load coal comes offline And with the challenges of intermediate renewables power, customers continue to need gas.

Speaker 4

Through the next decade, We expect the gas market to remain stable with gas generation growing low single digits. Orders were driven by Gas Power Services, Aero and Stone, It's up double digits. Gas equipment was down despite booking 6 more heavy duty gas turbines as timing for HAs remain uneven across quarters. We continue to stay selective with disciplined underwriting to grow our installed base. And this quarter, we booked orders for smaller frame units.

Speaker 4

Demand for aero derivative power continues. For the year, we expect about 60 unit orders, up more than 5x year over year. Revenue was down slightly. Equipment was down due to reduced turnkey scope at Gas Power and the continued exit of newbuild coal Consistent with our strategy, we are on track to achieve about 30% turnkey revenue as a percentage of heavy duty equipment revenue this year, down from 55% in 2019, a better risk return equation. At the same time, Gas Power shipped 11 more units year over year.

Speaker 4

Gas Power Services was up high single digits, trending better than our initial outlook Due to strong CSL volume, we now expect gas power services to grow high single digits this year. Stream services was also up. Margins expanded year over year, yet were down sequentially due to outage seasonality. Gas power was positive and improved year over year, driven by services growth and aero shipment. We remain confident in our high single digit margin outlook for the year.

Speaker 4

STIM is progressing through the newbuild coal exit. And by year end, we expect our equipment backlog to be less than $1,000,000,000 compared to $3,000,000,000 a year ago. Power conversion was positive and expanded in the quarter. Overall, we're encouraged by our steady performance. Power is on track to meet its outlook, including high single digit margins in 23 plus.

Speaker 4

Our team is focused on winning the right orders, growing services and increasing free cash flow generation. Moving to Slide 8. As a reminder, following the GECAS close in the 4th quarter, we will transition to 1 column reporting and roll in the remainder of GECAS Capital into corporate. Going forward, our results, including adjusted revenue, profit and free cash flow, will exclude insurance. To be clear, We continue to provide the same level of insurance disclosures.

Speaker 4

In all, this simplifies the presentation of our results as we focus on our industrial core. At Capital, the loss in continuing operations was up year over year, driven primarily by a non repeat of tax benefit partially offset by the discontinuation of the preferred dividend payment. At Insurance, we generated 360,000,000 Net income year to date driven by positive investment results and claims still favorable to pre COVID levels. However, this This resulted in a positive margin with no impact to earnings for a 2nd consecutive year. The margin increase was largely driven by higher discount rates, reflecting our investment portfolio realignment strategy with a higher allocation towards select growth assets.

Speaker 4

Claims cost curves continue to hold. In addition, the teams are preparing to implement the new FASB accounting standard consistent with the industry, and we're working on modeling updates. Based on our year to date performance, Capita still expects a loss of approximately $500,000,000 for the year. In discontinued operations, Capital reported a gain of about $600,000,000 primarily due to the recent increase in AerCap stock price, which is updated quarterly. Moving to corporate.

Speaker 4

Our priorities are to reduce functional and operational costs as we drive leaner processes and embrace decentralization. The results are flowing through with costs down double digits year over year. We are now expecting corporate costs to be about $1,000,000,000 for the year. This is better than our prior $1,200,000,000 to $1,300,000,000 guidance. As you can see, lean and decentralization aren't just concepts.

Speaker 4

They are driving better execution and culture change. They are supporting another strong quarter, and they are enabling our businesses to play more often, and ultimately, they're driving sustainable long term Now Larry, back to you.

Speaker 3

Carolina, thank you. Let's turn to Slide 9. Our teams continue to deliver strong performance. We're especially encouraged by our earnings improvement, which us confident in our ability to deliver our outlook for the year. You've seen today that our transformation to a more focused, simpler, stronger Hi Tec Industrial is accelerating.

Speaker 3

We're on the verge of closing the GECAS AerCap merger, a tremendous milestone for GE. Stepping back, our progress has positioned us to play offense. We just wrapped up our annual strategic reviews with nearly 30 of our business units. These complement our quarterly operating reviews, but have a longer term focus as we answer 2 fundamental questions: What game are we playing and how do we win? These reviews were exceptionally strong this year across the board with the most strategic and cross functional thinking we've seen in my 3 years, enabling us to drive long term growth and value across GE, while delivering on our mission of building a world that works.

