Our results over the last several years reflect the global economic environment in which we operate. Global markets have been, and remain, strong. Orders for products and services continue to increase. Emerging markets continue to grow and to offer us new opportunities. Abundant global liquidity is providing us capital market opportunities, but reducing risk spreads. In these highly competitive markets, we have, over the last three years, achieved organic revenue growth averaging 8% and significantly accelerated our globalization. Revenues from our operations located outside the United States plus all U.S. exports (global revenues) grew by more than 60% over this period. We also experienced a weaker U.S. dollar, escalating energy costs and higher fossil fuel-related raw material prices. Our debt continues to receive the highest ratings of the major rating agencies. As the following pages show, our diversification and risk management strategies enabled us to continue to grow revenues and earnings to record levels during this challenging time.
Of our six segments, Infrastructure (28% and 34% of consolidated three-year revenues and total segment profit, respectively) was one of the most significantly affected by the recent economic environment. During these years we invested in other lines of power generation, such as wind power, and developed product services. As a result, Energy revenues have grown significantly over these years and the business is positioned well for continued growth in 2007 and beyond. We also continued to invest in market-leading technology and services at Aviation, Water and Transportation. At December 31, 2006, we had 1,419 commercial aircraft, of which all but one were on lease, and we held $14.0 billion (list price) of multiple-year orders for various Boeing, Airbus and other aircraft, including 63 aircraft ($4.3 billion list price) scheduled for delivery in 2007, all under agreement to commence operations with commercial airline customers. Product services and sales of our Evolution Series locomotives continue to be strong.
Commercial Finance and GE Money, formerly Consumer Finance, (together, 27% and 32% of consolidated three-year revenues and total segment profit, respectively) are large, profitable growth businesses in which we continue to invest with confidence. In a competitive environment, these businesses grew earnings by a combined $1.2 billion and $1.3 billion in 2006 and 2005, respectively. Commercial Finance and GE Money have delivered strong results through solid core growth, disciplined risk management and successful acquisitions. The most significant acquisitions affecting Commercial Finance and GE Money results in 2006 were the custom fleet business of National Australia Bank Ltd.; Antares Capital Corp.; the Transportation Financial Services Group of CitiCapital; and joint ventures with Garanti Bank and Hyundai Card Company. These acquisitions collectively contributed $0.9 billion and $0.3 billion to 2006 revenues and net earnings, respectively.
We have achieved strong growth in Healthcare (10% and 12% of consolidated three-year revenues and total segment profit, respectively) with a combination of organic growth and strategic acquisitions. Healthcare realized benefits from the acquisitions of IDX Systems Corporation in 2006, Amersham plc (Amersham) in 2004 and Instrumentarium in 2003, expanding the breadth of our product and service offerings to the healthcare industry, and positioning us well for continued strong growth.
NBC Universal (10% and 12% of consolidated three-year revenues and total segment profit, respectively) has developed into a diversified world-class media company over the last several years, largely through the combination of NBC with Vivendi Universal Entertainment LLLP (VUE) in 2004. Nevertheless, the technology and business model for the entertainment media industry continues to evolve, and NBC Universal’s recent results were somewhat disappointing. In 2006, we made significant progress in our turnaround efforts and believe that NBC Universal is well positioned to compete in this challenging environment.
Industrial (22% and 10% of consolidated three-year revenues and total segment profit, respectively) is particularly sensitive to economic conditions. Higher capacity, in combination with declining or weak volume growth in many of the industries in which it operates, resulted in increased competitive price pressures. The Consumer & Industrial business continued to grow through product innovation and its focus on high-end appliances.
The Plastics business was hit particularly hard during these three years because of additional pressure from significant inflation in natural gas and certain raw materials such as benzene. As a result of these factors and the 2006 sales of GE Supply and Advanced Materials, we do not expect this segment to experience significant growth in 2007.
Overall, acquisitions contributed $3.9 billion, $9.6 billion and $12.3 billion to consolidated revenues in 2006, 2005 and 2004, respectively. Our consolidated earnings in 2006, 2005 and 2004 included approximately $0.5 billion, $0.9 billion and $1.2 billion, respectively, from acquired businesses. We integrate acquisitions as quickly as possible. Only revenues and earnings from the date we complete the acquisition through the end of the fourth following quarter are attributed to such businesses. Dispositions also affected our ongoing results through lower revenues of $2.6 billion, $2.0 billion and $3.0 billion in 2006, 2005 and 2004, respectively. This resulted in lower earnings of $0.1 billion in both 2006 and 2005 and $0.5 billion in 2004.
Significant matters relating to our Statement of Earnings are explained below.
