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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Thursday, October 22, 2015

One More Letter to $FHCO After they Blocked my Effort to Improve Exec Comp

A few weeks ago I sent a letter to the Chairman and Board of $FHCO asking for a proposal to be included in the proxy re: chg'd exec comp.

With a board that avgs 71 y/o and +13 years of svc I'm not surprised they responded with obstructions and not open arms. Since I am not a shareholder for the continuous year (thank goodness for my portfolio) they won't consider it.

But the thing is, the same people running the company are the same people who've been there since the product was approved by the FDA in 2009, and its still not on drugstore shelves, which means either the product sucks, they suck, or somewhere in between. I'm in the group that thinks its somewhere in between.

Yet, even if the product sucks (and I've been assured by some it does and others it doesn't) there are so many condoms on the shelves of every drugstore I've ever been to, at least one female condom can fit there as well, even if its just a novelty. If it ain't the FC2 it will be something else someday.

And thus this letter (see below). I cut the part where I pan their decisions to hire an ex-pharma exec and an ex-marketer of IUD's (who is also on the board), b/c it seemed appropriate to be nice. But I am dumbfounded, speechless, nonplussed in the true definition of the word, why they'd hire execs with those kinds of expertise for a product that's the anti-IUD and the anti-pharmaceutical. It's like hiring a vasectomy surgeon to sell condoms. They need brand strategy and consumer distribution expertise not ex-pharma folks.

In my view, at least if we can align comp structure, I know they won't be paid unless my capital is put to best use, which so far, it hasn't.

Here is the full letter going out to the board today and please remember this is not a solicitation to buy / sell / transact business just shared out loud thoughts and ideas.

-- END --

Dear OB:


I was disappointed by your response to my letter regarding my shareholder proposal for changing executive compensation. I had hoped you would welcome the proposal not put up roadblocks to cause its exclusion.

My goal in recommending an alternative comp structure is simple and threefold
To find a system that is fair to executives
To find a system that incentivizes good long term capital allocation not short term goals
To find a system that aligns the interests of shareholders and management

The current compensation plan isn’t fair.
As your filings point out, you have no control over the timing of public sector purchasing patterns. Since the public sector remains your largest customer, one order, the timing of which you have no control over, can determine whether or not executives are compensated.

Last year, executives did not receive bonuses. This year, because of the Brazil tender, they likely will (including yourself). The key point is that your current executive compensation system doesn’t reward decisions from the FHCO C-suite, but rather decisions made in developing world health departments thousands of miles away.

Executives should be compensated for the decisions and efforts they make, not someone else’s.

The system doesn’t motivate long term planning or capital allocation.
Your current plan is based on one year sales and margins over which – as you’ve long established - executives have limited control. As a result, spending on marketing campaigns or strategies with long term payoffs negatively impacts the compensation for executives, disincentivizing long term planning.

Executives should not be compensated solely on short term results as your current policy now holds.

The system doesn’t align interests of shareholders and management.
Ending the dividend to invest in your business is an equivalent indication that you can allocate capital better than your shareholders can. The system I recommended in my proposal rewards good capital allocation and ensures that the capital you’ve taken from shareholders is put to the best and highest use, as your shareholders themselves likely would have done with their dividends.

A plan that promotes good capital allocation would incent better decisions and might improve outcomes.

I hope you and the board will address the shortcoming of your current executive compensation plan and consider implementing one – perhaps along the lines of the ones I recommended in my earlier letter - that is forward thinking and rewards good long term capital planning.

Above all, I want to see evidence of a management team that makes sound long-term high-return capital decisions while providing safe, low cost and accessible choices in women’s reproductive health. I imagine we stand on common ground with respect to that goal.

A few additional comments.
As you are aware, I previously recommended in prior communications with you and Ms. King two low cost ideas to help expand your product reach.

1. Explore a partnership with SHE Sustainable Health Enterprises.

SHE, as you know, has created a program to locally manufacture and distribute affordable menstrual pads in Africa (Saathi does a similar program in India). They have a partnership with J&J and their founder, Elizabeth Scharpf, is an advocate for expanded use of the female condom.

In fact, in an interview I read online, she is asked: “You’re going to a desert island, and you’re allowed one food, one drink and one feminist. What do you take?” and she answers: “Cherry pie, champagne and whoever invented the female condom.”

It is easy to imagine a wealth of opportunities available through a partnership with SHE to reach a shared customer base in Africa, your largest market. I previously recommended you reach out to her and I've emailed with her several times. In response to my suggestion, both you and Ms. King replied: “She didn’t return a phone call”. That is not leadership regarding a potential partnership with an influential advocate of your product.

