Tuesday, October 6, 2009

How to Read 10K Reports Revisited - Cracking the Code

A portfolio manager friend of mine told the following joke to the students in my investor relations class last April: Question: If you are a public company, how do you hide something from analysts? Answer: You put it in the 10-K report. There is a lot of truth to this. Reports on Form 10-K are dense, laid out in a fashion to follow a government bureaucrat’s idea of how to display information and written mostly by lawyers and accountants. This is a deadly combination.

Because of this, companies can sprinkle little tidbits of information throughout the filing and comply with disclosure requirements without really telling you much unless you learn how to read the code. (I just read the latest Dan Brown thriller, so it may influence my writing here.) To me cracking the code means opening up two or three years worth of filings on your computer, seeing what’s changed and applying some simple math. I’ve written about this before (see my blog posts dated September 10, 2008 and March 5, 2009) but I like to revisit it periodically to show how disclosure is not necessarily the same as telling you what’s really going on.

This time I decided to look at Sysco Corporation’s 10-Ks for the past three years. I chose Sysco because having worked there, I know the company well, but it’s been long enough ago so that I did not have a hand in writing any of the 10-Ks in question. Further, Sysco, which has been faced with a shift in their industry – consumers who, in the face of economic duress, are dining out at restaurants less often – seems to be managing the downturn about as well as you could expect. Because Sysco has been coping with deteriorating sales trends by reducing their expenses, I thought that if I focused on headcount, some interesting things might pop out that perhaps should have merited more discussion in the filing. I was not disappointed.

To begin, I called up three years of 10-K filings and did a word search on “employees”. It turns out that Sysco had 47,000 full time employees last year, compared to 50,000 in 2008 and 50,900 in 2007. This means that the decline in employees is 6% this year compared to last year and 7.7% over a two-year period. Interestingly, nowhere in this year’s filing does the company talk about the trend except to mention “reduced headcount” without telling what it previously was. For that you have to go back to the previous filings. This is fairly typical of what you see companies do: give you the fact, but neither explain it or put it in the context of quantity or time. They’ve complied with the technical disclosure requirement, but haven’t really explained what’s going on.

While I was going through this exercise, I also noticed that they were engaged in a similar exercise in disclosing the number of sales related personnel. This year Sysco states that they have 13,000 sales, marketing and support staff. You have to go to the previous years’ filings to find out that this compares to 14,000 a year ago and 14,400 two years ago. So the decline in sales oriented personnel was 7.1% last year and 9.7% over a two-year period. This outpaces the decline in overall headcount and the decline in overall sales, and raises some interesting questions about sales going forward, but nowhere in the filing does Sysco address this topic. For example: Does this mean that Sysco thinks they had too many sales people before? Is this decline in sales personnel an indication of Sysco’s thinking that sales are likely to remain depressed going forward? Have they reorganized their sales force along different lines? With 9,000 more customers than in 2007 (391,000 then versus 400,000 in 2009) and 9.7% fewer sales personnel, what’s happening to customer service levels? Unfortunately, you will search in vain for answers to these questions in the 10-K.

And in this, Sysco is not alone. Companies focus on checking the regulatory boxes when they write their 10-Ks. In spite of the SEC’s efforts to the contrary, these are mostly documents that look back at the previous period’s results. What investors need is something that helps them gauge the future prospects of the company by pointing out trends and important correlations. And for that, companies leave them on their own. And then they whine that investors are undervaluing them because they don’t understand how rosy their future prospects look. As Pogo once said, “We have met the enemy and he is us.”

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