Speaker 3

We're positioned to truly shape the future of flight With new technology for sustainability and efficiency, such as the recent catalyst engine launch, the first clean sheet turboprop including our new cloud based Edison TruePaks to help radiologists adapt to higher workloads and increased exam complexity with improved diagnostic accuracy. Through our leadership in the energy transition, we're helping the world tackle the trilemma of sustainability, affordability and reliability From launching new tech platforms at renewables such as the Haliade X in Cyprus to our recently announced flexible transformer project with the Department of Energy to growth in the world's most efficient gas turbines. To be clear, we still have work to do. And as we do it, we're operating increasingly from a position of strength, serving our customers in vital global markets with a focus on profitable growth and cash generation. Our free cash flow will continue to grow towards a high single digits percentage of sales level and we have an opportunity to allocate more resources on capital deployment to support GE's growth over time.

Speaker 3

Steve, with that, let's go to questions.

Speaker 1

Thanks, Larry. Before we open the line, I'd ask everyone in the queue to consider your fellow analysts again and ask one question so we

Operator

And our first question is from Julian Mitchell from Barclays.

Speaker 5

Good morning, everyone. Maybe my question would just be around free cash flow. So you'd mentioned that free cash flow would be up in 2022. I just wanted to make sure, is that sort of comparable with that $375,000,000,000 to $475,000,000,000 guide for this year? Or is that sort of apples to apples once you roll in what's left of capital into the cash flow for this year?

Speaker 5

And a related question is, you talked on Slide 9 about the high single digit cash flow margin over time. Just wanted to make sure there's no that does not mark a shift from the sort of 2023 plus timeframe you'd mentioned before. Thank you.

Speaker 4

So Julien, maybe let me start then. You talked about the 2022 remarks that we made. Like for like, we expect industrial free cash flow to step up. We expect our business earnings to improve. We expect that through top line growth And margin expansion that will turn into profit, which we then believe well, which we then will see go to cash, right?

Speaker 4

Then if you look a little bit outside of We do have a couple of significant cash flow items to think about. We have mentioned the supply chain headwinds that we think will continue into next year. So that will hamper both on the profitability, but also on inventory. And then we have the headwind of AD and A. We talked about that in this year.

Speaker 4

It's going to be a More positive, but it's going to be a big headwind in next year. And this is really only a timing effect because of when customers expect to deliver the aircrafts, right? And overall, my last comment on industrial side would be, if you look at working capital, with that growth in mind, we will need some working capital to fund the top line growth, Right. But on the other hand, we also expect to continue to improve working capital management, for example, in receivables and to some extent also to inventory. Within that, we do see improvement in linearity if it's possible as well.

Speaker 4

So that's like for like on the industrial side. If we then add the consolidated capital or basically what's left of capital than consolidated in, like for like, we expect it to also increase. And the increase on top of that would mainly be driven by the lower interest that we will see from debt reduction. So we are confident in an overall growing trajectory,

Speaker 3

And I would say just to the second question, the simple short answer is No change whatsoever relative to our expectations with respect to high single digit free cash flow margins, Right. When we talk about that, let's just take for simplicity say 8% On a revenue base akin to where we were in 2019, right, that pencils out on a $85,000,000,000 to $90,000,000,000 revenue base to say 7,000,000,000 of free cash. That's really going to be an earnings, lower restructuring spend And better working capital management story, clearly from a profit perspective that's going to be an aviation led dynamic, healthcare right in behind it and then we still anticipate that we turn power profitable And we get a couple of $1,000,000,000 of profit from power. You deduct, call it, dollars 1,000,000,000 for corporate, But you get close to it, let's call it, dollars 10,000,000,000 of op profit, convert that net of interest and taxes in 90%, you get to that same $7,000,000,000 figure. So we think we're on our way, but again, the short answer is no change.

Operator

And our next question is from Nigel Coe from Wolfe Research.

Speaker 6

Good morning, everyone.

Speaker 3

Good morning, Nigel. Good morning, Nigel.

