UCP Director Peter Lori Out Of Compliance With Stock Ownership Guidelines – Again. James Pirrello’s Poor Conduct In Q3. Unfortunate UCP Incentive Comp.

UCP Director Peter Lori Noncompliant – Again

According to the UCP Director Stock Ownership Guidelines, within 3 years of appointment, all UCP Directors must own equity equivalents equal to at least 3 times their annual cash retainer.

UCP Director and Univision CFO Peter H. Lori is out of compliance with those Guidelines. Mr. Lori’s third anniversary as a UCP Director passed in July of 2016. Based on the 2015 UCP Proxy Statement, the latest information available, Mr. Lori’s annual cash retainer was $85,000. Three times this amount is $255,000. Per Mr. Lori’s latest Form 4, he owns 23,273 shares and equity equivalents. With UCP shares currently selling for $9.90, Mr. Lori’s UCP position has a value of $230,000. Mr. Lori is about $25,000 short of compliance.

Mr. Lori received almost $2.4 million in total compensation at Univision last year. We find it concerning that a UCP Director with this level of wealth, who influences the stewardship of our enterprise, refuses to buy more shares in our company, which currently sell at a 15% discount to tangible book value.

Mr. Lori cannot attribute his noncompliance to surprise. We first wrote about this issue almost a year ago, on April 8, 2016 in our post entitled “UCP Directors Cortney, Lori & Wade Nearly Noncompliant With Director Stock Ownership Guidelines.

This situation speaks poorly of UCP Chairman and Chair of the Compensation Committee, Michael Cortney. We hope Mr. Cortney will ensure that the 2016 UCP Proxy explains the parameters for the Stock Ownership Guidelines, both for Directors and Executives. As we have written about extensively, Mr. Cortney and UCP eliminated the Guidelines for Executives section last year – and failed to tell shareowners.

Going back to Mr. Lori, if he does not want to purchase more UCP shares at 85% of net equity, and align his interests with other owners, he should resign from the Board. If Mr. Lori does not want to buy more shares and does not want to resign, then the other UCP Directors should remove him from the Board.

RLI Teaches Bogue & Pirrello About Honesty

We have written about the disingenuous attempt by UCP CEO Dustin Bogue and CFO James Pirrello to convince the investing public to net the Citizens goodwill writedown with the reduction in contingent commission, to artificially inflate earnings.

As we read the 2016 Annual Reports of our investees, we came across a similar situation which was communicated differently – with honesty and integrity.

We are proud, long term shareholders of RLI Corporation, a property casualty insurance company that we assert is the best pure underwriter in the country. We have owned our shares for 7 years, having purchased them in the recession. Within the PC Industry and among investors, RLI has an impeccable reputation for honesty and clarity.

In a rare capital allocation miss in 2016, RLI wrote down the goodwill from a small 2014 acquisition. GAAP required RLI to reduce the associated contingent commission, an accounting adjustment which improved earnings – just like at UCP. How did RLI communicate the contingent consideration reduction, which had a positive effect on earnings? It didn’t.

The pertinent press release does not mention the contingent commission. Here is the related disclosure:

Net realized gains for the quarter included a $7.2 million realized loss from goodwill impairment. This non-cash goodwill impairment charge was related to RLI’s medical professional liability unit, which was acquired in 2012. As disclosed in previous SEC filings, the fair value of this business has declined in recent periods. Continued premium declines, coupled with adverse loss experience in the most recent quarter, resulted in the impairment charge.

Nothing more.

RLI refrained from mentioning the positive adjustment in the earnings call. Well-known insurance analyst Randy Binner, of FBR Capital Markets & Co., asked the RLI team about the goodwill impairment. The RLI team described the circumstances leading to the writedown and their mistaken assumptions, but nothing more.

In order to learn about the contingent commission reduction and its effect on earnings, an investor has to dig through the RLI 10-K footnotes on Page 75:

“It was determined that the carrying cost of our medical professional liability goodwill exceeded the fair value. As a result, we recorded a $7.2 million non-cash impairment charge included as a net realized loss in the consolidated statement of earnings during the second quarter of 2016… As an additional consequence of the premium declines and adverse loss experience, the remaining portion of the contingent earn-out agreement associated with our acquisition of this medical professional liability business was eliminated, resulting in a $1.5 million reduction to expenses for 2016.”