Insurance exit. In 2006, we substantially completed our planned exit of the insurance businesses through the sale of the property and casualty insurance and reinsurance
businesses and the European life and health operations of GE Insurance Solutions Corporation (GE Insurance Solutions) and the sale of GE Life, our U.K.-based life insurance operation, to Swiss Reinsurance Company (Swiss Re). Also during 2006, we completed the sale of our remaining 18% investment in Genworth Financial, Inc. (Genworth), our formerly wholly-owned subsidiary that conducted most of our consumer insurance business, including life and mortgage operations, through a secondary public offering.
We reported the insurance businesses described above as discontinued operations for all periods presented. Unless otherwise indicated, we refer to captions such as revenues and earnings from continuing operations simply as “revenues” and “earnings” throughout this Management’s Discussion and Analysis. Similarly, discussion of other matters in our consolidated financial statements relates to continuing operations unless otherwise indicated.
We declared $10.7 billion in dividends In 2006. Per-share dividends of $1.03 were up 13% from 2005, following an 11% increase from the preceding year. In December 2006, our Board of Directors raised our quarterly dividend 12% to $0.28 per share. We have rewarded our shareowners with over 100 consecutive years of dividends, with 31 consecutive years of dividend growth.
Except as otherwise noted, the analysis in the remainder of this section presents the results of GE (with GECS included on a one-line basis) and GECS. See the Segment Operations section for a more detailed discussion of the businesses within GE and GECS.
GE sales of product services were $30.3 billion in 2006, a 12% increase over 2005. Increases in product services in 2006 and 2005 were widespread, led by continued strong growth at Infrastructure and Healthcare. Operating profit from product services was approximately $8.3 billion in 2006, up 19% from 2005, reflecting ongoing improvements at Infrastructure and Healthcare.
Postretirement benefit plans reduced pre-tax earnings by $2.3 billion, $1.7 billion and $1.2 billion in 2006, 2005 and 2004, respectively. Costs of our principal pension plans increased over the last three years primarily because of the effects of:
- Prior years’ investment losses which reduced pre-tax earnings from the preceding year by $0.5 billion, $0.5 billion and $0.6 billion in 2006, 2005 and 2004, respectively, and
- Lowering pension discount rates which reduced pre-tax earnings from the preceding year by $0.1 billion, $0.1 billion and $0.4 billion in 2006, 2005 and 2004, respectively.
Considering current and expected asset allocations, as well as historical and expected returns on various categories of assets in which our plans are invested, we have assumed that long-term returns on our principal pension plan assets would be 8.5% throughout this period and in 2007. U.S. generally accepted accounting principles provide for recognition of differences between assumed and actual returns over a period no longer than the average future service of employees.
We expect costs of our principal pension plans to stabilize in 2007. However, our labor agreements with various U.S. unions expire in June 2007, and we will be engaged in negotiations to attain new agreements. While results of the 2007 union negotiations cannot be predicted, our recent past negotiations have resulted in agreements that increased costs.
Our principal pension plans had a surplus of $11.5 billion at December 31, 2006. We will not make any contributions to the GE Pension Plan in 2007. To the best of our ability to forecast the next five years, we do not anticipate making contributions to that plan as long as expected investment returns are achieved. At December 31, 2006, the fair value of assets for our other pension plans was $2.6 billion less than their respective projected benefit obligations. We expect to contribute $0.6 billion to these plans in 2007, compared with $0.5 billion and $0.4 billion in 2006 and 2005, respectively.
The funded status of our postretirement benefit plans and future effects on operating results depend on economic conditions and investment performance. See notes 6 and 7 for additional information about funded status, components of earnings effects and actuarial assumptions. See the Critical Accounting Estimates section for discussion of pension assumptions.
GE other costs and expenses are selling, general and administrative expenses. These costs were 14.0%, 14.7% and 14.6% of total GE sales in 2006, 2005 and 2004, respectively.
GE operating profit is earnings from continuing operations before interest and other financial charges, and income taxes. GE operating profit excluding the effects of pension costs was $15.5 billion in 2006, up from $13.6 billion in 2005 and $11.3 billion in 2004 (15.2%, 14.8% and 13.5% of GE industrial revenues in 2006, 2005 and 2004, respectively). The increase in 2006 operating profit reflected higher productivity (principally Industrial and Healthcare), volume (Infrastructure) and prices (Infrastructure), partially offset by higher material and other costs across all segments. The increase in 2005 operating profit reflected higher productivity (principally Healthcare and Infrastructure), volume (Infrastructure and NBC Universal) and prices (Industrial), partially offset by higher material and other costs across all segments.
