General Electric Company
16 April 2002
Richard F. Wacker
General Electric Company, Vice President
3135 Easton Turnpike, Fairfield, CT 06431
Corporate Investor Communications
203 373-2468, Fx: 203 373-2071
Dial Comm: 8*229-2468, Fx: 8*229-2071
April 15, 2002
To Our Shareholders and the Investment Community:
For months now we have seen articles that - after describing questionable
practices at other companies - admonished investors to beware of similar
practices 'at other large or complex companies, such as GE.' When some companies
ran into difficulties in the debt markets, investors were warned that others --
'such as GE' - could face liquidity crises and collapse. We've addressed these
issues calmly, with explanations of our results, activities, culture and
processes. We understand that being the best makes one a lightning rod, and we
accept that level of scrutiny.
However, we do protest inaccurate and unbalanced journalism. On Sunday, The New
York Times published a story that was biased and one-sided. The article, Wait a
Second: What Devils Lurk In the Details?, contains factual inaccuracies and weak
analysis. Those facts about GE's performance that are accurately presented come
directly from our Guide to the Financial Section produced for our annual report
and the materials posted with our first quarter earnings release (both available
at www.ge.com/investor). Attached is a description of the most significant
errors - for example, the erroneous interpretation of GE Capital's first-quarter
revenues, or the attribution of 6 cents a share to 2001 earnings from a gain on
the sale of Americom while omitting reference to the 6 cents of charges taken in
the fourth quarter.
The article did articulate one point accurately if incompletely: 'Heightened
investor interest, even suspicion, toward financial reports is a completely new
challenge.' It is a challenge that companies and journalists must accept and
approach responsibly, so that a great number of investors are not harmed by
actions of the few seeking to benefit from misinformation.
The key facts of the first quarter are very clear:
• GE earned more money from business operations than in any first quarter in
its history, $3.5 billion (or 35 cents per share), before the one-time
effect of the accounting change we described very clearly.
• GE's businesses generated more cash than in any first quarter in its
history, $2.2 billion ex-progress collections. Cash ex-progress grew faster
• GE reaffirmed its earnings guidance of $1.65-$1.67 for 2002.
The chief concern of knowledgeable investors and analysts is - rightly so -- the
source of GE's earnings growth as the hugely successful gas turbine segment of
Power Systems slows with the US power industry. We believe that investor
concerns will be addressed as our short-cycle businesses enter the second half
of the year with strong, positive volume comparisons, as our other long-cycle
businesses gain momentum and as we continue to execute on our growth
We welcome your informed analysis and discussion of the Company and its
prospects. We acknowledge our responsibility to ensure transparency for our
investors. We will continue to deliver the consistently excellent earnings
growth that has rewarded GE investors in the past and will again.
The Devil In the Details:
The New York Times, April 14, 2002
Sources cited in the article:
All of the sources cited are long-term GE bears or acknowledged short-sellers.
There was no disclosure as to the financial position or analytical views of the
sources in (or short) GE stock, with the exception of Mr. Olstein, and this
disclosure ('a modest number of shares') is vague. There were no comments from
knowledgeable GE investors or analysts.
Dealing with Economic Cycles:
The Times: 'After the long boom, contending with a stagnant economic environment
is unfamiliar territory for G.E....'
GE operates in every significant market in the world and these markets all move
through economic cycles. GE describes its operations and results in terms of
'Long Cycle' and 'Short Cycle' businesses. We have been in these businesses for
decades and managed to produce consistent earnings growth as a Company through
economic cycles... always outperforming peers. See Jeff Immelt's letter to
shareowners in our annual report, page 2. A key strength of the GE business
model is the portfolio of businesses we manage. When some businesses are working
through down cycles (as with the Short Cycle businesses today) others are
powering through up-cycles (as with Power Systems and GE Capital today).
The basis for the comment is unclear.
GECS 1st Quarter 2002 Revenue:
The Times: 'G.E.'s first-quarter results also indicate that the Capital Services
juggernaut, which has powered the company's overall results for more than a
decade, is finally slowing. Revenue at the subsidiary fell 6 percent - largely a
result of a decline in sales, general and administrative expenses - while
earnings rose 8 percent.' (emphasis added)
If you can understand the linkage of revenue to SG&A expenses, please contact
The facts of the revenue declines at GECS (approximately $800 million lower in
the 1st quarter of 2002 than a year earlier) were articulated on the conference
call, as they have been each quarter by the analysts that follow the company:
• Reflecting declines in repositioned and run-off activities
GECS continuously assesses its business activities and exits some for
Sale of GE Americom (strategic sale) -$ 220
and others with poor future earnings prospects:
Exit of money losing AFS in the US -$ 100
Restructure of money losing ITS - 300
As these activities run off, we naturally have lower revenues compared to
• Revenue effect of lower interest rates (associated with lower matched
A significant portion, nearly $100 billion, of GE Capital's financing assets
are 'floating rate assets' -- some credit card receivables, inventory
financing, and many equipment and real estate loans and leases -- where the
amount of the customer payment is tied to the current level of interest
rates (similar to a consumer's adjustable rate mortgage). Lower interest
rates, therefore, result in lower financing revenue.
