Wednesday, January 24, 2007

Universal Technical Institute -- Failing Grade

In December 2006, Universal Technical Institute Inc. (UTI-$22.32), provider of post-secondary education for students seeking careers as professional automotive, diesel, collision repair, motorcycle and marine technicians, said its fiscal 2006 income from operations fell by about 27.1%—to $40.7 million—on a sharp increase in costs and expenses.

Management had previously believed the road to sequentially higher profits was—to paraphrase from the movie
Field of Dreams: “If you build it, [they] will come.”

At a
Bank of America 35th Annual Investment Conference in September 2005, management declared that a sound growth strategy was predicated on a customer-centric, “recruit to demand” approach. They predicted that the technical markets UTI serviced would produce NEW job openings of about 51,000 per annum, with aggregate market growth of 12% -to- 19% by 2012.

How best to meet this anticipated growth? New opportunities = NEW campuses + existing campus & industry driven curriculum expansions.

Seating capacity utilization for the fiscal year ended September 30, 2006 was 64.9% as compared to 69.9% during the same period a year ago.

“Numerous external and internal factors led to lower capacity utilization,” said UTI’s management. OOPS! Seating capacity build-out grew faster than student enrollment.

Operating margin for the year ended September 30, 2006 was 13.1% down from 18.0 percent. Lower than planned students, as well as higher operating costs including compensation related costs, advertising, depreciation and a reduction in force, lowered margins as compared with the year ended September 30, 2005.

Recognizing the need to cut costs [w/o admitting errors in their business model], management in September 2006
announced a headcount reduction in its workforce:

  • "These actions, while extremely difficult, are essential to UTI improving operational effectiveness and efficiencies. Numerous external and internal factors have led to lower capacity utilization resulting in the need to reduce our operating costs. This workforce reduction is one component of a broader corporate effort to create a more efficient organizational structure. When Company-wide initiatives focused on improving capacity utilization are fully realized, the Company can build on a more efficient operating structure," commented Kimberly McWaters, President and Chief Executive Officer.

One hundred dollars invested in UTI Common Stock on December 17, 2003, was worth $67.90 as of September 30, 2006. In comparison, $100 invested in the NYSE index earned a cumulative total return worth $136.90 in the same period.

In view of the Company’s inability to execute on its business plan—student enrollment issues—the 10Q Detective believes that UTI deserves a failing grade.

One passage in the Company’s vision statement reads: “We make decisions based on the organization’s purpose, the legitimate needs of our people, and the necessity of profit.”

Has UTI demonstrated integrity in all interactions—including governance—while earning the trust and respect of others?

John C. White has served as UTI’s Chairman of the Board since October 1, 2005. The Board saw fit to pay Messer. White almost $470,000 in salary and cash bonus last year, healthcare and other “fringe benefits” of $34,139, and $129,154 in restricted stock awards.

For a Company looking to reduce its operating costs, might such compensation be considered excessive? In awarding Mr. White his incentive compensation awards, the Committee
“considered Mr. White’s position within UTI and his contributions to the continuing success of the Company.”

Dubious compensation metrics—we are being rhetorical—given that the Chairman usually carries little or no real power in terms of policy or operating decision making.

If the Company gave a monkey a gavel and sat him in the Chairman’s seat at Board meetings, would the monkey have been deserving of $470,000 in salary/bonuses?

Since 1991, UTI has leased, too, some of its properties from entities controlled by John C. White or entities in which Mr. White’s family members have an interest. In FY ’06, total payments made by UTI to these entities totaled approximately $1.87 million.

Mr. White beneficially owns about 2.7 million shares, or 9.7%, of the common stock outstanding, worth an estimated $60.3 million.

Disgruntled shareholders and enrolled UTI students can learn one lesson — and an old one at that—by observing governance habits at UTI: “He who has the gold makes the rules!”

Valuation Analysis

UIT is selling for about 30.4 times September 2008 consensus EPS estimates of 74 cents, near the high end of its trailing four-year peak-trough.

In addition, competition from online and campus-based for-profit educators—e.g. Apollo Group (APOL), Career Education (CECO), and ITT Educational (ESI), coupled with industry perception problems –closer federal oversight (alleged fraudulent payment claims at some degree program schools) and complaints of non-qualified academic staffs--will probably pressure UTI’s operating and share price performance in the coming quarters.

Editor David J Phillips does not hold financial interests in any of the companies mentioned in this posting. The 10Q Detective has a Full Disclosure policy.

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