Interest on borrowings and other financial charges amounted to $19.3 billion, $15.1 billion and $11.6 billion in 2006, 2005 and 2004, respectively. Substantially all of our borrowings are through GECS, where interest expense was $18.1 billion, $14.2 billion and $11.1 billion in 2006, 2005 and 2004, respectively. Changes over the three-year period reflected increased average borrowings and increased interest rates. GECS average borrowings were $389.0 billion, $346.1 billion and $319.2 billion in 2006, 2005 and 2004, respectively. GECS average composite effective interest rate was 4.7% in 2006, compared with 4.2% in 2005 and 3.5% in 2004. Proceeds of these borrowings were used in part to finance asset growth and acquisitions. In 2006, GECS average assets of $514.5 billion were 9% higher than in 2005, which in turn were 7% higher than in 2004. See the Financial Resources and Liquidity section for a discussion of interest rate risk management.
Income taxes are a significant cost. As a global commercial enterprise, our tax rates are affected by many factors, including our global mix of earnings, legislation, acquisitions, dispositions and the tax characteristics of our income. Our tax returns are routinely audited and settlements of issues raised in these audits sometimes affect our tax provisions.
Income taxes on consolidated earnings from continuing operations were 16.1% in 2006, compared with 17.8% in 2005 and 18.2% in 2004. Our consolidated income tax rate decreased from 2005 to 2006 as growth in lower-taxed earnings from global operations, including one-time tax benefits from non-U.S. tax net operating losses and the non-U.S. gain on disposition of the Advanced Materials business, exceeded 2005 tax benefits from a reorganization of our aircraft leasing business, a repatriation of non-U.S. earnings at a reduced rate of U.S. tax and favorable settlements with tax authorities.
Our consolidated income tax rate was essentially unchanged in 2005 from 2004 because the 2005 tax benefits from a reorganization of our aircraft leasing business and from the growth in lower-taxed global operations were about the same as the 2004 tax benefits from favorable U.S. Internal Revenue Service (IRS) settlements, the NBC Universal combination, the 2004 reorganization of our aircraft leasing business and a lower tax rate on the sale of a portion of Genpact, our business process outsourcing operation.
A more detailed analysis of differences between the U.S. federal statutory rate and the consolidated rate, as well as other information about our income tax provisions, is provided in note 8. The nature of business activities and associated income taxes differ for GE and for GECS and a separate analysis of each is presented in the paragraphs that follow.
Because GE tax expense does not include taxes on GECS earnings, the GE effective tax rate is best analyzed in relation to GE earnings excluding GECS. GE pre-tax earnings from continuing operations excluding comparable GECS earnings were $12.8 billion, $11.9 billion and $10.4 billion for 2006, 2005 and 2004, respectively. On this basis, GE’s effective tax rate was 20.2% in 2006, 23.1% in 2005 and 19.0% in 2004.
The decrease in the 2006 rate from 2005 was primarily attributable to growth in lower-taxed earnings from global operations, including one-time tax benefits from non-U.S. net operating losses and the non-U.S. gain on the disposition of the Advanced Materials business. These benefits, which decreased the GE rate by 4.5 percentage points, are included in note 8 in the line “Tax on global activities including exports.” Partially offsetting these items was the lack of a counterpart to the 2005 repatriation of non-U.S. earnings at a reduced U.S. tax rate, discussed below (0.9 percentage points) and a decrease in benefits from favorable audit resolutions with tax authorities (0.8 percentage points). The effects of 2006 favorable audit resolutions are reflected in note 8 in the lines “All other — net” (0.8 percentage points) and “Tax on global activities including exports” (0.7 percentage points).
The increase in the 2005 rate over the 2004 rate was primarily attributable to the lack of current-year counterparts to the 2004 settlements with the IRS and 2004 tax benefits associated with the NBC Universal combination, both discussed below, that together reduced the 2004 rate by 7.2 percentage points. Partially offsetting this increase were the favorable effects of a number of audit resolutions with taxing authorities and our 2005 repatriation of non-U.S. earnings at the reduced U.S. tax rate provided in 2004 legislation (together representing a 3.2 percentage point reduction of the GE tax rate). These 2005 tax benefits are reflected in note 8 in the lines “All other — net” (1.6 percentage points) and “Tax on global activities including exports” (1.6 percentage points).
The 2004 GE rate reflects two items that decreased the rate by 7.2 percentage points — settling several issues with the IRS for the years 1985 through 1999 and tax benefits associated with the NBC Universal combination. As part of the IRS settlements, we closed two significant issues: the 1997 tax-free exchange of the Lockheed Martin convertible preferred stock we received on the disposition of our Aerospace business in 1993, and a 1998 tax loss on the sale of a Puerto Rican subsidiary. The tax portion of these settlements is included in the line “IRS settlements of Lockheed Martin tax-free exchange/Puerto Rico subsidiary loss” in note 8. The tax benefits associated with the NBC Universal combination are included in the line “All other — net” in note 8.
