Form 10-Q

The Rules

The 10-Q is the quarterly report every public company must file. It’s similar to the 10-K, a firm’s official annual report, but with some significant differences. For starters, by definition the 10-Q covers only the most recent quarter, typically comparing those results with numbers for the same quarter of the previous year. In addition, companies must file 10-Qs more quickly than 10-Ks — within 40 days of the end of a fiscal quarter, as opposed to 60 days for most 10-Ks — making them a bit more timely. And 10-Qs forego the detailed description of a firm’s business that starts a 10-K. Instead, 10-Qs jump right into the financial statements.

A 10-Q typically has two sections: Part I: Financial Information, including financial statements and management’s discussion of them; Part II: Other Information, such as legal issues and significant stock sales.

What to Look For

You can use the 10-Q much as you do the 10-K, bearing in mind that the quarterly report focuses primarily on the company’s financial numbers. Here are some tips about how to interpret the data:

• Do the results measure up? You should check the company’s numbers (earnings, revenues, units sold, debts, expenses) to see if they’re similar to projections. The reasons why (or why not) should be laid out in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
• Check receivables. If you have concerns about the company’s business, take a look at the receivables line of the cash-flow statement. If receivables have climbed relative to sales, for example, that may mean the company is having a hard time collecting from customers. In extreme cases, this is where you might find hints that a company is cooking the books.

  Say a CFO is $4 million short of reaching a quarterly revenue target. He might call a loyal customer and offer to sell $4 million worth of equipment — with the understanding that the customer can return it the next month. “The company books $4 million in unrealized revenue, and the CFO makes his numbers,” says Alex Motola, manager of the Thornburg Growth Fund. “But the company will never get that money.”

  Motola recommends taking an especially close look at receivables if the company made its revenue numbers by a hair. Check past 10-Qs to see what portion of quarterly revenues receivables normally make up — the percentage varies by company and industry — and be suspicious if they jumped. “Say a company barely makes its quarterly numbers and receivables go up 15 percent from what’s normal,” he says. “There’s not necessarily a fire, but there’s definitely smoke.”

• Check the tax bill. Another place to look if you’re uneasy about a business is any footnote or subsection in the cash flow statement that details a change in taxes paid. Be skeptical if the company reports strong earnings growth but isn’t paying much more in tax.

  Motola uses Enron as an example. “Enron’s financials assumed rapidly growing earnings, but the tax line items on their balance sheet weren’t increasing,” he says. “They weren’t paying more in tax because they weren’t really earning that money.”

  A company’s tax bill may lag its income for valid reasons, but those reasons should be spelled out in the notes immediately following the financial statements.

• *Evaluate recent acquisitions. When a public company buys a privately owned firm, it can be difficult to judge how well the combined entity will do right away. A segment of the 10-Q that’s usually titled “Business Combinations” can help. The section has the revenue the firm would have generated if it had owned the acquired firm during the entire quarter. It also shows the total revenue for both companies during the same quarter a year earlier. With that information, you can estimate the acquired company’s growth rate and project how much it might add to the overall bottom line.