Alexander Motola, 2013 1

How to Read a 10-KAlexander Motola, CFA

Alexander Motola, 2013 2

Quality of Earnings, Ch. 2Auditors are essentially consultants,

hired by the company they are auditing (see pg. 17 – “opinion shopping”)

DBL suggested taking the audits at face value; DBL went bankrupt in 1990 due to illegal activities in the junk bond market

Many examples in the book of clean audits where the company was out of business or had massive restatements shortly thereafter

Pg. 17 – “How much is 2+2?”

Alexander Motola, 2013 3

10-K: Why Read It? We are looking for things that are

material, that as investors we want more clarity on, that might give us an advantage versus other investors

It is not fraud free nor hyperbole free, but it is the “cleanest” source of primary information we will get

“K” has much more detail than the “Q” or the press releases

There is an art and a science to this; experience helps, and being alert helps – you are basically a detective or an investigative reporter

Alexander Motola, 2013 4

10-K: What is it? SEC filing, delivered to SEC within a specific

time from the FYE (for your companies it is 75 days for the K, 40 for the Q)◦ It is NOT reviewed in most cases by the SEC; just

made available to the investing public◦ Required of US based (Domicile) companies; some

companies are TRADED in the US, but not headquartered here – those companies file an abbreviated document called a 6-K

It covers specifically the just completed fiscal year (Annual Report), but has comparable data in it from prior years◦ There is actually a different document which is

referred to as the “Annual Report” (technically the “Annual Report to Shareholders”)

SEC filing are available in many places, but always on EDGAR (sec.gov)

Alexander Motola, 2013 5

10-K: Cover PageNot much here

◦Name & HQ location◦Fiscal Year End date◦At the bottom of page, the number

of shares outstanding as of the filing date Useful if there’s a lot of dilution Useful if there’s an aggressive buyback

program

Alexander Motola, 2013 6

10-K: Part IBusiness/Overview

◦Very generic discussion of what they do, where they do it

Alexander Motola, 2013 7

10-K: Part ISegments – what they are

Alexander Motola, 2013 8

10-K: Part ISegments – % of revenue (not

useful to us, we will calculate our own

Products and Services – description◦Important

More details – always be the lookout for something unusual

Alexander Motola, 2013 9

10-K: Part IIn Part I, the company lays out

the factors that impact their industry◦Regulation, competition,

environmental, etc.◦There is some clarity on specific

industry terms, standards, etc.◦Read all of this, it is important◦Forward Looking Statements should

be read once (for your edification, it’s largely boilerplate, and I always skip it)

Alexander Motola, 2013 10

10-K: Part I – RISK FACTORSA mix of boilerplate & extremely

important informationThey must disclose issues and

concerns they face, if somewhat opaquely

First listed issue for CTL: “Increasing competition, including product substitution, continues to cause access line losses, which has adversely affected and could continue to adversely affect our operating results and financial condition.” – this means landlines are being lost to people using cell phones as their only phone

Alexander Motola, 2013 11

10-K: Part I – RISK FACTORSCollective bargaining risks with

the labor force – 38% (and when)Discussion of specific risks from

acquisitions (unlike the rosy press releases) – substantial integration expenses, etc.

Regulatory RisksLiquidity, Capital, and Div Risks

◦$20B in debtFor the IAC: you can’t present

them all, but figure out what’s important, and drill down

Alexander Motola, 2013 12

10-K: Part I – Legal ProceedingsExtremely important

◦Mgmt. tends to be dismissive of litigation, either they will win or they are insured, reserved, etc.

◦Legal cases can be quite serious◦You will want to understand what is

serious and what is not, you will be asked (IAC)

Alexander Motola, 2013 13

10-K: Part II – MD&AFirst comes “Selected Financial Data” –

the purely financial information isn’t important (you will get better data later in the filing), but the “metrics” are important, so highlight them

MD&A “Management’s Discussion and Analysis”Overview – more description. In this

overall section, they are going to breakdown the events of the year – this is the more important qualitative info you will have about last fiscal year

For CTL, the focus in on their acquisitions and the revisions to their segment reporting

Alexander Motola, 2013 14

10-K: Part II – MD&AWe get some idea of the

acquisitions and their impact. Notice the dates the acquisitions closed.

Alexander Motola, 2013 15

10-K: Part II – MD&ADid they really grow in 2011

(internally or organically)? We are going to try to figure that out…

- Clearly access lines are declining, and it’s hard to gauge the rate of growth in broadband subs without more data…

Alexander Motola, 2013 16

10-K: Part II – MD&ATons of revenue information

◦ 4 categories, 4 segments, impacts to categories of the acquisitions (CTL core business is NOT growing)

◦ Expense and margin information about each segment, and qualitative info about what’s happening in each segment

◦ More detail on each expense line item above and below the line

◦ If you get all this revenue detail in a spreadsheet, you can calculate your own % of revenue for each item, growth rates of each item, etc.

Alexander Motola, 2013 17

10-K: Part II – MD&ACritical accounting policies

◦Most don’t read this; I always do (and changes show up in BLACKLINE)

◦Beyond the scope of this class◦Pensions are often discussed in

detail here, which can often be a hugely understated liability based on their assumptions

Debt detail, future obligations, Cap Ex detail, OBS (essentially B/S and SCF detail)

Auditor’s statement (QoE, Ch. 2)

Alexander Motola, 2013 18

10-K: Part II – Financials, etc.Basic Financials, plus comprehensive

income, Statement of Shareholder’s Equity, etc.

Footnotes◦ Revenue Recognition – this is extremely

IMPORTANT. It tells what can be recognized as revenue, and when

“We recognize revenue for services when the related services

are provided. Recognition of certain payments received in

advance of services being provided is deferred until the

service is provided. These advance payments include

activation and installation charges, which we recognize as

revenue over the expected customer relationship period,

which ranges from eighteen months to over ten years

depending on the service.”

Alexander Motola, 2013 19

10-K: Part II – FootnotesWe know that SG&A includes advertising…

We can analyze SGA-ads, we can look at ads as a % of revenue, and we can wonder why advertising declined YOY from FY11 to FY12

Alexander Motola, 2013 20

10-K: Part II – AcquisitionsLots to examine here

◦This is what they reported…

◦This is what it would look like if they owned the new companies all along…

◦Is CTL REALLY growing?

Alexander Motola, 2013 21

10-K: Part II – FootnotesA/R is discussedForeign Currency impact should

be normalized and analyzed (for CTL it is di minimis). Company may also hedge.

Debt ScheduleCredit Facilities and CovenantsMore Pension details, including

actuarial assumptionsTax detailReclassification of revenues or

expenses

Alexander Motola, 2013 22

SummaryMust read the key SEC filingsThe format for the K (and Q) are

always similar for every US company, but what is in there will vary by company, industry, etc.

Always look to mine information – everyone knows most of the data, you are looking for more and better information