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.

Avnet’s recently announced that it needs more time to tie up its books for the December quarter and will be late in filing its Form 10Q with the SEC. The electronics wholesaler has historically been a timely filer, but asset impairment issues have the Avnet accountants working late. The company says it needs more time to complete tests of goodwill and other intangible assets to determine if the assets are “impaired”—do the assets still have the earning power to justify values carried on the company’s balance sheet?

The December 2008 quarter results included a $10.0 million after-tax charge for restructuring and integration, but made not mention of other unusual charges.  However, in the late filing notice, Avnet disclosed it has already determined that the assets are indeed impaired and that a “significant charge” will be recorded in the December quarter.  It is just a matter of checking the math and then parsing the explanation of just how many apples in Avnet’s barrel have gone rotten. 

It would seem Avnet apples have a very short shelf life, with nearly a third of goodwill and over half of intangible assets arising from a series of twelve acquisitions Avnet completed over just the past two years. Deals done in the frenzy of an equity market bubble rarely hold up well against the test of time.

Avnet held $1.8 billion in goodwill on its balance sheet at the end of December 2008, representing a 30% increase in the last two years. Goodwill is composed of $1.2 billion related to electronics marketing and $644.1 million related to the company’s technology solutions.  The company also had $114.9 million in net intangible assets (last disclosed at the end of September 2008) associated with customer relationships, over half of which arose from the June 2008 purchase of Horizon Technology Group Plc. 

Customer relationships might be the most vulnerable of Avnet’s intangible assets. At the end of last year Avnet claimed relationships with over three hundred of the world’s leading electronic component and computer product manufacturers and software developers.  It is these supply relationships that Avnet uses to serve its customer base of more than 100,000 electronics designers, manufacturers, and resellers.  It is a “who is who” that includes the likes of Siemens, Jabil Circuit, Flextronics, and Garmin.

Jabil is cutting its workforce and Flextronics already charged of all of its goodwill assets in a $5.9 billion charge recorded at the end of 2008. Indeed, it may be Flextronics action, announced just six days after Avnet announced its December quarter results that made Avnet auditors take a second look at the value of Avnet goodwill and intangible assets.

Reporting by contributor Debra Fiakas, who does not hold a financial interest in any stocks mentioned in this article. The 10-Q Detective has a Full Disclosure Policy.

Although fuel prices per metric ton have receded more than 47 percent from record high levels, cruise operator Carnival admits that 2009 will be a challenging year, with weaker consumer spending resulting in falling demand and softer cruise pricing, and a stronger U.S. dollar (versus the Euro) hurting European markets. In addition, customers are opting to book trips closer to the actual date departure, looking for bargain pricing on these close-in bookings. Despite limited visibility in forward operating profitability, Carnvial remains committed to expanding berth capacity, according to the company’s 2008 regulatory 10-K filing:

As of January 28, 2009, we had signed agreements with three shipyards providing for the construction of 17 additional cruise ships scheduled to enter service between March 2009 and June 2012. These additions are expected to result in an increase in our passenger capacity of 38,056 lower berths. The net impact of these additions is a 22.5% increase in passenger capacity as compared to our January 28, 2009 passenger capacity [total of 169.040 lower berths on 88 ships].

Management remains optimistic that the long-term growth potential of the cruise industry remains healthy, given relatively modest market penetration in North America, the largest market for alternative vacations to land-based resorts. In 2008, 19.9% of Americans had cruise experience-with 51 million Americans expressing interest in taking a cruise by 2011-according to a Cruise Market Profile Study published by the Cruise Line Industry Association.

Expansion will not come cheap, however, as Carnival has $17.4 billion in cash obligations coming due through 2013, including: shipbuilding costs of $8.3 billion; long-term liabilities and interest payments totaling $8.1 billion and $2.5 billion; and, operating leases, port facilities, and other purchase obligations totaling $1.7 billion. In December 2008, Standard & Poor’s Rating Services assigned a negative outlook to Carnival’s A- credit rating, citing concern that the weakened state of the economy and continued pull back in consumer spending would pressure cash flow. Albeit the current state of the economy will likely lead to lower revenues in 2009, an analysis of the company’s balance sheet suggests a sequential decline in operating results would not materially impact Carnival’s ability to meet its debt obligations. For example, of the $17.4 billion, only $5.2 billion comes due in 2009, and long-term debt has a weighted-average maturity of five years.

