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.”

Getting Useful IR Data for Free

Occasionally, while doing research on the web for something I’m working on, I will run across something that I didn’t know about, pause, and think, “Huh, I wonder if I’m the only one who hasn’t known about this until now?” Such was the case recently when I was engaged in research about the change in ownership of a company.

There is a web site, www.whalewisdom.com that I have found to be very useful in tracking change in investor ownership. The improbable name comes from (I think) the fact that they attempt to follow the investments of some of the largest hedge funds, the whales, and derive some measure of wisdom from what they are doing. The site is set up to help investors track the holdings of hedge funds, but it is also very useful for tracking the change in investor ownership of companies as well. The site has compiled data from SEC filings about investor ownership in companies and put it into reasonably useful form.

As most investor relations officers in the U.S. know, the Investment Advisors Act of 1940 requires that all investment advisors with assets under management of over $100 million file a report of their holdings on a quarterly basis with the SEC. The quarterly reports are known as 13 F filings and are helpful in understanding your company’s shareholder base. There is an entire cottage industry of firms that provide this sort of information to investor relations officers. Generally, this information tends to be expensive and bundled with lots of other services. The advantage of the Whale Wisdom site is that it’s free – and you don’t even have to register to use it. In this day and age of constrained budgets, that’s a big advantage.

There are several useful things you can do on the web site. You can select a company, yours, your competition or some other company, and see who owns them. You can look at ownership changes over time, as the information on filings goes back to September 30, 2007. I find this particularly useful, as when you look at a whole year’s worth of data, trends become much clearer then if you are looking at a single quarter. Are good, solid, long-term holders trimming their positions? Are more hedge funds moving in? Are you losing growth investors and getting value investors in their place? (I’ve seen this with several companies I follow closely as they have hit the wall on organic growth. When you start seeing lots of value investors, you know the P/E ratio will be a long time recovering.) You can even download the information to an Excel spreadsheet if you want to manipulate the data further.

Often times the investors themselves won’t tell you what they’re doing – the larger funds are particularly sensitive to this – so it’s up to you to figure it out. If the type of investor you are getting doesn’t match your story, it’s time to sit down and reconsider reality.

Another nice thing the site does is allow you to type in the name of an investment firm and see their holdings. So if you’ve got a new investor you’ve never heard of before, you can go see what else they own and get a feel for their investment style. You can sort their holdings to see how important you are in their investment universe. You can even see if the firm has any 13D filings, indicating the possibility that they may be a more active (read hostile) type of shareholder.

Due to the schedule of 13F filings – 45 days following the close of each calendar quarter – the information is not up to the minute. You wouldn’t want to rely upon it if you were in the middle of a proxy contest. But if you are interested in looking at longer-term trends in your company’s stock, this site is helpful. And the price is right.

Personal Note: Investor Relations Musings is taking a vacation next week, as I join 8,000 of my closest friends biking across the great state of Iowa in the rolling party known as RAGBRAI. If you are a faithful reader, do not fear, the blog will return in two or three weeks, as soon as I’ve had a chance to recover from my vacation.