Friday, June 26, 2009

Rewarding Stupidity at Computer Portfolio Services

The share price of Computer Portfolio Services (CPSS-$0.69) has plummeted 89 percent in the last two years as its financial results continue to be hammered by credit losses in its managed portfolio of sub-prime auto loans. The specialty finance company is now alleging that the only way to motivate and retain key employees is to exchange and re-price outstanding stock options, according to its proxy statement. One might wonder how this exchange will create any long-term benefit—except dilution to the holdings of non-management shareholders.

Management insists that the best course of action for the company is to replace deeply ‘underwater’ stock option awards—with an exercise price greater than $2.50 a share—with new stock option grants. Options to purchase approximately 7.5 million shares are outstanding, of which options to purchase approximately 4.2 million shares would be eligible for surrender and exchange. Under the proposal, chief executive Charles Bradley has much to gain, owning 887,000 eligible options at an average weighted exercise price of $4.72 a share. Together, the top nine executives own almost 44 percent of eligible options (at an average, weighted price of about $5.00).

For fiscal 2008, the company posted total revenues of $368.4 million, a decrease of 6.6%, to $368.4 million. Net loss for the full year 2008 was $(26.1) million, compared to net income of $13.9 million in 2007, due to rising default rates and losses resulting from the sales of some packaged auto loans.

Management opines that the steep decline in Computer Portfolio Services’ stock price was mostly driven by factors external to how it operates the business:

Our management has taken actions to address the unprecedented economic environment. We undertook significant cost-reduction actions in late 2008 and early 2009. As of May 31, 2009, we have taken actions to eliminate a total of approximately $35 million of annual operating expenses for 2009. Among these actions are (i) a reduction in the number of employees from 873 at May 31, 2008 to 542 at May 31, 2009, (ii) a general freeze on salaries, suspending our long-established practice of annual adjustments, and (iii) as to officer-level employees, a 20% reduction in bonuses earned for achieving their personal performance goals in 2008. However, despite the actions we have taken to reinvigorate our business and improve our performance, our efforts have not had a significant effect on our stock price, which remains at a level significantly below that which prevailed in the years 2006 and 2007.

Following this logic, the 10-Q Detective argues that Bradley should return his cash bonuses of $1.06 million and $1.5 million that the Board rewarded to him for alleged performance in 2008 and 2007. As any farmer knows, when you plant the lettuce and it fails to grow well, you don’t blame the lettuce. Bradley and his team had no problem taking the accolades and the lettuce during the boom years!

Look, ain't no use in cryin'
Your story I ain't buyin'
Forget about it, ain't no use in tryin'
~ R&B singer-songwrite Montell Jordanl

A swap price of $1.00 per share—44 percent above the current price—would result in an incremental 12 percent hit to compensation expenses, or $457,000 (excluding tax-gross up considerations). If options are to remain a key incentive tool, tell us again how non-management shareholders benefit if top executives know that they will also be rewarded with stock option swaps if they screw up?

Editor David J Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

1 comment:

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