10-Q Detective

For the first quarter of fiscal 2009, Universal Technical Institute post anemic year-on-year net revenue growth of 0.1 percent to $90.1 million. The increase in net revenues related primarily to average tuition hikes of three percent to five percent, partially offset by an approximate two percent decline in average undergraduate full-time student enrollment and a decrease in students retaking courses.

Despite problems in the auto industry, Kimberly McWaters, President and Chief Executive Officer of UTI, a leading provider of technical education training in automotive, diesel, and collision repair, told analysts on the earnings call that strong year-over-year 82 percent growth in leads generated and a 20 percent increase in contracts written will drive comparable annual growth in average student population during the last half of fiscal 2009.

McWaters admitted, however, that growth in student populations lag such trends. At first-quarter ended December, average undergraduate full-time student capacity stood at only 66.2% of 24,670 total seats available. Albeit total starts increased by six percent to 3,319 newly enrolled students, actual show rates—defined as is the number of student starts as a percentage of those who were scheduled to start during the same timeframe—fell by 220 basis points in the quarter. After careful assessment of the drivers behind the decline, UTI management believes that weaknesses in the economy and/or concerns with the health of the automotive industry impacted students’ ability to begin school as planned.

Given the solid growth in new contracts written, management opines that focusing on show rate improvement will drive gains in operating efficiencies, including capacity utilization. Looking ahead, the flaw in this premise, however, is that improving attendance will require higher military and veteran discounts—and more students are seeking an increase in need-based tuition scholarships—which will pressure margins.

In addition, in 2007, the federal government reduced the subsidies to student loan providers. UTI began funding the gap by easing loan accessibility to students, which has not been without risk. An increase in lending activity has increased default rates, according to UTI’s first-quarter 2009 regulatory 10-Q filing:

Bad debt expense increased $1.2 million for the three months ended December 31, 2008. We monitor the adequacy of our allowance for doubtful accounts on an ongoing basis. In light of our experience during the past year related to the general economic conditions, changes in the student funding environment, and our internal execution challenges, we have increased our allowance for doubtful accounts by $0.6 million during the three months ended December 31, 2008. The remaining $0.6 million increase in bad debt expense is primarily due to an increase in the number of accounts which were transferred to our collections agency.

At December 31, UTI had committed to provide approximately $7.4 million, composed of 1,278 loans representing an average student balance of $5,755. It is likely as the recession drags on that student loan defaults will rise in coming quarters—which could jeopardize the company’s ability to access possible federal loans in the offing.

Pep Boys said Friday it closed a new $300 million senior secured revolving credit facility, replacing a prior facility that was set to expire on December 9, 2009. The financing was expected and does little to change the auto parts retailer’s dependence on sale-leaseback transactions of owned properties to access funds vital for capital expenditures, inventory purchases, and store renovations. For the nine-months ended November 1, 2008, the company had completed transactions involving 63 stores, raising $210 million, according to the regulatory 10-Q filed with the SEC on December 10.

Chief Executive Officer Mike O’Dell told analysts on the third-quarter 2008 earnings call that the company’s “liquidity position remained strong.” Yes, there is no significant debt maturating until October 2013, but the balance sheet is highly levered, with total debt approaching 85 percent of stockholder equity. Working capital stood at $207 million, but currents assets were principally composed of $585 million of inventory. In addition, the company is struggling to meet debt servicing, with a loss from continuing operations (EBITDA) of $11.8 million and interest expenses of $7 million (at November 1).

Pep Boys may be a great place to go to get “great prices on tires, oil changes, and automotive maintenance” — to quote O’Dell — but against a backdrop of rising unemployment and greater economic uncertainty, in my opinion, customers will continue to defer spending on automotive care. Focusing on solid operational execution — combined with cost reductions, postponement of new store openings, and tighter spending controls (including $10 million cutback in advertising and marketing) — will do little to lift operating profitability in the current environment.

