Red Flags in Amended Annual Reports - Quarterly Update #2
Amended annual reports deserve investor's attention because they often deliver bad news.
Why amended 10-Ks are important?
Companies frequently submit revised annual 10-K reports to make technical changes, such as filing proxy information or correcting minor typos. These amendments are typically routine and hold little significance for investors.
Nevertheless, some amended reports convey adverse news, such as uncovering inaccuracies in previously submitted financial statements or reporting deficiencies in internal controls. These revisions warrant scrutiny because the disclosed negative information may be substantial, and the amended filing could serve as the initial source for announcing such developments. (For additional examples, see the discussion at The Dig).
Amended 10-K filings - quarterly update #2
In this quarterly update, I examine the reasons for the 10-K amendments filed between January 1, 2024, and March 31, 2024. Companies filed 169 amended 10-K reports in the March 31, 2024 quarter.
Table 1 below reflects the primary reasons for the amendments.
The discussion of selected categories is below.
Audit opinion or consent updates. In the March 31, 2024 quarter, 37 10-K/As were filed to correct or modify information contained in audit opinions or auditor’s consents. While most of the issues involved correcting the opinion's signature dates, several amendments were more substantial.
MOMENTOUS HOLDINGS CORP (Ticker: MMNT) filed an amended 10-K on March 21, 2024, to include an audit opinion for the year ended May 31, 2023, signed by the audit firm Beckles and Co. Inc. The Company noted that the previous opinion for the year ended May 31, 2023, was signed by JP Centurion & Partners PLT and included a “disclaimer” language stating that JP Centurion was unable to obtain sufficient evidence to determine whether financial statements are presented fairly. Disclaimer opinions are rare. According to the Audit Analytics audit opinions database, MMNT was the only 10-K filer receiving a disclaimer opinion in the past two years.
Healthcare Triangle, Inc. (Ticker: HCTI) filed an amended 10-K on January 4, 2024, to remove the audit report issued by Ram Associates & Company LLC for the year December 31, 2021, and include a report issued by BF Borgers for the stated year. The PCAOB sanctioned Ram Associates on August 10, 2023, and revoked the audit firm’s registration with the PCAOB. A revocation of registration of an audit firm casts a shadow on the financial reports signed by that firm and is a red flag for investors. Notably, the Company dismissed Ram Associates on January 25, 2023, and engaged BF Borgers CPA PC to audit its financial statements for the year ending December 31, 2022.
Restatements & error corrections. In the March 31, 2024 quarter, 17 10-K/As were filed to disclose errors in previously filed financial statements – including 14 to correct consolidated financial results and 3 to correct numbers in the footnotes. The amended filings primarily provided additional details to the previously disclosed errors – say it differently: the amended filings were not the first announcement of the restatement.
Based on the check box disclosure on the cover page, in five cases, the errors were considered a restatement in the context of Rule 10D-1, and none of these errors required a compensation recovery analysis.
For EQUITY LIFESTYLE PROPERTIES INC (Ticker: ELS), the restatement and the amended 10-K were prompted by the SEC's comments. In its May 17, 2023 comment letter, the SEC asked the Company to clarify what issues were included in the reclassification from net investment in real estate to other assets on the cash flow statement. The company acknowledged that the reclassification was to correct an error. The SEC pressed, and on October 25, 2013, the Company reported a little r revision. After additional follow-up comments from the SEC citing the materiality of the errors, the Company determined on January 22, 2024, that the accounting mistakes were material and should be reported as a Big R restatement.
Notably, in December 2023, SEC’s Chief Accountant Paul Munter warned companies that the errors in the presentation of the cash flow statement could be material:
“In certain instances, the staff in OCA have been presented with analyses that conclude an error in the statement of cash flows is not material because it is an error in classification only. We have not found such analyses and their corresponding arguments persuasive since classification itself is the foundation of the statement of cash flows.”
In addition to cash flow inquiries, the SEC also raised concerns about how certain non-GAAP metrics are calculated. Specifically, the SEC noted that non-GAAP metrics that add back the change in deferred revenue liability create tailored accounting measures that are prohibited by Regulation G. The Company agreed to refrain from including the change in deferred revenue liability in calculating any non-GAAP financial measures in future filings.
The SEC review of Equity Lifestyle Properties’ financial statements included 11 back-and-forth letters and spanned over 252 days – much longer than a typical 40-to-50-day SEC review.
Disclosure or internal control issues. In the March 31, 2024 quarter, 14 10-K/As were filed to disclose revisions of Disclosure Control (DCP) or Internal Control (ICFR) reports.
Four companies disclosed a change in conclusion about the effectiveness of previously filed ICFR or DCP reports from effective to ineffective. In two cases, the amendments were prompted by the SEC comment letters, and in one case, inquiries from an audit firm led to the discovery of a material weakness.
Intrepid Potash, Inc. (Ticker: IPI) filed an amended 10-K report on January 16, 2024, to update the disclosure of mining properties under Section 1300 of Regulation S-K. The Company determined that the omission of the Section 1300 disclosure constitutes a material weakness in the Company’s Disclosure Control for the year December 31, 2022. The additional disclosure related to mining properties and the re-evaluation of the Disclosure Controls were prompted by the SEC comment letter.
Infinera Corp (Ticker: INFN) filed an amended 10-K report on February 29, 2024, to disclose that the company reexamined its “…stand-alone sales price (“SSP”) methodology as it relates to revenue allocation between product revenue, which is recognized upon delivery, and certain components of services revenue, which is recognized over a period of time.” The reexamination revealed a material weakness in the Company’s Internal Control over Financial Reporting for the year ending December 31, 2022. The review was prompted by inquiries from the Company’s audit firm, Ernst & Young LLP, following the inspection of Infinera's audit by the PCAOB.
Harbor Custom Development, Inc. (Ticker: HCDIQ) filed an amended 10-K report on January 18, 2024, to file management’s ICFR report. The omission of the ICFR report led the Company to conclude that Disclosure Controls were ineffective. The amendment was prompted by the SEC comment letter in which the SEC requested that the company file an omitted report and consider the impact of the omission on the DCP.
ESCALADE INC (Ticker: ESCA) filed an amended 10-K report on March 29, 2024, to reflect material weaknesses in the Company’s ICFR and DCP. The material weaknesses were related, among other issues, to IT general controls, inadequate control over the period-end process, and insufficient documentation. The disclosure did not indicate how the material weaknesses were discovered.
Exhibits. In the March 31, 2024 quarter, 14 companies filed amended 10-K filings to update or add exhibits to financial statements. Notably, in 9 of the 14 cases, the amendment was filed to provide missing or incomplete Exhibit 97, Clawback Policy. New SEC Rule 10D-1 - effective December 1, 2023 - requires companies to adopt a policy to clawback erroneously paid compensation following error corrections. The policy should be attached as an exhibit to the annual reports.
Financial statements of an equity investee. In the March 31, 2024 quarter, 11 companies filed amended 10-K filings to add audited financial statements of significant investees pursuant to Rule 3-09 of Regulation S-X. An amended 10-K filed solely to provide the investee’s financial statement is generally not a red flag because sometimes the investee's financials are not available at the time of the investor’s 10-K filing. However, substantial delays in providing the investee’s financials could be a red flag if the delay is related to the investee's operational or liquidity issues (see an example of Medical Properties Trust’s investee Steward Health Care System LLC).
For questions and historical amended 10-K analysis, please contact olga@deepquarry.com