In fiscal 2008, Carnival’s net cash from operations declined year-over-year 16.7% to $3.4 billion, reflecting the timing in receipt of customer deposits (as more guests opted for close-in bookings). Free cash flow was a negative $38 million, principally resulting from $2.7 billion spent on the ongoing shipbuilding program.

In light of the current uncertainties in the global economy and a desire to preserve cash and liquidity, the board of directors voted to suspend the quarterly division beginning in March 2009. This move will save about $1.2 billion in cash outflows this year.

At November 30, 2008, although Carnival had a working capital deficit of $4.1 billion, if one excluded customer deposits and debt obligations not maturing in 2009, the adjusted working capital deficit decreased to $950 million. Total debt was a manageable 32.9% of capital and a fixed-charge ratio of 5.8 times indicates the company has more than enough financial muscle to satisfy its existing financing expenses.

Despite the deteriorating global economy in 2008, net cruise revenues increased 12.9% year-on-year to $11.5 billion, driven by both a 6.7 percent increase in available passenger capacity and a 3.7% increase in passenger ticket prices, partially offset by a 1.6% decrease in onboard sales. Cruise occupancy held stable at 105.7 percent.

Carnival cannot cancel existing newbuld contracts without substantial financial penalties. I caution readers, therefore, that contrary to management’s optimism, If the recession persists into 2010, forcing consumers to opt out of cruises altogether, the company will likely need to access the debt markets for shipbuilding financing.

KLA-Tencor Corp., a leading maker of inspection and measurement systems for semiconductor manufacturers, posted a consolidated loss of $434.3 million in the second-quarter 2009 as the weak economy continued to drive a slowdown in demand from its customers. In addition to the bad news that customer demand is forecasted to remain weak for the duration of 2009, as consumers in most countries slash discretionary spending for electronics and other goods that use chips, KLA-Tencor is being hit with another poke in the eye by volatile currency movements. Approximately 83 percent of its operations are concentrated in Europe and Asia, according to the chip equipment maker’s 10-Q regulatory filing.

Although KLA-Tencor attempts to hedge its currency risk, its concentrated exposure to customers in Asia translates into lost profits when the dollar weakens against local currencies. The U.S. dollar emerged from a multi-year slump and gained 4.5 percent against the Euro, but lost 18 percent in value against the Yen last year. And, in China, the Renminbi has gone up 20 percent against the greenback in the past three years. By geographic region, Europe and Japan/China represent about 11 percent and 45 percent of total revenue. Consequently, for the three and six-months ended December 31, the company lost $17.9 million and $81.6 million on currency adjustments.

Chief Executive Rick Wallace told analysts on the second-quarter 2009 earnings call the company saw few signs of any meaningful recovery in business prospects for the third-quarter-and management was guarding against the possibility that chip maker demand-and sales-could actually decline further from already cyclical lows. In my opinion, continued economic weakness in the U.S., coupled with the printing of billions more in paper by the Treasury to prop up a mortally-wounded banking system, will likely weaken the U.S. dollar more against key currencies-translating to additional currency losses for KLA-Tencor in coming quarters.

For the quarter ended December 26, 2008, net revenue was $1.8 billion, a decrease of 17% over the quarter ended December 28, 2007. Total hard drive shipments increased to 35.5 million for the second quarter of 2009 as compared to 34.2 million for the second quarter of 2008. The decreases in revenue resulted from a decline in average hard drive selling prices [16 percent to $51 per unit] during the three months ended December 26, 2008. The decline in our average hard drive selling prices reflect a very competitive pricing environment as a result of all competitors having anticipated more robust demand and consequently having too much supply available for the demand that materialized. The decline in our ASPs was partially offset by increases in unit shipments, which resulted from our continuing diversification into non-desktop markets. For example, we shipped 13.8 million 2.5-inch drives in the three months ended December 26, 2008. This compares to 8.7 million units in the three months ended December 28, 2007. Revenue from all non-desktop PC markets comprised of 65% of hard drive revenue for the quarter ended December 26, 2008 as compared to 54% for the prior-year period.