Of the 562 store locations operated by the Company at November 1, 235 were owned and 327 are leased. Expect more sale-leaseback transactions this year, too.

As is common in the recreational vehicle industry, Winnebago Industries has entered into repurchase agreements with lending institutions, which provide that, in the event of default by RV dealers on the their agreement to repay financing, Winnebago has guaranteed to repurchase the financed merchandise. Amid the current recession, which has caused many RV dealerships to fold, inventory repurchases climbed 189% year-on-year to $4.9 million during the first quarter of 2009 ended November 29, according to its 10-Q regulatory filing:

• The company incurred a significant increase in losses associated with repurchases due to challenging motor home industry conditions (loss recognized increased to $479,000 from $37,000 last year). As a result, we have increased our repurchase reserve as of November 29, 2008, to provide for potential future losses. Repurchase reserves under our repurchase agreements at November 29, 2008 and August 30, 2008 were $1.7 million and $661,000, respectively.
• The agreements provide that our liability will not exceed 100 percent of the dealer invoice and provide for periodic liability reductions based on the time since the date of the original invoice. Our contingent liability on these repurchase agreements was approximately $142.6 million at November 29, 2008.

Going forward, given the tightening of credit standards by lenders, Chairman and Chief Executive Bob Olson said that the nation’s top-selling motor home manufacturer expects that repurchase activity will remain high — persisting for some time, possibly into early 2010. In addition, as motor home shipments for November plummeted 77 percent year-over-year to a multi-year monthly low of 700 units, the company acknowledged that it may also be necessary to offer greater discounts in order to relocate returned vehicles to alternative dealers.

In my opinion, however, Winnebago remains one of the better-positioned RV makers, due to its solid balance sheet. The company has $34 million in cash, working capital of $102 million, and no long-term debt.

Despite posting flat first-quarter 2009 earnings of $131.4 million on anemic sales growth of 1.6 percent, AutoZone, a leading retailer of automotive parts and accessories, remains upbeat about its longer-term prospects, according to its 10-Q regulatory filing for the 12-weeks ended November 22:

• In the midst of a very challenging macro environment, our business displayed a great deal of resilience. The sales of new vehicles have declined significantly while scrappage rates have remained stable. This leads to an aging U.S. fleet, which historically has be en beneficial to us. On the other hand, miles driven declined for the twelfth straight month in October [down 3.6% year-to-date]. While we believe higher gas prices have contributed to these trends, we have seen a material decline in gas prices in the last few months and we are optimistic that, over time, the decline in gas prices will lead to a more normalized trend in miles driven which could eliminate one of the major challenges our industry has faced for the last couple of years.

Chief Executive Officer Bill Rhodes told analysts on the earnings call that despite the adverse impact Hurricane Gustav and Hurricane Ike had on September sales results, the company continued to achieve strong returns on invested capital, yielding 23.9% in the latest period, up from 23 percent last year at this time. 

Although it is “worth noting that while the economy continues to challenge customers’ pocketbooks, spending has proved resilient,” said Rhodes. Sales of select discretionary products, such as car wash and wax accessories, have slowed, but most merchandise categories (including sales floor items like wiper blades, filtration, oil, and chemicals) continue to witness year-on-year sales gains. In addition, the company has not seen wholesale shifts in sales mix to lower price point merchandise. 

As Congress fiddles while the Detroit Big Three automakers burn, AutoZone’s future looks brighter.