Note to Messrs. Bogue and Pirrello: That is how an honest and competent management team conveys bad news to the owners of the business.

Q3 Earnings Call Revisited – Mr. Pirrello’s Deception?

While we are on the subject of dishonest and deceptive executive communication, let’s go back to the UCP Q3 earnings call. At the time, we noticed something strange in this exchange between Mr. Pirrello and Alan Ratner, builder analyst at Zelman & Associates. But we kept silent because we hoped it was a misunderstanding and that Mr. Pirrello would prove to be shareholder oriented and honest. After the Q4 UCP earnings call, we realized that our expectations would not be realized.

On the Q3 call, Mr. Ratner astutely noted that the math in the UCP press release did not add up; real estate lots were missing. At the end of Q2 2016, UCP owned 4,919 lots. During Q3 2016, UCP delivered 199 lots. At the end of Q3 2016, UCP owned at 4,361 lots. So lots declined by 558 but deliveries were only 199. This meant 359 lots are missing – what gives? asked Mr. Ratner.

At first, Mr. Pirrello avoided the question by discussing the need for greater scale in certain markets and providing assurance that lots had not been moved off the balance sheet. But Mr. Ratner appropriately pressed on a second time. To which, Mr. Pirrello responded:

Alan I wish I knew it off the top of my head. I’d like to get back to you on that and do the analysis.”

Mr. Ratner let the matter go and got off the line. Moving to the next questioner, Mr. Pirrello can be heard whispering, “I know where they are.

What’s the deal Jamie? Where are they? Don’t the owners of the business deserve to know? What are you hiding?

PICO’s Unfortunate UCP Incentivization

In the December press release announcing changes to PICO compensation, investors saw the following provision:

“PICO’s ownership interest in UCP, Inc. has been ‘carved-out’ of the Executive Bonus Plan to allow the Board of Directors of PICO to separately incentivize management to pursue PICO’s objectives with respect to its stake in UCP.”

We understand this provision to mean that PICO either will, or already has, crafted some incentive payments for “management,” which we assume to be CEO Max Webb and/or CFO John Perri, for the monetization of PICO’s 10.6 million Series A units in UCP.

We assume the particulars of these incentives remain undisclosed for strategic reasons. Given UCP’s refusal to create value for owners, which has produced a power struggle between UCP and PICO, it would be bad taste and bad strategy for PICO to publicize incentives for what will be a zero sum game.

Since the initial disclosure in December 2016, we have voiced our objection to this “carve out.” In the meantime, we sought disconfirming evidence for our opinion. While we have given this effort more than a college try, we have yet to find a supporter; the best we could find was one fence sitter.

The press release says “management,” so let’s begin the analysis there.

Mr. Perri is PICO’s CFO. For many years prior, he was Chief Accounting Officer under John “The Juicer” Hart. As historical CAO and current CFO, Mr. Perri seems pretty far removed from the mechanics of a UCP transaction. Mr. Perri will likely play a strong supporting role in any UCP transaction- as CFO that is his job. But it appears he will be one step removed from the crucial gears and cogs of any deal and he will be unable to accelerate the timeline or increase the price – both of which are criteria for the payment of incentives.

When UCP is transacted, Mr. Perri will have work to do; he is PICO’s CFO. But we pay Mr. Perri $440,000 per year with the expectation that he will do some non-bonus producing work. A supporting role, which corresponds with a typical CFO job description, does not deserve a cut of the proceeds.

Which brings us to Mr. Webb. This gentleman was PICO’s CFO for many years and has been a member of the UCP Board since July 2013, when it went public. Mr. Webb is now PICO’s CEO and remains on the UCP Board. So Mr. Webb wears two hats – as PICO’s CEO and as a UCP Director.

Should Mr. Webb be incentivized as PICO’s CEO?

As CEO, Mr. Webb is paid a half a million dollars a year to implement corporate strategy as laid out by the PICO Board. That strategy mandates the sale of assets and return of capital to owners. Many of those assets are fully owned by PICO, but UCP is not.