GECS' 'matched funding' discipline results in those assets being funded with
floating rate debt (such as commercial paper or long-term floating rate
notes), and the lower financing revenues are offset by lower matched
borrowing costs on that debt.
Since GECS finances assets based on the 'spread' between (a) the finance
revenue received from our customer and (b) the borrowing costs paid to our
debt holders, GECS profitability is not materially impacted as interest
rates rise or fall.
The interpretation of these revenue declines at GECS as signs of lower
profitability is simply inaccurate. As Keith Sherin emphasized on Thursday's
call, the growth in assets -- $57 billion, up 15% from a year earlier -- as the
key driver for future earnings growth.
GECS Return on Equity:
The Times: 'Robert E. Friedman, accounting analyst at Standard & Poor's equity
research unit in New York, found another flaw. While GE Capital has fueled much
of the parent company's growth, he said, it does not generate high returns on
capital when its debt is stripped away.' (emphasis added)
Neither the 'flaw' nor how it is calculated is made clear. Perhaps The Times
could practice the transparency it preaches and provide the explanation rather
than a simple unsupported assertion.
As for all financial services businesses involved in lending activities,
financing assets are funded with both debt and equity. The lender earns a return
on equity after paying the borrowing costs on the debt. GECS return on equity
was 21.8% in 2001 and 21.7% for the first quarter of 2002. These are excellent
return levels, reflecting the diversified set of financing businesses and risk
management practices that are GECS strengths.
1st Quarter 2001 Cash Flow:
The Times: 'G.E.'s first-quarter results had one final peculiar aspect worth
noting. The company's cash flow from operations declined by 53 percent, yet
earnings grew by 17 percent. Careful analysts are always on the lookout for wide
discrepancies between reported earnings and cash flows. When earnings growth at
a company exceeds the growth in its cash flows, the disparity can be a sign that
accounting gimmicks are being used to dress up reported earnings.(emphasis
The company said the discrepancy reflected the decline in so-called progress
collections, the intermediate payments customers make for purchases of turbines
and jet engines while they are being built. The drop in cash flow reflected a
drop in those payments as orders were canceled. '
Total Cash From Operating Activities was indeed down 53% from the first quarter
of 2001, reflecting the impact of progress collections as we have articulated
and highlighted continuously.
2002 2001 V%
CFOA ex-Progress 2,189 1,849 18%
Progress Collections (743) 1,207 U
Total CFOA 1,446 3,056 -53%
GE has consistently communicated Cash From Operating Activities excluding
Progress Collections (CFOA ex-Progress) as the most useful measure of cash
generated by our business units. It has grown:
• 18% to $2.2 billion in the first quarter of 2002, faster than the growth
• 13% to $13.8 billion in 2001, faster than the growth of earnings.
It has been the most useful measure because we received significant progress
collections in the past several years as a result of the spike in turbine demand
(driving total CFOA to be much greater than CFOA ex-progress). In 2001, total
CFOA including progress collections was $17.2 billion versus the $13.8 billion
It will be the most useful measure in the future because progress collections
will be a use of cash (as in the first quarter of 2002) as we ship the gas
turbine units for which the progress payments were made, and have fewer new
orders for which we will be receiving new progress payments.
Progress collections are monies GE received from customers upfront and
throughout the production process of gas turbines or jet engines. By holding the
money in advance of shipment, GE has protected its investors from the risks of:
• volume shortfalls after significant investment in building production
• order cancellation following investment in the production of individual
• credit risk of customers after shipping very expensive units ($40+ million
per gas turbine)
The program of obtaining progress collections has proved to be very effective
protection for GE investors as we manage through the downturn of the gas turbine
cycle. While we regret that some customers have had to cancel orders, we have
succeeded in protecting GE shareholders from any loss as a result of those
cancellations, and that is our number 1 job. In all cases where turbine orders
were cancelled, GE had collected progress payments in excess of the termination
fee. And as we have been communicating for months, we are fully prepared to
manage - and grow - through the inevitable downturn in turbine shipments.
Far from being 'peculiar' or a red flag, the 'Careful analysts' had only to look
as far as GE's disclosure and every report issued by any analyst following GE.
Power Systems Termination Revenues:
The Times states: 'The customers were required to pay cancellation fees,
generating $476 million in revenue at the subsidiary, or 9 percent of its total
sales. This resulted in net profits of $326 million, or 3 cents a share in the
GE's CFO Keith Sherin clearly stated on the earnings conference call that the
contribution to earnings from termination payments was 2 cents per share in the
quarter. That is the after-tax equivalent to $326 million benefit net of costs
associated with the terminations.
Off Balance Sheet Obligations
The Times states: 'In its most recent annual report, G.E. for the first time
outlined the size of the obligations that are off its balance sheet in
special-purpose entities.... At the end of last year, that figure stood at $43.2
billion. Some analysts say that taking a conservative approach to the balance
sheet would require that those off-balance-sheet obligations be added to the
total debt held by the company, which stood at $220 billion at year-end. Those
off-balance-sheet obligations would increase G.E.'s debt by 20 percent.'
