How to Read a 10-K: The Annual Report, Section by Section, in About an Hour

What a 10-K is, and what it is not

Every company with shares listed in the United States files a Form 10-K with the Securities and Exchange Commission once a year, within 60 days of its fiscal year end for the largest companies and within 75 or 90 days for smaller ones. It contains a description of the business, a discussion of the year's results by management, audited financial statements with their notes, the auditor's report, and a list of the risks the company faces. Its structure is prescribed by regulation, so every 10-K has the same items in the same order, which makes them comparable across companies and years.

It is not the same thing as the annual report many companies mail to shareholders, which is a marketing document with photographs that often wraps the 10-K or summarises it. Nor is it the proxy statement, which covers executive pay, board elections and shareholder votes and is filed separately a few weeks later. The 10-K is the document with the audit and the legal exposure attached, and that is why its words are chosen carefully. The quarterly version is the 10-Q, covered in the how to read a 10-Q article.

The sections, in reading order

The form's order is Part I (business and risks), Part II (results and financial statements), Part III (governance, usually by reference to the proxy) and Part IV (exhibits). The useful reading order is different:

1. Item 1, Business. How the company makes money: products, segments, customers, suppliers, competition, regulation, seasonality, employees. Fifteen minutes here is worth more than any analyst note, because the company describes itself in its own words and must not mislead.
2. Item 7, Management's discussion and analysis. Why revenue, margins and cash moved, segment by segment; liquidity and capital resources, including debt maturities; and the critical accounting estimates, the judgments on which the reported numbers most depend.
3. Item 8, Financial statements and notes. The income statement, balance sheet and cash flow statement, then the notes: revenue recognition and disaggregation, debt, leases, commitments and contingencies, income taxes, segments, and any note on significant customers.
4. The auditor's report, at the front of Item 8. Look for a clean opinion, for the critical audit matters the auditor chose to describe, and for any mention of going concern.
5. Item 1A, Risk factors. Mostly boilerplate, but companies must update it, so compare it with last year's and read whatever is new.
6. Item 9A, Controls and procedures. One paragraph normally; a reported material weakness is a serious flag.
7. Item 3, Legal proceedings, and the related note, for anything large enough to matter.
8. The proxy statement, separately, for how management is paid and on what measures, which tells you what they will optimise.

Worked example: an hour with Northfield Tools (illustrative)

Northfield Tools is a fictional industrial company. An hour with its 10-K produced this:

None of this appears in the earnings release, and all of it changes how the year's 9% growth should be read. The earnings analysis guide sets out how the release, the call and the filings fit together.

Red flags worth checking every year

• Customer or supplier concentration. Any customer above 10% of revenue must be disclosed. One large customer is a dependency; one large customer in financial trouble is a crisis in waiting.
• Related-party transactions. Business with entities controlled by executives or directors, in a note of its own. Occasionally innocent, often not.
• A change of auditor, especially after a disagreement, or an audit opinion with a going-concern paragraph.
• A material weakness in internal controls in Item 9A, which means the numbers themselves are less reliable.
• Recurring non-recurring items. Restructuring charges or impairments that appear every year are operating costs under another name.
• Changes in accounting estimates that lift earnings: longer asset lives, lower reserves, more optimistic revenue-recognition judgments.
• Cash from operations persistently below net income, or receivables and inventory growing faster than sales.
• Debt maturing within two years with no obvious means of repayment, and covenants with little headroom.
• Growing 'other' lines in the segment note or the balance sheet, which is where things go to avoid being explained.

Tools and habits that make it faster

Filings are free on EDGAR, the SEC's database, where full-text search finds any phrase across every filing and the "Financial Report" view presents the statements as tables. The habit that pays most is reading this year's 10-K beside last year's: the changes in risk factors, accounting estimates, customer concentration and the auditor's critical audit matters are the news, and everything that stayed the same can be skipped on the second pass. Keep a note of the three numbers you will check next year and what would worry you, which is the beginning of an investment thesis.

VALYSTR's company pages take their financials from these filings, with free cash flow, return on capital and leverage computed from the filed statements; the free cash flow formula and net debt to EBITDA articles show how each is built from the lines described here.