How to read a 10-K?
Which information is included in a company’s “annual report on Form 10-K” filed with
the Securities and Exchange Commission?
Find out by walking through an example of the table of contents of a 10-K filing.
A big part of the success in analyzing an annual report is knowing where to look!
For this overview, I have taken as an example the 10-K filing
of a well-known company called 3M.
Their 2017 10-K document is 176 pages in length (longer than for example Apple and Alphabet,
but shorter than GE).
A significant part of the volume of a 10-K is made up by exhibits attached at the end
of the document, such as the 3M executive life insurance plan, and the company’s long
term incentive plan.
I personally must admit that I have never spent time reading those sections (I fully
trust the company’s compensation committee and audit committee plus the company’s auditors
on that!), so the “net workload” of reviewing a 10-K document may be less intimidating than
it seems.
In compliance with SEC rules, the 10-K document has 4 parts (with Roman numerals), and one
level below that items numbered 1 through 16.
That doesn’t mean there are only 16 items in a 10-K, as we will soon see.
By taking you through an example of an actual 10-K document rather than just a theoretical
discussion, I can also show you the volume of pages for each section.
For me personally, item 1 business, item 6 selected financial data (a one-page summary
for the latest 5 years), and the financial statements in item 8 are the first things
to read in a 10-K report, followed by a review of item 7 the MD&A.
Let’s review them in numerical order, and find out what’s in them.
Item 1 - “Business”.
This is a good place to start to understand how the company operates: a description of
the company’s business, including its main products and services, what subsidiaries it
owns, and what markets it operates in.
Very useful to read, especially as companies and their business environment
are constantly changing.
How is the company organized?
What are the leading businesses?
Have there been any significant acquisitions or divestitures?
Item 1A - “Risk Factors”, information about the most significant risks that apply
to the company or to its securities.
Interesting to read, to understand the context of the business.
Be aware that this is a listing and discussion of known and identified risks.
By their very nature, unidentified risks, sometimes referred to as unknown unknowns,
have traditionally been outside the scope of risk management.
Item 1B - “Unresolved Staff Comments”.
This section will state “None” for most companies (including 3M in 2017), and will
only have information when the SEC has raised any questions about the company’s statements
that have not been resolved.
If there are any items in here, study them carefully!
Item 2 - “Properties”.
Where are the company’s headquarters located?
How many manufacturing sites in how many countries does it have?
Does the company lease or own most of its physical properties?
Item 3 - “Legal Proceedings”.
These are either listed here in item 3, or the reader is referred to item 8 notes to
the financial statements.
The outcome of legal proceedings and claims brought against a company
is subject to significant uncertainty.
The accounting for a contingency like a lawsuit is essentially to recognize only those losses
that are probable and for which a loss amount can be reasonably estimated.
Item 4 – “Mine Safety Disclosures”.
Very specific to companies that have mining operations, which for 3M is the case.
Item 5 - “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities”, contains information about the company’s equity securities,
such as share price highs and lows, dividends, and stock repurchases by the company.
Item 6 - “Selected Financial Data”.
This is a good 1-page overview to “zoom out” and get a longer time perspective.
It contains a 5-year comparison for items like sales, net income, earnings per share,
dividends, assets and debt.
The income statement and cash flow statement in item 8 usually have 3 years’ worth of
detailed financial information, and the balance sheet two years (last year’s ending balance
and this year’s ending balance).
A 5-year comparison can alert you to longer term trends.
Item 7 – “MD&A”, or Management’s Discussion and Analysis of Financial Condition and Results
of Operations.
The MD&A is designed to provide a reader of the financial statements with a narrative
from the perspective of management.
Transparency is the key here.
Very important to understand business performance, and operational drivers of this performance.
In the case of 3M in 2017, the MD&A is 35 pages.
Item 7A - “Quantitative and Qualitative Disclosures about Market Risk”, items such
as interest rate risk, foreign currency exchange risk,
commodity price risk or equity price risk.
Item 8 - “Financial Statements and Supplementary Data”.
In volume of pages, this tends to be the largest section of a company’s 10-K.
It has the auditor report, each of the financial statements, and a huge amount of notes to
those financial statements.
My approach tends to be to analyze the financial statements, make a list of items that I want
to review, and then dig through the notes to find the information related to those items,
rather than trying to read item 8 from start to finish.
Item 9 - “Changes in and Disagreements with Accountants on Accounting and Financial Disclosure”
requires a company, if there has been a change in its accountants, to discuss any disagreements
it had with those accountants.
Many investors view this disclosure (if applicable) as a red flag.
Item 9A - “Controls and Procedures” includes information about the company’s disclosure
controls and procedures and its internal control over financial reporting.
Item 9B - “Other Information” includes any information that was required to be reported
on a different form during the fourth quarter of the year covered by the 10-K, but was not
yet reported.
For most companies in most years this is another “not applicable” section.
Part III (items 10 through 14) covers amongst others corporate governance, executive compensation
and audit fees, and looks a little light in terms of number of pages.
There’s a clear reason for that.
Although these disclosures are required by the 10-K, most companies meet this requirement
by providing the information in a separate document called the proxy statement, which
companies provide to their shareholders in connection with annual meetings.
If the information is provided through the proxy statement, the 10-K would include a
statement from the company that it is incorporating the information from the proxy statement by
reference – in effect directing readers to go to the proxy statement document to find
this information.
Item 15 is a long reference list of related schedules and exhibits.
Item 16 is either blank, or a redirect to the table of contents in the front of the
10-K filing.
So where to start, when you want to read a 10-K.
For me personally, item 1 business, item 6 selected financial data (a one-page summary
for the latest 5 years), and the financial statements in item 8 are the first things
to read in a 10-K report, followed by a review of item 7 the MD&A.
Let’s see where the journey takes you!
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