Prices and margins will continue to erode until end-user demand stabilizes and customers can access credit financing to begin upgading storage systems, which is forecasted to occur in first-half 2010. No matter how one spins it, hard drives exist in a commodity marketplace, where demand and supply balance remain critical. Nonetheless, in my view, Western Digital can stumble through the trough of this economic slowdown by cutting costs. Management told analysts on the second-quarter earnings call it believes the company can remain profitable and cash flow positive by maintaining operating expenses in the range of 9 percent to 11 percent of revenues at a $1.5 billion quarterly run-rate (by “re-sizing” production-slash output-and idling or closing facilities). Although year-on-year the cash conversion cycle more than doubled to nine days, the company threw off $300 million in cash from operations during the December quarter, ending with total cash and cash equivalents on hand of $1.4 billion.

The first one-terabyte hard drive came to market less than two years ago. Does the average consumer really need an additional 1,000-gigabytes of storage? Probably not. But when the global economy turns around, and original equipment manufacturers start pumping out next-generation electronics that gobble ever-larger volumes of digital content, such as graphic files for gamers, mobile devices with multiple applications, home-entertainment systems capable of storing 1,000 movies, and higher capacity business database and external file servers, Western Digital will be ready with its 2-terabyte hard drive.

Byetta

Activist investor Carl Icahn announced in a regulatory filing with the Securities and Exchange Commission his intention to nominate a slate of five directors to the board of Amylin Pharmaceuticals at the drugmaker’s May 2009 annual meeting, and to solicit proxies in favor of that slate. The move raises questions about whether Icahn plans to push Amylin for a management shakeup or position the company for a sale.

What’s Icahn’s interest in Amylin? Ill-timed purchases of stock in 2008—in the mistaken belief that the shares were undervalued, according to a May 2008 regulatory filing. The billionaire investor’s position of approximately 11.4 million shares, acquired at an estimated purchase of $26.23 a share, has lost almost 58 percent in value, as prescription sales of Amylin’s lead product Byetta, the diabetes medication sold in partnership with Eli Lilly,  slowed to a crawl in the second-half 2008 after the FDA announced several severe cases of acute pancreatitis among patients taking the drug.

Icahn’s frustration with current management and Chief Executive Daniel Bradbury is understandable. Byetta is currently prescribed as adjunctive therapy, administered as a subcutaneous injection 30 to 60 minutes before the first and last meal of the day. The safety issues surrounding Byetta, however, have both delayed an FDA decision on the use of Byetta as single-agent therapy—previously expected by year-end 2008—and raised fears among industry watchers that Amlyn’s decision to seek approvability for exenatide once-weekly long-acting release (LAR) based solely on data from its DURATION-1 will prove to be a costly error in judgement. Management gambled that the surest path to marketing approval was to demonstrate comparability in efficacy between twice-daily injections and exenatide LAR. However, this rush-to-file strategy will likely backfire on the company. In light of the pancreatitis controversy (and high-profile pharma drug withdrawals over the last several years), the FDA will face political pressure to require additional safety testing, forcing Amlyn to delay its plans for exenatide LAR’s new drug application to the FDA until late 2009, as additional patient data from DURATION-2 and –3 study information will not be available prior to the second and third-quarter of 2009, respectively.  

The impact of a delay in bringing exenatide LAR could prove disastrous to Amalyn, for competitive threats to Byetta loom around the bend, with Onglyza (saxagliptin), a joint venture between Bristol Myers and AstraZeneca in Phase III clinical development,  and Novo Nordisk’s Victoza (Iraglutide, the same class as exenatide, but with allegedly better efficacy) expected to be reviewed by a FDA Advisory Committee in March 2009.

It is foolish to think that Icahn can do much to expedite the development of diabetic and obesity compounds in Amlyn’s portfolio. He might, however, be more ‘persuasive’ in convincing Bradbury and the board to sell the company to its diabetic partner, Eli Lilly. Afterall, in October 2008, he pushed Imclone into the arms of Lilly after taking control of the oncology company in a bruising 2006 proxy fight.