Speaker 6

Great. Thanks for the detail on the ADA next year, the 1.2. I just want to confirm that I seem to expect some help from progress collections in aviation next year, assuming we're in a recovering order But the real question is on the insurance testing in 3Q. And I know this is a I think the 10 Q call out is an 11% surplus. So I'm just curious, Carolina, what does that mean for Future cash payments going forward, at what point does the service become so large that that could have some good news for cash in going forward?

Speaker 4

Thanks for the question, Nigel. Yes, so it is a fact that we did do the testing on the alertness, and we had Good news, I would say, as expected. And when you have a positive margin, that means no charge to the P and L. And the margin was 11% Positive, which is significantly higher than what we have seen. It was mainly driven by the discount rate increase, an increase from 5.7% to 6.15%.

Speaker 4

I would say that increase was really driven by asset allocation and really helped us to increase the amount allocated to growth assets, where we're going from 9 to 15. The other variables had like morbidity, mortality, inflation, they were small impact. So we're really happy with that. And your question then on top of that sort of for the synergies. So the cyclies or the cash flow testing, that is what decides If there is a need to add cash to the insurance.

Speaker 4

I would say like this, it's not one to 1. The variables are similar to our alternatives, but they are used under moderately adverse conditions. I would say the modeling will happen beginning Next year, as usual, we will look at our investment portfolio realignment and the changes that led into that model. We also look at the future cash flow, but it could have some adverse effects because we're using more granular assumptions. But I would say, overall, the good news from the allergens goes very well for the CFTs, but it's not one to 1.

Operator

And our next question is from Jeff Greg from Vertical Research Partners.

Speaker 7

Thank you. Good morning, everyone.

Speaker 1

Good morning, Jeff. Hi, Jeff. Hello.

Speaker 7

Hope everybody is well. Larry or Carolina, can we talk a little bit more about price cost? I think your message on the pressures into the first half are pretty clear. Kind of this kind of question of kind of cost in the backlog, so to speak, that needs to work its way through the system. I wonder if you could just kind of size this a little bit for us or put it in the context of what you're actually capturing Price, say, on current orders, maybe what kind of the price cost Total headwind or tailwind is in 2021 versus what you're kind of expecting in 2022 based on what you can see in the backlog?

Speaker 4

So, Jeff, why don't I start and then Larry, you can jump in. Sure. If we start with inflation, I just want to reiterate that, Of course, we're hit by inflation, but it's a bit different depending business by business. We have the shorter cycle businesses like Healthcare, where we are feeling the impact faster Then the longer cycle like power and we have sort of services in between. On the longer cycle ones, they are more protected because of the, I would say the extended purchasing and production cycles.

Speaker 4

We are seeing the main pressures on commodities like steel, but also logistics pressures increasing, right? Specific to 2021, we have felt inflation, but so far we've been able to offset it and we expect the impact for the full year limited in 2021, the net impact. For 2022, we do expect to see significant pressure, and I would say it's top of our list Priorities for next year. And we're taking both price and cost countermeasures.

Speaker 3

Yes. Jeff, I think that's right. And as you would imagine in an environment like this, we're not only working The value add, value engineering, the more traditional cost actions aggressively, we're working with the supply base as feverishly as we can both on availability and on cost. That said, as Carolina was alluding to, on the price side, we're doing all we can in the shorter cycle businesses. It's a little easier, say in healthcare where we've got more like for like.

Speaker 3

We can see those price actions. We're beginning to see some early traction there. Services is a bit mixed, but where we have opportunity say on spares And within the escalation frameworks within some of the longer term service agreements, we're obviously going to Get what we can there. You spoke to projects. I mean that's a little bit more bespoke, but it while it's difficult to measure price like for like, We are managing the margins with some of the longer term procurement efforts that Carolina alluded to.

Speaker 3

Just more broadly on the backlog, It was important to remember when you look at what is $380,000,000,000 of backlog, 70% of that's in Aviation, virtually all of that is in Services. So certainly a competitive space, But between the catalog pricing dynamics and some of the escalation protection, we think we're well positioned, but we take nothing for granted there. Outside of Aviation, the backlog is also in services where similar dynamics apply. But again, Limited pressure net net in 2021, building headwinds for us next year. We've got time to work both the cost and the price countermeasures.

