I'm a dinosaur when it comes to the electronic age. I'm the only one in my family that uses a desktop personal computer while everyone else is using laptops and tablets. I'm still running the Windows Operating system while most of the others have moved to Apple products. I prefer to have paper copies of all my bills in order to have a record of expenses when tax time rolls around. I keep hard copies of all of my trade confirmations and monthly statements so I have a record of transactions and positions in order to file the requisite claims for the occasional class action claims and settlements.
I also prefer to receive physical copies of corporate annual reports and proxy statements so I can slowly thumb through the pages of data and dog-ear those pages that might turn into articles for Seeking Alpha. So, it shouldn't surprise anyone that an oversized envelope from Capstone Turbine (CPST) arrived in the mail this past week. One section that always interests this investor is executive compensation.
Although I consider it a futile exercise, I routinely vote against the "ADVISORY VOTE ON THE COMPENSATION OF THE COMPANY'S NAMED EXECUTIVE OFFICERS AS PRESENTED IN THE PROXY STATEMENT." And, since the Directors structure the compensation plans and are recommending that shareholders vote in favor of the pay packages, I also routinely withhold my vote for all the directors.
It's not just Capstone executives that I believe are overpaid, it's nearly all executives in publicly traded companies. In the comments section of a Capstone article written last week I was asked the following question:
So much to stay away? I hate it when they live high on the hog while share price is diluted away. Is compensation in line?
My reply was:
"Is compensation in line?"
I'm absolutely the wrong person to ask about an opinion on exec compensation. Aside from Warren Buffet, I find US company director and exec compensation packages exorbitant. Much of the dilutive effect comes from changes to the tax laws that limited the deductibility for salaries over $1 million.
That article was generally positive about the opportunity of Capstone as an investment. The company has been growing revenues, entering into new vertical markets and new geographies, and has been improving gross margins. It also continues to generate significant losses, including a $23 million loss in its most recent fiscal year on record revenue of $128 million. I had also noted that shareholder equity had been significantly diluted over the past few years, in part due to executive and director compensation. So, how do investors really know if the compensation is "in line"?
Half of the roughly 50 pages of the 2013 proxy statement are devoted to a discussion of executive and director compensation. Below are three statements regarding the executive compensation plan:
The Compensation Committee believes that the Company's executive compensation program should... Attract and retain individuals of superior ability and managerial talent by offering total compensation that is competitive with a group of companies that are of comparable size within similar industries and other companies with which the Company competes for executive talent... ...Provide compensation that aligns the financial interests of executives with those of Capstone's stockholders through long-term equity incentives that take into account the Company's performance...
In setting compensation, the Compensation Committee reviews information from Aon Hewitt regarding comparative market data, including comprehensive analyses of total compensation and compensation components based on published survey data sized to our annual revenue. The published surveys used by the Compensation Committee in its analysis covers publicly-traded technology and manufacturing industry companies that are between $50 million and $200 million in revenue.
The information provided by Aon Hewitt is described above under "-Overview-Role of Compensation Consultant." The data included the levels of compensation paid at the 50th percentile and 75th percentile of the comparable companies. The Compensation Committee did not set compensation for Named Executive Officers at these or any other percentiles but, instead, used this data as benchmarks in assessing the appropriateness of our compensation arrangements.
It all seems somewhat reasonable. Select a peer group for total compensation, and then construct a compensation plan that aligns executive pay with shareholder interests. I would feel somewhat more comfortable if the proxy did not include the phrase that the compensation committee "did not set compensation for Named Executive Officers at these or any other percentiles."
As investors, we certainly want to see the executives compensated in a manner that aligns their interests with ours. We should also want to see them fairly compensated. That's where the process breaks down. What constitutes fair compensation? Especially if the compensation committee states that it did not set compensation at "these or any other percentiles."
Capstone is a company that has been selling micro-turbines for 15 years and is still looking to turn a profit. Should the compensation committee be including pay scales for executives running profitable companies? And, even if it could devise a peer group of executives operating companies at a loss, it still begs the question of whether that compensation is "fair."
Looking at the proxy statement shows the compensation for five "named executive officers" for the past three years. During that time, the share price declined from $1.27 to $0.90. During that time the company was notified that the NASDAQ was considering delisting the stock. During that time the company had average annual revenue of $106 million and an average annual loss of $27 million.
The total compensation of that executive team was nearly $3.2 million per year. For the individual executives, their average annual compensation ranged from a low of $325 thousand for the CFO to a high of $1.14 million for the CEO. (The remaining three officers were more closely bunched together, ranging from $0.53 million to $0.61 million.)
Is their compensation in line with the industry? If we are to believe the compensation committee, it should be. As a shareholder looking at the share price decline, the bonuses awarded and the compensation for a team that exceeds 3% of revenue, I find it to be excessive, regardless of whether or not it is in line with a peer group. And, I will be voting my shares against Proposals 2 and 3 that address executive compensation and I will also vote against the board of directors that unanimously recommended that I vote in favor of the plan.
Regardless, I will continue to hold the stock in the speculative part of my portfolio devoted to higher risk assets that have the potential for well above average returns... even though it does appear that the executive compensation is not well aligned with this particular shareholder's interests.
Additional disclosure: I also hold a position in Apple, and hold no positions in any of the other companies mentioned in this article.