GE’s “Material Weakness” Not That Material

Usually when a 10-K (Annual Report) filing comes out, the first thing traders peer at is the ‘Legal Proceedings’ section and the ‘Auditor notes’.  Particularly of note, they look for phrases such as "Going Concern" and "Material Weakness," among others.  It was surprising to see the "material weakness" actually come up in the screen on a company the size of GE, but if you look at the explanation it looks like it is not a huge deal at all:

We identified the following material weakness in our internal control over financial reporting –  we did not have adequately designed procedures to designate each hedged commercial paper transaction with the specificity required by Statement of Financial Accounting Standards 133, Accounting for Derivative Instruments and Hedging Activities, as amended. The restatement that resulted from this material weakness is discussed in (b) below. Solely as a result of this material weakness, we concluded that our disclosure controls and procedures were not effective as of December 31, 2006. Other than with respect to the identification of this material weakness, there was no change in our internal control over financial reporting during the quarter ended December 31, 2006, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

The company remedied part of this by doing some restatements.  The "Legal Proceedings" section was actually shorter than on many smaller companies and that is perhaps some of what was adding gains right after the open on the stock besides a pre-market upgrade from UBS to a Buy from Attractive and the target was raised from $40.00 to $45.00.

The company also showed that its 2006 share buybacks were 49 million shares and it still has $11.8 Billion that it can use to repurchase stock.  Traders have taken the stock down today and it is either because of the weak market or because of the restatement from the "material weakness" note.  If it is on the material weakness note then they are probably reading too far into it and not qualifying the details in the statement.

GE said it is positioned for sustained high single-digit revenue and double-digit earnings growth, while expanding margins and returns.  GE had been positive on the day early on, but shares are now down 0.4% at $35.20.  Today’s high is $35.60 and the 52-week trading range is $32.06 to $38.49.

Jon C. Ogg
February 27, 2007

Jon Ogg is a partner in 24/7 Wall St., LLC and he can be reached at [email protected]; he does not own securities in the companies he covers.