Speaker 3

And as Carolina said, I don't think we've got a higher priority operationally here in the short term than those 2.

Operator

And our next question is from Deane Dray from RBC Capital Markets.

Speaker 1

Thank you. Good morning, everyone.

Speaker 3

Hey, Dean. Hi, Dean.

Speaker 1

Hey, I'd like to get some more comments, if we could, on the aviation aftermarket visibility, that 40% up Year over year and shop visits, similar to what your competitors have announced. Just talk about Visibility, the ramp on departures and your capacity, I know there had been some cuts. Do you have the capacity to handle all this? I know lean is helping. And then a related question, what kind of R and D investments are you making today Or you're planning for to help the airlines hit their carbon neutral goals by 2,050?

Speaker 3

Dan, I would say with respect to the aftermarket, I think you highlighted some of the keys for us, right? Very pleased with the shop visit activity being up 40% in the 3rd quarter, better than we had anticipated. Think we were calling for up 25%. We will see sequential improvement. It's not going to be as pronounced year to year here in the 4th Probably, it's going to be up call it 30.

Speaker 3

In October thus far, we're off to a good start in terms of underlying activity. All of that's been coupled with, I would say, robust spare part demand from 3rd party providers. So right, it's that coupling of, if you will, volume and value that are going to Set us up for a pretty good second half here and going into next year. We're working through supply chain Challenges here be it material, be it labor as we are everywhere else, I think we're positioned here at least as best we can see. Glad you highlighted the lean improvements, right?

Speaker 3

Rather than just throwing a lot of bodies and a lot of capital into the breach, we really are trying to work the Process, Russell Stokes and the team in services understand that very well, which is why we highlighted some of the turnaround improvements that we did in our formal remarks. You go back to, I guess, what was technically the Q2, but there middle of June, John Slattery in concert with our partners at Safran announced the CFM RISE program, which really is a multi generational Technology investment program to make sure we're on a path, be it with sustainable aviation fuels, be it hybrids, be it hydrogen to be in a position to maintain the industry leadership this business has enjoyed for decades. So there's a lot to come. We're going to be spending, And we're going to be spending smartly in and around those areas to launch technologies that ultimately transition into product programs as our airframer and airline customers deem appropriate. So a lot going on short term and long term, but again we really like where Aviation Particularly with the departure trends and the outlook here in the near term.

Operator

Our next question is from Steve Tusa from JPMorgan.

Speaker 2

Hi, guys. Good morning.

Speaker 4

Good morning, Steve. Good morning, Sam.

Speaker 2

You mentioned the sequential kind of margin increase in Aviation. I think the These were a little bit weaker this quarter. For Q4, I think your kind of implied guidance, I know it's kind of a wide range and you guys haven't really updated in a while, Gets me to kind of a midpoint of $1,000,000,000 for 4Q. You just had a nice sequential increase from 2Q to 3Q. Is that Kind of the right number.

Speaker 2

And then as a follow-up to that, for next year with the $1,500,000,000 headwind as AD and A normalizes, What mechanically like what's the math that can overcome that kind of headwind for aviation to grow free cash?

Speaker 4

Okay. So if we start with And the margin and you talked about the margin going into the 4th quarter, right? So what we are seeing and I think an important add on the Q3 is that we see a shift clearly towards services, right? So in the Q3, we had 20% growth of services while equipment was down. So this better mix also tilted toward external really is what makes you see the drop through, right?

Speaker 4

And Larry talked about higher shop visits, so 40% up year over year. We also saw the strong 3rd party sales up around 30. For the 4th quarter, we have the seasonality, as you know, but we also don't expect it to be as high for the 4th quarter. So we expect to continue sort of from the Q3 into the Q4 with a sequential improvement. And overall, that's how you get to our low double digit margins for 2021.

Speaker 4

We haven't specifically said exactly what the profit is in the Q4 for Aviation. But with all those pieces, you sort of piece it together. For 2022, you asked about aviation free cash flow. So I would say a couple of things. You're right on the AD and A.