AutoNation and CarMax, two of the largest U.S. auto retailers, could learn from America’s Car-Mart, which focuses on the “buy here/pay here” segment of the used car market. Contrary to what franchised auto dealerships are forecasting, the Bentonville, Arkansas-based chain continues to record higher sales and operating profits. For the second-quarter of fiscal 2009 ended October 31, Car-Mart reported year-on-year growth in net income of 11 percent to $3.9 million, on a six-percent rise in sales to $72 million.All the more remarkable, considering Car-Mart’s 91 automotive dealerships primarily sell older model, used vehicles and provides financing for substantially all of its customers — most of whom are higher risk, non-prime borrowers, as detailed in the 2008 regulatory 10-K filing:

• The Company’s installment sales contracts typically include down payments ranging from 0% to 17% (average of 7%), terms ranging from 12 months to 36 months (average of 27.3 months), and annual interest charges ranging from 6% to 19% (average of 12.8% at April 30, 2008). The Company requires that payments be made on a weekly, bi-weekly, semi-monthly or monthly basis to coincide with the day the customer is paid by his or her employer.

Whereas competitors, such as AutoNation and CarMax, currently face difficulty in moving trucks and sport utility vehicles off their lots, due to changing consumer buying patterns and/or restricted access in obtaining auto financing, Car-Mart is finding success in selling basic and affordable transportation. Against a backdrop of rising unemployment, Car-Mart’s decision to not focus on luxury or sports cars is paying dividends. The average car sold in 2008 cost $8,690, and was between three and ten years of age with 80,000 to 130,000 miles on the odometer.

Lending money to sub-prime borrowers is not without challenges. For the three months ended October 31, provision for credit losses was 22 percent of net sales! Car-Mart, however, operates a decentralized business strategy, with each dealership responsible for making customer credit decisions and collecting on the loans it originates. And, substantially all associate incentive compensation is tied directly — or indirectly — to collection results. Historically, credit losses, on a percentage basis, tend to be higher at new and developing stores (under six years of age), for those dealerships tend to have more inexperienced managers (in making credit decisions and collecting on customer loans) and less repeat (reliable) customers.

On average, accounts more than 56 days past due are considered delinquent. For the October-end quarter, net charge-offs as a percentage of average finance receivables was 6.2 percent, down 50 basis points from the prior year. By comparison, one of the largest U.S. used-vehicle retailers, CarMax, reported a delinquency rate (of 31 days past due) in October of only 3.76 percent — yet auto analysts project same-store used vehicle sales in coming months to continue to fall.

Going forward, although Car-Mart’s delinquency trends are likely to go higher — given rising unemployment — consumer demand (and sales) for its Honda Accords, Ford Escorts, etc., should more than offset anticipated losses from credit-impaired borrowers.

Ford said it burned through $7.7 billion in its third-quarter ended September 30, reflecting operating losses and the carmaker’s purchase of Ford Credit debt securities. To conserve cash, Ford has undertaken several cost reduction initiatives, including salaried job cuts and reduced capital spending (up to $1 billion in both 2009 and 2010). Even if management is successful in meeting its objective of trimming $5 billion in cash ouflows from North American operations, the company is still obligated to fund $13.2 billion owed to retired workers (and spouses) covered under terms of a Health Care Settlement Trust Agreement reached with the United Auto Workers union.

In conjunction with a 2007 collective bargaining agreement between Ford and the UAW, obligation to provide post-retirement health care benefits, such as medical, dental, and vision, shifted from the auto maker to a union-administered trust, called a voluntary employees beneficiary association (VEBA), after December 2009. Approved by a federal judge on August 29, funding terms of the settlement are outlined in the third-quarter 2008 regulatory filing:

• · cash of $2.73 billion; 
• a $3 billion principal amount secured note, which bears interest from January 1, 2008 at 9.5% per annum, matures on January 1, 2018, and is secured on a second-lien basis with the collateral we have pledged as part of our secured Credit Agreement; 
• a $3.3 billion principal amount convertible note, which bears interest from January 1, 2008 at 5.75% per annum, matures on January 1, 2013, and is convertible into Ford Common Stock at a conversion price of $9.20 per share; 
• an obligation to continue to make payments for ongoing retiree health care costs through 2009, which we estimate to have a present value of $1.5 billion; and, 
• an obligation to make 15 annual installment payments of $52.3 million beginning in April 2008.