If UCP is sold outright, UCP will form its own committee, hire its own investment bankers and professionals, conduct its own sale process. Mr. Webb may be called upon to shoulder extra work in such a case, but again – we operate under the assumption that for $496,000 per year, shareholders can expect Mr. Webb to engage in work that isn’t subject to special incentives. Perhaps we are old fashioned.

If PICO sells its UCP stake in a separate transaction, Mr. Webb will have to work to do. But will he deserve a cut of the proceeds? We ask a question in response: Can Mr. Webb meaningfully shorten the timeline or increase the price? Our answer is “no,” based on how builders are bought and sold.

Large builders have highly sophisticated land buying operations. They employ professionals whose sole job is to buy land in specific markets. Such professionals employ a regimented and elaborate process for underwriting land. They start broad, looking at the community, its regulatory atmosphere, the local economy, population growth, household income. Then they narrow the analysis to the properties, the surrounding area, comparable transactions, the logistical access, proximity to employers and schools. Finally, they examine the lots, the sizes, the configurations, the infrastructure.

Then the builder analyzes how the parcels fit into its larger portfolio. Is this a contiguous acquisition or entry into a new market? Does the builder already have strong trade relations in the area? Is the builder familiar with local regulations and municipal authorities? The list goes on.

All variables contribute to a purchase price, which is calculated based on strict criteria and fundamental analysis. There isn’t much a seller can do to cajole larger amounts of cash from a buyer. We aren’t talking about technology or patents or intangible human assets. We are talking about land. Of all goods and services that are traded in an economy, land is one of the most readily subject to valuation.

As a result, we fail to see where Mr. Webb can shorten the timeline or bring PICO shareholders a higher price for this transaction.

Want proof for our opinion that verbiage doesn’t influence builder valuation? Look no further than UCP’s stock price. It trades at a pathetic 85% of tangible net equity and at about 67% of our estimate of fair market value. This valuation persists in the face of desperate and deceptive efforts by Messrs. Bogue and Pirrello to talk up the stock. Zelman & Associates just published a report on UCP with the words in the title “Discount Justified.”

Messrs. Bogue and Pirrello can’t convince the investing public to pay more for UCP. They can’t convince builder analysts to pay more for UCP. They can’t convince debt investors to lend money to UCP. How are they going to convince a sophisticated and experienced buyer to pay more for UCP? They can’t. And neither can Mr. Webb. No one can.

In either a sale or stake transaction, will Mr. Webb have to work to bring such a deal to the finish line? Of course. But we go back to our fundamental question: what is he being paid half-million dollars a year for? Does half a mil just get the guy to his desk for 40 hours per week? Do shareowners have to pay for every service rendered, besides visits to the water cooler?

Should Mr. Webb be incentivized as a UCP Director?

Mr. Webb is one of 6 Directors on the UCP Board. UCP is a publicly traded company with its own ticker symbol on the NYSE. When UCP is transacted, the Board will have to form a committee, hire investment bankers and other professionals, provide access to a data room and show professionals to the properties.

In such a case, Mr. Webb will be one of 6 Directors. We fail to see how in this role, Mr. Webb would qualify for a bonus upon a transaction.

This brings us to a fundamental question: what is the purpose of incentives?

We argue that in a change of control transaction, such as UCP, value can come from two sources:

  • Time, where value is derived if the transaction takes place sooner; and
  • Price, where value is derived if the transaction garners a higher price.

Neither Mr. Webb nor Mr. Perri are accelerating the timetable of a UCP monetization. In early February, PICO filed a 13D/A with an alternative Director nominee and 7 corporate governance improvement proposals. This is exactly what a hostile activist would do if stuck at impasse with an investee. Since PICO has gone hostile, Mr. Webb’s efforts towards a speedy monetization are not bearing fruit.

Neither Mr. Webb nor Mr. Perri are garnering a higher price for a UCP monetization. The primary assets of UCP do not leave the headquarters at 5:00 p.m., Monday through Friday. UCP’s most valued asset is its land – no promotional effort will change that.