Pilgrims Pride_logo

On December 1, 2008, Pilgrim’s Pride voluntarily filed for financial relief under Chapter 11 of the U.S. Bankruptcy Code after losing $820 million in 2008 and failing to renegotiate its debt agreements with lenders. The largest U.S. chicken processor allegedly struggled with low meat prices caused by an oversupply of chicken and weak consumer demand, and record high costs for the corn and soybeans used in its animal feed. A read of the company’s amended 2008 regulatory 10-K, filed with the SEC on January 26, 2009, suggests that (a) senior executives more interested in self-enrichment and (b) a self-serving board of directors failed to safeguard shareholders’ interests and minimize opportunistic behavior on the part of management. Ergo, neglect of fiduciary responsibilities played a significant role as year-on-year financial results and the capital structure deteriorated beyond the tipping point.

In fact, several lawsuits have been filed on behalf of shareholders, alleging among other complaints: (a) the company’s hedges to protect it from adverse changes in costs were not working and in fact were harming the Company’s results more than helping; (b) the company’s financial results were continuing to deteriorate rather than improve, such that the company’s capital structure was threatened; (c) the company was in a much worse position than its competitors due to its inability to raise prices for customers sufficient to offset cost increases, whereas its competitors were able to raise prices to offset higher costs affecting the industry; and (d) the Company had not made sufficient changes to its business model to succeed in the more difficult industry conditions.

Ovem lupo commitere is Latin for ‘To set a wolf to guard sheep.’ The proverbial foxes guarding the chickens at Pilgrims Pride were none other than founder Lonnie “Bo” Pilgrim, 80, and family members:

·         The company paid cash compensation to Bo totaling $2.1 million and $3.2 million in 2008 and 2007 to serve as ‘Senior Chairman’ of the Board. Self-enrichment on a scale befitting Roman Emperors or French Nobility is a common occurrence among company founders—especially in the case of Bo Pilgrim, who beneficially controls 62.3% of the voting stock of the company. As an aside, Bo was instrumental in the December 2007 acquisition of poultry producer Gold Kist for $1.1 billion—which aggravated an already strained debt load. In spite of the challenges facing Pilgrim’s Pride today, the empirical evidence suggests that Bo seems more focused on related-party (personal) transactions:

1.      Pilgrim paid $1.01 million to Bo under a chicken grower’s contract in 2008;

2.      Bo is the owner of Pilgrim and Pilgrim Poultry G.P (PPGP), which rents facilities to the company for the production of eggs. During fiscal 2008, PPGP earned fees of $775,000 on the rented facilities; and,

3.      Since 1985, the company had leased an airplane from Bo Pilgrim under a lease agreement, which provided for monthly lease payments of $33,000 plus operating expenses. During fiscal 2008, lease expenses and operating expenses totaled $396,000 and $59,970 associated with the use of this airplane. (Albeit the company’s financial health caught a summer cold, it took the board until November 18 to cancel this aircraft lease.)

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• Bo Pilgrim’s son, Ken Pilgrim, 50, serves as Co-Chairman of the Board, earning cash compensation of $544,077 and $588,887 in 2008 and 2007.
• Additionally, his other son, Pat Pilgrim; and his daughter, Greta Pilgrim-Owens, were employed by the company and received total compensation for fiscal 2008 of $220,281 and $227,669, respectively.
• The company purchases grain from Pat Pilgrim, too, who earned $392, 398 for purchases in 2008. Pat also provided hauling services to the company in fiscal 2008, for which he was paid $47,962.
• Conflicts of interest involving certain members of the Board call into question the ethics of Pilgrim’s corporate governance system, too. For example, Director Blake Lovette’s son-in-law, Ted Lankford, is employed as a Complex Manager at Athens, AL, and was paid total compensation of $132,350 in 2008. Blake Lovette serves on the Compensation Committee.
• In addition, Pilgrim also employs former Vice-Chairman of the Board Clifford E. Butler’s son, Shane Butler, as Senior Vice President Prepared Foods Regional Operations, who was paid total compensation of $240,967 in 2008.