GECS effective tax rate was 11.6% in 2006, compared with 11.9% in 2005 and 17.4% in 2004. The 2006 GECS rate was about the same as 2005 as growth in lower-taxed earnings from global operations was largely offset by a smaller benefit on the reorganization, discussed below, of our aircraft leasing business. The increased benefits from lower-taxed earnings from global operations (2.4 percentage points) and the lower benefits from the reorganization of our aircraft leasing business (1.9 percentage points) are included in the line “Tax on global activities including exports” in note 8.
The 2005 GECS rate reflects the net benefits, discussed below, of a reorganization of our aircraft leasing business and an increase in lower-taxed earnings from global operations. Together, these items more than account for the 7.2 percentage point decrease in rate from 2004 reflected in the line “Tax on global activities including exports” in note 8. Partially offsetting these benefits was the nonrecurrence of the benefits from 2004 favorable settlements with the IRS and the low-taxed disposition of a majority interest in Genpact. The lack of counterparts to these items increased the 2005 GECS tax rate by 1.7 percentage points. The favorable settlements with the IRS are included in the line “All other — net” and the benefit of the low-taxed disposition of a majority interest in Genpact is included in the line “Tax on global activities including exports” in note 8.
As a result of the repeal of the extraterritorial income (ETI) taxing regime as part of the American Jobs Creation Act of 2004 (the Act), our aircraft leasing business no longer qualifies for a reduced U.S. tax rate. However, the Act also extended to aircraft leasing, the U.S. tax deferral benefits that were already available to other GE non-U.S. active operations. These legislative changes, coupled with a reorganization of our aircraft leasing business and a favorable Irish tax ruling, decreased the GECS effective tax rate 1.1 percentage points in 2006, compared with 3.0 and 1.6 percentage points in 2005 and 2004, respectively.
Global risk management
A disciplined approach to risk is important in a diversified organization such as ours in order to ensure that we are executing according to our strategic objectives and that we only accept risk for which we are adequately compensated. It is necessary for us to manage risk at the individual transaction level, and to consider aggregate risk at the customer, industry, geography and collateral-type levels, where appropriate.
The GE Board of Directors oversees the risk management process through clearly established delegation of authority. Board and committee meeting agendas are jointly developed with management to cover risk topics presented to our Corporate Risk Committee, including environmental, compliance, liquidity, credit and market risks.
The GECS Board of Directors oversees the risk management process for financial services, and approves all significant acquisitions and dispositions as well as borrowings and investments. All participants in the risk management process must comply with approval limits established by the Board.
The GECS Chief Risk Officer is responsible, through the Corporate Risk Function, for establishing standards for the measurement, reporting and limiting of risk; for managing and evaluating risk managers; for approving risk management policies; and for reviewing major risk exposures and concentrations across the organization. The GECS Corporate Risk Function analyzes certain business risks and assesses them in relation to aggregate risk appetite and approval limits set by the GECS Board of Directors.
Threshold responsibility for identifying, quantifying and mitigating risks is assigned to our individual businesses. We employ proprietary analytic models to allocate capital to our financing activities, to identify the primary sources of risk and to measure the amount of risk we will take for each product line. This approach allows us to develop early signals that monitor changes in risk affecting portfolio performance and actively manage the portfolio. Other corporate functions such as Financial Planning and Analysis, Treasury, Legal and our Corporate Audit Staff support business-level risk management. Businesses that, for example, hedge financial risk with derivative financial instruments must do so using our centrally-managed Treasury function, providing assurance that the business strategy complies with our corporate policies and achieves economies of scale. We review risks periodically with business-level risk managers, senior management and our Board of Directors.
GECS employs about 18,000 dedicated risk professionals, including 11,400 involved in collection activities and 680 specialized asset managers who evaluate leased asset residuals and remarket off-lease equipment.
GE and GECS manage a variety of risks including liquidity, credit and market risks.
- Liquidity risk is the risk of being unable to accommodate liability maturities, fund asset growth and meet contractual obligations through access to funding at reasonable market rates. Additional information about our liquidity and how we manage this risk can be found in the Financial Resources and Liquidity section and in notes 18 and 27.
- Credit risk is the risk of financial loss arising from a customer or counterparty failure to meet its contractual obligations. We face credit risk in our lending and leasing activities (see the Financial Resources and Liquidity and Critical Accounting Estimates sections and notes 1, 13, 14 and 29) and derivative financial instruments activities (see note 27).
- Market risk is the potential loss in value of investment and other asset and liability portfolios, including financial instruments and residual values of leased assets. This risk is caused by changes in market variables, such as interest and currency exchange rates and equity and commodity prices. We are exposed to market risk in the normal course of our business operations as a result of our ongoing investing and funding activities. Additional information can be found in the Financial Resources and Liquidity section and in notes 15 and 27.
Other risks include natural disasters, availability of necessary materials, guarantees of product performance and business interruption. These types of risks are often insurable, and success in managing these risks is ultimately determined by the balance between the level of risk retained or assumed and the cost of transferring risk to others.
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