Speaker 4

It is a timing issue. So we'll have a big headwind next year on the AD and A side. But what we do see is we expect turn to flight to continue. So we will expect to see basically utilization being driven, which means more hours slow, which means higher billings on our CSAs. So you know that cash comes before the profit.

Speaker 4

So we do expect to have really good uptick on services and the cash flow. So basically on the C and S side there, yes, SG and A will be a headwind, but on top of that, you also have the profit that we will see from More shop visits. So overall, the mix of that gets us to a positive place. I think it's mainly the services and the sales That is the big positive.

Operator

And our next question is from Joe Ritchie from Goldman Sachs.

Speaker 8

Thank you. Good morning, everyone.

Speaker 1

Hey, Joe.

Speaker 8

Just maybe just sticking with free cash flow for a second and thinking about the 4Q implied guidance. Typically, 4Q is your seasonally strongest quarter. The step up from 4Q to 3Q seems to be a little bit seasonally weaker than what we've seen in prior years. So I'm just curious if any puts and takes that we need to be aware of as we kind of think about the sequential bridge for free cash flow 3Q to 4Q? Thank you.

Speaker 4

Joe, let me answer that. So I think it's important to take a step back. And if we look at jumping off point for 2020 for free cash flow for Full year, the free cash flow, excluding factoring and biopharma, we were at $2,400,000,000 in 2020. If you take our midpoint of our guide now and you add back the factoring, you get to $5,000,000,000 for this year. Just to put in perspective, we're going from last year $2,400,000,000 to midpoint of $5,000,000,000 this year.

Speaker 4

So we're doubling the cash flow for 2021. We are also seeing linearity improvements in 2021, which is part of the reason with the 4th quarter not being as unlinear as it has been before. After the range that we have, there are basically 2 main areas that bring us uncertainty. 1 is on the supply chain challenges And the other one is the PTC pressure that we then expect to impact progress. So what does that exactly mean for the Q4?

Speaker 4

Well, we'll have higher sequential profit and we expect to see free cash from the market improving and some of the usual seasonality, but it will still be down year over year. The supply chain challenges, you'll see through earnings, but also through inventory, right? It's going to be a lot stuck in WIP that isn't going out. And then for the full year, Q4 last year, you remember we had big renewable progress of $1,000,000,000 So we don't expect that to happen this year. And then I also previously talked about the Aviation MAX Settlements and CARES Act as positive one offs in Q4 last year.

Speaker 4

If you take that all together, that's how you get to the Q4 and importantly, how we get to $5,000,000,000 of jumping off points of free cash flow this year, This is really important proof point and step to our high single digit fee margin journey that Larry talked about a little while ago.

Operator

And our next question is from Andrew Obin from Bank of America.

Speaker 9

Yes, good morning.

Speaker 3

Good morning, Andrew.

Speaker 9

Just a question, longer term, long term care seems to be in better shape, power is stabilizing. Once we consolidate balance sheet, that's a lot easier and there is a path for delivering. Back when you spoke about a lot Can you just talk about where we are about thinking about strategic optionality and sort of putting in historical context what you guys said about What you guys said about long term care, renewables, etcetera? I know it's a broad question, but whatever you can share with us. Thank you.

Speaker 3

Sure. Sure, Andrew. Let me take a swing at that. I would say that again, we're really pleased with the progress on both the deleveraging and the operational improvements. We still have to close the transaction, work through the follow on debt reductions, but be in a position to have line of sight now on what will be a cumulative approximately $75,000,000,000 debt reduction over the last 3 years allows us, I think, to look at the balance sheet and begin to think about playing more offense and take advantage of the strategic optionality that we have been looking to build and grow.

Speaker 3

That goes hand in hand with the underlying improvements, some of which I would argue you see in these numbers. Others, Like what I saw on the shop floor in Lynn a few weeks back, you don't see yet, but which I think give us confidence that more improvements in terms of top line, bottom line and Cash are forthcoming. And all that really does is I think allow us to both invest in the business more aggressively organically And inorganically, that's why we were so excited about the BK Medical transaction, admittedly small, but the strategic The value add operationally, our $3,000,000,000 high performing ultrasound business will generate And the high single digit returns we think we will have in time, that's what we should be doing more of in concert with what we're going to do organically. All of that really sets us up, I think, Andrew, to be in a position to really Realize the full potential of these wonderful businesses in the GE portfolio. There are a host of ways That could play out over time.

