GE Faces An SEC Probe of Accounts -- WSJ

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (January 25, 2018).

General Electric Co. said securities regulators have opened a probe into the company's accounting practices, a new challenge to the conglomerate's efforts to untangle its problems and turn around its struggling business.

The Securities and Exchange Commission is investigating how the company recognized revenue from long-term service contracts for projects like power-plant repairs and jet-engine maintenance, GE said. The Boston-based giant, which reported revenue of $122 billion for 2017, has about $15 billion of such service contracts on its books.

The SEC first inquired about the contract accounting in late November after the company sharply revised its financial projections, according to a person familiar with the matter. Last week, the agency sought additional information about GE's review of its insurance business after the company disclosed a massive charge, this person said.

The U.S. investigation brings more uncertainty to an industrial powerhouse that has fallen on hard times, and adds to the obstacles that new CEO John Flannery must overcome. It also provides fuel for analysts and investors who have long regarded GE's accounting and some of its holdings as a "black box."

"If you were concerned about black box issues in the past, aren't you much more concerned about it today?" said John Inch, an analyst at Deutsche Bank.

GE's finance chief, Jamie Miller, who disclosed the probe on an earnings call with investors Wednesday, said the company is cooperating with the SEC. She said the probe was in "very early stages." In an interview, Ms. Miller said she has been conducting a "deep review" of GE finances and that she hasn't seen indications of accounting problems.

The disclosure came after GE reported declines in fourth-quarter revenue and profit. Shares of GE had rallied as much as 5% in premarket trading, but surrendered those gains after the SEC probe was announced. Shares have tumbled 45% over the past 12 months.

Ms. Miller, who used to run GE's Transportation unit and took over as finance chief on Nov. 1, played down the specter of additional unexpected charges at GE, noting that she is "pretty well through" her review of the company's balance sheet. She said she continues to review GE's financial processes, systems and past decisions.

GE's accounting has long been a subject of scrutiny. The company regularly beat Wall Street's estimates under former CEO Jack Welch. The precision with which it did so, though, led critics to question the results.

In 2009, GE paid $50 million to settle SEC allegations that it had used improper accounting methods to boost earnings and revenues in 2002 and 2003. The company didn't admit or deny the SEC's allegations in agreeing to the settlement.

Under former CEO Jeff Immelt, the company wound down much of its lending business in the wake of the financial crisis and made big acquisitions to expand its power and oil businesses. But the industrial units struggled in recent years to generate enough cash to pay the company's dividend, prompting the company's move in November to cut the investor payout by half.

GE has a growing portfolio of "contract assets" coming mostly from its core power and aviation businesses. These are assets based on revenues GE books on multiyear contracts before it has the cash in hand, for things such as servicing power plants and building complex equipment like gas-power systems. The company has said it would eventually realize all the cash related to those contracts.

GE's contract assets on its balance sheet were $28.9 billion at the end of December, down slightly from September but up $3.7 billion from a year ago. A spokesperson said about $15.2 billion of the balance is from long-term service agreements, with the remainder related to equipment contracts. The service contracts are generally 10 to 30 years long.

The level of contract assets relies in part on GE's own estimates and assumptions about how much profit it will ultimately reap from those contracts, and analysts have said they have little visibility into those estimates. In the first nine months of 2017, earnings stemming from the increase in contract assets amounted to $1.93 billion, according to GE, more than half the company's pretax earnings from continuing operations.

Last week, GE surprised investors when it disclosed it would book a $6.2 billion charge in its fourth quarter related to its insurance operations and needed to set aside $15 billion over seven years to bolster insurance reserves at its GE Capital unit.

Mr. Flannery, who took over last summer and slashed GE's financial projections, has promised to simplify the company's business. Last week, he put the possibility on the table of breaking apart the company, saying he was evaluating whether to separate its major business units into public companies.

"There will be a GE in the future, but it will look different than it does today," Mr. Flannery said Wednesday. "We have a long way to go but the mission is clear."

He reiterated that he will do "whatever it takes" to make sure the core businesses are positioned for growth. "We are looking at any option we need to think about in that context," he said.

GE already is exploring ways to shed its majority stake in Baker Hughes, which includes GE's former oil business, as well as sell its century-old Lighting business. The company also is looking to sell its Transportation unit, which builds locomotives, according to people familiar with the matter.

On Wednesday, the company said it is working on more than 20 deals to rearrange its portfolio. It aims to shed $20 billion in assets. It expects to cut costs by more than $2 billion in 2018 -- more than the $1.7 billion cut in 2017 -- and will soon announce a revamped board of directors.

GE also said it would restate its 2016 and 2017 financial results because of newly adopted revenue recognition rules around its long-term service contracts. The change will result in "a lower asset balance and lower earnings going forward," Ms. Miller said, but "doesn't change anything related to our cash balances or cash flows."

The restatement is separate from the SEC inquiry and isn't related to accounting errors or other reporting problems, a GE spokesperson said. The accounting rule changes require the prior-period results to conform with the new standard.

The latest quarterly results show continued woes in GE's Power business, where revenue fell 15% and profits tumbled 88% from a year ago. The business, GE's biggest by revenue, sells turbines to power plants around the globe. In the quarter, the division's orders dove 25%.

GE revealed the problems in the power business in the fall, detailing how it misjudged a major shift in the market. Last month, it targeted cutting 12,000 jobs the division, nearly 18% of the unit's workforce.

For the fourth quarter, GE reported a loss of $9.64 billion, or $1.13 a share, down from a profit of $3.67 billion, or 39 cents a share, last year. The results were weighed down by the insurance-related charge as well as costs tied to U.S. tax overhaul. Revenue fell 5.1% from a year ago to $31.4 billion. The company said its quarterly revenue was $33.1 billion including assets that the company has put up for sale.

--Michael Rapoport contributed to this article.

Write to Thomas Gryta at thomas.gryta@wsj.com

Corrections & Amplifications On an adjusted basis, GE reported a profit of 27 cents a share in the latest quarter. An earlier version of this article incorrectly stated it was a loss. (Jan. 24, 2018)

(END) Dow Jones Newswires

January 25, 2018 02:47 ET (07:47 GMT)