- The Washington Times - Tuesday, April 4, 2006

“Nobody’s perfect” is a theme running through many of the 2005 annual reports being circulated by companies. Chief executive officers are acknowledging, if only in a sentence or two of their messages to shareholders, that their companies are not infallible:

“Without question, 2005 was a difficult year for Pfizer and for our investors,” begins CEO Hank McKinnell.

• “I made a few tough calls in 2005 that may have had a short-term impact on the stock,” said General Electric Co.’s Jeffrey R. Immelt.

• “We have communicated our commitment to cooperate fully with all investigations of accounting, brokerage commissions, sales practices and other matters,” explains American International Group Inc.’s Martin Sullivan.

Because annual reports traditionally are colorful puffery, any candor is an improvement. There also is greater financial disclosure and much plainer English this year, specialists said. With CEOs no longer citing the aftermath of the September 11, 2001, terrorist attacks as an underlying reason for less-than-stellar earnings, concern has shifted to issues such as energy prices, particularly among transportation companies.

“Airlines are under so much financial pressure that many of them haven’t even filed their SEC documents yet, let alone their glossy annual reports,” said Nancy Davis Kho, director of business development for Global Reports LLC (www.global-reports.com) in Kensington, which has a library of annual reports. “The effect of higher gas and oil prices is a topic that many CEOs are talking about in their annual report letters this year.”

Some companies are still complaining in their annual report messages about the complexity and expense of new financial reporting regulations the government required after the Enron and WorldCom scandals.

In some instances, photos and artwork still divert attention from more important financial data.

“I’m looking at the 2005 Walt Disney annual report, a work of art with Johnny Depp and ‘Pirates of the Caribbean’ on the cover, with page after page about the magic of Disney,” said Michelle Leder, editor of the Footnoted.org blog that closely tracks financial filings. “Except for a brief summary inside the cover, however, it isn’t until Page 57 that financials start and you actually learn something about how the company is doing.”

With the exception of Berkshire Hathaway Inc. boss Warren Buffett, famous for his detailed and comprehensive letter to shareholders, CEO letters often are fluff, Ms. Leder said. She skims a report’s financial footnotes before anything else because they explain how results were derived and can tip off the investor to potentially damaging lawsuits.

“The proof of the pudding is still making sure what the company writes about actually has taken place,” said Kenneth Janke, chairman of the National Association of Investors Corp., which works to educate investors and investment clubs, in Madison Heights, Mich. “Corporations now tell shareholders about the potential of the industry in which they operate and whether it is No. 1, 2 or 3 in it, which is helpful.”

The 10-year compound growth rate of both sales and earnings is useful information, said Mr. Janke, whose group uses the BetterInvesting.org Web site. Providing such historical background is a priority of electronic-device maker Gentex Corp., a 2005 national winner of the BetterInvesting Nicholson Awards for quality annual reports.

“I’ve written the Gentex annual report since 1988, and while we don’t invest a lot of money in it, we do receive high marks for being readable and providing more financial information than is required,” said Connie Hamblin, vice president of investor relations for Gentex in Zeeland, Mich. “For example, we give a 15-year financial summary, and that’s a lot of years to show.”

The traditional annual report, which is frequently provided online, is the colorful face that the company wishes to present to shareholders, employees and the public. It has a definite public relations feel to it.

More to the point is the Form 10-K the company must file with the Securities and Exchange Commission within 60 days after the end of the company’s fiscal year. This document includes an overview of the business, encompassing its products, properties, legal proceedings and financial statements for the previous fiscal year. Some cost-conscious companies in recent years have released no conventional annual report, instead providing just the 10-K filing.

When you examine an annual report, it’s fine to check out the pictures because they may help you better understand the firm’s products and services. But, more importantly, you should dissect its financial information. Besides footnotes, look at the auditor’s report to see whether it qualifies its approval of the company’s statements. The management discussion and analysis should be candid.

Scrutinize the report’s financial statements that track sales, profit, spending on research and development, inventory and debt levels over time. Be sure that you grasp the company’s brands and subsidiaries. Some complicated companies require more study. Too many investors buy stock in companies they really don’t understand, which was a major problem in the tech boom.

The annual report’s sales and marketing information should make clear where the company actually makes its money. The 10-year summary of financial figures, the list of directors and officers, and the stock price history are other important reads in determining where the company has been and where it is headed.

Send questions to Andrew Leckey, 184, 369-B Third St., San Rafael, CA 94901-3581, or by e-mail at [email protected]


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