On January 27, the United States Bankruptcy Court approved the company’s hiring of Don Jackson as president and chief executive officer. “As Pilgrim’s Pride begins the reorganization process, we believe the company and its stakeholders would be best served by a fresh perspective on the opportunities available to us through restructuring,” said Lonnie “Bo” Pilgrim. “Don Jackson is a proven leader with the essential skills and industry insight to position Pilgrim’s Pride to emerge from Chapter 11 as a stronger, more efficient, and more focused company.” Might this fresh perspective also include the firing of named executive officers and board members instrumental in the company’s current situation?—the only senior executive to have left the company is former chief executive O.B. Goolsby, who died from a stroke while still in the employment of the company in December 2007.

In conjunction with the Chapter 11 filing, the company sought—and received approval—to enter into a $450 million debtor-in-possession financing facility arranged by Bank of Montreal as lead agent (the “DIP Financing”).

It is worth noting, too, that the $450 million debtor-in-possession financing facility involves financial performance guarantees. Pilgrim must meet minimum monthly levels of EBITDA. For the three-month period ended April 25, 2009, the company must show EBITDA of $57,200,000, according to the amended 10-K filing. With the same management and board in power at Pilgrim, however, it is difficult to imagine how the poultry producer will emerge from the down cycle as a much stronger and more efficient competitor.

Whole Foods Market is that rare, publicly traded company that actually does align the interests of its management team with those of its workers and stockholders. In fiscal 2008, the natural foods and organic grocery chain’s compensation and benefits program continued to reflect the company’s philosophy of egalitarianism. Cash compensation (salary and non-equity bonuses) for executives remained capped at a multiple of 19 times the average annual wage of hourly workers, or $652,400 and $34,334, respectively, according to the annual proxy filing.

In contrast, the chief executive officers of large U.S. companies averaged $10.8 million in total compensation in 2006, more than 364 times the pay of the average U.S. worker, according to a 2007 survey presented by the AFL-CIO union.

In 2008, Whole Foods founder and chief executive officer John Mackey voluntarily cut his annual salary to one dollar (and earned zero in cash incentive bonus). The annualized average rate of pay for all named executive officers, excluding Mackey, was $412,000. Albeit no named executive officer received performance-based bonuses in 2008, four executives (excluding Mackey) did receive $150,000 in discretionary bonuses approved by the board. Amid the recession, as hard-pressed consumers are turning more to value foods, the company is struggling to attract traffic through its store doors to purchase premium—more expensive—organic, grocery items. Given the economy, the company has opted not to issue guidance on comparable store sales for 2009.

Approximately 96% of the options granted under Whole Food’s plan have been granted to workers who are not executive officers. Unfortunately, in less prosperous times, the good intentions of egalitarian philosophy are no better than clothing ourselves in fig leaves. Workers dependent on option bonuses for discretionary spending learn to go without—as they make less per hour than the executives. The share price of Whole Foods has plummeted almost 70 percent in the past 52-weeks, closing at $11.48 a share in trading on Tuesday.  The weighted average exercise price of options granted to executives and non-executives was $21.52 a share and $24.72 a share as of January 2009.

Tod Nielsen, Chief Executive of Borland Software, is moving from the top honcho role at the software development provider to a supporting role as chief operating officer at VMware, a leader in desktop and storage virtualization. Borland was reticent on the reason behind Nielsen’s resignation — other than to say “the appointment of Erik Prusch to Acting President and CEO was consistent with the Board’s on-going succession planning process.” Might the fact that the company is expecting a significant year-on-year sales shortfall — fourth-quarter 2008 sales are expected to come in at about $40 million, down from fourth-quarter 2007 sales of $61.5 million — be the catalyst behind the executive shuffle?Of interest, the company made no mention of plans to recruit a new CEO. Could the lack of clarity on succession be a budget issue, too? In the same announcement, Borland revealed Prusch will not be getting extra pay for additional responsibilities and, in another cost-cutting initiative, 130 employees, or 15 percent of the work staff, will be let go during the first quarter 2009.

Borland’s current experience with executive succession matters is in sharp contrast to the drama playing out at Apple Inc. Investors have been fretting for months about the ability of Steve Jobs to lead Apple, given his apparent health issues. How the PC and gadgets company handled dissemination of news on the health of its chief executive has triggered an investigation by the Securities and Exchange Commission, according to a report by the Bloomberg news agency. The SEC purportedly wants to ensure Apple did not mislead investors about Jobs’ health.

