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.

PICO’s Preliminary Proxy Produces Pleasure. UCP Occupies Low Moral Ground.

As promised, on March 10 PICO Holdings released its Preliminary Proxy Statement. Given that financial statements represent the highlight of our lives, we perused it over the weekend. There was much to like.

The 2017 PICO Proxy

We will review the Proxy Statement highlights and point out some interesting factoids.

Voting for Directors will be a far more pleasurable experience this year: all candidates deserve our votes. Thus far, these men have markedly improved PICO in all respects: corporate governance, asset sales, communication, accountability, expense reduction. Let’s not forget, four of the five candidates took bold action in December 2016, removing two self-interested Directors that exercised control. All five nominees will get RPN’s votes.

The fused CEO/Chairman proposal doesn’t stand a chance and we will vote “Against.” Max Webb has thus far done a fine job as CEO, but he has an almost-two decade track record of silence in the face of shareholder abuse. We believe that a Chairman’s first reaction to abuse of owners should be a clenched fist, followed by a self-imposed “Time Out” in order to avoid a fight.

This description does not apply to Mr. Webb.

Proposals 3-5 are simple. Compensation at PICO has improved markedly, although after the corruptly conceived Juicer Employment Agreement, it only could have gotten worse if PICO were donated to John Hart.

We would have preferred a compensation plan that started from scratch, call it “Zero-Based Compensation.” But that was not an option. The PICO Board was legally obligated to use the Juicer Employment Agreement as a starting point. As a result, both Director and Executive Compensation are acceptable, but on the high side of fair. The only aspect of PICO Compensation that induces a frown today is the glaring absence of a time value of money component.

Delaware Reincorporation 3.0

Delaware Reincorporation, and the related authorization for adjournment, make their third appearance on a PICO proxy. The Reincorporation Proposal was mostly produced by cut and paste – which is good for owners cuz it reduced legal costs.

The stated rationale for the Delaware Reincorporation Proposal is protection of Net Operating Losses. The NOLs provide an offset to operating profit and/or capital gains (calculated from tax basis – not carrying value). However, if an “ownership change” occurs, as defined by Section 382 of the Internal Revenue Code, utilization of the NOLs would be significantly limited, reducing their value.

Below is an abbreviated definition of an ownership change:

An ownership change occurs if on a testing date the percentage ownership of one or more 5% shareholders has increased by more than 50% over the lowest percentage during the testing period, for any 3 year period preceding the testing date.

Yeah, it gets complicated. A more thorough examination is beyond the scope of this post. Beyond our pay grade. And beyond our mental faculties.

Last year, shareholders appropriately voted down Reincorporation Proposal 2.0. Shareholders risked the economic value of the NOLs in exchange for retention of greater influence over PICO corporate governance. Thus far, this bet has paid off and we salute all shareholders who voted “Against” Reincorporation Proposal 2.0 and “Against” Adjournment last year.

This year, RPN will vote “For” the Reincorporation Proposal 3.0 for three broad reasons.  First, there are improvements to the Reincorporation Proposal. Most important to many shareholders, the 2017 Reincorporation Proposal maintains cumulative voting. It also retains other shareholder protections, namely the ability take action by written consent and a 10% threshold to call a special meeting.

Last year, Andy Shapiro of Lawndale Capital Management, astutely made much of the blank check preferred stock provisions, which he noted, could be used in manners adverse to shareowners. The 2017 Reincorporation Proposal addresses this concern with the following provision in the Certificate of Incorporation:

“Section 4.4.(b)

b . Notwithstanding Section 4.4(a) above to the contrary, without stockholder approval, the Board is only authorized to provide by resolution or resolutions from time to time for the issuance, out of the unissued shares of Preferred Stock, of one or more series of Preferred Stock by filing a Preferred Stock Designation, solely in connection with the Corporation’s adoption of a tax benefits preservation plan.”

We thank Mr. Shapiro for championing this issue.

Sharp-eyed readers likely noticed the absence of director removal by majority vote from Reincorporation Proposal 3.0. The 2016 Reincorporation Proposal provided:

The Delaware Certificate allows for the removal of a director by the vote of a majority of the shareholders.”