GE has always disclosed the size of the contingent liabilities from the use of
off-balance-sheet arrangements. In the 2001 annual report, GE chose to
significantly expand the disclosure given heightened sensitivity in the current
environment. GE's disclosure has been well received.
The commercial paper obligations issued by the special purpose entities are
supported by the cash flows of the high quality assets sold to the entities. The
commercial paper of these entities has the highest A1+/P1 ratings from the major
agencies. Clearly any discussion of the SPEs' debt without mentioning the $43
billion of assets they hold is incomplete and, as a result, misleading.
GE follows the accounting instructions of the FASB for special purpose entities
and, of course, will continue do so if the accounting treatment for these
1st Quarter 2002 Earnings - Impact of FAS142 Accounting Change:
The Times: 'For the first quarter, G.E. reported that earnings rose 17 percent,
to $3.518 billion -- but those results excluded the effects of a mandated
accounting change. Including the change, a charge to earnings for a writedown of
goodwill, G.E.'s earnings actually fell 2.7 percent.'
These are exactly the results GE communicated.
The mandated accounting change is related to FAS 142, affects all companies, and
reflects the cumulative impact of the accounting change. FAS 142 changed the way
goodwill is measured and valued, and all companies are required to reflect the
impact of the change in the first quarter of 2002. Because it is a cumulative
impact of the change in measurement methodology related to all prior periods,
the amount of the charge is not reflective of first quarter operations.
For year-on-year comparison purposes, we believe it is appropriate to focus on
earnings before accounting changes.
GE's 2001 Earnings Growth:
The Times: ...by Mr. Olstein's reckoning, about 25 cents a share, or 18 percent
of the profits, came from nonrecurring sources at the company.
• Gain on Americom Sale: Portfolio gains including this sale generated 6
cents a share in earnings for G.E., Mr. Olstein said.
• Pension Contribution to Earnings: Next, he calculated that a $1.5
billion gain in the company's pension plan, left over from the heady
bull-market days, accounted for 8 cents a share in G.E.'s earnings last
• Securitization: The total gain was $1.3 billion, up from $500 million
in 2000, and accounted for 6 cents a share in earnings last year. Such
gains, however, cannot be counted on year in and out.
• GECS Earnings Growth: Mr. Olstein estimated that the entire gain shown
by GE Capital... was a result of a significantly lower tax rate. That
tax-rate decline added 5 cents a share to the company's earnings.
This is classic 'cherry picking' and indicative of the one-sided nature of the
article. All of these items were fully disclosed and highlighted in the Guide to
the Financial Section of our annual report which is available on our website. Of
course no mention is made of:
• The non-recurring 4th quarter charges ($656 million) described on page 56
of the annual report.
• Lower gains on investment securities and GE Equity investments, which when
combined with the securitization activity, resulted in lower overall gains
($500 million) on financial instruments.
• The loss associated with the events of September 11th ($400 million)
There is also no mention that within our 2002 guidance of $1.65 - $1.67 per
share GE has communicated that we:
• Expect securitization activity to be lower in 2002 by $300 million
• Have assumed lower growth in income from pension assets and a reduction of
approximately $500 million in contribution to earnings.
The only thing new in this discussion is the number of items favorable to GE
that have been excluded from the analysis.
GECS Equity Infusion:
The Times: 'a new, tangible question has arisen about the health of GE Capital
Services. In the fourth quarter of last year, G.E. gave GE Capital a $3.043
billion cash infusion. The contribution has made some analysts wonder whether GE
Capital has experienced losses in its financing business that required the
parent company to shore up its balance sheet. That $3 billion infusion to GE
Capital was equal to one-third of the subsidiary's tangible net worth --
shareholder's equity minus intangible assets -- at the time. The $3 billion
contribution offset a $2 billion decline in GE Capital's tangible net worth at
'The company said it had made the $3 billion contribution to GE Capital so that
the subsidiary could acquire Heller Financial last year.' (emphasis added)
The idea that the equity contribution was to 'shore up' GECS balance sheet for
undisclosed losses is simply wrong. Surely The Times' 'accounting expert' could
identify how losses would flow through the financial statements and into equity
as reductions in retained earnings. GECS retained earnings grew $3.4 billion.
The equity contribution, as GE communicated, was related to the acquisition of
Heller Financial Services, which closed in November of 2001.
GECS dividends to the GE parent approximately 30% - 35% of its earnings. The
balance of its earnings is retained in GECS to fund asset growth. GE Capital
maintains debt / equity leverage of approximately 8:1, and so it must grow
equity $1 billion through retained earnings to fund each $8 billion of asset
growth. By the fourth quarter of 2001, GECS had already generated very strong
organic and acquisition growth, and the addition of an additional $24 billion of
assets with Heller would exceed the level of growth supported by GECS' strong
retained earnings. GE made the investment decision to contribute equity to GECS
to support profitable asset growth.
This information is provided by RNS
The company news service from the London Stock Exchange