September 17, 2019

New Year’s Eve Was Kind of a Bummer for Hertz

Man, I hope executives at Hertz got shitfaced on New Year’s Eve, because being told the company has to pay a $16 million civil penalty to the Securities and Exchange Commission to settle a case involving numerous accounting violations is not a stellar way to end 2018/begin 2019.

An SEC cease-and-desist order filed on Dec. 31 says that from at least February 2012 through March 2014, Hertz’s public filings materially misstated pretax income because of accounting errors made in a number of business units and over multiple reporting periods, as reflected in the restatement Hertz filed in July 2015.

The SEC order states:

Part of the misstated income resulted from errors made in various accounts that are subject to management estimate. For example, Hertz’s car rental business routinely recovers sums of money from third parties for damages that occur during rental. Hertz estimated an allowance for uncollectible amounts as an offset to what it recorded as potential recoveries. For years, Hertz’s allowance related expenses were understated and income was inflated because Hertz relied on inappropriate estimation methodologies that resulted in inadequate allowances and write-offs. The inappropriate methodologies occurred within a pressured corporate environment where, in certain instances, there was an inappropriate emphasis on meeting internal budgets, business plans, and earnings estimates.

Hertz routinely estimated how long it would hold cars before getting rid of them and replacing them. Those planned holding periods were part of the formula Hertz used to depreciate its car rental assets, and also could have impacted other aspects of Hertz’s business, such as maintenance costs, the order states.

But in 2013, Hertz decided to extend the holding periods of a huge portion of its U.S. car rental fleet. Many of the company’s top models, for example, had their planned holding periods extended from 20 to 24 or 30 months. That decision, and its impact on aspects of Hertz’s business, were not adequately disclosed to investors, the order says:

During 2013, Hertz did not adequately disclose its decision to extend the planned holding period for substantial portions of its fleet. To the contrary, in its Form 10-Q for the second quarter of 2013, filed on August 2, 2013, Hertz stated the following concerning its depreciation policies in Management’s Discussion of and Analysis of Financial Condition and Results of Operations (“MD&A”): “Depreciation rates are reviewed on a quarterly basis based on management’s routine review of present and estimated future market conditions and their effect on residual values at the time of disposal. During the six months ended June 30, 2013, depreciation rates being used to compute the provision for depreciation of revenue earning equipment were adjusted on certain vehicles in our car rental operations to reflect changes in the estimated residual values to be realized when revenue earning equipment is sold.” Hertz did not state in this Form 10-Q – as the Restatement later did – the significant adjustment it had made to extend the planned holding periods.

Also that year, “after having already revised its earnings guidance downward, Hertz reaffirmed the revised guidance publicly in November 2013 despite certain internal analysis indicating that the revised guidance had been based in part on inaccurate information and that certain recent internal estimates fell below the low end of that guidance range,” the order says.

Evidently, the new guidance reduced projected 2013 net income from a range of $1.78 to $1.88 per share to a new range of $1.68 to $1.78 per share, and an internal analysis projected Hertz’s 2013 results at $1.72 per share.

But …

Within two weeks, however, certain new internal analysis and data forecasted Hertz’s performance to be below the low end of the revised guidance range. Strenuous “gapclosing” efforts ensued, but by the end of October a Hertz internal estimate for 2013 still projected EPS at $1.66. Moreover, the company’s process of identifying “opportunities and risks” not yet built into its projections for year-end financial results yielded a lower number: $1.65 per share.

Hertz had analysis done to determine why internal estimates had changed so quickly. One analysis determined that the September 2013 revision had been flawed in part. Methodological errors occurred, such as recognizing marketing credits in 2013 when the accounting department had determined that in part they could only be recognized in 2014.

Nonetheless, Hertz reaffirmed its $1.68-1.78 guidance range when it issued its third quarter 2013 financial statements on November 4, 2013.

On July 16, 2015, Hertz restated its financial results for 2012, 2013, and prior periods, including selected data for 2011 (unaudited). Including revisions made in early 2014, the company reduced its previously reported GAAP pretax income by a total of $235 million.

According to the SEC order, the restatement identified 17 areas with material accounting errors across Hertz’s business units, identified additional information regarding historical depreciation and planned holding periods, identified 11 separate material weaknesses in Hertz’s internal controls over financial reporting, and acknowledged that “an inconsistent and sometimes inappropriate tone at the top” had existed and may have contributed to a number of errors, misstatements, and omissions.

After investors said he had “completely lost credibility” and “I’m sure he got the message that people don’t want him,” Mark Frissora resigned in September 2014 as Hertz CEO, a position he had held since 2006.

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