In addition to the foregoing payments, Ford agreed to transfer plan assets, with a fair value of $3.5 billion to the trust. At August 29, the cash of $2.73 billion, together with the interest payments of $238 million due on the notes (issued in April), and the first installment of $52.3 million, had been transferred to the planned retiree health account. If Ford runs out of cash, who will foot the bill for the other monies owed to the VEBA, including the principal amounts of the convertible notes – American taxpayers?

Avis Budget Group warned on Nov. 7 that it might be unable to comply with financial covenants contained in its principal corporate credit facility, due to slowing demand for vehicle rental services and increases in borrowing costs associated with fleet financing. Avis’ car and truck rental businesses require substantial capital, as the company discussed in its third-quarter 2008 FORM 10-Q filing:

• “We expect our cost of borrowing under our two asset-backed rental car conduit facilities to increase approximately 3% per annum as a result of amendments to such facilities we entered into in October 2008. In connection with such amendments, we obtained a 60-day extension for the 364-day facility that matured in October 2008 while we continue to work with the lenders under that facility on a longer-term extension. There can be no assurance that we will be able to obtain such longer-term extension or an extension for our other asset-backed rental car conduit facility, which matures in February 2009.”

• “Due to reduced demand for travel services, rising borrowing costs and other factors, we may be unable to generate sufficient earnings to enable us to satisfy the financial covenants contained in our senior credit facilities. Failure to comply with these covenants would cause a default under such facilities. If such a default were to occur, there can be no assurance that we would be able to refinance or obtain a replacement for such facilities on reasonable terms.”

At September 30, Avis’ balance sheet staggered under $12 billion in debt, including $5.6 billion in borrowings from Avis Budget Rental Car Funding and $1.3 billion for Budget truck financing. In addition, the company is contractually committed to purchase approximately $2.7 billion of vehicles from General Motors and Ford over the next twelve months.

Although the company is carrying $12.4 billion in assets on the books, about 64 percent is in vehicles. Raising cash through fleet sales could prove to be difficult. Chief Operating Officer Bob Salerno told analysts on the third-quarter earnings call demand for used vehicles has slowed as both dealers and consumers were getting squeezed by credit availability. He remained cautious on the outlook for the used car market, expecting it to stay soft until dealers’ [and customers'] access to credit improves.

In the trailing twelve-months, the company generated about three times more income (before interest expense, taxes, depreciation, and amortization) than the $124 million in borrowing costs. Avis generates about 81 percent of domestic car rental revenue from corporate-owned on-airport locations. In coming months, overcapacity in the rental industry, combined with an overall reduction in business and leisure air travel, suggest the liquidity outlook for Avis could go from bad to worse.

Labor unions in the United States and Canada on Tuesday expressed concern about the prospect of job losses from any merger between General Motors Corp. and Chrysler LLC, which is controlled by private equity group Cerberus Capital Management.  But Chairman and CEO Rick Wagoner could be rewarded handsomely in severance benefits — offset somewhat by stock losses — in the event of a change in control and his subsequent separation from the company, according to the company’s recent proxy statement:

“There is no general severance plan for executives. At the discretion of the Executive Compensation Committee, Named Executive Officers could receive severance pay up to 2.99 times base salary and annual bonus target. Other salaried employees may receive up to 12 months salary upon involuntary separation.”

The annual target cash compensation for Wagoner is $5.0 million per annum, which includes a base salary of $2.2 million. So the board could offer Wagoner up to $15 million in severance pay.

Wagoner’s stock-based performance incentives, worth approximately $10 million at December 31, 2007 (common stock at $24.89), can now be cashed in for about $2.6 million. In addition, some 2.9 million incentive options awarded to Wagoner in the last decade at exercise prices between $20.90 a share to $75.50 a share are now worthless.

Upon separation from the company, Wagoner, 55, would be eligible to receive an annual annuity payment of $61,200 from his supplemental retirement plan. He will, however, have to wait until the age of 60 to tap his executive retirement plan, worth an estimated $19.7 million at December 31, 2007. In addition, Wagoner had a 2007 year-end non-qualified deferred compensation account worth an estimated $765,000.

