GE Report Raises Doubts

Immelt Is Optimistic, But Analysts Question Tax Rate, Restatement

By KATHRYN KRANHOLD

January 20, 2007; Page A3

General Electric Co. Chairman Jeffrey Immelt is looking to the future with three deals already unveiled this year, but his optimism was partially overshadowed Friday by questions about the quality of GE earnings and a restatement.

GE announced it would restate earnings back to 2001 -- for the second time in two years -- in connection with how it accounted for derivative transactions.

• The News: General Electric more than doubled its net income in the fourth quarter, but said it would restate earnings back to 2001.

• The Issue: Lower than expected tax rates and the restatement -- the second in two years -- raise questions about the quality of GE earnings.

• Outlook: Chairman Immelt calls GE a "safe and reliable growth company;" he is seeking a buyer for its plastics unit.

[GE] Its fourth-quarter earnings also caused concern among investors and analysts who noted that the company again got a boost from a lower-than-expected tax rate. GE shares fell 2.8% to close at $36.95 in 4 p.m. composite trading on the New York Stock Exchange. Before Friday, GE shares had risen more than 15% in the past six months.

GE reported fourth-quarter net income of $6.57 billion, or 64 cents a share, more than double net income of $3.16 billion, or 30 cents a share, in the same quarter a year earlier. The prior year's results included a $2.7 billion expense as GE exited the reinsurance business.

Revenue rose 11% to $44.62 billion. The results were in line with GE forecasts and analysts' expectations.

But some analysts said they were troubled by issues related to the restatement and the lower tax rate. Analysts estimated that lower tax rates at GE's industrial and financial business boosted earnings by three to four cents. "A Rubik's Cube may in fact be easier to figure out" than the meaning of GE's results, wrote Scott Davis, an analyst with Morgan Stanley.

Mr. Davis said it was "unclear" why GE's tax rates were lower than the company had estimated in December, when GE estimated its 2006 tax rate would be around 17.2%. Friday, GE reported an annual tax rate of about 16% for 2006. Had GE's tax rate been 17.2%, it would have posted a 9.2% increase in earnings from continuing operations for 2006 over 2005, instead of 10.7%.

GE Chief Financial Officer Keith Sherin said the $270 million gained from lower tax rates went toward restructuring and other corporate expenses.

Russell Wilkerson, a GE spokesman, acknowledged the company "covered a lot of ground" in the meeting.

The restatement relates to GE's accounting for financial instruments known as interest-rate swaps, which GE uses on its short-term borrowing. Mr. Sherin said the restatement lowers GE's net income by $343 million from 2001 to 2005, and boosted 2006 profits by $130 million in the first three quarters.

In a Securities and Exchange Commission filing, GE said it failed to specify what transactions it intended to hedge when issuing commercial paper. GE has $90 billion in commercial paper outstanding, Mr. Sherin said. Of that, $12 billion is hedged to protect against interest rate volatility.

Certain hedged financial transactions can qualify for special accounting treatment that allows companies to forego reporting the quarterly change in market value; those changes, when included, can make financial results more volatile. But the SEC doesn't want companies to use hedging techniques to manipulate earnings, said Charles Mulford, a professor of accounting at the Georgia Institute of Technology's College of Management.

Mr. Sherin said GE believed it was following proper procedures. But the SEC's chief accounting officer disagreed, prompting the restatement. In May 2005, GE also restated its earnings dating back to 2001 after incorrectly applying an accounting rule for derivatives.

Of the two restatements, Mr. Sherin said, "I don't think it's systemic in any way." The SEC is continuing an investigation into GE's derivative accounting.

The company's earnings report comes on the heels of three acquisitions -- totaling $14.83 billion -- in health care, aviation and oil and gas. GE also confirmed that it is seeking a buyer for its plastics unit. Together, Mr. Immelt said, the transactions have "dramatically improved the business portfolio" for GE. "The long-term outlook for the company, in 2007 and beyond, is just a safe and reliable growth company," Mr. Immelt said.

Operating profit at its infrastructure division, which includes aircraft engines and power turbines, rose 19% to $2.89 billion in the fourth quarter. The commercial-finance unit posted an 18% increase in operating profit, to $1.51 billion; its real estate division saw earnings soar 61% to $626 million.

The company's industrial division including plastics, appliances and lighting, reported operating profit fell 12% to $673 million. Operating profit at NBC Universal, which has dragged the company down for more than a year now, increased 5% to $841 million.

-- Bob Sechler contributed to this article.

Write to Kathryn Kranhold at kathryn.kranhold@wsj.com7

URL for this article: http://online.wsj.com/article/SB116905599400279122.html

QUESTIONS:

1.) GE announced 4th quarter earnings that more than doubled its year-earlier results, showed revenue that rose 11%, and met analysts expectations and the company's own forecasts. Yet what happened to GE's stock price?

2.) What is the "quality of earnings"? Why are analysts concerned about the quality of earnings?

3.) What is GE's effective tax rate? What is the statutory tax rate? How can a financial statement user find out why a company's effective tax rate differs so greatly from the statutory rate, as does GE's?

4.) How did analysts assess the impact of GE's changing tax rate on the net income for the period? Clearly describe the steps taken and the meaning of the results.

5.) Why did the SEC require GE to restate earnings in relation to its accounting for derivatives? In your answer, state which type of derivative it was for which GE did not undertake proper accounting.

6.) Why does the issue with restating earnings raise an issue with the quality of GE's earnings?