Speaker 3

But first things first, right? We've got some business here with the Gcash and AerCap merger to work through. We've got these operating challenges to navigate through the Q4 and going into next year. But I really do think we're increasingly operating from a position of strength. I like where we are.

Speaker 3

And in time, we will realize the full value of these businesses.

Operator

And our next question is from Markus Schmidtermeyer from UBS.

Speaker 10

Hi, good morning, everyone.

Speaker 6

Good morning, Martin.

Speaker 10

Good morning. Hi. Maybe a question on power. Could you update us on the steam power restructuring progress and any view on the potential impact here on the fixed cost base for that business? And is there anything sort of like that changes how you view that business given the French government push recently investment push in Nuclear and Renewables, so is that really separate in your business on the steam side between coal and nuclear?

Speaker 10

Thank you very much.

Speaker 4

Hi, Markus. Let me start by talking to the restructuring then. First of all, in stream, which is now part of the Power segment and also run by Scott. We have Valerie and her team working through the restructuring there. I would say they are on track.

Speaker 4

It's a big restructuring. We do expect margins to turn in 2023 and basically have the restructuring to tamper down by them. And then the business is going to be 2 thirds services going forward at a significantly lower overhead cost, is what you were alluding to. So we see good traction, but we're still in the middle of it. So again, it will take time until 2023, But then we'll have a very different business with a high service element and lower overheads.

Speaker 3

Marcus, I think the other part of your question was really with respect To the steam generators for nuclear applications, as you will appreciate, our focus Continues to be on running that business as well as we can for our customers. Recently, we did acknowledge that we are in discussions with EDF regarding a potential transaction. If there's an opportunity to create value, we'll certainly pursue it. But if you step back for a moment, I think we are of the view that nuclear overall has an important role to play in the energy transition. We know the French Government is strongly of that view.

Speaker 3

They aren't alone. I was in the U. K. Last week where we had similar conversations, Particularly in and around advanced nuclear technology, particularly in the case of the small modular reactors, which We know can provide carbon free, dependable baseload and flexible capacity as we move forward here. So we've got a lot of capabilities In and around nuclear, really the whole nuclear life cycle.

Speaker 3

So we don't talk a lot about it, but it is part of the power framework for the energy transition and one we'll continue to manage as best we can going forward.

Operator

And our next question is from Joe O'Dea from Wells Fargo. Good morning, everyone.

Speaker 9

Good morning, Joe.

Speaker 4

Good morning, Joe.

Speaker 3

Good morning, Joe.

Operator

Hi. I wanted to ask on PTC and how you're planning for that and what's your Base case assumptions are what you're thinking about in terms of important dates on the timeline. You talked about the step down in installs expected next year. How temporary that is or what you're seeing, how much kind of persistent pressure it can put on the install market?

Speaker 3

Joe, let me take that. I think with respect to the U. S. Market for onshore wind, We do see a step down here going into 2022, probably stepping down from say 14 to 10 gigawatts. It's not yet set in stone because these conversations are active and underway In Washington, given all the legislation under review that run up to COP26 and the like, I think what we are incorporating in our commentary here today is a more pessimistic perhaps, but updated view relative to the very near term.

Speaker 3

So in the absence of Those incentives in the short term, we're going to feel pressure both on new unit orders and in repowering. So some of that impacts cash, some of that impacts margins relative to repowering installations this year. The good news is This is all part of a long term extension given the administration's commitment to the energy transition to the role of both onshore and relatedly offshore wind in that transition. So if you take the decade long view, The impetus or the imperative for us is really to manage these businesses better, to generate better margins, operating margins. But in the short term, we've got some additional pressures just given the reduction in demand that will follow the uncertainty around the tax incentives.

Speaker 3

And they hit us hard because the North American market, the U. S. Market is clearly the best onshore wind market for us on a global basis.

Operator

And our next question is from Nicole DeBlase from Deutsche Bank.

Speaker 11

Yes, thanks. Good morning.

