General Electric (GE) Financial Changes Immaterial: A Sideshow Compared To Catalysts

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General Electric’s (NYSE:GE) 10-Q filing included some accounting changes that will have an impact on results from the years 2000 to 2004.  Before you have a conglomerate accounting irregularity freak-out session, there are many other things to worry about elsewhere like the weakening stock market because these changes to results are in reality quite small and really do not look company-wide.  Sure, this may make cover stories for the weekend versions of the Wall Street Journal and will be in other papers this weekend, but that’s because it is easier to garner more interest if there are concerns and possible scandals to report.

If you follow "Legal Proceedings" then this is not really anything GE investors should worry about.  Based upon what I was able to garner from a recent luncheon with GE’s CFO Keith Sherin companies this spread out and anywhere close to this large will have reviews in some form or another in one unit or another for the end of days.  That is the price in a post-Enron financial world.  If you want a prediction right here and right now you heard it from me: this isn’t the last restatement or accounting change you’ll ever see, and this isn’t likely a systematic problem spread across General Electric.  Take a look at some of at the copied verbatim for exact wording out of the 10-Q:

In connection with the SEC’s investigation, the Audit Committee of our Board of Directors, with the assistance of independent counsel, undertook a review of the Rail transactions. Based on this review and as further described below, we have determined that revenues had been inappropriately accelerated so that they were recognized in the fourth quarter of each of the years 2000 through 2003 rather than in the first quarter of the following year. Our management and Audit Committee determined that the effects of the Rail transactions are not material to our financial statements under applicable SEC guidance and accounting literature. If the transactions had been recorded in the appropriate quarters, the effects on GE’s consolidated revenues, earnings before income taxes and accounting changes and net earnings would have been less than 0.2% in each year.

In each of the years, basic and diluted net earnings per share would have been unaffected had these transactions been correctly recorded, except that, because of rounding, (1) 2003 diluted net earnings per share, understated by $.0009, would have increased by $.01, and (2) 2002 basic net earnings per share, overstated by $.0022, would have decreased by $.01. In addition, in fiscal years 2001 through 2004, basic and diluted net earnings per share, as originally reported, would have been unaffected if these transactions had been correctly recorded.

The effects of the Rail transactions on revenues and profit for the segments containing the Rail business, as originally reported, from 2000 through 2004 would have been less than 4.5% in all annual and quarterly periods other than the fourth quarter of 2002 and the first and fourth quarters of 2003. Industrial Products and Systems segment revenues and profit were overstated by 8.8% and 14.5%, respectively, in the fourth quarter of 2002 and understated by 30.0% and 35.4% in the first quarter of 2003; Transportation Systems segment revenues and profit were overstated by 22.6% and 16.6%, respectively, in the fourth quarter of 2003. Transportation Systems was the smallest of GE’s 13 segments in 2003, representing 1.9% of consolidated revenues and 2.3% of consolidated earnings before income taxes and accounting changes.

In the Rail transactions, we transferred locomotive titles but not sufficient substantive risks and rewards of ownership to financial intermediaries. One quarter after title transfer, we delivered those locomotives to the ultimate railroad customers. Our Audit Committee has determined that, in connection with the Rail transactions, several individuals in our Rail business and in our capital markets group engaged in intentional misconduct that misled those responsible for accounting oversight and further that the transactions were also not adequately examined by those responsible for accounting oversight.

Ultimately you will have to decide on your own how material this is.  Back in February we noted how the "Material Weakness" section in the Annual Report was not all that material for a company this large and with this many units.  If this was very material, then there be changes to internal controls and procedures in the filing and those were deemed effective. I won’t bother trying to explain all of the changes going on in accounting, but in the luncheon I attended in New York City with GE’s CFO Keith Sherin this week one of the points that the CFO discussed was the ongoing accounting reviews and changes.  He specifically noted some derivative restatements and said that FAS-133 reviews were ongoing.  My own impression is that this is being mandated not just at GE but is much more systemic with conglomerates and SEC reviews in general, particularly as Mr. Sherin noted that FAS-133 needs some simplifications and some more common sense rubbed over it. 

Mr. Sherin gave a broad overview of the company, and my own personalysis interpretations will tell you in as close to matter of fact as an outsider can that this is not an issue keeping anyone up at night other than the actual motions and time involved.  There are many more positive engines (no pun intended) right now that are acting as drivers for the company.  Keith Sherin used the term "growth company" more than once, and with a broad 20% target for return on capital each year you can see why. 

Unfortunately the stock market has the sniffles, that turned into a full blown cold Thursday, and if Friday’s end of day trading was any indication then the doctor is worried the market may have to go to the doctor if the patient doesn’t improve this weekend.  Hopefully the market will have a bit more stabilized trading next week, because we have a series of segments we’ll be running on General Electric with both sides of the coin on each.  But after being able to give this a couple days of segmenting analysis the company sure seems like it has a hell of a lot more going for it in the near future compared to accounting worries that can be blown way out of proportion if they are ‘spun’ with a crafty pen.  There is always some pause that has to be given now any time there is any word of accounting restatements, but remember that the media can sell you more newspapers and keep you watching longer if they can convince you a scandal is looming. 

You should be worried much more about the good old stock market in general dragging GE than this issue, or at least that is the opinion of yours truly.  This stock was holding its own quite well and managing to hold $40.00 until the market cracked and if you look at and compare the intraday charts on GE versus the DJIA and the S&P 500 this week then you can see that the DJIA and S&P 500 are pulling GE down rather than GE acting as a catalyst hurting the markets.  Anyhow, it is always safe to assume there can be more disclosures such as this, but so far GE still looks like it wants to act as a leader when the market goes up rather than a drag.  Stay tuned next week as we roll out some of these feature stories on various aspects of the company with analysis on each.

Jon C. Ogg
July 27, 2007

Jon Ogg can be reached at jonogg@247wallst.com; he does not own securities in the companies he covers.