Read Those 10-Ks Carefully
SEC filings contain useful information
By Michael A. Martorelli
It's annual report season again. In the past, drug companies were like most others; they competed to see which company could produce the thickest annual report, with the most colorful pictures of lab workers, drug salesmen, and patients. The descriptions of the ways they helped humanity cope with disease were heart-rending; the stories of how they discovered particular drugs were exciting and inspirational. The graphics were explosive; the numerical facts extensive. Biotechnology companies couldn't compete with expensive and splashy presentations, but they could and did explain the breakthrough nature of their science. A good annual report could be a report card for analysts, a source of pride for employees and shareholders, a goodwill ambassador for all who visited any of the company's locations, and a recruiting brochure with some longevity.
I must admit, I haven't written away for an annual report for some time; but I suspect the graphics, the pictures, and the inspirational stories of discovering drugs and treating patients are a bit toned down. Some time ago, most large companies began supplementing and then replacing their extravagant and extensive Annual Reports to Shareholders with the fact-filled and SEC-mandated Form 10-K Annual Report. The package might not be as enticing, but the content is usually superior.
Even with access to quarterly conference calls, periodic Investor Days, and frequent investor conference presentations, professional analysts and portfolio managers still count heavily on 10-Ks -- and on quarterly Form 10-Qs as well. Those documents almost always contain many useful facts and factoids not found anywhere else. The best information is sometimes buried in the dry verbiage of accounting and regulatory language, but it's there, and it's usually more revealing than management's scripted conference calls and presentations.
It's tempting for individual shareholders, company employees, and those who work for the outsourcing partners, corporate collaborators, vendors, consultants and other firms that deal regularly with publicly-held drug development organizations to ignore 10-Ks. They can be daunting; but try spending a long Sunday afternoon this month with the 10-K of the company of your choice. Here are just some of the delicious nuggets of information you'll find:
- complete details of the company's pension plan, including the status of its funding
- the size of the firm's largest customers -- and how they have changed during the past three years
- compensation plans for key senior executives (and their post-retirement benefits)
- borrowing levels, bank commitments, debt covenants and off balance sheet obligations
- descriptions of business units, including product lines, competitive positions, and growth strategies
- R&D pipelines, including spending levels on work done internally and with outside partners (sometimes including discussion of their CMO supply arrangements)
- information on taxes paid, accrued and owed
- descriptions of changes in currency values and their impact on financial results
- information on legal disputes, environmental problems, and related nasty contingencies
The Form 10-K includes all the financial information the company is required to file with the SEC. It's easy to focus on the Income Statement; but look carefully at the Balance Sheet as well, because that's where you'll find information about inventories, receivables and debt levels. If you want some insight into the way cash has flowed in and out of the company, study the line items of the Consolidated Statement of Cash Flows. Many analysts and money managers believe that Cash Flow is a more important indicator of a company's financial health than Net Income; the former tracks the passage of cash in and out of the till, while the latter is a reflection of many assumptions and accounting adjustments. Only in the Form 10-K does the company show these cash inflows and outflows in extensive detail and for each of the past three years.
Finally, please read the footnotes. Large, complex companies sometimes need more than two dozen footnotes to satisfy the SEC's requirements for explanations; smaller, one-product firms may get by with closer to a dozen. Many professional investors read the footnotes even before the statements. Those footnotes are the hiding places of some of the nuggets of information I listed earlier.
There's no excuse for every shareholder, employee, supplier, collaborator partner, vendor, contractor or anyone else dealing with a publicly-held drug development organization not to know everything included in that company's Form 10-K. Of course, publicly-owned CROs laboratories, advertising firms, software providers, etc. file 10-Ks too; employees of drug and biotechnology firms have no excuse to be ill-informed about their partners' and vendors' business and financial status.
