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.

Nancy Pelosi Explains how 335 Million Dollars for STD\’s Will Stimulate The Economy

The Commerce Department said Thursday orders to U.S. factories for big-ticket manufactured goods fell by 5.7 percent in December, the fifth straight monthly drop, while sales of new homes plunged 14.7 percent last month, the slowest monthly pace on record.

The Labor Department said a record 4.78 million people claimed unemployment insurance for the week ending January 17. As a proportion of the work force, the number of unemployment recipients is the highest since August 1983. In a nod to the depressed economic climate, Caterpillar Inc. announced this week its intention to fire 22,000 workers, as the company scrambles to cope with a downturn in demand for its construction and mining equipment.

Mirroring the fact that the economic downturn is growing darker on the global horizon, too, electronics giant NEC Corp. reported today it will cut 20,000 workers worldwide to stanch mounting losses. And, as part of the $819 billion U.S. Economic Stimulus Bill supported by House Democrats, Speaker Nancy Pelosi explains to American taxpayers how $335 million for sexually transmitted diseases will stimulate business growth!

For-profit education provider ITT Educational Services has delivered sales and earnings growth in past economic downturns, as more people pursued post-secondary education to learn new, or upgrade existing, skills in order to help them compete in a soft economy and a tighter job market. Results for the third-quarter of 2008 ended September 30 proved no different, with sales and operating income up year-on-year 17 percent and 28 percent, on a 19.4% jump in student enrollment. Going forward, however, ITT’s prospects during the current economic climate might be less sanguine, for disruptions in the credit markets have reduced significantly the amount of private loans available to potential students.

Chairman and Chief Executive Kevin M. Modany told analysts on the company’s third-quarter 2008 conference call that its students did not suffer any additional restrictions on their ability to access private student loans during the quarter. In addition, based on recent conversations with the lenders who offered private loans to ITT’s students during the third quarter, he did not anticipate students would have more difficulty obtaining third-party private loans  during the remainder of 2008. A look at ITT’s third-quarter 2008 FORM 10-Q filing, however, suggests evidence to the contrary:

• Beginning in the second quarter of 2008, we have extended larger amounts of unsecured credit to our students due to a decrease in private education loans made to our students by third-party lenders. We categorized these receivables based on the credit profiles of our students and recorded an allowance for doubtful accounts based on our historical collection experience related to amounts owed by students with similar credit profiles.
• If our collection trends were to differ significantly from our historical collection experience, we would make a corresponding adjustment to our allowance for doubtful accounts. We write off the accounts receivable due from former students when we conclude that collection is not probable.

At September 30, accounts receivables more than doubled year-on-year to $33.3 million and allowance for doubtful accounts increased more than 230 percent to $12.8 million. In addition, bad debt expense as a percentage of revenue increased to 5.0% in the three months ended September 30, 2008, compared to 1.8% in the prior year period. Management also admitted that it expected its bad debt expense could increase further during the remainder of 2008, primarily due to increases in internally funded student financing.

CEO Modany contradicted himself, too, when he said that the funding gap for students on a forward looking 12-month basis would be about 13 percent of annual revenue, compared to a historical one percent to three percent of sales. In my opinion, should underwriting standards become more restrictive and the market for private student loans tighten further, internal funding for tuition could rise as high as 25 percent of annual sales.

ITT also said in the 10-Q regulatory filing that the company would “continue providing internally funded financing to our students who fail to qualify for private education loans made by third-party lenders.” By definition, this implies the company will be boosting enrollment by lending monies to those with lower credit score ratings –and who statistically are “higher default” risks. If so, expect bad debt expense to rise materially in coming months.