The Annual and Quarterly Reports on Forms 10K and 10Q are documents that come under the heading, “Important, but boring”. If you are an investor trying to read one of these things, it’s equivalent to drinking a glass of warm milk just before bedtime. It’s guaranteed to induce drowsiness. And that’s just the way companies want it. These things are written by teams of accountants and lawyers, whose job it is to comply with the law and regulations set out by the SEC and the courts, while saying as little as possible. While the SEC may mandate the use of “plain English”, there is no obligation to make the language interesting. It is yet another example of the focus of our corporate disclosure system on complying with regulation rather than attempting to clearly state what is going on.
Yet there’s lot of good information in there, if you can persist and find a way to dig it up. The tricky bit is that often the interesting information is what’s changed from what they used to say or what is no longer being said. And that’s hard to figure out. If you are a sell side analyst who has intimate familiarity with the company filing the report, things that are not being said may instantly pop up at you, but for the rest of us, remembering what is not there, but should be, or what has been subtly changed, is a much more difficult task. As I thought about this it occurred to me that these reports are rather lengthy documents, which no one could write from scratch every quarter. What the writers of these documents do is take last year’s document from the same time period and mark it up for changes. Certain things have to get changed – after all, the numbers aren’t going to stay the same every year; but other changes give you some insights into what the company may not be saying and how they view their disclosure obligations.
So the thing to do is to lay out this year’s and last year’s report side by side and work your way through the important sections. Just to take an example, I looked at CVS, the large drugstore chain. Picking a subject at random, I went to see how many pharmacists they have on staff, as it might be an important indicator of service levels. Here’s what I found:
“As of December 29, 2007, we employed approximately 200,000 associates, which included more than 20,000 pharmacists…”
In and of itself, this snippet of information doesn’t tell me a whole lot – if you combine it with the number of stores they had open at the end of the year, 6,301, you have a ratio of 3.17 pharmacists for every store. So I laid it next to what they said the previous year:
“As of December 30, 2006, we employed approximately 176,000 associates; of which approximately 20,000 were pharmacists…”
Now things start to get interesting – did CVS really add 24,000 new employees but no net new pharmacists? Or are they hiding behind the weasel words “more than 20,000” in 2007 versus “approximately 20,000” in 2006. Further digging showed that CVS completed a big merger with Caremark in 2007, so they could have added a significant number of employees, but they also added 99 net new stores from 2006, so the ratio of pharmacists to stores fell from 3.22 in 2006 to 3.17 in 2007. Just to maintain the same ratio of pharmacists to stores in 2007, CVS would have had to add 318 pharmacists. Furthermore, the old Caremark was a pharmacy services provider, so presumably they had pharmacists on staff that transferred over to the new combined CVS.
So what does this tell me as an investor about CVS? It sure raises a lot of questions, none of which CVS tries real hard to answer in their filings, to wit:
1. Did CVS reduce service hours and staffing for pharmacists in their stores? Have they suddenly gotten more efficient? Were 2006 staffing levels too high?
2. Is CVS having trouble hiring enough pharmacists? This was an issue with them several years ago, causing a decline in earnings and should therefore be of interest to current investors. It might even rise to the level of what an investor would consider important in making an investment decision about their stock.
3. Why doesn’t CVS use exact numbers when describing how many pharmacists they employ? Can’t CVS be bothered? Or is it that their systems aren’t good enough? You would think they would have records and systems that tell them, especially at yearend.
4. Does the use of weasel language such as “more than” and “approximately” about a key type of employee make you nervous?
5. Where are all the pharmacists from Caremark?
6. Should an investor start to look at other numbers CVS uses to see if they tie out?
The drafting of an Annual Report on Form 10K passes through many hands in a large corporation, from the internal accountants, internal securities law lawyer, investor relations personnel, outside securities law lawyers, the General Counsel, senior executives and the Disclosure Committee. When you see a change such as the one above, you have to conclude that there was a deliberate choice to be vague on the topic and hope nobody would notice.