The question of executive succession is one of expendability. At Apple, investors apparently view Jobs as irreplaceable, making the road ahead bumpy for Chief Operating Officer Tim Cook, who will lead day-to-day operations in Jobs’ absence. Borland’s Prusch will likely not have the SEC peering over his shoulder, for the company has a paltry market capitalization of $49.5 million. Borland just does not receive the media interest showered on Apple, with a $79 billion market cap.

For the shareholder, however, financial stakes are just as real at Borland. BORL shares are trading 75 percent below the stock’s 52-week high. AAPL shares are down 57 percent from its year high.

Then there is the issue of management change at Citigroup. The financial web logs and chat rooms are abuzz with talk about the future of the faltering financial titan’s chief executive, Vikram Pandit. Although Pandit sacrificed his bonus for last year, even that gesture may not be enough to silence the clamor for blood at the beleaguered bank. Would the “succession planning process” make room for Pandit at Borland?

Image Credit: ABC, “Dancing With The Stars”

Reporting by contributor Debra Fiakas, who does not hold a financial interest in any stocks mentioned in this article. The 10-Q Detective has a Full Disclosure Policy.

Lawrence Rogers, Chief Executive Officer of Sealy Corp., told analysts on the bedding manufacturer’s year-end earnings call that despite a reported 2008 loss of $2.9 million on a year-on-year 12 percent decrease in total net sales of $1.5 billion, he firmly believed that Sealy’s broad portfolio of brands, which includes Sealy Posturepedic, Stearns & Foster and Bassett brand names, across different price points — coupled with strong retail relationships and a diversified geographic presence — should position the company to maintain its leadership position in the bedding industry amid the challenging economic backdrop. [2007 wholesale market share was approximately 20.9 percent, almost 1.4 times greater than its next largest competitor, according to Furniture/Today, a furniture industry publication.] Albeit Sealy does have greater financial flexibility under recently amended credit agreements, lack of visibility into the timing of an economic turnaround could break an anemic balance sheet, as acknowledged in the 2008 regulatory 10-K filing:

• While we believe that we will have the necessary liquidity through our operating cash flow and revolving credit facility for the next year to fund our debt service requirements, capital expenditures and other operational cash requirements, we may not be able to generate sufficient cash flow from operations, realize anticipated revenue growth and operating improvements or obtain future borrowings under the senior credit agreements in an amount sufficient to enable us to do so. In addition, we rely on the revolving credit facility to provide a significant portion of our operational cash flow needs and debt service requirements. While this facility remains in place through April 2010, we expect there will be a need to refinance this debt upon its maturity. Additionally, the senior and subordinated debt mature in the following years through 2014, and we will likely be required to refinance this debt as it matures. We may not be able to affect any future refinancing of our debt on commercially reasonable terms or at all.

During the fourth quarter, Sealy successfully amended its credit agreement to increase the maximum leverage ratio under its financial covenants. The amendment increased the maximum permitted leverage ratio of total debt to EBITDA to 5.85 times through the third quarter of 2009; then stepping down to 5.50 times through the second quarter of 2010.

The amendment also loosened the minimum interest coverage to 2.0 times interest expense, increasing to 2.75 times by June 2010.

As of November 30, 2008, the company’s debt — net of cash — stood at $756.8 million, and Sealy’s leverage ratio of total debt to adjusted EBITDA and interest coverage ratio (as defined by the credit agreement) was 4.69 times and 2.87 times.

Rogers admitted on the conference call that the company does not expect to see year-over-year improvement until the second half of 2009. Operating under the notion that sales will continue below prior year levels, management will need to de-leverage its fixed costs, perhaps by shutting down assembly lines or even closing plants.

In addition, the company has a $9.2 million obligation arising from under-funded pension plans, which will require the company to contribute at least $1.2 million to the plans in 2009 (more if the realized returns are less than projected).

As mentioned, Sealy’s strategy is to weather the current retail slump by offering a breadth of product offerings across various price points. Once the global economy begins to recover, the company plans to capitalize on mattress sales at the premium end of the market (i.e. greater than $1,000 per set). However, if EBITDA drops below $130 million in 2009 — tripping debt covenants — opportunities for growth could quickly fall prey to a discounting policy mandated by bankers looking for debt repayments.