While I don’t talk much about my job as a lawyer here on the Dough Roller, I can tell you this–I’ve read more Form 10-Ks than I care to remember. A Form 10-K is an annual report that public companies must file with the Securities and Exchange Commission (the SEC). And if you are a stock picker or just interested in how a public company is performing, understanding how to navigate a 10-K is a must. So let’s dig in.
A Brief History of the Form 10-K
The stock market crash that ushered in the Great Depression was in October of 1929 (October 24th–Black Thursday–and October 29th–Black Tuesday–to be precise). The federal government, under President Roosevelt’s leadership, took many actions to address the economic turmoil that followed. Two such actions included the Securities Act of 1933 and the Securities Exchange Act of 1934.
Important: If you want to impress your friends at the next party, refer to these two statutes as the 33 Act and the 34 Act.
While this is an oversimplification, the 33 Act covers a company’s initial public offering. Basically, the 33 Act requires a company that wants to go public to provide detailed information about the company and its financial statements to the investing public. As required by the SEC, it provides this information through several forms, one of which is Form S-1. If you want to see an example of an S-1, check out the S-1 that Bankrate.com recently filed, which contains quite a lot of interesting information about the business of online publishing and internet marketing.
The 34 Act accomplished two things important to us today. First, it established the SEC. Second, it required public companies to periodically update the investing public about the condition of the company. While the information provided during an IPO is great, things do change. And the 34 Act made sure that public companies kept investors apprised of those changes.
Trivia Question: Who was the first Chairman of the SEC? Hint: The first Chairman’s son would one day become President of the United States. See below for the answer.
As implemented by rules established by the SEC, these periodic filings include Form 8-K (current report), Form 10-Q (quarterly report), and of interest to us today, Form 10-K (annual report).
Form 10-K Overview
There are four parts to a Form 10-K, each dictated by rules established by the SEC. The first two parts provide narrative and financial data about the company, including the company’s audited financial statements. Parts III and IV include information about executive compensation, related party transactions, and various exhibits to the Form 10-K. Here’s a list of the required sections of a 10-K, along with a brief description of some of the more important items from an investor’s perspective (although they are all important):
ITEM 1. Description of Business:
ITEM 1A. Risk Factor: Companies disclose risks to their business. Risks can include competition, expiration of patents, liquidity, and a host of other things. It’s an important part of the 10-K to read when you are evaluating an investment.
ITEM 1B. Unresolved Staff Comments: This is a fairly new requirement. From time to time, the staff of the SEC’s Division of Corporation Finance (“CorpFin” for short)will issue what are called comment letters to public companies. These comment letters often raise questions about a company’s financial statements, and can result in a protracted discourse between the staff of the SEC and a company’s management. If matters raised in a comment letter have not be resolved when the company’s Form 10-K is filed, the unresolved matters must be disclosed in Item 1B. The disclosure requirement encourages companies to resolve staff comment letters expeditiously.
ITEM 2. Description of Properties:
ITEM 3. Legal Proceedings: Here companies discuss material litigation. Depending on the industry and specific circumstances, this section can be extremely important in evaluating a company.
ITEM 4. Submission of Matters to a Vote of Security Holders:
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
ITEM 6. Selected Financial Data: As the heading suggests, here companies will disclose financial data management believes is important to the entity. Item 6 is not the audited financial statements, and not all data disclosed in this section is consistent with Generally Accepted Accounting Principles (e.g., pro forma disclosures).
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations: Also known as “MD and A,” item 7 is one of the most important sections of a Form 10-K to evaluate as an investor. In MD and A, management discusses the company’s performance and future prospects.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 8. Financial Statements and Supplementary Data: This is where you’ll find the company’s audited financial statements. This section includes the audit report and the company’s balance sheet, income statement, statement of cash flows, and statement of stockholders’ equity. In addition, there are footnotes to the financial statements, which are also audited.
ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
ITEM 9A(T). Controls and Procedures
ITEM 9B. Other Information
ITEM 10. Directors, Executive Officers and Corporate Governance
ITEM 11. Executive Compensation: Reference is often made to the company’s Proxy Statement for this information. The Proxy Statement is another important filing to evaluate as an investor.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
ITEM 14. Principal Accounting Fees and Services
ITEM 15. Exhibits, Financial Statement Schedules Signatures:
Where to find a company’s 10-K
There are several ways to get a company’s 10-K. You can find most companies’ Form 10-K on their website, usually under an “investors” heading. Alternatively, you can look up any company’s 10-K in the SEC’s EDGAR database.
Make no mistake, a Form 10-K can be a lengthy, intimidating document. However, it’s filled with information that serious investors should evaluate when considering an investment in a company. While many investors leave decisions about which companies to invest in to the managers of their mutual funds, investors who make their own decisions should quickly become familiar with digesting the information in a company’s annual Form 10-K.
Trivia Question Answered: President Roosevelt appointed Joseph P. Kennedy, Sr., father of President John F. Kennedy, to serve as the Chairman of the newly established SEC.