Let’s contrast a UCP sale with that of Fish Springs Ranch. Messrs. Webb, Perri and Dorothy Timian-Palmer are the best individuals in the entire world to sell the PICO’s Fish Springs asset. Collectively, they have an incredible amount of knowledge related to the Fish Springs asset. There is no liquid market for Fish Springs fractional interests and no deep pool of buyers. It is going to take a lot of specialized effort to monetize this asset. An intelligently calculated bonus is appropriate in this case.

But as we have indicated, the dynamics at UCP are far different.

Some would argue that a bonus will incentivize “management” to focus on UCP. According to this theory, since the water assets have higher potential sales prices and hence, larger bonuses for Messrs. Webb and Perri, these men will be more inclined to ignore UCP and go for the larger pot of gold. Could Messrs. Webb and Perri really be that greedy? Would they ignore a UCP transaction, which would benefit shareholders, because there was no bonus in it for them? We ask again: why are we paying a collective near-million dollars annually to these men?  Does that just get them to their desks for 40 hours per week and nothing more?

One astute PICO observer recently stated, “The payment of any bonus to any executive or director for the sale of PICO’s stake in UCP is crazy.” We agree.

We feel that Andrew Cates and the Comp Committee are underplaying PICO shareholder’s hand. We admit that Messrs. Webb and Perri and Mrs. Timian-Palmer are likely the best people in the world to do the jobs they’ve been hired to do — wind down PICO and return capital to shareowners. It would be a nightmare to replace them, in terms of time, energy and money. Our shareholder-oriented Directors, Mr. Cates, Eric Speron and Daniel Silvers, gave heroically in 2016 to pull PICO weeds out by the roots.

But the Comp Committee is not without leverage and, when executive demands for more money are beyond reason, it should push back. The chances of Mr. Webb walking out the PICO door and finding another CEO job at $500,000 per year are zero. Ditto for Mr. Perri. These gentlemen do not have horizontal career and compensation options.  Any abrupt departure by either gentleman would mean an enormous drop in pay and prestige.

Further limiting their chances, Messrs. Webb and Perri are stained by the Juicer Legacy. Both men worked at Juicer’s side for many years. They turned a blind eye to abysmal corporate governance and shareholder abuse in the extreme for almost two decades each. “Willingness to ignore corruption and malfeasance” does not appear on too many job applications. In fact, most employers seek the opposite character attribute.

We are always in favor of harmoniously negotiated solutions. There is enormous value in peace and goodwill. But sometimes people get greedy and make demands that are irrational and unreasonable. In such a case, we risk peace for the benefit of economic rationality. There has to be a line somewhere.

While PICO needs both men, these men need PICO equally. Any breakup would be mutually destructive. Mr. Cates and the PICO Comp Committee should consider this when unreasonable requests for bonuses surface. And we believe an unreasonable request has surfaced.

If Messrs. Webb and Perri are so greedy and self-interested that they won’t prioritize a UCP transaction unless paid a bonus, then shareholders should be informed. If this is the case, then Mr. Silvers, who is a can-do director with more deal experience than anyone else on the Board, should roll up his sleeves and get UCP transacted.

Would this be outside the normal scope of his duties? Would this require a lot of work he probably would prefer to delegate? “Yes” on both counts. But by taking UCP on, Mr. Silvers would enhance his capacity as a businessman, rocket his professional reputation as a director and increase his future earnings power enormously (he would also be the favored candidate for RPN’s Man of the Year 2017).

We have supported Mr. Cates and the Comp Committee for the recent changes to compensation. We and many others, feel the current executive compensation resides at the high boundary of fair. Several observers say it is too high. The Comp Committee’s hands were tied by the Juicer Employment Agreement; Messrs. Webb and Perri had a solid legal bridge to excellent compensation and they used it.

However, we feel incentive compensation to monetize the UCP stake has gone way too far. If Messrs. Webb and Perri are demanding it, we feel they have crossed the line into inappropriate greed. If the Comp Committee is offering it, we feel it has crossed the line into supplication and neglect of shareholder capital.

Let us ask Mr. Cates and the Comp Committee a question: If you deny Messrs. Webb and Perri incentive compensation for selling the UCP stake, will they walk? Sure, such a denial would meet an unwelcome response, but we and every other member of our panel, conclude the request is irrational and unreasonable.

