What a 10-K is hiding (and where to look)

Where companies hide bad news

Every 10-K filing has two parts: the part the company wants you to read and the part it has to file. The part it wants you to read is the front: the CEO letter, the highlights, the glossy charts. The part it has to file is the back: the financial statements, the footnotes, the legal disclosures.

The bad news is always in the back. Almost without exception.

Red flag 1: revenue recognition language that "smooths" results

Look in the Notes to Financial Statements for the section called "Revenue Recognition" or "Significant Accounting Policies." Read it carefully. You're looking for language like:

• "Revenue from long-term contracts is recognized on a percentage-of-

completion basis using management's estimates of total contract costs."

• "Customer acceptance is presumed at the time of shipment unless

otherwise specified."

• "Returns reserves are estimated based on historical experience."

None of these are inherently wrong. All of them are levers. A company that's missing its quarter can tighten or loosen these estimates and move reported revenue by a meaningful percentage without violating GAAP.

The signal: when a company changes one of these policies year over year, or when its revenue grows faster than its accounts receivable suggests it should, the estimates may be doing more work than the business.

Red flag 2: a deferred revenue line that doesn't grow with revenue

For subscription and SaaS businesses, deferred revenue (the cash you've collected but not yet recognized) is a leading indicator. If reported revenue is up 30% year over year but deferred revenue is flat, the business has actually slowed down — the company is just recognizing revenue faster.

The opposite is also true. Stripe-like businesses that grow deferred revenue faster than reported revenue are typically accelerating, even if the income statement looks flat.

Where to look: the balance sheet, current liabilities, line called "Deferred Revenue" or "Customer Advances."

Red flag 3: stock-based compensation as a percent of revenue

Stock-based compensation is a real cost. The fact that it doesn't move through the cash flow statement doesn't make it free. Diluted share count growth is the real dilution rate.

Healthy ratio: SBC < 10% of revenue for mature companies, < 25% for growth companies. Above 25% and the company is essentially printing shares to compensate employees, and existing shareholders are paying for the entire payroll in dilution.

Where to look: the income statement (SBC is usually broken out in operating expenses) and the cash flow statement (SBC always shows up as an add-back in operating activities).

Red flag 4: working capital releasing cash that shouldn't be released

Working capital is accounts receivable + inventory - accounts payable. When a business grows, working capital normally grows too — you have to fund more receivables and inventory.

If a company is reporting growth but working capital is shrinking (releasing cash), one of two things is true: either the business is becoming more efficient (good) or the company is squeezing customers and suppliers in ways that aren't sustainable (bad).

Where to look: the cash flow statement, operating activities, line called "Changes in working capital" or its components.

Red flag 5: a tax rate that doesn't match the law

US corporate tax rate is currently 21%. Most companies actually pay somewhere between 18% and 25% after credits and deductions.

When a company reports a tax rate below 10% or above 35%, you need to understand why. Common explanations: tax credits (legitimate), non-recurring items (one-time), or aggressive international structures (potentially fragile).

Where to look: income statement (effective tax rate) and the "Income Taxes" footnote, which always reconciles statutory rate to effective rate. Read it.

Red flag 6: management's discussion of "non-GAAP" measures that exclude growing items

Every 10-K has a Management Discussion & Analysis (MD&A) section. Read the part where they reconcile GAAP to non-GAAP earnings.

Companies typically exclude:

• Stock-based compensation (the recurring kind)
• Amortization of acquired intangibles (often recurring)
• "Restructuring" charges (sometimes recurring for years)
• Litigation expense (sometimes recurring)

If the exclusions are stable as a percent of revenue, that's a disclosure preference. If the exclusions are growing as a percent of revenue, you're watching the gap between reported performance and economic performance widen.

Red flag 7: customer concentration that grew

Public companies must disclose any customer that represents 10% or more of revenue. Look in the "Risk Factors" section or the "Revenue" footnote.

Customer concentration isn't inherently bad. Some great businesses have huge anchor customers. But if a company that had no >10% customer last year suddenly has one (or worse, two), three things might be true:

• The business pivoted toward a market with consolidated buying power
• An anchor customer demanded better terms in exchange for staying
• Revenue from smaller customers shrank, mathematically promoting the

larger ones

In all three cases, pricing power probably went down. Watch gross margins for the next four quarters.

The order I read 10-Ks in

After many years of doing this, here's the order I open the pages:

1. Risk Factors. Usually 20-40 pages. Skim for new risks vs last year's 10-K. New risks are signal. 2. Selected Financial Data. Five years of summary numbers on one page. Spot the trend before getting distracted by the latest year. 3. MD&A. This is the company's own narrative. Read it knowing they want you to think a specific thing. 4. Cash flow statement. Always the cash flow statement before the income statement. Cash is harder to fake than earnings. 5. Income statement + balance sheet. Now read the headlines. 6. Notes to Financial Statements. The truth lives here. Specifically: revenue recognition, deferred revenue, segment reporting, related-party transactions, and subsequent events.

The whole exercise takes 90-180 minutes per company. If you're investing real money, it's the cheapest research you'll ever do.

What we automate at Veridion

Our Veridion Score reads SEC filings nightly across the broad scored universe: core most-traded US equities, major ETFs, user-held names, Capital Web holdings, and an active common-stock expansion. Coverage badges matter for newly listed or thinly reported names. The fundamentals factor in the Score includes:

• Year-over-year change in deferred revenue
• Year-over-year change in stock-based comp as % of revenue
• Working capital growth rate vs revenue growth rate
• Effective tax rate vs statutory rate
• Customer concentration trend

You can read what the Score does at /static/lab.html. The factors are public. The specific coefficients are under NDA for Pro and Enterprise customers.