This provision was removed from the 2017 Reincorporation Proposal. We were not pleased at first, but a little research yielded the rationale. Under Delaware General Corporate Law, when shareowners enjoy cumulative voting, directors cannot be removed without cause (unless the entire board is removed) if the number of votes cast against such removal would be sufficient to elect the director under cumulative voting.

In other words, the removal by majority vote in the 2016 Reincorporation Proposal was a result of the absence of cumulative voting. We breathed easier.

The second area of improvement which motivates us to vote “For” Reincorporation 3.0 involves the people. These Directors are different; up until now, these gentlemen have proven themselves to be shareholder oriented and trustworthy. Corporate governance has been improved, capital is poised to be returned and promises have mostly been fulfilled. Greater integrity deserves greater trust.

The third reason we will vote for Reincorporation 3.0 relates to corporate governance improvements. Implementation of best practices at PICO have left these Directors sufficiently vulnerable such that owners can implement change quickly and easily, if necessary. “Vulnerable” might not be the best word, perhaps “accountable” would be better. But with hard delcassification, cumulative voting, Director compensation paid in shares and two large shareowners on the Board, we feel that NOL protection can be prioritized over maximum equityholder rights.

There are PICO hawks who plan to vote against Reincorporation 3.0. The hawks make two justifications for their posture. First, they say that the main motivation for Delaware Reincorporation is to reduce Directors’ personal liability and increase legal indemnification.

We don’t know if it is the “main” motivation, but it is inarguable that PICO Directors will sleep better if Delaware Reincorporation is effectuated.

Second, the hawks argue that the corporate governance improvements are nice, but the ultimate measure of shareholder orientation is still missing: return of capital. According to the hawks, one more year of greater Director accountability is in order. Once owners have some dead presidents in hand, the leash can be loosened and PICO can be reincorporated in Delaware.

This second hawk argument has merit; to the best of our knowledge, no capital return has begun. But as we survey the entire PICO panorama, taking in all the factors we mentioned above, we will give this Board the benefit of the doubt.

And we expect prompt return of capital to avoid making RPN look stupid.

Before you vote, you should know that we have been wrong in this area before. We were optimistic about, and wrote favorably of, Raymond “Delaymond” Marino, Hapless Howie Brownstein and James Pirrello, all of whom have turned out to be shareholder disappointments. RPN’s resolution for 2017 is to be better evaluators of character.

We understand that this Board has a complicated decision regarding return of capital. There are several options, all with costs, benefits, supporters and detractors. But as our Crack Strategist said: “Look, even if you buy back 10,000 shares per day at an accretive price, that’s still accretive to shareholder value.”

Given PICO’s current share price, we believe the Board should begin repurchasing shares, even if in only token amounts. Token value creation is better than no value creation. PICO could alert owners to the buyback before the Annual Meeting with a press release covering other sundry matters, with mention of capital return in an “Oh by the way” fashion. That way, RPN could advocate for Reincorporation 3.0 with confidence and PICO hawks would be quieted.

PICO Proxy Trivia

Trivia 1: The PICO Board met 24 times in 2017. Twenty-four times! That’s about once every two weeks. The average Board in a typical year might meet 10 times; 15 is considered frequent. Twenty-four times is off the chart.

We believe the inordinately high meeting frequency was due to a few factors. First, the initial months of 2016 were a stormy sea of changes, fights, shifts and controversies. Second, once “Delaymond” Marino became Chairman, all PICO matters took up far more time, energy and money than necessary. Third, during the latter half of the year, there has been a lot to do – asset sales, compensation agreements, committee assignments, a palace coup… the list goes on.

Daniel Silvers, Andrew Cates and Eric Speron definitely earned their pay in 2016. We expect the 2017 Director workload to be considerably lighter.

Trivia 2: This is a young Board. The average age is 45 years old and Mr. Webb is the senior Director at a whopping 55.

Trivia 3: Audit fees paid to Deloitte & Touche LLP came down about $357,000 or 16%. It is hard to give credit where it is due. Audit fees came down about the same amount from 2015 to 2016 when Kristina “Malificent” Leslie and Juicer were running the show. Asset sales should help reduce this further, to the chagrin of Deloitte.