Speaker 4

Good

Speaker 11

I was hoping to dig into the supply chain challenges a little bit here. And I know It's kind of become a little bit spread across a lot of your businesses. You mentioned that it's becoming challenging in aviation as well. But Larry, are you seeing any signs of abatement there? We've heard a few companies Talk about the view that like August September were the pinnacle of supply chain challenges and things might be easing a little bit.

Speaker 11

Would love to hear what GE is seeing.

Speaker 3

Nicole, I've talked to some of those CEOs. Some of those CEOs are friends of mine. I'm not sure we're yet at a place where we would say The things are stable. We may have line of sight. We may have improvements 1 commodity or in one business, but almost without fail.

Speaker 3

The next day, right, a commodity, a supplier, A logistics provider that we thought was good for the next 6 weeks or the next 6 months offers up a revision to that outlook. So I think I've used a phrase I probably shouldn't, but I'll repeat it. It really is akin to playing whack a mole, right? By business, by commodity, by geography, it just seems like every day, There's new news to battle with. I couldn't be more pleased with the way our team is navigating all of this, both in terms of availability and cost.

Speaker 3

We've got new procurement leadership in a number of businesses. We're really trying to make sure that we're true to our lean imperative of safety, quality, delivery and cost in that order. We don't want to have a short term Band Aid that costs us long term, But it really is a tactical muscular endeavor right now that we're working our way through. You've heard others. You've heard some of the key suppliers talk about electronic components likely to be At least a 2, 3 quarter challenge, maybe longer.

Speaker 3

That's important for us in certain businesses and certainly in some of our higher margin businesses. But we're working through it. It's probably more challenging, if not more challenging than I've ever seen in my career, But we'll work our way through it. Things will level out in time. And I think that given this was an area where we wanted to strengthen our operational capabilities, while it's more challenging in the short term, will be better for Median to long term.

Speaker 1

Hey, John. We only have time for one more question. Could you please proceed with what's going to be our last question?

Operator

Yes. And our final question is from Andy Kaplowitz from Citigroup.

Speaker 12

Hey, good morning, guys. Just slipped in. That growth could have been 9 points higher and you obviously have very strong orders despite the weaker revenues. So do you get those 9 points Back in 2022. And or does the backlog you're building give you confidence in the stronger than usual revenue environment in 2022?

Speaker 3

Andy, for sure, right. And it's not our style to try to build back A better headline here, but that's 9 points of real pressure given the supply chain issues that Nicole was just Proving is on. And again, I think Carolina mentioned that the Ford Ventilator effort a year ago for the HHS Was a significantly tough comp. But if you look at the 19% orders growth, if you look at what's happening both in the public and the private spheres, Plus what we're doing increasingly both from a commercial and from a product perspective, we've talked about the 25 to 70 basis points over time, I've got more conviction about our potential to do that than I did a year ago. Just off a U.

Speaker 3

K. Trip where I had some quality time with a number of our business leaders over there, our PDX business in particular, Lots of good things going on. We've got a CEO transition here in the offing That we're excited about, Kieran Murphy has done a heck of a job with that business. Pete Arduini coming in is, I think very much committed to those types of expectations. He's certainly coming because he's excited about the potential that he sees across the GE Healthcare portfolio.

Speaker 3

So wish it weren't As much of a camouflaged headline here, given the supply chain issues, we'll work through it I just feel like this is a strong business that will get stronger over time.

Speaker 1

Larry, we're out of time, but any final comments?

Speaker 3

Steve, I know we're over, but let me just, if I may, take a moment to thank our employees and our partners around the Earl, for what are truly extraordinary efforts here given the pandemic and the recent challenges, Yes. My thanks go out to everybody. We're operating from a position of strength today. I also want to thank our investors for their continued support. We certainly appreciate your interest, your investment in our company and your time today.

Speaker 3

Steve and the IR team as always stand ready to help and assist in any way possible as you consider GE in your investment processes.

Speaker 1

Thank you. Thanks, John.

Operator

Thank you. Ladies and gentlemen, that concludes today's conference. Thank you for participating and you may now disconnect.

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Earnings Conference Call
GE Aerospace Q3 2021
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