2. Expand your creative / brand development.

I have also suggested that you hire a creative / brand team from one or two “innovator cities” (perhaps offering equity as a form of long term alignment) to test creative programs and get your product on shelves. This suggestion was simply ignored and I see no evidence to support your statements that you have already initiated a successful brand building strategy.

I think we both agree that bending the consumer sales curve will require smart long-term investments in sales, marketing and distribution today, with the benefits in years 2, 3 and beyond. I also think we both agree that getting the right consumer brand strategy is the key to fixing recent cash flow degradation, stagnant shareholder equity, rising competition, and risks associated with a being one-product company.

So please consider changing your incentives to align them towards the long term investments required to bend the sales curve. Doing so will help provide shareholders more faith and trust that decisions from management and the board are made with optimal long-term capital allocation in mind.



Tuesday, October 13, 2015

Another year, another attempt to improve exec comp at $FHCO

A few weeks ago, I submitted the following letter to the board of FHCO and its CEO / Chairman OB Parrish regarding executive compensation. Alas, I haven't been a shareholder for the last continuous 12-months, a good thing for my portfolio  since the stock is down more than 50% y/y but a bad thing for myself as shareholder since comp is a strong way to align goals, and they are prejudiced against short-term shareholders.

My effort is to comp execs on ROIC. My reasoning is that once they stopped paying shareholders a dividend to invest in the business their capital allocation decisions should have become paramount.
They haven't, and shareholders suffer.

They SHOULD invest in their business no doubt. The industry has changed - the product is no longer a monopoly - and the company has spent considerable money and efforts to broaden its consumer appeal, but without articulating or explaining the strategy and with no improvement in the goals they seek to attain.

I believe they are going about it all wrong - old fashioned ex-pharma marketing - versus just getting it on shelves, and I've suggested low cost creative and strategic partnerships to no avail. I think they are afraid to make fun of themselves and therefore try something risky (the consumer product is risque).

Whatever ... since I can't effect how they are going to spend their money at least I can try to make sure they understand that cost of money and try to ensure compliance with a return.

So while the board has discretion to consider this proposal it is unlikely hey will oblige. With an average age of 71 years and an average length of service of 14 years this is not a group that invites new ideas.

Dear Mr. Secretary

Last year I wrote a letter to the Board regarding a proposal on executive compensation that I had hoped would be addressed at the annual meeting. However, the letter was sent too late for the deadline.

I am writing a similar letter with substantially the same proposal for inclusion in the proxy materials for the 2016 shareholder meeting (see below).

In the year since I wrote the initial letter, the stock has lost 65% of its value. Concurrently, year-to-date unit sales are up 44% and year-to-date revenues and operating income have grown 33%. So management is likely to receive its bonuses even after a year of shareholder suffering and negative cash flow generation. There is clearly a misalignment.

A compensation system that incentivizes principles of good capital allocation will re-align interests between owners and managers, ensure optimal investments in the business and re-instill confidence that management is making wise, capable and thoughtful decisions that will reward shareholders over the long term. I sincerely hope the Board allows shareholders to consider this proposal at its next meeting.

Sincerely
Long Cast Advisers, LLC

CC:
O.B. Parrish, CEO & Chairman
Brian Bares, Institutional Shareholder


A PROPOSAL TO CHANGE EXECUTIVE COMPENSATION

The current executive compensation system is based on unit sales and operating margin targets. It has as its greatest virtue, simplicity. It is not ideal but neither is it inappropriate for a single product company in an industry characterized as a monopoly.

However, recent issues have arisen that require exploration of a new executive compensation plan:

The industry is no longer a monopoly.
The company has cancelled its dividend.
The company is seeking to use capital once reserved for shareholders in the form of dividends for internal growth and / or acquisitions.
The company, once a great cash flow generator, is currently a cash flow user.

With these changes, especially the cancellation of the dividend and the recent cash “burn”, it is obvious that the role of management has expanded from one of maintaining market share to one of capital allocation.

I therefore propose that the board terminate the current compensation plan and adopt one based on capital allocation and cash flow. I suggest one of three options: Returns on Incremental Invested Capital (ROIIC) targets, Economic Value Add, or Cash EPS. Any of these would be better choices for a company that diverts capital from its shareholders to fund internal and acquired growth.

A compensation structure that rewards wise, capable and thoughtful capital allocation would be the best way to ensure that the owners of the company, who no longer have access to the company’s capital via dividends, are getting the greatest value for their shares.