As pointed out BNET auto industry analyst Jim Henry, U.S. auto sales for September fell 26.6% from the year-ago month, due to the prolonged credit crisis that’s making it harder for some consumers to get auto loans and for automakers to finance their own operations. Operating results at Texas-based AmeriCredit Corp, which has focused predominantly on servicing sub-prime borrowers (with credit scores of 630 or lower) underscores why — going forward — it could get even more problematic for those folks looking to access car financing. Late payments and loan charge-offs are rising, as indicated in the auto finance lender’s annual filing for fiscal 2008 ended June 30:

1. Accounts 31 to 60 day delinquencies were 6.0% at June 30, 2008, compared to 5.3% at March 31, and 4.7% last year. Accounts greater than 60 days delinquent were 2.9% at the end of the quarter compared to 2.3% at March 31, 2008, and 2.1% last year.
2. The provision for loan losses increased to $1.1 billion for fiscal 2008, or 7.0% of average finance receivables, up from $727.7 million, or 5.3 percent, for fiscal 2007.
3. AmeriCredit’s stated policy is to charge off an account in the month in which the account becomes 120 days contractually delinquent if the related vehicle was not repossessed. The writedowns totaled $39.8 million and $39.4 million at June 30, 2008 and 2007, respectively.

In my opinion, the immaterial year-on-year increase in charge-offs is disingenuous, for the company offers flexible payment deferral plans to consumers late with payments. As a percentage of finance receivables, deferment levels (one to-four times) increased 490 basis points to 24.3% from the year-ago period.

Chief Executive Dan Berce assured analysts on the year-end earnings call that the company was being aggressive in protecting liquidity by lowering origination levels by two-thirds — with plans to underwrite about $3 billion in new loans in its current fiscal year — and that AmeriCredit was on track to achieve an unrestricted cash balance in the range of $300.0 million — $400.0 million throughout fiscal year 2009.

In my opinion, the company could face liquidity problems in the coming months, with total debt of $14.6 billion running more than seven times shareholder equity and the possibility that two or three asset-backed securitization trusts could potentially trigger margin calls in 2009.

Berse summed up the current credit environment on the call when he said: “I don’t think anybody ever thought the capital markets would be in the condition they’re in today. So anything can happen in another 15 months — I guess better or worse.”

Could AmeriCredit soon join GMAC Financial Services, HSBC, and Triad Financial– which have already retrenched from writing high-risk car loans?

In this sluggish economic environment, CarMax is getting aggressive in attempts to move pre-owned vehicles off its lots. In the last month, the nation’s largest retailer of used cars has upgraded its search tools for folks looking to avoid the showroom floor. Previously, the retailer’s website could be used to research information on autos of various makes and models. Now, from the comfort of home, a car buyer shopping for pre-owned vehicles can click-on and search for cars based on a combination of personal preferences, such as desired vehicle type and fuel-efficiency parameters.

As I mentioned in this August item, aggressive incentives offered by new vehicle makers, coupled with consumer preferences for smaller cars in the face of higher gas prices, is denting demand at the used car retailer. CarMax derives about 80 percent of sales from used vehicles and is struggling to move bloated inventory of trucks and SUVs off its lots. New tools that can help customers — who are just beginning the used car shopping process — find the vehicle that they want or need, combined with no-haggle pricing, is a welcome aid for those of us who stall purchase-making to avoid answering questions from the dreaded salesman. Approximately 70 percent of in-store customers visit the website before coming to a brick & mortar store.

The company’s initiative runs tandem to shifting more of its consumer awareness spending from traditional print media to online advertising. J.D. Power and Associates found that used vehicle shoppers are more likely to find their car of choice on the Internet than by searching through print classified ads, according to Autoshopper.com. Now if only I could get my PC to serve me coffee, too.