UVE corporate governance and 2009 summary

• Directors were paid $80,000 in 2009, I'd say about average for the size of the company. It was all paid in cash (no stock awards) unfortunately.
• Bradley Meier, Chairman, CEO and President, is the founder of the company. Four other directors/executive officers have been with the company for at least 12 years. Meier owns almost 18 million shares, or 45% of the total shares outstanding. As a group, the directors and executive officers own 57.5%.
• The company used a compensation consultant company to analyze and compare compensation for UVE management versus other similar insurance and growth companies. It found that UVEs CEO, COO and CFO compensation ranked above the 90th percentile versus the comparative companies. UVE believes this is reasonable as the consultant found that UVEs performance (5 year net revenue growth, 5 year total shareholder return and 3 year net income increase) was also above the 90th percentile, and net margin was in the top quartile.
• The employment agreements with the CEO, CFO and COO provide for an automatic 20% increase in base salary every year. In 2009, the CEO received over $1.3M and the COO over $900K. Compare these salaries to the CEO of AAON, Norman Asbjornson. AAON has a market cap almost twice as large as UVE ($412M vs. $204M). According to AAONs 2009 proxy statement, Asbjornson's base salary was less than $300K. I realize it's not fair to only compare UVE to AAON base salaries, but still, it's hard not to.
• The CEO and COO receive non-equity incentive compensation based on a percentage of pretax net income. This amounted to almost $2M for the CEO and $1.5M for the COO in 2009.
• The company does not provide its executives any qualified or nonqualified pension plans, supplemental executive retirement plans, deferred compensation plans or other forms of compensation for retirement, besides the standard 401K matching contributions provided to all employees.
• The proxy statement noted that the company overpaid incentive compensation to Meier and the COO in the fourth quarter of 2009 by $217K and $163K, respectively. The amounts were repaid to the company in February, 2010. I wonder how something like this happens?

So, all in all, I'm not impressed with the structure of the compensation of executives and directors. I find the base salaries to be too large, and too much of the overall compensation comes from cash. I do like the founder of the company is still running the company, and they have been returning cash to shareholders via dividends - while it's not paid consistently, over the past year it totaled $0.44/share or about a 9% yield.

I was also very disappointed with the results from 2009's fourth quarter, which is probably affecting my sentiments towards their compensation. I'm hoping the fourth quarter was just an anomaly and things will turn back positive when first quarter results are announced, which should be soon.

AAON corporate governance and 2009 summary

I've only owned AAON for a few months but so far I really like their management and how they treat their employees and shareholders. Most of the following information came from their 2009 proxy statement and annual report. I love reading proxy statements! It's actually one of the first things I check out when starting to examine a new company.

• Insider stock ownership: Norman Asbjornson, CEO and chairman of the board, owns 3.4 million shares, or a little over 20% of the outstanding shares. As a group, directors and executive officers hold almost 29% of the shares.
• Executive management compensation is very low. Norman Asbjornson base salary was less than $300,000, the rest of the officers made approximately $163,000 each. Asbjornson's total compensation (including restricted stock awards, profit sharing, matching 401K contributions, payments for personal car leases and health care account contributions) totaled $359,000. Asbjornson also did not receive a bonus in 2009.
• Director compensation is also very reasonable. Cash payments ranged from $15,000 up to $31,000 with an average of $22,000. Stock awards added another $21,000 for each director.
• 401K - The company matches 50% up to the first 9%. Also allows employees to sell AAON stock back to the company to provide diversification.
• 10% of the pre-tax profits are paid equally to all employees.
• 3 of the 5 executive officers have been with the company since its founding in 1988.
• AAON started paying a dividend in 2006 and have increased it every year. The dividend is distributed in 2 semi-annual payments.
• AAON has also had 3 stock buyback plans in the last 10 years, in which they have bought back 4.8 million shares, or approximately 22% of the total shares outstanding.
• I like that their annual report lists all the company employees.
• They have almost zero debt and have a ROE of 25%.

To me, this is a great example of good management! From a numbers perspective, revenues were down 12% in 2009 compared to 2008, but this isn't bad compared to many other companies. And due to cost cutting and other efficiency measures, operating income and margins were higher in 2009 than 2008. EPS came in at $1.60/share, the same as 2008 (even though 2009 net income was less than 2008 due to less shares outstanding in 2009).

The only thing I saw in the annual report that I will pay attention to is that they are getting into the lower tonnage market. They have traditionally stayed in the higher tonnage area where there are less competitors. But they feel with their manufacturing experience and financial strength, they are ready to enter this more competitive, but much larger, market. They expect some short-term impacts to margins but believe it will be accretive to earnings. Let's see how this plays out over the year.

