GE relies on cost cuts, tax dip in tough quarter

BOSTON (Reuters) - They say nothing is certain but death and taxes. Tell that to the shareholders of General Electric Co.

The largest U.S. conglomerate reported earnings on Friday that beat expectations despite a drop in revenue that was more dramatic than Wall Street had predicted. Those earnings reflected the pay-off from major cost-cutting over the past year, a greater reliance on the high-margin service business but also a sharp drop in the company's tax rate.

Thanks to higher loss provisions at the company's hefty GE Capital finance arm, the company's tax rate fell to 7 percent from 16 percent a year ago, a change that helped the bottom line, but which some investors consider a sign of poor "earnings quality."

"Earnings quality did play a role again," said Edward Jones analyst Matt Collins. "You had a 7 percent tax rate in the quarter, so clearly that was a factor. They are seeing benefits from restructuring that they had taken previously."

While companies across the economy are cutting jobs, closing facilities and looking for any other ways to bring costs in line with falling revenue, some investors note there is a limit to how long companies can rely on belt-tightening to hold up their profits.

"It's not sustainable," said Peter Klein, senior portfolio manager at Fifth Third Asset Management, which owns GE shares. "The story of the second quarter is that a lot of companies are reporting better-than-expected earnings, but it's coming all through the middle."

U.S. companies including International Business Machines Corp, Johnson & Johnson and Google Inc this week have reported earnings that topped Wall Street's expectations in part because of the benefits of cost-cutting.

RISKY LINE TO WALK

While cutting costs is a nearly universal management response to an economic downturn, companies run the risk of pulling back so much that they are unable to respond quickly to upticks in demand when the economy begins to recover.

GE officials said they have kept that risk in mind, raising their spending on new products even as they look for other ways to cut costs.

"In terms of cost-out projects, we've dramatically downsized the company," said Chief Financial Officer Keith Sherin, in an interview. "If you look at the base costs being down $4 billion year over year, a lot of that involves less people, it involves incredibly thoughtful sourcing."

GE reported a 17 percent drop in second-quarter revenue, a steeper decline than the 10 percent fall Wall Street expected, according to Reuters Estimates. A heavier reliance on its service business -- maintaining the jet engines and railroad locomotives it has already sold -- also helped the bottom line, since service revenue is more profitable for GE than equipment sales.

For their part, GE officials -- who no longer provide investors with targets for per-share profit or revenue -- said that revenue met their internal forecasts for the quarter.

The Fairfield, Connecticut-based company has spent $5 billion on restructuring since 2007, though GE officials decline to say how many jobs they have cut. Chief Executive Jeff Immelt said management is weighing another $2 billion in restructuring programs.

"The more restructuring we can do this year positions 2010 for improved outlook for earnings and beyond," Immelt told investors on a conference call. "That's really what the goal is, is to continue to take costs out of GE."

Investors said they would be glad to see GE get its restructuring behind it.

"Management has gone out and said that they want to get a lot of their restructuring done in 2009, so that when you look to 2010, once global demand does recover, you may see GE start to outperform," said John Koczara, portfolio manager at AMBS Investment Council, in Grand Rapids, Michigan, which holds GE shares. "GE has taken a lot of their medicine and is going to be a healthier patient in 2010."

(Reporting by Scott Malone; editing by Leslie Gevirtz)