The Management Discussion and Analysis, or MD&A, portion of the 10-k is the meat and potatoes of a company’s annual report and one of the best ways to track a company’s recent progress.

While the contents of this section may vary, the Management Discussion and Analysis is great for getting specific insight into an industry and how it is moving both from a market growth and margins perspective.

Parsing the MD&A sections of multiple competitors can be a fantastic way to do a very in-depth research of an industry without paying thousands of dollars to one of those boutique “market research firms”, some of whom have been proven to be plain wrong or outright scams.

Out of the 16 Items of the 10-k, the MD&A appears in Item 7, properly called Management’s Discussion and Analysis of Financial Condition and Results of Operation. You will see this, and all of the 16 Items, on every single 10-k—though the contents inside these Items may vary greatly.

MD&A Example: Blackberry Ltd ($BB)

Let’s take the 10-k of a random software company, in this case Blackberry Ltd ($BB). This report was filed on 4/7/20 and includes data from the company’s 2020 Fiscal Year.

For this company, they had the following sub-sections within their MD&A, which I’ll add commentary to as we go along:

Note I excluded some of their non-GAAP reconciliations sections, which is not a common feature except in special situations.

Cautionary Note Regarding Forward-Looking Statements

Most of this is, as my good friend and colleague Dave Ahern says, typical boilerplate language. You should be able to skim over this, unless there are important accounting policies buried within, but in the case of Blackberry those are embedded later.

Business Overview

If you’re ever digging into a company or industry for the first time and want to get a brain dump download on the basics of that industry, this along with the usual business overview at the top of the 10-k is the best place to go.

Read this thoroughly and with full concentration, as oftentimes industry or business specific acronyms or concepts are described in this part.

Any parts about acquisitions and ownership structures are also critical to take note of, for understanding the scope of the business segments or total enterprise as a whole.

For example, I had a stock the other day that was a holding company with fully-owned subsidiaries with a similar name to the parent. Misreading these relationships or skimming them over can easily lead to wrong conclusions.

Fiscal 2020 Summary Results of Operations

Here we got the “meat and potatoes” when it comes to “what have you done for me lately”. You should be able to glean important metrics to help you calculate simple ratios like gross margins and sales or EPS growth.

Even more exciting, though, are the words that explain things like… why margins improved or got worse, whether volumes are up or down, and other important details on sales that are particular to the industry.

This section of the Management Discussion and Analysis is particularly helpful if a company has many markets it participates in within a given business segment, as many managements choose to reveal particular sales trends about those markets in these notes.

Non-GAAP Financial Measures

Sometimes businesses feel that GAAP accounting measures don’t accurately reflect a good representation of the nuts and bolts of a business and its results, and sometimes this can be industry wide as well. If that’s the case for the business you are examining, you’ll probably see a section like this somewhere in Item 7 too.

Key Metrics

Similar to the non-GAAP financials above, management clearly felt that their results required additional explaining or alternative pieces of data to better tell the picture. Take the data in this context, but it can also be very helpful in analysis at times.

Financial Condition

In this section management will usually pull out the figures from the balance sheet and other statements that they feel best present the company’s liquidity and long term health situation.

Sometimes you can find little golden nuggets in this section (well, in all sections of the MD&A), as important details regarding revolvers, senior notes, or other debt instruments can be found, among other pertinent facts relating to a company’s financial condition such as capital expenditure plans.

Accounting Policies and Critical Accounting Estimates

The key part of this section is the opinion of the auditor who reviewed this company’s financials. From parsing through this section you should be able to determine whether the auditor had a qualified or unqualified opinion, which is a very important difference to understand as a “qualified opinion” can be a precursor to accounting fraud.

Item 7 is followed by Item 7A, which is “Quantitative and Qualitative Disclosures about Market Risk”. This section provides a good summary of risks that are pertinent to company results and the ways that these can be reflected in stock prices—such as the level of exposure to foreign exchange and interest rate risk, and/or risks of customer concentration either with accounts receivables or by percentage of revenues, if there is such risk for the business.

Looking at another software company in a similar space to Blackberry, Citrix Systems, and the Management Discussion and Analysis section on their 10-k, there were listed another section within Item 7 not seen with Blackberry:

Contractual Obligations and Off-Balance Sheet Arrangement

This was included in Blackberry’s Financial Condition section of Item 7 but not as its own special section. It makes for a good example of how the MD&A for companies can be different, and the extent of management’s wiliness to transparently disclose as much information as they can (or not).

In the case of Contractual obligations, this is a section you should see somewhere in a company’s 10-k, whether in the footnotes (a treasure trove!) or like you see here in Item 7. Contractual obligations outline example what kind of capital commitments the company faces in the next 1, 2, 5+ years.

These obligations can include things like rent on a property (often called operating lease or financing lease), debt and interest due (on bonds, notes, or otherwise), and purchase obligations for capital expenditures—among other things.

Why the MD&A is Critical

What makes the Management Discussion and Analysis section so important is that you are getting this information straight from management. Within this section, management has the prerogative to include as much or as little information as they want about the business and its results.

It’s a great resource because you are getting analysis “straight from the source”, and from the personnel who are most intimately involved with the company. As Warren Buffett says about what he likes to see in a company’s 10-k:

“I’d like to have a report that would be identical to what if I owned half of a company but was away for a year but had a partner who owned the other half. When I came back, that he would tell me what had taken place during the past year and what he foresaw coming up. If we read a bunch of public relations gobbledygook, and we see lots of pictures and no facts, it has some effect on our attitude toward the business. We want to understand the business better when we get through the annual report than when we picked it up.”

Investor Takeaway

Reading through the Management Discussion and Analysis (MD&A) section of a company’s 10-k is a critical step towards understanding how a business is doing and what it does, straight from the leadership of that company.

Once you’ve mastered this step, you can move on to dissecting the entire 10-k report, in a way that’d make even Warren Buffett proud.