Good Management

My next few articles will probably deal with the level of corporate governance at some of the companies I invest in. This is a good time for that type of article as I have a stack of annual reports and proxy statements to look over. One of my criteria for buying stock is good management. As Peter Lynch wrote, he'd rather buy a mediocre company with great management than a great company with mediocre management.

The way I interpret good management (or good corporate governance) is:

• Executive management with large holdings of stock.
• Along the lines with the one above, stock ownership guidelines for management that requires a minimum amount of stock to be held, such as 3 times base salary (and whether they can count the options and restricted stock awarded to them).
• Management length of employment, and involvement by the founder(s)
• Board of directors that don't overpay themselves.
• Salaries and/or bonuses that are sane and don't increase dramatically, especially after a year when the stock price suffered.
• Separation of Chairman and CEO
• Paying of a dividend and increasing it regularly
• Using corporate cash wisely

There's probably nothing too dramatic and surprising on this list. It's just trying to make sure management goals are aligned with the stockholder, and that they are rewarding the stockholder.

I'd like to point out not all the companies I'm invested in pay a dividend. Nevertheless, it's just one more way for management to demonstrate its commitment to rewarding shareholders.

Determining if a company is using cash wisely is a more abstract concept, and is harder to quantify. I like the Peter Lynch measure - what type of corporate headquarters does the company have? Is it a huge, expensive and elaborate campus like Medtronic? Or a more humble structure like Graco? I think this speaks towards the priorities of management.

GGG 1Q10 earnings announcement

Graco is based in Minneapolis, where I also live, so it's easier to follow. Graco makes fluid handling and management equipment (paint sprayers, equipment for lubrication, finishes, coatings, etc). A lot of their business comes from contractors and housing, so needless to say things have been rough the past couple of years. But with the latest quarterly report things look to be on the upswing. EPS came in at $0.34/share, Revenue grew 19% (16% constant currency), with over half of the increase coming from Asia. Each of their 3 divisions (Lubrication, Contractor, Industrial) showed revenue growth and much better operating margins. They have beat analysts estimates in each of the last 4 quarters.

Their press release did not include a balance sheet or cashflow statement. This usually upsets me, but as is customary with Graco, they filed their 10Q on the same day as their earnings release. I am primarily interested in the cashflow statement - it is usually desirable to see cashflow from operations higher than net income. Plus, I want to compare the growth rate of cashflow year-over-year to revenues and earnings. For me, cash speaks much louder than earnings.

For this quarter, cashflow from operations of $16M did not impress me. This is 20% less than net income for the quarter and a larger drop from the year ago period. This was caused by an increase in inventories and account receivables, which the company attributed to the growing sales. So this may turn out to be a good thing, and for now I'm not worried about it, but will definitely watch it over the rest of the year.

Graco looks to be setting themselves up for continued growth. As the economy improves, the lubrication and industrial divisions should grow well. And once the housing market returns that will bode well for the contractor division. As this quarter also showed, Asia and Europe are also showing good growth.

Graco is a great example of the type of company I like to invest in - a small, shareholder-friendly company in boring industries. They've raised their dividend every year for at least the past 10 years, and for the last 5 years the dividend has increased at an average rate of 8.9% annually. They also will occasionally pay a special dividend, the last time was a $1.50/share dividend in 2004. They're not in a high-growth industry but by being innovative and careful with spending they continue to generate a lot of cash and grow earnings. I will write more about why I like Graco in a later post.

Why?

I hope to use this blog for a couple of purposes. The first is to track and discuss the companies and their stock that I own (or am considering) in my portfolio. By using this forum I hope to explain my reasoning for buying or selling a stock. This should help me make sure I've done my due diligence before making a move and stop me from making rash decisions. Well, at least that's the theory.

A secondary purpose of the blog is to explain my stock picking philosophy, and why I believe individual investors can do better than the overall market and most investment advisors and analysts. Much of my philosophy comes from Peter Lynch, the great Fidelity mutual fund manager. Of course, I have my own nuances and tweaks to Lynch's investment style (which probably explains why my results aren't anywhere near how well he did throughout his career!).

Note, nothing on this website should be considered as a recommendation to buy or sell any company's stock! Everybody has their own risk level and set of goals for their investments, which are likely very different than mine. If you follow this blog, then consider it an educational tool. You should never invest in a stock without doing full due diligence.