Trivia 4: The Board has dismissed compensation consultants Compensia – an action that deserves so much applause it would would bruise our hands. We feel this firm’s name should have been “Largessia.” The “consultants” at Compensia, more akin to hookers in office attire, would bless anything for a fee. Over the last several years, Compensation Chair Carlos “NACD-Decorated Horse Thief” Campbell, produced one ridiculously abusive pay scheme after another, all of which inordinately benefited Juicer and other PICO Executives. And all of them were endorsed by Compensia. If Compensia blessed those pay packages, its “professionals” would have blessed anything for a fee.

Show Bylinsky The Money!

We were displeased to learn that Greg Bylinsky, of Bandera Partners, has not been appointed to the Compensation Committee. We believe that compensation is the territory where large shareholders should roam.

One example: Mr. Webb and PICO CFO John “JP” Perri will be primarily responsible for calculating their own bonuses. The Compensation Committee will oversee and approve their work product. We feel this arrangement is structurally flawed – we don’t like the idea of two men with almost 40 years of combined institutional PICO knowledge tallying their own bonuses, to be supervised by three men with 3 years of combined institutional PICO knowledge. Given the information disparity, this sounds to us like a rigged game; we feel this pot is better distributed by men whose fortunes are more significantly affected.

Another example: how will the $10.5 million Juicer Termination Payment be categorized for bonus calculation purposes? We think it should be treated as an administrative expense. Messrs. Webb and Perri will surely disagree. To keep peace, Directors with minimal ownership will be tempted to side with the Executives. But Messrs. Speron and Bylinsky may not see things that way. These men’s limited partners own approximately 8.1% of PICO shares. The Juicer Termination Payment, on a pretax basis, will cost them $851,000.

The full Board will approve Executive Bonuses. But before that, the Compensation Committee will interpret and administer the calculations. Here is the operative sentence from the SEC filing:

2. Administration

The Plan will be administered by the Compensation Committee of the Board of Directors of the Company. The Committee will have the sole discretion and authority to administer and interpret the Plan, and the decisions of the Committee will in every case be final and binding on all persons having an interest in the Plan.

We believe that both large shareholders should be members of the Compensation Committee, in order to “administer and interpret.”

PICO Stands Tall While UCP Cowers

Given the corporate governance improvements at PICO and the measures contained in the PICO 2017 Proxy, UCP occupies the deep moral low ground.

At PICO, changes implemented and poised to be implemented, represent modern best practices. At UCP, corporate governance is a sorry affair. Here are the examples of poor corporate governance and entrenchment at UCP:

A) Classified Board;

B) No stockholder action by written consent;

C) Directors removable by shareholders only for cause;

D) Special Meetings only called by Board, Chairman or CEO;

E) No cumulative voting; and

F) Potentially abusive preferred stock issuance.

PICO recently filed a 13D/A as majority investor in UCP. PICO makes 7 Proposals to improve corporate governance at UCP, all of which PICO has adopted itself. In other words, PICO isn’t asking UCP to do anything it has not already done.

PICO’s 7 Proposals for UCP should be included in the UCP Proxy Statement and endorsed by the UCP Board. If approved by UCP’s independent shareholders, UCP should adopt the 7 Proposals.

Anything less will be interpreted as entrenchment and breach of fiduciary duty.

UCP Communicates Dishonestly With Investors. Bogue & Pirrello Manipulate “Core Earnings.”

Since UCP‘s Q4 earnings report and call, the stock has collapsed, dropping from $11.35 to $9.95, or 13%. Other builders’ shares have not performed similarly, leading us to believe that the investor community’s disapproval was specific to UCP and its outlook. As we wrote in our post of March 1, we found much to disapprove as well. This chart compares UCP’s stock price performance over the last 10 days with the iShares U.S. Home Construction ETF (Ticker: ITB):


We were not disapproving enough. There is more to dislike about UCP’s Q4 results than we realized. Today, we elaborate on what we believe to be a slow motion collapse of UCP.