Mr. Cates and the Comp Committee might want to reconsider this decision on another basis. We called our activist attorney panel member and explained the situation. His first comment: “Whoooaaaa! These guys better be careful if they are trying to build reputations as activist directors!”

We leave this topic with two thoughts. First, this is why Greg Bylinsky of Bandera Partners, should be appointed to the Comp Committee. Along with Mr. Speron, these investors own 8.1% of PICO and are affected dollar-for-dollar by all financial incentives.

Second, this is why Max Webb should not – and will not – be Chairman come May 5. It is hardly characteristic of a leader to demand compensation for every act at every turn.

Diversity Of Opinion & Disconfirming Evidence

We are big fans of diversity of opinion and we constantly seek disconfirming evidence. On three occasions, we have been forced to pick up fork and knife and mindfully eat a plate of crow – we had to admit we were wrong. We don’t like admitting we were wrong – no one does. But after years of practicing humility and flexibility, we haven’t found a more fruitful way to live – or to operate RPN.

Although diversity of opinion is a buzzword today, the concept is old as the hills. Ron Chernow, author of the smashing biography on George Washington, entitled “Washington: A Life,” notes that General Washington sternly instructed aides to inform him of all gossip, both positive and negative. Explaining this practice in a letter , General Washington wrote, “I can bear to hear of imputed or real errors. The man who wishes to stand well in the opinion of others must do this, because he is thereby enabled to correct his faults or remove the prejudices which are imbibed against him.”

We grow concerned when people get upset in the face of diversity of opinion. Everyone is entitled to their opinion and we all are wrong sometimes. Recently, a businessperson, in the face of a different opinion, felt threatened and gave us the unsolicited suggestion to “pick and choose your battles.”

We were amused.

First, we have found that when people impose unsolicited suggestions on us, it is usually because they seek to control some aspect of our behavior, while hiding more devious motives. Was this person really concerned about RPN’s strategic direction or were they trying to prevent us from printing something?

Second, RPN does not “pick and choose battles” in the strategic sense. We are dedicated to maximizing value for all PICO and UCP shareowners. If the amounts of money are large enough and the conduct sufficiently egregious, it will receive our attention. We don’t have allies and enemies, we don’t use political capital to call in favors, no individual is sacred, not even the principals of  RPN.

Indeed, we have said all along internally that if the costs RPN foists upon shareholders ever exceed the value we are capable of creating, we will shut RPN down. Nothing is sacred around here.

No intellectually honest person can claim that RPN is a bad thing. To disparage RPN is to disparage sunlight. More than most corporate situations, PICO and UCP benefit from a diversity of ideas and an abundance of transparency.  On a net basis, RPN has enhanced shareholder value.

Freedom of speech is an American ideal; more generally, it separates the free world from the oppressed. Diversity of opinion is responsible for an enormous amount of societal progress. But not every issue is sufficiently relevant to grab the attention of “the press.” Almost all smallcap and microcap companies operate with zero wider scrutiny. As PICO/UCP shareholders know all too well, such obscurity permits corruption, entrenchment and abuse of shareowners in the extreme.

Can you imagine the Juicer Employment Agreement, with its $11 million in Termination Payments, occurring at AIG (adjusted for market cap)? It is unlikely. No AIG Director wants their name in the Wall Street Journal for such an act. It would be embarrassing and it would be career suicide.

If each company had its own “Wall Street Journal,” its own press coverage so to speak, would corporate governance in America be improved? Would shareholder value be enhanced? We think so.

You are always welcome to disagree with us. You may write a comment, send us an email or write a guest column. In the case of the latter, we only require that it be articulate and researched, with relevant documentation. You may request attribution or you may write anonymously. If your ideas are dissonant with ours, after thoughtful consideration and consultation of our panel, we may admit we were wrong. But that is always the case – whether you publish your opinion or not. We approach life every day with the following maxim: “We could be wrong about this.”

We leave you with another quote from George Washington:

If the freedom of speech is taken away, then dumb and silent we may be led, like sheep to the slaughter.

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