“That’s How It Starts”

In the movie “Training Day,” there is an alley fight scene where rookie cop Jake apprehends two crackheads. Veteran cop Alonzo begins a mock interrogation of the suspects. One of the suspects responds with hostile and vulgar language, to which Alonzo laughs and replies, “That’s how it starts.”

UCP’s conduct over the last several months, perpetrated by Chairman Michael Cortney, CEO Dustin Bogue and CFO James Pirrello, has deteriorated. We have documented the surreptitious removal of the Officer Stock Ownership Guidelines, the Q3 earnings shortfall that was dubiously blamed on the weather, the suspect netting of the Citizens goodwill writedown with the contingent consideration reduction, the undeserved salary increase and Golden Parachute fortification on behalf of Mr. Bogue.

We now add to the list of questionable conduct by Messrs. Cortney, Bogue and Pirrello: grossly inflated earnings presented to the investing public.

That’s how it starts.

On the Q4 Earnings Call, in his scripted remarks, Mr. Bogue said, “For the full year net income was a record $1.15 per share which included $0.31 of net one time benefits. Excluding one-time items Core Earnings would be $0.84 per share.”

Mr. Bogue relied on this $.84 per share number when he said, “Our return on equity improved to 6.5% in 2016 compared to under 3% in the prior year.”

Mr. Pirrello joined the fantasy when he stated, “For the full year, UCP’s net income to public shareholders was $9.2 million or $1.15 per share compared to $0.30 in 2015. This earnings improvement is driving higher returns on equity which steadily trended higher over the past five quarters rising to 6.5% in Q4 2016 compared to 2.7% in the prior year.”

Mr. Pirrello digs himself further into the make-believe hole when he elaborates, “During the quarter we also released our valuation allowance against our deferred tax asset. The impact was a contribution of $5.5 million which provides benefits exclusively to UCP’s Class A shareholders. . . .  Excluding these one-time items and the tax benefit, core EPS for the fourth quarter and full year were $0.28 and $0.84 per share and still represent record levels.”

Messrs. Bogue and Pirrello even produce a pretty slide, highlighting their “improvements.”  See the Slide here.

Economic Reality – 85% Worse

This is what Messrs. Bogue and Pirrello told the investing public, the builder analysts on Wall Street, UCP’s shareholders and its majority owner PICO Holdings. Let’s check the veracity of these figures.

Here is how UCP arrives at its $.84 “Core Earnings” figure:

                           Net Income             EPS
                           ----------           ------ 
Reported                       $9,238            $1.15
  Goodwill Writedown           $4,223            $0.21
  Abandonment/Impairment       $3,112            $0.16
  Valuation Allowance         ($5,482)          ($0.68)
                           ----------           ------ 
                              $11,091            $0.84
                           ==========           ======

So far so good.

Except there are two problems. One small problem and one big problem. We take the small problem first.

UCP’s “Core Earnings” figure incorporates three adjustments for noncash items. Unfortunately for Messrs. Bogue and Pirrello, there were FOUR noncash items in 2016. And the noncash item these men innocently forgot to adjust had a positive effect on earnings.

Messrs. Bogue and Pirrello do an excellent job of adding back noncash reductions to earnings per the goodwill writedown and the real estate abandonment/impairment charges. They eliminate the effect of the valuation allowance, which sharply increased net earnings.

But alas, these men innocently forgot about the noncash reduction to the contingent consideration, which positively affected consolidated net income by $2.347 million.

To recap: 2016 produced 4 noncash adjustments to earnings, two boosted earnings and two reduced earnings. Messrs. Bogue and Pirrello dutifully reversed the two that punished earnings but innocently forgot to reverse an adjustment that boosted earnings: the contingent consideration.

We find the failure to adjust for the contingent consideration to be especially suspicious given that Messrs. Bogue and Pirrello added back the noncash negative effects of the goodwill writedown. The goodwill writedown and the reduction in contingent consideration are linked. They occurred simultaneously. You could not have one without the other. They go together like divorce and alimony.

(We were going to say, “They go together like poor performance and no bonus” – but at UCP, poor performance is rewarded with a raise, Golden Parachute fortification and a soon-to-arrive bonus. Just ask Messrs. Cortney and Bogue.)

Here is the “Core Earnings” breakdown with the reduction in contingent consideration reversed – a more honest presentation of “Core Earnings”:

                           Net Income              EPS
                           ----------             -----
Reported                       $9,238             $1.15
  Goodwill Writedown           $4,223             $0.21
  Abandonment/Impairment       $3,112             $0.16
  Contingent Consideration    ($2,347)            ($0.12)
  Valuation Allowance         ($5,482)            ($0.68)
                            ---------             ------
                               $8,744              $0.72
                            =========             ======

The contingent consideration reduction was noncash, just like the real estate impairments, the goodwill writedown and the removal of the valuation allowance. Yet Messrs. Bogue and Pirrello conveniently forgot to reverse this noncash item, which would have reduced UCP’s earnings per share figure by $.12 from $.84 to $.72, a reduction of 15%.

Messrs. Bogue and Pirrello trumpet an improved return on equity of 6.5%, based on “Core Earnings.” We suppose these men would label this measure “Core Return on Equity.” That’s pretty funny. Using an average of beginning and ending equity, we calculate UCP’s “Core Return on Equity” as:

$.72/($95 million/8 million shares) = 5.9%

This difference of 0.6% in return on equity is not too bad, given some of the shenanigans we have seen in the PICO/UCP saga. RPN’s Core Return on Equity is only 10% lower than UCP’s figure of 6.5%.

But there is more.

To review, there were four noncash items in 2016. Messrs. Bogue and Pirrello only reversed 3 of them, innocently forgetting to reverse the contingent consideration, which boosted earnings. Messrs. Bogue and Pirrello also innocently forgot to mention another item: a tax payment for $4,830 million. Let’s see its effect on the UCP “Core Earnings” figure:

                     UCP Core Earnings      RPN Cash Earnings  
                    ------------------      -----------------
Reported                      $1.15                  $1.15
  Goodwill Writedown          $0.21                  $0.21
  Abandonment/Impairment      $0.16                  $0.16
  Contingent Consideration      --                  ($0.12)
  Valuation Allowance        ($0.68)                ($0.68)
  Cash Tax Payment to PICO      --                  ($0.59)
                              -----                 ------
      Total                   $0.84                  $0.13
                              =====                 ======

Messrs. Bogue and Pirrello innocently forgot to tell analysts, shareowners and the investing public that UCP made a tiny little tax payment of $4,830 million to PICO in 2016. Unlike other expenses, which are “shared” 43%/57% with PICO, the tax payment inures 100% to UCP.

In mirror image fashion, Mr. Pirrello says so himself. On the Q4 Earnings Call, he says: “During the quarter we also released our valuation allowance against our deferred tax asset. The impact was a contribution of $5.5 million which provides benefits exclusively to UCP’s Class A shareholders.”

What Mr. Pirrello innocently forgot to tell us was that UCP made a cash tax payment of $4,830 million to PICO, which is borne exclusively by UCP’s Class A shareholders.

As we stated in a post several months ago, UCP’s tax payments to PICO are “off-income statement.” They do not appear on the face of the P&L. Instead, these payments are recorded in the “Financing Activities” section of the Cash Flow Statement, under “Distribution To Noncontrolling Interest.”

Anyone doubt that the $4,830 million was a tax payment? Here is the excerpt from Page 12 of the UCP 2016 10-K: “During the years ended December 31, 2016 and December 31, 2015, UCP, LLC made distributions of $4.8 million and $1.0 million, respectively, to PICO toward its tax liability. . . .”

Sounds like a tax payment to us.

We have a question for Messrs. Bogue and Pirrello: Since when do “Core Earnings” not include tax payments?

This pesky little tax payment reduces UCP’s “Core EPS” by a smidgen: from $.84 cents to $.13 cents, equal to an 85% reduction. Instead of the 6.5% “Core ROE” trumpeted by Messrs. Bogue and Pirrello, RPN’s “Core ROE” for UCP amounts to:

$.13/($95 million/8 million shares) = 1%

Messrs. Bogue and Pirrello boast about their “improved” return on equity of 6.5%, but the true figure is 1%. A slight difference.

Messrs. Bogue’s and Pirrello’s definition of “Core Earnings,” which conveniently ignores tax payments, brings up a host of opportunities. Next time we go out on a date, we will say, “Well baby, we earned $24,000 in 2016, but our ‘Core Earnings’ were $30,000.”

We are going to call Fair Issac and get them to change our FICO score. We will inform them that our creditworthiness shouldn’t be based on after tax income, but on “Core Earnings,” which disregards taxes. We call this “Core FICO.”

Utilization of “Core FICO” may get us that Platinum Card from American Express that we have always wanted.

Call your mortgage broker. Tell them you want a loan for a bigger home. When your broker asks why, say you just realized your “Core Earnings” are 25% more than your tax return indicates.

We could go on forever.

UCP Jumps The Whale

A few months back, we published a post entitled “UCP Jumps The Shark – Dustin Bogue’s Builder Coming Undone.” We had no idea how prescient that piece was: UCP is now jumping larger marine animals.

We have kept a running list of all the improprieties perpetrated by Messrs. Cortney, Bogue and Pirrello. To our constantly growing list, we now add “Dishonest Earnings Presentation.”

Proper conduct seems to be slipping through these men’s hands like water.

This same phenomena occurred at PICO. Certain Directors and Executives became so fearful and desperate that their conduct crashed down through one ethical level after another. Over time, it only got worse; never better. The same thing is happening at UCP.

We are puzzled by the antics of Messrs. Cortney, Bogue and Pirrello. We would think they would want to end the self-humiliation and self-inflicted pain and reach a harmonious solution with the owners of the business.

But alas, these men flounder on. Their list of transgressions against shareowners grows and they face a stare-down with their majority owner. It will likely only get worse from here.

Code Violation

It appears to us the UCP’s own Code of Business Conduct & Ethics warns against the exact conduct now perpetrated by Messrs. Cortney, Bogue and Pirrello. Here is an excerpt:

When you are faced with a business situation where you must determine the right thing to do, you should ask the following questions:

• Am I following the spirit, as well as the letter, of any law, this Code or other Company policy?

• Would I want my actions reported on 60 Minutes?

• What would my family, friends or neighbors think of my actions?

• Will there be any direct or indirect negative consequences for the Company?”

Messrs. Cortney, Bogue and Pirrello appear to be disregarding their own Code.

The Importance Of Base Case

In his intriguing book, “Thinking Fast and Slow,” Daniel Kahneman invites readers to respect base cases. For example, numerous studies indicate that roughly 50% of marriages end in divorce. Yet soon-to-be-weds always assume their marriage has a 100% probability of ever-lasting blissful success. Mr. Kahneman wisely counsels against scenario analysis that deviates significantly from a base case.

UCP Directors and Executives should look at the PICO base case.

Fourteen months ago, the PICO Board was comprised of 7 corrupt and incompetent Directors. All of them have been removed. In the process, two recently appointed self-interested directors were removed. That is a total of nine Directors removed.

More impressive than the gross number is the success rate: 100%.

Messrs. Cortney, Bogue and Pirrello should also consider the manner in which these 9 Directors were removed. Three (John “The Juicer” Hart, Kenneth “The Slug” Slepicka, and Carlos “The NACD-Decorated Horse Thief” Campbell) were thrown out in complete humiliation. These three men severely damaged their professional reputations and their future earnings power. Two others, Raymond “Delaymond” Marino and Hapless Howie Brownstein, were embarrassingly tossed by their own Board (an action cheered by shareholders). Again, these two men leave with damaged reputations and diminished earnings power.

The only Directors who departed PICO with their reputations and earnings power intact, did so quickly and quietly (Julie Sullivan, Kristina “Malificent” Leslie and Robert Deuster).

Shareholders have already begun the process at UCP. Kathleen Wade will likely be ejected from the UCP Board faster than Charles Oakley from a Knicks game.

We feel Messrs. Cortney, Bogue and Pirrello would do well to objectively analyze the base case before them. Perhaps they will find similarities and can derive a prudent future course of action therefrom.

We started this post with the phrase, “That’s how it starts.”

It remains to be seen how Messrs. Cortney, Bogue and Pirrello choose to finish.

images                             James Pirrello       Dustin Bogue